Kenexa 10-K 2011
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2010
For the transition period from to
Commission File number 000-51358
(Exact Name of Registrant as Specified in Its Charter)
Registrant’s Telephone Number, Including Area Code: (610) 971-9171
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer o Accelerated Filer x Non-accelerated Filer o Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Act). Yes o No x
The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2010 was approximately $219,393,624. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the Nasdaq Global Select Market on June 30, 2010. For purposes of determining this amount only, the Registrant has defined affiliates of the Registrant to include the executive officers and directors of Registrant and holders of more than 10% of the Registrant’s common stock on June 30, 2010.
The number of shares outstanding of the Registrant’s Common Stock, as of March 14, 2011 was 23,210,191.
DOCUMENTS INCORPORATED BY REFERENCE
DECEMBER 31, 2010
This Annual Report on Form 10-K and the documents incorporated herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements are therefore entitled to the protection of the safe harbor provisions of these laws. These forward-looking statements, which are usually accompanied by words such as “may,” “might,” “will,” “should,” “could,” “intends,” “estimates,” “predicts,” “potential,” “continue,” “believes,” “anticipates,” “plans,” “expects” and similar expressions, involve risks and uncertainties, and relate to, without limitation, statements about our market opportunities, our strategy, our competition, our projected revenue and expense levels and the adequacy of our available cash resources. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from those expressed or forecasted in, or implied by, such forward-looking statements, particularly those factors discussed in “Item 1A - Risk Factors” in this Annual Report on Form 10-K.
Although we believe that the expectations reflected in these forward-looking statements are based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report on Form 10-K may not occur and our actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We disclaim any obligation or undertaking to disseminate any update or revision to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
We provide software, proprietary content and services that enable organizations to more effectively recruit and retain employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We offer the software applications that form the core of our on-demand solutions, which materially reduce the costs and risks associated with deploying traditional enterprise applications. We complement our software applications with tailored combinations of outsourcing services, proprietary content and consulting services based on our 23 years of experience assisting customers in addressing their Human Resource (HR) requirements. Together, our software applications and services form complete and highly effective solutions available from a single vendor. We believe that these solutions enable our customers to improve the effectiveness of their talent acquisition programs, increase employee productivity and retention, measure key HR metrics and make their talent acquisition and employee performance management programs more efficient.
As of December 31, 2010, we had a global customer base of approximately 6,800 companies across a number of industries, including financial services and banking, manufacturing, government, life sciences, biotechnology and pharmaceuticals, retail, healthcare, hospitality, call centers, and education, including approximately 255 companies on the Fortune 500 list published in May 2010. Our customer base includes companies that we billed for services during the 12 months ended December 31, 2010 and does not necessarily indicate an ongoing relationship with each such customer. For the year ended December 31, 2010, we provided our talent acquisition and employee performance management solutions on a subscription basis to approximately 6,000 customers, with an average subscription term of two years. The remainder of our customers in 2010 engaged us to provide discrete professional services and may not engage us for future services once a project is completed. No single customer accounted for more than 10% of our revenue in the year ended December 31, 2010.
We derive revenue primarily from two sources, subscription fees for our solutions and fees for discrete professional services. During the years ended December 31, 2010, 2009 and 2008, subscription revenue comprised approximately 78.8%, 84.9% and 80.2%, respectively, of our total revenue. Our top 80 customers contributed approximately 52.7%, 54.9% and 56.3% of our total revenue for the years ended December 31, 2010, 2009 and 2008, respectively. Our customers typically purchase multi-year subscriptions, which provide us with a recurring revenue stream. Historically, our customers have renewed more than 90% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal. Recently however, the economic downturn has adversely impacted this trend, resulting in lower annual renewals. Our customers renewed 84% and 80% of their contracts for each of the years ended December 31, 2010 and 2009, respectively which represented 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those years.
We are a Pennsylvania corporation. We began our operations under predecessor companies Insurance Services, Inc., or ISI, and International Holding Company, Inc., or IHC, in 1987. In December 1999, we reorganized our corporate structure by merging ISI and IHC with and into Raymond Karsan Associates, Inc., or RKA, a Pennsylvania corporation and a wholly owned subsidiary of Raymond Karsan Holdings, Inc., or RKH, a Pennsylvania corporation. Each of RKA and RKH were newly created to consolidate the businesses of ISI and IHC. In April 2000, we changed our name to TalentPoint, Inc. and we changed the name of RKA to TalentPoint Technologies, Inc. In November 2000, we changed our name to Kenexa Corporation, or Kenexa, and we changed the name of TalentPoint Technologies, Inc. to Kenexa Technology, Inc., or Kenexa Technology. Currently, Kenexa transacts business primarily through Kenexa Technology and its wholly owned subsidiaries.
Our principal executive offices are located at 650 East Swedesford Road, Second Floor, Wayne, PA 19087.
Our telephone number is (610) 971-9171. We maintain an Internet website at http://www.kenexa.com. We are not incorporating by reference into this Annual Report on Form 10-K any material from our website. The reference to our website is an inactive textual reference to the uniform resource locator (URL) and is for your reference only.
On June 11, 2009 and July 16, 2009, two putative class actions were filed against Kenexa Corporation and our Chief Executive Officer and Chief Financial Officer in the United States District Court for the Eastern District of Pennsylvania, purportedly on behalf of a class of our investors who purchased our publicly traded securities between May 8, 2007 and November 7, 2007. On September 28, 2010, the court granted Kenexa’s motion to dismiss the complaint filed on June 11, 2009. The plaintiffs filed a motion for reconsideration of the court’s decision on October 12, 2010, which was denied by the court on November 29, 2010. The plaintiffs failed to file a timely appeal, and, as a result, the actions were concluded in Kenexa's favor.
In May 2010, we launched a major upgrade to our product line. Our 2x platform™ includes applications such as Kenexa 2x Recruit™, Kenexa 2x BrassRing®, Kenexa 2x Onboard™ and our first-to-market Kenexa 2x Mobile™ solution. Future modules to the 2x platform include Kenexa 2x Perform™, Kenexa 2x Assess™, Kenexa 2x Analytics™ and Kenexa 2x Survey™. We believe that Kenexa 2x enables customers to improve productivity, increase cost savings, ensure compliance with corporate and legal mandates, and raise employee engagement.
In July 2010, in accordance with our UBS AG agreement, we exercised our right to sell our auction rate securities back to UBS and liquidated our auction rate security portfolio in its entirety. (See Note 3 - Investments to the Consolidated Financial Statements for further details.)
On July 26, 2010, we acquired all of the outstanding stock of The Centre for High Performance Development (Holdings) Limited (“CHPD”) which operates as a leadership development and management training company based in London, England for a purchase price of approximately $4.2 million in cash. The total cost of the acquisition, including estimated legal, accounting, and other professional fees was approximately $4.4 million. We deposited $0.4 million into escrow to cover any claims for indemnification. We acquired all assets and liabilities of CHPD using our existing cash and expect the acquisition of CHPD will enhance our existing research and content portfolio as well as provide our customers with the ability to more efficiently implement the results of their employee engagement surveys.
On August 31, 2010, we entered into a secured credit agreement with PNC Bank, N.A., as administrative agent, in connection with our acquisition of Salary.com. The secured credit agreement included a maximum amount available under the credit facility of $25.0 million including a sublimit of up to $2.0 million for letters of credit and swing loans. Borrowings under the new credit facility were secured by substantially all of the Company’s assets and the assets of its subsidiaries.
On October 1, 2010, we acquired all of the outstanding stock of Salary.com, Inc., a Delaware corporation (“Salary.com”), which provides on-demand compensation software that helps businesses and individuals manage pay and performance, for a purchase price of approximately $78.4 million in cash. The total cost of the acquisition, including estimated legal, accounting, and other professional fees was approximately $82.8 million. We used cash and borrowings against the credit facility to fund the acquisition. We believe there is a significant opportunity to expand Salary.com’s adoption in large organizations and on a global basis because its compensation analysis software is highly synergistic with our current suite of talent acquisition and retention solutions.
In connection with the acquisition of Salary.com, we assumed responsibility for the suit filed on August 13, 2010 by former shareholders and option holders of Genesys Software Systems, Inc. (the “Genesys Parties” and “Genesys,” respectively) against Salary.com, Inc. and Silicon Valley Bank –Trustee Process Defendant in Massachusetts Superior Court. The Genesys Parties asserts claims for breach of contract, breach of implied covenant of good faith and fair dealing, violation of the Massachusetts Unfair Business Practices Act, and declaratory judgment seeking damages of $2.0 million in contingent consideration related to the purchase of Genesys by Salary.com, plus other monetary damages and fees. On September 7, 2010, Salary.com filed an answer and counterclaim against the Genesys Parties, and certain former shareholders of Genesys, asserting breach of contract, breach of implied covenants of good faith and fair dealing, fraud, violation of the Massachusetts Unfair Business Practices Act, civil conspiracy, negligent misrepresentation, and declaratory judgment seeking to dismiss the original complaint and unspecified monetary damages. The $2.0 million in contingent consideration was accrued for in the financial statements at December 31, 2010.
On, October 20, 2010, we terminated and paid all outstanding amounts under our secured credit agreement, dated August 31, 2010, and entered into a senior secured credit agreement (the “amended credit agreement”) with PNC Bank. The maximum amount available under the amended credit agreement is $60.0 million, comprised of a $35.0 million revolving facility, including a sublimit of up to $5.0 million for letters of credit and a sublimit of up to $2.5 million for swing loans (the “Revolving Facility”), and a $25.0 million term facility (the “Term Facility”). We may request to increase the maximum amount available under the Revolving Facility to $50.0 million. The amended credit agreement will terminate, and all borrowings will become due and payable, on October 19, 2013. We and each of our U.S. subsidiaries are guarantors of the obligations under the amended credit agreement. Borrowings under the amended credit agreement are secured by substantially all of our assets (including a pledge of the capital stock of our subsidiaries (but limited to only 65% of the voting stock of first-tier foreign subsidiaries)). As of December 31, 2010 we borrowed $59.5 million under the amended credit agreement in connection with the acquisition of Salary.com and to enhance working capital. In January 2011, we made payments of approximately $25.7 million under the amended credit agreement.
On February 2, 2011, Dorno Investment Partners, LLC filed a Petition for Appraisal of Stock in the Court of Chancery of the State of Delaware against Kenexa Compensation, Inc., the new name for the surviving entity subsequent to the all cash, short form merger of Salary.Com, Inc. and Spirit Merger Sub, Inc. on October 1, 2010. Dorno was the beneficial owner of 143,610 shares of Salary.Com, Inc. common stock on the merger date and demanded and continues to demand appraisal of the fair value of 140,000 shares pursuant to Delaware law. Dorno demands fair value for its shares, interest from October 1, 2010, costs, attorney’s fees, and other appropriate relief.
We believe that superior customer support is critical to our customers. Our customer support group assists our customers by answering questions and troubleshooting issues involving our solutions. Customer support is available 24 hours a day, 7 days a week by telephone and Internet from a member of our customer support team. Members of our customer support team receive comprehensive training and orientation to ensure that our customers receive high-quality support and service. Each of our customers is assigned a single point of contact. When an issue is reported to us, our customer support personnel follow a clearly defined escalation process to ensure that mission-critical issues are resolved to the satisfaction of the customer.
We utilize our talent acquisition and employee performance management solutions to recruit and manage our customer support personnel. We believe that applying these solutions to our customer service department has resulted in a customer support group with superior skills, competencies and aptitude for customer service. As of December 31, 2010, our customer support group consisted of 1,043 employees. The majority of our customer support groups reside in the following locations: Massachusetts, Nebraska, Pennsylvania, Texas, Argentina, China, England, Germany, India, and Poland.
As of December 31, 2010, we had 1,963 employees, consisting of 315 employees in sales and marketing, 429 employees in development, 1,043 employees in delivery of our solutions and 176 employees in general and administrative positions. As of December 31, 2009, we had 1,459 employees, consisting of 243 employees in sales and marketing, 291 employees in development, 776 employees in delivery of our solutions and 149 employees in general and administrative positions. None of our employees are represented by a union. We consider our relationship with our employees to be good and have not experienced any interruptions of our operations as a result of labor disagreements.
Talent acquisition is the sourcing, recruiting, screening and assessment of employees. Employee performance management is the systematic process by which an organization tracks, monitors and optimizes employee behavior and productivity, and evaluates performance through employee reviews, appraisals and business metrics.
Drivers of Demand for Talent Acquisition and Employee Performance Management Applications
According to the Bureau of Economic Analysis, an agency of the U.S. Department of Commerce, the amount spent on U.S. labor in 2010 was approximately $6.4 trillion, or approximately 48.6% of the total U.S. gross domestic product. We believe that the drivers for human capital are affected by intense competition for qualified employees as a result of an aging workforce, declining tenure of employees, increased globalization and the growing service component of the U.S. economy.
