424B4 1 d424b4.htm FORM 424(B)(4) Form 424(B)(4)
Table of Contents

Filed Pursuant to Rule 424(b)(4)
File Number 333-124028

PROSPECTUS

 

5,000,000 Shares

 

LOGO

 

Common Stock

 

Kenexa Corporation is selling 5,000,000 shares of common stock. This is an initial public offering of shares of our common stock. Prior to this offering, there has been no public market for our common stock. See “Underwriting” for a discussion of the factors considered in determining the initial public offering price. Our common stock has been approved for quotation on the Nasdaq National Market under the symbol “KNXA.”

 

Our business and an investment in our common stock involve significant risks. These risks are described under the caption “ Risk Factors” beginning on page 8 of this prospectus.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 


 

     Per
Share


   Total

Public offering price

   $ 12.00    $ 60,000,000

Underwriting discounts and commissions

   $ 0.84    $ 4,200,000

Proceeds, before expenses, to us

   $ 11.16    $ 55,800,000

 

The underwriters may also purchase up to 750,000 shares from us at the public offering price, less underwriting discounts and commissions, solely to cover over-allotments.

 

The underwriters expect to deliver the shares in New York, New York on June 29, 2005.

 


 

SG Cowen & Co.

Needham & Company, LLC

JMP Securities

 

June 24, 2005


Table of Contents

 

LOGO

 

 

 


Table of Contents

TABLE OF CONTENTS

 

    Page

Prospectus Summary

  1

Risk Factors

  8
Special Note Regarding Forward-Looking Statements   22

Use of Proceeds

  23

Dividend Policy

  23

Redemption and Conversion Transactions

  24

Capitalization

  27

Dilution

  29

Selected Consolidated Financial Data

  30
Management’s Discussion and Analysis of Financial Condition and Results of Operations   32

Business

  54
    Page

Management

  68
Certain Relationships and Related Party Transactions   80

Principal Shareholders

  84

Description of Capital Stock

  87

Shares Eligible for Future Sale

  93
Certain Material U.S. Federal Income Tax Considerations for Non-U.S. Holders   96

Underwriting

  99

Legal Matters

  102

Experts

  102

Where You Can Find More Information

  102

Index to Consolidated Financial Statements

  F-1

 


 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information that is different. We are offering to sell and seeking offers to buy shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.

 

This prospectus contains statistical data that we obtained for a fee from certain industry publications and reports, including International Data Corporation. None of these industry reports were prepared in contemplation of this offering.


Table of Contents

PROSPECTUS SUMMARY

 

This summary highlights some of the information contained elsewhere in this prospectus. This summary is not complete and does not contain all of the information that you should consider before investing in our common stock. You should read the entire prospectus carefully, especially the risks of investing in our common stock discussed in the “Risk Factors” section of this prospectus and our consolidated financial statements and the related notes appearing at the end of this prospectus.

 

Company Overview

 

We provide software, services and proprietary content that enable organizations to more effectively recruit and retain employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We offer the software applications that form the core of our solutions on an on-demand basis, which materially reduces the costs and risks associated with deploying traditional enterprise applications. We complement our software applications with tailored combinations of outsourcing services, consulting services and proprietary content based on our 18 years of experience assisting clients in addressing their human resource, or HR, requirements. Together, our software applications and services form what are commonly referred to as solutions. We believe that these solutions enable our clients 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 sell our solutions to large- and medium-sized organizations through our direct sales force. As of March 31, 2005, we had a client base of approximately 2,100 companies, including approximately 90 companies on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services during the 12 months ended March 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately 65.6% of our revenue for the year ended December 31, 2004 and approximately 64.8% of our revenue for the three months ended March 31, 2005. Our clients typically purchase multi-year subscriptions which provide us with a recurring revenue stream. During 2004, our clients renewed approximately 89.6% of the aggregate contract value up for renewal during the period.

 

We derive revenue primarily from two sources, subscription fees for our solutions and fees for discrete professional services. During the year ended December 31, 2004 and for the three months ended March 31, 2005, subscription revenue comprised approximately 78.5% and 75.9%, respectively, of our total revenue.

 

Industry Overview

 

Drivers of Demand for Talent Acquisition and Employee Performance Management Applications

 

Based on our experience, we believe that organizations are increasingly acknowledging the value of their employees and the intense competition to hire and retain qualified employees. Notwithstanding these dynamics, we believe that few organizations have systemized best practices for talent acquisition and employee performance management or have implemented software applications to support these processes. As a result, we believe that these processes are generally inefficient, ineffective and expensive. The absence of effective systems and processes can have a number of negative implications on an organization, including the failure to retain qualified employees, optimize productivity and remove poor performers. These dynamics are driving the market for comprehensive talent acquisition and employee performance management solutions. International Data Corporation, or IDC, estimated in 2004 that the worldwide market for e-recruiting and employee performance management applications will grow from approximately $460.0 million in 2003 to $1.1 billion by 2008, a 19% compound annual growth rate, and the worldwide market for human resources business process outsourcing will grow from approximately $6.9 billion in 2003 to $14.2 billion in 2008, a 16% compound annual growth rate.

 

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Emergence of On-Demand Applications

 

Based on our experience, we believe that organizations have become increasingly dissatisfied with traditionally purchased and deployed enterprise software applications, resulting in the growing adoption of the on-demand model. The on-demand model fundamentally changes both the purchasing and deployment of enterprise software applications, replacing the large, up-front expense of perpetual software licenses with more manageable subscription fees and reducing implementation time and expense while providing a strong incentive to software vendors to ensure that applications provide the expected benefits to clients. As a result of these dynamics, IDC expects the worldwide market for software provided on an on-demand basis, or software-as-a-service, to grow from approximately $3.0 billion in 2003 to $9.1 billion by 2008, a 24.6% compound annual growth rate.

 

Our Solution

 

We provide talent acquisition and employee performance management solutions that we believe enable our clients to achieve the following benefits:

 

    More effective and consistent talent acquisition programs. Our solutions enable our clients to expand the pool of qualified applicants, 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, document compliance with regulatory requirements and ensure cultural fit between candidates and the organization.

 

    Greater employee productivity and retention. Our solutions enable organizations to create individual employee development plans, align employee goals with the broader goals of the organization, design and administer effective and consistent employee surveys, implement productive mentoring and succession planning programs and encourage and manage behavioral change.

 

    More cost-effective talent acquisition and employee performance management programs. Our solutions increase the cost-effectiveness of talent acquisition and employee performance management programs by automating functions, increasing scalability, enhancing effectiveness and creating economies of scale through the outsourcing of non-core 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 and to link best HR practices with business objectives.

 

    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 enterprise software applications.

 

Our Strategy

 

Our objective is to be the leading global provider of talent acquisition and employee performance management solutions. To achieve this goal, we intend to:

 

    focus on talent acquisition and employee performance management solutions;

 

    provide innovative and industry-specific solutions to our clients;

 

    cross-sell additional solutions to current clients;

 

    leverage our highly efficient development center in Hyderabad, India;

 

    expand our global presence and client base; and

 

    pursue complementary acquisitions.

 

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Risks Affecting Our Business and Strategy

 

Our business is subject to numerous risks, which are highlighted in the section entitled “Risk Factors” immediately following this Prospectus Summary. As of March 31, 2005, we had an accumulated deficit of $51.3 million, a majority of which was due to interest charges related to our adoption of SFAS 150. We are also subject to other risks such as the failure of the marketplace to accept the on-demand delivery of our products, competition from existing competitors due to the low barriers to entry in our industry, or the termination or non-renewal of subscriptions for our solutions by our clients. If the market does not accept our products, or if we face increased competition in our industry, our financial condition will be materially adversely affected and it will be much more difficult to achieve profitability, and to continue to grow our business.

 

Company Information

 

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 management system. Between 1994 and 1998, we acquired 15 businesses that enabled us to offer comprehensive human capital management, or HCM, services integrated with web-based technology. HCM is the business process and practice of hiring, deploying and managing an organization’s employees.

 

Since 1999, we have focused on building a comprehensive suite of talent acquisition and employee performance management solutions. Consistent with this strategy, from 1999 to 2003, we discontinued and exited three businesses, reduced our focus on position-specific recruiting services and acquired four businesses which enhanced our screening and behavioral assessments solutions and skills testing technologies. Since 2000, an increasing proportion of our revenue has been derived from talent acquisition and employee performance management solutions as opposed to professional services.

 

About Us

 

We began our operations 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.

 

We are a Pennsylvania corporation. Our principal executive offices are located at 650 East Swedesford Road, 2nd Floor, Wayne, PA 19087. Our telephone number is (610) 971-9171. We maintain an Internet website at http://www.kenexa.com (which is not intended to be an active hyperlink in this prospectus). The information contained on, connected to or that can be accessed via our website is not part of this prospectus.

 

In this prospectus, the terms “Kenexa,” “we,” “us” and “our” refer to Kenexa Corporation and its subsidiaries, including Kenexa Technology.

 

This prospectus contains references to a number of trademarks which are our registered trademarks or trademarks for which we have pending registration applications or common law rights. These include Kenexa, the Kenexa logo, Interview Builder, Kenexa CareerTracker, Kenexa Insight, Kenexa Prove It!, Kenexa Recruiter, Kenexa Selector, Kenexa Survey Scorecard and PeopleQuest. This prospectus also contains other trademarks of Kenexa as well as trademarks of other persons.

 

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The Offering

 

Common stock offered by us

5,000,000 shares (plus an additional 750,000 shares if the underwriters exercise their over-allotment option in full).

 

Common stock to be outstanding after this offering

16,694,513 shares.

 

Directed Share Program

The underwriters have reserved for sale, at the initial public offering price, up to 250,000 shares of our common stock being offered for sale to our business associates, employees, friends and family members of our employees. The number of shares available for sale to the general public in this offering will be reduced to the extent these persons purchased reserved shares. Any reserved shares not purchased will be offered by the underwriters to the general public on the same terms as the other shares.

 

Use of proceeds

We will use approximately $28.6 million of the net proceeds of this offering to pay part of the consideration for the redemption of all of the outstanding shares of our series A redeemable participating preferred stock, or series A preferred stock, and approximately $11.4 million of the net proceeds of this offering to pay part of the consideration for the redemption of all of the outstanding shares of our series B redeemable participating preferred stock, or series B preferred stock.

 

 

We intend to use the balance of the net proceeds for general corporate purposes, including working capital and capital expenditures. We may also use a portion of the proceeds to acquire or invest in strategic businesses or technologies. You should read the discussion in the “Use of Proceeds” section of this prospectus for more information.

 

Risk factors

See “Risk Factors” beginning on page 8 and the other information in this prospectus for a discussion of the factors you should consider before you decide to invest in our common stock.

 

Nasdaq National Market symbol

KNXA.

 

The number of shares of our common stock to be outstanding after this offering is based on 11,694,513 shares of common stock outstanding as of June 3, 2005. This number excludes:

 

    802,051 shares of our common stock issuable upon exercise of outstanding options subject to the terms of our 2000 Stock Option Plan as of June 3, 2005 at a weighted average exercise price of $10.28 per share;

 

    an additional 4,040,859 shares of our common stock reserved for future grants under our 2005 Equity Incentive Plan adopted in connection with this offering, including 630,900 shares of our common stock issuable upon exercise of options granted in connection with this offering, each with an exercise price equal to the initial offering price;

 

    794,142 shares of our common stock issuable upon exercise of warrants outstanding as of June 3, 2005 at a weighted average exercise price of $17.54 per share; and

 

    396,195 shares of our common stock issuable upon exercise of warrants held by our management which will terminate upon the completion of this offering pursuant to an agreement with the warrant holders.

 

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Unless we specifically state otherwise, information in this prospectus:

 

    gives effect to the restoration of our treasury shares to our authorized but unissued common stock in March 2005;

 

    gives effect to the reclassification of our class A common stock into our common stock prior to this offering;

 

    gives effect to the redemption of all of the outstanding shares our series A preferred stock for a combination of approximately $28.6 million in cash and 1,134,126 shares of our common stock in connection with this offering;

 

    gives effect to the redemption of all of the outstanding shares of our series B preferred stock for a combination of approximately $11.4 million in cash and 724,250 shares of our common stock in connection with this offering;

 

    gives effect to the conversion of all of the outstanding shares of our class B common stock and class C common stock into 2,179,152 and 2,100,060 shares, respectively, of our common stock in connection with this offering;

 

    gives effect to the exercise of warrants held by certain of our principal shareholders for 396,195 shares of our common stock at an exercise price of $0.01 per share in connection with this offering; and

 

    assumes no exercise of the underwriters’ over-allotment option.

 

In addition, unless we specifically state otherwise, information in this prospectus gives effect to a 0.8-for-1 reverse stock split of our common stock to be effected prior to the completion of this offering, including all historical financial data in this prospectus which gives retroactive effect to the 0.8-for-1 reverse stock split of our common stock.

 

After this offering, our directors, executive officers and shareholders who each own greater than 5% of our outstanding common stock and their affiliates, in the aggregate, will beneficially own approximately 56.7% of the outstanding shares of our common stock. This concentration of ownership will enable them to influence or control matters requiring shareholder approval, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. Shareholders who each own greater than 5% of our outstanding common stock and their affiliates, in the aggregate, will receive approximately $38.9 million in cash in respect of their shares of our series A preferred stock and series B preferred stock redeemed in connection with this offering.

 

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Summary Consolidated Financial Information

 

The following table summarizes our consolidated financial data for the periods indicated. The data for each of the three years ended December 31, 2002, 2003, and 2004 have been derived from our audited consolidated financial statements. The data for each of the three month periods ended March 31, 2004 and 2005 have been derived from our unaudited consolidated financial statements, which, in the opinion of management, contain all adjustments necessary to fairly present the information set forth below. The historical data presented in the table below for each of the three years ended December 31, 2002, 2003 and 2004 and the three months ended March 31, 2004 and 2005 gives retroactive effect to a 0.8-for-1 reverse stock split of our common stock to be effected prior to the completion of this offering. You should read this information in conjunction with the “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of this prospectus and our consolidated financial statements and the related notes elsewhere in this prospectus. Our historical results are not necessarily indicative of results for any future period. The pro forma as adjusted basic and diluted net income available to common shareholders per common share gives effect to the repurchase of our class A common stock, the restoration of our treasury shares to our authorized but unissued capital stock, the redemption of all of the outstanding shares of our series A preferred stock and series B preferred stock, the conversion of all of the outstanding shares of our class B common stock and class C common stock, and the issuance of shares of our common stock in this offering, as if each had occurred at the beginning of the periods presented. Accordingly, pro forma as adjusted basic and diluted income available to common shareholders per share excludes interest on mandatory redeemable preferred stock, cumulative effect of change in accounting principle related thereto, and accretion of redeemable class B common stock, class C common stock, series A preferred stock and series B preferred stock.

 

    For the
Year Ended December 31,


    For the
Three Months Ended
March 31,


 
    2002

    2003

    2004

    2004

    2005

 
                      (unaudited)     (unaudited)  
    (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

                                       

Revenue:

                                       

Subscription revenue

  $ 22,749     $ 25,511     $ 36,348     $ 8,183     $ 10,871  

Other revenue

    9,685       8,480       9,952       1,837       3,461  
   


 


 


 


 


Total revenue

    32,434       33,991       46,300       10,020       14,332  

Total operating expenses

    25,394       24,135       30,340       7,049       8,588  

(Loss) income from continuing operations before income tax and interest expense

    (1,348 )     1,088       3,730       667       1,684  

Net loss available to common shareholders (1)

  $ (971 )   $ (11,197 )   $ (5,112 )   $ (1,706 )   $ (9,699 )

Basic and diluted net loss available to common shareholders per share

  $ (0.16 )   $ (1.86 )   $ (0.85 )   $ (0.28 )   $ (1.74 )

Weighted average shares used to compute net loss available to common shareholders per common share—basic and diluted

    6,054,383       6,033,834       5,995,389       6,033,834       5,572,490  

Pro forma as adjusted income from continuing operations before income tax and interest expense available to common shareholders per common share—basic

                  $ 0.22             $ 0.10  

Pro forma as adjusted income from continuing operations before income tax and interest expense available to common shareholders per common share—diluted

                  $ 0.22             $ 0.10  

Weighted average shares used to compute pro forma as adjusted income from continuing operations before income tax and interest expense available to common shareholders per common share—basic

                    16,694,513               16,694,513  

Weighted average shares to compute pro forma as adjusted income from continuing operations before income tax and interest expense available to common shareholders per common share—diluted

                    16,775,897               16,877,572  

(1) We adopted SFAS 150 effective July 1, 2003. SFAS 150 required us to record the mandatory redeemable preferred stock at fair value at the date of adoption and reflect the difference between carrying value and fair value as a cumulative effect of a change in accounting principle. Changes in fair value after the initial adoption date are treated as interest expense. Dividends on mandatory redeemable preferred stock are also treated as interest expense. The interest and change in accounting principle charges to net income will discontinue upon the completion of this offering with the redemption of our series A preferred stock and series B preferred stock.

