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Executives

Don Volk - CFO

Rudy Karsan - Chairman and CEO

Troy Kanter - President and COO

Analysts

Justin Bandy - KeyBanc Capital Markets

Brendan Barnicle - Pacific Crest Securities

Ajay Kasargod - Piper Jaffray

Peter Goldmacher - Cowen & Co.

Nate Swanson - Thinkequity

Andrey Glukhov - Brean Murray

Joe Wilson - RBC Capital Markets

Brad Mook - Boenning & Scattergood

Laura Lederman - William Blair

David Haines - Needham and Company

Brian McGrath - Credit Suisse

Chris Rowen - Soleil Securities

Kenexa Corp. (KNXA) Q4 2007 Earnings Call February 7, 2008 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen. Welcome to the Kenexa fourth quarter 2007 Earnings Call. (Operator Instructions).

Now I'd like to turn the conference over to Mr. Don Volk, Kenexa's Chief Financial Officer. Please go ahead, sir.

Don Volk

Thank you, Tom. With me today on the call is Rudy Karsan, our Chairman and CEO and Troy Kanter, our President and COO. Today we will review Kenexa's fourth quarter 2007 results, which were announced after the market closed this afternoon. We will also provide guidance for the first quarter and full year 2008 outlook. We will then open up the forum 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 actual performance to vary from our current expectations is 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 expressed 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 financial measures is currently available on our company website with the press release issued earlier today. Our website is located at www.kenexa.com.

I will now turn the call over to our Chairman and Chief Executive Officer, Rudy Karsan.

Rudy Karsan

Thanks, Don, and thanks to all of you for joining us on the call, as we review our fourth quarter results which were highlighted by strong cash flow and revenue and non-GAAP earnings per share that were in-line or above our guidance.

Our momentum with new customers continues to be strong, with interest in our Kenexa Recruiter BrassRing offering helping to drive a record number of new preferred partner customers in the fourth quarter.

Kenexa is among the largest talent management vendors and we believe we continue to grow faster than the industry growth rates.

As we entered 2008 and beyond, we believe that Kenexa's industry leading technology domain, expertise, proprietary content, and large and growing customer base positions us well competitively. We are highly focused on continuing to leverage this position to drive profitability and cash flow for our shareholders.

Taking a look at the numbers for the fourth quarter, our total revenue came in at $47.7 million, an increase of 31% year-over-year. Subscription revenue, which is a more strategic component of our business, came in at $38.7 million, an increase of 30% year-over-year and above the high end of our guidance for the quarter. The year-over-year growth in subscription revenue was driven primarily by solid bookings across our key product categories and continued strength in our renewal rates.

From a profitability perspective, we generated record non-GAAP operating income of $10.3 million which was within our guidance range and represented a quarterly non-GAAP operating margin of 21.6%. Non-GAAP EPS was $0.32 in the quarter above our guidance.

Of note, we incurred over $2000 or about $0.05 a share in professional expenses and other fees related to the evaluation of a potential M&A opportunity that we did not move forward with. This expense was not anticipated at the time we provided our guidance for the quarter.

Looking at cash flow, we generated $15.6 million in cash from operations during the fourth quarter, brining up full year total to $38.6 million, which is up over a 100% compared to 2006%.

We believe that Kenexa is unique from the perspective that we are generating year-over-year revenue growth that is above the industry average while also delivering best-in-class profitability margins with strong cash flow. We expect each one of these characteristics to continue in 2008.

Since our last earnings call and the Analyst Day that we hosted in early December, the market sentiments regarding the health of the economy has continued to deteriorate, including recently published job report.

As a result, investors have been understandably concerned regarding what this might mean for software vendors, in general, and talent management vendors in particular.

If the hiring environment in the state of the economy continues to worsen over the course of 2008, our experience tell us that it is more likely than not that it eventually becomes the more difficult selling environment for all vendors.

If such a situation was to occur, we have said it before and we reiterate it again, we will do whatever is reasonable and possible to protect the earnings of Kenexa, and we believe we are one of the best position vendors to do so based on our relative critical math, existing high levels of profitability and our global execution model.

One can continue to speculate on the economy, but all we can speak to with certainty is what we currently see occurring in our business and the talent management market.

On that basis, we just signed a record number of new customers in the fourth quarter. Our pipeline remains robust, and our customers and prospects have not at this time changed their buying behavior.

A characteristic of the hiring market that is positive for talent management vendors is the fact that the strong majority of hiring every year relates to replacing workers that turnover as opposed to net new job growth.

At the same time, the performance management market is more focused on retention and productivity of existing employees. From a high level and long-term perspective, the key underlying drivers of market demand remained the same, easing up to work force, the declining tenure of employees, increased globalization, fluidity of organizational structures and pressures on the HR department to minimize costs.

