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Kenexa 10-K 2012
form10k.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                     to                    
Commission File number 000-51358
Company Logo
Kenexa Corporation
(Exact Name of Registrant as Specified in Its Charter)
 
     
Pennsylvania
 
23-3024013
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
   
650 East Swedesford Road, Wayne, PA
 
19087
(Address of Principal Executive Offices)
 
(Zip Code)

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
(Title Class)

     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 x  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.  o

     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 Nox

    The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2011 was approximately $603,292,010. 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, 2011. 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, 2011.

    The number of shares outstanding of the Registrant’s Common Stock, as of March 9, 2012 was 27,254,301.

DOCUMENTS INCORPORATED BY REFERENCE
     
       DOCUMENT
 
FORM 10-K REFERENCE
Portions of Proxy Statement for 2012 Annual Meeting of Shareholders
 
      Part III

 
 
 
KENEXA CORPORATION
FORM 10-K
DECEMBER 31, 2011
TABLE OF CONTENTS
 
         
     
Page
 
PART I
       
Item 1.
  3  
Item 1A.
  16  
Item 1B.
  30  
Item 2.
  30  
Item 3.
  31  
Item 4.
  32  
         
PART II
       
Item 5.
  32  
Item 6.
  34  
Item 7.
  36  
Item 7A.
  63  
Item 8.
  64  
Item 9.
  99  
Item 9A.
  99  
Item 9B.
  101  
         
PART III
       
Item 10.
  102  
Item 11.
  102  
Item 12.
  102  
Item 13.
  102  
Item 14.
  102  
         
PART IV
       
Item 15.
  103  


 
2

 

PART I

This Annual Report on Form 10-K, including the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. These forward-looking statements include, but are not limited to, plans, objectives, expectations and intentions and other statements contained herein that are not historical facts and statements identified by words such as “expects,” “anticipates,” “will,” “intends,” “plans,” “believes,” “seeks,” “estimates” or words of similar meaning. These statements may contain, among other things, guidance as to future revenue and earnings, operations, prospects of the business generally, intellectual property and the development of products. These statements are based on our current beliefs or expectations and are inherently subject to various risks and uncertainties, including those factors discussed in “Item 1A - Risk Factors” in this Annual Report on Form 10-K. Actual results may differ materially from these expectations due to changes in global political, economic, business, competitive, market and regulatory factors, our ability to implement business and acquisition strategies or to complete or integrate acquisitions.  We do not undertake any obligation to update any forward-looking statements contained herein as a result of new information, future events or otherwise. References herein to “Kenexa,” “we,” “our,” and “us” collectively refer to Kenexa Corporation, a Pennsylvania corporation, and all of its direct and indirect U.S., U.K., Canada, China, India, and other foreign subsidiaries.

 
 ITEM 1.
Business

Company Overview

We are a leading provider of software-as-a-service, or SaaS, solutions that enable organizations to more effectively recruit, retain and develop employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We complement our software applications with tailored combinations of proprietary content, outsourcing services and consulting services based on our 24 years of experience assisting customers in addressing their Human Resource (HR) requirements. Together, our software applications, content and services form complete solutions that our customers find more effective than the point technology or service solutions available from other vendors. 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.

Customers

We market our solutions primarily to organizations with more than 2,000 employees.  As of December 31, 2011, we had a global customer base of approximately 8,970 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 279 companies on the Fortune 500 list published in May 2011.  Our customer base includes companies that we billed for services during the period ended December 31, 2011 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately 47.7%, 52.7% and 54.9%, of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively.

For the year ended December 31, 2011, we provided our talent acquisition and employee performance management solutions on a subscription basis to approximately 8,170 customers, with an average subscription term of two years. The remainder of our customers in 2011 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 for the year ended December 31, 2011.

We derive revenue primarily from two sources, subscription fees for our solutions and fees for discrete professional services.  Subscription revenue comprised approximately 72.2%, 78.8% and 84.9% of our total revenues for the years ended December 31, 2011, 2010 and 2009, respectively.  Our customers typically purchase multi-year subscriptions and we recognize subscription revenue ratably over the term of the underlying contract.  These aspects of our business model provide us with recurring revenue streams and revenue visibility.  For each of the years ended December 31, 2011, 2010 and 2009, our customers renewed 86%, 88% and 88%, respectively, of the aggregate value of multi-year subscription contracts up for renewal.


 
3

 

Company History

We are a Pennsylvania corporation. We began our operations in 1987 under predecessor companies Insurance Services, Inc., or ISI, and International Holding Company, Inc., or IHC. 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.

Recent Events

On January 11, 2011, we acquired substantially all of the assets and assumed selected liabilities of Talentmine, LLC (“Talentmine”),  developer of a global performance-based talent assessment and development system with real-time analytics and reports to help employers improve service quality, employee retention and business results, based in Lincoln, Nebraska, for a purchase price of approximately $3.0 million in cash.  We believe the acquisition of Talentmine will provide us with valuable assessment content, intellectual property and key talent.

On February 14, 2011, we entered into a share purchase agreement with JRA Technology Ltd. (“JRA”), a leading provider of employee climate/culture and related surveys based in Auckland, New Zealand, for a purchase price of approximately 9.0 million NZD or $6.9 million in cash.  We believe the acquisition of JRA will provide us with valuable retention content by broadening our solution suite and increasing our geographic reach in the middle market.

On May 25, 2011, we completed a public offering of 3,000,000 shares of our common stock at a price to the public of $27.75 per share. We also sold an additional 450,000 shares of our common stock to cover over-allotments of shares. Our net proceeds from the offering, after payment of all offering expenses and commissions, aggregated approximately $91.4 million. 

On June 28, 2011, we entered into a settlement agreement with Taleo Corporation resolving all outstanding litigations between the parties.  As a result, all litigations between Taleo and us have been dismissed with prejudice.  The settlement agreement also includes a license of certain Kenexa intellectual property to Taleo and a license of certain Taleo intellectual property to Kenexa. A $3.0 million net cash settlement to Kenexa for all intellectual property licenses and settlement of litigations was recorded in the second quarter as a reduction to legal expenses.

In June 2011, we entered into a settlement agreement with Dorno Investment Partners, LLC and on June 30, 2011, the Court dismissed the action with prejudice.

On August 2, 2011, we entered into a share purchase agreement with The Ashbourne Group (“Ashbourne”), a supplier of HR and occupational psychology services based in London, England, for a purchase price of approximately $1.8 million in cash.  We believe the acquisition of Ashbourne will provide us with valuable assessment, learning and development products based on government competencies and performance standards.

In September 2011, we entered into a settlement agreement with the Genesys Parties under which Kenexa paid approximately $1.8 million in connection with an assumed liability from Salary.com.   On October 5, 2011, the Court dismissed the action with prejudice.

On October 27, 2011, we announced the pending transfer of our common stock listing from the NASDAQ to the New York Stock Exchange ("NYSE"), which became effective on November 9, 2011, when our Common Stock was authorized for listing and trading on the NYSE under our current ticker symbol "KNXA."

On November 14, 2011, we entered into a share purchase agreement with Batrus & Hollweg, L.C. (“BHI”), a provider of talent management solutions, particularly in the hospitality sector based in Frisco, Texas, for a purchase price of approximately $17.2 million, including cash and contingent consideration. At the date of acquisition, we accrued $5.1 million of contingent consideration, based upon our estimated revenue growth within the hospitality industry. We believe the acquisition of BHI, along with their extensive research on talent management best practices, will add to the Company's existing research and content portfolio.
 
       On February 6, 2012, we acquired substantially all of the outstanding capital stock of OutStart, Inc. (“OutStart”), a leading provider of SaaS e-learning solutions and services, based in Boston, Massachusetts, for a purchase price of approximately $46.1 million, including adjustments for certain working capital accounts as defined in the purchase agreement. The acquisition of OutStart will expand the Company’s reach into the e-learning market and enable Kenexa to provide a broader and deeper suite of talent management solutions. We will integrate OutStart’s Learning Management Suite, which includes award-winning social and mobile learning solutions, with Kenexa’s Global Talent Management solutions including its Performance Management suite.
 

 
4

 
Customer Support

We believe that superior customer support is critical to our customers. Our Global Support Center 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 Global Support Center. Members of our customer support team receive comprehensive training and orientation to ensure that our customers receive high-quality support and service. 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, 2011, our customer delivery and support group, including our Global Support Center, consisted of 1,637 employees. The majority of our customer support groups reside in the following locations: Massachusetts, Nebraska, Pennsylvania, Texas, Argentina, China, England, Germany, India, and Poland.

Employees

As of December 31, 2011, we had 2,744 employees, consisting of 389 employees in sales and marketing, 477 employees in development, 1,637 employees in delivery and support of our solutions and 241 employees in general and administrative positions.  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.

