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Tech Target, Inc. (NASDAQ:TTGT)

Q2 2008 Earnings Call

August 13, 2008 4:30 pm ET

Executives

Rick Olin – Vice President, General Counsel and Secretary

Greg Strakosch - Chairman and Chief Executive Officer

Eric Sockol – Chief Financial Officer, Treasurer

Don Hawk - President

Analysts

David Joseph - Morgan Stanley

Brian Fenske - Lehman Bros.

Ross Sandler - RBC Capital Markets

Mark May - Needham & Co.

Analyst for Jim Freeland - Cowan & Co

Sandeep Aggarwal - Collins Stewart, LLP

Operator

Welcome to the Tech Target second quarter 2008 earnings conference call. (Operator Instructions) The following members of management will be participating in today’s call: Greg Strakosch, CEO, Chairman and Co-founder; Don Hawk, President and Co-Founder; Eric Sockol, CFO and Treasurer; and Rick Olin, VP and General Counsel.

I would now like to turn the presentation over to your host for today’s call, Rick Olin, General Counsel at Tech Target.

Rick Olin

I would like to remind everyone that during the course of this conference call Tech Target will make certain statements that may be considered to be forward-looking statements within the meeting of the Private Securities Litigation Reform Act of 1995 including particularly our guidance as to future financial results. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and those actual results may differ materially from those contemplated by such forward-looking statements. These risks include market acceptance of our products and services; relationships with our customers; strategic partners, and our employees; difficulties in integrating acquired businesses and changes in economic or regulatory conditions or other trends affecting the internet, internet advertising, and information technology industries.

For a description of other risks we encourage you to read the section entitled Risk Factors in our annual report filed on Form 10-K as well as other filings that we have made with the SEC. In addition, our forward-looking statements speak only as of the date of this call and we undertake no obligation to update these forward-looking statements. Tech Targets policy regarding financial guidance is as follows: As part of our quarterly earnings call for the quarters Q1 to Q3 we will provide guidance for the then-current quarter in which the call is occurring as part of the Q4 and year end earnings call the company will provide guidance for both Q1 as well as the full year. The company does not intend to further update quarterly guidance on a full year basis or quarterly guidance until the next scheduled earnings call. I will now turn the call over to Greg.

Greg Strakosch

I would like to welcome everyone to our call. Although like most other advertising business Tech Target has been affected by the slow-down of the economy, especially in the second half of Q2, we are disappointed with our results. However it is important to point out that despite these macro challenges Tech Target is a growing and profitable company.

During the quarter we grew on-line revenue 28% and reported our highest revenue quarter ever. Despite a shortfall in anticipated revenues we still achieved a healthy adjusted EBIDTA margin of 26%. We continue to see the largest IT vendors migrate their ad budgets online. Online revenue from the twelve largest vendors was up 53% for the quarter. As a result overall branding spend was up as well. Conversely we are seeing mid-size and smaller companies who make up the majority of our revenue being very cautious. As we have discussed in previous calls the small customer segment was core strength of Knowledge Storm.

There are two main buckets of advertising dollars where online growth comes from. The first is the migration of dollars from both traditional media to online media to catch up with the change in audience behavior; and the second is the migration from non-measurable media to measurable media with the increased focus on ROI. This migration is occurring and it is still in its early stages and we are getting those dollars and gaining market share against our traditional media rivals.

The second bucket of online growth comes from additional incremental marketing dollars. When new dollars are added into marketing budgets a larger percentage of these dollars are allocated to online advertising versus traditional offline campaigns. Obviously in a tougher macro marketing budgets are growing at a slower pace as our customers are telling us that it is taking them longer for them to close their deals.

This plays out when you look at the results by different sectors that we are in. For example in our storage and data center groups, which are our two biggest online groups in terms of revenue, these market segments are very healthy on a relative basis compared to other IT segments. Storage is benefiting from the increases in online data being stored and the compliance requirements around that. The data center markets bank on the growth in the server virtualization and power conservation. These are two growing markets where we benefit both from the migration of ad budgets and the new incremental marketing dollars. Both of these groups’ online revenue grew by over 75% in Q2 08 compared to Q2 07.