Irrespective of whether IT budgets come under increased scrutiny in 2008, we are confident that these factors will persist for the foreseeable future and we believe that creates a positive long-term demand environment and market opportunity for Kenexa.

In any market environment, we believe that Kenexa's unique value proposition of software, content, and services positions the company well to continue gaining market share.

If you look at the types of people employed at Kenexa, the types of sales reps that Kenexa uses and the thought leadership we have brought on board by several acquisitions, all are very different than what you might see from a typical software company, and we think this clearly distinguishes us in the talent management market.

Unlike most software companies, our beginning focus is how to solve business problems for the HR department and business executives as a whole. Then we go about doing so by using the best combination of technology, content and services.

We believe that talent management is increasingly viewed as a strategic priority by the world's largest 2500 organizations. And these are the situations where Kenexa competes and performs the best as the result of our unique approach.

A significant event during 2007 that enabled Kenexa to better meet the talent acquisition needs of the high end of the market with the integration of our acquisition of BrassRing.

BrassRing brought Kenexa a very strong, functionally rich, on-demand solution that has multiple language capabilities. This was previously a goal in Kenexa's broad suite of solutions.

We are very pleased with the market reception that we are being seeing relative to our high-end offering.

During the fourth quarter, we closed business related to our Kenexa Recruiter BrassRing solution with customers such as Baxter International, Sony, Vertex Pharmaceuticals, Home Depot Canada, McCain Foods and Air Products among others.

To put our momentum with the Recruiter BrassRing solution more in perspective, we added several times the number of new customers in the fourth quarter alone compared to what BrassRing added on a standalone basis for the entire full year of 2006.

At the time we announced the BrassRing acquisition we stated that we were confident we would be able to increase the growth of their business, as a result of combining the strength of their technology offerings, with Kenexa's much larger brand distribution and a long-term financial viability.

We believe our progress after doing the first full year following the acquisition provides evidence that we have been successful in doing what we set out to accomplish. In addition to winning new customers, we continue to enjoy renewal rates of over 90% related to the Kenexa Recruiter BrassRing solution. It is also encouraging to hear the positive commentaries from customers and prospects, as it relates to the continued execution of our R&D plans, numerous releases and advancements that we are making to what was already a leading technology solution in the marketplace.

During the fourth quarter, we also won new customer such as McDonald's, where we are designing an assessment system for the recruitment of their hourly-paid staff at over 1200 restaurants spanning the UK and Northern Ireland.

As it relates to our employee retention solutions, we closed business with customers such as Siemens, Molson Coors, US Bank, CVS, AMC, (inaudible) Expedia.com. Alchem Labs and AstenJohnson. High quality customers such as these provide ample opportunity for Kenexa to expand our presence over time, as we demonstrate our unique value which is evidenced by consistent and solid growth in our PQ Metric. This metric increased to over the $1.2 million level in the fourth quarter, reaching the upper end of our 30% to 50% growth target in this metric year-over-year.

Taking a look at our overall customer base at the end of 2007, we have more than 4000 customers including over 500 preferred partner customers. Those are customers that spend more than 50,000 annually with us. A 131 of those preferred partners are in the Fortune 500 and we have just under 200 of the Fortune 500 companies of customers in total.

We are highly focused on continuing to get our foot in the door at these companies, with the large 2500 organizations in the world being the primary target of our efforts. We believe the breadth of our value proposition is unique in the industry and it provides us with a significant long-term opportunity to expand our presence with these companies over time.

The EPO segment of our business which we discussed at length at our last earnings conference call is an area that provides Kenexa with the unique opportunity to build close relationships with customers.

We have a dozen or so EPO customers and it's a majority of our business, minority of our business at 15% to 20% of our revenue, but it provides us with the main expertise that no other on-demand software company has. Our perspective on this segment of our business has not largely changed since our last earning call.

Our expectations take into consideration the elongated sale cycle space during the third quarter combined with the fact that we'll not be until the second half of the year that we are in a position to better leverage our global infrastructure capabilities.

On the margin, developments in our EPO business have been more positive than not over the past couple of months. In particular, we had previously shared that our expectation was for the company's EPO customer base to be net even at the halfway point of 2008, and that we were targeting to be up one EPO customer on the net basis by the end of the year.

Furthermore we share with you that we had three renewals in the year. We do not plan on providing a detailed progress report on a quarterly basis. However, in the short-term, we will provide greater perspective in order for investors to increasingly understand what is driving this portion of our business.

With respect to renewals, we were successful in renewing a deal with a biopharmaceutical company, while we were not going to continue our relationship with the company in the manufacturing industry.