Industry Overview

Talent acquisition is the sourcing, recruiting, screening, development 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 2011 was approximately $6.6 trillion, or approximately 50.0% 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:
 
 
Inefficiency. Many organizations rely on manual, paper-based processes and they cannot effectively manage the massive number of candidates presented by today's many recruiting resources, including unsolicited inquiries, internal referrals, career fairs, campus recruiting, Internet job boards and third-party referrals, among many others. As a result, they fail to identify high potential candidates or fail to process those candidates in a timely manner.
 
  
Redundancy. Many organizations do not maintain easily searchable databases of processed candidates and they often conduct redundant searches. A candidate who did not meet the criteria for a certain position may meet the criteria for alternative or future positions. Without a centralized, automated, and easily searchable database, a candidate may be overlooked.
 
  
Ineffectiveness. Organizations generally do not employ sophisticated screening and assessment mechanisms. As a result, most hiring decisions are at best loosely based on objective indicators of future success and fail to match high-potential candidates with roles or positions that leverage their unique abilities and experience. This lowers the probability that a new hire will succeed and negatively impacts employee productivity and satisfaction.
 

 
5

 



 
Inconsistency. Many organizations screen applications and resumes based on rudimentary criteria and base hiring decisions primarily on subjective, ad hoc interviews. This process lacks consistency and objectivity. Furthermore, once hired, organizations need auditable processes to ensure that employees are on-boarded consistently, in compliance with government regulations and company procedures.  Inconsistencies in these processes not only negatively impact the effectiveness of recruiting programs and subsequent employee success, but also may expose organizations to regulatory liability.
 
  
High cost and inflexibility. As a result of their inflexibility and absence of a variable cost structure, organizations must either maintain larger HR departments or purchase a greater supply of third-party services in order to accomplish their recruiting and on-boarding goals, significantly increasing the costs of their talent acquisition programs.


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 starts from the moment an offer of employment is made and 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 to optimize development. We believe that the absence of effective employee performance management systems and processes has the following negative implications:
 
 
Failure to retain and develop top performers. The absence of systems and processes to ensure the fulfillment, motivation and internal mobility of key employees negatively impacts an organization's ability to retain and develop its top performing employees. Management may not have the opportunity to rectify problems with valued employees before they depart from the organization without a system and processes to highlight these issues. Reducing employee turnover can have a material, positive impact on an organization’s expenses and bottom line. Increasing employee engagement can have a material impact on the top line.
 
  
Failure to optimize productivity. Maximum productivity is obtained when employees believe their roles match their evolving skill sets, find their jobs challenging and have confidence in their upward mobility. The absence of strong employee performance management systems contributes to the failure to accomplish these goals, and even if organizations succeed in retaining employees, they may not be able to maintain maximum productivity from their employees.
 
  
Failure to remove poor performers. An employee who does not fulfill his or her role effectively may have a continuing negative impact on an organization. To the extent that a poor performer has managerial responsibility, this negative impact on the organization increases materially. Without systems that identify poor performers, organizations may not be able to address weaknesses within their human capital in a timely manner.

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.

 
6

 
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:
 
 
Expensive and time consuming implementation. A traditional enterprise software application requires an organization to invest in ancillary IT such as hardware systems, application servers, databases, storage, and backup systems. In addition, the organization must employ consultants or additional IT staff to develop and maintain application integrations into increasingly complicated IT environments and customize the application for specific needs. The ancillary costs of a complex deployment can equal multiples of the perpetual license fee for the software application and deployment itself can take several months or even years to complete.
 
 
Expensive maintenance. Once the software application has been deployed, the organization must make further investments to maintain the application. In addition to the maintenance fee paid to the software vendor, which is typically approximately 20% of the perpetual license fee for all software used in running the application, the organization must retain both an IT staff capable of maintaining and upgrading the software as well as personnel to train new users to operate the applications. Upgrades must be made to all applications required to run the software such as operating system, databases, security patches, etc. We believe that because of the expense that typical application upgrades entail, software upgrades significantly lag behind available technology, denying end users the benefits of new technologies and solution functionalities.
 
  
Limited incentives to ensure customer success. A typical perpetual software license requires the customer to pay up-front a material amount for the license, with a significantly smaller amount, typically approximately 20%, paid annually for basic support and upgrades. This model leaves little incentive for the software vendor to ensure a successful implementation and on-going customer satisfaction.

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 or thin-client, access the applications, which are designed to be easily configured and integrated with a customer’s existing applications.

The on-demand model fundamentally changes the purchasing, deployment and evolution 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 and often evolving benefits to the customer, resulting in consistent customer service. The on-demand model also reduces research and development support costs for the software vendor.  Through multi-tenant, single codebase architectures, 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.  Further, customers have the benefit of enabling new functionalities through configuration settings when their organization is ready.

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.

 
7

 
Our Solutions

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 practices. We believe that by delivering our products via 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, talent acquisition and employee performance management solutions that meet organizations’ specific needs requires a combination of software, operational excellence, services and domain-specific knowledge and expertise. Accordingly, we complement our software applications with consulting services, outsourcing services, hosting operations, data security 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.
 
 
More effective and consistent talent acquisition programs. Our talent acquisition solutions are comprised of two major components that enable our customers to increase the consistency and effectiveness of their recruiting programs. The first component is our applicant tracking system, which automates and streamlines the recruiting process. The second component is our testing and assessment solutions, which ensures that candidates have the desired knowledge, skills, behavior and experience necessary to be successful in the desired position. Our talent acquisition solutions enable our customers to:
 
 
  
 expand the pool of qualified applicants;
 
  
 accurately communicate a powerful employment brand that draws “best fit” candidates to the organization;
 
 
 
 identify high-potential candidates more quickly;
  
 accurately measure candidate skills, aptitude and experience;
 
  
 
 create interviews focused on necessary skills and qualities indicative of success;
  
 increase interview consistency and objectivity;
 
  
 
 identify training needs immediately;
  
 integrate new hires into the company in a consistent and documented fashion;
 
  
 
 document compliance with regulatory requirements; and
  
 
 ensure cultural fit between candidates and the organization.
 
 
Greater employee productivity and retention. Our employee performance management solutions combine software, proprietary content and consulting services to automate and systematize employee performance management leading practices. Specifically, our solutions enable organizations to automate goal setting, performance appraisal, succession planning, career planning, and compensation management activities; manage learning and development events; design and administer effective and consistent employee surveys and implement productive mentoring programs. Our solutions include tools that facilitate the development of action plans to address weaknesses and cultivate strengths identified through these processes. We complement the software components of our solutions with consulting services that help to encourage and manage behavioral change within an organization. As a result, we understand that our customers experience greater employee productivity and improved employee retention after implementing our solutions, and thus directly impact business outcomes.
 
 
Compensation. Compensation plays a key role in an organization’s ability to attract and retain top performers, and our compensation data and software solutions ensure that our customers are offering pay packages that are both externally competitive and internally equitable. With tools to support market pricing, salary range development and merit budget allocation, we help companies optimize investments in their most important resource – people.
 
 
 
 
8

 
 
  
More cost-effective talent acquisition and employee performance management programs. We believe that our solutions increase the cost-effectiveness of talent acquisition and employee performance management programs in three ways. First, our solutions automate these activities, enabling organizations to maintain smaller HR departments and eliminate some third-party services. Second, our solutions enable organizations to more effectively identify high-potential candidates and retain qualified employees. Third, our solutions provide management the opportunity to achieve economies of scale by outsourcing non-core functions while also ensuring the application of best HR practices and leading technology to these functions.
 
 
Application of analytics to talent acquisition and employee performance management programs. Our solutions enable organizations to use the data generated by their talent acquisition and employee performance management programs in order to improve these programs. Specifically, our solutions enable management to identify overall trends that could improve the efficiency and effectiveness of their processes. For example, we enable our customers to identify their most productive recruiting channels, establish criteria indicative of success in various roles and identify problems that could lead to employee turnover.
 
  
Ease of integration, configuration and deployment. We provide the software applications that form the core of our solutions on an on-demand basis, eliminating the material expenses and complexity of traditionally purchased and deployed software applications. We combine this deployment model with an intuitive user interface to facilitate rapid and widespread adoption within the HR department. Our solutions are designed for ease of use by non-technical staffing professionals, managers, candidates and employees. We believe that these aspects of our solutions enable organizations to quickly achieve the anticipated benefits.


Our Strategy

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:
 
 
Focus on strategic talent management solutions. Unlike some vendors that provide broad suites of HR administrative software, we have focused on the strategic HR functions that have the greatest potential to build and improve the workforces of our customers. We believe that this focus has enabled us to deliver solutions that meet the unique needs of our customers in these areas. We also believe that this focus has helped us to generate an increasingly recognized brand in these markets, which are expected to grow at a materially faster rate than the broader Human Capital Management (HCM) market over the next five years. We intend to continue to broaden our footprint in the integrated talent management space in order to leverage our increasingly recognized brand in these markets and these positive market dynamics.
 