Over the past two decades, many organizations have implemented software systems that systematize best practices and drive efficiency in most departments, including enterprise resource planning systems (“ERP”), customer relationship management systems and supply chain management systems. These software applications provide a wide array of benefits that both assist revenue growth and eliminate expenses. Based on our experience, however, we believe that the HR departments of many of these organizations have only implemented HR information systems, which track basic employee information for payroll and benefits purposes, or rudimentary applicant tracking systems. Although these systems provide some level of automation, they do little to increase the effectiveness of talent acquisition and employee performance management programs. We believe that few organizations have systematized best practices for talent acquisition and employee performance management or have implemented software applications to support these processes and provide HR professionals with critical analytics and metrics.
Our experience indicates that, presently, many organizations' talent acquisition functions consist of manual, paper-based processes, category software solutions addressing limited aspects of the talent acquisition equation, and ad hoc outsourcing and third-party or custom software applications with limited functionality. As a result, we believe that they suffer from the following shortcomings:
Similarly, we believe that many organizations have neither automated nor applied best practices to employee performance management. In our experience, most organizations’ employee performance management processes consist of annual performance reviews and informal mentoring programs. We believe that effective employee performance management requires a consistent, systematized process that identifies employee strengths, weaknesses and issues in a timely manner, continually aligns employee goals with the evolving goals of the organization, monitors opportunities for internal advancement and enables management to analyze employee data over time. We believe that the absence of effective employee performance management systems and processes has the following negative implications:
We believe that the failure to employ sophisticated systems in their talent acquisition and employee performance management processes inhibits organizations from leveraging valuable data generated through these functions. This can negatively impact organizations in several ways, including the failure both to identify overall trends that could improve the efficiency and effectiveness of its processes and to quickly identify problems that could lead to employee turnover.
Emergence of On-Demand Applications
Based on our experience, we believe that organizations have become increasingly dissatisfied with traditional enterprise software applications, resulting in the growing adoption of the on-demand model for enterprise software. Historically, organizations have purchased perpetual software licenses and deployed enterprise software applications on-site within their IT environment. This traditional method of purchasing and deploying enterprise software applications has left many organizations questioning whether the benefits of these technologies outweigh the following burdens:
Developments in technology have enabled software developers to offer enterprise software applications on an on-demand basis. By leveraging the Internet, multi-tiered architectures, advances in security and open standards for application integration, software vendors can offer software applications to their customers as a service, hosting the software on servers operated by the software vendor. Customers, using an Internet browser, access the applications, which are designed to be easily configured and integrated with a customer’s existing applications.
The on-demand model fundamentally changes both the purchasing and deployment of enterprise software from a customer perspective. Rather than making large, up-front investments in perpetual licenses, customers purchase limited term subscriptions for on-demand software applications. Further, because only an Internet browser is required to access on-demand software applications, which can be easily configured to meet the buyer’s specific needs, organizations eliminate the expense of ancillary technology and third-party services required to implement, configure and maintain the enterprise application on-site. Finally, the finite duration of customer subscriptions provides a strong incentive to software vendors to ensure that the software provides the expected benefits to the customer, resulting in consistent customer service. The on-demand model also reduces research and development support costs for the software developer. Because only limited versions of the software exist at any one time, the on-demand model relieves the burden of maintaining and upgrading historical versions of the software so that customers benefit from a steady stream of the most recent features and technologies.
We believe that talent acquisition and employee performance management applications are particularly well-suited to the on-demand model. Talent acquisition and employee performance management applications are generally purchased by an organization’s HR department. Because the HR departments of most organizations have little historical experience making capital expenditures for enterprise software applications, we believe that providing these departments the opportunity to license software applications on a subscription basis eliminates a major impediment to the adoption of talent acquisition and employee performance management applications.
We are a leading provider of integrated talent management solutions. Our solutions enable organizations to implement systematic talent acquisition and management practices including compensation strategies that ensure the efficient, effective and consistent hiring, on-boarding and development of qualified and talented individuals. Our solutions also provide employee performance management systems that help to ensure that organizations retain and optimize the performance of qualified individuals, identify employees who fail to perform, and identify successors for critical positions. In addition, our solutions help organizations manage learning and assessment opportunities and events to develop employees for both current and desired future jobs. Finally, our solutions enable customers to determine its workforce’s engagement level, and diagnose where changes in behavior (for individual employees, managers and senior leaders) or HR programs will improve organizational performance and business outcomes.
Our solutions are built around a suite of easily configurable software applications that automate and support leading talent management leading practices. We believe that by delivering our products via Software as a Service (SaaS), we materially reduce the costs and risks associated with traditional enterprise software application implementations. We also believe that implementing feature-rich and scalable, highly configurable on a real-time basis, talent acquisition and employee performance management solutions that meet organizations’ specific needs requires a combination of software, services and domain-specific knowledge and expertise. Accordingly, we complement our software applications with consulting services, outsourcing services and proprietary content. Together, these components form solutions that enable our customers to improve the quality of their hiring programs, increase employee productivity and retention, design tailored compensation philosophies, enhance employee learning and development, increase employee engagement, and make their integrated talent management programs more cost-effective.
Our objective is to be the leading global provider of human capital management business solutions for global organizations with more than 2,000 employees. Key elements of our strategy include:
Our Products and Services
We offer unified business solutions that support hiring, retention and performance management for the entire employee lifecycle.
Talent Acquisition Solutions:
We provide complete Recruitment Technology systems for the largest, most complex organizations in the world. Our web-based technology provides everything organizations need to locate and track talented candidates as they move through the hiring process. Built using cutting-edge technologies, our Recruitment Technology solutions deliver comprehensive support of recruiting processes, giving companies visibility and access to critical hiring and retention data.
Our Onboarding solution is built on the belief that every new employee needs to have the right information to be effective. Our solution offers form management for legal documents, workflow and electronic signatures. We help companies extend a positive brand impression through ongoing communication and socialization that reinforces their culture and business practices. This helps organizations reduce the amount of time it takes employees to be fully competent in their jobs—increasing productivity and return on investment as well as providing an auditable on-boarding process.
We offer Employee Assessments that help organizations select and retain top performers based on seven key areas that predict individual performance and potential—experience, skills, abilities, personality, motivation, situational judgment and culture fit. Our tools are delivered in the most usable formats—online, interviews and assessment centers. All of our solutions can be used as standalone systems or easily integrated with the quality and efficiency of recruiting and selection processes. They allow organizations to make better hiring and promotion decisions, and ensure that employees are a perfect fit in the organization’s culture.
We offer skills tests that improve the screening process by helping organizations quickly identify and select the most talented candidates. Easy-to-use and administer, Kenexa Prove It!® System offers more than 1,000 validated assessments for specific job classifications, including software, office/professional, call center, financial, healthcare, industrial, legal and technical positions. Test results are received instantly—ideal for selecting candidates in a fast-paced, competitive environment.
We offer structured interviews that assess candidates with greater accuracy, objectivity and consistency, while improving the fit of new hires within each organization's culture. Kenexa Interview Builder® System provides a powerful online structured interview reference library of more than 3,000 questions that increase interviewer confidence, efficiency, accuracy and defensibility. With the ability to custom select behavioral, situational, attitudinal and job knowledge questions, Interview Builder encourages candidates to speak freely about their experiences and provides a broad spectrum of job analysis tools, job description templates, interview guides and competency profiles.
Our Employment Branding offering applies the same consumer branding principles of attracting and retaining customers to attracting and retaining top employees. It’s a practice built on research that uncovers the strengths, weaknesses and hidden elements of an organization’s culture. Employment Branding integrates seamlessly with every Kenexa solution to create award-winning recruitment campaigns, provide candidates with an engaging career site experience, uncover the right media mix for sourcing, give insight into employee engagement and help retain top performers.
Recruitment Process Outsourcing (“RPO”)
Our RPO offering delivers a higher quality of candidate, fast. With operations around the globe, we use technology and human ability to reach highly qualified candidates and deliver them real-time to recruiters. We understand organizations need us to provide better recruiting for less, and use our global resources to drive cost savings and improve their workforces. Kenexa’s RPO offering provides global recruitment services for the largest companies in the world.
Talent Retention Solutions:
We offer comprehensive Performance Management solutions that integrate performance management, compensation management, career development, goal alignment and succession planning. Our solutions enable companies to increase productivity, streamline processes, increase accountability and enhance employee engagement.
We deliver Employee Surveys that provide the measurements needed to further each organization and improve business outcomes. With the industry’s best psychologists and top HR experts, we believe we are the proven leader in survey design, administration, reporting and behavior change. Our depth of experience, proven track record, high client retention rate, industry leading normative data and global footprint make us unique. Our tools and technology are intuitive and customized for each organization, making them easy for survey champions, employees and managers to use.
Our Learning Management solution enables organizations to deliver and track employee learning. Our system is ideal for all types of training, including skills and behavioral learning, new-hire orientation, leadership education and sales training. We help companies tailor the delivery of learning management processes by division, business unit and geography.
We understand that leadership development efforts are not universal—they must be tailored to each organization’s specific metrics and processes. Our Leadership Solutions are designed to address core business needs by increasing the quality of leadership in organizations. We offer Leadership Audit, Leadership Assessments and Leadership Development solutions that align with each company’s business strategies to help drive greater organizational performance and success.
Our ComAnalyst® suite of compensation management solutions is designed for use by compensation professionals to ensure that our costumers are offering pay packages that are both externally competitive and internally equitable. CompAnalyst® is built around a core data set of employer-reported market data that is benchmarked and mapped for jobs held by a majority of U.S. employees. Our compensation products allow our global customers on-demand acces to various applications and modules that provide a complete source of data to value jobs, particpate in surveys and analyze pay competitiveness.
Our consumer solutions provide individuals with compensation-focused tools and content to help advance their careers. Products consist of free-to-user applications as well as premium products that are sold directly to individuals visiting the Salary.com® website.
Technology, Development and Operations
We believe that the current market desires integrated talent management solutions that deliver a high degree of business value by linking human capital management solutions more directly to business outcomes. Available in a Software as a Service (SaaS) context, extending a customer’s enterprise, this technology must be easy to use and inexpensive to configure and integrate with the customer enterprise. Our solutions deliver this value by meeting the diverse needs of key stakeholders (Executives, HR, line managers, and employees), by supporting enterprise processes, and by integrating seamlessly with a wide variety of internal and third party applications and services.
Kenexa’s technology strategy focuses on the following areas: i) continued roadmap developments enhancing our products, ii) continued adoption of common services, and iii) continued development of modules on the 2x platform™. Common Services and the Kenexa 2x Products™ include:
This strategy enables us to meet the needs of our current customer base while developing and deploying future capabilities with little to no customer impact, and thus delivers a high degree of customer care while bringing innovative solutions to market.
Our software is designed to support easy-to-use features such as dynamic workflows, job templates and user configuration that enable customers to adapt the application for their specific requirements. Dynamic workflows are designs that facilitate business processes whereby one step in the process cannot be completed until all prior steps have been completed.
Innovation is an important part of our business. We believe that three primary factors drive our innovation: our employees, our domain experts and our customers. We have a formalized system to cultivate participation from all of our employees in research and development. We also leverage the experience of our research scholars and domain experts, who produce white papers, case studies and thought pieces which form the foundation for our innovation. Our research and development team maintains a repository of ideas, and selected ideas are presented to the market validation team. Market validated ideas progress to the prototype stage. The executive team reviews prototypes and selects those with the highest potential, which then enter the product development phase. In addition to our employees and domain experts, some of the key ideas are generated from customer feedback gathered during user group meetings, customer symposiums, and advisory councils.
We follow a development methodology that we believe allows us to develop projects quickly and then proceed on a predictable, low risk path for high-quality results. We conduct our product development through our global development teams. We are in the process of transitioning from being an ISO 9001:2000 certified organization to the Capability Maturity Model Integration (CMMI) approach. We intend to seek CMMI certification in the coming years.
Recognizing that socio-political drivers require data to be regionally located and managed, Kenexa’s hosting strategy provides regional data centers. Our data centers in Sterling, Virginia and Blanchardstown, Ireland serve as our hosting facilities for our on-demand solutions. Kenexa is scheduled to open its Shanghai, China hosting facility in late 2011 or early 2012. We also have data centers in Massachusetts, Pennsylvania, Nebraska, England, and India. We seek to adhere to industry standards and best practices in our global operations. Our goal is to deliver world-class hosted solutions that are highly available, scalable and reliable across our suite of Talent Management solutions. We believe that we offer best-in-industry security to our customers and demonstrate this through a number of security related certifications including CyberTrust Enterprise, CyberTrust Application, TRUSTe, and SafeHarbor. We seek to deliver quality service with service level guarantees to customers.