Conversely in other IT segments that are more challenged we experienced growth rates below what we originally expected. Examples include the Windows market, which is suffering from the lack of demand that was anticipated from the Vista launch; the networking market where I think that company’s may desire an upgrade but decided to postpone the upgrade and continue to get by with what they have in place. I think that same scenario is playing out in the enterprise application and vertical software markets where the current application may benefit from an upgrade but the feeling is “it is good enough for now”.

The weaknesses in the vertical software market and the enterprise application markets have especially impacted revenues associated with our Knowledge Storm property. Historically these two market segments contributed the largest portion of Knowledge Storm’s revenues.

In regard to events we did achieve a growth rate of 14% in the quarter, however, later in the quarter we started to see softness due to two primary factors. First, travel budgets are being cut and scrutinized from both the exhibitors and attendees, and secondly event marketing budgets are under pressure. To be proactive and control costs we have scaled back our events schedule in the second half by cutting approximately a dozen one day events.

Turning to print, we continue to see advertisers migrate away from it. We expect this trend to accelerate during the down-turn. While print only makes up 4% of our overall revenue, the decrease in revenue depresses our overall growth rate. With the macro hit slowing our growth rate we are working proactively to align our expenses appropriately with revenue. Approximately 75% of our cost structure is labor, so we have slowed down our rate of new hiring and are [inaudible] all discretionary spending.

In October our 2009 budget process begins and our goal is to produce a budget where all expenses and revenues are properly aligned. We expect to remain profitable and continue to invest in our growth. We will continue to launch new websites, expand internationally, and be opportunistic in regards to acquisitions. In the meantime I want to assure you that management is extremely focused on the business. We believe that the downturn is an opportunity to strengthen our competitive position and gain additional market share. We view the long-term trend as clearly in our favor.

The migration away from offline to online advertising and the shift from branding to regeneration will allow us to continue to grow and we believe these trends will negatively impact our competition. In the last Tech downturn in 2001 and 2003 our growth rate slowed but we continued to gain market share which we believe was a critical catalyst allowing us to accelerate our growth from 2004 to the first half of 2008. We are confident in our business model and our ability to do that again when the macro-environment picks up.

I will now turn the call over to our CFO, Eric Sockol.

Eric Sockol

I am pleased to share with you the financial results for Q2 2008. Before we get into the results I wanted to comment that the actual results are inline with the preliminary results we communicated on July 24. We are reporting revenues for Q2 of $29.3 million which represents an increase of 19% over Q2 2007. Our revenues broken out by individual revenue streams are as follows: online revenues of $20.8 million, which is an increase of 28% over Q2 2007 and represents 71% of total revenues for the quarter. As we have discussed previously, 2008 organic growth rates are difficult to extrapolate because we have completely integrated and merged Knowledge Storms products and operations into those of Tech Target’s.

During Q2 approximately $300,000 of revenue came from existing contracts that were acquired from the Knowledge Storm. As of the acquisition date, excluding these contracts, online revenue growth for the quarter is approximately 26%.

Event revenues of $7.3 million, which is an increase of 14% over 2007, represents 25% of total revenues for the quarter. Print revenues, of $1.3 million, which is a decrease of 34% over Q2 2007, and represent only 4% of total revenues for the quarter.

Our customer concentration and renewal rates remain favorable during the quarter. Our top ten customers represented 26% of total revenues, and no one advertiser represented more than 5% of total revenue. Our Q2 total customer renewal rate for our top 100 customers was 97%.

Moving on to growth profit for Q2 2008, total gross margin profit decreased slightly to 69% compared to 70% for the comparable prior year quarter. Regarding our largest revenue stream online gross profit margin decreased to 74% compared to 76% in Q2 of 2007.