 

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The following table represents a summary of our consolidated balance sheet data as of March 31, 2005. The information in the “actual” column in the table below is derived from our unaudited consolidated balance sheet as of March 31, 2005, which in the opinion of management contain all adjustments necessary to fairly report the information set forth below. The historical data presented in the table below as of March 31, 2005 gives retroactive effect to a 0.8-for-1 reverse stock split of our common stock to be effected prior to the completion of this offering. The “pro forma” data in the table below reflect our capitalization as of March 31, 2005, with adjustments for each of the following which will occur upon the completion of this offering:

 

    the issuance of 1,134,126 shares of our common stock in partial consideration of the redemption of all of the outstanding shares of our series A preferred stock;

 

    the issuance of 724,250 shares of our common stock in consideration of the redemption of all of the outstanding shares of our series B preferred stock;

 

    the issuance of 2,179,152 shares of our common stock upon the conversion of all of the outstanding shares of our class B common stock;

 

    the issuance of 2,100,060 shares of our common stock upon the conversion of all of the outstanding shares of our class C common stock;

 

    the issuance of 396,195 shares of our common stock upon the exercise of warrants held by certain of our principal shareholders; and

 

    the incurrence of a $18.1 million charge due to the accretion on the class B common stock, class C common stock, series A preferred stock and series B preferred stock, and a $0.9 million charge due to accrued dividends on the series A preferred stock and series B preferred stock.

 

The “pro forma as adjusted” column in the table below further reflects the sale of 5,000,000 shares of our common stock in this offering at an initial public offering price of $12.00 per share, after deducting the estimated underwriting discounts and commissions and our estimated offering expenses, and our application of approximately $28.6 million of the estimated net proceeds of this offering in partial consideration of the redemption of all of the outstanding shares of our series A preferred stock and approximately $11.4 million of the estimated net proceeds of this offering in partial consideration of the redemption of all of the outstanding shares of our series B preferred stock.

 

     As of March 31, 2005

 
     Actual

    Pro Forma

   

Pro Forma

As Adjusted


 
           (in thousands)        

Consolidated Balance Sheet Data:

                        

Cash and cash equivalents

   $ 9,156     $ 9,156     $ 22,506  

Total assets

     32,970       32,970       46,320  

Short term debt, net

     —         —         —    

Capital lease, short term

     163       163       163  

Unearned revenue

     5,572       5,572       5,572  

Long term debt:

                        

Series A preferred stock

     48,594       28,600       —    

Series B preferred stock

     18,844       11,400       —    

Capital lease, long term

     237       237       237  

Other long term debt, net

     —         —         —    

Redeemable class B common stock

     7,448       —         —    

Redeemable class C common stock

     5,211       —         —    

Class A common stock

     80       117       167  

Treasury stock, at cost

     (9,287 )     (9,287 )     (9,287 )

Total shareholders’ (deficiency) equity

     (59,871 )     (19,709 )     33,641  

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below together with all of the other information included in this prospectus before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could materially suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business

 

Our business may not continue to grow if the markets for our products do not continue to grow.

 

Our growth is dependent upon the continued adoption of on-demand software as a key mechanism for delivering solutions in these markets. The rapidly evolving nature of this market reduces our ability to accurately evaluate our future prospects and forecast quarterly or annual performance. The adoption of on-demand talent acquisition and employee performance management solutions, particularly among organizations that have relied upon traditional software applications, requires the acceptance of a new way of conducting business and exchanging and compiling information. Because these markets are new and evolving, it is difficult to predict with any assurance the future growth rate and size of these markets which, in comparison with the overall market for enterprise software applications, is relatively small.

 

If our on-demand delivery model is not widely accepted, our operating results will be harmed.

 

The on-demand delivery of enterprise software is new and, to a large extent, unproven, and it is uncertain whether this model will achieve and sustain high levels of demand and market acceptance. The majority of our clients access and use our software solutions on an on-demand basis. If the preferences of our clients change and our clients elect to deploy our software on-site, either upon the initiation of a new agreement or upon the renewal of an existing agreement, we would potentially incur higher costs and encounter greater complexity in providing maintenance and support for our software. Potential clients may be reluctant or unwilling to purchase enterprise software on-demand for a number of reasons, including security and data privacy concerns. If such organizations do not adopt the on-demand delivery model, then the market for our solutions may develop more slowly than we expect. The inability of our on-demand delivery model to achieve widespread market acceptance would harm our business.

 

Our business will suffer if our existing clients 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. During 2004, our clients renewed approximately 89.6% of the aggregate contract value eligible to be renewed during the period. If our clients terminate their agreements, fail to renew their agreements, renew their agreements upon less favorable terms to us 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; and

 

    our ability to develop complementary products and services.

 

Most of our existing clients have entered into subscription agreements with us that expire between one and three years from the initial contract date. Our clients have the right to terminate their contracts and are not obligated to renew their subscriptions for our solutions after the expiration of the initial terms of their

 

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subscription agreements. In addition, our clients 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 clients. Our future success also depends in part on our ability to sell new solutions to our existing clients.

 

If we fail to develop or acquire new products or enhance our existing solutions to meet the needs of our existing and future clients, our revenue may decline.

 

To remain competitive, we must continually improve and enhance the responsiveness, functionality and features of our existing solutions and develop new solutions that address the talent acquisition and employee performance management requirements of organizations. If we are unable to successfully develop or acquire new solutions or enhance our existing solutions, our revenue may decline and our business and operating results will be adversely affected. We intend to introduce enhanced solutions to generate additional revenue, attract new clients and respond to competition. We may not succeed in developing or introducing new or enhanced solutions or developing or introducing them in a timely manner, and new or enhanced solutions that we develop or introduce may not achieve the market acceptance necessary to generate significant revenue.

 

In addition, it is possible that 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 client relationships.

 

If our efforts to attract new clients or to sell additional solutions to our existing clients are not successful, our revenue growth will be adversely affected.

 

To grow our revenue, we must continually add new clients and sell additional solutions to existing clients. If our existing and prospective clients do not perceive our solutions to be of sufficiently high value and quality, we may not be able to attract new clients or to increase sales to existing clients. Our ability to attract new clients and to sell new solutions to existing clients will depend in large part on the success of our sales and marketing efforts. However, our existing and prospective clients 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 clients 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. Additionally, some clients may request 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 clients.

 

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 clients, fail to attract new clients 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 Authoria, Inc., BrassRing LLC, Deploy Solutions, Inc., iCIMS, Inc., Integrated Performance Systems, Inc., InScope Corporation, PeopleClick, Inc., Performix Technologies, Inc., Pilat HR Solutions, Inc., Qwiz, Inc., Recruitmax Software, Inc., SHL Group plc, Success Factors, Inc., Taleo Corporation, Unicru, Inc., Virtual Edge Corporation, Webhire, Inc. and Workstream Inc. that offer products that compete with one or more applications contained in our solutions. In some aspects of our business, we also compete with established vendors of enterprise resource planning, or ERP, software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG, Siebel Systems, Inc. and Lawson,

 

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Inc. To a lesser extent, we compete with vendors of employment process outsourcing services and survey services such as Accolo, Inc., The Gallup Organization, Hyrian, LLC and Recruitment Enhancement Services. 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.

 

Many 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 client 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 clients 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 client needs in a given market. Further, our competitors may be able to respond more quickly than we can to changes in client requirements.

 

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. In addition, our competitors may announce new products, services or enhancements that better meet the price or performance needs of clients or changing industry standards.

 

If we encounter barriers to the integration of our software with software provided by our competitors or with the software used by our clients, our revenue may decline and our research and development expenses may increase.

 

In some cases our software 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 advance software releases, which would restrict our ability to adapt our software to facilitate integration with these new releases and could result in lost sales opportunities. In addition, our software is designed to be compatible with the most common third-party ERP systems. If the design of these ERP systems changes, integration of our software with new systems would require significant work and substantial allocation of our time and resources and increase our research and development expenses.

 

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 clients. 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. As a result, decreased demand for enterprise application software and services, and in particular talent acquisition and employee performance management solutions, caused by a weakening global economy may cause a decline in our revenue. Historically, economic downturns have resulted

 

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in overall reductions in corporate information technology spending. In particular, software for talent acquisition and employee performance management software may be viewed by some of our existing and potential clients as a lower priority and may be among the first expenditures reduced as a result of unfavorable economic conditions. In the future, potential clients 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.

 

We derived approximately 78.5% of our revenue during the year ended December 31, 2004 and 75.9% of our revenue for the three months ended March 31, 2005 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 unearned 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.

 

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 clients is recognized over the applicable subscription term.

 

Our financial performance may be difficult to forecast as a result of our focus on large clients 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 clients may be composed of large sales made to a relatively small number of clients. Our failure to close a sale in any particular quarter will 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 clients about the uses and benefits of our solutions and the on-demand delivery model;

 

    the discretionary nature of our clients’ purchase and budget cycles;

 

    the competitive evaluation of our solutions;

 

    fluctuations in the talent acquisition and employee performance management requirements of our prospective clients;

 

    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 clients.

 

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We have a history of operating losses after interest on mandatory redeemable shares and we cannot assure you that we will achieve profitability.

 

We have significant obligations to the holders of our series A preferred stock and series B preferred stock. As a consequence of our adoption of SFAS 150 as of July 1, 2003, we have reclassified our series A preferred stock and series B preferred stock as liabilities and have recorded interest expense on mandatory redeemable preferred stock of $1.7 million and $8.4 million for the years ended December 31, 2003 and 2004, respectively, and $8.5 million for the three months ended March 31, 2005. We had net losses available to common shareholders of $1.0 million, $11.2 million and $5.1 million for the years ended December 31, 2002, 2003 and 2004, respectively, and $9.7 million for the three months ended March 31, 2005. As of March 31, 2005, we had an accumulated deficit of $51.3 million and a cash balance of $9.2 million. We will use approximately $40 million of the proceeds of this offering as well as 1,858,376 shares of our common stock to redeem all of the outstanding shares of our series A preferred stock and series B preferred stock. If we do not complete this offering, we will need to obtain alternative financing to satisfy the preferred stock obligations, and it may be more difficult to achieve profitability and to continue to grow our business.

 

If our security measures are breached and unauthorized access is obtained to client data, clients 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 clients and their existing and potential employees, and security breaches could expose us to a risk of loss of, or unauthorized access to, this information, resulting in possible litigation and possible liability. Although we have never sustained such a breach, if our security measures were ever breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, an unauthorized party obtained access to this confidential data, our reputation could be damaged, our business may suffer and we could incur significant liability. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not discovered until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of our security measures could be harmed and we could lose sales and clients.

 

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 clients. These profiles contain personal information, including job experience, 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 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.

 

We may increase our sales and marketing efforts to clients outside the United States, which would expose us to additional risks associated with international operations, including the risks of managing a geographically diverse operation and foreign currency exchange rate fluctuations.

 

As a part of our future business strategy, we intend to increase our international sales efforts in Canada, Europe and Asia. However, we do not currently have any specific plans or commitments with respect to any such expansion and may not be successful in these efforts. International operations and sales subject us to risks and

 

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challenges that we would otherwise not face if we conducted our business only in the United States. For example, we will depend on third parties to market our solutions through foreign sales channels, and we may be challenged by laws and business practices favoring local competitors. In addition, our ability to succeed in foreign markets will depend on the ability of our software to properly filter foreign languages. We must also adopt our pricing structure to address different pricing environments and may face difficulty in enforcing revenue collection internationally.

 

In addition, a portion of our international sales are denominated in foreign currencies, and we incur operating expenses in Indian Rupees. We expect our exposure to foreign exchange gains and losses to increase in the future.

 

If the unemployment rate increases materially, our business may be harmed.

 

To the extent that the unemployment rate increases materially, our existing and potential clients may no longer consider improvement of their talent acquisition and employee performance management systems a necessity, which could have a material adverse effect on our business, results of operations and financial condition. Demand for our solutions depends in part on our clients’ ability to hire their employees. According to the U.S. Bureau of Labor Statistics, the unemployment rate in May 2005 of 5.1% was at its lowest level since September 2001.

 

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 clients. 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 clients;

 

    product liability suits against us;

 

    diversion of development resources;

 

    injury to our reputation; and

 

    increased maintenance and warranty costs.

 

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 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 no issued patents, and currently have only one pending patent application. There is no guarantee that the U.S. Patent and Trademark Office will grant this patent, or do so in a manner that gives us the

 

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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 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. 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. 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.

 

Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources, either of which could seriously harm our business.

 

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 number of products and competitors grows and the functionality of products in different industry segments overlaps. Our competitors or other third parties may challenge the validity or scope of our intellectual property rights. A claim may also be made relating to technology that we acquire or license from third parties. If we were subject to a claim of infringement, regardless of the merit of the claim or our defenses, the claim could:

 

    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 our clients; 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.

 

Changes in the regulatory environment and general economic condition in India and elsewhere could have a material adverse effect on our business.

 

Adverse changes in the business or regulatory climate in India could have a material adverse effect on our business. In addition, wages in India 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 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, results of operations and financial condition.

 

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

 

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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.

 

Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.

 

As a result of fluctuations in our revenue and operating expenses, our quarterly operating results may vary significantly. We may not be able to curtail our spending quickly enough if our revenue falls short of our expectations. We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our new product development efforts and hire additional personnel. Our operating results may fluctuate in the future as a result of the factors described below and elsewhere in this prospectus:

 

    our ability to renew and increase subscriptions sold to existing clients, attract new clients, cross-sell our solutions and satisfy our clients’ 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;

 

    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.

 

If we do not retain key personnel, our ability to manage our business and continue our growth could be negatively impacted.

 

We have grown significantly in recent years, and our management remains concentrated in a small number of key employees, 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 our executive officers, particularly Nooruddin S. Karsan, Elliot H. Clark, Troy A. Kanter, Donald F. Volk, Sarah M. Teten, Ramarao V. Velpuri, Bill L. Erickson, Kevin T. Hudson, P. Grant Parker and Raghuveer Sakuru 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.

 

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Our chief financial officer is a defendant in litigation that may require a significant amount of his attention.

 

Our chief financial officer, who has been with us since 1996, is one of the named defendants in litigation based on services provided nearly 10 years ago by him, a former partner of his and the accounting firm of which the two were partners. The plaintiffs’ claims against the defendants are based on theories of professional negligence, breach of fiduciary duty, breach of contract, and negligent and fraudulent misrepresentation in connection with services that were provided to the plaintiff by the defendants. Many of the allegations relate to activity that occurred after our chief financial officer left his former firm. Although our chief financial officer believes that these claims are without merit and is vigorously defending against them, defending against these claims may be time consuming and costly for our chief financial officer.

 

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 are currently experiencing a period of rapid growth in our operations, which has placed, and will continue to place, a significant strain on our management, administrative, operational, technical and financial infrastructure. In particular, continued rapid growth will require us to invest significant resources in additional infrastructure and to hire additional personnel. We decreased our employee base from 403 employees on December 31, 2002 to 393 on December 31, 2003, but then increased our employee base to 522 employees at December 31, 2004 and 533 employees at March 31, 2005, and we expect to continue to significantly increase the number of personnel throughout the remainder of 2005, which will increase our expenses. 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 will be adversely affected.

 

We may engage in future 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. We do not have recent experience acquiring companies and the companies we have acquired have been small. Between 1994 and 2001, we acquired 19 businesses. Since 2001, we have not completed any acquisitions. 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 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;

 

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    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 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.

 

These factors 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, including a portion of the net proceeds of this offering. To the extent that we issue shares of our capital stock or other rights to purchase shares of our capital stock as consideration for acquisitions, 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. They may also result in goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges.

 

Evolving European Union regulations related to confidentiality of personal data may adversely affect our business.

 

In order to provide our solutions to our clients, we rely in part on our ability to access our clients’ employee data. The European Union has 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 our safe harbor no longer applies, our ability to conduct business in the European Union may be adversely affected.

 

Our ability to use net operating loss carryforwards in United States may be limited.

 

As of December 31, 2004, we had net operating loss carryforwards from U.S. operations of approximately $15.7 million for federal purposes. We intend to use our U.S. net operating loss carryforwards to reduce the U.S. corporate income tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code of 1986 generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership. Our ability to utilize the net operating losses may be limited by prior changes in our ownership and the issuance of common stock in this offering, and the consummation of the transactions contemplated in this prospectus, may also result in such a limitation. To the extent our use of net operating loss carryforwards is significantly limited, our income could be subject to U.S. corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.

 

Any impairment in the value of our goodwill will result in an accounting charge against our earnings, which could negatively impact our stock price.

 

As of December 31, 2004, we had $8.5 million of goodwill, representing approximately 26% of our total assets as of such date. As a result of acquisitions that we may complete in the future, we may be required to record additional goodwill. In accordance with U.S. generally accepted accounting principles, we conduct an impairment analysis of our goodwill annually and at such other times when an event or change in circumstances

 

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occurs which would indicate potential impairment. As a result of the sale our pharmaceutical training division in December 2003, we wrote off $0.6 million of goodwill associated with prior acquisitions against the net gain on the sale. If we determine significant impairment of our goodwill as a result of any of those tests, we would be required to record a corresponding non-cash impairment charge against our earnings that could negatively affect our stock price.