Our Hosting Operations and Security teams include multiple Certified Information Systems Security Professionals, or CISSPs, with training in the latest security and availability threats. Our data centers are continuously and proactively monitored by a comprehensive set of tools, personnel, as well as partnering with a third party intrusion detection vendor, 24 hours a day, 7 days a week. Our hosted data center has built-in power redundancy from multiple power grids with uninterrupted power supplies backed up by N+1 diesel generators designed to provide uninterrupted service to our customers. The hosted infrastructure is designed with a focus on quality, reliability, scalability, privacy and security.
Our intellectual property rights are important to our business. We rely on a combination of patents, copyright, trade secret, trademark and other common laws in the United States and other jurisdictions, as well as confidentiality procedures, systems and contractual provisions to protect our proprietary technology, processes and other intellectual property.
Although we rely on patents, copyright, trade secret and trademark law, written agreements and common law, we believe that the following factors are more essential to establishing and maintaining a competitive advantage:
Others may develop products that are similar to our technology. We generally enter into confidentiality and other written agreements with our employees and partners, and through these and other written agreements, we attempt to control access to and distribution of our software, documentation and other proprietary technology and other information. However, despite our efforts to protect our proprietary rights, third parties may, in an unauthorized manner, attempt to use, copy or otherwise obtain and market or distribute our intellectual property rights or technology or otherwise develop a product with the same functionality as our software. Policing unauthorized use of our software and intellectual property rights is difficult, and nearly impossible on a worldwide basis. Therefore, we cannot be certain that the steps we have taken or will take in the future will prevent misappropriation of our technology or intellectual property rights, particularly in foreign countries where we do business or where our software is sold or used, where the laws may not protect proprietary rights as fully as do the laws of the United States or where enforcement of such laws is not common or effective.
Substantial litigation regarding intellectual property rights exists in the software industry. From time to time, in the ordinary course of our business, we are subject to claims relating to our intellectual property rights or those of others, and we expect that third parties may commence legal proceedings or otherwise assert intellectual property claims against us in the future, particularly as we expand the complexity and scope of our business, the number of similar products increases and the functionality of these products further overlap. We cannot be certain that no third party intellectual property rights that exist could result in a claim against us in the future. These actual and potential claims and any resulting litigation could subject us to significant liability for damages. In addition, even if we prevail, litigation could be time consuming and expensive to defend and could affect our business materially and adversely. Any claims or litigation from third parties may also limit our ability to use various business processes, software and hardware, other systems, technologies or intellectual property subject to these claims or litigation, unless we enter into license agreements with the third parties. However, these agreements may be unavailable on commercially reasonable terms or not available at all.
Sales and Marketing
Our target customers are large and medium-sized organizations with complex talent acquisition and employee performance management needs. We sell our solutions to both new and existing customers primarily through our direct sales force, which is comprised of inside sales, telesales and field sales personnel. Our marketing strategy focuses on building Kenexa’s value proposition in the marketplace, increasing the productivity of our sales engine and establishing relationships with industry influencers.
We believe that our customer relationships provide us with a meaningful opportunity to cross-sell additional solutions to our existing customers and to achieve greater penetration within the organizations. We have established a program intended to increase cross-selling into our largest customers, and we expect to continue to create innovative programs designed to incent our employees and maximize the value we provide to each of our customers.
Our marketing initiatives are generally targeted toward specific vertical industries or specific solutions. Our marketing programs primarily consist of:
We have experienced, and expect to continue to experience, intense competition from a number of companies. We compete with niche point solution vendors, some of whom are privately held, such as Peopleclick Authoria, iCIMS, Inc., Global Innovation Corp, Kronos, Pilat HR Solutions, Inc., Previsor, Inc., SHL Group plc, SuccessFactors, Inc., and Taleo Corporation, which offer products that compete with one or more applications in our suite of solutions. In some aspects of our business, we also compete with established vendors of enterprise resource planning software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG and Lawson, Inc. To a lesser extent, we compete with vendors of recruitment process outsourcing services and survey services, including Accolo, Inc., Alexander Mann Solutions, The Right Thing and survey services such as The Gallup Organization. We believe the principal competitive factors in our industry include:
We believe that we generally compete favorably with respect to these factors.
We may face future competition in the talent acquisition and employee performance management market from large, established companies, such as Oracle and SAP, as well as from emerging companies. Barriers to entry into our industry are relatively low, new software products are frequently introduced and existing products are continually enhanced. In addition, we expect that there is likely to be consolidation in our industry, which could lead to increased price competition and other forms of competition. Established companies not only may develop their own competitive products, but may also acquire or establish cooperative relationships with current or future competitors, including cooperative relationships between both larger, established and smaller public and private companies.
In addition, our ability to sell our solutions will depend, in part, on the compatibility of our software with software provided by our competitors. Our competitors could alter their products so that they will no longer be compatible with our software or they could deny or delay access by us to advance software releases, which would limit our ability to adapt our software to these new releases. If our competitors were to bundle their products in this manner or make their products non-compatible with ours, our ability to sell our solutions might be harmed which could reduce our gross margins and operating income.
Securities and Exchange Commission Filings
We file annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and other information with the SEC. Members of the public may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Members of the public may also obtain information on the Public Reference Room by calling the SEC at 1-800-732-0330. The SEC also maintains an Internet web site that contains reports, proxy and information statements and other information regarding issuers, including us, that file electronically with the SEC. The address of that site is www.sec.gov. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and other information filed by us with the SEC are available, without charge, on our Internet web site, www.kenexa.com as soon as reasonably practicable after they are filed electronically with the SEC.
We operate in a market environment that involves significant risks, many of which are beyond our control. The following risk factors may adversely impact our results of operations, cash flows and the market price of our common stock. Although we believe that we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our performance or financial condition.
Our business will suffer if our existing customers terminate or do not renew their software subscriptions.
We expect to continue to derive a significant portion of our revenue from renewals of subscriptions for our talent acquisition and employee performance management solutions. Our customers renewed 84% and 80% of their contracts for each of the years ended December 31, 2010 and 2009, respectively which represented 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those years., Historically our customers have renewed in excess of 90% of their subscriptions with us. If our customers terminate their agreements, fail to renew their agreements, renew their agreements upon less favorable terms to us, defer existing agreements or fail to purchase new solutions from us, our revenue may decline or our future revenue growth may be constrained.
Maintaining the renewal rate of our existing subscriptions is critical to our future success. Factors that may affect the renewal rate for our solutions include:
Most of our existing customers have entered into subscription agreements with us that expire between one and three years from the initial contract date. Our customers have the right to terminate their contracts under certain circumstances and are not obligated to renew their subscriptions for our solutions after the expiration of the initial terms of their subscription agreements. In addition, our customers may negotiate terms which are less favorable to us upon renewal, or may request that we license our software to them on a perpetual basis, which may reduce recurring revenue from these customers. For example, some of our RPO customers restructured their RPO agreements with us during 2009, in the midst of the economic downturn, to decrease the amount of fixed fee services and increase the amount of variable fee services provided pursuant to the agreement. Our future success also depends in part on our ability to sell new solutions to our existing customers.
If the unemployment rate increases or fails to materially decrease, our business may be harmed.
Demand for our solutions depends in part on our customers’ ability to hire and retain their employees. According to the U.S. Bureau of Labor Statistics, the U.S. unemployment rate in February 2011 was 8.9%. It is unknown whether unemployment will decrease, increase, or remain constant throughout 2011 and beyond as a result of the general downturn in macroeconomic conditions in the U.S. and globally. If the unemployment rate increases our existing and potential new customers may no longer consider improvement of their talent acquisition and employee performance management systems to be a necessity and may have less of a need to hire and retain employees, which could have a material adverse effect on our business, results of operations and financial condition.
If we fail to adequately protect our proprietary rights, our competitive advantage could be impaired, and we may lose valuable assets, experience reduced revenue and incur costly litigation to protect our rights.
Our intellectual property rights are important to our business, and our success is dependent, in part, on protecting our proprietary software and technology and our brand, marks and domain names. We rely on a combination of patent, copyright, trademark, trade secret and other common laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. It may be possible for unauthorized third parties to copy our software and use information that we regard as proprietary to create products and services that compete with ours, which could harm our competitive position and cause our revenue to decline.
We have six issued patents and nine pending patent applications. There is no guarantee that the U.S. Patent and Trademark Office will grant these patents, or do so in a manner that gives us the protection that we seek. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect promptly unauthorized use of our intellectual property. Existing intellectual property laws only afford limited protection.
To the extent that we expand our international activities, our exposure to unauthorized copying and use of our software and proprietary information may increase despite procedures and systems that control information access. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed products may be unenforceable under the laws of certain jurisdictions and foreign countries in which we operate. Further, the laws of some countries, and in particular India, where we develop much of our intellectual property, do not protect proprietary rights to the same extent as the laws of the United States. For example, companies seeking to enforce proprietary rights in India can experience substantial delays in prosecuting trademarks and in opposition proceedings.
Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources, either of which could seriously harm our business. In the event that we are unable to protect our intellectual property rights, especially those rights that we develop in India, our business would be materially and adversely affected.
Reductions in information technology spending could limit our ability to grow our business.>
Our operating results may vary based on changes in the information technology spending of our customers. The revenue growth and profitability of our business depend on the overall demand for enterprise application software and services. We sell our solutions primarily to large organizations whose businesses fluctuate with general economic and business conditions. Historically, corporate information technology spending has been one of the first costs that businesses cut, especially during economic downturns. Software for talent acquisition and employee performance management software may be viewed by some of our existing and potential customers as a lower priority and may be among the first expenditures reduced, especially during unfavorable economic conditions. As a result, potential customers may decide to reduce their information technology budgets by deferring or reconsidering product purchases, which would negatively impact our operating results.
Because we recognize revenue from the sale of our solutions ratably over the term of the subscription period, a significant downturn in our business may not be immediately reflected in our operating results.
A decline in new or renewed subscriptions in any one quarter may not impact our financial performance in that quarter, but will negatively affect our revenue in future quarters. If a number of contracts expire and are not renewed in the same quarter, our revenue could decline significantly in that quarter and in subsequent quarters.
For the years ended December 31, 2010, 2009 and 2008, we derived approximately 78.8%, 84.9% and 80.2%, respectively, of our total revenue, from the sale of subscriptions for our solutions and expect that a significant portion of our revenue for the foreseeable future will be derived from those subscriptions. We recognize the associated revenue ratably over the term of the subscription agreement, which is typically between one and three years. As a result, a significant portion of the revenue that we report in each quarter reflects the recognition of deferred revenue from subscription agreements entered into during previous periods. Accordingly, the effect of significant declines in sales and market acceptance of our solutions may not be reflected in our short-term results of operations, making our results less indicative of our future prospects.
Historically, our customers have renewed more than 90% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal. However, our customers renewed 84% and 80% of their contracts for each of the years ended December 31, 2010 and 2009, respectively which represented 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those years. We cannot assure you that our renewal rate will return to its historical levels, or that it will not decrease.
If our revenue does not meet our expectations, we may not be able to curtail our spending quickly enough and our cost of revenue, compensation and benefits, and product development would increase as a percentage of revenue. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any one period, as revenue from new customers is recognized over the applicable subscription term
Our revenue is highly susceptible to changes in general economic conditions, and a recession or other downturn in the U.S. economy, or in any geographic market in which we provide services, could substantially impact sales of our services and overall results of operations.
Our operating results may vary based on changes in the information technology spending of our customers. The revenue growth and profitability of our business depend on the overall demand for enterprise application software and services. We sell our solutions primarily to large organizations whose businesses fluctuate with general economic and business conditions. Our customers may reevaluate their expenditures on enterprise application software and services, and in particular talent acquisition and employee performance management solutions, especially given the recent financial crisis in today's economic environment, which could cause them to cancel all or any portion of our services or delay the payment of their bills for services previously performed by us. As a result, in the event of a prolonged recession or even a less severe downturn in general economic conditions, our results of operations could be negatively impacted as a result of decreased demand for enterprise application software and services, and in particular talent acquisition and employee performance management solutions, and the impact could be more pronounced for us than for those businesses that deliver products or services that customers deem to be a higher priority. In particular, software for talent acquisition and employee performance management software may be viewed by some of our existing and potential customers as a lower priority and may be among the first expenditures reduced as a result of unfavorable economic conditions. As a result, potential customers may decide to reduce their information technology budgets by deferring or reconsidering product purchases, which would negatively impact our operating results. In addition, volatility and disruption of financial markets could limit our customers’ ability to obtain adequate financing or credit to purchase and pay for our services in a timely manner, or to maintain operations, and result in a decrease in demand for our services that could have a negative impact on our overall results of operations.