In terms of new business activity, while we've not completed all of the details to a new EPO relationship at the large technology vendor, we've already begun the initial stages of implementation work during the first quarter.

If we are to move ahead in this regard, we would be net even which is consistent with our expectations and we continue to believe that we'll finish the year with at least one net new customer. And based on opportunities we are currently pursuing, we may get to that level somewhat sooner than we organically expected.

In summary, our fourth quarter results were solid and closed out a year in which Kenexa had many important achievements. We significantly grew our customer base, successfully integrated the BrassRing acquisition, expanded our global presence, grew our brand recognition as a leader in the talent management market, this all contributed to our revenue growth and market share gains in 2007. But we are even more proud of our strong profitability and cash flow. We faced some challenges during the third quarter; however, we took quick actions to improve our performance in these areas and are optimistic about our overall growth and profitability outlook for 2008.

As I've said many times before, we believe that there will be very few large companies to ultimately emerge in the talent management market in the next few years. We continue to believe Kenexa is well positioned to become one of those winners due to our broad suite of technology solutions across both the hiring and retention side of the market, our proprietary content and demand expertise.

I will now turn it over to Don Volk to review the financials in greater detail. Don?

Don Volk

Thanks Rudy. I will now review our results for the fourth quarter of 2007. Let me start with the P&L.

Total revenue for the fourth quarter was $47.7 million, an increase of 31% over last year and 2% on a sequential basis. Total revenue was in-line with our guidance range. Within total revenue, subscription revenue was $38.7 million, representing growth of 30% on a year-over-year basis and 1% sequentially. Subscription revenue was above the high end of our guidance for the quarter.

At 81% of total revenue, subscription revenue was slightly above the high end of our targeted mix of the high 70% to 80% range. The remaining $9 million of total revenue in the fourth quarter came from other and professional services, which increased 36% over last year and 5% compared to the prior quarter. The majority of the revenue from this line comes from discrete professional services.

Our clients typically purchase multi-year subscriptions with an average length of approximately two years and our diverse customer base continues to renew in the 90% plus range.

During the quarter, we added over 50 preferred partners and the average annual revenue out of our top 80 customers what we refer to as PQ increased to over $1.2 million. This was at the end of our target for the year and is up from the $800,000 level at the end of 2006.

Turning to profitability, we would be providing non-GAAP measures for each fourth quarter 2007 expense category, which excludes stock-based compensation charges associated with the implementation of FAS-123R and amortization of intangibles associated with previous transactions. All comparisons will be using the non-GAAP current period results.

Non-GAAP gross margin was 73% in the quarter. This was up approximately 2 percentage points from the prior quarter due to the higher mix of subscription revenue combined with the wind down of the EPO engagement that we discussed last quarter. We continue to expect non-GAAP gross margins to fluctuate within our long-term target of the low 70% range depending on the mix of business in any given quarter.

Looking at operating expenses, non-GAAP sales and marketing came in at $9 million or 19% of revenue, a slightly increase in absolute dollars on a sequential basis, but down 1% as a percentage of revenue from a year ago.

Non-GAAP R&D expense came in at $4.5 million consistent with the prior level and representing 9% of revenue. This is at the high end of our long-term targeted R&D spend of 6% to 9% of revenue.

Non-GAAP G&A expenses were approximately $9.6 million, an increase of approximately $700,000 on a sequential basis and representing 20% of revenue. The increase in G&A expenses was related to over $200,000 expense incurred related to professional fees tied to the acquisition opportunity we evaluated but did not move forward with.

In addition, the fourth quarter included increased expenses associated with our expansion into Europe.

Our non-GAAP income from operations was a record $10.3 million for the fourth quarter. This represented an increase of 29% on a year-over-year basis and a non-GAAP operating margin of 21.6% in-line with the prior quarter and our guidance range.

During the fourth quarter, our non-GAAP effective tax rate for reporting purposes was 29%, resulting in non-GAAP net income of $7.9 million and non-GAAP net income per diluted share of $0.32 based on 25.2 million shares. This was above the high end of our guidance. Non-GAAP net income per diluted share was $0.31 in the year ago period. However, it was based on lower effective tax rate of 19% and 21.2 million shares outstanding.

The year-over-year increase in shares outstanding is the result of the secondary offering completed in early 2007, offset to some degree by the execution of our share repurchase program in the fourth quarter of 2007.

Turning to our results on a GAAP basis, which include approximately $800,000 related to the allocation of stock-based compensation and approximately $1.2 million related to the amortization of intangibles associated with previous acquisitions.