As we have mentioned in prior calls, and as Greg also mentioned, labor costs make up the majority of our cost structure, and therefore our cost structure can produce positive or negative leverage based on how much revenue we achieve during a quarter. During Q2 we experienced a shortfall of approximately $1.5 million in anticipated online revenues, which in turn resulted in a decrease in gross profit margin as well as adjusted EBIDTA margins.

For the quarter we are reporting $7.5 million in adjusted EBIDTA, which represents less than a 1% decrease compared to Q2 2007. We define adjusted EBIDTA as earnings before interest, taxes, depreciation and amortization, as well as further adjusted for stock-based compensation. Our adjusted EBIDTA margin for the quarter was 26% compared to 31% in Q2 of 2007. The mid-point of our Q2 guidance anticipated an adjusted EBIDTA margin of 29%.

Moving on to operating expenses, please note that all the amounts that I will be discussing exclude depreciation, amortization, and stock-based compensation. Q2 2008 total operating expenses as a percentage of total revenues was 44% compared to 40% in Q2 2007. As a general comment, our total operating expenses as percentage of total revenues are higher than anticipated as a result of the shortfall in revenues. For each of the specific expense line items as percentage of total revenues selling and marketing expenses increased 2%, product development expenses increased 3%, and general administrative expenses decreased 1% from the prior year period.

The increase in selling and marketing as well as product development is primarily attributable to increased labor costs. Our selling and marketing organizations had an average of 49 additional heads over Q2 2007. The labor increases and product development are related to the additional technical resources gained through the acquisition of Knowledge Storm. These employees were not included in Q2 2007 and the decrease in G&A is primarily favorable leverage as a result of stable G&A costs over the prior year combined with increased revenues.

For Q3 we expect total operating expenses as percentage of revenues to continue to be higher than planned due to the sudden changes in the macro economic environment as well as the historical nature of Q3 being a slow revenue quarter. This cost/revenue relationship is factored into our Q3 guidance. The mid-point projects an adjusted EBIDTA margin of 18%. We are proactively controlling costs by slowing our rate of hiring and closely monitoring all discretionary costs.

As Greg mentioned our online revenue is experiencing healthy growth and we expect that to continue. For the remainder of 2008 we expect our quarterly operating costs to be flat with Q2. Q4 historically is our strongest revenue quarter, and we expect an increase in Q4 revenues to result in favorable operating leverage reducing an adjusted EBIDTA margin of approximately 30% for the quarter.

In approximately 60 days we will begin our formal and highly structured 2009 budget process. A key goal of the budge process is to properly realign operating costs with our 2009 revenue expectations. As a reminder, 2009 guidance is included as part of our year-end earnings call.

Net income for Q2 2008 was $1.7 million compared to net income of $3.2 million in Q2 2007. Net income for diluted share for the quarter was $.04 compared to the net income for diluted share of $.08 for 2007 and that is on a pro-forma basis. Net income adjusted for amortization and stock-based compensation as further adjusted for the related income tax impact was $4.3 million for Q2 2008, a decrease of 12% compared to $4.9 in Q2 of 2007. Adjusted net income for diluted share was $.10 for Q2 2008, compared to $.13 in Q2 of 2007.

In closing, our balance sheet and financial position remains strong. As of June 30, 2008, our cash and short-term investments totaled $67.7 million, and our bank debt was $4.5 million. This wraps up my review of the financial results and at this time I will turn the call over to Don.

Don Hawk

As Greg mentioned we see an economic downturn as an opportunity to further extend our lead. I would like to share some thoughts about the short-term trends we are seeing in our lead generation business and how they play out with various segments of our customer base. I would also like to talk about how the Knowledge Storm acquisition is playing out for us both in the immediate macro-economic environment and with regard to its long-term impact.