Our financial performance may be difficult to forecast as a result of our focus on large customers and the long sales cycle associated with our solutions.
Our sales cycles are generally up to nine months and in some cases even longer. This long sales cycle impedes our ability to accurately forecast the timing of sales in a given period which could adversely affect our ability to meet our forecasts for that period. We focus our sales efforts principally on large organizations with complex talent acquisition and employee performance management requirements. Accordingly, in any single quarter the majority of our revenue from sales to new customers may be composed of large sales made to a relatively small number of customers. Our failure to close a sale in any particular quarter may impede revenue growth until the sale closes, if at all. As a result, substantial time and cost may be spent attempting to close a sale that may not be successful. The period between an initial sales contact and a contract signing is relatively long due to several factors, including:
If our efforts to attract new customers or to sell additional solutions to our existing customers are not successful, our revenue growth will be adversely affected.
To increase our revenue, we must continually add new customers and sell additional solutions to existing customers. If our existing and prospective customers do not perceive our solutions to be of sufficiently high value and quality, we may not be able to attract new customers or to increase sales to existing customers. Our ability to attract new customers and to sell new solutions to existing customers will depend in large part on the success of our sales and marketing efforts. However, our existing and prospective customers may not be familiar with some of our solutions, or may have traditionally used other products and services for some of their talent acquisition and employee performance management requirements. Our existing and prospective customers may develop their own solutions to address their talent acquisition and employee performance management requirements, purchase competitive product offerings or engage third-party providers of outsourced talent acquisition and employee performance management services. These sales challenges may require us to increase our investment in sales efforts, including by hiring additional employees and expanding upon our existing training for our sales force; if we incur these additional costs without achieving a corresponding increase in sales to new and existing customers, then our results of operations may be adversely affected. Additionally, some customers may require that we license our software to them on a perpetual basis or that we allow them the contractual right to convert from a term license to a perpetual license during the contract term, which may reduce recurring revenue from these customers.
Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.
As a result of fluctuations in our revenue and operating expenses, our quarterly operating results may vary significantly. We may not be able to curtail our spending quickly enough if our revenue falls short of our expectations. We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our new product development efforts and hire additional personnel. Our operating results may fluctuate in the future as a result of the factors described below:
We believe that period-to-period comparisons of our results of operations are not necessarily meaningful as our future revenue and results of operations may vary substantially. It is also possible that in future quarters our results of operations will be below the expectations of securities market analysts and investors. In either case, the price of our common stock could decline, possibly materially.
Our business may not continue to grow if the markets for our products do not continue to grow.
Our growth is dependent upon the continued adoption of on-demand software as a key mechanism for delivering solutions in these markets. The rapidly evolving nature of this market reduces our ability to accurately evaluate our future prospects and forecast quarterly or annual performance. The adoption of on-demand talent acquisition and employee performance management solutions, particularly among organizations that have relied upon traditional software applications, requires the acceptance of a new way of conducting business and exchanging and compiling information. Because these markets are new and evolving, it is difficult to predict with any assurance the future growth rate and size of these markets which, in comparison with the overall market for enterprise software applications, is relatively small.
Interruptions or delays in service from our Web hosting facilities could impair the delivery of our service and harm our business.
We provide and manage our service through computer hardware and software that is currently located in a Qwest Web hosting facility in Sterling, VA USA and ServeCentric facility in Blanchardstown, Ireland. All Web hosting facilities are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events. Despite security including continuous guards, dedicated cages, etc., these facilities are also subject to break-ins, sabotage, intentional acts of terrorism, vandalism and similar misconduct. Despite precautions that we take at these facilities, the occurrence of a natural disaster, act of terrorism or other unanticipated problem at any of these facilities could result in lengthy interruptions in our service. Interruptions in our service may reduce our revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions and adversely affect our renewal rates. Our business will be harmed if our customers and potential customers believe our service is unreliable or if our Disaster Recovery Plan (DRP) fails to provide adequate disaster recovery capabilities.
If our security measures are breached and unauthorized access is obtained to customer data, we may incur liabilities and customers may curtail or stop their use of our solutions, which would harm our business, operating results and financial condition.
Our solutions involve the storage and transmission of confidential information of customers and their existing and potential employees, and security breaches could expose us to a risk of loss of, or unauthorized access to, this information, resulting in possible litigation and possible liability. Although we have never sustained such a breach, if our security measures were ever breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, an unauthorized party obtained access to this confidential data, our reputation could be damaged, our business may suffer and we could incur significant liability. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not discovered until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of our security measures could be harmed and we could lose sales and customers.
If we fail to develop or acquire new products or enhance our existing solutions to meet the needs of our existing and future customers, our revenue may decline.
To remain competitive, we must continually improve and enhance the responsiveness, functionality and features of our existing solutions and develop new solutions that address the talent acquisition and employee performance management requirements of organizations. If we are unable to successfully develop or acquire new solutions or enhance our existing solutions, our revenue may decline and our business and operating results will be adversely affected. If we do not succeed in developing or introducing new or enhanced solutions in a timely manner, they may not achieve the market acceptance necessary to generate significant revenue.
In addition, evolving technology may enable new deployment mechanisms that make our on-demand business model obsolete. To the extent that we are not successful in continuing to develop our solutions in correlation with evolving technology, we may not be successful in establishing or maintaining our customer relationships.
Releases of new solutions and enhancements to existing solutions may cause purchasing delays, which would harm our revenue.
Our practice and the practice in the industry in which we compete is to regularly develop and release new solutions and enhancements to existing solutions. As a result, our future success could be hindered by delays in our introduction of new solutions and/or enhancements of existing solutions, delays in market acceptance of new solutions and/or enhancements of existing solutions, and our, or our competitors’, announcement of new solutions and/or solution enhancements or technologies that could replace or shorten the life cycle of our existing solutions. In addition, clients may delay their purchasing decisions in anticipation of our new or enhanced solutions or new or enhanced solutions of our competitors. Delays in client purchasing decisions could seriously harm our business and operating results. Moreover, significant delays in the general availability of new releases or client dissatisfaction with new releases could have a material adverse effect on our business, results of operations, cash flow and financial condition.
We may not receive significant revenue as a result of our current research and development efforts.
Developing and localizing software is expensive and the investment in product development often involves a long payback cycle. We have made and expect to continue to make significant investments in software research and development and related product opportunities. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results if not offset by corresponding revenue increases. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, it is difficult to estimate when, if ever, we will receive significant revenue as a result of these investments.
The use of open source software in our solutions may expose us to additional risks and harm our intellectual property>.
Some of our solutions use or incorporate software components that are subject to one or more open source licenses. Open source software is typically freely accessible, usable and modifiable. Certain open source software licenses require a user who intends to distribute the open source software as a component of the user’s software to disclose publicly part or all of the source code in the user’s software. In addition, certain open source software licenses require the user of such software to make any derivative works of the open source code available to others on unfavorable terms or at no cost. This can subject previously proprietary software to open source license terms.
While we monitor the use of all open source software in our solutions, processes and technology and try to ensure that no open source software is used in such a way as to require us to disclose the source code to the related product or solution when we do not wish to do so, such use could inadvertently occur. Additionally, if a third-party software provider has incorporated certain types of open source software into software we license from such third party for our solutions, we could, under certain circumstances, be required to disclose the source code to our solutions. This could harm our intellectual property position and have a material adverse effect on our business, results of operations and financial condition.
Our ability to license our software is highly dependent on the quality of our services offerings, and our failure to offer high quality services could adversely affect our subscription revenue and results of operations.>
Once our software has been implemented and deployed, our customers depend on us to provide them with ongoing support and resolution of issues relating to our software. Therefore, a high level of service is critical for the continued marketing and sale of our solutions. If we do not efficiently and effectively implement and deploy our software products, or succeed in helping our customers quickly resolve post-deployment issues, our ability to sell software products to these customers would be adversely affected and our reputation in the marketplace and with potential customers could suffer.
If we encounter barriers to the integration of our software or services with software provided by our competitors or with the software used by our customers, our revenue may decline and our research and development expenses may increase.
In some cases our software or services may need to be integrated with software provided by our competitors. These competitors could alter their products in ways that inhibit integration with our software, or they could deny or delay access by us to such software releases, which would restrict our ability to provide our services or adapt our software to facilitate integration with this software and could result in lost sales opportunities. In addition, our software is designed to be compatible with the most common third-party ERP systems. If the design of these ERP systems changes, integration of our software with new systems would require significant work and substantial allocation of our time and resources and increase our research and development expenses.
Material defects or errors in our software could affect our reputation, result in significant costs to us and impair our ability to sell our solutions, which would harm our business.
The software applications forming part of our solutions may contain material defects or errors, which could materially and adversely affect our reputation, result in significant costs to us and impair our ability to sell our solutions in the future. The costs incurred in correcting any material product defects or errors may be substantial and would adversely affect our operating results. After the release of our products, defects or errors may also be identified from time to time by our internal team and by our customers. Such defects or errors may occur in the future. Any defects that cause interruptions to the availability of our solutions could result in:
If we are unable to compete effectively with companies offering enterprise talent acquisition and employee performance management solutions, our revenue may decline.
We may not have the resources or expertise to compete successfully in the future. If we are unable to successfully compete, we could lose existing customers, fail to attract new customers and our revenue would decline. The talent acquisition and employee performance management solutions markets are rapidly evolving and highly competitive, and we expect competition in these markets to persist and intensify. Barriers to entry into our industry are low, new software products are frequently introduced and existing products are continually enhanced. We compete with niche point solution vendors such as PeopleClick Authoria, iCIMS, Inc., Global Innovation Corp, Kronos Incorporated, Pilat HR Solutions, Inc., Previsor, Inc., SHL Group plc, SuccessFactors, Inc., and Taleo Corporation that offer products that compete with one or more applications contained in our solutions. In some aspects of our business, we also compete with established vendors of enterprise resource planning, or ERP, software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG and Lawson, Inc. To a lesser extent, we compete with vendors of recruitment process outsourcing services, including Accolo, Inc., Alexander Mann Solutions, The Right Thing, and survey services such as The Gallup Organization. In addition, many organizations have developed or may develop internal solutions to address enterprise talent acquisition and employee performance management requirements that may be competitive with our solutions.
Some of our competitors and potential competitors, especially vendors of ERP software, have significantly greater financial, support, technical, development, marketing, sales, service and other resources, larger installed customer bases, longer operating histories, greater name recognition and more established relationships than we have. In addition, ERP software competitors could bundle their products with, or incorporate capabilities in addition to, talent acquisition and employee performance management functions, such as automated payroll and benefits, in products developed by themselves or others. Products with such additional functions may be appealing to some customers because they would reduce the number of different types of software or applications used to run their businesses. Our niche competitors’ products may be more effective than our solutions at performing particular talent acquisition and employee performance management functions or may be more customized for particular customer needs in a given market. Further, our competitors may be able to respond more quickly than we can to changes in customer requirements or regulatory changes.
We may engage in acquisitions or investments which present many risks, and we may not realize the anticipated financial and strategic goals for any of these transactions.
We have focused on developing solutions for the enterprise talent acquisition and employee performance management market. Our market is highly fragmented and in the future we may acquire or make investments in complementary companies, products, services or technologies. Acquisitions and investments, including our recent acquisition of Salary.com, involve a number of difficulties that present risks to our business, including the following:
The factors noted above could have a material adverse effect on our business, results of operations and financial condition or cash flows, particularly in the case of a larger acquisition or multiple acquisitions in a short period of time. From time to time, we may enter into negotiations for acquisitions or investments that are not ultimately consummated. These negotiations could result in significant diversion of management time, as well as out-of-pocket costs.
The consideration paid for an investment or acquisition may also affect our financial results. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash or obtain debt or equity financing. To the extent that we issue shares of our capital stock or other rights to purchase shares of our capital stock as consideration for an acquisition or in connection with the financing of an acquisition, including options or other rights, our existing shareholders may be diluted, and our earnings per share may decrease. In addition, acquisitions may result in the incurrence of debt, large one-time write-offs, including write-offs of acquired in-process research and development costs, and restructuring charges. Acquisitions in the future may require us to incur additional indebtedness to finance our working capital and may also result in goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges.
Mergers or other strategic transactions involving our competitors could weaken our competitive position or reduce our revenue.
