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Taleo Corporation (NASDAQ:TLEO)

Q1 2008 Earnings Call

May 6, 2008, 8:30 am ET

Executives

Carolyn Bass – Investor Relations

Michael Gregoire - Chairman and Chief Executive Officer

Katy Murray - Executive Vice President and Chief Financial Officer

Derrick Mercer - Chief Executive Officer of Vurv

Analysts

Tom Ernst - Deutsche Bank

Brendan Barnicle - Pacific Crest Securities

Brad Reback - Oppenheimer & Co.

Nate Swanson - ThinkEquity

Steven Koenig - KeyBanc Capital Markets

Michael Nemeroff - Wedbush Morgan Securities Inc.

Sasa Zorovic - Goldman Sachs

Daniel Cummins - Lime Rock Research

Operator

Welcome to the first quarter 2008 Taleo Corporation’s earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Carolyn Bass, Investor Relations for Taleo.

Carolyn Bass

Thank you for joining us for Taleo’s first quarter 2008 earnings conference call. This is Carolyn Bass, Investor Relations for Taleo and with me today on the call is Mike Gregoire, President and Chief Executive Officer, and Katy Murray, Taleo’s Chief Financial Officer. Also joining us today is Derrick Mercer, Chief Executive Officer of Vurv. Mike and Katy will offer some prepared remarks lasting for approximately 20 minutes and then we’ll open up the call for a Q&A session. Please note that we will be limiting today’s call to 60 minutes in length.

Also note that our prepared remarks today contain some forward looking statements. These statements include but are not limited to statements regarding Taleo’s future financial performance, risks surrounding the dissatisfaction of closing conditions and subsequent integration and performance of Vurv, new product development, market growth, demand for Taleo’s solutions and general business conditions. These statements are based solely on information available to Taleo at the date of this call.

All current expectations, forecasts and assumptions are subject to a number of risks and uncertainties that can cause actual results to differ materially from those anticipated by these forward looking statements. We refer to our SEC filing including part 1 item 1A of Taleo’s annual report on form 10-K as filed with the SEC on March 14, 2008 as well as other reports filed by Taleo with the SEC. These forward looking statements should not be relied upon as representing Taleo’s views of any subsequent date and Taleo undertakes no obligation to update these forward looking statements to reflect events or circumstances after the date they were made.

In addition to the discussion today we will be using GAAP and non-GAAP numbers. Our GAAP numbers and the reconciliation of our non-GAAP numbers to our GAAP numbers are contained in our Q1 2008 earnings press release. This is available on Taleo’s website at www.tleo.com and in the filing of Form 8-K. In addition, note that a webcast of today’s call will be available on the Investor Relations site of Taleo’s website.

And with that, it is my pleasure to turn the call over to Mike.

Michael Gregoire

Thank you for joining us for our Q1 2008 earnings conference call. We will begin the call by reviewing the highlights of our first quarter results. Then we will speak about the acquisition of Vurv which will be announced this morning.

Now I will turn it over to Katy Murray, CFO, to review our financial results.

Katy Murray

As you have already seen in the press releases that crossed the wire earlier this morning we have posted solid Q1 results and we will be looking to further strengthen our leadership position with the acquisition of Vurv. It’s a very exciting start to 2008.

To start the call, I will focus on Taleo’s Q1 performance and I will then discuss Q2 guidance for Taleo and then our thoughts for the combined entities. As a reminder, I will be discussing our financial performance in both GAAP and non-GAAP measures. Please refer to the reconciliation of our GAAP and non-GAAP financials which can be found in today’s press release.

For the first quarter, we reported GAAP net income of $1.6 million or $0.06 per fully diluted share and non-GAAP net income of $3.9 million or $0.14 per fully diluted share. These results represent a 76% and 67% improvement over the GAAP and non-GAAP net income results reported in the first quarter of last year.

Total revenue for the first quarter was $37.2 million representing a 30% year over year growth and 8% sequential growth. Application revenue was $30.2 million or 81% of total revenue representing 28% growth over Q1 of 2007. During the first quarter we recognized $7 million in services revenue or 19% of total revenue. We do expect services revenue to be in line in Q2. During the quarter we added 12 new enterprise customers and closed 5 enterprise deals with the first year ASP to be greater than $250,000.

We continue to see momentum in our SMB business and in Q1 we reached a quarterly record of adding 185 new Taleo business edition customers. On a year-over-year basis we have grown our customer base by over 60% ending Q1 with over 1700 customers.

We continue to be very pleased with the growth of our international operation and in the first quarter of 2008 we continue to see this momentum. International revenue contributed approximately 11% in the first quarter representing year over year growth of over 50%. Our international operations will continue to be a focus for investment this year.

On a blended basis, gross margin for the first quarter including stock comp and amortization expense was 68% with an application margin of 79% up slightly from the 78% in the first quarter of 2007 and in the prior quarter. For the first quarter we reported a GAAP consulting margin of 19%. On a blended basis, we expect gross margin in Q2 to remain flat.