  
Provide innovative and industry-specific solutions to our customers. During the past three years, we have introduced several new solutions, each in response to the unique needs of the market and our customers. We intend to continue to work closely with our key customers to further develop innovative solutions that increase the effectiveness of their recruiting programs and contribute to greater employee retention and productivity. We have also introduced specific solutions for the following vertical industries: financial services and banking, manufacturing, life sciences, biotechnology and pharmaceuticals, retail, government, healthcare, hospitality, call centers, and education. We intend to develop specific solutions for additional vertical industries.
 
  
Cross-sell additional solutions and further penetrate current customers. During the year ended December 31, 2011, our customers renewed approximately 86% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal. 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. We expect to continue to create innovative programs designed to provide our employees with strong incentives to maximize the value we provide to each of our customers.
 
  
Continue to leverage our global sourcing strategy to provide quality solutions efficiently and deliver solutions from low cost centers of excellence. We established offices in Hyderabad, India in 2003. In January 2008, we completed construction and opened our facility in Vizag, India. We currently have approximately 427 employees working in our offices in Hyderabad and Vizag.  We also have approximately 108 employees working in our Argentina office and 42 employees in our Poland office. We believe our sourcing strategy will continue to provide significant benefits to our customers including cost benefits and year-round customer service, 24 hours a day, 7 days a week.
 
  
Expand our global presence and customer base. For the year ended December 31, 2011, our global presence includes more than 30 offices in over 20 countries. Although our primary focus has been on the U.S. market, our solutions are also well suited to addressing problems faced by organizations outside the United States. In the future, we intend to expand our distribution efforts in Europe, Latin America, the Middle East and the Asia/Pacific region. For the years ended December 31, 2011 and 2010, the percentage of revenue generated from customers outside the United States was 26.5% and 26.3%, respectively.
 
 
Pursue complementary acquisitions. We have completed 34 acquisitions of businesses since 1994. These acquisitions have helped us to adapt our business to the evolving needs of our customers. We believe that the HCM market is significantly fragmented. Many competing companies have strong technology or vertical market expertise but lack the scale to compete with the industry leaders in the long term. We continue to identify similarly situated companies that we believe could broaden the functionality and strength of our existing solutions.

 
9

 
 
Our Products and Services

We offer unified business solutions that support hiring, retention and performance management for the entire employee lifecycle.

Talent Acquisition Solutions:

Recruitment Technology
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.

Onboarding
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.

Employee Assessments
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.

Skills Tests
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, the 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.

Structured Interviews
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. The 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.

Employment Branding
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 some of the largest companies in the world.


 
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Talent Retention Solutions:

Performance Management
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.

Employee Surveys
We deliver Employee Surveys that provide the measurements needed to 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.

Learning Management
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.

Leadership Solutions
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.

Compensation
Our CompAnalyst® suite of compensation management solutions is designed for use by compensation professionals to ensure that our customers are offering pay packages that are both externally competitive and internally equitable. The CompAnalyst® product 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 access to various applications and modules that provide a complete source of data to value jobs, participate in surveys and analyze pay competitiveness.

Consumer
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.
 
 
 
 
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Technology, Development and Operations

Technology

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 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 is to provide solutions with an ever-improving set of functionalities and capabilities driven by the marketplace.  These improvements target meeting business needs through a richly constructed set of integrated talent management user experiences.  Kenexa solutions provide a continuous stream of roadmap capabilities enhancing the 2x platform™.

Kenexa 2x Platform Products are delivered as a SaaS and represent the next generation of Kenexa development, via an integrated talent management application on a unified data model, security infrastructure, and user experience, with a competency based universal talent record that enables organizations to aggregate talent data across the enterprise and spanning entire employee life cycles. Kenexa 2x has been architected to use Common Services for various functions and to integrate with a rapidly growing number of third party solutions such as social networks, background checkers, Work Opportunity Tax Credit (WOTC), Department of Homeland Security eVerify, Job Distribution, Video Interviews, etc.

                Kenexa solutions also utilize a Service Oriented Architecture (SOA) and Extract Transform Load (ETL) tools to integrate its applications to other applications, vendors and customers.  This approach also includes application functionality that can be leveraged across multiple Kenexa applications, enables extension of best-of-breed capabilities, and drives rapid code deployment across applications. The benefit to Kenexa customers is that it enables us to bridge current applications with future needs, and better meet the diverse needs of our customer base.

Kenexa’s mobile strategy varies by the targeted user’s needs and capabilities.  This strategy utilizes Web Clipping to provide appropriate mobile device functionality to users where mandated by users.  Similarly, for mobile users needing to leverage a rich user experience including push notifications, Kenexa provides mobile solutions targeted for the respective device, which leverage the rich native user experience available.  This approach to mobility is specifically architected to ensure secure solutions in mobile contexts.
  
These strategies enable us to meet the needs of our current customer base while developing and deploying future capabilities with little to no customer impact, and thus deliver 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.
 
Development

Innovation is an important part of our business. We believe that a number of factors drive our innovation including: the creativity of our employees, our domain expertise 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 the Agile development methodology that we believe allows us to develop projects quickly and then proceed on a predictable, low risk path for high-quality results. Our development environments are integrated and include a number of tools including consistently managed and integrated source code control, test management tools, customer relationship management, automated test tools, etc.  We conduct our product development through our global development teams following a defined sourcing strategy. The technical team models its development methodology after the Capability Maturity Model Integration (CMMI) model. We intend to seek CMMI certification in the coming years.
 
 
 
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Operations

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; Blanchardstown, Ireland; and Shanghai, China serve as our hosting facilities for our on-demand solutions.  Kenexa opened its Shanghai, China hosting facility in late 2011. We also have data centers in Massachusetts, Pennsylvania, Nebraska, United Kingdom, 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 and personnel, and we partner with a third party intrusion detection vendor, 24 hours a day, 7 days a week. Our hosted data centers have 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.
 
 
Intellectual Property

Our intellectual property rights are important to our business. We rely on a combination of patents, copyrights, trade secrets, 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 laws, written agreements and common law, we believe that the following factors are more essential to establishing and maintaining a competitive advantage:
 
 
the technological skills of our research and development personnel;
     
  
the domain expertise of our consultants and outsourcing service professionals;
     
  
frequent enhancements to our solutions;
     
  
continued expansion of our proprietary content; and
     
  
high levels of customer service.

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.


 
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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:
 
 
participation in and sponsorship of conferences, symposiums, regional user groups, networks, tradeshows and industry events;
     
  
direct marketing campaigns;
     
  
advertising in online media outlets, trade and mainstream publications;
     
  
creation of white papers, case studies, sales materials and thought leadership papers;
     
  
leveraging our website to provide product and company information, podcasts, social media forums, and resources to professionals;
     
 
focusing public relations efforts on building and enhancing our brand in the marketplace; and
     
 
expanding our global distribution through strategic partnerships.
 

 
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Competition

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., SHLPreVisor, Inc., Mercer, Towers Watson and MarketPay, 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 and Taleo), SAP AG (SuccessFactors) 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, ADP (The Right Thing) and survey services such as The Gallup Organization. We believe the principal competitive factors in our industry include:

 
 
solution breadth and functionality;
     
  
ease of deployment, integration and configuration;
     
  
domain expertise;
     
  
industry-specific expertise;
     
  
service support, including consulting services and outsourcing services;
     
  
solution price;
     
  
breadth of sales infrastructure; and
     
  
breadth of customer support.

We believe that we generally compete favorably with respect to these factors.

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 Securities and Exchange Commission (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.

 
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ITEM 1A.
Risk Factors

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.  For each of the years ended December 31, 2011 and 2010, 79% and 84%, respectively, of our customers renewed their contracts which represented 86% and 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.  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:
 
 
the price, performance and functionality of our solutions;
     
  
the availability, price, performance and functionality of competing products and services;
     
  
the effectiveness of our support services;
     
  
our ability to develop complementary products and services;
     
 
the willingness of our customers to continue to invest their resources in our solutions in light of other demands on those resources; and
     
 
the macroeconomic environment.

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 2012 was 8.3%, the lowest level since June 2008, however, it is unknown whether unemployment will decrease, increase, or remain constant throughout 2012 and beyond.  If the unemployment rate increases, our existing and potential new customers may not 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.


 
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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 four 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 has been and 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, 2011, 2010 and 2009, we derived approximately 72.2%, 78.8% and 84.9%, 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.

For each of the years ended December 31, 2011 and 2010, 79% and 84%, respectively, of our customers renewed their contracts which represented 86% and 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.



 
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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:
 
 
the need to educate potential customers about the uses and benefits of our solutions and the on-demand delivery model;
     
  
the discretionary nature of our customers’ purchase and budget cycles;
     
  
the competitive evaluation of our solutions;
     
  
fluctuations in the talent acquisition and employee performance management requirements of our prospective customers;
     
 
potential economic downturns and reductions in corporate IT spending;
     
 
announcements or planned introductions of new products or services by us or our competitors; and
     
 
the lengthy purchasing approval processes of our prospective customers.