We believe that our industry is highly fragmented and that there is likely to be consolidation, which could lead to increased price competition and other forms of competition. Increased competition may cause pricing pressure and loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. Our competitors may establish or strengthen cooperative relationships with business process outsourcing vendors, systems integrators, third-party consulting firms or other parties. Established companies may not only develop their own products but may also merge with or acquire our current competitors. In addition, we may face competition in the future from large established companies, as well as from emerging companies that have not previously entered the markets for talent acquisition and employee performance management solutions or that currently do not have products that directly compete with our solutions. It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share or sell their products at significantly discounted prices, causing pricing pressure. In addition, our competitors may announce new products, services or enhancements that better meet the price or performance needs of customers or changing industry standards. If any of these events occur, our revenues and profitability could significantly decline.
Because our products collect and analyze applicants’ and employees’ stored personal information, concerns that our products do not adequately protect the privacy of applicants and employees could inhibit sales of our products.
Some of the features of our talent acquisition and employee performance management applications depend on the ability to develop and maintain profiles of applicants and employees for use by our customers. These profiles contain personal information, including job experience, banking information, social security numbers, home address and home telephone number. Typically, our software applications capture this personal information when an applicant creates a profile to apply for a job, is being on-boarded, and an employee completes a performance review. Our software applications augment these profiles over time by capturing additional data and collecting usage data. Although our applications are designed to protect user privacy, privacy concerns nevertheless may cause employees and applicants to resist providing the personal data necessary to support our products. Any inability to adequately address privacy concerns could inhibit sales of our products and seriously harm our business, financial condition and operating results.
Evolving European Union regulations related to confidentiality of personal data may adversely affect our business.
In order to provide our solutions to our customers, we rely in part on our ability to access our customers’ employee and applicant data. The European Union and other jurisdictions have adopted various data protection regulations related to the confidentiality of personal data. To date, these regulations have not restricted our business as we have qualified for a safe harbor available for U.S. companies that collect personal data from areas under the jurisdiction of the European Union. To the extent that these regulations are modified in such a manner that this safe harbor is no longer available, our ability to conduct business in the European Union may be adversely affected
We may face risks associated with our international operations that could impair our ability to grow our revenue.
We generate a significant portion of our revenue outside the United States. For example, for the year ended December 31, 2010 and 2009, the percentage of revenue generated from customers outside the United States was 26.3% and 20.9%, respectively. We intend to continue selling into our existing international markets and to expand into international markets where we currently do not conduct business, which will require significant management attention and financial resources. If we are unable to continue to sell our products effectively in the existing international markets and expand into additional international markets, our ability to grow our business would be adversely affected. Some of the key factors that may affect our ability to maintain and expand our operations and sales in foreign countries include:
Foreign currency exchange rate risks may adversely affect our results of operations.
Material portions of our revenue and expenses are generated by our operations in foreign countries, and we expect that our foreign operations will account for a material portion of our revenue and expenses in the future. Substantially all of our international expenses and revenue are denominated in foreign currencies, mostly the Indian rupee, British pound, euro and Canadian dollar. For the year ended December 31, 2010, we generated approximately 26.3% of our total revenue and incurred approximately 25.0% of our total costs in foreign currencies. As a result, our financial results could be affected by factors, such as changes in foreign currency exchange rates or weak economic conditions in European markets and other foreign markets in which we have operations. Fluctuations in the value of those currencies in relation to the U.S. dollar have caused and will continue to cause dollar-translated amounts to vary from one period to another. We also incur currency transaction risk whenever one of our operating subsidiaries enters into either a purchase or a sales transaction using a currency other than the local currency in which it receives revenue and pays expenses. Given the volatility of exchange rates, we may not be able to manage effectively our currency translation or transaction risks, which may adversely affect our financial condition and results of operations.
Changes in the regulatory environment and general economic condition in India, China and elsewhere could have a material adverse effect on our business.
The business and regulatory climates in India, China and other developing economies in which we operate are constantly evolving; developments in the regulatory environment in particular are difficult to predict, and enforcement of current and new laws and regulations may not be consistent. Adverse changes in the business or regulatory climate in these countries, including developments that make enforcement of our property rights more challenging or expensive, could have a material adverse effect on our business.
In addition, wages in India, China and other developing economies in which we operate are increasing at a faster rate than in the United States. In the event that wages continue to rise, the cost benefit of operating in India and elsewhere may diminish. India has also experienced significant inflation in the past and has been subject to civil unrest and terrorism. There can be no assurance that these and other factors will not have a material adverse effect on our business and results of operations.
We may not be able to raise capital on terms that are favorable to us.
As of December 31, 2010, we had cash and cash equivalents of $52.5 million. Changes in our operating plans, lower than anticipated revenue, increased expenses or other events, may cause us to seek additional debt or equity financing. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and consolidated results of operations. Additional equity financing would be dilutive to the holders of our common stock, and debt financing, if available, may involve significant cash payment obligations and covenants or financial ratios that restrict our ability to operate our business.
Our credit facility contains certain financial covenants, the breach of which may adversely affect our financial condition.
We have a senior secured credit agreement with PNC Bank, N.A., under which we had drawn down $59.5 million as of December 31, 2010. Our agreement with PNC Bank contains financial covenants that require us to maintain certain ratios. If we are not in compliance with our financial covenants, the amounts drawn on the facility may become immediately due and payable. Any requirement to immediately pay outstanding amounts under a credit facility may negatively impact our financial condition and we may be forced by our creditor into actions, which may not be in our best interests. As of December 31, 2010, we were in compliance with our financial covenants.
Our results of operations may be adversely affected if we are subject to a protracted infringement claim or a claim that results in a significant damage award.
We expect that software product developers, such as ourselves, will increasingly be subjected to infringement claims as the numbers of products and competitors grow and the functionality of products in different industry segments overlaps. Our competitors or other third parties may challenge the validity or scope of our intellectual property rights. A claim may also be made relating to technology that we acquire or license from third parties. If we were subject to a claim of infringement, regardless of the merit of the claim or our defenses, the claim could:
Litigation could be costly for us to defend, have a negative effect on our operating results and financial condition or require us to devote additional research and development resources to change our software.
Our data is obtained from a variety of sources, some of which may not be available to us in the future.
Our proprietary compensation data sets are comprised of extensive data. We obtain our data from a variety of sources, including major consulting firms and our partners, the SEC and other U.S. government agencies and other third party providers, and through our own research efforts. We generally obtain data on a non-exclusive basis and in a summary form. While we do not generally have an ability to resell such data in its entirety, we use such data internally in generating our proprietary data sets. We cannot assure you that the data we require for our proprietary data sets will be available from these sources in the future or that the cost of such data will not increase. From time to time in the past, third parties have sent us letters asserting that our use of data may have violated our agreement with them or infringed upon their copyright. Although we believe that our purchase and use of all third party surveys complies with copyright law and any applicable license agreements, we cannot assure you that we will prevail in any such claims asserted against us and any litigation, regardless of its validity, may involve significant costs and could divert our management’s time and attention from developing our business.
If any third party successfully asserts a claim that we have violated their copyrights or our license agreements with them, we may be required to remove the applicable data from our data sets and regenerate our data sets without such data. Additionally, we may no longer be able to obtain data from the provider or other providers on reasonable terms, if at all. Any inability to obtain data may have a material adverse effect on our business, financial condition and results of operations.
Further, as we expand our customer base to include customers outside of the United States, we may not be able to obtain sufficient international data on reasonable terms to support our data sets. We plan to obtain data which we believe is sufficient to build proprietary data sets in order to support the development of an international business. We expect to incur substantial expense to build proprietary data sets for international markets. We cannot assure you that we will be able to successfully obtain sufficient data to develop proprietary data sets for international markets.
We employ technology licensed from third parties for use in or with our solutions, and the loss or inability to maintain these licenses on similar terms or errors in the software we license could result in increased costs, or reduced service levels, which would adversely affect our business.
We include in the distribution of our solutions certain technology obtained under licenses from other companies. We anticipate that we will continue to license technology and development tools from third parties in the future. There may not always be commercially reasonable software alternatives to the third-party software that we currently license, or any such alternatives may be more difficult or costly to replace than the third-party software that we currently license. In addition, integration of our software with new third-party software may require significant work and substantial allocation of our time and resources. Also, to the extent we depend upon the successful operation of third-party products in conjunction with our software, any undetected errors in these third-party products could prevent the implementation or impair the functionality of our software, delay new solution introductions and injure our reputation. Our use of additional or alternative third-party software would require us to enter into license agreements with third parties, which could result in higher costs.
If we do not retain our executive officers, our ability to manage our business and continue our growth could be negatively impacted.
We have grown significantly in recent years, and management responsibilities remain concentrated in a small number of executive officers, most of whom have been employed with us for at least five years. Our future success will depend to a significant extent on the continued service of these executive officers, namely Nooruddin S. Karsan, Troy A. Kanter, Donald F. Volk, James P. Restivo, and Archie L. Jones, Jr. as well as our other key employees, software engineers and senior technical and sales personnel. We have not entered into employment agreements with any of our employees. The loss of the services of any of these individuals or group of individuals could have a material adverse effect on our business, financial condition and results of operations. Competition for qualified personnel in the software industry is intense, and we compete for these personnel with other software companies that have greater financial and other resources than we do. If we lose the services of one or more of our executive officers or other key personnel, or if one or more of them decide to join a competitor or otherwise compete directly or indirectly with us, our business could be harmed. Searching for replacements for key personnel could also divert management’s time and attention and result in increased operating expenses.
We will not be able to maintain our revenue growth if we do not attract, train or retain qualified sales personnel.
If we fail to successfully maintain and expand our sales force, our future revenue and profitability will be adversely affected. We depend on our direct sales force for substantially all of our revenue and intend to make significant expenditures in upcoming years to expand our sales force. Our future success will depend in part upon the continued expansion and increased productivity of our sales force. To the extent that we experience attrition in our direct sales force, we will need to hire replacements. We face intense competition for sales personnel in the software industry, and we may not be successful in hiring, training or retaining our sales personnel in accordance with our plans. Even if we hire and train a sufficient number of sales personnel, we may not generate enough additional revenue to exceed the expense of hiring and training the new personnel.
Failure to implement the appropriate controls and procedures to manage our growth could harm our growth, business, operating results and financial condition.
We have and may continue to have periods of growth in our operations, which has placed, and may continue to place, a significant strain on our management, administrative, operational, technical and financial infrastructure. We increased our employee base from 693 employees in 2005 to 1,220 employees in 2006; 1,373 employees in 2007; and 1,535 employees in 2008. In 2009, due to the continued deterioration in the economic environment we experienced a decrease in employees to 1,459. In 2010, we increased our employees to 1,963.
The increase in employees during 2008 was primarily due to the addition of 135 employees that we acquired as a part of our acquisition of Quorum International Holdings Limited (“Quorum”). The increase in employees during 2010 was primarily due to the addition of 333 employees that we acquired as a part of our acquisitions of CHPD and Salary.com.
To manage our growth, we will need to continue to improve our operational, financial and management processes and controls and reporting systems and procedures. This effort may require us to make significant capital expenditures or to incur significant expenses, and may divert the attention of our personnel from our core business operations, any of which may adversely affect our financial performance. If we fail to successfully manage our growth, our business, operating results and financial condition may be adversely affected.
Evolving regulation of the Internet may increase our expenditures related to compliance efforts, which may adversely affect our financial condition.
As Internet commerce continues to evolve, increasing regulation by federal, state and/or foreign agencies becomes more likely. We are particularly sensitive to these risks because the Internet is a critical component of our business model. For example, we believe that increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation, collection, processing or use of personal or consumer information could affect our customers’ ability to use and share data, potentially reducing demand for solutions accessed via the Internet and restricting our ability to store, process and share data with our customers via the Internet. In addition, taxation of services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services, which could harm our business.
The failure of our solutions to comply with employment laws may require us to indemnify our customers, which may harm our business.
Some of our customer contracts contain indemnification provisions that require us to indemnify our customers against claims of non-compliance with employment laws related to hiring. To the extent these claims are successful and exceed our insurance coverages, these obligations would have a negative impact on our cash flow, results of operation and financial condition.
Our reported financial results may be adversely affected by changes in generally accepted accounting principles.
Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our historical or future financial results. For example, prior to January 1, 2006, we were not required to record share-based compensation charges if the employee’s stock option exercise price was equal to or exceeded the deemed fair value of the underlying security at the date of grant. However, effective January 1, 2006 we are required to record the fair value of stock options as an expense in accordance with new accounting pronouncements.
Anti-takeover provisions of Pennsylvania law and our articles of incorporation and bylaws could delay and discourage takeover attempts that shareholders may consider to be favorable.
Certain provisions of our articles of incorporation and applicable provisions of the Pennsylvania Business Corporation Law may make it more difficult for a third party to, or prevent a third party from, acquiring control of us or effecting a change in our board of directors and management. These provisions include:
The Pennsylvania Business Corporation Law further provides that because our articles of incorporation provide for a classified board of directors, shareholders may remove directors only for cause. These and other provisions of the Pennsylvania Business Corporation Law and our articles of incorporation and bylaws could delay, defer or prevent us from experiencing a change of control or changes in our board of directors and management and may adversely affect our shareholders’ voting and other rights. Any delay or prevention of a change of control transaction or changes in our board of directors and management could deter potential acquirers or prevent the completion of a transaction in which our shareholders could receive a substantial premium over the then current market price for their shares of our common stock.