 

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 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 clients’ 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 clients via the Internet. In addition, taxation of services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of internet-based services, which could harm our business.

 

The failure of our solutions to comply with employment laws may require us to indemnify our clients, which may harm our business.

 

Some of our client contracts contain indemnification provisions that require us to indemnify our clients against claims of non-compliance with employment laws related to hiring. To the extent these claims are successful and exceed our insurance coverages, these obligations would have a negative impact on our cash flow, results of operation and financial condition.

 

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

 

Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our historical or future financial results. For example, we currently are not required to record stock-based compensation charges if the employee’s stock option exercise price is equal to or exceeds the deemed fair value of the underlying security at the date of grant. However, effective January 1, 2006 we will be required to record the fair value of stock options as an expense in accordance with new accounting pronouncements.

 

Risks Related to this Offering

 

We cannot assure you that a market will develop for our common stock or what the market price of our common stock will be.

 

Before this offering, there was no public trading market for our common stock, and we cannot assure you that one will develop or be sustained after this offering. If a market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at an attractive price or at all. We cannot predict the prices at which our common stock will trade. The initial public offering price for our common stock was determined through our negotiations with the underwriters and may not bear any relationship to the market price at which our common stock will trade after this offering or to any other established criteria of the value of our business. It is possible that, in future quarters, our operating results may be below the expectations of securities analysts and investors. As a result of these and other factors, the price of our common stock may decline, possibly materially.

 

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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 bylaws that will be in effect upon completion of this offering 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 bylaws 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 acquirors 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.

 

The price of our common stock may be volatile.

 

In the past several years, technology stocks have experienced high levels of volatility and significant declines in value from their historic highs. The trading price of our common stock following this offering may fluctuate substantially. The price of our common stock that will prevail in the market after this offering may be higher or lower than the price you pay, depending on many factors, some of which are beyond our control and may not be related to our operating performance. These fluctuations could cause you to lose all or part of your investment in our common stock. 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;

 

    actual or anticipated changes in the expectations of securities analysts;

 

    general economic conditions and trends;

 

    major catastrophic events;

 

    sales of large blocks of our stock; or

 

    departures of key personnel.

 

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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.

 

Sales of outstanding shares of our common stock into the market in the future could cause the market price of our common stock to drop significantly, even if our business is doing well.

 

If our existing shareholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the 180-day contractual lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline below the initial public offering price. After this offering, approximately 16,694,513 shares of our common stock will be outstanding, assuming no exercise of the underwriters’ over-allotment option. Of these shares, 5,495,298 shares of our common stock (including the 5,000,000 shares of our common stock sold in this offering) will be freely tradable, without restriction, in the public market. SG Cowen & Co, Inc. may, in its sole discretion, permit our directors, officers, employees and current shareholders who are subject to the 180-day contractual lock-up to sell shares prior to the expiration of the lock-up agreements. The lock-up is subject to extension under certain circumstances. See “Shares Eligible for Future Sales—Lock-Up Agreements.”

 

After the lock-up agreements pertaining to this offering expire 180 days from the date of this prospectus, up to an additional 11,199,215 shares will be eligible for sale in the public market, 9,131,855 of which are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act of 1933 as amended, or the Securities Act, and various vesting agreements. In addition, the 794,142 shares subject to outstanding warrants and the 4,842,910 shares underlying options that are either subject to the terms of our 2000 Stock Option Plan or reserved for future issuance our 2005 Equity Incentive Plan will become eligible for sale in the public market to the extent permitted by the provisions of various option agreements and warrants, the lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. For additional information, see “Shares Eligible for Future Sale.”

 

We may be exposed to claims relating to our repurchase of shares of our common stock prior to this offering.

 

In December 2004, we conducted a share repurchase which closed on January 5, 2005. In the aggregate, we repurchased 873,114 shares of our common stock from eight former employees at $1.25 per share (or, before giving effect to the reverse stock split, 1,091,392 shares of our common stock at $1.00 per share). We decided to initiate this offering after this share repurchase. It is possible that one or more of those individuals could seek to bring a claim against us alleging inadequate disclosure because of the proximity of this offering to the repurchase. Litigation is inherently unpredictable and we cannot assure you that we would be successful in our vigorous defense of any such claims.

 

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution.

 

If you purchase shares of our common stock in this offering, you will experience substantial and immediate dilution of $10.50 per share, because the price that you pay will be substantially greater than the net tangible book value per share of the common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon the exercise of options to purchase common stock under our equity incentive plans, if we issue restricted stock to our employees under these plans or if we otherwise issue additional shares of our common stock.

 

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We do not intend to pay dividends for the foreseeable future.

 

We have never declared or paid any dividends on our common stock. We intend to retain all of our earnings for the foreseeable future to finance the operation and expansion of our business, and we do not anticipate paying any cash dividends in the future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases. See “Dividend Policy” in this prospectus.

 

We have broad discretion in the use of the net proceeds of this offering.

 

We will use approximately $28.6 million of the net proceeds of this offering to pay part of the consideration for the redemption of all of the shares of our series A preferred stock outstanding prior to this offering and approximately $11.4 million of the net proceeds of this offering to pay part of the consideration for the redemption of all of the shares of our series B preferred stock outstanding prior to this offering. We intend to use the remainder of the net proceeds from this offering, as determined by our management in its sole discretion, for general corporate purposes, including working capital needs and potential strategic acquisitions and investments. However, we have not determined the specific allocation of the remaining net proceeds among these additional uses. Our management will have broad discretion over the use and investment of the net proceeds of this offering, and, accordingly, investors in this offering will need to rely upon the judgment of our management with respect to the use of proceeds, with only limited information concerning management’s specific intentions.

 

Insiders will continue to have substantial control over us after this offering, which could limit your ability to influence the outcome of key transactions, including a change of control.

 

Our directors, executive officers and each of our shareholders who own greater than 5% of our outstanding common stock and their affiliates, in the aggregate, will beneficially own approximately 56.7% of the outstanding shares of our common stock after this offering. As a result, these shareholders, if acting together, would be able to influence or control matters requiring approval by our shareholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. They may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our shareholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that involve risks and uncertainties. These forward-looking statements, which are usually accompanied by words such as “may,” “might,” “will,” “should,” “could,” “intends,” “estimates,” “predicts,” “potential,” “continue,” “believes,” “anticipates,” “plans,” “expects” and similar expressions, relate to, without limitation, statements about our market opportunities, our strategy, our competition, our projected revenue and expense levels and the adequacy of our available cash resources. This prospectus also contains forward-looking statements attributed to third parties relating to their estimates regarding our industry. These statements are only predictions based on current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from those expressed or forecasted in, or implied by, such forward-looking statements, including those factors discussed in “Risk Factors.”

 

Although we believe that the expectations reflected in these forward-looking statements are based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We disclaim any obligation or undertaking to disseminate any updates or revision to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

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USE OF PROCEEDS

 

We estimate that we will receive net proceeds from the sale of the shares of our common stock in this offering of approximately $53.4 million, after deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be approximately $61.7 million.

 

We will use approximately $28.6 million of the estimated net proceeds of this offering to pay part of the consideration for the redemption of all of the outstanding shares of our series A preferred stock and approximately $11.4 million of the estimated net proceeds of this offering to pay part of the consideration for the redemption of all of the shares of our series B preferred stock.

 

We intend to use the balance of the net proceeds of this offering for general corporate purposes, including working capital. We believe opportunities may exist to expand the international distribution and sale of our solutions and to expand our current business through strategic acquisitions and investments in technology, and we may use a portion of the proceeds for these purposes. We have not yet determined all of our anticipated expenditures and cannot estimate the amounts to be used for each of the purposes discussed above. We presently have no commitment or agreement relating to any acquisitions or to expand our operations into any other country. We are not currently a party to any contracts or letters of intent, nor do we have any arrangements or understandings, with respect to any strategic acquisitions or investments. The amounts and timing of any expenditure will vary depending on the amount of cash generated by our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have broad discretion in applying the net proceeds from this offering.

 

Pending the uses described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities. We cannot predict whether the proceeds invested will yield a favorable return.

 

DIVIDEND POLICY

 

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.

 

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REDEMPTION AND CONVERSION TRANSACTIONS

 

Current Capitalization

 

As of June 3, 2005, we had outstanding:

 

    5,160,730 shares of class A common stock;

 

    54,479 shares of class B common stock;

 

    1,526,813 shares of class C common stock;

 

    29,953 shares of series A preferred stock; and

 

    12,042 shares of series B preferred stock.

 

As of June 3, 2005, we had warrants outstanding for the purchase of a total of 794,142 shares of our class A common stock. In addition, we had warrants outstanding for the purchase of a total of 396,195 shares of our common stock which are held by our management and which will terminate upon the closing of this offering pursuant to an agreement with such warrant holders. No consideration was paid or is payable in respect of the termination of their warrants. As of June 3, 2005, we also had outstanding options to purchase 802,051 shares of common stock.

 

Our articles of incorporation provide that upon the registered public offering of our common stock for aggregate proceeds exceeding $25 million and the satisfaction of other conditions:

 

    we are required to redeem all of the outstanding shares of our series A preferred stock and series B preferred stock for an amount in cash, shares of our common stock, or a combination of cash and shares of our common stock;

 

    all of the outstanding shares of our class B common stock will automatically convert into shares of our common stock at a rate of 40 shares of our common stock for each share of our class B common stock; and

 

    all of the outstanding shares of our class C common stock will automatically convert into shares of our common stock at a rate 0.8 shares of our common stock for each share of our class C common stock.

 

In addition, our articles of incorporation provide that if, upon the conversion of our class C common stock, the holders of our class C common stock have not received a minimum return as set forth in our articles of incorporation with respect to their investments in our class C common stock and our series A preferred stock, we will issue up to an additional 29.333336 shares of our common stock with respect to each share of our class C common stock outstanding prior to such conversion.

 

Outstanding shares of our series A preferred stock and series B preferred stock are entitled to receive dividends in an amount equal to 6% and 8% per annum, respectively, of the $1,000 stated value of those shares, compounded quarterly. The redemption value for each share of our series A preferred stock is equal to the sum of:

 

    the stated value of $1,000;

 

    all accrued but unpaid dividends on the share of series A preferred stock as of the redemption date; and

 

    a participation factor equal to the fair market value of 9.3336 shares of our common stock as of the redemption date, which upon an initial public offering would be the initial public offering price per share of our common stock.

 

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The redemption value for each share of our series B preferred stock is equal to the sum of:

 

    the stated value of $1,000;

 

    all accrued but unpaid dividends on the share of series B preferred stock as of the redemption date; and

 

    a participation factor equal to the fair market value of 20.1072 shares of our common stock as of the redemption date, which upon an initial public offering would be the initial public offering price per share of our common stock.

 

On June 29, 2005, the aggregate redemption values for all of the outstanding shares of our series A preferred stock and our series B preferred stock will be approximately $42.2 million and $20.1 million, respectively.

 

In connection with this offering, we have entered into an investor agreement with all of the holders of our series A preferred stock, series B preferred stock, class B common stock and class C common stock. The investor agreement, which is described below, sets forth the specific mechanics of the redemption of our series A preferred stock and series B preferred stock and the conversion of our class B common stock and class C common stock upon the completion of this offering.

 

Reclassification of Common Stock and Reverse Split

 

Prior to the completion of this offering, each outstanding share of our class A common stock will be reclassified into one share of our common stock. In connection with this reclassification, we will effect a 0.8-to-1 reverse split of our common stock.

 

Investor Agreement

 

We have entered into an agreement with all of the holders of our class B common stock, class C common stock, series A preferred stock and series B preferred stock. Two of these shareholders, Parthenon Investors, L.P. and PCIP Investors, are our affiliates by virtue of their beneficial ownership of our common stock and their affiliation with a member of our Board of Directors. See “Management,” “Certain Relationships and Related Party Transactions” and “Principal Shareholders.”

 

Redemption of Preferred Stock and Conversion of Common Stock

 

Under the terms of the investor agreement and in accordance with the terms of our articles of incorporation, upon the completion of this offering:

 

    all of the outstanding shares of our series A preferred stock will be redeemed for a combination of approximately $28.6 million in cash and 1,134,126 shares of our common stock;

 

    all of the outstanding shares of our series B preferred stock will be redeemed for a combination of approximately $11.4 million in cash and 724,250 shares of our common stock;

 

    2,179,152 shares of our common stock will be issued upon the conversion of all of the outstanding shares of our class B common stock; and

 

    2,100,060 shares of our common stock will be issued upon the conversion of all of the outstanding shares of our class C common stock, including 878,609 shares of our common stock issuable as a consequence of our failure to satisfy the minimum return provisions of our articles of incorporation.

 

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The portion of the redemption price payable for the series A preferred stock and series B preferred stock not payable in cash is payable in shares of common stock at the initial public offering price. The investor agreement provides that if the portion of the redemption price paid in cash to the holders of our series A preferred stock and series B preferred stock is less than $40 million in the aggregate, the shares of common stock payable in respect of the redemption price for our shares of series A preferred stock and series B preferred stock will be issued at a discount to the initial public offering price. The maximum discount will be 20% of the initial offering price of our common stock if we pay $30 million or less of the redemption price for our series A preferred stock and series B preferred stock in cash. We do not intend to use less than an aggregate of $40 million of the net proceeds of this offering to redeem all of the outstanding shares of our series A preferred stock and series B preferred stock.

 

Upon the completion of this offering, there will be no outstanding shares of our series A preferred stock, series B preferred stock, class B common stock or class C common stock.

 

Amendment of Warrants

 

In addition, under the terms of the investor agreement (1) the holders of our outstanding warrants have agreed, in connection with this offering, to exercise all of the warrants with an exercise price of $0.01 per share, for a total of 396,195 shares of our common stock, and (2) the remaining outstanding warrants have been amended to provide that certain provisions regarding adjustments to the shares available upon the exercise of, and exercise prices under, those warrants will terminate upon completion of the offering.

 

Termination of Stockholders Agreement

 

The investor agreement and an agreement with other shareholders provides that our second amended and restated stockholders agreement will terminate upon the completion of this offering.

 

Board Observer Rights

 

The investor agreement provides that, upon the completion of this offering, Parthenon Investors, L.P. will have the right to appoint a nonvoting representative to attend all meeting of our board of directors until such time as Parthenon Investors, L.P. beneficially owns less than 5% of the outstanding shares of our common stock on a fully diluted basis.

 

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CAPITALIZATION

 

The following table describes our capitalization as of March 31, 2005. Our capitalization is presented:

 

    on an actual basis, giving retroactive effect to a 0.8-for-1 reverse stock split of our common stock to be effected prior to the completion of this offering;

 

    on a pro forma basis to give effect to:

 

  the restoration of our treasury shares to our authorized but unissued common stock;

 

  the reclassification of each share of our class A common stock into one share of common stock prior to this offering;

 

  the issuance of 1,134,126 shares of our common stock in partial consideration of the redemption of all of the outstanding shares of our series A preferred stock;

 

  the issuance of 724,250 shares of our common stock in consideration of the redemption of all of the outstanding shares of our series B preferred stock;

 

  the issuance of 2,179,152 shares of our common stock upon the conversion of all of our outstanding shares of our class B common stock;

 

  the issuance of 2,100,060 shares of our common stock upon the conversion of all of the outstanding shares of our class C common stock;

 

  the issuance of 396,195 shares of our common stock upon the exercise of warrants held by certain of our principal shareholders; and

 

    on a pro forma as adjusted basis to give effect to:

 

  the sale by us of 5,000,000 shares of our common stock in this offering and the application of the net proceeds from the sale (after deducting offering expenses and underwriting discounts and commissions);

 

  the use of approximately $28.6 million of the net proceeds of this offering in partial consideration of the redemption of all of the outstanding shares of our series A preferred stock; and

 

  the use of approximately $11.4 million of the net proceeds of this offering in partial consideration of the redemption of all of the outstanding shares of our series B preferred stock.

 

In addition, the pro forma and pro forma as adjusted data reflect a charge of $18.1 million due to the accretion on the class B common stock, class C common stock, series A preferred stock and series B preferred stock, and a charge of $0.9 million due to accrued dividends on the series A preferred stock and series B preferred stock. We will incur these charges in connection with the redemption and conversion transactions upon completion of this offering.

 

You should read the capitalization table together with the sections of this prospectus entitled “Use of Proceeds,” “Selected Consolidated Financial Data,” “Redemption and Conversion Transactions” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes included elsewhere in this prospectus.