The market for our solutions among large customers may be limited if they require customized features or functions that we do not intend to provide.

Prospective large customers may require customized features and functions unique to their business processes. If prospective customers require customized features or functions that we do not offer, then the market for our solutions will be more limited among these types of customers and our business could suffer. In addition, supporting large customers could require us to devote significant development services and support personnel and strain our personnel resources and infrastructure. If we are unable to address the needs of these customers in a timely fashion or further develop and enhance our solutions, these customers may not renew their subscriptions or may seek to terminate their relationship, renew on less favorable terms, fail to purchase additional solutions or assert legal claims against us, all of which have happened in the past. If any of these were to occur, our revenue may decline and we may not realize significantly improved operating results from our customer base.


 
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As more of our sales efforts are targeted at larger customers, our sales cycle may become more time-consuming and expensive, we may encounter pricing pressure and implementation challenges and we may have to delay revenue recognition for some complex transactions, all of which could harm our business and operating results.

As we target more of our sales efforts at larger customers, we will face greater costs, longer sales cycles and less predictability in completing some of our sales. Our quarterly results of operations also may vary significantly depending on when we complete sales to these large customers. For large customers, a purchase decision may be a company-wide decision and, if so, these types of sales would require us to provide greater levels of education regarding the use and benefits of our service, as well as education regarding our compliance with applicable privacy and data protection laws and regulations to prospective customers with international operations. As a result of these factors, these sales opportunities may require us to devote greater sales support and professional services resources to individual customers, driving up costs and time required to complete sales and diverting sales and professional services resources to a smaller number of larger transactions, while potentially requiring us to delay revenue recognition on some of these transactions until the technical or implementation requirements have been met.

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, hire additional personnel, and further regionalize and scale our hosting operations. Our operating results may fluctuate in the future as a result of the factors described below:
 
 
our ability to renew and increase subscriptions sold to existing customers, attract new customers, cross-sell our solutions and satisfy our customers’ requirements;
     
  
changes in our pricing policies;
     
  
the introduction of new features to our solutions;
     
  
the rate of expansion and effectiveness of our sales force;
     
  
the length of the sales cycle for our solutions;
     
  
new product and service introductions by our competitors;
     
  
concentration of marketing expenses for activities, such as trade shows and advertising campaigns;
     
 
opening of new co-location data centers driven through socio-political market demands;
     
 
further enhancements to hosting operations to meet security and disaster recovery commitments;
     
 
vendor costs resulting from the consolidation of acquired companies;
     
  
concentration of research and development costs; and
     
  
concentration of expenses associated with commissions earned on sales of subscriptions for our solutions.

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.
 
 
 
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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 SaaS 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 CenturyLink (formerly Qwest) Web hosting facility in Sterling, Virginia; a ServeCentric hosting facility in Blanchardstown, Ireland and a China Datacom Corporation hosting facility in Shanghai, China.  All Web hosting facilities are vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events. Despite physical security including continuous guards, dedicated secured cages, monitored systems, etc., these facilities are also subject to break-ins, sabotage, industrial espionage, 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. 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 and appropriately integrate 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.



 
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We may not receive significant revenue as a result of our current research and development efforts.

Developing and localizing software in a global context 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 language localization as well as legal compliance of the processes, forms, etc. embodied within provided solutions.  Accelerated and regular product feature and compliance related introductions often 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 with respect 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 service 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 systems. If the design of these systems changes, integration of our software with new systems may require significant work and substantial allocation of our time and resources and increase our research and development expenses.



 
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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:
 
 
lost or delayed market acceptance and sales of our solutions;
     
  
loss of customers;
     
  
product liability suits against us;
     
  
diversion of development resources;
     
  
injury to our reputation; and
     
  
increased maintenance and warranty costs.

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., SHLPreVisor, Inc., Mercer, Towers Watson and MarketPay, 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 ERP, software with much greater resources, such as Oracle Corporation (PeopleSoft and Taleo), SAP AG (SuccessFactors) and Lawson, Inc. To a lesser extent, we compete with vendors of RPO services, including Accolo, Inc., Alexander Mann Solutions, ADP (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.



 
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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 acquisitions of BHI and OutStart, involve a number of difficulties that present risks to our business, including the following:
 
 
we may be unable to achieve the anticipated benefits from the acquisition or investment;
     
  
we may have difficulty integrating the operations and personnel of the acquired business, and may have difficulty retaining the key personnel of the acquired business;
     
  
we may have difficulty incorporating the acquired technologies or products with our existing solutions;
     
  
our ongoing business and management's attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically and culturally diverse locations;
     
  
we may lose customers of those companies that we acquire for reasons such as a particular customer desiring to have multiple service vendors;
     
 
we may have difficulty maintaining uniform standards, controls, procedures and policies across locations; and
     
  
we may experience significant problems or liabilities associated with product quality, technology and legal contingencies.

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.


 
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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 may 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, or concern increases regarding the USA Patriot Act or other similar laws, our ability to conduct business in the European Union may be adversely affected.
 
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, 2011, we generated approximately 26.5% of our total revenue and incurred approximately 26.0% 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 foreign currency exchange rate 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.

We operate a global business that exposes us to additional risks.

We operate in over 60 countries and a significant part of our revenue comes from international sales. Operations outside the U.S. may be affected by changes in trade protection laws and regulations affecting trade and investment, including the Foreign Corrupt Practices Act and similar local laws. Deterioration of labor, political, social, or economic conditions in a specific country or region and difficulties in staffing and managing foreign operations may also adversely affect our operations or financial results.  In addition, 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.

Unexpected changes in tax rates and regulations could negatively impact our operating results.

We currently conduct significant activities internationally. Our foreign subsidiaries accounted for 26.5% of our total revenues during the year ended December 31, 2011, and 26.3% of our total revenues during the year ended December 31, 2010. 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.

 
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We may face risks associated with our international operations that could impair our ability to grow our revenue.

We generate revenue outside the United States and for the years ended December 31, 2011 and 2010, the percentage of revenue generated from customers outside the United States was 26.5% and 26.3%, 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:
 
 
 
difficulty in staffing and managing foreign operations, including our ability to provide services to our customers;
     
 
building and maintaining a competitive presence in existing and new markets;
     
 
difficulty enforcing contracts and collecting accounts receivable, leading to longer collection periods;
     
 
certification, qualification and compliance requirements and expenses relating to our products and business;
     
 
regulatory requirements, including import and export regulations;
     
 
changes in currency exchange rates;
     
 
dependence on third parties to market our solutions through foreign sales channels;
     
 
reduced protection for intellectual property rights;
     
 
less stringent adherence to ethical and legal standards by prospective customers;
     
 
potentially adverse tax treatment;
     
 
the need to localize products for other languages and country-specific business requirements and regulations;
     
 
difficulty competing with local vendors;
     
 
language and cultural barriers; and
     
 
political and economic instability.


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, China 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, 2011, we had cash and cash equivalents of $67.5 million and investments of $61.5 million, providing us with available funds of approximately $129 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.


 
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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 borrowings of $30.0 million as of December 31, 2011. 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, 2011, 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 have challenged and may challenge in the future 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 infringement claims could:

 
require costly litigation to defend and resolve, and the payment of substantial damages;
     
 
require significant management time and attention;
     
 
cause us to enter into unfavorable royalty or license agreements;
     
 
require us to discontinue the sale of our solutions;
     
 
create negative publicity that adversely affects the demand for our solutions;
     
 
require us to indemnify and defend our customers; and/or
     
 
require us to expend additional development resources to redesign our software.

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 compensation 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, 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.


 
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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 have 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 due to the addition of 333 employees that we acquired as a part of our acquisitions of The Center for High Performance Development (CHPD) and Salary.com. In 2011, we increased our employees to 2,744 in response to the increase in demand of our solutions and services and our acquisitions.

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.


 
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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 operations and financial condition.

Our reported financial results may be adversely affected by changes in generally accepted accounting principles.

    Accounting principles generally accepted in the United States, or GAAP, are subject to interpretation by the Financial Accounting Standards Board, or FASB, the SEC, the American Institute of Certified Public Accountants, or AICPA, the Public Company Accounting Oversight Board and various other organizations formed to promulgate and interpret accounting principles. A change in these principles or interpretations could have a significant effect on our historical or future financial results.
 
    The application of GAAP to our operations may also require significant judgment and interpretation as to the appropriate treatment of a specific issue. These judgments and interpretations are complicated by the relative newness of the on-demand, vendor-hosted software business model, also called software-as-a-service, or SaaS, and the relative lack of interpretive guidance with respect to the application of GAAP to the SaaS model. We cannot ensure that our interpretations and judgments with respect to the application of GAAP will be correct in the future and any incorrect interpretations and judgments could adversely affect our business.
 