The following were expense levels determined in accordance with GAAP: Cost to goods sold $13.2 million, sales & marketing $9.2 million, R&D $4.4 million and G&A $10.3 million.

For the fourth quarter, our GAAP income from operations was $8.3 million or a margin of 17%. Also for the December quarter, the GAAP net income applicable to common shareholders was $5.9 million, resulting in GAAP diluted EPS of $0.24. A reconciliation of GAAP to non-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 had cash and cash equivalents and short-term investments of $96.5 million at December 31, 2007, a decrease from $113.8 million at the end of the prior quarter. The decrease in cash was primarily the result of $25.5 million in cash used to repurchase the company's common shares during the quarter. In November, we announced that the Board had authorized the company to repurchase up to 2 million shares of our common stock.

We have completed our share buyback during the first quarter of 2008, consistent with the terms of the plan. The cash outflow relative to the repurchase plan was partially offset by $15.6 million and positive cash from operations in the quarter.

It is not unusual for cash from operations to be flattish or even down in the fourth quarter compared to the third quarter. However, it was up 44% sequentially. For the full year 2007, Kenexa generated $38.6 million in cash from operations, an increase of over a 100%, compared to $18.6 million in 2006. The significant increase in cash flow on a year-over-year basis has been driven by our strong profitability, incremental improvement in the efficiency of our operations as we proceeded with the integration of BrassRing acquisition and the momentum of our business.

Accounts receivable DSOs were 60 days, compared to 60 days at the end of the prior quarter and 68 days at the end of the year ago quarter. And our deferred revenue at the end of the quarter was $35.1 million.

And now for a quick summary of our full year 2007 results, total revenue was $181.9 million representing an increase of 62% compared to the full year 2006. Subscription revenue was $148.7 million, an increase of 64% compared to the full year 2006, while professional services and other revenue was $33.3 million, an increase of 54% over the same period of 2006.

Non-GAAP income from operations which excludes stock-based compensation expense, amortization of intangibles associated with recent acquisitions and one-time consulting fees and tax benefits related to research and development credit carrybacks was $37.6 million for the full year 2007. This represented a 68% increase compared to the full year 2006.

Non-GAAP net income per diluted share was $1.16 for the full year 2007, an increase compared to $0.96 for the full year 2006.

On a GAAP basis and for the full year 2007, income from operations was $31 million. Net income was $23.5 million or $0.93 per diluted share. This compares to GAAP net income of $15.9 million and $0.78 per diluted share for the full year 2006.

I'd now like to turn to guidance for the full year and the first quarter of 2008. For the full year 2008, we are reiterating the revenue and EPS guidance provided following our Analyst Day in mid-December. We expect total revenue of $221 million to $227 million. Subscription revenue to be $177 million to $182 million.

Non-GAAP operating income of $44.6 million to $45.4 million. Assuming a 30% effective rate for reporting purposes and 24 million shares outstanding, we expect our diluted non-GAAP EPS to be a $1.38 to a $1.42. For the first quarter of 2008, we are also reiterating the revenue and EPS guidance provided following our Analyst Day.

We expect the following: Revenue to be $48.2 million to $49.2 million. Subscription revenue to be $38.6 million to $39.4 million. Non-GAAP income from operations to be $6.9 million to $7.3 million. Assuming a 30% effective tax rate for reporting purposes and 24 million shares outstanding, we expect our diluted non-GAAP earnings per share to be $0.22 to $0.23.

Our first quarter and full year 2008 guidance assumes a $2.3 million, one-time charge related to the opening of our new development office in India. This represents a net impact of $0.10 per diluted share. We currently expect our sequential growth to increase in the second quarter, due to a combination of the strong increase in BrassRing-related business in the second half of 2007 and the fourth quarter in particular. The ramping of the new EPO customer, that Rudy referred to in his remarks, combined with a solid pipeline of business that we continue to pursue. As always, we'll provide more specific 2Q guidance when he host our 1Q earnings call some time in May.

In summary, our fourth quarter results were in-line or above our guidance and we completed a year in which Kenexa delivered solid revenue growth, a non-GAAP operating margin north of 20% and strong cash flow.

As we look to 2008, we believe that Kenexa's differentiated business model and value proposition will help us to gain market share and we'll remain highly focused on delivering growth, profitability and cash flow.

We'd now like to turn the call back to the operator to begin the Q&A session. Tom?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go first to Steve Koenig with KeyBanc Capital Markets.

Steve Koenig - KeyBanc Capital Markets

Hi guys, this is just [Justin Bandy] filling in Steve.

Rudy Karsan

Hi, Justin.

Justin Bandy - KeyBanc Capital Markets

Hi, quick question. I was wondering how linearity was in Q4, also what close rates were like? And does your 2008 guidance anticipate similar close rates to those that you saw in 2007?