From time to time, we have conducted share repurchase programs, which may restrict our funds available for other actions and negatively affect the market price of our securities.
Since November 2007, we have repurchased 3,125,651 shares of our common stock under share repurchase plans at an average price per share of $17.80 and an aggregate cost of $55.8 million. These shares were restored to original status and accordingly are presented as authorized but not issued. Share repurchases may not have the effects anticipated by our board of directors and may instead harm the market price of our securities. Share repurchase plans may use a significant portion of our cash reserves, and could limit our future flexibility to complete acquisition transactions or fund other growth opportunities. In addition, the share repurchases are subject to regulatory requirements. We may become subject to lawsuits regarding the use of our cash for share repurchases or for the failure to follow applicable regulatory requirements in connection with our share repurchase program. Our repurchase plans will also likely result in an increase in the share percentage ownership of our existing shareholders, and such increase may trigger disclosure or other regulatory requirements for our larger shareholders. As a result, certain shareholders may liquidate a portion of their holdings. In addition, our repurchase plans may decrease our public float as shares are repurchased by us on the open market pursuant to the plan and may have a negative effect on our trading volume. Such outcomes may have a negative impact on the liquidity of our common stock, the market price of our common stock and could make it easier for others to acquire a larger percentage of our voting securities. For the years ended, December 31, 2010 and 2009 no repurchases were made under the stock repurchase plan.
The market price of our common stock has been, and may continue to be, volatile, and our shareholders may be unable to resell their shares at a profit.
The market price of our common stock has been subject to significant fluctuations and may continue to fluctuate or decline. From September 2008 through December 31, 2010, our common stock has been particularly volatile as the price of our common stock has ranged from a high of $24.01 to a low of $3.66. In the past several years, technology stocks have experienced high levels of volatility and significant declines in value from their historic highs. Additionally, as a result of the current global credit crisis and the concurrent economic downturn in the U.S. and globally, there have been significant declines in the values of equity securities generally in the U.S. and abroad. Factors that could cause fluctuations in the trading price of our common stock include the following:
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. If our stock price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management’s attention and resources from our business.
We currently conduct significant activities internationally. Our foreign subsidiaries accounted for 26.3% of our total revenues during the year ended December 31, 2010, and 20.9% of our total revenues during the year ended December 31, 2009. Our financial results may be negatively impacted to the extent tax rates in foreign countries where we operate increase and/or exceed those in the United States and as a result of the imposition of withholding requirements on foreign earnings.
We lease our headquarters in Wayne, Pennsylvania. The table below provides information concerning our principal facilities, as of December 31, 2010, including the approximate square footage, the approximate monthly rent and the lease expiration date of each facility. We believe that our facilities are in good operating condition and will adequately serve our needs for at least the next 12 months. We also anticipate that, if required, suitable additional or alternative space will be available on commercially reasonable terms, in office buildings we currently occupy or in space nearby, to accommodate expansion of our operations.
On January 30, 2011, our lease expired and we closed our facility in Needham, Massachusetts. The personnel at our Needham location were relocated to our Waltham facility. We have renewed the lease for our Waltham facility for a term due to expire on April 29, 2018. During April 2011, three of our facilities located in England, including the lease referenced above, will be consolidated and our personnel will be relocated to a new facility in London, England. The lease for the new facility in London, England is through March 2021.
We sublease space in our Wayne, PA and Vizag, India facilities. The total minimum sublease rentals received under noncancelable subleases for the years ended December 31, 2010 and 2009 was $349 and $152, respectively, for Wayne and Vizag. The total minimum sublease rentals to be received under noncancelable subleases through 2014 is estimated at $1,463 for Wayne and Vizag as of December 31, 2010.
On August 27, 2007, a complaint was filed and served by Kenexa BrassRing, Inc. against Taleo Corporation in the United States District Court for the District of Delaware. Kenexa alleges that Taleo infringed Patent Nos. 5,999,939 and 6,996,561, and seeks monetary damages and an order enjoining Taleo from further infringement. The trial of this matter is currently scheduled to begin on June 27, 2011.
On May 9, 2008, Kenexa BrassRing, Inc. filed a similar lawsuit against Vurv Technology, Inc. in the United States District Court for the District of Delaware, alleging that Vurv has infringed Patent Nos. 5,999,939 and 6,996,561, and seeks monetary damages and an order enjoining further infringement. This lawsuit has been consolidated with the Kenexa BrassRing, Inc. versus Taleo Corporation lawsuit.
On June 25, 2008, Kenexa Technology, Inc. filed suit in the United States District Court of Delaware against Taleo Corporation for tortious interference with contract, unfair competition, unfair trade practices and unjust enrichment. On August 28, 2009, Taleo filed an amended answer and counterclaim against Kenexa BrassRing, Inc. asserting copyright infringement against Kenexa by the users accessing the Taleo system on behalf of Kenexa’s recruitment process outsourcing customers. Kenexa seeks monetary damages and to enjoin the actions of Taleo. Taleo seeks monetary damages and to enjoin the actions of Kenexa.
On November 7, 2008, Vurv Technology LLC, sued Kenexa Corporation, Kenexa Technology, Inc., and two former employees of Vurv, who now work for Kenexa , in the United States District Court for the Northern District of Georgia. In this action, Vurv asserts claims for breach of contract, computer trespass and theft, misappropriation of trade secrets, interference with contract and civil conspiracy. Vurv seeks unspecified monetary damages and injunctive relief. On July 17, 2009, Kenexa BrassRing, Inc. and Kenexa Recruiter, Inc. filed suit against Taleo Corporation, a current Taleo employee and a former Taleo employee in Massachusetts Superior Court. Kenexa amended the complaint on August 27, 2009 and added Vurv Technology LLC, two former employees of Taleo and two current employees of Taleo. Kenexa asserts claims for breach of contract and the implied covenant of good faith and fair dealing, unfair trade practices, computer theft, misappropriation of trade secrets, tortious interference, unfair competition, and unjust enrichment. Kenexa seeks monetary damages and injunctive relief.
Securities Class Actions
On June 11, 2009 and July 16, 2009, two putative class actions were filed against Kenexa Corporation and our Chief Executive Officer and Chief Financial Officer in the United States District Court for the Eastern District of Pennsylvania, purportedly on behalf of a class of our investors who purchased our publicly traded securities between May 8, 2007 and November 7, 2007. The complaint filed on July 16, 2009 has since been voluntarily dismissed. On September 28, 2010, the court granted Kenexa’s motion to dismiss the complaint filed on June 11, 2009 in its entirety. The plaintiffs filed a motion for reconsideration of the court’s decision on October 12, 2010, which was denied by the court on November 29, 2010. The plaintiffs failed to file a timely appeal, and, as a result, the actions were concluded in Kenexa's favor.
Genesys Shareholder Suit
On October 1, 2010, Kenexa completed its acquisition of Salary.com, Inc. which included responsibility for the suit filed on August 13, 2010 by former shareholders and option holders of Genesys Software Systems, Inc. (the “Genesys Parties” and “Genesys,” respectively) against Salary.com, Inc. and Silicon Valley Bank –Trustee Process Defendant in Massachusetts Superior Court. The Genesys Parties asserts claims for breach of contract, breach of implied covenant of good faith and fair dealing, violation of the Massachusetts Unfair Business Practices Act, and declaratory judgment seeking damages of $2.0 million in contingent consideration related to the purchase of Genesys by Salary.com, plus other monetary damages and fees. On September 7, 2010 Salary.com filed an answer and counterclaim against the Genesys Parties, and certain former shareholders of Genesys, asserting breach of contract, breach of implied covenants of good faith and fair dealing, fraud, violation of the Massachusetts Unfair Business Practices Act, civil conspiracy, negligent misrepresentation, and declaratory judgment seeking to dismiss the original complaint and unspecified monetary damages. The $2.0 million in contingent consideration was accrued for in the financial statements at December 31, 2010.
Salary.com Appraisal Suit
On February 2, 2011, Dorno Investment Partners, LLC filed a Petition for Appraisal of Stock in the Court of Chancery of the State of Delaware against Kenexa Compensation, Inc., the new name for the surviving entity subsequent to the all cash, short form merger of Salary.Com, Inc. and Spirit Merger Sub, Inc. on October 1, 2010. Dorno was the beneficial owner of 143,610 shares of Salary.Com, Inc. common stock on the merger date and demanded and continues to demand appraisal of the fair value of 140,000 shares pursuant to Delaware law. Dorno demands fair value for its shares, interest from October 1, 2010, costs, attorney’s fees, and other appropriate relief.
We are involved in claims, including those identified above, which arise in the ordinary course of business. In the opinion of management, we have made adequate provision for potential liabilities, if any, arising from any such matters. However, litigation is inherently unpredictable, and the costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in any such matters, could have a material adverse effect on our business, financial condition and operating results. Furthermore, the Company believes that the litigation matters described above, due to their current state are neither probable nor reasonably estimable at the time of filing.
Market Information and Dividends
Our common stock has been quoted on The Nasdaq Stock Market, LLC under the symbol “KNXA” since June 24, 2005. Prior to that date, there was no public market for our common stock. The following table sets forth, for the periods indicated, the high and low sales prices of our common stock reported by The Nasdaq Stock Market, LLC.
On March 9, 2011, the last reported sale price of our common stock on The Nasdaq Stock Market, LLC was $24.66 per share. As of March 9, 2011, there were approximately 66 holders of record of our common stock.
We have not declared or paid any cash dividends on our common stock since our inception. We intend to retain future earnings, if any, to finance the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Consequently, shareholders will need to sell shares of our common stock to realize a return on their investment, if any.
Unregistered Sales of Equity Securities and Use of Proceeds
STOCK PERFORMANCE GRAPH AND CUMULATIVE TOTAL RETURN
The following graph shall not be deemed incorporated by reference into any of our filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference therein.
Prior to June 24, 2005, we were not publicly traded and there was no public market for our securities. The graph below compares the cumulative total return of our common stock with that of the Nasdaq Composite Index, the Nasdaq Computer & Data Processing Index and the S&P Smallcap 600 Index from December 31, 2005 through December 31, 2010. The graph assumes that you invested $100 at the close of market on December 31, 2005 in shares of our common stock and invested $100 on December 31, 2005 in each of these indexes, and in each case assumes the reinvestment of dividends. The comparisons in this graph are provided in accordance with Securities and Exchange Commission disclosure requirements and are not intended to forecast or be indicative of the future performance of shares of our common stock.
ITEM 6. Selected Consolidated Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below are derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K and "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of this Annual Report on Form 10-K. The consolidated statements of operations data for each of the years ended December 31, 2010, 2009 and 2008 and the consolidated balance sheet data as of December 31, 2010 and 2009 are derived from, and qualified by reference to, our audited consolidated financial statements and related notes appearing elsewhere in this filing. The consolidated statements of operations data for each of the years ended December 31, 2007 and 2006 and the consolidated balance sheet data as of December 31, 2008, 2007 and 2006 are derived from our audited consolidated financial statements not included in this filing.
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the “Selected Consolidated Financial Data” section and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations and intentions. Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the “Item 1A-Risk Factors” section and elsewhere in this Annual Report on Form 10-K.
We provide business solutions for human resources which include a comprehensive suite of on-demand software applications and complementary services, including outsourcing services and consulting, to help global organizations recruit high performing individuals and increase employee productivity and retention. We employ a large force of organizational and industrial psychologists and statisticians who study the science of human behavior and its impact on business outcomes. This research is the foundation of our suite of software applications and supporting services that enable our customers to improve business results through human resources. Based on our 23 years of experience assisting customers in addressing their human resource requirements we believe our software applications and services form solutions that enable our customers to improve the effectiveness of their talent acquisition programs, increase employee productivity and retention, measure key HR metrics and make their talent acquisition and employee performance management programs more efficient.
Since 1999, we have focused on providing talent acquisition and employee performance management solutions on a subscription basis and currently generate a significant portion of our revenue from these subscriptions. Our customers typically purchase multi-year subscriptions with an average length of approximately two years. For the years ended December 31, 2010 and 2009, subscription revenue represented approximately 78.8% and 84.9% of our total revenue, respectively. We generate the remainder of our revenue from discrete professional services that are not provided as part of an integrated solution on a subscription basis.