Moving to specific GAAP operating expense metrics, our sales and marketing costs were $10.7 million, an increase of approximately $700,000 from the prior quarter related primarily to our annual sales and services kick off meeting which we held in Q1. On an ongoing basis, we do not expect significant fluctuations in sales and marketing expenses in percentage of revenue.

R&D expenses were approximately $7 million which is an increase of the $6.5 million incurred in Q4 and is in line with expectations. We will continue to focus on enhancement to our existing product offerings and the delivery of our unified talent management systems in 2008. We expect R&D expenses as a percentage of revenue to remain consistent.

Finally, G&A expenses were $6.6 million up from the $5.6 million reported in Q4 of 2007. Included in our first quarter G&A costs was approximately $750,000 of estimated settlement cost related to our outstanding patent infringement litigation. This amount was not included as an adjustment to get to our reported non-GAAP net earnings.

In regards to income taxes for the first quarter of 2008, we reported net income tax expense of $87,000. Our income tax expense is predominantly driven by international and AMT taxes. As noted in our non-GAAP reconciliation, we recorded and AMT tax valuation allowance reversal of $262,000. For Q2, excluding any discrete items, we expect our GAAP and non-GAAP tax rate to be less than 10%. At March 31, total cash, excluding restricted cash, was approximately $91.7 million. This is an increase of $5.6 million from the prior quarter.

Cash flow from operations for Q1 was $7.3 as compared to $14 million in the first quarter of last year. As a reminder, the prior year reflected an additional $9.6 million of cash funding that was paid to our managed service provider on April 2 after the end of the quarter. That compares to $400,000 for the current quarter which was paid out on April 1. Cash flow from operations adjusted for these two items increased by approximately $2.5 million on a year over year basis.

Deferred revenue and customer deposits totaled $41.3 million representing a $4.3 million increase over last quarter. The increase in our deferred revenue was a result of bookings and renewals. But as a reminder, fluctuations and deferred revenue are impacted by the timing of our invoicing and payments as well as the mix of annual and quarterly billings. DSOs for the first quarter adjusted for the increase in deferred revenue was 73 days an increase from the 64 days for the first quarter of last year.

Turning to other operating metrics, at March 31 we had 686 employees, a net increase of 30 employees from December. Annualized revenue per employee was $217,000 for the quarter, an improvement over the fourth quarter and the $194,000 reported in the first quarter of 2007. At March 31 we had 48 employees compensated on the basis of sales achievement. Of the 48, 33 are quota carrying sales reps focused on new and install based business and indirect channel operating opportunities. The other 15 individuals focus on renewals and other sales related activities. In addition, we have approximately 18 sales reps focused on our SMB business shield.

I would now like to spend a few minutes discussing our acquisition of Vurv. Total estimated consideration using yesterday’s closing price of $20.32 is approximately $128.8 million. Consideration is comprised of 4.1 million shares of Taleo common stock, $36.5 million in cash, subject to adjustment for third party expenses and certain other specified items, and we are assuming up to $9 million of debt. The transaction is subject to customary closing conditions and regulatory approvals and we are expecting it to close by mid or late June.

To give you a frame of reference to the size of Vurv, for the calendar year ending in 2007, Vurv’s trailing 12 month revenue was in the mid $40 million range. While we are not providing specific guides today, we are expecting the transaction to be credence to our GAAP earnings for fiscal year 2008, however not to our GAAP earnings. As most of you know, purchase accounting requires the write down in the acquired deferred revenue, therefore this, and the timing of the closing, will impact the amount of revenue that we will be able to recognize in future periods. In addition, on a GAAP basis, we will have an increase in amortization of tangible expense.

Given the timing of this transaction, we intend to hold another analyst call next month closer to the time of closing, so that we can be in a position to clearly detail the financial impact and synergies of the combined entities and the guidance for 2008. Turning to the second quarter guidance for Taleo, we expect total revenue to be in the range of $38.1 to $38.4 million; positive cash flow from operations with depreciation expense of approximately $2.3 million, and stock comp expense of $2.5 million. Non-GAAP, fully diluted EPS to be $0.13 based on the fully diluted share count of $29.5 million.

Related to the acquisition, while we will be able to capitalize certain costs associated with this transaction, there will be expenses that we will be incurring in Q2 that will be expensed, and therefore, are impacting our fully diluted non-GAAP EPS. These calls are not related to one specific area or one type of expense, but investments across the organization that we feel necessary to insure a smooth close and integration. Again, as I just mentioned, we will be planning an analyst call a bit later in the quarter to provide additional information regarding the transaction and financial outlook.

In conclusion, I am very pleased with our Q1 results and we are very excited about the combination with Vurv and the opportunity ahead of us. With the combination we feel we are creating a strong operational foundation that will continue to scale to support not only our continued growth, but for our combined customer base. With that, I would like to turn the call back over to Mike.

Michael Gregoire

Q1 was another strong quarter for Taleo, as we demonstrated solid execution against our business strategy and continue to innovate across a number of areas. Q1 revenue and our earnings per share exceeded expectations. During the quarter, we continued capitalizing on growth opportunities while also making new, strategic, longer term investments that will help us extend our leadership position as the next generation of talent management evolves. I am pleased with our ability to maintain momentum from last year’s strong performance and drive results that enabled us to expand our global market presence across our key business segments, as well as deliver innovative talent management solutions to customers.