Rudy Karsan

Linearity was pretty stable to the quarter, and the answer to the second question is yes.

Justin Bandy - Keybanc Capital

All right, great. Thanks guys.

Operator

We'll take our next question from Brendan Barnicle with Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Hi guys. I was wondering if could give us any sense on what do you think P3 might grow in '08? And also a little more color on why subscription revenue will be down sequentially in Q1 -- that sounds a typical pattern?

Rudy Karsan

You answer the second question, Don. I will the answer the first question.

Don Volk

Okay. Go ahead with the first.

Rudy Karsan

Okay. The PQ, so what we are thinking about is that we're going to be revalued in the whole PQ program for our customers for 2008, and it's not a Street reporting number, it's actually the way we operate the business.

I think we will complete most this Brendan by the end of -- I want to say February, maybe early March, and it's a strategic priority for us and so it's a big growth driver. I expected to be a strong number, but I will share more specific next quarter.

Don Volk

On the guidance, Brendan, what we do on our guidance is we take our total revenue in the range, and then we just multiply it times 80% to project subscriptions. If you go back and look at history, you will see that that's been our pattern.

Operator

And we'll take our next question from Ajay Kasargod with Piper Jaffray.

Ajay Kasargod - Piper Jaffray

Okay, great. Thank you. And actually, Don, maybe as a follow-up to the prior question asked. In the past, your kind of Q4 to Q1 revenue growth was much more substantial than the current year. Maybe it's a law of larger numbers, but this year it's a little bit more muted. Can you just kind of talk about that relative to your guidance, and it is law of large numbers customer signs. I want this with that question first?

Don Volk

Don't forget that last year between Q4 and Q1, in Q4 we had half of the quarter for BrassRing, which was $4.5 million, and then we jumped up in Q1 to up a $9 million run rate. Right.

Ajay Kasargod - Piper Jaffray

Okay. So you have a one-time benefit of $4.5 million last year Q1 versus Q4 okay. Okay, great. And then also when you guys have in the current economic environment, Rudy you addressed this in your opening remarks, what would you consider to be the most challenged in your outlook? Would it be with your PQ customers, or would it be with your other customer base? Could you give us a little bit of better handle on that?

Rudy Karsan

Yes. If you kind of think about it in terms of growth, the current environment is very tight for anything related to housing obviously and financial companies. If we look at our covered PQ customer base, it is extremely varied by verticals. So, it's really hard for me to give you a global answer by PQ versus new prospects. We tend to think of the market more in terms of verticals.

What we have really seen is our growth is driven by total job changes not necessarily by making job growth. So as the environment gets tougher and if it does get tougher, you will see that there might be some movement in the total number of employee growth where it will be affected. But as of now, we haven't seen any signs, and if you remember on the Analyst Day, the analyst asked the questions of the customer directly to see if there budgets had shrunk, and the answer I think you uniformly got was, no they haven't. And that's what we are seeing.

Ajay Kasargod - Piper Jaffray

Okay, great, and then.

Rudy Karsan

And then just let me add little bit more to the Q1 number. Bear in mind that the big customer, the big EPO customer that we lost in Q3/Q4 had a very large amount of revenue in Q1 of 2007. If you are comparing Q1 '07 versus Q1 '08, you must got to treat that as a divestiture.

Ajay Kasargod - Piper Jaffray

Okay. Could you give us a little bit, I mean could you give us a basis of how much that was last year, so we can have a better apples-to-apples comparisons?

Rudy Karsan

It would above the $1.5 a quarter, I think the number we used at the end of the earnings call for Q3 was a $1.5. Don, if I remember it correctly.

Don Volk

That's correct.

Ajay Kasargod - Piper Jaffray

Okay, great. And then just one final question. Can you just talk a little more detail about the one-time expenditure in India in terms of the new facility? And I just want to make sure that that's a clear year. Your current guidance of a $1.38 to $1.42 now includes that expense. Was that expense factored when you gave preliminary guidance at the Analyst Day? Thanks.

Rudy Karsan

Yes, it was.

Ajay Kasargod - Piper Jaffray

Okay, great. Thank you.

Operator

We'll take our next question from Peter Goldmacher with Cowen & Co.

Peter Goldmacher - Cowen & Co.

I just want to follow up on that $0.10 for DSO. When you gave guidance of $0.22 to $0.23 in Q1, are we backing out that dime? And then, so you are actually raising your full year guidance by keeping it the same? Or are you taking down 1Q guidance?

Rudy Karsan

We are including the $2.3 million in our expenses for Q1 and our expenses for the full year. So without that $2.3 million, we would be $0.10 a share higher.