Lead generation is clearly the largest component of our online revenues. In a negative economic environment lead gen. has some important protections against weakness but it is not entirely immune. One thing that is important to note is that the impact of an economic slow-down plays out very differently based on the size of the customer.

Our larger customers tend to have lead generation as one component of a diversified marketing strategy. As these larger customers look to tighten their marketing spending in a down economy they are most likely to make cuts in the areas of their marketing spend that are the least efficient or the least directly measurable. In this context we would anticipate that their spending with us would hold up well.

For smaller IT vendors however, online lead gen. may already represent a large share of their overall marketing spend. So when these customers look to tighten their marketing budget there aren’t as many non-measurable or non-efficient areas in which to cut back. While wholesale cutbacks are unlikely, the pace of these smaller customers spending throughout the year is susceptible to a slow-down. In a down economy it takes our customers longer to convert the leads that we send them into actual sales. And we may see these customers slowing the pace of their spending with us to match their ability to close the leads that we generate with them.

These short-term dynamics are playing out in our results. Greg alluded to the very strong growth that we have been seeing with the largest IT vendors. Larger IT vendors are interested not only in lead generation but also in increasing their brand awareness and establishing thought leadership. With these vendors not only is our lead generation business holding up well but we are also seeing strong growth in our product offerings to support these other objectives. For example, heightened demand from large advertisers was the primary driver behind nearly 70% year-over-year growth within our display advertising and sponsorship offerings, as well as strong growth in our video offerings and custom content creation.

We see considerable upside for this type of business and it is good evidence of our continued ability to grow as traditional marketing budgets shift to online. Conversely, the short-term challenges to our original 2008 revenue assumptions have been centered on those areas of our business that had the highest exposures, small and mid-sized customers. Our continued emphasis on sales penetration and our successful retention of many of Knowledge Storm’s customers have allowed us to grow our customer base substantially. The total number of online advertisers in Q2 08’ was up 43% versus the previous year.

But many of these incremental customer additions are small to mid-sized spenders and we are seeing increased caution on spending. I will provide a data point to illustrate this dynamic. While our top 50 online customers in the quarter grew their average spend by 36% year-over-year, the average online spend of customers outside of our top 50 declined by 15%. We are succeeding in diversifying the customer base and successfully delivering ROI to a new base of small to mid-size customers and as these customers ramp up their spending in a more favorable economic environment we will gain additional benefit.

Although it is not possible to track revenues from our acquisition of Knowledge Storm specifically given how we have integrated the product offerings, it is clear that both of these short-term trends that I am discussing, the weakness in the specific market segments and the cautionary spending by smaller accounts, have had an impact on the 2008 revenue contribution from that acquisition. Knowledge Storm’s two largest market segments were enterprise applications and vertical software and it had a high percentage of small to mid-size customers.

However, the primary rationale for that acquisition was to ensure our scalability over the long term, and on that basis we feel that Knowledge Storm will prove to be a key driver of our success. The addition of Knowledge Storm has increased our enterprise IT related monthly website visits by over 80% on a year-over-year basis. The Knowledge Storm teams core competency on SEM and SEO have augmented the performance on vendor campaigns. The sites existing registered user base has infused our e-mail list with new members and the site is serving as an important source of new member acquisition for us. Most importantly our position as the clear leader for IT lead generation is resonating in the market as evidenced by the dramatic growth in the customer base.

In summary, we are very bullish on our prospects. Our largest customers are growing their spending with us despite a tougher economy; we have increased our penetration of small and mid-sized advertisers, and anticipate gaining additional benefit as the macro environment improves and these advertisers increase their lead generation spending. And with the successful integration of Knowledge Storm into our already strong network of sites, we are the clear market leader in IT lead generation and are growing rapidly in online branding. So with that I look forward to your questions and I turn it back over to Greg.

Greg Strakosch

I would like to share our guidance with you. In the third quarter of 2008 we expect revenues to be between $25 and $26 million and adjusted EBIDTA to be between $4.3 and $5.1 million. For 2008 we are maintaining our previous guidance of revenue between $108 and $112 million, and adjusted EBIDTA between $25 and $27 million.