Q1 revenue was $37.2 million, representing 30% growth year over year. Our non-GAAP net income increased to $3.9 million, or $0.14 per share, representing a 67% growth over Q1 a year ago. Overall, we continued to drive top line revenue growth while increasing leverage of our operating model to drive margin growth. During the quarter, our new performance management product continued to build momentum.

As we announced, Taleo performance went GA in February, on schedule, and our two early release customers, Freeport-McMoRan and TeleTech, both went live with their deployments. Sales momentum for Taleo performance continues to build both with inner install base and also with new customers. They recognize the ground breaking nature of Taleo performance and appreciate the benefits of a unified recruiting and performance management solution. In early April, Children’s Healthcare of Atlanta purchased Taleo performance as their performance management solution. Our pipeline continues to build at a solid rate.

This quarter, we added 12 new enterprise customers. In North America, new customers included Burns & McDonnell, CIBER, InfoPrint Solutions, and Vail Resorts, among others. International had another tremendous quarter and continues to build on the momentum we established there in 2007. International revenues increased 52% over a year ago and now represent 11% of Taleo’s revenues. New international customers closed in Q1 were Merck, TuV, and Renault.

Q1 was also a strong quarter for our SMB business. Revenues increased 145% over last year and we added 185 new TuV customers, an accomplishment that marked Q1 as the biggest organic growth quarter in the history of the TuV product. We continue to gain small and big market share, and now have more than 1400 customers using our TuV product, including new Q1 customers including Columbia Sportswear, BJETS India, City of Evanston, EntertainmentCruises.com, Reunion.com, and URS Australia.

We continue to closely monitor the macro economic environment and global hiring trends. As I explained last quarter, historical economic analysis indicate that companies still face significant hiring needs even in a down economy. Voluntary turnover is not eliminated in a tough economy. Gross job creation, the key metric for Taleo’s business, also continues at a high level as the work force shifts industries and careers. According the most recent Bureau of Labor statistics released in February, the voluntary turnover rate did not change significantly in any industry over the last 12 months.

The statistics also indicated that the number of gross jobs created have remained at the same level for the past 24 months. We are seeing these trends reflected in Taleo’s operating volumes as well. In Q1, Taleo customers hired more people and sourced more candidates than in any other quarter in the company’s history. While key economic indicators continue to point to a slowdown in the U.S., we maintain our belief that Taleo is well positioned for the future. We will continue to focus on our strategy of top line growth and margin expansion.

In terms of executive leadership, I would like to announce the promotion of Neil Hudson to Executive Vice President of World Wide Field Operations. For the past three years, Neil has been instrumental in leading Taleo’s international sales operations to successfully expand our business outside the US.

It was under his leadership that our international revenue in 2007 increased 63% year-over-year. In his new role, Neil assumes responsibility for North America, EMEA, and Asia Pacific sales operations, customer success, and global alliances. Effective today, Jeffrey Carr, Executive Vice President for Alliances in North America Sales has left Taleo to pursue other opportunities. I would like to thank Jeff for his contributions to the company and wish him the best of luck.

To sum up the quarter, Q1 marked a solid start to 2008 for Taleo. We executed against our business strategy, continued to capitalize on growth opportunities around the world, and delivered talent management innovation to our customers. To continue our momentum and solidify our leadership position in talent management, I am pleased to announce our definitive agreement to acquire Vurv Technologies.

Vurv, based in Jacksonville, Florida, has 330 employees and has established itself as one of the leaders in talent management. With over 1700 customers in 18 countries, Vurv’s customers include 13 of the Fortune 100, as well as a strong presence in the mid market and SMB space. Vurv’s product line is both strong and broad, including recruiting performance management and compensation. Vurv’s team of talented management remains experts as deep as any in the industry. The combination of Taleo and Vurv creates a true force in talent management.

The company has strengthened this leadership position in the following five areas with this transaction: market leadership. The combined entity leaves the market in revenue and has over 3400 customers. This acquisition expands our leading position in the inner price base to 48 of the Fortune 100, in the SMB space, where we have over 2800 customers. A year ago, I announced we were going to enter the SMB arena. Today I can tell you that we are now the leading provider of talent management solutions, with more SMB customers than any other vendor.

Secondly, comprehensive product offerings, Taleo offers a unified talent management platform that supports the leading recruiting product, the industry’s most innovative performance product, and now compensation capabilities as well. Third, geographies, with the stronger presence in both EMEA and APAC, Taleo is now in a better position to take advantage of these new growth markets. We also have new data centers located in key international regions.

Fourth, world class development, two of the best development teams are now combined to form the talent management engineering dream team, jointly focused on building the next generation of talent applications. And lastly, thought leadership. We believe Taleo now has the deepest and broadest talent management expertise in the industry, with more software and service talent matter experts than other company in the industry. Taleo’s acquisition of Vurv will form one of the largest on-demand companies in the world, and one that is poised to capitalize on the talent management opportunity. We believe Taleo’s acquisition of Vurv represents an inflection point in the industry that will result in the increased adoption of talent management solutions and reinforce its value of proposition.