    Additionally, the FASB is currently working together with the International Accounting Standards Board (IASB) to converge certain accounting principles and facilitate more comparable financial reporting between companies who are required to follow GAAP and those who are required to follow International Financial Reporting Standards (IFRS). These efforts may result in different accounting principles under GAAP, which may have a material impact on the way in which we report financial results in areas including, but not limited to, revenue recognition, lease accounting, and financial statement presentation. We expect the SEC to make a determination in the near future regarding the incorporation of IFRS into the financial reporting system for U.S. companies. A change in accounting principles from GAAP to IFRS may have a material impact on our financial statements and may retroactively, adversely affect previously reported transactions.
 
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 classification of our board of directors into three classes, with one class elected each year;
 
 
prohibiting cumulative voting in the election of directors;
 
 
the ability of our board of directors to issue preferred stock without shareholder approval;
 
 
our shareholders may only take action at a meeting of our shareholders and not by written consent;
 
 
prohibiting shareholders from calling a special meeting of our shareholders;
 
 
our shareholders must comply with advance notice procedures in order to nominate candidates for election to our board of directors or to place shareholders proposals on the agenda for consideration at any meeting of our shareholders; and
 
 
prohibiting us from engaging in some types of business combinations with holders of 20% or more of our voting securities without prior approval of our board of directors, unless a majority of our disinterested shareholders approve the transaction.

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.


 
28

 
 
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, 2011, our common stock has been particularly volatile as the price of our common stock has ranged from a high of $33.19 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:
 
 
price and volume fluctuations in the overall stock market from time to time;
     
 
significant volatility in the market price and trading volume of software companies in general, and HR software companies in particular;
     
 
actual or anticipated changes in our earnings or fluctuations in our operating results;
     
 
general economic conditions and trends;
     
 
major catastrophic events;
     
 
sales of large blocks of our stock; or
     
 
departures of key personnel.

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 are at risk of securities class action litigation.

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. More specifically, in 2009 two putative securities class actions were filed against us. While these actions were concluded in our favor, there can be no assurance that other securities class actions will not be filed against us in the future. 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.

 
29

 
 
ITEM 1B.

Not Applicable.

 
 ITEM 2.
Properties

The table below provides information concerning our principal facilities, as of December 31, 2011, 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.  We lease our headquarters in Wayne, Pennsylvania.

 
 
 
Location
 
Approximate
Square
Footage
 
Monthly
Rent
 
Lease Expiration
Frisco, Texas
 
48,481
 
$
69,545
 
March 31, 2017
Lincoln, Nebraska
 
56,449
 
$
86,828
 
April 30, 2016
London, England
 
14,660
 
$
51,001
 
February 10, 2021
Minneapolis, Minnesota
 
15,474
 
$
31,561
 
February 28, 2015
Shanghai, China
 
23,371
 
$
58,221
 
May 26, 2013
Vizag, India
 
60,000
 
$
 
Owned
Waltham, Massachusetts
 
65,546
 
$
132,458
 
April 29, 2018
Wayne, Pennsylvania
 
36,635
 
$
100,295
 
May 31, 2020
 

We sublease space in our Wayne, PA facility and lease space in our Vizag, India facility. The total minimum rentals received under noncancelable subleases and leases for the years ended December 31, 2011 and 2010 was $340 and $349, respectively, for Wayne and Vizag.  The total minimum rentals to be received under noncancelable subleases and leases through 2014 is estimated at $1,009 for Wayne and Vizag as of December 31, 2011.



 

 
30

 
 
 ITEM 3.
Legal Proceedings

Taleo Litigation

On June 28, 2011, Kenexa Corporation and its subsidiaries (“Kenexa”) and Taleo Corporation and its subsidiaries (“Taleo”) (together, the “parties”) entered into a settlement agreement and other related documents resolving all outstanding litigations between the parties (“Settlement Agreement”).  As a result of the Settlement Agreement, all litigations between the parties have been dismissed with prejudice.  The Settlement Agreement also includes a license of certain Kenexa intellectual property to Taleo and a license of certain Taleo intellectual property to Kenexa.  A $3.0 million net cash settlement to Kenexa for all intellectual property licenses and settlement of litigations was recorded in the second quarter as a reduction to legal expenses.

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 assert 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.  The parties entered into a settlement agreement in September 2011 whereby Kenexa paid approximately $1.8 million in contingent consideration.  On October 5, 2011, the Court dismissed the action with prejudice.

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.  It demanded appraisal of the fair value of 140,000 shares pursuant to Delaware law, together with interest from October 1, 2010, costs, attorney’s fees, and other appropriate relief.  The parties entered into a settlement agreement in June 2011, and on June 30, 2011, the Court dismissed the action with prejudice.

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.


 
31

 
 
 ITEM 4.
Mine Safety Disclosure
 
Not applicable.


PART II
 
 ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases of Equity Securities

Market Information and Dividends

Our common stock has been quoted on The New York Stock Exchange under the symbol “KNXA” since November 9, 2011.  Prior to that date our stock was quoted on The Nasdaq Stock Market, LLC following our initial public offering on June 24, 2005.  There was no public market for our common stock prior to June 24, 2005. 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 and The New York Stock Exchange.
 
   
Common Stock Price
   
High
 
Low
Year Ended December 31, 2010:
           
First Quarter
  $ 14.52     $ 9.58  
Second Quarter
  $ 16.05     $ 11.08  
Third Quarter
  $ 18.52     $ 10.75  
Fourth Quarter
  $ 22.91     $ 17.44  
Year Ended December 31, 2011:
               
First Quarter
  $ 27.78     $ 20.06  
Second Quarter
  $ 33.19     $ 23.10  
Third Quarter
  $ 30.98     $ 15.51  
Fourth Quarter
  $ 29.60     $ 13.96  

On March 9, 2012, the last reported sale price of our common stock on The New York Stock Exchange $28.63 per share. As of March 9, 2012, there were approximately 65 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

Not Applicable.


 
32

 

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.

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, NYSE Composite and the S&P Smallcap 600 Index from December 31, 2006 through December 31, 2011. The graph assumes that you invested $100 at the close of market on December 31, 2006 in shares of our common stock and invested $100 on December 31, 2006 in each of these indices, 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.

 
Stock Performance Graph

 


 
33

 


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, 2011, 2010 and 2009 and the consolidated balance sheet data as of December 31, 2011 and 2010 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, 2008 and 2007 and the consolidated balance sheet data as of December 31, 2009, 2008 and 2007 are derived from our audited consolidated financial statements not included in this filing.

   
For the year ended December 31,
   
2011
 
2010
 
2009
 
2008
 
2007
   
(in thousands, except share and per share data)
Revenues:
                   
   Subscription
 
$
204,230
 
 
$
154,689
   
$
133,854
 
 
$
163,420
   
$
148,662
 
   Other
   
78,709
     
41,664
     
23,815
     
40,312
     
33,264
 
Total revenues
   
282,939
     
196,353
     
157,669
     
203,732
     
181,926
 
Cost of revenues
   
112,173
     
68,433
     
53,371
     
61,593
     
50,920
 
Gross profit
   
170,766
     
127,920
     
104,298
     
142,139
     
131,006
 
                                         
Operating expenses:
                                       
Sales and marketing
   
63,394
     
48,177
     
35,182
     
40,780
     
35,324
 
General and administrative
   
53,933
     
48,481
     
40,801
     
48,884
     
39,332
 
Research and development
   
19,089
     
11,901
     
9,757
     
15,555
     
17,737
 
Depreciation and amortization
   
32,447
     
19,661
     
14,264
     
12,088
     
7,584
 
Restructuring charges
   
     
     
     
1,979
     
 
Goodwill impairment charges
   
     
     
33,329
     
167,011
     
 
Total operating expenses
   
168,863
     
128,220
     
133,333
     
286,297
     
99,977
 
                                         
   Income (loss) from operations
   
1,903
     
(300)
     
(29,035)
     
(144,158)
     
31,029
 
Interest (expense) income, net
   
(1,575)
     
14
     
(44)
     
1,395
     
3,098
 
   Loss on change in fair market value of investments, net
   
(244)
     
(379)
     
(12)
     
     
 
Income (loss) before income taxes
   
84
     
(665)
     
(29,091)
     
(142,763)
     
34,127
 
Income tax (expense) benefit
   
(3,955)
     
(2,344)
     
(1,927)
     
38,071
     
(10,579)
 
Net (loss) income
 
$
(3,871)
   
$
 (3,009)
   
$
 (31,018)
   
$
 (104,692)
   
$
 23,548
 
Income allocated to noncontrolling interest
   
(234)
     
(550)
     
(61)
     
     
 
Accretion associated with variable interest entity
   
(3,159)
     
(2,202)
     
     
     
 
Net (loss) income allocable to common shareholders
 
$
(7,264)
   
$
(5,761)
   
$
 (31,079)
   
$
 (104,692)
   
$
 23,548
 
Basic net (loss) income per share
 
$
(0.28)
   
$
(0.25)
   
$
 (1.38)
   