I will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Joseph - Morgan Stanley.

David Joseph - Morgan Stanley

You have talked before about [inaudible] 75% of them being fixed. I was wondering how that is spread over online events and print and how are you planning on bringing efficiencies in this challenging economic environment?

Eric Sockol

As far as the 75% of the costs we are referring to labor, and for online that number is possibly higher because there really isn’t a third party cost associated. In the area of events there is a big labor element but there is specific costs related to the location of the event and F&B. As far as print is concerned, print is a very small percent of the business, and there are some publication costs. We only have two monthly publications.

As Greg had mentioned, what we have done is that we have slowed down our rate of hiring, it is important to note that we are a growing, profitable business, and we are continuing to invest in the business, but we have slowed down our rate of hiring and we are also very closely looking at discretionary costs. The corporate headquarter controls all the costs, there aren’t costs being spend remotely. We have a good handle on costs.

David Joseph - Morgan Stanley

You talked about longer sales cycles and I was wondering if you are taking any initiative in terms of more competitive pricing to reduce this cycle.

Eric Sockol

We are not seeing any pressure in terms of pricing. It is not our strategy to lower pricing, so it is that our customers are telling us that it is taking them longer to close the leads that were there.

Greg Strakosch

To clarify the point there, the longer sales cycles that we are referring to are on behalf of the people that we sell to. So the IT vendors that we sell advertising to are telling us that their sales cycles are elongating in this period. It takes them longer to close the leads that we provide to them, and therefore that has an impact on their spending with us.

Operator

Your next question comes from Brian Fenske - Lehman Brothers.

Brian Fenske - Lehman Brothers

What percentage of your customer base would you classify as small or medium sized? You had segmented the large vs. those guys.

What percentage of your business would you classify as display and sponsorship versus a lead gen and then finally, would you say that Knowledge Storm revenues were down year-over-year?

Eric Sockol

In terms of what we disclosed about our top ten customers who tend to be very large IT vendors is 26% in the quarter. There are some other large vendors beyond the top ten but roughly 2/3 of our revenue comes from companies that I would characterize as under a billion in revenue.

Greg Strakosch

And the second question was what percentage of the revenue was coming from display and sponsorship versus lead gen, is that right?

It is a little difficult to draw a clear line of demarcation on those because for example we run sponsorship programs that have lead generation aspects to them, and we run lead generation programs that do have branding elements to them as well in terms of how the content is accessed on the website and how they are displayed. By the way, the answer to that question is if you take display and sponsorship and characterize them as 100% branding, which would be inaccurate, that is less than 20% of our overall online revenues.

Brian Fenske - Lehman Brothers

If you could strip out Knowledge Storm would the revenues that have been down year-over-year this quarter?

Eric Sockol

As we have communicated we can’t do that because of the way that the business has been integrated, the products and salespeople etc. So really we can’t respond to that. I think Don gave some color anecdotally on what he has seen in the marketplace, but we can’t quantify that.

Don Hawk

The way we integrated the products we can’t do an apples-to-apples, but keep in mind our online revenue was up 28% in the quarter. We can’t attribute it in a black and white way like that.

Operator

Your next question comes from Ross Sandler - RBC Capital Markets.

Ross Sandler - RBC Capital Markets

If I am doing the math correctly, the implied margins for Q3 that 18% range EBIDTA margin, then it jumps up to around the 33% range for Q4. You never had a 33% margin in Q4 previously, even when the environment was a little better, so what gives you the confidence that you are reining in the expense growth given the current environment?