Over the past year, three key factors have contributed to talent management evolution into a phase of accelerated growth. These factors include a broader footprint. In industries such as CRM and business intelligence, a broader solution created critical mass of accelerated adoption and consolidated momentum around two or three category leaders. Talent management is now evolving from an industry with dozens of vendors offering point solutions to a few leading vendors offering a broader footprint that will make it easier for customers to buy and deploy talent management solutions.

Secondly, scale. The leading vendors can now offer talent management solutions that scale to reliably support thousands of customers around the world, from the largest enterprises to the smallest SMV’s. And thirdly, financial stability, a few selected vendors will achieve the financial stability to provide a low risk investment for customers. As these trends continue to develop, the value proposition for talent management will only get stronger. Taleo has led the way in driving these industry trends. With the Vurv acquisition, has achieved the critical mass necessary to put talent management in the fast lane as the next big business software category.

Taleo is defining the future of talent management, where we are focusing on mobilizing talent to drive business performance, instead of automating processes to cut costs. We believe the next generation of talent management will provide companies with the 360 degree view of their workforce and enable and employ a centric foundation for acquiring and managing talent. The Vurv acquisition will help Taleo realize our vision as it brings together two of the best product lines in the industry, two of the best development teams, and key thought leaders from both companies to build the next generation of talent applications.

Taleo performance was the first step in realizing this vision. Vurv is the next step in the unified Taleo-Vurv product line will yet be another step to transform talent management into a more compelling and impacting platform that can mobilize talent to drive business performance.

With regards to execution, our goal is to incorporate the best of Vurv’s intellectual property and product line into the Taleo platform, delivering a unified recruiting performance and compensation solution. The development process should be complete within 18 months. Customers from both companies will be supported on current platforms during this period. They will have the opportunity to upgrade to the industry’s most advance and comprehensive talent management solution. I would now like to turn some time over to Derrick Mercer, CEO of Vurv, to discuss his thoughts on the proposed acquisition. Derrick.

Derrick Mercer

On behalf of the Vurv management team, I just want to say thank you and we are thrilled about our agreement with Taleo. Taleo and Vurv both share passion for delivering world class technology solutions to help our customers improve business performance through their people. We believe that this acquisition will benefit our combined customer base by focusing the industry’s leading resources on a single development investment.

Customers will have a straightforward upgrade path to unify talent management platforms, which grows in value over time. Over the 12 years we have been in business, the Vurv team has done an outstanding job of building our position as a leader in our industry. I am very proud of Vurv’s team and the work we have done together. I am also confident that our customers will benefit greatly from this transaction and look forward to seeing our combined teams take the company to the next level. At this point, I am going to rejoin the Vurv team as we prepare for this transition. So I will turn the call back over to Mike and drop off the line. Thanks for your time and your interest in our exciting plans.

Michael Gregoire

In closing, we believe this acquisition is an excellent outcome for customers, employees, partners, and shareholders of Taleo and Vurv. The acquisition of Vurv will enable Taleo to accelerate our efforts to deliver on our vision and helping crease the global adoption of talent management solutions.

I would now like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tom Ernst - Deutsche Bank.

Tom Ernst - Deutsche Bank

You commented about your expectations to do well despite whether macro weakness comes. I am curious, are you seeing any shifting at all in your pipeline, your closing rates or any hints that demand for Taleo is softening?

Michael Gregoire

I will give you three data points, some of them are conflicting. First, pipeline is growing at an accelerated rate and a lot of that has to do with performance, having a net new product in a big market has had a big impact on our pipeline. So, pipeline has grown. If you take a look at the volume of traffic, this was something I was pleasantly surprised with. If I take a look at it how many people went through this system in Q4 and how many people went through this system in Q1, we had a pretty significant uptake in the number of users as well as the number of resumes processed through the system, which was something I was not, quite frankly expecting with the current market conditions.

I think people are still moving around from job to job and that volume and that turn makes our business proposition that much more valuable. I have seen slight delays in getting deals done. In the enterprise market, we are seeing a little bit more scrutiny with respect to getting approvals, but transactions are still moving through, they are just getting that one extra level of review to make sure that this is something that is required by the company.

In the SMB business, as you saw, we had a great SMB quarter and that transaction volume seems to be moving along as well. Three points higher is up, volume is up, pipeline is up, the amount of calories you have to put in to finally sign off on a deal requires more effort, but those deals are still getting done. Is that helpful, Tom?

Tom Ernst - Deutsche Bank

What would you say is the priority of motivation in terms of acquiring Vurv? Obviously there is some additive product, and I do not think you mentioned the optimization product that Vurv has. Is the motivation scale, or is it some of the additive technologies, and what was your priority in the deal?

Michael Gregoire

I would say scale is the number one priority. Vurv is a great company with great technology. Our ability to take some of their best thinking, and what we are planning with our own best thinking, and provide a platform for customers that want to get to a unified talent management system. I think that having their engineers and some of their domain experts with ours accelerates our road map. The whole idea in a growing market like ours, Tom, is get to market quick with the best product. I think that we have positioned ourselves to make sure that that happens.