 

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     As of March 31, 2005

 
     Actual

    Pro Forma

    Pro Forma
As Adjusted


 
           (unaudited)        
     (in thousands, except share and per share data)  

Redeemable participating preferred stock

                        

Long term debt:

                        

Series A preferred stock, $0.01 par value; 30,000 shares authorized and 29,953 shares issued and outstanding; 47 pro forma shares authorized, no shares issued and outstanding; 47 pro forma as adjusted shares authorized, no shares issued and outstanding

     48,594       28,600       —    

Series B preferred stock, $0.01 par value; 12,042 shares authorized, issued and outstanding; no pro forma shares authorized, issued and outstanding; no pro forma as adjusted shares authorized, issued and outstanding

     18,844       11,400       —    
    


 


 


Total long term debt

   $ 67,438     $ 40,000     $ —    
    


 


 


Redeemable common stock

                        

Redeemable class B common stock, $0.01 par value; 200,000 shares authorized, 54,479 shares issued and outstanding; 145,521 pro forma shares authorized and no shares issued and outstanding; 145,521 pro forma as adjusted shares authorized and no shares issued and outstanding

     7,448       —         —    

Redeemable class C common stock, $0.01 par value; 2,000,000 actual shares authorized, 1,526,813 shares issued and outstanding; 473,187 pro forma shares authorized and no shares issued and outstanding; 473,187 pro forma as adjusted shares authorized and no shares issued and outstanding

     5,211       —         —    
    


 


 


Total redeemable common stock

   $ 12,659     $ —       $ —    
    


 


 


Shareholders’ Deficiency

                        

Class A common stock, $0.01 par value; 100,000,000 shares authorized, 7,982,628 shares issued and outstanding; 100,000,000 pro forma shares authorized and 11,694,513 shares issued and outstanding; 100,000,000 pro forma as adjusted shares authorized and 16,694,513 shares issued and outstanding

     80       117       167  

Additional paid-in capital

     886       59,923       119,873  

Accumulated deficit

     (51,270 )     (70,247 )     (76,897 )

Accumulated other comprehensive income

     89       89       89  

Treasury stock at cost, 2,821,843 shares

     (9,287 )     (9,287 )     (9,287 )

Note receivable for class A common stock

     (369 )     (304 )     (304 )
    


 


 


Total shareholders’ (deficiency) equity

   $ (59,871 )     (19,709 )     33,641  
    


 


 


Total capitalization

   $ (59,871 )   $ (19,709 )   $ 33,641  
    


 


 


 

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DILUTION

 

If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering.

 

Our pro forma net tangible book value as of March 31, 2005 was approximately $(28.2) million, or approximately $(1.69) per share. Pro forma net tangible book value per share is determined by dividing the amount of our tangible net worth, or total tangible assets less total liabilities, by the pro forma number of shares of our common stock outstanding after giving effect to the transactions described in “Redemption and Conversion Transactions” in this prospectus. Dilution to new investors represents the difference between the amount per share paid by investors in this offering and the pro forma net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to our sale of the shares offered hereby at an initial public offering price of $12.00 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses and the application of the estimated net proceeds therefrom, our pro forma net tangible book value as of March 31, 2005 would have been $25.1 million, or $1.50 per share. This represents an immediate increase in pro forma net tangible book value of $3.19 per share to existing shareholders and an immediate dilution in pro forma net tangible book value of $10.50 per share to new investors. The following table illustrates this per share dilution:

 

Initial public offering price per share

        $ 12.00

Pro forma net tangible book value per share as of March 31, 2005

   $(1.69)       

Increase per share attributable to new investors

   3.19       
    
      

Pro forma net tangible book value per share after this offering

          1.50
         

Dilution per share to new investors

        $ 10.50
         

 

The following table sets forth, on a pro forma basis as of March 31, 2005, after giving effect to the transactions described in “Redemption and Conversion Transactions” in this prospectus, the total number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid to us by existing shareholders and by new investors who purchase shares of common stock in this offering, before deducting the estimated underwriting discounts and commissions and estimated offering expenses:

 

     Shares Purchased

    Total Consideration

    Average Price Per
Share


     Number

   Percent

    Amount

   Percent

   

Existing shareholders

   11,694,513    70.0 %   $ 16,814,976    21.9 %   $ 1.44

New investors

   5,000,000    30.0       60,000,000    78.1       12.00
    
  

 

  

 

Total

   16,694,513    100.0 %   $ 76,814,976    100.0 %   $ 4.60
    
  

 

  

 

 

The foregoing tables and calculations assume no exercise of any options or warrants outstanding as of June 3, 2005. Specifically, these tables and calculations exclude:

 

    802,051 shares of our common stock issuable upon exercise of outstanding options subject to our 2000 Stock Option Plan as of June 3, 2005 at a weighted average exercise price of $10.28 per share;

 

    an additional 4,040,859 shares of our common stock reserved for future grants under our 2005 Equity Inventive Plan adopted in connection with this offering, including 630,900 shares of our common stock issuable upon exercise of options granted in connection with this offering;

 

    794,142 shares of our common stock issuable upon exercise of warrants outstanding as of June 3, 2005 at a weighted average exercise price of $17.54 per share; and

 

    396,195 shares of our common stock issuable upon exercise of warrants held by our management which will terminate upon the completion of this offering.

 

New investors will experience additional dilution upon the exercise of warrants or options to purchase common stock or if we issue restricted stock to our employees under our 2005 Equity Incentive Plan.

 

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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 prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus. The consolidated statement of operations data for each of the years ended December 31, 2002, 2003 and 2004 and the consolidated balance sheet data as of December 31, 2003 and 2004 are derived from, and qualified by reference to, our audited consolidated financial statements and related notes appearing elsewhere in this prospectus. The consolidated statement of operations data for each of the years ended December 31, 2000 and 2001 and the consolidated balance sheet data as of December 31, 2000, 2001 and 2002 are derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of operations data for each of the three month periods ended March 31, 2004 and 2005 and the consolidated balance sheet data as of March 31, 2005 are derived from our unaudited consolidated financial statements which, in the opinion of management, contain all adjustments necessary to fairly present the information set forth below. All of the historical consolidated financial data set forth below gives retroactive effect to a 0.8-for-1 reverse stock split of our common stock to be effected prior to the completion of this offering. Our historical results are not necessarily indicative of results for any future period.

 

   

For the

Year Ended December 31,


   

For the

Three Months Ended
March 31,


 
    2000

    2001

    2002

    2003

    2004

    2004

    2005

 
                                  (unaudited)     (unaudited)  
    (in thousands, except share and per share data)  

Consolidated Statement of Operations Data:

                                                       

Revenue:

                                                       

Subscription revenue

  $ 16,538     $ 18,683     $ 22,749     $ 25,511     $ 36,348     $ 8,183     $ 10,871  

Other revenue

    13,889       9,688       9,685       8,480       9,952       1,837       3,461  
   


 


 


 


 


 


 


Total revenue

    30,427       28,371       32,434       33,991       46,300       10,020       14,332  

Cost of revenue (exclusive of depreciation, shown separately below)

    6,450       8,664       8,388       8,768       12,230       2,304       4,060  
   


 


 


 


 


 


 


Gross profit

    23,977       19,707       24,046       25,223       34,070       7,716       10,272  
   


 


 


 


 


 


 


Operating expenses:

                                                       

Sales and marketing

    21,587       16,635       11,088       10,470       13,350       3,306       3,603  

General and administrative

    9,475       11,197       8,684       7,482       10,243       2,210       3,313  

Research and development

    2,148       3,070       2,982       3,463       4,271       926       1,120  

Depreciation and amortization

    1,959       2,682       2,640       2,720       2,476       607       552  
   


 


 


 


 


 


 


Total operating expenses

    35,169       33,584       25,394       24,135       30,340       7,049       8,588  
   


 


 


 


 


 


 


(Loss) income from continuing operations before income tax and interest expense

    (11,192 )     (13,877 )     (1,348 )     1,088       3,730       667       1,684  
   


 


 


 


 


 


 


Interest expense

    2,739       848       423       352       160       48       12  

Interest on mandatory redeemable preferred shares (1)

    —         —         —         1,667       8,386       2,068       8,534  
   


 


 


 


 


 


 


Loss from continuing operations before income tax

    (13,931 )     (14,725 )     (1,771 )     (931 )     (4,816 )     (1,449 )     (6,862 )

Income tax (benefit) expense on continuing operations

    (3,417 )     (276 )     (84 )     33       (723 )     2       40  
   


 


 


 


 


 


 


Loss from continuing operations

    (10,514 )     (14,449 )     (1,687 )     (964 )     (4,093 )     (1,451 )     (6,902 )

Income from discontinued operations, net of tax (2)

    2,428       425       283       15       —         —         —    
   


 


 


 


 


 


 


Net loss before cumulative effect of change in accounting principle

    (8,086 )     (14,024 )     (1,404 )     (949 )     (4,093 )     (1,451 )     (6,902 )

Cumulative effect of change in accounting principle (1)

    —         —         —         11,233       —         —         —    

Extraordinary item:

                                                       

Loss on early extinguishment of debt, net of income tax benefit of $37,595

    (173 )     —         —         —         —         —         —    
   


 


 


 


 


 


 


Net loss

  $ (8,259 )   $ (14,024 )   $ (1,404 )   $ (12,182 )   $ (4,093 )   $ (1,451 )   $ (6,902 )
   


 


 


 


 


 


 


Accretion of redeemable class B common shares and redeemable class C common shares

  $ 3,033     $ 2,882     $ (3,609 )   $ (3,443 )   $ 1,019     $ 255     $ 2,797  

Accretion of series A preferred shares and series B preferred shares

    —         —         133       872       —         —         —    

Accrued dividends on series A preferred shares and series B preferred shares

    1,303       2,609       3,043       1,586       —         —         —    
   


 


 


 


 


 


 


Net loss available to common shareholders

  $ (12,595 )   $ (19,515 )   $ (971 )   $ (11,197 )   $ (5,112 )   $ (1,706 )   $ (9,699 )
   


 


 


 


 


 


 


Basic and diluted loss per share:

                                                       

Net loss from continuing operations

  $ (2.56 )   $ (3.24 )   $ (0.21 )   $ (0.00 )   $ (0.85 )   $ (0.28 )   $ (1.74 )

Net income from discontinued operations

    0.41       0.07       0.05       0.00       —         —         —    

Net loss from cumulative effect of change in accounting principle

    —         —         —         (1.86 )     —         —         —    
   


 


 


 


 


 


 


Net loss per share available to common
shareholders

  $ (2.15 )   $ (3.17 )   $ (0.16 )   $ (1.86 )   $ (0.85 )   $ (0.28 )   $ (1.74 )

Weighted average shares used to compute net loss available to common shareholders per common share—basic and diluted

    5,879,599       6,145,521       6,054,383       6,033,834       5,995,389       6,033,834       5,572,490  

 

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     As of December 31,

    As of
March 31,
2005


 
     2000

    2001

    2002

    2003

    2004

   
     (in thousands)     (unaudited)  

Consolidated Balance Sheet Data:

                                                

Cash and cash equivalents

   $ 1,816     $ 756     $ 410     $ 3,078     $ 9,494     $ 9,156  

Total assets

     35,901       27,400       26,149       25,309       33,288       32,970  

Short term debt, net

     19,948       4,086       3,817       1,558       —         —    

Capital leases, short term

     479       336       351       292       199       163  

Unearned revenue

     923       1,968       2,577       3,260       6,650       5,572  

Long term debt:

                                                

Series A preferred stock

     —         21,090       23,420       35,471       41,727       48,594  

Series B preferred stock

     —         10,895       11,741       15,048       17,178       18,844  

Capital leases, long term

     638       311       156       147       277       237  

Other long term debt, net

     1,562       54       3       —         —         —    

Redeemable class B common stock

     15,001       6,714       5,201       3,747       5,291       7,448  

Redeemable class C common stock

     —         9,181       7,085       5,096       4,571       5,211  

Class A common stock

     80       80       80       80       80       80  

Treasury stock

     (7,609 )     (7,983 )     (8,195 )     (8,195 )     (8,772 )     (9,287 )

Total shareholders’ deficiency

     (12,903 )     (32,224 )     (33,050 )     (44,221 )     (49,803 )     (59,871 )

(1) We adopted SFAS 150 effective July 1, 2003, which required us to record the mandatory redeemable preferred stock at fair value at the date of adoption and reflect the difference between carrying value and fair value as a cumulative effect of a change in accounting principle. Changes in fair value after the initial adoption date are treated as interest expense. Dividends on mandatory redeemable preferred stock are also treated as interest expense. The interest and change in accounting principle charges to net income will discontinue upon the completion of this offering with the redemption of our series A preferred stock and series B preferred stock.
(2) Discontinued operations related to our pharmaceutical training and technology solutions group division for the years ended December 31, 2000, 2001, 2002 and 2003 are as follows (dollars in thousands):

 

     For the
Year Ended December 31,


 
     2000

   2001

   2002

   2003

 

Revenue:

                             

Subscription revenue

   $ —      $ —      $ —      $ —    

Other revenue

     26,340      18,825      14,239      6,046  
    

  

  

  


Total revenue

     26,340      18,825      14,239      6,046  

Cost of revenue

     12,349      10,522      7,565      2,714  
    

  

  

  


Gross profit

     13,991      8,303      6,674      3,332  

Total operating expenses

     9,894      7,542      6,179      4,153  

Interest expense

     51      52      24      23  
    

  

  

  


Income (loss) from discontinued operations before income taxes

     4,046      709      471      (844 )

Gain on sale of discontinued operations

     —        —        —        869  

Income tax expense

     1,618      284      188      10  
    

  

  

  


Net income from discontinued operations

   $ 2,428    $ 425    $ 283    $ 15  

 

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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 of this prospectus and our consolidated financial statements and related notes appearing elsewhere in this prospectus. 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 set forth in the “Special Note Regarding Forward-Looking Statements.” 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 “Risk Factors” section and elsewhere in this prospectus.

 

Overview

 

We provide software, services and proprietary content that enable organizations to more effectively recruit and retain employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We offer the software applications that form the core of our solutions on an on-demand basis, which materially reduces the costs and risks associated with deploying traditional enterprise applications. We complement our software applications with tailored combinations of outsourcing services, consulting services and proprietary content based on our 18 years of experience assisting clients in addressing their human resource requirements. Together, our software applications and services form solutions that we believe enable our clients to improve the effectiveness of their talent acquisition programs, increase employee productivity and retention, measure key HR metrics and make their talent acquisition and employee performance management programs more efficient.

 

Since 1999, we have focused on providing talent acquisition and employee performance management solutions on a subscription basis and currently generate a significant portion of our revenue from these subscriptions. During the year ended December 31, 2004 and for the three months ended March 31, 2005, revenue from these subscriptions comprised approximately 78.5% and 75.9%, respectively, of our total revenue. We generated the remainder of our revenue from discrete professional services that were not provided as part of an integrated solution on a subscription basis. These subscription-based solutions provide us with a recurring revenue stream and we believe represent a more compelling opportunity in terms of growth and profitability than discrete professional services. As a result, since 1999 discrete professional services have represented a consistently decreasing percentage of our revenue. We expect that trend to continue.

 

We sell our solutions to large- and medium-sized organizations through our direct sales force. As of March 31, 2005, we had a client base of approximately 2,100 companies, including approximately 90 companies on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services during the 12 months ended March 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately 65.6% and 64.8% of our revenue for the year ended December 31, 2004 and for the three months ended March 31, 2005, respectively.

 

Our revenue has increased at a compound annual growth rate of approximately 19.5% since 2002, from $32.4 million for the year ended December 31, 2002 to $34.0 million for the year ended December 31, 2003 to $46.3 million for the year ended December 31, 2004. Historically, a substantial portion of our clients have renewed their subscriptions each year. During 2002, 2003 and 2004, our clients renewed approximately 80%, 97% and 89.6%, respectively, of the aggregate contract value up for renewal during each of those periods.

 

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

 

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1997, responding to a growing demand from our customers, we embarked on a strategy 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 HCM services integrated with on-demand technology.

 

In 1999, we commenced 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:

 

    in 1999, we exited our temporary staffing business;

 

    in 2000 and 2001, we acquired four businesses which enhanced our screening and behavioral assessment solutions and skills testing technologies;

 

    since 2002, we have reduced our strategic focus on position-specific recruiting services; and

 

    in 2003, we discontinued our Oracle implementation business and discontinued and sold our pharmaceutical training division.

 

As a result of our shift in strategic focus, since the beginning of 2000, an increasing proportion of our revenue has been derived from talent acquisition and employee performance management solutions and a decreasing portion of our revenue has been derived from discrete professional services. In 2000, our revenue derived from subscriptions for these solutions comprised approximately 54.4% of our total revenue. This percentage increased to approximately 65.9%, 70.1%, 75.1%, 78.5% and 75.9% of total revenue, respectively, for the years ended December 31, 2001, 2002, 2003, 2004 and for the three months ended March 31, 2005. This transition in revenue mix resulted in decreasing revenue from 2000 to 2001, 14.3% revenue growth from 2001 to 2002 and relatively flat revenue growth between 2002 and 2003 as incremental revenue from our talent acquisition and employee performance management solutions was offset by a decline in revenue from discrete professional services. More recently, customer adoption of the on-demand model for software delivery and need for solutions that improve employee recruiting and retention have driven consistent quarterly revenue growth since December 31, 2002.