Peter Goldmacher - Cowen & Co

Okay. So you are taking -- so you are leading, let's say you are leading 1Q the same and taking up the full-year earnings?

Don Volk

No.

Rudy Karsan

So, let me try answer in this Peter. So if I just assume that it's going to be a $1.40, which is between $1.38 and the $1.42.

Peter Goldmacher - Cowen & Co

Rudy Karsan

The $1.40 stays at $1.40, we had to build it.

Peter Goldmacher - Cowen & Co

Right.

Rudy Karsan

So Q1 is going to come in the low 20s, and the balance of the year will be in that $1.15 to $1.20 range.

Peter Goldmacher - Cowen & Co

Okay. So Q1 consensus was $0.30, right and consensus for the full year is -- so Q1 consensus is $0.30, Q1 for the full year is above $1.40?

Rudy Karsan

Yes.

Peter Goldmacher - Cowen & Co

So let's say Q1 is still $1.40.

Rudy Karsan

No.

Don Volk

No, what you do is got to say I am just using round numbers here, Q1 is $0.20.

Peter Goldmacher - Cowen & Co

Yes.

Don Volk

And then Q2 will be $0.40, Q3 will be $0.40, Q4 will be $0.40.

Peter Goldmacher - Cowen & Co

Okay. Got it.

Don Volk

Okay.

Peter Goldmacher - Cowen & Co

Okay.

Don Volk

These are round numbers, this is in guidance.

Peter Goldmacher - Cowen & Co

Right, yeah, okay. That's fine. I understand that. One of the other statistics you guys have talked about in the past is your visibility into numbers heading into the New Year. I think you've said historically it's been about 70% visibility into the income statement heading into the New Year just with stuff roaming up on the balance sheet and contracts. Has that number changed at all?

Don Volk

The number is consistent.

Rudy Karsan

The 69 to 71 depending on whether you look at a top end or the bottom end of our range, so, not in the middle of 70.

Peter Goldmacher - Cowen & Co

Okay. And on the competitive environment, have you started to see any pricing becoming more of a factor from some of your other competitors?

Troy Kanter

Hi, Peter, this is Troy. No, we are in.

Peter Goldmacher - Cowen & Co

Hi, Troy.

Troy Kanter

Pricing has been pretty consistent.

Peter Goldmacher - Cowen & Co

Okay, great. Thanks guys.

Operator

We will take our next from Nate Swanson with ThinkEquity.

Nate Swanson - Thinkequity

Hi, thanks for taking my question. I was wondering if you could talk about your R&D initiatives for 2008, what new products or features we should be looking for this year?

Don Volk

2008, as we explained to you in the Analyst Day, Nate, was that it's going to be very focused in on bringing unified services on our platform of ATS's. Ruling out that in kind of second half of next year, you will see a new -- not a new ATS, but an evolution of the ATS of our legacy ATS, which we haven't named yet.

So we have got the core platform coming out, which is going to be the services model for the entire group of both performance management as well as the ATS and as well as [Tastic Solutions], and we are looking for consolidation and robustness in 2008. We will see some significant features and functionality improvements in the second half, and we're beginning -- we've already signed on, I think, five beta customers on that, and we're thinking of doing a full demo some time in Q1.

Nate Swanson - Thinkequity

Okay. Will that term be available for us to?

Don Volk

Yeah. We want to, we are trying to figure out what the best way to handle that would be.

Nate Swanson - Thinkequity

Okay. Then a quick follow-up. In terms of your partner strategy relative to your competitors, it seems like you spend a little time developing your partners' relationships or network, what is your thought there?

Don Volk

We continue trying to expand that but we haven't been able to execute very well on that front. We've got a minimal amount of revenue coming in from partnership, I would say less than 3% of our revenues from partners, may be 4%.

To develop the stronger partnership on the federal government side with CGI, and that's being a source of new business for us, partners with the HR consulting firms like Mercer and (inaudible) have been a source for us. But we haven't got the 20%, 30% number where a lot of our competitions are in. We are under five on that. And we are going to continue to hammer away at it.

Nate Swanson - Thinkequity

Right.

Don Volk

I guess we have been kidding around internally -- in 2006 that number was 1%, somebody told me 14 for fiscal 2007.

Operator

And we'll take our next question from Andrey Glukhov with Brean Murray.

Andrey Glukhov - Brean Murray

Yes, thanks for taking the question. I guess, first of all, Rudy, basically you guys announced that you completed the buyback and you bought back stock at the higher levels than where it's now. What are your thoughts on the future use of cash in that regard?