Tom Ernst - Deutsche Bank

I know that you have mentioned in the past that Vurv is one of your key competitors, but in the enterprise how much more does Vurv show up as a competition than some of the other competitors you have had?

Michael Gregoire

Vurv has been a very strong company and I would rank them consistently as one the better competitors. Covering this space there is a lot of different competitors in this space. We see them pretty much across the board. Also has a geographical presence, Taleo all geographies. We see number one competitors in different geographies, even in the United States.

For example, we never would see Vurv in the South, but we would see them in the Northeast. We would not see Vurv in Australia, but we would see them in different parts of the Midwest. I think with the consolidation of the talent management space, you are going to see most of these bigger vendors try to work through getting the best players to come on board their platform. The early movers get to work with the best players and Vurv is fairly one of the best players and we are very pleased that we are able to make that transaction happen.

Operator

Your next question comes from Brendan Barnicle - Pacific Crest.

Brendan Barnicle - Pacific Crest Securities

When was Vurv [inaudible] and two, how is it that you will be structuring it so that it will not be diluted on a non-GAAP basis?

Carolyn Bass

Vurv, over the last several years, has done an incredible job of looking at their leverage within their operating model. From a GAAP basis, obviously, with stock comp expense, they have had a number of acquisitions, etc. They have had the same type of expenses that we do on stock comp amortization, so on a GAAP basis, not yet profitable but definitely moving that way, on a non-GAAP basis, have made tremendous progress over the last year.

A reminder, their fiscal year ends on January 31, 2007, so while not profitable for the full year, moving that way, coming out of their last fiscal year of January, 2008. For us, as we are looking at the transaction and ensuring that it not be diluted I think there are a number of opportunities. One, companies are very similar obviously; we would always look for the type of synergies in some of the back office facilities, data centers, those types of things that we are running in redundancy.

That is really what our focus is going to be. It has been very important for us over the last several years, to run profitably and continue to show revenue growth at the top line. That discipline has not changed. That is something that Mike and I are very focused on as we continue through fiscal year of 2008 and also as we go into 2009.

Brendan Barnicle - Pacific Crest Securities

As you look at the Vurv product, going forward, are you going to have to do a consolidated platform at some point that will require additional integration work or will you run as two separate products for some period of time. What is the road there?

Michael Gregoire

Definitely consolidation into one platform, we feel very strongly about that. We also feel very strongly about supporting customers on the current platform that we are on until the unified platform is there. That is one of the beauties of the on demand model, is that we have all of the technologies and data and understand all of the integration points. It is all here within our data centers and with our engineers. We can really focus on what is the best method to make sure that customers have a compelling reason and a compelling platform to move to. This is about the future of talent management.

I have used both CRM and business intelligence as two examples of consolidated industries. If you go back and study these things, even ten years ago, nobody knew what CRM was, nobody knew why you needed it, and nobody knew why it was important. Today you cannot run your business without it. We view that talent management is going to be exactly in the same space.

Having the best platform in the market and helping customers get onto that platform, where they can move seamlessly through recruiting through performance management to compensation. We think that is going to be the next big killer business app.

Brendan Barnicle - Pacific Crest Securities

Lastly, Mike, on Jeff Carr’s departure, are any additional folks leaving because of that? Is there any other restructuring going on in sales as part of that?

Michael Gregoire

With respect to the merged entities, obviously we are going to be taking a look at synergies with respect to our distribution engines. This was the first part in setting ourselves up to be a very large software company that delivers all day, every day. In order to do that, we have to make sure that we structure for scale and make sure that we structure to ensure that our customers are continuously supported. That was the first move in this plan.

Operator

Your next question comes from Brad Reback - Oppenheimer.

Brad Reback - Oppenheimer & Co.

Could you give us a sense of how fast Vurv was growing?

Katy Murray

From a growth perspective, obviously as a private company, there were a lot of questions out there. I think it is consistent to say that Vurv was growing with the rest of the industry, where we were all seeing that 30% revenue growth in the high 20’s. As a reminder though, Vurv did have a bit of a mix on the application revenue, there was some old license.

They do have a more substantial services business, so they do have a little bit more of a different mix of revenue when you are looking at application and software as a service to services. From a total revenue growth, consistent with what you would have expected to see in the industry of our peer group.

Brad Reback - Oppenheimer & Co.

So, on the north of $40 million dollars on the TTN basis exiting December of 2007, can you give us a sense of how much of that was pure subscription?

Katy Murray

Obviously, for the majority of it, again, not trying to move on the number, it is more about the license piece of it as well. I would say that if you were looking at it as an apples to apples basis, you are north anywhere from 60% to 65% as being the pure software as a service, the application. There was some historical license, obviously that was still out there, and that is in the mix as well.

Brad Reback - Oppenheimer & Co.

Was this a competitive deal or was it sole sourced to you?

Katy Murray

That is not something that we are in the position to comment on.

Brad Reback - Oppenheimer & Co.

Okay, and on service revenue, just looking forward to 2Q, you said ‘in line’. Does that imply that it would be flat with 1Q?