 

From our inception through 1999, our operations were funded primarily through internally generated cash flows and our line of credit. In December 1999, we issued common stock and warrants to purchase common stock to several investors, including Parthenon Investors, L.P. and PCIP Investors, for approximately $22.0 million. In connection with this investment, we repurchased common stock held by a co-founder and former president of our predecessor for consideration of approximately $6.9 million and restructured our outstanding debt. On June 16, 2000, we entered into a bridge financing in which we issued promissory notes in an aggregate principal amount of $10.0 million to Parthenon and PCIP for aggregate cash proceeds of $8.1 million, representing an original initial issue discount of $1.9 million. In connection with the bridge financing, Parthenon and PCIP also exercised warrants to purchase shares of common stock that were acquired in the 1999 financing for an aggregate exercise price of $1.9 million.

 

In February 2001, we issued common and preferred stock to Wafra Acquisition Fund 14, L.P. for approximately $15.5 million and to Parthenon and PCIP in exchange for the cancellation and discharge of the bridge notes issued in 2000. In March 2001, we issued common and preferred stock to Westbury Equity Partners SBIC, L.P. for approximately $6.0 million in cash. In the same transaction, we redeemed a portion of the shares of common and preferred stock held by Parthenon and PCIP for an aggregate price of approximately $2.4 million.

 

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Table of Contents

Recent Events

 

We have entered into an agreement with all of the holders of our class B common stock, class C common stock, series A preferred stock and series B preferred stock. Under the terms of the agreement and according to the terms of our articles of incorporation, upon the completion of this offering, we will redeem all of the outstanding shares of our series A preferred stock and series B preferred stock as described below:

 

     Cash Payable

    

Shares of Common Stock Issuable


•    Series A preferred stock

   $28.6 million      1,134,126 shares              

•    Series B preferred stock

   $11.4 million      724,250 shares              
All of the outstanding shares of class B common stock and class C common stock will convert as described below:
           

Shares of Common Stock Issuable


•    Class B common stock

     2,179,152 shares              

•    Class C common stock

     2,100,060 shares              

 

In addition, the agreement provides that, in connection with this offering, certain of our shareholders will exercise warrants for a total of 396,195 shares of our common stock with an exercise price of $0.01 per share.

 

In connection with the redemption and conversion transactions described above, we expect to incur a charge of $18.1 million due to the accretion on the class B common stock, class C common stock, series A preferred stock and series B preferred stock, and a charge of $0.9 million due to accrued dividends on the series A preferred stock and series B preferred stock. We will incur these charges in connection with the redemption and conversion transactions upon completion of this offering which we expect to be during the second quarter of 2005.

 

In December 2004, we conducted a share repurchase which closed on January 5, 2005. In the aggregate, we repurchased 873,114 shares of our common stock from eight former employees at $1.25 per share or, before giving effect to the reverse stock split, 1,091,392 shares of our common stock at $1.00 per share, of which 369,075, or 461,344 before giving effect to the revise stock split, were repurchased in December 2004. Although we did not decide to initiate a process for an initial public offering until after the share repurchase, and we believe that the disclosures we made in connection with the share repurchase fairly presented the factors that might affect the price of our stock, we recognize that one or more of those individuals may seek to bring a claim against us. If a claim were asserted against us, we do not believe we would have any legal liability, and we would defend vigorously against any such claim.

 

Our board of directors on May 27, 2005 approved a reverse stock split and reclassification of our class A common stock into shares of our common stock. The ratio for the reverse stock split is 0.8-for-1, as determined by our board of directors. Immediately after the application of the reverse stock split, each share of our class A common stock will be reclassified as one share of our common stock. We expect to effect this reverse split and reclassification of our class A common stock into our common stock by amending our amended and restated articles of incorporation prior to the completion of this offering. The board of directors may choose to abandon the reverse split and reclassification at any time prior to the filing of the reverse split and reclassification amendment. All previously reported share amounts have been retroactively adjusted to give effect to the reverse stock split and reclassification of our class A common stock into our common stock.

 

Sources of Revenue

 

We derive revenue primarily from two sources: (1) subscription revenue for our solutions, which is comprised of subscription fees from clients accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from clients purchasing additional support that is included in the basic subscription fee; and (2) fees for discrete professional services.

 

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Our clients primarily purchase renewable subscriptions for our solutions. The typical term is one to three years, with some terms extending up to five years. The majority of our subscription agreements are not cancelable for convenience, although our clients have the right to terminate their contracts for cause if we fail to provide the agreed upon services or otherwise breach the agreement. A client does not generally have a right to a refund of any advance payments if the contract is cancelled. We expect that we will maintain our renewal rate of approximately 89.6% of the aggregate contract value up for renewal for the year ended December 31, 2004 in each of 2005, 2006 and 2007. The revenue derived from subscription fees is recognized ratably over the term of the subscription agreement. We generally invoice our clients in advance in monthly or quarterly installments and typical payment terms provide that our clients pay us within 30 days of invoice. Amounts that have been invoiced are recorded in accounts receivable prior to the receipt of payment and in unearned revenue to the extent revenue recognition criteria have not been met. As the subscription component of our revenue has grown and clients’ willingness to pay us in advance for their subscriptions has increased, the amount of unearned revenue on our balance sheet has grown at a higher rate than our revenue. As of December 31, 2002, 2003, and 2004, our unearned revenue was $2.6 million, $3.3 million and $6.6 million, respectively. We expect this trend to continue. We generally price our solutions based on the number of software applications and services included and the number of client employees. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services.

 

A small portion of our clients purchase discrete professional services. These services primarily consist of consulting and training services. In addition, we recognize a small amount of revenue from sales of perpetual software licenses. The revenue from these services and licenses is recognized differently depending on the type of service or license provided as described in greater detail below under “Critical Accounting Policies.”

 

We generate substantially all of our revenue from within the United States. During the years ended December 31, 2003 and 2004 and for the three months ended March 31, 2005, approximately 95.0%, 91.2% and 90.3% of our revenue, respectively, were derived from sales in the United States. Although, we derive a small amount of our revenues from areas outside the United States, we believe that global markets represent a significant opportunity and we intend to expand the international distribution and sale of our solutions. At this time, we do not have any specific plans or commitments with respect to this expansion. During the years ended December 31, 2003 and 2004, and for the three months ended March 31, 2005, approximately, 5.0%, 8.8% and 9.7%, respectively, of our revenue were derived from areas outside the United States. Other than the revenues that we generated from clients in the Netherlands and the United Kingdom, which amounted to 7.0% and 3.3% of our revenue for the year ended December 31, 2004, and 2003 respectively, we did not have revenue from any other country in 2004 in excess of 0.5% of our total revenue for 2004 or 2003.

 

Cost of Revenue

 

Our cost of revenue primarily consists of compensation, employee benefits and travel-related expenses for our employees and independent contractors who provide consulting or other professional services to our clients. Additionally, our application hosting costs, amortization of third-party license royalty costs, technical support personnel costs, overhead allocated based on headcount and reimbursed expenses are also recorded as cost of revenue. Many factors affect our cost of revenue, including changes in the mix of products and services, pricing trends, changes in the amount of reimbursed expenses and fluctuations in our client 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 business expands, we expect that third-party license royalty costs and personnel costs associated with the delivery of our solutions will continue to increase.

 

Operating Expenses

 

We classify our operating expenses as follows:

 

Sales and Marketing. Sales and marketing expenses primarily consist of personnel and related costs for employees engaged in sales and marketing, including salaries, commissions, and other variable compensation, travel expenses and costs associated with trade shows, advertising and other marketing efforts and allocated

 

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overhead. We expense our sales commissions at the time the related revenue is recognized, and we recognize revenue from our subscription agreements ratably over the term of the agreements. Investment in sales and marketing commencing in 2003 resulted in significant revenue growth during 2003 and 2004. We intend to continue to invest in sales and marketing to pursue new clients and expand relationships with existing clients. As a result, we expect sales and marketing expense to increase. However, we do not expect sales and marketing expense to increase significantly as a percentage of revenue.

 

Research and Development. Research and development expenses primarily consist of personnel and related costs, including salaries, and employee benefits, for software engineers, quality assurance engineers, product managers, technical sales engineers and management information systems personnel. Our research and development efforts have been devoted primarily to new product offerings and incidental enhancements and upgrades to our existing products. Historically, we have capitalized a small percentage of our research and development expenses. Capitalized research and development expenses totaled $1.6 million, $0.7 million and $0.4 million for the years ended December 31, 2002, 2003 and 2004, respectively. The remaining research and development expenses have been expensed as incurred. We expect research and development expenses to increase in the future as we employ more personnel to support enhancements of our solutions and new solutions offerings. However, we expect research and development expenses to decrease as a percentage of revenue primarily due to increased efficiencies from our global development center.

 

General and Administrative. General and administrative expenses primarily consist of personnel and related costs for our executive, finance, human resources and administrative personnel, professional fees and other corporate expenses and allocated overhead. As we expand our business and incur additional expenses associated with being a public company, we believe that general and administrative expenses will increase in dollar amount and may increase as a percentage of revenue in 2005 and future periods.

 

Discontinued Operations

 

By 2002, we began to make significant progress in the sales of our talent acquisition and employee performance management solutions and began to redirect resources to those solutions. As part of this change of focus, we began to exit lower-margin businesses with less predictable revenue streams. Accordingly, in November 2003, we decided to discontinue our pharmaceutical training division and Oracle implementation business. In December 2003, we sold our pharmaceutical training division for $3.0 million in cash for a net gain of approximately $0.9 million. See note 3 in our audited consolidated financial statements for additional discussion.

 

Key Performance Indicators

 

The following tables summarize the key performance indicators that we consider to be material in managing our business:

 

    

For the

Year Ended December 31,


   

For the

Three Months Ended
March 31,


 
         2002    

        2003    

        2004    

    2004

    2005

 
     (in thousands, except for percentages)  
                       (unaudited)  

Total revenue

   $ 32,434     $ 33,991     $ 46,300     $ 10,020     $ 14,332  

Subscription revenue as a percentage of total revenue

     70.1 %     75.1 %     78.5 %     81.7 %     75.9 %

Loss (income) from continuing operations before income tax and interest expense

   $ (1,348 )   $ 1,088     $ 3,730     $ 667     $ 1,684  

Net cash provided by operating activities

   $ 2,032     $ 3,322     $ 10,051     $ 188     $ 750  
     As of December 31,

    As of March 31,

 
     2002

    2003

    2004

    2004

    2005

 
     (in thousands)  

Unearned revenue

   $ 2,577     $ 3,260     $ 6,650     $ 3,223     $ 5,572  

 

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The following is a discussion of some of the terms used in the tables above.

 

Subscription revenue as a percentage of total revenue. Subscription revenue as a percentage of total revenue can be derived from our consolidated statement of operations. This performance indicator illustrates the evolution of our business towards subscription-based solutions, which provide us with a recurring revenue stream and which we believe to be a more compelling revenue growth and profitability opportunity. We expect the percentage of subscription revenue to continue to increase in future periods due to our continuing focus on subscription-based solutions and our continued investment in marketing efforts.

 

Net cash provided by operating activities. Net cash provided by operating activities is taken from our consolidated statement of cash flows and represents the amount of cash generated by our operations that is available for investing and financing activities. Historically, our net cash provided by operating activities has exceeded our net income primarily due to the positive impact of unearned revenue. We expect this trend to continue because of the advance payment structure of our subscription agreements and because as our sales increase, we expect incremental costs to decline.

 

Unearned revenue. We generate revenue primarily from multi-year subscriptions for our on-demand talent acquisition and employee performance management solutions. We recognize revenue from these subscription agreements ratably over the term of the contract, which are typically one to three years. We generally invoice our clients in quarterly or monthly installments in advance. Unearned revenue, which is included in our consolidated balance sheets, is the amount of invoiced subscriptions in excess of the amount recognized as revenue. Unearned 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 customer willingness to pay us in advance for their subscriptions has increased, the amount of unearned revenue on our balance sheet has grown at a higher rate than our revenue growth rate. We expect this trend to continue.

 

The following table reconciles beginning and ending unearned revenue for each of the periods shown:

 

    

For the

Year Ended December 31,


   

For the

Three Months Ended

March 31,


 
     2002

    2003

    2004

    2004

    2005

 
                       (unaudited)  
     (in thousands)  

Unearned revenue at beginning of period

   $ 1,968     $ 2,577     $ 3,260     $ 3,260     $ 6,650  

Total invoiced subscriptions during period

     23,358       26,193       39,738       8,146       9,793  

Subscription revenue recognized during period

     (22,749 )     (25,510 )     (36,348 )     (8,183 )     (10,871 )
    


 


 


 


 


Unearned revenue at end of period

   $ 2,577     $ 3,260     $ 6,650     $ 3,223     $ 5,572  

 

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.

 

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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 clients accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from clients purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for discrete professional services. Because we provide our solution as a service, we follow the provisions of Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revenue Recognition. On August 1, 2003, we adopted Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. 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 client;

 

    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 on a monthly basis over the lives of the contracts. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

 

Discrete professional services and other revenues, when sold with subscription and support offerings, are accounted for separately since these services have value to the customer on a stand-alone basis and there is objective and reliable evidence of fair value of the delivered elements. Our arrangements do not contain general rights of return. Additionally, when professional services are sold with other elements, the consideration from the revenue arrangement is allocated among the separate elements based upon the relative fair value. Professional services and other revenues are recorded as follows: Consulting revenues are recognized upon completion of the contracts that are of short duration (generally less than 60 days) and as the services are rendered for contracts of a longer duration.

 

In determining whether revenues from professional services can be accounted for separately from subscription revenue, we consider the following factors for each agreement: availability of professional services from other vendors, whether objective and reliable evidence of the 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. If the professional service does not qualify for separate accounting, we recognize the revenue ratably over the remaining term of the subscription contract. In these situations we defer the direct and incremental costs of the professional service over the same period as the revenue is recognized.

 

We record out-of-pocket expenses incurred in accordance with EITF issue 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, which requires that reimbursements received for out-of-pocket expenses be classified as revenue and not as cost reductions. Before the December 15, 2001 effective date of EITF Issue 01-14, out-of-pocket reimbursements from clients were netted with the applicable costs. These items primarily include travel, meals and certain telecommunication costs. During 2002, 2003 and 2004, reimbursed expenses totaled $0.9 million, $0.8 million and $1.3 million, respectively.

 

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Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts for estimated losses resulting from clients’ inability to pay us. The provision is based on our historical experience and for specific clients that, in our opinion, are likely to default on our receivables from them. In order to identify these clients, we perform ongoing reviews of all clients 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. In addition, we have experienced significant growth in number of clients, and we have less payment history to rely upon with these clients. We rely on historical trends of bad debt as a percentage of total revenue and apply these percentages to the accounts receivable associated with new clients and evaluate these clients 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.

 

Capitalized Software Research and Development Costs

 

In accordance with EITF Issue 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware,” we apply AICPA Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, will be capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Maintenance and training cost are expensed as incurred. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal software in any of the periods covered in this audit report.

 

Goodwill and Other Identified Intangible Asset Impairment

 

On January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets which superseded Accounting Board Opinion No. 17, Intangible Assets. Upon adoption of SFAS No. 142, we ceased amortization of existing goodwill and are required to review the carrying value of goodwill for impairment. If goodwill becomes impaired, some or all of the goodwill could be written off as a charge to operations. This comparison is performed annually or more frequently if circumstances indicate that the carrying value may not be recoverable. We have reviewed the carrying values of goodwill of each business unit by comparing the carrying values to the estimated fair values of the business components. The fair value is based on management’s estimate of the future discounted cash flows to be generated by the respective business components and comparable company multiples. Such cash flows consider factors such as future operating income, historical trends, as well as demand and competition. Comparable company multiples are based upon public companies in sectors relevant to our business based on our knowledge of the industry. Changes in the underlying business could affect these estimates, which in turn could affect the recoverability of goodwill. We determined that the carrying values of our goodwill did not exceed the fair values and as a result we do not believe that impairment of goodwill existed at December 31, 2004.

 

Accounting for Stock-Based Compensation

 

Stock-based compensation is measured in accordance with Accounting Principles Board Opinion, APB, No. 25. We measure compensation expenses for our employee and director stock-based compensation plans using the intrinsic value method. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of our common stock at the date of grant over the amount an employee must pay to exercise the option. Because there is no public market for our stock, we consider internal and external factors to assist in

 

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our determination of the fair value of our common stock. Internal factors include the success of our sales efforts, client retention and overall profitability. External factors consist of market conditions and comparable public companies. We made assumptions and estimates in the preparation of our valuation, including assumptions and estimates related to projected cash flows, discount rates, comparable market value multiples, the value of preferences associated with our preferred stock, the effect that those preferences have on the value of our common stock, and the likelihood at various points in time of certain transactions taking place such as a public offering, sale of our company, raising additional private financing or liquidation. If we had made different estimates and assumptions our conclusions and the related stock-based compensation recorded may have been different.