Eric Sockol

Actually we had two quarters where we have been 32% EBIDTA margin. In Q4 2006 we were 32.5% I think, but it was north of 32%. And in Q2 of 2007 we were 32%. We probably would have been in that same ballpark last Q4 except that we acquired Knowledge Storm in the beginning of November and we had to carry a lot of costs and we weren’t able to recognize a lot of revenue from purchase accounting, so that depressed our EBIDTA margin. We have achieved greater than 32% historically, and Q4 has been a quarter that has done that. Our internal projections feel that is attainable.

Ross Sandler - RBC Capital Markets

Do you think at some point that the hiring slowdown and related expense reductions will become a detriment to long term growth.

Eric Sockol

We are still hiring; we are still investing, because the business is growing. We had a plan for higher revenues so the expense plan was matched with that higher revenue so we are just matching the expenses with the revenues. Since we are still growing we are still hiring, we just don’t need to hire as many people as we originally anticipated. We are still in investment mode; still gaining market share, still very bullish on the opportunity of our competitive position and the macro headwinds don’t change the long-term [inaudible] at all.

Ross Sandler - RBC Capital Markets

When you sell these integrated packages with white papers and web casts and other things of that nature, are you seeing any push-back on the pricing for the packages, or is it just a case of budgets are now smaller than what you expected before and you are going to give your advertisers less if the budgets come in less?

Eric Sockol

It is far more the latter, more that budgets are being curtailed more than concessions. We have always been a premium-priced alternative in the market, which makes sense given the model, how targeted we are relative to other alternatives. Even in the midst of a downturn we maintain that position in the marketplace.

We maintain the position of being a premium-priced player given the ROI we are driving in our solutions. What we are seeing is that customers are coming with smaller budgets and they are trying to align their lead gen spending in particular with how long it takes them to close the deals. That is the metric they use as a success metric and it is the metric they use to gauge their spend level is their close rate against the leads provided. If you are in a situation where leads are taking longer to close that is going to impact spend.

Ross Sandler - RBC Capital Markets

Have you ever run the analysis on the ROI for certain online channels? Can you back into an ECPM or an ECPA cost per lead or however metric you may define things, and then once you have that number, then what leverage or pricing flexibility do you still have? Are you under-priced relative to 50% where you think you might be when the macro gets better, or is it more?

Eric Sockol

That is a hard question to answer for a couple of reasons. One it is very different from segment to segment. Some people are selling $500,000 software packages with 80% gross margins; other people are selling $10,000 hardware with 50% gross margins. That number is all over the board; and typically our customers don’t share with us their back end close rates because we are already the high-priced guy in the market and they are not going to give us any more ammunition. In general, because of the strong ROI, and the high renewal rates and increasing the spend with us and because of the inventory we have been able to increase pricing every year and we don’t see anything that makes us change our view on that.

Operator

Yout next question comes from Mark May - Needham & Co.

Mark May - Needham & Co.

The first question has to do with metrics, which I know you are not accustomed to providing every quarter, but given the environment that we are in I think it would be helpful if you could give us a sense of the number of integrated programs that ran in the quarter, and how that changed both sequentially and year-over-year. Any other metrics in terms of number of leads or anything else that you would provide would be helpful. And the next question would be about 09’ planning and how you look to realign your costs to correspond with your revenue outlook. What kind of target margin do you have for the business over the next year or two?

Eric Sockol

On your first question about the metrics, we don’t share that information so we can’t really respond to that on this call.

Mark May - Needham & Co.

What about the change? If you don’t respond to the number can you talk about the rate of change? The number of leads or the size of the programs, or average spend per program?

Don Hawk

I would be happy to give some color on that. As I alluded to in my prepared comments, what we are seeing is that we are increasing customers and deal sizes are getting smaller, right? And that is really centered on those small to mid sized customers, because as we said in the comments at the large end of the market we are growing the business.

At the small to mid-size end the number of deals we are doing isn’t going down as evidenced by the fact that the number of customers on a year-over-year basis was up 23%. We are seeing these customers that we are adding are spending more cautiously than what we have seen historically or than what was baked into our original revenue assumptions. That would be my comments on the number of programs.