Rudy Karsan

We didn't say what we bought it back for, and I don't really know what the average price was and I don't know what now is either. So, I won't comment on that because I just don't know. Future uses of cash, we haven't really made a decision on that. We are still acquisitive.

Real property prices have not come down. I don't know what the future is going to bring. We have a board meeting next week. It is an item on our agenda, and we will continue to think and talk about it, and when we have made a decision, we'll be letting the Street know immediately as to what the decision is.

Andrey Glukhov - Brean Murray

Okay. And then on the metrics front, can you update us how many sales guys did you have and may be the sales force hiring plans for the next year?

Rudy Karsan

I'll let Troy do that.

Troy Kanter

Hi, Andrey, we are a little over a 150, and the way we plan for this year, it will probably look at new hires or expansion in that 15- to 20-range.

Andrey Glukhov - Brean Murray

Thank you.

Operator

And our next question comes from Robert Breza with RBC Capital Markets.

Joe Wilson - RBC Capital Markets

This is [Joe Wilson] on for Rob. Thanks for taking my question.

Don Volk

Hi Joe.

Joe Wilson - RBC Capital Markets

Hi, just a quick question on CapEx expectations for the year. Maybe if you could just give some color around that? And then also just kind of following-up on the sales force headcount which geographies I guess you kind of expect to growth the headcount there?

Don Volk

You want to do the geographies, Troy, and I will do the CapEx?

Troy Kanter

We are -- let's see, from a geography perspective -- a little more heavily weighted on North America; we are experiencing more expansion in Europe. So as a percentage that will grow, and also will be adding smaller number in Asia as well. So the rough breakdown would be US 60% of that 50 to 20 number, and then the balance between Asia and Europe.

Joe Wilson - RBC Capital Markets

Okay.

Don Volk

On the CapEx, Joe we expect somewhere between $6 million and $12 million. It's hard to give specific because of the timing of certain decisions related to some international development.

Joe Wilson - RBC Capital Markets

Okay. Great. Thank you.

Operator

And we'll take our next question from Brad Mook with Boenning & Scattergood.

Brad Mook - Boenning & Scattergood

Thanks. Hi, guys. I want to make sure I understand what's going on in the EPO business. Rudy, I think you said your three renewals this year, and so far you've gotten one and you lost one?

Rudy Karsan

Correct.

Brad Mook - Boenning & Scattergood

Okay. And when you said, and then I think, in addition to the renewals you had said at the Analyst Day, your two customers kind of late in the pipeline?

Rudy Karsan

Correct. And we signed one, and we've still got two customers late in the pipeline.

Brad Mook - Boenning & Scattergood

Okay. And the renewal that you lost, what was your thinking on that when you gave your initial guidance of a net one add for the year? Did you think you're going to lose it or were you hoping to get it?

Don Volk

What we were hoping to do, Brad, was to be net even at the end of six months, so we knew we had three events, two customers in the pipeline and one renewal, and we were hoping for one out of those three events to occur. Out of the three events, two have already taken place, where we are at still at Net One. The other one that was still in the pipeline is still in the pipeline, and we've added one, and that's why we said on the margin we're now positive.

Brad Mook - Boenning & Scattergood

I got you. Okay, that makes sense. And then looking at, John, your comment about the Q1 subscription guidance, little surprise that the way you approach delivering that guidance, just taking 80% of the total revenue number, and I am curious when you look subscriptions (inaudible) went down substantially, does that take you by surprise or is there something in there that?

Don Volk

No, we do not expect subscription to be down sequentially. If you look at the mid-point in the high end, it's up sequentially. So we don't expect that subscription to be down at all.

Brad Mook - Boenning & Scattergood

Okay, fair enough. I hadn’t done the math. I was looking at somebody else's. Thank you.

Operator

And we'll just go to next question from Laura Lederman with William Blair.

Laura Lederman - William Blair

Thanks for taking my questions as well. Of the deals that you lost, are there renewal in the EPS side can you talk a little about (inaudible) and why you won the other one and then separately can you talk a little bit about why you walked from that particular acquisition, was the price not a fit? And also, along the lines of acquisitions, are you looking at small one and large ones? So it's two questions with a sub part, so really four. Thanks.

Don Volk

Sure. Let's see, start with the acquisition, if price and fit relative to where we expected that numbers to be versus where we saw when we got into due diligence. So again, there's a lot of properties that we are going to be rested in, but we just aren't willing to sort of come forward at some evaluations that people are asking for now.

Laura, that relates to our EPO wins. I think the big one was again being able to integrate all the pieces that we bring to Bare to have a technology solution and measurement and analytic solution and assessment solution combined with our global expansion, that we've worked on to be able to facilities large complex global deals, I think that was a big differentiator for us in that win.