 

See “Recent Accounting Pronouncements” and “New Accounting Pronouncements” in note 2 of our audited consolidated financial statements for a discussion of Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment, which will require a change in our method of accounting for stock based compensation in the first quarter of 2006. SFAS No. 123(R) will require us to record compensation expense based on the fair value of the awards as the grant date and will result in increased expenses. However, we do not expect this to have a material effect on our financial statements.

 

Accounting for Income Taxes

 

We account for income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” or SFAS 109, 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. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of 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.

 

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. We also rely on the advice of consulting administrators in determining an adequate liability for self-insurance claims. As of December 31, 2003 and December 31, 2004, self-insurance accruals totaled approximately $0.1 million and $0.2 million, respectively. We continuously review the adequacy of our insurance coverage. Material differences may result in the amount and timing of insurance expense if actual experience differs significantly from management’s estimates.

 

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Consolidated Results of Operations and Geographic Information

 

Consolidated Historical Results of Operations

 

The following table sets forth certain consolidated historical results of operations data 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.

 

    

For the

Year Ended December 31,


    For the
Three Months
Ended March 31,


 
         2002    

        2003    

        2004    

        2004    

        2005    

 
                       (unaudited)  

Revenue:

                              

Subscription revenue

   70.1 %   75.1 %   78.5 %   81.7 %   75.9 %

Other revenue

   29.9 %   24.9 %   21.5 %   18.3 %   24.1 %
    

 

 

 

 

Total revenue

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenue

   25.9 %   25.8 %   26.4 %   23.0 %   28.3 %
    

 

 

 

 

Gross profit

   74.1 %   74.2 %   73.6 %   77.0 %   71.7 %
    

 

 

 

 

Operating expenses:

                              

Sales and marketing

   34.2 %   30.8 %   29.0 %   33.0 %   25.2 %

General and administrative

   26.8 %   22.0 %   22.0 %   22.0 %   23.1 %

Research and development

   9.2 %   10.2 %   9.2 %   9.2 %   7.8 %

Depreciation and amortization

   8.1 %   8.0 %   5.3 %   6.1 %   3.9 %
    

 

 

 

 

Total operating expenses

   78.3 %   71.0 %   65.5 %   70.3 %   60.0 %
    

 

 

 

 

(Loss) income from continuing operations before income tax and interest expense

   (4.2 )%   3.2 %   8.1 %   6.7 %   11.7 %

Interest expense

   1.3 %   1.0 %   0.3 %   0.5 %   0.1 %

Interest on mandatory redeemable preferred shares

       4.9 %   18.1 %   20.6 %   59.5 %
    

 

 

 

 

(Loss) income from continuing operations before income tax

   (5.5 )%   (2.7 )%   (10.3 )%   (14.4 )%   (47.9 )%

Income tax (benefit) expense from continuing operations

   (0.3 )%   0.1 %   (1.6 )%   0.0 %   0.3 %
    

 

 

 

 

(Loss) from continuing operations

   (5.2 )%   (2.8 )%   (8.7 )%   (14.4 )%   (48.2 )%

Income from discontinued operations, net of tax

   0.9 %   0.0 %            
    

 

 

 

 

Cumulative effect of change in accounting principle

       33.0 %            

Net (loss)

   (4.3 )%   (35.8 )%   (8.7 )%   (14.4 )%   (48.2 )%
    

 

 

 

 

 

Geographic Information

 

The following table summarizes the distribution of revenue by geographic region as determined by billing addresses for each of the periods shown:

 

    

For the

Year Ended December 31,


    For the
Three Months
Ended March 31,


 
         2002    

        2003    

        2004    

        2004    

        2005    

 
                       (unaudited)  

United States

   95.7 %   95.0 %   91.2 %   95.6 %   90.3 %

Europe, Middle East and Africa

   3.9 %   4.0 %   7.6 %   3.7 %   5.7 %

Canada

   0.3 %   0.3 %   0.5 %   0.4 %   3.7 %

Asia-Pacific and other

   0.1 %   0.7 %   0.7 %   0.3 %   0.3 %
    

 

 

 

 

Total revenue

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
    

 

 

 

 

 

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Comparison of Three Months Ended March 31, 2004 and 2005

 

Revenue

 

Total revenue increased by 43.0% to $14.3 million for the three months ended March 31, 2005 from $10.0 million for the three months ended March 31, 2004. Our subscription revenue increased by 32.8% to $10.9 million or 75.9% of revenue for three months ended March 31, 2005 from $8.2 million or 81.7% of revenue for the three months ended March 31, 2004. This increase is attributable to increasing sales of our talent acquisition and employee performance management solutions primarily due to the increasing adoption of the on-demand model for software generally and talent acquisition and employee performance management solutions in particular. Our other revenue increased by 88.4% to $3.5 million for the three months ended March 31, 2005 from $1.8 million for 2004. This increase was primarily due to an increase in our success-based fees generated as a result of our increased subscription revenue and the sale of a perpetual license.

 

Cost of Revenue

 

Cost of revenue increased by 76.2% to $4.1 million for the three months ended March 31, 2005 from $2.3 million for the three months ended March 31, 2004. As a percentage of revenue, cost of revenue increased by 5.3%. The increase in the cost of revenue was primarily due to our increased revenue. The increase in the cost of revenue as a percentage of revenue was caused by our mix of sales. In particular, in quarters where we have sold a license agreement, the cost of revenue was lower.

 

Sales and Marketing

 

Sales and marketing expense increased by 9.0% to $3.6 million for the three months ended March 31, 2005 from $3.3 million for the three months ended March 31, 2004. The $0.3 million increase was primarily related to an increase in commissions due to higher sales of $0.2 million and an increase in marketing expenses of $0.1 million. We intend to increase the number of our sales and marketing employees significantly during the remainder of 2005.

 

General and Administrative

 

General and administrative expense increased by 50.0% to $3.3 million for the three months ended March 31, 2005 from $2.2 million for the three months ended March 31, 2004. The $1.1 million increase was primarily due to an increase in performance bonuses for our general and administrative staff as well as an increase in professional fees incurred in connection with this offering. We expect that the costs of being a public company, including the costs of compliance with the Sarbanes-Oxley Act of 2002 and other regulations governing public companies will increase our general and administrative expenses in the future.

 

Research and Development

 

Research and development expenses increased by 20.9% to $1.1 million for the three months ended March 31, 2005 from $0.9 million for the three months ended March 31, 2004. The $0.2 million increase in research and development was due to the development of additional enhancements to our applicant tracking system.

 

Depreciation and Amortization

 

Depreciation and amortization decreased by 9.1% to $0.5 million for the three months ended March 31, 2005 from $0.6 million for the three months ended March 31, 2004. The $0.1 million decrease was due to an early version of our applicant tracking system becoming fully depreciated.

 

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Comparison of Years Ended December 31, 2003 and 2004

 

Revenue

 

Total revenue increased by 36.2% to $46.3 million for the year ended December 31, 2004 from $34.0 million for 2003. The $12.3 million increase in total revenue was primarily a result of new purchases of solutions by existing and new clients and contract renewals. Our subscription revenue increased by 42.5% to $36.3 million or 78.5% of revenue for the year ended December 31, 2004 from $25.5 million or 75.1% of revenue for 2003. Our other revenue, which is composed primarily of discrete professional fees, increased by 17.4% to $10.0 million or 21.5% of revenue for the year ended December 31, 2004 from $8.5 million or 24.9% of revenue for 2003. We believe that subscription-fee based revenue increased more quickly than other revenue due to our continuing shift in focus toward subscription-based solutions and away from discrete professional services. We believe that the increase in total revenue was attributable to increased sales of our solutions driven primarily by improving economic conditions, increasing adoption of the on-demand model for software delivery generally and for talent acquisition and performance management solutions in particular, and increased effectiveness of our marketing program.

 

Cost of Revenue

 

Cost of revenue increased by 39.5% to $12.2 million for the year ended December 31, 2004 from $8.8 million for 2003. As a percentage of total revenue, cost of revenue increased to 26.4% for the year ended December 31, 2004 from 25.8% for 2003. The increase in cost of revenue was primarily the result of our increased revenue and related third-party license royalty costs, which comprised $0.7 million of the increase, and personnel costs associated with the delivery of our talent acquisition and employee performance management solutions, which comprised $2.1 million of the increase. The latter increase was primarily due to an increase in personnel responsible for delivery of our solutions from 186 employees as of December 31, 2003 to 264 employees as of December 31, 2004. The increase as a percentage of total revenue was primarily attributable to an increase in reimbursed expenses.

 

Sales and Marketing

 

Sales and marketing expenses increased by 27.5% to $13.4 million for the year ended December 31, 2004 from $10.5 million for 2003. The $2.9 million increase in sales and marketing expense was due to an increase in selling personnel cost of $2.6 million due to the addition of 17 employees in 2004, an increase in marketing and advertising of $0.6 million and an increase in sales support related cost of $0.6 million, offset by a decrease in bad debt expense $0.9 million.

 

General and Administrative

 

General and administrative expense increased by 36.9% to $10.2 million for the year ended December 31, 2004 from $7.5 million for 2003. The $2.7 million increase in general and administrative expense was due to an increase in performance bonuses of $1.2 million, an increase in employee benefits of $0.5 million, an increase in rent of $0.2 million, a non-cash charge of $0.2 million related to the issuance of options with an exercise price of less than the fair value of the stock underlying the option on the date of grant and an increase in general infrastructure cost to support our growth. The charge related to the issuance of options represents the estimated difference between the fair market value of the share price and the exercise price of the options at the date of the grant.

 

Research and Development

 

Research and development expenses increased by 23.3% to $4.3 million for the year ended December 31, 2004 from $3.5 million for 2003. The $0.8 million increase in product development expenses was due to an increase in expenses related to the expansion of our global development center, the transition of our research and development efforts to Hyderabad, India, and enhancements to the features of our on-demand software applications and other software. As a result of the transition of our research and development efforts to India, we

 

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expect to expand the features and functionality of our solutions without increasing research and development expenses as a percentage of revenue. As a percentage of revenue, product development expenses decreased due to efficiencies generated by our global development center. We also increased the number of employees in product development from 81 as of December 31, 2003 to 136 as of December 31, 2004.

 

Depreciation and Amortization

 

Depreciation and amortization decreased by 9.0% to $2.5 million for the year ended December 31, 2004 from $2.7 million in 2003.

 

Income (Loss) from Discontinued Operations

 

Discontinued operations resulted in net income, net of income tax, of $15,000 for the year ended December 31, 2003. This income was generated by the pharmaceutical training division and the Oracle implementation business which were sold and exited, respectively, in 2003. The income includes gain on sale of $0.9 million offset by a loss from discontinued operation of $0.8 million. Income (loss) from discontinued operations is not reflected in the financial results for the year ended December 31, 2004, as these businesses were no longer part of our operations.

 

The operating results for the pharmaceutical training division and the Oracle implementation business are classified as discontinued operations in the statements of operations for all periods presented, net of tax. A summary of discontinued operations is as follows:

 

    

For the

Year Ended December 31,


           2003      

          2004      

     (in thousands)

Revenue:

              

Subscription revenue

   $     $        –

Other revenue

     6,046      
    


 

Total revenue

   $ 6,046     $

Cost of revenue

     2,714      
    


 

Gross profit

   $ 3,332     $

Total operating expenses

     4,153      

Interest expense excluding interest on mandatory redeemable preferred shares

     23      
    


 

Loss from discontinued operations before income taxes

   $ (844 )   $

Gain on sale of discontinued operations

     869      

Income tax expense

     10      
    


 

Net income from discontinued operations

   $ 15     $
    


 

 

Interest Expense

 

Interest expense decreased by 54.7% to $0.2 million for the year ended December 31, 2004 from $0.4 million for 2003. The $0.2 million decrease in interest expense was primarily attributable to the repayment in 2004 of all borrowings on our line of credit.

 

Interest on Mandatory Redeemable Preferred Stock

 

Interest on mandatory redeemable preferred stock increased 402.9% to $8.4 million for the year ended December 31, 2004 from $1.7 million for 2003. The increase was due to the adoption of SFAS No. 150 in 2003, whereby the dividends, and changes in fair value of the mandatory redeemable preferred stock were recorded as a

 

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cumulative change in accounting principle through July 1, 2003 and as interest expense in the subsequent periods. As a result of the redemption of all of the outstanding shares of preferred stock in connection with this offering, we will not have this expense in the future.

 

Income Tax (Benefit) Expense

 

Income tax expense decreased to a $0.7 million benefit for the year ended December 31, 2004 from $0.0 million for 2003. The $0.7 million decrease in incomes tax expense was primarily attributable to the recognition of net operating loss carryforwards. Our net operating loss carryforward balance as of December 31, 2004 was $15.7 million.

 

Comparison of Years Ended December 31, 2002 and 2003

 

Revenue

 

Total revenue increased by 4.8% to $34.0 million for the year ended December 31, 2003 from $32.4 million for 2002. Our subscription revenue increased by 12.1% to $25.5 million or 75.1% of revenue for the year ended December 31, 2003 from $22.7 million or 70.1% of revenue for 2002. This increase is attributable primarily to increasing sales of our talent acquisition and performance management solutions due to improving economic conditions and the increasing adoption of the on-demand model for software delivery generally and talent acquisition and performance management solutions in particular. Our other revenue decreased by 12.4% to $8.5 million for the year ended December 31, 2003 from $9.7 million for 2002. This decrease in revenue was primarily due to the decrease in sales of our position-specific recruiting services as a result of the shift in our strategic focus to on-demand talent acquisition and performance management solutions.

 

Cost of Revenue

 

Cost of total revenue increased by 4.5% to $8.8 million for the year ended December 31, 2003 from $8.4 million for 2002. As a percentage of revenue, cost of revenue decreased by 0.1% from 25.9% to 25.8%. The increase in cost of revenue was primarily the result of our increased revenue, an increase of $6,900 in the average compensation of our service delivery employees, and a 39-person increase in the number of sales employees.

 

Sales and Marketing

 

Sales and marketing expenses decreased by 5.6% to $10.5 million for the year ended December 31, 2003 from $11.1 million for 2002. The $0.6 million decrease in sales and marketing expense was primarily due to a $0.9 million reduction in bad debt expense due to enhanced credit procedures offset by a $0.2 million increase in advertising and marketing and a $0.1 million increase in sales related travel expenses.

 

General and Administrative

 

General and administrative expense decreased by 13.8% to $7.5 million for the year ended December 31, 2003 from $8.7 million in 2002. The $1.2 million decrease in general and administrative expense was primarily due to the reduction of general and administration staff by 5 employees. This was accomplished by serving branch offices out of a centralized location.

 

Research and Development

 

Research and development expenses increased by 16.1% to $3.5 million for the year ended December 31, 2003 from $3.0 million for 2002. The $0.5 million increase in research and development was due to the development of enhancements to our applicant tracking program and additional features. The number of employees engaged in product development increased from 50 employees as of December 31, 2002 to 81 employees as of December 31, 2003.

 

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Depreciation and Amortization

 

Depreciation and amortization increased by 3.0% to $2.7 million for the year ended December 31, 2003 from $2.6 million in 2002.

 

Income (Loss) from Discontinued Operations

 

Discontinued operations resulted in net income of $15,000 for the year ended December 31, 2003 as compared to net income of $283,000 for the year ended December 31, 2002.

 

The operating results for the pharmaceutical training division and the Oracle implementation business are classified as discontinued operations in the statements of operations for all periods presented, net of tax. A summary of discontinued operations is as follows:

 

     For the
Year Ended December 31,


 
           2002      

           2003      

 
     (in thousands)  

Revenue:

                 

Subscription revenue

   $      $  

Other revenue

     14,239          6,046  
    

    


Total revenue

     14,239        6,046  

Cost of revenue

     7,565        2,714  
    

    


Gross profit

     6,674        3,332  

Total operating expenses

     6,179        4,153  

Interest expense excluding interest on mandatory redeemable preferred shares

     24        23  
    

    


Income (loss) from discontinued operations before income taxes

     471        (844 )

Gain on sale of discontinued operations

            869  

Income tax expense

     188        10  
    

    


Net income from discontinued operations

   $ 283      $ 15  
    

    


 

Interest Expense

 

Interest expense remained unchanged for the year ended December 31, 2003 as compared to 2002, at $0.4 million.

 

Interest on Mandatory Redeemable Preferred Stock

 

Interest on mandatory redeemable preferred stock increased to $1.7 million for the year ended December 31, 2003 as compared to $0.0 million for the year ended December 31, 2002. The increase was due to the adoption of SFAS No. 150 in 2003, whereby the dividends, and changes in fair value of the mandatory redeemable preferred stock were recorded as a cumulative change in accounting principle through July 1, 2003 and as interest expense in the subsequent periods. As a result of the redemption of all of the outstanding shares of preferred stock in connection with this offering, we will not have this expense in the future.

 

Income Tax (Benefit) Expense

 

Income tax expense increased to $0.0 million for the year ended December 31, 2003 as compared to a benefit of $0.1 million for the year ended December 31, 2002.