Katy Murray

Flat, with an opportunity for some modest upside, Q1 service revenue was a substantial increase over the fourth quarter. As we have talked about in the past, services revenue has a tendency on a quarterly basis to be a little bit more volatile depending on the types of engagements that we are in. We are expecting to see Q2 at least in line with where Q1 was.

Brad Reback - Oppenheimer & Co.

The litigation settlement you had talked about, the 750K. Can you give us some color? Is that the litigation you had with [Conesca], or with somebody else?

Katy Murray

Well, it is an estimated amount right now so I want to be clear that it is not a final settlement. It is an estimated accrual that we took. As far as naming specifics, I am not at liberty to do that. Again, we do disclose all of our commitments and contingencies in our 10-Q and all of the filings that we have had, even in the recent 10-K.

Operator

Your next question comes from Nate Swanson - Think Equity.

Nate Swanson – ThinkEquity

I know Vurv was stronger internationally, but could you give us a sense of how many total sales reps they had and perhaps, what percentage of revenues was coming from international?

Michael Gregoire

We are not going to break out the Vurv revenues at this time. They did have a very strong presence obviously in the U.K. and that is one of the catalysts for the deal. We feel that we are stronger in Asia PAC, obviously. We did very well there, especially in 2007. France and the Netherlands would be another place that Taleo had strength. Putting these two together, we really improve our global positioning. Super strong strength now going into the U.K. additive strength in both Northern Europe and in some of the Nordics.

As we get to Asia, this is another area where we get to double our size overnight in a lot of large and small numbers. You have to take that with a grain of salt. This definitely accelerates our distribution road map pretty much overnight. We are going to give more information about that on the next call.

Basically, how we are structuring for success, where the synergies are going to come from, our go to market plan, our product road map. All of the stuff that you would expect us to be thinking through hard. We are in the process of doing that right now and we want to come out to both customers and employees, partners and shareholders with what our detailed plans are with respect to all of those topics.

Nate Swanson – ThinkEquity

I know you will go probably go into more detail on the next call, but it would seem like this should accelerate volunteer revenue growth and your longer term operating margins. Maybe over a period of two to three years?

Katy Murray

Yes, Nate, absolutely. One of the things we have always been consistent on is looking for the opportunity to continue to drive leverage across our model, to deliver to the bottom line on the operating margin side, as well as top line growth. As I mentioned a minute ago, Vurv has been doing a very nice job of positioning themselves, moving towards profitability. Obviously that is something that we will continue to focus on in the combined entities, and look to see how we can increase the leverage and increase the scale not only just over 2008, but also 2009 and 2010, and how to accelerate that.

Nate Swanson – ThinkEquity

On the performance management suite it sounds like you are seeing good momentum there. Are there any metrics that you can give us in terms of customer demos or pipeline expectations? Also, it seems like you have been looking for some sales reps to hire with some performance management selling experience. Are you happy with your ability thus far to attract those types of sales reps?

Michael Gregoire

We focus a great deal of attention on performance management as you would expect us to. Pipeline is definitely growing faster than the recruiting pipeline, if that is helpful. We are definitely getting in front of customers, doing demos and getting more traction with respect to some of the larger customers that are looking for a company that knows how to get 24 million transactions done all day, every day. A company that has experience walking in and out of dozens of countries and that can get an implementation team in place to make sure that a global implementation goes off. I think that is working out very well for us.

We have had no problems attracting great talent to Taleo. Taleo is a fun company to work at. It is a winning company, a company that is profitable, has stability, and has great customers. Most people have been around the marketplace and have experience, which is the kind of people we are looking for, a little bit more mature approach to business. They are attracted to our company and we have had zero problems at all attracting A players.

Operator

Your next question comes from Steve Koenig - KeyBanc Capital Market.

Steven Koenig - KeyBanc Capital Markets

Our first question is about SMB growth, which looks very good once again. What are the drivers behind that growth? About Taleo specific and market specific? Wondering if you are seeing any hesitancy in those deals or increased scrutiny in the enterprise deals?

Michael Gregoire

There are two things. First of all, there is no shortage of demand in SMB because they are trying to solve the same problem everybody else is. They want to be able to get people to come work at their company just as much as a large multinational does. Unfortunately, what they do not have is a big web presence. They do not have a sophisticated workflow. They do not have a way of keeping track of the people that would want to come work for their company, nor do they have a way of sourcing it.

Our solution to the SMB absolutely hits that problem right straight on. Nobody wants to go run a business today without having internet capabilities. By having our recruiting solution for SMB, they instantaneously get a very professional web page where people can apply to their jobs. Plus it gets hits by all of the search engines. If you are Googling for a job in a specific geographic location, and you have a Taleo website, it is going to get picked up by that search.

If you do not have a web presence, you are never going to get picked up by that search. Pretty much everyone that you want to hire that is looking for a job, you are going to want to make sure that they have some internet skills and they can do a simple search on Google, Yahoo, or MSN, and make sure that they are looking for those jobs. Where we differentiate is we have, in my opinion, the most efficient go to market strategy.