You are also asking about number of leads. The number of leads in the aggregate isn’t a terribly meaningful number for us internally as an operational metric and the reason for that is that the lead programs that we run tend not to be gross robot leads; we run a lot of programs where customers actually don’t want all the leads that we can deliver, they want specific types of leads. They won’t North American, or a particular company size or vertical industry. If you try to track aggregate lead metrics on a year-over year or period basis you end up with a lot of apples to oranges comparisons.

What I would say to you is that the number of leads we can generate on a period to period basis is determined by the size of the deals that we are taking down, and the number of customers. I have already commented on the number of customers and the size of the deals especially in the mid and small end of the market.

Mark May - Needham& Co.

I know some of your deals have guaranteed minimum leads, and has there been any change in terms of your ability to fulfill the minimum requirements of some of the programs? Has there been an increase in shortfalls in recent months?

Eric Sockol

A lot of our programs are lead-guaranteed. We fulfill 100% of the programs that we sell. We continue to do that in an environment where customers are buying less in the IT market you see some of that show up in your lead generation programs, but at the end of the day we deliver on 100% of the programs that we sell, and that is the guarantee that we make to customers. We continue to be able to do that.

Greg Strakosch

In terms of your question about target margins; in 2007 our EBIDTA was 26% and what we have said is that with the inherent operating leverage in the model we will look to increase that every year. That will certainly be top of the mind as we plan for 2009.

Mark May - Needham & Co.

I’m sorry, that you will be over 26% in 09’?

Eric Sockol

We haven’t gone through that process yet, but what we said before the macro turned is that 07’ was 26% and we thought that we could increase that percentage each year. That is what would be top of mind is that is the 09’ plan.

Mark May - Needham & Co.

Does that mean that you would contemplate some cost reductions in your planning?

Eric Sockol

We don’t need to reduce costs because we are growing revenue. We are going to try to reduce the rate of increase of costs but we are not in a position where we are cutting costs because of the growth. But we have to go through that process and we are looking at the margin for next year when we go through that process over the coming months. We are obviously going to weigh all those things.

Mark May - Needham & Co.

I wanted to clarify that you mentioned a $300,000 contribution from Knowledge Storm, but there was a specific way that you characterized that, that there were contracts that had been signed since you acquired

Eric Sockol

What I was stating was that when we acquired Knowledge Storm there was a certain amount of contracts that had been entered into prior to the acquisition. There was only $300,000 of revenue associated with contracts that existed before we acquired the company. And then as the nature of our business is that the average length of our contracts is about 90 days, so we acquired Knowledge Storm seven or eight months ago and we have already combined the products but any existing business from Knowledge Storm our sales force has had to go out and sell those new product offerings. We are showing that as a data point that there is very little contractual legacy business related to Knowledge Storm.

Mark May - Needham &Co.

Just to clarify, if I remember correctly, Knowledge Storm prior to you acquiring them was in the $3 million a quarter revenue level, is that right?

Eric Sockol

In that ballpark, yes.

Operator

Your next question comes from Analyst for Jim Freeland - Cowan & Co.

Analyst for Jim Freeland - Cowan & Co.

Could you give any more color on the timing of the weakness? I know the second half of the quarter was worse than the first half but could you talk about how June compared to May, and any color on initial take-aways from July and how it compared?

Don Hawk

In terms of the quarter June was definitely the weakest month in terms of expectations of the quarter. In terms of Q3 July is historically a slow month anyway, so it is hard to take much away from that, and what has happened so far in the quarter is that we have incorporated into our Q3 guidance.

Analyst for Jim Freeland - Cowan & Co.

In the largest categories of storage and data center you had really strong growth. Was that consistent throughout the quarter, or did that change at all? Did you feel that it could have grown any faster or was it un-impacted?

Don Hawk

Everything is being impacted by the macro right now. Every segment is being affected. The macro is across the board.

Analyst for Jim Freeland - Cowan & Co.