 

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Unaudited Quarterly Statements of Operations

 

The following tables present our unaudited quarterly results of operations for each of the nine quarters in the period ended March 31, 2005 and our unaudited quarterly results of operations expressed as a percentage of our subscription and other revenues for the same periods. You should read the following tables in conjunction with our audited consolidated financial statements and related notes appearing at the end of this prospectus. We have prepared the unaudited information on a basis consistent with our audited consolidated financial statements and have included all adjustments, which, in the opinion of management, are necessary to fairly present our operating results for the quarters presented. Our historical unaudited quarterly results of operations are not necessarily indicative of results for any future quarter or for a full year.

 

    For the Three Months Ended

 
   

March 31,
2003


   

June 30,

2003


    September 30,
2003


    December 31,
2003


    March 31,
2004


   

June 30,

2004


    September 30,
2004


    December 31,
2004


    March 31,
2005


 
          (unaudited)        
    (in thousands)  

Consolidated Statement of Operations Data:

                                                                       

Revenue

                                                                       

Subscription

  $ 5,238     $ 6,309     $ 6,763     $ 7,200     $ 8,183     $ 8,921     $ 9,347     $ 9,897     $ 10,871  

Other

    2,530       1,928       1,885       2,138       1,837       2,485       2,559       3,072       3,461  
   


 


 


 


 


 


 


 


 


Total revenue

    7,768       8,237       8,648       9,338       10,020       11,406       11,906       12,969       14,332  

Cost of revenue (exclusive of depreciation, shown separately below)

    2,235       1,993       2,404       2,135       2,304       2,736       3,495       3,695       4,060  
   


 


 


 


 


 


 


 


 


Gross profit

    5,533       6,244       6,244       7,203       7,716       8,670       8,411       9,274       10,272  
   


 


 


 


 


 


 


 


 


Operating expenses:

                                                                       

Sales and marketing

    1,949       2,767       2,578       3,176       3,306       3,383       3,212       3,449       3,603  

General and administrative

    1,636       1,907       1,752       2,186       2,210       2,471       2,516       3,047       3,313  

Research and development

    919       801       936       808       926       1,201       1,107       1,035       1,120  

Depreciation and amortization

    715       691       679       634       607       569       638       662       552  
   


 


 


 


 


 


 


 


 


Total operating expenses

    5,219       6,166       5,945       6,804       7,049       7,624       7,473       8,193       8,588  
   


 


 


 


 


 


 


 


 


(Loss) income from continuing operations before income tax and interest expense

    314       78       299       399       667       1,046       938       1,081       1,684  
   


 


 


 


 


 


 


 


 


Interest expense

    91       80       117       65       48       47       43       21       12  

Interest on mandatory redeemable preferred shares

                827       840       2,068       2,085       2,109       2,124       8,534  
   


 


 


 


 


 


 


 


 


Income (loss) from continuing operations before income tax

    223       (2 )     (645 )     (506 )     (1,449 )     (1,086 )     (1,214 )     (1,064 )     (6,862 )

Income tax (benefit) expense on continuing operations

    0       0       0       (49 )     2       60       81       (865 )     40  
   


 


 


 


 


 


 


 


 


Income (loss) from continuing operations

    223       (2 )     (645 )     (457 )     (1,451 )     (1,146 )     (1,295 )     (199 )     (6,902 )

Income (loss) from discontinued operations, net of tax

    (78 )     195       (159 )     (25 )                              
   


 


 


 


 


 


 


 


 


Net income (loss) before cumulative effect of change in accounting principle

    145       193       (804 )     (482 )     (1,451 )     (1,146 )     (1,295 )     (199 )     (6,902 )

Cumulative effect of change in accounting principle

                11,233                                      
   


 


 


 


 


 


 


 


 


Net income (loss)

  $ 145     $ 193     $ (12,037 )   $ (482 )   $ (1,451 )   $ (1,146 )   $ (1,295 )   $ (199 )   $ (6,902 )
   


 


 


 


 


 


 


 


 


 

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Table of Contents
    For the Three Months Ended

 
   

March 31,

2003


   

June 30,

2003


    September 30,
2003


    December 31,
2003


    March 31,
2004


   

June 30,

2004


    September 30,
2004


    December 31,
2004


    March 31,
2005


 
          (unaudited)        

Consolidated Statement of Operations Data:

                                                     

Revenue

                                                     

Subscription revenue

  67.4 %   76.6 %   78.2 %   77.1 %   81.7 %   78.2 %   78.5 %   76.3 %   75.9 %

Other revenue

  32.6 %   23.4 %   21.8 %   22.9 %   18.3 %   21.8 %   21.5 %   23.7 %   24.1 %
   

 

 

 

 

 

 

 

 

Total revenue

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenues (exclusive of depreciation, shown separately below)

  28.8 %   24.2 %   27.8 %   22.9 %   23.0 %   24.0 %   29.4 %   28.5 %   28.3 %
   

 

 

 

 

 

 

 

 

Gross profit

  71.2 %   75.8 %   72.2 %   77.1 %   77.0 %   76.0 %   70.6 %   71.5 %   71.7 %

Operating expenses:

                                                     

Sales and marketing

  25.1 %   33.6 %   29.7 %   34.0 %   33.0 %   29.6 %   27.0 %   26.5 %   25.2 %

General and administrative

  21.0 %   23.2 %   20.3 %   23.4 %   22.0 %   21.7 %   21.1 %   23.5 %   23.1 %

Research and development

  11.8 %   9.7 %   10.8 %   8.7 %   9.2 %   10.5 %   9.3 %   8.0 %   7.8 %

Depreciation and amortization

  9.2 %   8.4 %   7.9 %   6.8 %   6.1 %   5.0 %   5.4 %   5.1 %   3.9 %
   

 

 

 

 

 

 

 

 

Total operating expenses

  67.1 %   74.9 %   68.7 %   72.9 %   70.3 %   66.8 %   62.8 %   63.1 %   60.0 %

Income from continuing operations before income tax and interest expense

  4.1 %   0.9 %   3.5 %   4.2 %   6.7 %   9.2 %   7.8 %   8.4 %   11.7 %

Interest expense

  1.2 %   1.0 %   1.4 %   0.7 %   0.5 %   0.4 %   0.4 %   0.2 %   0.1 %

Interest on mandatory redeemable preferred shares

  0.0 %   0.0 %   9.6 %   9.0 %   20.6 %   18.3 %   17.7 %   16.4 %   59.5 %
   

 

 

 

 

 

 

 

 

Loss from continuing operations before income tax

  2.9 %   (0.1 )%   (7.5 )%   (5.5 )%   (14.4 )%   (9.5 )%   (10.3 )%   (8.2 )%   (47.9 )%

Income tax (benefit) expense on continuing operations

  0.0 %   0.0 %   0.0 %   (0.5 )%   0.0 %   0.5 %   0.7 %   (6.7 )%   0.3 %
   

 

 

 

 

 

 

 

 

(Loss) income from continuing operations

  2.9 %   (0.1 )%   (7.5 )%   (5.0 )%   (14.4 )%   (10.0 )%   (11.0 )%   (1.5 )%   (48.2 )%

Income (loss) from discontinued operations, net of tax

  (1.0 )%   2.4 %   (1.8 )%   (0.3 )%   0.0 %   0.0 %   0.0 %   0.0 %   (0.0 )%
   

 

 

 

 

 

 

 

 

Loss before cumulative effect of change in accounting principle

  1.9 %   2.3 %   (9.3 )%   (5.3 )%   (14.4 )%   (10.0 )%   (11.0 )%   (1.5 )%   (48.2 )%

Cumulative effect of change in accounting principle

  0.0 %   0.0 %   129.9 %   0.0 %   0.0 %   0.0 %   0.0 %   0.0 %   0.0 %
   

 

 

 

 

 

 

 

 

Net income (loss)

  1.9 %   2.3 %   (139.2 )%   (5.3 )%   (14.4 )%   (10.0 )%   (11.0 )%   (1.5 )%   (48.2 )%
   

 

 

 

 

 

 

 

 

 

Comparison of Unaudited Quarterly Results

 

Revenue

 

Total revenue has increased each of our last nine quarters primarily due to purchases of our solutions by new clients, purchase of additional solutions by existing clients and contract renewals. Our subscription revenue increased in every quarter presented from $5.2 million for the three months ended March 31, 2003 to $10.9 million for the three months ended March 31, 2005. Our other revenue increased from $2.5 million for the three months ended March 31, 2003 to $3.5 million for the three months ended March 31, 2005. We believe that subscription revenue increased more quickly than other revenue due to our continuing shift in focus toward subscription-based solutions and away from discrete professional services.

 

Cost of Revenue

 

Cost of revenue for the quarters presented has fluctuated based on the mix of sales between subscription revenue and other revenue. Cost of revenue was highest as a percentage of total revenue for the three months ended September 30, 2004. This was caused by the mix of sales included in other revenue in that quarter. In particular, sales of perpetual licenses can have a meaningful impact on cost of revenue.

 

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Sales and Marketing

 

Sales and marketing expenses have decreased as a percentage of total revenue for each of the three month periods ended March 31, 2004 through March 31, 2005. Sales and marketing expenses have increased in terms of absolute dollars through the same period as a result of increased marketing programs and variable compensation programs. The decrease as a percentage of sales is a result of the effectiveness of the marketing program and the effectiveness of an experienced sales force.

 

General and Administration

 

General and administrative expenses for the quarters presented have generally increased each quarter due to an increase in performance bonuses. Headcount and professional fees have also increased to support our growth.

 

Research and Development

 

Research and development expenses for the quarters presented have generally increased each quarter due to an increase in product development expenses and enhancements and upgrades to our existing products.

 

Liquidity and Capital Resources

 

Since we were formed in 1987, we have financed our operations primarily through internally generated cash flows, our line of credit and the issuance of preferred and common stock. As of December 31, 2004, we had cash and cash equivalents of $9.5 million and accounts receivable of $8.5 million. We have no debt and less than $1.0 million in capital equipment leases. As of December 31, 2004, the aggregate outstanding balance, including accumulated dividends, on our series A preferred stock and series B preferred stock was $41.7 million and $17.2 million, respectively. All of the outstanding preferred stock will be redeemed for cash and shares of common stock in connection with this offering.

 

In 2004, we had cash provided from continuing operations of $10.1 million. We used cash in investing activities in the amount of $1.2 million and we used cash in financing activities of $2.5 million. Our net increase in cash and cash equivalents was $6.4 million. In addition, we repaid the $1.6 million outstanding balance on our line of credit. We expect this positive cash flow to continue in future periods.

 

We have a $10 million line of credit with PNC Bank, National Association that is collateralized by all of our assets, including a pledge of capital stock of certain of our subsidiaries. Our maximum available borrowing under the line is subject to a borrowing base which is 85% of eligible receivables and 75% of unbilled receivables. As of December 31, 2003 and 2004, the maximum available borrowing amount was $2.7 million and $3.7 million, respectively.

 

Operating Activities

 

Net cash provided by operating activities for continuing operations was $1.5 million for the year ended December 31, 2002, $4.0 million for the year ended December 31, 2003 and $10.1 million for the year ended December 31, 2004. Net cash provided by operating activities for the year ended December 31, 2002 primarily resulted from non-cash charges to net income of $4.9 million, in addition to an increase in unearned revenue of $0.6 million offset by of a net loss of $1.7 million and changes in working capital of $2.3 million. Net cash provided by operating activities for the year ended December 31, 2003 primarily resulted from net loss of $12.2 million and non-cash charges to net income of $18.9 million, an increase in unearned revenue of $0.7 million offset by working capital changes of $3.4 million. Non-cash charges include an $11.2 million adjustment for the effect of a change in accounting resulting from the adoption of SFAS No. 150 on July 1, 2003 whereby the dividends, and changes in fair value of the mandatory redeemable preferred stock were recorded as a cumulative

 

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change in accounting principle through July 1, 2003 and as interest expense in the subsequent periods. As a result of the redemption of all of the outstanding shares of preferred stock in connection with this offering, we will not have this expense in the future. Net cash provided by operating activities for the year ended December 31, 2004 primarily resulted from net loss of $4.1 million plus non-cash charges to net income of $10.4 million plus an increase in unearned revenue of $3.4 million plus changes in working capital of $0.4 million. Non-cash charges to net income include $8.4 million of accrued interest on mandatory redeemable preferred stock.

 

Investing Activities

 

Net cash used in investing activities for continuing operations was $1.8 million for the year ended December 31, 2002, $0.8 million for the year ended December 31, 2003 and $1.2 million for the year ended December 31, 2004. Net cash used in investing activities was related to capitalized software activities and purchases of computer hardware. Net cash provided from investing activities for discontinued activities was $3.0 million for the year ended December 31, 2003. In November 2003, we decided to discontinue our pharmaceutical training division and we discontinued our Oracle implementation business. The sale of the pharmaceutical training division in December 2003 for $3.0 million in cash produced a net gain of approximately $0.9 million.

 

Financing Activities

 

Net cash used by financing activities was $0.6 for year ended December 31, 2002, $2.9 million for the year ended December 31, 2003 and $2.5 million for the year ended December 31, 2004. For the years ended December 31, 2002, 2003 and 2004, net cash used by financing activity consisted of repayments of borrowings under the line of credit, repayments of notes payable and repayments of capital lease obligations. Repayments on our line of credit were $1.5 million and $1.6 million in the years ended December 31, 2003 and 2004, respectively, while we borrowed $0.5 million on our line of credit in the year ended December 31, 2002. Repayments of our capital lease obligations were $0.4 million for each of the years ended December 31, 2002 and 2003 and were $0.3 million for the year ended December 31, 2004. Repayments of notes payable were $0.7 million and $0.7 million for the years ended December 31, 2002 and 2003 and zero for the year ended December 31, 2004. We also used $0.6 million to repurchase shares of our common stock owned by certain of our former employees during the year ended December 31, 2004.

 

We believe that our cash and cash equivalent balances and cash flows from operations will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next 12 months. We will use $40 million of the proceeds from this offering to pay part of the consideration for the redemption of all of the outstanding shares of our series A preferred stock and series B preferred stock. See the “Use of Proceeds” section of this prospectus. Our available borrowings under our line of credit on December 31, 2003 and 2004 were $2.7 million and $3.7 million, respectively. Amounts outstanding on the line of credit were $1.6 million and $0 on December 31, 2003 and 2004, respectively. We intend to continue to invest our cash in excess of current operating requirements in interest-bearing, investment-grade securities. Changes in our operating plans, lower than anticipated revenue, increased expenses or other events, including those described in “Risk Factors,” may cause us to seek additional debt or equity financing on an accelerated basis. 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. We do not, however, have any current plans to issue additional equity, including any preferred stock, in the near future.

 

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Contractual Obligations and Commitments

 

The following table summarizes our contractual arrangements at December 31, 2004, after giving effect to the completion of this offering and our application of the net proceeds, and the timing and effect that such commitments are expected to have on our liquidity and cash flows in future periods:

 

     Payments due by period

     2005

   2006

   2007

   2008

   2009

     (in thousands)

Contractual Obligations

                                  

Capital leases

   $ 234    $ 176    $ 92    $ 32      –  

Operating leases

     2,390      1,917      1,603      1,448    $ 1,314

Mandatory redeemable preferred stock

          65,073               
    

  

  

  

  

Total

   $ 2,624    $ 67,166    $ 1,695    $ 1,480    $ 1,314
    

  

  

  

  

 

The amounts listed above for capital leases represent payments that we are required to make for equipment. If we fail to remain current with our obligations for any of these capital leases, we would be in default, and our continued failure to cure such a default would cause our remaining obligations under the defaulted capital lease to become immediately due.

 

The amounts listed above for operating leases represent our leases for office space. If we fail to make rent payments on any of these leases when due, we will be required to pay all remaining rent payments on the leases.

 

Mandatory redeemable preferred stock represents our redemption obligations, including all accrued and unpaid dividends on our series A preferred stock and series B preferred stock. We are required to redeem our series A preferred stock and series B preferred stock on the earlier of August 16, 2006 or a liquidation event, including this offering. Pursuant to the terms of our articles of incorporation, our series A preferred stock and series B preferred stock can be redeemed, at the option of the holder, for cash, stock, or a combination of cash and stock. All of our series A preferred stock and series B preferred stock will be redeemed upon the completion of this offering. We have entered into an investor agreement with the holders of our series A preferred stock and series B preferred stock regarding the manner and consideration to be paid with respect to the outstanding shares of our series A preferred stock and series B preferred stock at the time of the offering. See “Redemption and Conversion Transactions.”

 

Quantitative and Qualitative Disclosures About Market Risk

 

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. We do not hold or issue financial instruments for trading purposes.

 

Foreign Currency Exchange Risk

 

In 2004, approximately 91.2% of our total revenue was comprised of sales to clients in the United States. A key component of our business strategy is to expand our international sales efforts, which will expose us to foreign currency exchange rate fluctuations. A 10% change in the value of the U.S. dollar relative to each of the currencies of our non-U.S-generated sales would not have resulted in a material change to our results.