We have a low priced solution. We try to be the low price leader. We try to give as much value for that price because we believe it is a volume business. We are still strong in the high 90’s, so not only do we get the customers, once we get them, we keep them. I have not seen any material slow down. I do think more people buy in more chunky spaces. The SMB business gets sold on a per seat basis, so instead of buying 5 seats they buy 2 or 3 just to get themselves up and running. We are seeing a little bit of that, but the number of customers and the transaction volume has not slowed. Is that helpful, Steve?

Steven Koenig - KeyBanc Capital Markets

Just one follow up in terms of your overall revenues. When you balance the deal scrutiny that you referred to, with the fact that your sales tends intends to get done, you have probably seen some acceleration in bookings, etc. towards the year end. How should we think about the sequential growth of application revenue in the Q2 to Q3 timeframe? On the one hand, we have implementations happening of those year end deals, but on the other hand we may have more deal scrutiny and a harder economy.

Katy Murray

I think on the application growth sequentially we have seen a lot of variability in ours. We have seen quarters that have been 3% to 4%, then you see a quarter that is 8%. It is going to be hard to model because to Mike’s point, part of what is great about our business and sales model is that we are not back end loaded. We are not under any pressure at any time at the end of the quarter to try to close a deal just to close a deal. I think that is some of the variability that you are seeing.

I think as we are going through, obviously 2008, looking at application revenue in that consistent range of somewhere in the mid single digits is the right place to look. I think on an average you are always going to have a quarter that may be an acceleration. Some of that is also due to the timing of when a deal closes, so if a deal closes early in the quarter, we get a full quarter of revenue. That is just something that we cannot predict, necessarily.

Again, we are closing the best deals and want to make sure that we get the right terms for so that we do not put ourselves in pressure of a certain number of deals that we have to close by a certain time. If you will look at the sequential growth more in that single mid digit, I think that is going to be the best way to average. Then when you have some variability on the quarters it will work out probably in that next quarter.

Operator

Your next question comes from Michael Nemeroff - Wedbush.

Michael Nemeroff - Wedbush Morgan Securities Inc.

On the performance management side, as you are entering that market, can you give us a sense of who the competition is, how often you are seeing them, potentially some win rates?

Michael Gregoire

With respect to competition, I think it is pretty square. We see [euphoria], we see success factors, we see people/oracle, we see the SAP, and those are the primary lead in competitors in that space. It is way too early for us to be talking about any trends with respect to win rates at this time, Michael.

Michael Nemeroff - Wedbush Morgan Securities Inc.

Katy, when you say that you are forecasting for pro forma accretion for the Vurv transaction in 2008, is that based on a pro forma revenue figure that you will give us going forward?

Katy Murray

It will be. That is one of the things that I mentioned. With the right down of the deferred, the timing of the closing, Vurv is a quarterly biller. There are a lot of factors that will go into the amount of the deferred revenue that will be brought over as part of the purchase. Again, we do the next call roughly about a month from now.

We will be able to give a lot more visibility to what those numbers are, what the expected revenue will be and then what a pro forma revenue will be. Again, we would anticipate that that would actually burn off pretty quickly over time because they are a predominantly quarterly biller like we are. The impact of that does work itself out over a few quarters, but there will be some impact in the third quarter obviously.

Michael Nemeroff - Wedbush Morgan Securities Inc.

Could you just talk a little bit about how long the implementation times are taking, especially on the enterprise deals?

Michael Gregoire

On recruiting or on performance, Michael?

Michael Nemeroff - Wedbush Morgan Securities Inc.

Both, that would be great.

Michael Gregoire

On recruiting, we have tons of data in respect to that and we look at that as primarily in the enterprise space. You are looking at about 8 weeks on average for a multinational. On SMB, 60% of our customers self implement and that gets done in 1 to 2 weeks, relatively straightforward on the SMB.

On the enterprise side with recruiting, it really depends on what the customer wants to do, how complex their workflow is and how integrated they want to have the Taleo system into their back office systems. About 80% of our customers that run recruiting solutions run either SAP or Oracle, and I would say of those, more than half of them use our TCC product which allows both synchronization into the back office.

On the performance management side, it depends once again what modules that they are implementing. There are four modules in performance management. You have performance, career, success, and planning and goals alignment. Customers that implement all of them, we expect that implementation to be roughly 8 weeks.

Michael Nemeroff - Wedbush Morgan Securities Inc.

Katy, just touching on what Mike said earlier about additional approvals needed. Can you give us a sense of how the bookings growth was relative to the same period last year? On an apples-to-apples basis, if you could talk about recruiting?

Katy Murray

That was generous, Michael. I do not like to give it out, I do not give it out. We always give it out at the beginning of the year. We were pleased again. We saw the 40% plus growth going into 2008. I think to Mike’s point, it is not a matter of that deals are not closing. It does take a little bit longer to go through deal approval. I am seeing that. I see that on my own side. I am getting involved in things even on our side at Taleo, just to understand long term expense impact and operating expense impact. I assume that is happening everywhere.

To Mike’s point, I do not think there is anything specific to indicate that we are being impacted from the economic piece or anything like that, whereas long term impacting is timing. Again, timing has always been something we have been able to work with. I think from a bookings perspective, as we went into 2007 and 2008, we felt good about the opportunity that we went into this year. You can see our deferred revenue grew. Cash grew. Our AR grew this quarter as well. When you look at all of those metrics, they are a pretty clear indication that there is a lot of activity still happening on the sales cycle and a lot of people that are still buying quickly and moving forward with the talent management solutions.