We sell our solutions to large and medium-sized organizations through our direct sales force. As of December 31, 2010, we had a global customer base of approximately 6,800 companies, including approximately 255 companies on the Fortune 500 list published in May 2010. Our customer base includes companies that we billed for services during the year ended December 31, 2010 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately $103.5 million, or 52.7%, of our total revenue for the year ended December 31, 2010.
Our customers typically purchase multi-year subscriptions which provide us with a recurring revenue stream. Our customers renewed 84% and 80% of their contracts for each of the years ended December 31, 2010 and 2009, respectively which represented 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those years. This renewal rate provides us with a strong base of recurring revenue. We believe that our strong customer relationships provide us with a meaningful opportunity to cross-sell additional solutions to our existing customers and to achieve greater penetration within an organization. As the business environment improves we expect renewal rates to improve to our historical renewal rate in excess of 90%.
In May 2010, we launched a major upgrade to our product line. Our 2x platform™ includes applications such as Kenexa 2x Recruit™, Kenexa 2x BrassRing®, Kenexa 2x Onboard™ and our first-to-market Kenexa 2x Mobile™ solution. Future modules to the 2x platform include Kenexa 2x Perform™, Kenexa 2x Assess™, Kenexa 2x Analytics™ and Kenexa 2x Survey™. We believe that Kenexa 2x enables customers to improve productivity, increase cost savings, ensure compliance with corporate and legal mandates, and raise employee engagement.
As of December 31, 2010 the national unemployment rate dropped 0.5% from the prior year to 9.4% and with the drop we have witnessed a slow but steady improvement in business conditions. The unemployment rate is slowly improving, and recent industry reports suggest that the unemployment rate will continue to improve over the balance of this year and into 2012.
We commenced operations in 1987 as a provider of recruiting services to a wide variety of industries. In 1993, we offered our first automated talent acquisition system and by 1997 we had expanded our business to provide employee research, employee performance management technology and consulting services. In late 1997, responding to a growing demand from our customers, we began to provide comprehensive human capital management services integrated with on-demand software. Between 1994 and 1998, we acquired 15 businesses that collectively enabled us to offer comprehensive Human Capital Management (“HCM”) services integrated with on-demand technology.
Over the past eleven years, we have pursued a strategy designed to focus our business on talent acquisition and employee performance management solutions and reduce our strategic focus on discrete professional services that generated less predictable revenue streams and lower margins. To that end:
As a result of our shift in strategic focus in 2000, we have focused on providing talent acquisition and employee performance management solutions on a subscription basis and currently generate a significant portion of our revenue from these subscriptions. We generate the remainder of our revenue from discrete professional services that are not provided as part of an integrated solution on a subscription basis. In 2000, revenue derived from subscriptions for these solutions comprised approximately 54.4% of our total revenue. Since 2005, subscription revenue has represented approximately 80% of our total revenue. For the years ended December 2010 and 2009, subscription revenue represented approximately 78.8% and 84.9% of our total revenue, respectively. This shift to subscription-based services has been driven by our customer’s adoption of the on-demand model for software delivery and need for solutions that improve employee recruiting and retention. We expect non-GAAP subscription revenue will be within a target range of 78% to 82% of our total revenues in 2011.
From our inception through 2001, our operations were funded primarily through internally generated cash flows and our line of credit, as well as private placements of our securities to institutional investors. On June 29, 2005, we completed our initial public offering and listed our common stock for trading on the Nasdaq Stock Market.
In July 2010, in accordance with our UBS AG agreement, we exercised our right to sell our auction rate securities back to UBS and liquidated our auction rate security portfolio in its entirety.
On July 26, 2010, we acquired all of the outstanding stock of CHPD which operates as a leadership development and management training company based in London, England for a purchase price of approximately $4.2 million in cash. The total cost of the acquisition including estimated legal, accounting, and other professional fees was approximately $4.4 million. We deposited $0.4 million into escrow to cover any claims for indemnification. We acquired all assets and liabilities of CHPD using our existing cash and expect the acquisition of CHPD will enhance our existing research and content portfolio as well as provide our customers with the ability to more efficiently implement the results of their employee engagement surveys.
On August 31, 2010, we entered into a secured credit agreement with PNC Bank, N.A., in connection with our acquisition of Salary.com. The secured credit agreement included a maximum amount available under the credit facility of $25.0 million, including a sublimit of up to $2.0 million for letters of credit and swing loans. Borrowings under the new credit facility were secured by substantially all of the Company’s assets and the assets of its subsidiaries. Prior to termination of the credit agreement as discussed below, the Company borrowed $25.0 million under the credit agreement in connection with the acquisition of Salary.com.
On October 1, 2010, we acquired all of the outstanding stock of Salary.com, which provides on-demand compensation software that helps businesses and individuals manage pay and performance, for a purchase price of approximately $78.4 million in cash. The total cost of the acquisition including estimated legal, accounting, and other professional fees of $4.4 million, was approximately $82.8 million. We used cash and borrowings against the credit facility to fund the acquisition. We believe there is a significant opportunity to expand Salary.com’s adoption in large organizations and on a global basis because its compensation analysis software is highly synergistic with our current suite of talent acquisition and retention solutions.
On, October 20, 2010, we terminated and paid all outstanding amounts under our secured credit agreement, dated August 31, 2010, and entered into an amended credit agreement with PNC Bank. The maximum amount available under the amended credit agreement is $60.0 million, comprised of a $35.0 million revolving facility, including a sublimit of up to $5.0 million for letters of credit and a sublimit of up to $2.5 million for swing loans (the “Revolving Facility”), and a $25.0 million term facility (the “Term Facility”). We may request to increase the maximum amount available under the Revolving Facility to $50.0 million. The amended credit agreement will terminate, and all borrowings will become due and payable, on October 19, 2013. We and each of our U.S. subsidiaries are guarantors of the obligations under the amended credit agreement. Borrowings under the amended credit agreement are secured by substantially all of our assets (including a pledge of the capital stock of their subsidiaries (but limited to only 65% of the voting stock of first-tier foreign subsidiaries)). As of December 31, 2010 we borrowed $59.5 million under the amended credit agreement in connection with the acquisition of Salary.com and to enhance working capital.
Sources of Revenue
We derive revenue primarily from two sources: (1) subscription revenue for our solutions, which is comprised of subscription fees from customers accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from customers purchasing additional support that is not included in the basic subscription fee; and (2) fees for discrete professional services.
Our customers primarily purchase renewable subscriptions for our solutions. The typical subscription term is one to three years, with some terms extending up to five years. The majority of our subscription agreements are not cancelable for convenience, but our customers have the right to terminate their contracts for cause if we fail to provide the agreed upon services or otherwise breach the agreement. A customer does not generally have a right to a refund of any advance payments if the contract is cancelled. Our customers renewed 84% and 80% of their contracts for each of the years ended December 31, 2010 and 2009, respectively which represented 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those years. As the business environment improves we expect renewal rates to improve to our historical renewal rate in excess of 90%.
Consistent with our historical practices, revenue derived from subscription fees is recognized ratably over the term of the subscription agreement. We generally invoice our customers in advance in annual or quarterly installments and typical payment terms provide that our customers pay us within 30 days of invoice. Amounts that have been invoiced are recorded in accounts receivable prior to the receipt of payment and in deferred revenue to the extent revenue recognition criteria have not been met. As of December 31, 2010, deferred revenue increased by $26.1 million or 52.2% to $76.1 million from $50.0 million at December 31, 2009. The increase in deferred revenue is a result of the increase in sales of our multiple elements or bundled arrangements and our acquisition of Salary.com. We generally price our solutions based on the number of software applications and services included and the number of customer employees. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services.
We derive other revenue from the sale of discrete professional services and translation services, as well as from out-of-pocket expenses. The majority of our other revenue is derived from discrete professional services, which primarily consist of consulting and training services and success fees. This revenue is recognized differently depending on the type of service provided, as described in greater detail below under “Critical Accounting Policies and Estimates.”
For the year ended December 31, 2010, approximately 73.7% of our total revenue was derived from sales in the United States. Foreign revenue that we generated from customers in the United Kingdom, Germany and China was approximately 8.3%, 3.4% and 2.7%, respectively. Revenue for other countries amounted to an aggregate of 11.9%. Other than the countries listed, no other country represented more than 2.0% of our total revenue for the year ended December 31, 2010. For the year ended December 31, 2010, the percentage of revenue derived from sales in the United States decreased over the prior year due our emphasis on global expansion.
Cost of Revenue
Our cost of revenue primarily consists of compensation, employee benefits and out-of-pocket travel-related expenses for our employees and independent contractors who provide consulting or other professional services to our customers. Additionally, our application hosting costs, amortization of third-party license royalty costs, technical support personnel costs, overhead allocated based on headcount and reimbursed expenses are also recorded as cost of revenue. Many factors affect our cost of revenue, including changes in the mix of products and services, pricing trends, changes in the amount of reimbursed expenses and fluctuations in our customer base. Because cost as a percentage of revenue is higher for professional services than for software products, an increase in the services component of our solutions or an increase in discrete professional services as a percentage of our total revenue would reduce gross profit as a percentage of total revenue. As our revenues increase, we expect our cost of revenue to increase proportionately, subject to pricing pressure related to economic conditions and influenced by the mix of services and software. To the extent new customers are added, we expect that the cost of services, as a percentage of revenue, will be greater than those services associated with existing customers.
We classify our operating expenses as follows:
Sales and Marketing. Sales and marketing expenses primarily consist of personnel and related costs for employees engaged in sales and marketing, including salaries, commissions, and other variable compensation, travel expenses and costs associated with trade shows, advertising and other marketing efforts and allocated overhead. We expense our sales commissions at the time the related revenue is recognized, and we recognize revenue from our subscription agreements ratably over the terms of the agreements. Consistent with our past practice, we intend to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers at levels we deem appropriate given our current economic conditions. We expect our sales and marketing expense to increase from current levels, mainly due to increased staff expense and continued emphasis on our rebranding effort.
General and Administrative. General and administrative expenses primarily consist of personnel and related costs for our executive, finance, human resources and administrative personnel, professional fees and other corporate expenses and allocated overhead. We expect general and administrative expenses to increase in the short term as we incur additional professional fees in connection with our patent infringement matter. However, in the longer term, based upon the current state of the economy, we believe that general and administrative expenses will remain the same or slightly increase in dollar amount and remain relatively constant or slightly decrease as a percentage of total revenue in 2011.
Research and Development. Research and development expenses primarily consist of personnel and related costs, including salaries, and employee benefits, for software engineers, quality assurance engineers, product managers, technical sales engineers and management information systems personnel and third party consultants. Our research and development efforts have been devoted primarily to the preliminary stages of project development and maintenance and training costs of our existing products. As we continue to execute on our strategies, including rolling out our 2x platform™ and continuing to develop feature enhancements, we believe that research and development expenses will remain flat or increase slightly in dollar amount in 2011.
Key Performance Indicators
The following tables summarize the key performance indicators that we consider to be material in managing our business, in thousands (other than percentages):
The following is a discussion of significant terms used in the tables above.
Non-GAAP financial measures>. We believe that non-GAAP measures of financial results provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. We use these non-GAAP measures to compare our performance to that of prior periods for trend analyses, for purposes of determining executive incentive compensation, and for budget and planning purposes. These measures are used in monthly financial reports prepared for management and in quarterly financial reports presented to our Board of Directors. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing financial measures with other companies in our industry, many of which present similar non-GAAP financial measures to investors.
We do not consider such non-GAAP measures in isolation or as an alternative to measures determined in accordance with GAAP. The principal limitation of such non-GAAP financial measures is that they exclude significant expenses that are required by GAAP to be recorded. In addition, they are subject to inherent limitations as they reflect the exercise of judgments by management about which charges are excluded from the non-GAAP financial measures.
In order to compensate for these limitations, we present our non-GAAP financial measures in connection with our GAAP results. We urge investors to review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not to rely on any single financial measure to evaluate our business.
Non-GAAP cash from operations.> Non-GAAP cash from operations consists of GAAP cash flows from operations adjusted for non-recurring payments of liabilities associated with our acquisitions and payments of acquisition related fees totaled $9.1 million. These exclusions are made to GAAP cash from operations to facilitate a consistent and more meaningful comparison to the prior year since their effect was not included in our 2009 results.
Non-GAAP revenue.> Non-GAAP revenue consists of GAAP revenue, adjusted to reverse the effect of the write down of deferred revenue associated with purchase accounting for the Salary.com acquisition. This effect during the three months ended December 31, 2010 was $3.1 million and is added back to Non-GAAP revenue because we believe its inclusion provides a more accurate depiction of total revenue arising from the Salary.com acquisition.