$
 (4.60)
   
$
 0.94
 
Diluted net (loss) income per share
 
$
(0.28)
   
$
(0.25)
   
$
(1.38)
   
$
 (4.60)
   
$
 0.93
 
                                         
Weighted average common shares – basic
   
25,524,227
     
22,645,286
     
22,532,719
     
22,779,694
     
24,926,468
 
Weighted average common shares – diluted
   
25,524,227
     
22,645,286
     
22,532,719
     
22,779,694
     
25,327,004
 



 
34

 


SELECTED CONSOLIDATED FINANCIAL DATA


   
For the year ended December 31,
   
2011
 
2010
 
2009
 
2008
 
2007
     
(in thousands)
 
Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
 
$
67,459
   
$
52,455
   
$
 29,221
   
$
 21,742
   
$
38,032
 
Short-term investments
   
51,807
     
     
29,570
     
4,512
     
58,423
 
Long-term investments
   
9,710
     
     
     
16,513
     
 
Total assets
   
405,644
     
307,422
     
202,343
     
218,465
     
347,889
 
Short-term debt, net
   
5,000
     
5,000
     
     
     
 
Capital lease obligations, short-term
   
282
     
271
     
211
     
143
     
140
 
Total deferred revenue
   
88,837
     
76,052
     
49,964
     
38,638
     
35,076
 
                                         
Capital lease obligations, long-term
   
218
     
146
     
259
     
108
     
94
 
Term loan and revolver, long-term
   
25,000
     
54,500
     
     
     
 
Other liabilities (1)
   
5,330
     
2,515
     
1,981
     
1,319
     
138
 
                                         
Common stock
   
271
     
229
     
226
     
225
     
240
 
Total shareholders’ equity
   
230,540
     
132,867
     
130,138
     
156,536
     
287,648
 


                 (1)
Amounts in 2011, 2010, 2009 and 2008 consists of ASC 740 income tax liabilities related to uncertain tax positions of $2,611, $2,515, $1,890 and $1,256, respectively.  See Critical Accounting Policies and Estimates, Accounting for Income taxes for further discussion.


 
35

 

ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

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.


Overview

We are a leading provider of software-as-a-service, or SaaS, solutions that enable organizations to more effectively recruit, retain and develop employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices.  We complement our software applications with tailored combinations of proprietary content, outsourcing services and consulting services based on our 24 years of experience assisting customers in addressing their Human Resource (HR) requirements. Together, our software applications, content and services form complete solutions that our customers find more effective than the point technology or service solutions available from other vendors. 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.

We derive revenue primarily from two sources, subscription fees for our solutions and fees for discrete professional services.  For the years ended December 31, 2011 and 2010, subscription revenue represented approximately 72.2% and 78.8% of our total revenue, respectively.  Our customers typically purchase multi-year subscriptions.  During the years ended December 31, 2011 and 2010, our customers renewed approximately 86% and 88%, respectively, of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal.  In addition, we recognize subscription revenue ratably over the term of the underlying contract.  These aspects of our business model provide us with recurring revenue streams and revenue visibility.  

We market our solutions primarily to organizations with more than 2,000 employees.  As of December 31, 2011, we had a global customer base of approximately 8,970 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 279 companies on the Fortune 500 list published in May 2011.  Our customer base includes companies that we billed for services during the year ended December 31, 2011 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately $134.9 million and $103.5 million, or 47.7%, and 52.7%, of our total revenue for the years ended December 31, 2011 and 2010, respectively.


 
36

 

Background

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.

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:
 
 
from 1999 to 2003, we exited our temporary staffing business; acquired four businesses which enhanced our screening and behavioral assessment solutions and skills testing technologies, reduced our strategic focus on position-specific recruiting services, discontinued our Oracle implementation business and sold our pharmaceutical training division;
 
  
in 2005, we expanded our presence in North America and enhanced our customer base through our acquisition of Scottworks Solutions, Inc.;
 
  
in 2006, we enhanced our talent acquisition solutions and customer base through our acquisitions of Webhire, Inc.,
Knowledge Workers Inc., Gantz-Wiley Research Consulting Group Inc., Psychometric Services Limited. and BrassRing Inc.;
 
  
in 2007, we enhanced our talent acquisition solutions and customer base through our acquisitions of Strategic
Outsourcing Corporation and HRC Human Resources Consulting GmbH;
 
 
in 2008, we expanded our global footprint in the talent acquisition space through our acquisition of Quorum International Holdings Limited;
 
 
in 2009, we entered into an ownership interest transfer agreement with Shanghai Runjie Management Consulting Company to gain presence in China’s human capital management market;
 
 
in 2010, we expanded our global footprint and added to our product offerings through our acquisitions of CHPD and Salary.com;
 
 
in 2011, we expanded our global footprint and added to our product offerings through our acquisitions of Talentmine LLC, JRA Technology Ltd., The Ashbourne Group and Batrus & Hollweg, L.C.; and
 
 
in 2012, we acquired OutStart a leading provider of SaaS e-learning solutions and services

Beginning in 2000, we focused on offering 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 2011 and 2010, subscription revenue represented approximately 72.2% and 78.8% of our total revenue, respectively.  This shift to subscription-based services has been driven by our customers’ 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 70% to 75% of our total revenues in 2012.

Since our initial public offering on June 29, 2005, our operations have been funded primarily through internally generated cash flows, and proceeds from follow-on stock offerings and borrowings under our long-term credit facilities. Following our initial public offering our common stock was listed for trading on the NASDAQ Stock Market.  On November 9, 2011, we transferred the listing of our common stock from the NASDAQ to the NYSE.
 

 
37

 

Recent Events

On January 11, 2011, we acquired substantially all of the assets and assumed selected liabilities of Talentmine, LLC (“Talentmine”), developer of a global performance-based talent assessment and development system with real-time analytics and reports to help employers improve service quality, employee retention and business results, based in Lincoln, Nebraska, for a purchase price of approximately $3.0 million in cash.  We believe the acquisition of Talentmine will provide us with valuable assessment content, intellectual property and key talent.

On February 14, 2011, we entered into a share purchase agreement with JRA Technology Ltd. (“JRA”), a leading provider of employee climate/culture and related surveys based in Auckland, New Zealand, for a purchase price of approximately 9.0 million NZD or $6.9 million in cash. We believe the acquisition of JRA will provide us with valuable retention content to broaden our solution suite and increasing our geographic reach in the middle market.

On May 25, 2011, we completed a public offering of 3,000,000 shares of our common stock at a price to the public of $27.75 per share. We also sold an additional 450,000 shares of our common stock to cover over-allotments of shares. Our net proceeds from the offering, after payment of all offering expenses and commissions, aggregated approximately $91.4 million. 

On June 28, 2011, we entered into a settlement agreement with Taleo Corporation resolving all outstanding litigations between the parties.  As a result, all litigation between Taleo and us has been dismissed with prejudice.  The settlement agreement also includes a license of certain Kenexa intellectual property to Taleo and a license of certain Taleo intellectual property to Kenexa. A $3.0 million net cash settlement in favor of Kenexa for all intellectual property licenses and settlement of litigations was recorded in the second quarter as a reduction to legal expenses.

In June 2011, we entered into a settlement agreement with Dorno Investment Partners, LLC and on June 30, 2011, the Court dismissed the action with prejudice.

On August 2, 2011, we entered into a share purchase agreement with The Ashbourne Group (“Ashbourne”), a supplier of HR and occupational psychology services based in London, England, for a purchase price of approximately $1.8 million in cash.  We believe the acquisition of Ashbourne will provide us with valuable assessment, learning and development products based on government competencies and performance standards.

In September 2011, we entered into a settlement agreement with the Genesys Parties whereby Kenexa paid approximately $1.8 million in connection with an assumed liability from Salary.com.  On October 5, 2011, the Court dismissed the action with prejudice.

On October 27, 2011, we announced the pending transfer of our common stock listing from the NASDAQ to the New York Stock Exchange ("NYSE"), and on November 9, 2011, our Common Stock was authorized for listing and began trading on the NYSE under its current ticker symbol "KNXA."

On November 14, 2011, we entered into a share purchase agreement with Batrus & Hollweg, L.C. (“BHI”), a provider of talent management solutions, particularly in the hospitality sector based in Frisco, Texas, for a purchase price of approximately $17.2 million, including cash and contingent consideration. At the date of acquisition, we accrued $5.1 million of contingent consideration, based upon our estimated revenue growth within the hospitality industry. We believe the acquisition of BHI, along with their extensive research on talent management best practices, will add to the Company's existing research and content portfolio.

         On February 6, 2012, we acquired substantially all of the outstanding capital stock of OutStart, Inc. (“OutStart”), a leading provider of SaaS e-learning solutions and services, based in Boston, Massachusetts, for a purchase price of approximately $46.1 million, including adjustments for certain working capital accounts as defined in the purchase agreement. The acquisition of OutStart will expand the Company’s reach into the e-learning market and enable Kenexa to provide a broader and deeper suite of talent management solutions. We will integrate OutStart’s Learning Management Suite, which includes award-winning social and mobile learning solutions, with Kenexa’s Global Talent Management solutions including its Performance Management suite.