Michael Nemeroff - Wedbush Morgan Securities Inc.

How many employees did Vurv have? I assume given the substantial overlap in the U.S. that most of the synergies will come in facilities in the U.S. Is that correct?

Michael Gregoire

Vurv had 330 employees. That is what we are going to do in a month’s time, Michael, is talk through all of the synergies and what are the best uses for those synergies for the combined entity.

Michael Nemeroff - Wedbush Morgan Securities Inc.

Will Derrick be staying on in some capacity at Taleo?

Michael Gregoire

He will be staying on for a short period after the close.

Operator

Your next question comes from Sasa Zorovic - Goldman Sachs.

Sasa Zorovic - Goldman Sachs

In the current market environment that you are currently experiencing, are you noticing any changes in pricing specifically? You mentioned the general scrutiny of deals. How about on the pricing side, given the current market, but also competitively.

Michael Gregoire

We have not seen pricing change. It has been pretty consistent over all of 2007. Q1 was no exception to that.

Sasa Zorovic - Goldman Sachs

Secondly, from acquisition strategy here, should we look at this as an acquisition as an opportunity of a very good company at a very good time? Or should we look at your evolving to become a consolidator in what appears to be a very fragmented industry?

Michael Gregoire

I would say both. We have always been very careful with our cash. We have always been very diligent in any acquisitions that we have gone through. We have a very disciplined approach to that. In a market that is not offering a lot for privately held companies, this was the time for a publicly held company with $92 million in cash, free cash flow, profitable, to start to flex it’s muscles and do some consolidation.

When you start to think of those, you always buy the best. You don’t buy the worst company out there, you would buy the best company out there. In our opinion, Vurv was one of the best companies for us to work with.

Operator

Your next question comes from Daniel Cummins - Lime Rock Research

Daniel Cummins - Lime Rock Research

I want to try to sketch out this map on getting to neutral accretive for calendar 2008, given that you may not close this deal until mid year. It looks like you have got about a dime of annualized dilution, just based on the consideration you are paying. I am assuming you will have some operating dilution in the September quarter, is that correct?

Katy Murray

That was one of the points about having another call in about a month to walk through this. We are planning on this to be accretive on a pro forma or a non-GAAP basis. I understand that you are looking at the amortization.

Daniel Cummins - Lime Rock Research

I wanted to keep this free and not get all tangled up here. Am I crazy to think that we are going to be on a very, very steep rebound in the December quarter to get to neutral accretive? To follow on that question, this would seem to add $0.20 to $0.30 of earnings for calendar 2009, if you pull it off.

Katy Murray

I think, Dan, to comment on 2009 is premature right now. We are still working through the planning on the impact for 2008. As I mentioned a minute ago, though, on a pro forma basis, we have always said that we would not look at a transaction that was not accretive to what we were doing. At a minimum, on a non-GAAP basis, and we approached that deal the same. As we continue to work through the synergy, one of the greatest impacts is what the impact on the deferred revenue will be.

We are working very closely on that to try and minimize what that impact will be and understand that. To your point, obviously, there would be a greater impact the closer to closing in the quarter immediately following because of the quarterly billing situation. That will work itself out in the more future quarters. However, again, I am not prepared to get into specifics. Tactical pieces on how we are going to obtain being accretive to our non-GAAP earnings, but I am comfortable and confident that we will obtain that, by saying that today.

Daniel Cummins - Lime Rock Research

On Jeff Carr, is the plan to replace him with someone coming on from Vurv, or somebody internally?

Michael Gregoire

What I did was I created a new position where I have one person responsible for sales operations on a global basis. For the last three years, I have had two people responsible for that. Now is the time that we have scale and we need a consistency of go to market. I need one person who can drive a unified strategy on a global basis.

That person was Neil Hudspith. He has done a fabulous job for the company. He can walk in and out of any country with comfort. He attracts A players and he is the kind of person, I think, the Vurv team will want to work with as he decides what is the best distribution strategy for our company. As we move from being a mid $150 million company to brushing up against our potential as being a very large technology player.

Daniel Cummins - Lime Rock Research

Is there anything new in terms of Vurv’s alliances, particularly for the SMB products that you are getting, that you can point to today?

Michael Gregoire

Not in particular.

Operator

At this time, we have reached our allotted time for questions.

Michael Gregoire

In closing, I want to thank all of you for taking the time to participate in the call with us. We had an absolutely fantastic Q1 as you can see, being on both the top line and the bottom line, which is par for the course of what we have done in all of 2007. As we start to work through our strategy of being a significant technology company, the acquisition of Vurv is a monumental step forward for us. We have performance management that is out in the market place today. We have a great new set of tools that we can use with respect to Vurv. We look forward to reporting, in about a month’s time, on how we are going to put these two great companies together to form, what we think, is the strongest platform in talent management.

Thank you very much and I look forward to seeing you out in the field.

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Source: Taleo Corporation Q1 2008 Earnings Call Transcript
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