Non-GAAP subscription revenue as a percentage of total revenue.> Non-GAAP subscription revenue as a percentage of total revenue can be derived from our consolidated statements of operations adjusted for the effect of the write down of the deferred revenue associated with purchase accounting for the Salary.com acquisition as described above. We expect that the percentage of non-GAAP subscription revenue will be within a target range of 78% to 82% of our total revenues in 2011.
Non-GAAP income from operations>. Non-GAAP income from operations is derived from income (loss) from operations adjusted for noncash or nonrecurring expenses. We believe that measuring our operations, using non-GAAP income from operations provides more useful information to management and investors regarding certain financial and business trends relating to our financial condition and ongoing results. We believe that the use of these non-GAAP financial measures provides an additional tool for investor to use in evaluating ongoing operating results and trends and in comparing our financial measures with other companies in our industry, many of which present similar non-GAAP financial measures to investors.
The Company’s non-GAAP financial measures as set forth in the table above exclude the following:
Share-based compensation>. Share-based compensation consists of expenses for stock options and stock awards that we began recording in accordance with ASC 718 during the first quarter of 2006. Share-based compensation was $4.5 million, $5.4 million and $5.8 million for the years ending December 31, 2010, 2009 and 2008, respectively. Share-based compensation expenses are excluded in our non-GAAP financial measures because they are difficult to forecast. This is due in part to the magnitude of the charges, which depends upon the volume and timing of stock option grants that are unpredictable and can vary dramatically from period to period, and external factors such as interest rates and the trading price and volatility of our common stock.
Amortization of intangibles associated with acquisitions>. In accordance with GAAP, operating expenses include amortization of acquired intangible assets which are amortized over the estimated useful lives of such assets. Amortization of acquired intangible assets was $5.8 million, $4.5 million and $5.5 million for the years ending December 31, 2010, 2009 and 2008, respectively. Amortization of acquired intangible assets is excluded from our non-GAAP financial measures because we believe that such exclusion facilitates comparisons to our historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.
Acquisition-related fees>. In accordance with ASC 805, Business Combinations, acquisition-related fees including advisory, legal, accounting and other professional fees are reported as expense in the periods in which the costs are incurred and the services are received. Acquisition-related fees of $4.6 million, for the year ended December 31, 2010 include legal, travel, and other fees not expected to recur from the acquisitions of Salary.com and CHPD. Acquisition-related fees are excluded in the non-GAAP financial measures because we believe that such exclusion facilitates comparisons to our historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.
Deferred revenue associated with acquisition>. Deferred revenue consists of the effect of the write down of the deferred revenue associated with purchase accounting for the Salary.com acquisition. This effect during the year ended December 31, 2010 was $3.1 million and is added back since we believe its inclusion provides a more accurate depiction of total revenue arising from the Salary.com acquisition.
Professional fees associated with variable interest entity>. We incurred professional fees in connection with our Chinese expansion in the amount of $0.7 million during the first quarter of 2009. We believe that such exclusion facilitates comparisons to our historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.
Severance expenses>. We incurred charges in the amount of $1.2 million in relation to additional severance expenses in the first quarter of 2009. These charges were excluded from non-GAAP income to facilitate a more meaningful comparison to the prior year’s results.
Expenses related to restructuring charges and related legal fees>. We incurred charges in the amount of $2.5 million in relation to restructuring in the fourth quarter of 2008. Such charges consisted of severance and outplacement benefit costs of $2.0 million and certain legal fees of $0.5 million in relation to the termination of approximately 200 employees.
Goodwill impairment charge>. We recorded a non-cash goodwill impairment charge in the first quarter of 2009 of $33.3 million and $167.0 million in the fourth quarter of 2008 of as a result of a substantial decrease in our stock price, reflecting the impact of the unprecedented turmoil in world economies and the resultant impact on our operations.
Noncontrolling Interest>. Noncontrolling interest of $0.1 million includes income from operations due to our variable interest entity partner and is excluded from the calculation of non-GAAP net income from operations because it is unrelated to our ownership in the venture.
Deferred revenue.> We generate revenue primarily from multi-year subscriptions for our on-demand talent acquisition and employee performance management solutions and our compensation module. We recognize revenue from these subscription agreements ratably over the hosting period, which is typically one to three years. We generally invoice our customers in annual, quarterly or monthly installments in advance. Deferred revenue, which is included in our consolidated balance sheets, is the amount of invoiced subscriptions in excess of the amount recognized as revenue. Deferred revenue represents, in part, the amount that we will record as revenue in our consolidated statements of operations in future periods. As the subscription component of our revenue has grown and our customer willingness to pay us in advance for their subscriptions has increased, the amount of deferred revenue on our balance sheet has grown. It is possible that this trend may vary as business conditions change.
The following table reconciles beginning and ending deferred revenue for each of the periods shown:
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible accounts receivable and accrued expenses. We base these estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates.
We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements:
We derive our revenue from two sources: (1) subscription revenues for solutions, which are comprised of subscription fees from customers accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for professional services, translation services and reimbursed out-of-pocket expenses. Because we provide our solutions as a service, we follow the provisions of Financial Accounting Standards Board (“FASB”) ASC 605-10, “Revenue Recognition” and FASB ASC 605-25 “Multiple Element Arrangements.” We recognize revenue when all of the following conditions are met:
We enter into arrangements with customers which may include consulting services, software licenses and data. For sales arrangements that contain multiple deliverables revenue is allocated among the deliverables using the selling price hierarchy established in ASU 2009-13 to determine the selling price of each deliverable. The selling price hierarchy allows for the use of estimated selling price (“ESP”) to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”). We determined our ESP of fair value for our application services based on the following:
To qualify as a separate unit of accounting, the delivered item must have value to the customer on a standalone basis; and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transactions is deferred until all elements are delivered.
We determine the selling price in multiple-element arrangements using VSOE or TPE if available. VSOE is determined based on the price charged for the same deliverable when sold separately and TPE is established based on the price charged by our competitors or third parties for the same deliverable. If we are unable to determine the selling price because VSOE or TPE does not exist, we use our ESP.
This change in policy increased our revenues by approximately $2.9 million for the year ending December 31, 2010.
Subscription Fees and Support Revenues. Subscription fees and support revenues are recognized ratably over the lives of the contracts. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
In accordance with FASB ASC 605-45, “Principal Agent Considerations,” we record reimbursements received for out-of-pocket expenses as revenue and not netted with the applicable costs. These items primarily include travel, meals and certain telecommunication costs. Reimbursed expenses for the years ended December 31, 2010, 2009 and 2008, totaled $3.3 million, $2.2 million and $4.7 million, respectively.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from customers’ inability to pay us. The provision is based on our historical experience and for specific customers that, in our opinion, are likely to default on our receivables from them. In order to identify these customers, we perform ongoing reviews of all customers that have breached their payment terms, as well as those that have filed for bankruptcy or for whom information has become available indicating a significant risk of non-recoverability. We rely on historical trends of bad debt as a percentage of total revenue over 90 days past due and apply these percentages to the accounts receivable associated with new customers and evaluate these customers over time. To the extent that our future collections differ from our assumptions based on historical experience, the amount of our bad debt and allowance recorded may be different.
We are self-insured for the majority of our health insurance costs, including claims filed and claims incurred but not reported subject to certain stop loss provisions. We estimate our liability based upon management’s judgment and historical experience. We also rely on the advice of consulting administrators in determining an adequate liability for self-insurance claims. Our self-insurance accruals which are reported on a gross basis totaled approximately $0.6 million for each of the periods ended December 31, 2010 and 2009. We continuously review the adequacy of our insurance coverage. Material differences may result in the amount and timing of insurance expense if actual experience differs significantly from management's estimates.
Capitalized Software Development Costs
In accordance with FASB ASC 985, “Software,” and FASB ASC 350, “Intangibles-Goodwill and Other,” costs incurred in the preliminary stages of a development project are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, will be capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Maintenance and training cost are expensed as incurred. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal software in any of the periods covered in this report.
Goodwill and Other Identified Intangible Asset Impairment
Since 2002, we have recorded goodwill in accordance with the provisions of FASB ASC 350, “Intangibles-Goodwill and Other,” which requires us to annually review the carrying value of goodwill for impairment. If goodwill becomes impaired, some or all of the goodwill would be written off as a charge to operations. This comparison is performed annually or more frequently if circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.
During the quarter ended December 31, 2008 we reevaluated our goodwill, due to adverse changes in the economic climate, a 49.5% decline in our market capitalization from October 1, 2008 (our annual testing date), and a downward revision in our earnings guidance for the quarter and year ended December 31, 2008. These factors signaled a triggering event, which required us to determine whether and to what extent our goodwill may have been impaired as of December 31, 2008. The first step of this analysis requires the estimation of our fair value, as an entity, and is calculated based on the observable market capitalization with a range of estimated control premiums as well as discounted future estimated cash flows. This step yielded an estimated fair value for us which was less than our carrying value including goodwill at December 31, 2008. The next step entails performing an analysis to determine whether the carrying amount of goodwill on our balance sheet exceeds our implied fair value. The implied fair value of our goodwill, for this step was determined in the same manner as goodwill recognized in a business combination. Our estimated fair value was allocated to our assets and liabilities, including any unrecognized identifiable intangible assets, as if we had been acquired in a business combination with our estimated fair value representing the price paid to acquire it. The allocation process performed on the test date was only for purposes of determining the implied fair value of goodwill with neither the write up or write down of any assets or liabilities, nor recording any additional unrecognized identifiable intangible assets as part of this process as of December 31, 2008. Based on the analysis, we determined that the implied fair value of goodwill was $32.4 million, resulting in a goodwill impairment charge of $167.0 million. The goodwill impairment charge had no effect on our cash balances.
During the quarter ended March 31, 2009 we reevaluated our goodwill due to continued adverse changes in the economic climate, a 32.5% decline in our market capitalization from December 31, 2008 through March 31, 2009 and a downward revision in internal projections. These factors signaled a triggering event, which required us to determine whether and to what extent our goodwill may have been impaired as of March 31, 2009. The allocation process performed on the test date was only for purposes of determining the implied fair value of goodwill with no assets or liabilities written up or down, nor any additional unrecognized identifiable intangible assets recorded as part of this process. Based on the analysis, a goodwill impairment charge of $33.3 million was recorded to write off the remaining balance of our goodwill for the quarter ended March 31, 2009. The goodwill impairment charge had no effect on the Company’s cash balances
Accounting for Income Taxes
We are subject to income taxes in the U.S. and various foreign countries. We record an income tax provision for the anticipated tax consequences of operating results reportable to each taxing jurisdiction in compliance with enacted tax legislation. We account for income taxes in accordance with FASB ASC 740, “Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
The realization of the deferred tax assets is evaluated quarterly by assessing the valuation allowance and by adjusting the amount of the allowance, if necessary. The factors used to assess the likelihood of realization are the forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. We have used tax-planning strategies to realize or renew net deferred tax assets in order to avoid the potential loss of future tax benefits. In addition, we operate within multiple taxing jurisdictions and are subject to audit in each jurisdiction. These audits can involve complex issues that may require an extended period of time to resolve. In our opinion, adequate provisions for income taxes have been made for all periods.
Our determination of the level of valuation allowance at December 31, 2010 is based on an estimated forecast of future taxable income which includes many judgments and assumptions primarily related to revenue, margins, operating expenses, tax planning strategies and tax attributes in multiple taxing jurisdictions. Accordingly, it is at least reasonably possible that future changes in one or more of these assumptions may lead to a change in judgment regarding the level of valuation allowance required in future periods.
Accounting for Share-Based Compensation
Share-based compensation expense recognized during the period is based on the value of the number of awards that are expected to vest multiplied by the fair value. We use a Black-Scholes option-pricing model to calculate the fair value of our share-based awards. The calculation of the fair value of the awards using the Black-Scholes option-pricing model is affected by our stock price on the date of grant as well as assumptions regarding the following:
In certain instances where market based, performance share awards are granted, we use the Monte Carlo valuation model to calculate the fair value. This approach utilizes a two-stage process, which first simulates potential outcomes for our shares using the Monte Carlo simulation. The first stage of the Monte Carlo simulation requires a variety of assumptions about both the statistical properties of our shares as well as potential reactions to such share price movements by our management. Such assumptions include the natural logarithm of our stock price, a random log-difference using the Russell 2000 stock index and a random variable using the specific deviations of our returns relative to the returns dictated by the CAPM model. The second stage employs the Black-Scholes model to value the various outcomes predicted by the Monte Carlo simulation. The resulting fair value, on the date of the grant (measurement date), is being recognized over the vesting period using the straight-line method.
Consolidated Historical Results of Operations
The following table sets forth certain consolidated historical results of operations data and expressed as a percentage of total revenue for the periods indicated. Period-to-period comparisons of our financial results are not necessarily meaningful and you should not rely on them as an indication of future performance.