 
38

 
 
Sources of Revenue

We derive revenue primarily from two sources: subscription revenue and other revenue.

Subscription revenue

Subscription revenue for our solutions is comprised of subscription fees from customers accessing our on-demand software, proprietary content, outsourcing services and consulting services and from customers purchasing additional support that is not included in the basic subscription fee.  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 or beyond. We generally price our solutions based on the number of software applications and services included and the number of customer employees with access to such applications. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services.  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.  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.

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, 2011, deferred revenue increased by $12.7 million or 16.8% to $88.8 million from $76.1 million at December 31, 2010.  The increase in deferred revenue is a result of the increase in bookings and billings for our products, content and services and an increase in sales of multiple arrangements.

For the years ended December 31, 2011 and 2010, our customers renewed approximately 86% and 88%, respectively, 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 periods.  We expect the overall renewal rate to improve to our historical renewal rate in the 90% range that we regularly achieved during pre-recessionary periods.

Other revenue

We derive other revenue from the sale of discrete consulting services and translation services, as well as from out-of-pocket expenses. The majority of our other revenue is derived from discrete consulting 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.”

Revenue by geographic region

For the year ended December 31, 2011, approximately 73.5% of our total revenue was derived from sales in the United States. Foreign revenue that we generated from customers in the United Kingdom, Germany, China and Canada represented approximately 8.8%, 2.0%, 3.3% and 2.6% of our total revenue, respectively.  Revenue from other countries amounted to an aggregate of 9.8% of our total revenue. Other than the countries listed, no other country represented more than 2.0% of our total revenue for the year ended December 31, 2011.  For the year ended December 31, 2011, the percentage of revenue derived from sales in the United States was relatively flat compared to the prior year.
 
Cost of Revenue and Operating Expenses

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 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 the cost of services associated with existing customers.


 
39

 

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 are also included. 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.

General and Administrative

General and administrative expenses primarily consist of personnel and related costs for our executive, finance and accounting, human resources and administrative personnel.  Professional fees, rent and other corporate expenses are also included in general and administrative expense.

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, user interface designers, architects, product managers, project managers, technical sales engineers and management information systems personnel and third-party consultants.  Our research and development efforts have been devoted to the development of new products and new features for our existing products.  Investments also include further development and deeper integrations of Kenexa content in support of its integrated talent management strategy.

We continue to enhance our 2x product suite which includes Kenexa 2x Recruit®, Kenexa 2x BrassRing®, Kenexa 2x Perform®, Kenexa 2x Onboard® and Kenexa 2x Mobile® with increased functionality, module touch points, and performance.  Future modules on the 2x platform include Kenexa 2x Assess™, Kenexa 2x Compensation™, and others as well as a leveraged use of Kenexa’s rich set of content.  We believe that Kenexa 2x enables customers to improve productivity, increase cost savings, ensure compliance with corporate and legal mandates, and raise employee engagement.

Depreciation and Amortization

Depreciation costs are related to our capitalized equipment, software, furniture and fixtures, leasehold improvements, and building.  Amortization costs are related to our intangible assets.

Key Performance Indicators

The following is a discussion of the key performance indicators that we consider to be material in managing our business.  The information provided below is stated in thousands (other than percentages). 
 
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 customers are more willing to pay us in advance for their subscriptions, the amount of deferred revenue on our balance sheet has grown.  This trend may vary as business conditions change.

The following table reconciles beginning and ending deferred revenue for each of the periods shown (in thousands):


      For the years ended December 31,
 
  
  2011    
2010
   
2009
Deferred revenue at the beginning of the year
  
$
76,052
   
$
49,964
   
$
38,638
 
Total invoiced subscriptions during period
  
 
217,015
     
166,468
     
145,180
 
Deferred revenue from acquisition
   
     
14,309
     
 
Subscription revenue recognized during period
  
 
(204,230)
     
(154,689)
     
(133,854)
 
Deferred revenue at end of year
  
$
88,837
   
$
76,052
   
$
49,964
 
 

 
40

 

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 these 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 to be recorded under GAAP.  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.

The Company’s non-GAAP financial measures as set forth in the tables below may exclude the following:

Share-based compensation.  Share-based compensation expense consists of expenses for stock options and stock awards recorded in accordance with ASC 718.  Share-based compensation expense is excluded in our non-GAAP financial measures because these amounts 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 which 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. We believe that this exclusion provides meaningful supplemental information regarding our operating results because these non-GAAP financial measures facilitate the comparison of results for future periods with results from past periods.

Amortization of intangibles associated with acquisitions.  In accordance with GAAP, operating expense includes amortization of acquired intangible assets which are amortized over the estimated useful lives of such assets.  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 include legal, travel, and other fees not expected to recur from our acquisitions. 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.

Taleo settlement and litigation-related fees.  Litigation-related activity which includes settlement proceeds and nonrecurring litigation fees, is excluded from our non-GAAP financial measures due to its infrequent and/or unusual nature and are not expected to recur. We believe that excluding these amounts provides meaningful supplemental information regarding our operating results because these non-GAAP financial measures facilitate the comparison of results for future periods with results from past periods.

Deferred revenue associated with acquisition.  Deferred revenue consists of the impact of the write down of the deferred revenue associated with purchase accounting for the Salary.com acquisition. This effect is added back since we believe its inclusion provides a more accurate depiction of total revenue arising from the Salary.com acquisition.


 
41

 

Non-GAAP cash from operating activities.>  Non-GAAP cash from operating activities consists of GAAP cash flows from operating activities adjusted for non-recurring payments of liabilities associated with our litigations and acquisitions and cash received from our Taleo litigation settlement.  These adjustments are made to GAAP cash from operations to facilitate a consistent and more meaningful comparison to the prior year period.

   
For the years ended December 31,
   
2011
 
2010
 
2009
   
(unaudited)
 
(unaudited)
 
(unaudited)
Cash from operating activities
  $ 55,344     $ 25,894     $ 35,520  
Payments associated with acquisitions
    696       4,534        
Acquisition related fees
          4,587        
Taleo settlement
    (3,000 )            
Settlements associated with litigations, net
    1,395              
Non-GAAP cash from operating activities
  $ 54,435     $ 35,015     $ 35,520  
 

Non-GAAP revenue.>  Non-GAAP revenue consists of GAAP revenue adjusted to reverse the write down of the deferred revenue associated with purchase accounting for the Salary.com acquisition.  The written-down deferred revenue 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 after adjusting subscription revenue to add back 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 range of 70% to 75% of our total revenues in 2012.

   
For the years ended December 31,
   
2011
 
2010
 
2009
   
(unaudited)
 
(unaudited)
 
(unaudited)
Revenue
                 
Subscription revenue
  $ 204,230     $ 154,689     $ 133,854  
Add: deferred revenue associated with acquisition
    8,146       3,065        
Non-GAAP subscription revenue
    212,376       157,754       133,854  
Other revenue
    78,709       41,664       23,815  
Non-GAAP revenue
    291,085       199,418       157,669  
                         
Cost of revenues
    112,173       68,433       53,371  
Less: share-based compensation expense
    252       238       369  
Less: Acquisition-related fees
          151        
Less: Severance expense
                651  
Non-GAAP gross profit
  $ 179,164     $ 131,374     $ 105,318  
                         
Non-GAAP subscription revenue as a percentage of total non-GAAP revenue
    73.0 %     79.1 %     84.9 %
Non-GAAP gross profit as percent of total non-GAAP revenue
    61.6 %     65.9 %     66.8 %

Non-GAAP income from operations>.  Non-GAAP income from operations is derived from GAAP 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 investors 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.

   
For the years ended December 31,
   
2011
 
2010
 
2009
   
(unaudited)
 
(unaudited)
 
(unaudited)
 Income (loss) from operations
  $ 1,903     $ (300 )   $ (29,035 )
Deferred revenue associated with acquisition
    8,146       3,065        
Share-based compensation expense
    6,369       4,542       5,364  
Amortization of acquired intangibles
    14,381       5,753       4,475  
Acquisition-related fees
    559       4,587        
Litigation related fees
    1,416              
Taleo settlement
    (3,000 )            
Gain on sale of asset
    (197 )            
Professional fees associated with variable interest entity
                687  
Severance expense
                1,156  
Goodwill impairment charge
                33,329  
Noncontrolling interest
                (61 )
 Non-GAAP income from operations
  $ 29,577     $ 17,647     $ 15,915  



 
42

 

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:

Revenue Recognition

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, proprietary content, outsourcing services and consulting services and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for discrete consulting services. Because we provide our solutions as a service, we follow the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-10, “Revenue Recognition” and ASC 605-25 “Multiple Element Arrangements.”  We recognize revenue when all of the following conditions are met:
 
 
there is persuasive evidence of an arrangement;
     
  
the service has been provided to the customer;
     
  
the collection of the fees is probable; and
     
  
the amount of fees to be paid by the customer is fixed or determinable.