On the one that we did not get renewed, there were some client-specific issues that we have been working on, and I don't think we were able to get those results in a way that was going to work for both our ourselves and for the customer. So, in general our renewal rates have been fairly significant. But on this large complex deals, there are always exceptions.

Laura Lederman - William Blair

And acquisitions, are you looking at large ones and small ones, just to get a sense of the size and potential impact of this going forward?

Don Volk

Yes, we're looking at a little bit of everything. It's a rapidly consolidating market. There are lot of companies in the space, but again their range and size from small to large.

Laura Lederman - William Blair

Thanks so much.

Operator

We'll take our next question from David Haines with Needham and Company.

David Haines - Needham and Company

Hey thanks. This is Richard Davis, David dialed in for me because, I don’t know how to use phone, I guess. Any case, I remember at the Analyst Day you guys were talking about taking the EPO business and kind of disaggregating it or unbundling it in the service offerings, such as discovery, generations, screening etcetera. Did you do that in the December quarter, or is that something that should be anticipated in '08? And is that a positive selling or what kind of response have you gotten from customers with regard to that?

Rudy Karsan

Yeah, it's a work-in-progress. So we begun to operationalize that and package that up and communicate that with customers and prospects. So we don't expect to see any revenue impact for that until late '08, but again the reception that we receive from the marketplace has been favorable.

David Haines - Needham and Company

Got it. And then the follow-up question would be, I think you talked about the pipeline at the Analyst Day, you were talking about getting 36 to 37 inbound inquiries a week, or really rather appreciating month at the time and then, you observed and if you kind of got over 35 inbound inquiries that will be a good, that will be a firm record and those kind of things. How is that trended if you are willing to talk about it, and if you don't I understand, but I was afraid I'd ask.

Rudy Karsan

Sure. Now, at this we are seeing consistent growth in that inbound activity. Our 13 week moving average, month over month, has moved up by at least one.

David Haines - Needham and Company

Got it, okay. Great, Thank you very much.

Operator

We'll go next to Brian McGrath with Credit Suisse.

Brian McGrath - Credit Suisse

Hey, guys. Just feel like good questions have already been asked and answered.

Rudy Karsan

So what are you going to do? So you are already telling us this is going to be bad question.

Brian McGrath - Credit Suisse

Well, some of those have been asked too, but going back to the visibility metric, that was one of my good questions. Could you just briefly review kind of how you define it? Because I remember, you have a very specific definition of how you find the visibility?

Don Volk

Yes. Its contracted revenue for the next 12 months plus renewals at 90%.

Brian McGrath - Credit Suisse

And, all right, real quick, you haven't talked at all about your, I guess you call it your backlog or your booked for unbilled balance. I know you don't normally ever talk about it quantitatively. But can you give us some sense of what we're looking out there, maybe relative to what you're showing in deferred revenue or just some idea of how that's looking?

Don Volk

Because we've been growing fairly rapidly like over 20%, you'd expect that number to be record at the end of every quarter and continues to be a record.

Brian McGrath - Credit Suisse

Thank you guys very much.

Operator

We will take our next question from Chris Rowen with Soleil Securities.

Chris Rowen - Soleil Securities

Hi, my question has been answered. Thanks.

Don Volk

Thank you.

Operator

And we'll go next to Brendan Barnicle with Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Thanks, Don. As we go back to look out next year, at sort of the expense line given much guidance around that. Where would you expect to see sort of the greatest leverage as a percentage of revenue and where might we see things increase as a percent of revenue?

Don Volk

When you say next year, you mean '09 of '08?

Brendan Barnicle - Pacific Crest Securities

'08.

Don Volk

Okay. So Brandon, we said that, and we said this since that Analyst Day is that we do not expect an increase in our operating margin as a percentage in '08. So we are looking at this year as an example is the $3.2 million we're spending on that move in India is that we are looking at this as at 20% plus year, but not significant expansion in those margins.

Brendan Barnicle - Pacific Crest Securities

Any more color within sales and marketing, R&D, G&A how they may move around?

Don Volk

Well I expect that $2.3 million to be distributed between G&A and R&D and then I expect to continue to leverage G&A going in to the future provided that we also are investing in sales and marketing, on our marketing expenses and we're investing in our expansion in Europe, which will run through G&A.

Brendan Barnicle - Pacific Crest Securities

All right.

Operator

And there are no further questions in the queue at this time. I would like to turn the call back over to Mr. Karsan for any closing remarks.

Rudy Karsan

Thank you very much. We really appreciate the support of our customers, our employees and our owners. Have a terrific evening, goodnight.

Operator

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.

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Source: Kenexa Corp. Q4 2007 Earnings Call Transcript
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