And a clarification on the costs; online costs and revenues since it is labor oriented you would not expect that to decline on a sequential basis, quarter to quarter, right?

Eric Sockol

I think you can expect that to be flat.

Don Hawk

The costs of revenue associated with online will be slightly down because there is from Q2 a decrease in online revenue. That is also something that is very seasonal; if you look back last year there was a decrease form Q2 to Q3 of about 10% in online revenue. We would see that type of decrease naturally anyway with the macro. The part about online revenue and the cost structure if you step back from online revenue we have an editorial cost that is classified in cost of sales online revenue and the type of third party costs are minimal related to online revenue. We have some hosting costs related to web casts and some other type of costs related to list rentals, but very minimal; single digit type percentages. So the majority is labor related, and the majority is in the area of the creation of the content.

Analyst for Jim Freeland - Cowan & Co.

And when you said that you expect operating expenses to be similar to the second quarter that was including costs of revenues + the operating expense lines?

Don Hawk

I was referring to the operating expenses was the selling and marketing product development in general administration when we were saying they were online. Total costs of revenues for Q3 will be slightly down and for Q4 will be more in line with Q2 because of the revenue . It is a little higher actually.

Analyst for Jim Freeland - Cowan & Co.

One more on the costs; on G&A a lot of leverage in the quarter. Was anything specific there in Q2 that you are able to take out?

Eric Sockol

Nothing really material.

Analyst for Jim Freeland - Cowan & Co.

Are you seeing any changes in the competitive landscape? Do you have a sense of how your competitors are reacting in this environment or a change in their willingness to invest in their websites maybe? What does the acquisition pipeline look like; are you seeing less competition for acquisitions and what do the multiples look like?

Eric Sockol

In terms of the acquisition pipeline we are very optimistic there, and we are always looking at things, and that hasn’t really changed. I don’t think the competitive environment in terms of acquisition has changed significantly either. In terms of competition in general no major changes. The one thing I anticipate though as the macro gets tough we know the customer’s behavior changes and they get much more focused on measurability and we are hearing some customers talking about shifting their focus from branding to lead gen and that benefits us.

Operator

Your next question comes from Sandeep Aggarwal - Collins.

Sandeep Aggarwal - Collins, Stewart LLP

A couple of questions. Can you talk about your ramp-up efforts for your international business and especially what kind of traction you are seeing with the new international focus you launched and then I have a couple of follow-ups.

Eric Sockol

International is still a very small part of our business, but it is growing very rapidly and it is to a place where we plan on continuing to make investments.

Sandeep Aggarwal - Collins, Stewart LLP

Any signs of traction for the new sites you launched in the last six months?

Eric Sockol

Those are still relatively small as we expected but they are growing nicely and we continue to invest in them and we continue to grow traffic and grow revenue.

Sandeep Aggarwal - Collins, Stewart LLP

During the call you mentioned about some acquisitions, can you talk about are they largely going to be vertically focused or geographically focused?

Eric Sockol

I think in general they will be vertically focused. The strategy, although we are open minded toward everything, the strategy is to build the international business the same way we built the U.S. business which is organically, and then have a tuck-in acquisition model.

Sandeep Aggarwal - Collins, Stewart LLP

The last questions on the metrics and I know you don’t share much. You mentioned there was a 97% renewal rate for the 100 advertisers. I was wondering what the revenue retention rate was for those 100 advertisers. Was it 100%, 110%, or 90%?

Eric Sockol

We don’t disclose that, but you know it is a very healthy renewal rate. Our customers are getting very good ROI from our programs and they continue to renew and spend more obviously by the 28% online growth rate.

Don Hawk

As well evidenced by the metric that I put out which is the growth rate on the top 50 customers for online in the quarter, which if I remember correctly over 50% on a year-over-year basis.

Operator

And that does conclude your question-and-answer session.

Greg Strakosch

Thank you everyone for joining us and we will talk to you next quarter.

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