 Subscription fees and support revenues are recognized ratably on a monthly basis over the terms 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.

Deferred revenue represents payments received or accounts receivable from the Company's customers for amounts billed in advance of subscription services being provided.

We record expenses billed to customers in accordance with ASC 605-45, “Revenue Recognition-Principal Agent Considerations,” which requires that reimbursements received for out-of-pocket expenses be classified as revenues and not as cost reductions.  These items primarily include travel, meals and agency fees.  Reimbursed expenses totaled $6.4 million, $3.3 million and $2.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.

For contracts entered into prior to our adoption of Accounting Standards Update (“ASU”) 2009-13, in determining whether revenues from consulting services could be accounted for separately from subscription revenue, we considered the following factors for each agreement: availability from other vendors, whether objective and reliable evidence of fair value exists of the undelivered elements, the nature and the timing of when the agreement was signed in comparison to the subscription agreement start date and the contractual dependence of the subscription service on the customer's satisfaction with the other services.

Pursuant to the transition rules contained in ASU 2009-13, we elected to early adopt the provisions included in the amendment effective January 1, 2010.  This change in policy increased our revenues by approximately $2.9 million for the year ended December 31, 2010.

We enter into arrangements with customers which may include consulting services, software licenses and delivery of data.  For arrangements that contain multiple deliverables, the selling price hierarchy established in ASU 2009-13 is used 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”).

To qualify as a separate unit of accounting, deliverable items 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 transaction is deferred until all elements are delivered.

 
 
43

 
   
                We determined our ESP of fair value for our application services based on the following:
 
 
We utilize a pricing model for our products which considers market factors such as customer demand for our products, and the geographic regions where the products are sold.  In addition, the model considers entity-specific factors such as volume based pricing, discounts for bundled products and total contract commitment.  Management approval of the model ensures that all of our selling prices are consistent and within an acceptable range for use with the relative selling price method.
     
 
While the pricing model currently in use captures all critical variables, unforeseen changes due to external market forces may result in revising some of the inputs.  These modifications may result in the consideration allocation differing from the one presently in use.  Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration.
     
 
The Company determined the ESP for consulting services based on sales of those services sold separately or on consulting rates estimated based on the value of the services being provided.
 
The revenue guidance contained in ASU 2009-13 modifies the way we account for certain of its arrangements, by allowing us to separate consulting services and corresponding license fees into two separate units of accounting.  These two deliverables represent the primary elements in those arrangements and are recognized upon performance or delivery of each service or product, respectively to the end customer.  Revenue related to consulting services is recognized as obligations are fulfilled on a proportional performance basis and typically earned over a three to six month period, while the license fees may be recognized over a two to five year period.  After the adoption of ASU 2009-13, costs associated with the delivery of our consulting services are expensed as incurred.

Multiple element arrangements consisting of multiple products are impacted by the new revenue guidance.  Under ASU 2009-13, total consideration for an arrangement is allocated to each product or service using the hierarchy of VSOE, third party evidence or the relative selling price method and is recognized as each product or service is delivered to the customer.  Consistent with current practice, revenue may be deferred if the arrangement includes any unusual terms, including extended payment terms, specified acceptance terms, or hold backs payable upon final acceptance of the product or service.

 
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.


Self-Insurance

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 and record the amount on a gross basis. We also rely on the advice of consulting administrators in determining an adequate liability for self-insurance claims.  At December 31, 2011 and 2010, self-insurance accruals totaled $1,083 and $595, and stop loss recoveries totaled $205 for December 31, 2010.  There were no stop loss recoveries for the year ended December 31, 2011.  Management continuously reviews the adequacy of the Company’s stop loss insurance coverage. Material differences may result in the amount and timing of health insurance claims if actual experience differs significantly from management’s estimates.

 
Capitalized Software Development Costs

In accordance with ASC 985, “Software,” and 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, and technological feasibility has been established, internal and external costs, if direct and incremental, are 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 costs 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.


 
44

 

Goodwill and Other Identified Intangible Asset Impairment

Since 2002, we have recorded goodwill in accordance with the provisions of 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 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 due to economic conditions.  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 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, 2011 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.


 
45

 
 
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:
 
 
Volatility is a measure of the amount by which the stock price is expected to fluctuate each year during the expected life of the award and is based on a weighted average of peer companies, comparable indices and our stock volatility. An increase in the volatility would result in an increase in our expense.
     
 
The expected term represents the period of time that awards granted are expected to be outstanding and is currently based upon an average of the contractual life and the vesting period of the options. With the passage of time actual behavioral patterns surrounding the expected term will replace the current methodology. Changes in the future exercise behavior of employees or in the vesting period of the award could result in a change in the expected term. An increase in the expected term would result in an increase to our expense.
     
 
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at time of grant. An increase in the risk-free interest rate would result in an increase in our expense.
     
 
The estimated forfeiture rate is the rate at which awards are expected to expire before they become fully vested and exercisable. An increase in the forfeiture rate would result in a decrease to our expense.
 
                 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 Capital Asset Pricing 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.



 
46

 

Consolidated Results of Operations and Geographic Information

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.

   
Kenexa Corporation Consolidated Statements of Operations
(in thousands, except for percentages)
     
   
For the Year Ended December 31,
   
2011
 
2010
 
2009
   
Amount
 
Percent of
revenues
 
Amount
 
Percent of
revenues
 
Amount
 
Percent of
revenues
Revenues:
                             
Subscription revenue
 
$
204,230
   
72.2
%
 
$
154,689
   
78.8
%
 
$
133,854
   
84.9
%
Other revenue
   
78,709
   
27.8
%
   
41,664
   
21.2
%
   
23,815
   
15.1
%
Total revenues
   
282,939
   
100.0
%
   
196,353
   
100.0
%
   
157,669
   
100.0
%
Cost of revenues
   
112,173
   
39.6
%
   
68,433
   
34.9
%
   
53,371
   
33.9
%
Gross profit
   
170,766
   
60.4
%
   
127,920
   
65.1
%
   
104,298
   
66.1
%
                                           
Operating expenses:
                                         
Sales and marketing
   
63,394
   
22.4
%
   
48,177
   
24.5
%
   
35,182
   
22.3
%
General and administrative
   
53,933
   
19.1
%
   
48,481
   
24.7
%
   
40,801
   
25.9
%
Research and development
   
19,089
   
6.7
%
   
11,901
   
6.1
%
   
9,757
   
6.2
%
Depreciation and amortization
   
32,477
   
11.5
%
   
19,661
   
10.0
%
   
14,264
   
9.0
%
Goodwill impairment charge
   
   
%
   
   
%
   
33,329
   
21.1
 %
Total operating expenses
   
168,863
   
59.7
%
   
128,220
   
65.3
%
   
133,333
   
84.5
%
                                           
Income (loss) from operations
   
1,903
   
0.7
%
   
(300
)
 
(0.1
)%
   
(29,035
)
 
(18.4
)%
Interest (expense) income, net
   
(1,575
 )
 
(0.6
)%
   
14
   
%
   
(44
)
 
— 
%
Loss on change in fair market value of investments, net
   
(244
 )
 
(0.1
)%
   
(379
)
 
(0.2
)%
   
(12
)
 
— 
%
Income (loss) before income taxes
   
84
   
%
   
(665
)
 
(0.3
)%
   
(29,091
)
 
(18.4
)%
Income tax expense
   
(3,955
 )
 
(1.4
)%
   
(2,344
)
 
(1.2
)%
   
(1,927
)
 
(1.2
)%
Net loss
 
$
(3,871
 )
 
(1.4
)%
 
$
(3,009
)
 
(1.5
)%
 
$
(31,018
)
 
(19.6
)%
Income allocated to noncontrolling interest
   
(234
 )
 
(0.1
)%
   
(550
)
 
(0.3
)%
   
(61
)
 
(0.1
)%
Accretion associated with variable interest entity
   
(3,159
 )
 
(1.1
)%
   
(2,202
)
 
(1.1
)%
   
   
%
Net loss allocable to common shareholders’
 
$
(7,264
 )
 
(2.6
)%
 
$
(5,761
)
 
(2.9
)%
 
$
(31,079
)
 
(19.7
)%
 

Geographic Information

The following table summarizes the distribution of revenue by geographic region as determined by billing address for the years ended December 31, 2011, 2010 and 2009.

   
For the Year Ended December 31,
   
2011
 
2010
 
2009
Country
 
Revenue
 
Percent of revenues
 
Revenue
 
Percent of revenues
 
Revenue
 
Percent of revenues
United States
  $ 208,027       73.5 %   $ 144,710       73.7 %   $ 124,652       79.1 %
United Kingdom
    24,941       8.8 %     16,240