 

The financial position and operating results of our United Kingdom and India operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date, and the local currency revenue and expenses are translated at average rates of exchange to the U.S. dollar during the period. The related translation adjustments were $0.02 million, $0.1 million and $0.1 million at December 31, 2003, 2004 and at March 31, 2005, respectively, and are included in additional paid-in capital. The foreign currency translation adjustment is not adjusted for income taxes as it relates to an indefinite investment in a non-U.S. subsidiary.

 

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Interest Rate Risk

 

The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. Our cash equivalents, which consist solely of money market funds, are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. We do not believe that a 10% change in interest rates would have a significant effect on our interest income.

 

Recent Accounting Pronouncements

 

In January 2003, the FASB issued FASB Interpretation No., or FIN, 46, Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a variable financial interest, or VIE. Variable interest entities within the scope of FIN 46 are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of this statement did not have an impact on our financial position, results of operations or cash flows since we currently have no variable interest entities. In December 2003, the FASB issued FIN 46R with respect to VIEs created before January 31, 2003, which, among other things, revised the implementation date to the first fiscal year or interim period ending after March 15, 2004, with the exception of special purpose entities. The consolidation requirements apply to all special purpose entities in the first fiscal year or interim period ending after December 15, 2003. We adopted the provision of FIN 46R effective January 1, 2004, and such adoption did not have a material impact on the financial statements since we currently have no special purpose entities.

 

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 affects the issuer’s accounting for three types of freestanding financial instruments:

 

    mandatory redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets;

 

    instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets, including put options and forward purchase contracts; and

 

    obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers’ shares.

 

SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 caused us to classify $50.5 million and $58.9 million of

 

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redeemable participating preferred stock as liabilities in years ended December 31, 2003 and 2004, respectively. We recorded interest expense on mandatory redeemable preferred stock of $8.4 million and $1.7 million in the years ended December 31, 2004 and 2003, respectively. Additionally, we also recorded a change of $11.2 million in 2003 resulting from a change in an accounting principle. There was no material effect on our cash flows from the adoption of SFAS No. 150. See the notes to our consolidated financial statements.

 

In December 2003, the SEC issued Staff Accounting Bulletin No. 104, “Revenue Recognition,” which updates and summarizes the Commission’s views on the application of generally accepted accounting principles to revenue recognition in financial statements. We believe that our revenue recognition policies conform to the requirements of Staff Accounting Bulletin No. 104.

 

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, an amendment of SFAS No. 123 and SFAS No. 95. SFAS No. 123(R) replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to recognize the fair value of stock options and other stock-based compensation to employees effective as of the beginning of its next fiscal year that begins after June 15, 2005. We will be required to implement SFAS No. 123(R) no later than the quarter beginning January 1, 2006. We currently measure stock-based compensation in accordance with APB Opinion No. 25. We anticipate adopting the modified prospective method of SFAS No. 123 (R) on January 1, 2006. Based on the stock options outstanding as of December 31, 2004, we will recognize compensation expense in future consolidated statements of income of approximately $0.07 million and $0.05 million in the years ended December 31, 2006 and 2007, respectively. The impact on our financial condition or results of operations will depend on the number and terms of stock options outstanding on the date of change, as well as future options that may be granted.

 

Change in Accountants

 

On November 20, 2003, upon the authorization of the board of directors of Kenexa acting on the recommendation of the audit committee of the board of directors, Kenexa dismissed PricewaterhouseCoopers LLP and engaged BDO Seidman, LLP as Kenexa’s independent registered public accounting firm. Kenexa did not consult with BDO Seidman, LLP on any financial or accounting reporting matters before its appointment. All of the audited financial statements included in this prospectus, including those for the year ended December 31, 2002, have been audited by BDO Seidman, LLP.

 

During the years ended December 31, 2001 and 2002, and through November 20, 2003, there were no disagreements with PricewaterhouseCoopers LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of PricewaterhouseCoopers LLP, would have caused them to make reference thereto in their reports on Kenexa’s financial statements for such years. The reports of PricewaterhouseCoopers LLP on Kenexa’s financial statements for the years ended December 31, 2001 and 2002 did not contain an adverse opinion or disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principle.

 

During the years ended December 31, 2001 and 2002 and through November 20, 2003, there were no reportable events, as defined in Item 304(a)(1)(v) of Regulation S-K.

 

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BUSINESS

 

Company Overview

 

We provide software, services and proprietary content that enable organizations to more effectively recruit and retain employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We offer the software applications that form the core of our solutions on an on-demand basis, which materially reduces the costs and risks associated with deploying traditional enterprise applications. We complement our software applications with tailored combinations of outsourcing services, consulting services and proprietary content based on our 18 years of experience assisting clients in addressing their HR requirements. Together, our software applications and services form what are commonly referred to as solutions. We believe that these solutions enable our clients to improve the effectiveness of their talent acquisition programs, increase employee productivity and retention, measure key HR metrics and make their hiring and employee performance management programs more efficient.

 

We sell our solutions to large- and medium-sized organizations through our direct sales force. As of March 31, 2005, we had a client base of approximately 2,100 companies, including approximately 90 companies on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services during the 12 months ended March 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately 65.6% of our revenue for the year ended December 31, 2004 and 64.8% of our revenue for the three months ended March 31, 2005. Our clients typically purchase multi-year subscriptions which provide us with a recurring revenue stream. During 2004, our clients renewed approximately 89.6% of the aggregate contract value eligible to be renewed during the period.

 

Industry Overview

 

Talent acquisition is the sourcing, recruiting, screening and assessment of employees. Employee performance management is the systematic process by which an organization tracks, monitors and optimizes employee behavior and productivity, and evaluates performance through employee reviews, appraisals and business metrics. IDC estimated in 2004 that the worldwide market for e-recruiting and performance management applications will grow from approximately $460.0 million in 2003 to $1.1 billion by 2008, a 19% compound annual growth rate, and the worldwide market for human resources business process outsourcing will grow from approximately $6.9 billion in 2003 to $14.2 billion in 2008, a 16% compound annual growth rate.

 

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 2004 was approximately $6.8 trillion, or approximately 56% of the total U.S. gross domestic product. In January 2005, HR Magazine reported that as much as 80% of a company’s worth is tied to its human capital. At the same time, competition for qualified employees continues to intensify, driven by the retirement of the baby-boomers, the increasing service component of the U.S. economy and improved economic conditions. According to the U.S. Bureau of Labor Statistics, the unemployment rate in May 2005 was at its lowest level since September 2001.

 

Over the past two decades, many organizations have implemented software systems that systemize best practices and drive efficiency in most departments, including enterprise resource planning systems, customer relationship management systems and supply chain management systems. These software applications provide a wide array of benefits that both increase 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. Based on our experience, we believe that few organizations have systemized 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.

 

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Our experience indicates that, presently, many organizations’ talent acquisition functions consist of manual, paper-based processes, 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. Because many organizations rely on manual, paper-based processes, 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. Because many organizations do not maintain easily searchable databases of processed candidates, 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 an 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.

 

    Inconsistency. Many organizations screen applications and resumes based on rudimentary criteria, and do not conduct sophisticated and objective assessments and base hiring decisions primarily on subjective, ad hoc interviews. This process lacks consistency and objectivity. This inconsistency not only negatively impacts the effectiveness of recruiting programs, 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 goals, significantly increasing the costs of their talent acquisition programs.

 

Similarly, based on our experience, we believe that many organizations have neither automated nor applied best practices to employee performance management. We believe that most organizations’ employee performance management processes consist of annual performance reviews and informal mentoring programs. According to a December 2004 study by Aberdeen Group, 52% of respondents reported that their organization is locked into paper-based evaluations that are conducted yearly and rarely reviewed again. In fact, Aberdeen Group reported that 90% of respondents cited improved employee performance management as a key to competitive advantage. We believe that effective employee performance management requires a consistent, systemized 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. The absence of effective employee performance management systems and processes has the following negative implications:

 

    Failure to retain top performers. We believe that 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 its top performing employees. Management may not have the opportunity to rectify problems with valuable employees before they depart from the organization without a system to highlight these issues. Based on U.S. Bureau of Labor Statistics data, the Employment Policy Foundation, a public policy research and education foundation, estimated that for the 12 months ended August 31, 2004, private sector average turnover was 25% and that the cost of an employee’s turnover was 25% of an employee’s salary. Reducing employee turnover can have a material impact on expenses. The Employment Policy Foundation estimated that for a firm with 40,000 full-time employees, the difference between a 15% turnover rate and a 25% turnover rate saves over $50 million annually.

 

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    Failure to optimize productivity. We believe that 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 recurring negative impact on an organization. To the extent that a poor performer has managerial responsibility, this negative impact on the organization expands 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.

 

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. Traditionally, 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 and storage systems. In addition, the organization must employ consultants or additional IT staff to integrate the application into increasingly complicated IT environments and customize the application for specific needs. The ancillary costs of a complex deployment can be multiples of the perpetual license fee for the software application and 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, 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.

 

    Limited incentives to ensure client success. A typical perpetual software license requires the client to pay a material amount up-front 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 client satisfaction.

 

Recent developments in technology have enabled software developers to offer enterprise software applications on an on-demand basis. Leveraging the Internet, multi-tiered architectures, advances in security and open standards for application integration, software vendors can offer software applications to their clients as a service, hosting the software on servers operated by the software vendor. Clients, using an Internet browser, access the applications, which are designed to be easily configured and integrated with a client’s existing applications.

 

The on-demand model fundamentally changes both the purchasing and deployment of enterprise software from a client perspective. Rather than making large, up-front investments in perpetual licenses, clients

 

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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 client subscriptions provides a strong incentive to software vendors to ensure that the software provides the expected benefits to the client, resulting in consistent customer service. The on-demand model also reduces research and development support costs for the software developer. Because only limited versions of the software exist at any one time, the on-demand model relieves the burden of maintaining and upgrading historical versions of the software. These dynamics are driving growth in the market for software on-demand, which IDC refers to as software-as-a-service. IDC estimated in 2004 the worldwide market for software-as-a-service will grow from approximately $3.0 billion in 2003 to $9.1 billion by 2008, a 24.6% compound annual growth rate.

 

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.

 

Our Solution

 

We are a leading provider of talent acquisition and employee performance management solutions. Our solutions enable organizations to implement systematic talent acquisition practices that ensure the efficient, effective and consistent hiring of qualified individuals. Our solutions also provide employee performance management systems that help to ensure that organizations retain and optimize the performance of qualified individuals and identify employees who fail to perform. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We believe that by providing our software applications on an on-demand basis, we materially reduce the costs and risks associated with traditional enterprise software application implementations. We also believe that implementing feature-rich and scalable, or easily configurable on a real-time basis, talent acquisition and employee performance management solutions that meet organizations’ specific needs requires a combination of software, services and domain-specific content. Accordingly, we complement our software applications with consulting services, outsourcing services and proprietary content. Together, these components form solutions that enable our clients to improve the quality of their hiring programs, increase employee productivity and retention and make their talent acquisition and employee performance 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 clients 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 skills, aptitude, personality and experience necessary to be successful in the desired position. Our talent acquisition solutions enable our clients to:

 

    expand the pool of qualified applicants;

 

    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;

 

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    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 systemize employee performance management best practices. Specifically, our solutions enable organizations to automate career tracking activities, 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 believe that our clients experience greater employee productivity and improved employee retention after implementing our solutions.

 

    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 clients 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 talent acquisition and employee performance management solutions. Key elements of our strategy include:

 

    Focus on talent acquisition and employee performance management solutions. Unlike some vendors that provide broad suites of HCM software, we have focused solely on talent acquisition and employee performance management, which are the strategic HR elements of our clients. We believe that this focus has enabled us to deliver solutions that meet the unique needs of our clients 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 HCM market over the next five years. We intend to continue to focus on talent acquisition and employee performance management in order to leverage our increasingly recognized brand in these markets and these positive market dynamics.

 

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    Provide innovative and industry-specific solutions to our clients. During the past three years, we have introduced several new solutions, each in response to the unique needs of our clients. We intend to continue to work closely with our clients 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; healthcare; hospitality; call centers; and education. We intend to develop specific solutions for additional vertical industries.

 

    Cross-sell additional solutions to and further penetrate current clients. During the year ended December 31, 2004, we renewed approximately 89.6% of the aggregate value of contracts subject to renewal. This renewal rate provides us with a strong base of recurring revenue. We believe that our strong client relationships provide us with a meaningful opportunity to cross-sell additional solutions to our existing clients 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 from each of our clients.

 

    Continue to leverage our highly efficient development center in India. We established a technology development center in Hyderabad, India in 2003. We currently have approximately 70 developers working in Hyderabad providing us with low-cost, 24 hours a day, 7 days a week development capabilities. Our cost per developer in India is 70% less than our cost per developer in the United States. We intend to continue to leverage this asset to deliver technologically advanced solutions to our clients.

 

    Expand our global presence and client base. We have grown to $46.3 million in annual revenue and approximately 2,100 clients primarily focused on the U.S. market. However, 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, the Middle East and the Asia/Pacific region. Although we have employed a direct sales force in the United States, we intend to expand our international distribution through partnerships. We believe that pursuing a channel strategy enables us to limit the costs associated with international expansion and acknowledges that different geographies present different cultural challenges best addressed by a local sales force.

 

    Pursue complementary acquisitions. We have completed 19 acquisitions of businesses since 1994. These acquisitions have helped us to adapt our business to the evolving needs of our clients. 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.

 

Our Products and Services

 

Our Talent Acquisition Solution

 

Kenexa Recruiter. The Kenexa Recruiter system is a web-based recruiting management system that streamlines and automates the entire recruiting process. Kenexa Recruiter includes the following features:

 

    converts our client’s corporate website into an interactive, branded career center where candidates can search and apply for jobs, update personal information and receive automatic notifications of available jobs of interest;

 

    integrates with our suite of testing and assessment technologies to identify candidates with the highest potential for success;

 

    enables clients to post job openings to over 1,100 free and fee-based Internet job boards;

 

    intelligently searches Internet job sites, corporate websites, personal web pages and a client’s database of resumes to automatically capture both passive and active candidates and pull their resumes directly to the desktop;

 

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    provides management with both standard and ad hoc reports to facilitate understanding of the status of clients’ talent acquisition programs;

 

    provides management with individualized HR dashboards that display rich data regarding the status of clients’ talent acquisition programs and access to the most frequently used functions;

 

    easily configurable to automate a client’s talent acquisition model and workflow processes;

 

    integrates easily with clients’ HR information systems such as Oracle (PeopleSoft), SAP, ADP and Lawson; and

 

    can be presented via an in-store kiosk as Kenexa Storefront, a solution tailored to the retail industry.

 

Kenexa PeopleQuest. Our PeopleQuest system enables clients to expand the pool of qualified candidates for an open position by automating the phone interview. By combining voice recognition technology from a third party, software and consulting services, the PeopleQuest solution assists clients in creating friendly and effective pre-recorded phone interviews tailored to their specific needs. Our software also automates the data gathering, screening and interview scheduling process so that high-potential candidates are processed efficiently.

 

Kenexa Prove It! The Kenexa Prove It! tool is an automated, easily configurable skills assessment tool that enables our clients to accurately identify qualified candidates. Integrating software with proprietary content, Kenexa Prove It! provides our clients with over 800 skills assessments for clerical, software, call center, industrial, healthcare and technical jobs.

 

Kenexa Selector. The Kenexa Selector tool is an automated, easily configurable candidate assessment tool that provides accurate performance predictions for hourly, sales and managerial positions. Kenexa Selector integrates our software with our proprietary content to elicit responses that reveal candidate personality, experience and problem-solving ability and then immediately translates this information into profiles of candidate strengths and weaknesses.

 

Kenexa Insight. The Kenexa Insight solution is a consulting-based solution that provides our clients with customized, research-based interviews that accurately and consistently identify talented candidates for hire and promotion. Our consultants work directly with our clients to analyze the most talented performers in different positions within their organization. We translate this analysis into complete structured interviews that identify candidates that have similar traits and behaviors to our clients’ most talented employees. We offer clients the option of conducting the interviews themselves or outsourcing this task to our professionals. Following the interview, we track the results to validate the relationship between the interview and actual performance.

 

Kenexa Interview Builder. Our Interview Builder tool is a software tool integrated with a reference library of proprietary content, including more than 1,200 interview questions and competency profiles. Our clients use Interview Builder to generate efficient, accurate and consistent interviews that encourage candidates to speak freely about their knowledge, abilities, skills and other crucial job requirements for more than 40 different competencies. We complement this proprietary content with training for creating and conducting competency-linked, structured interviews.

 

Our Employee Performance Management Solution

 

Kenexa CareerTracker. The Kenexa CareerTracker system is a complete employee performance management system that streamlines and automates the entire employee performance management process in order to improve employee retention and productivity. The Kenexa CareerTracker system consists of a suite of software applications complemented by proprietary content and consulting services that together support an ongoing performance appraisal process and continuous employee improvement.

 

Kenexa CareerTracker enables managers to:

 

    automatically track and categorize employees within the organization;

 

    align each department’s goal with those of the overall organization;

 

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    implement systematic employee performance appraisals; and

 

    implement sophisticated and automated mentor matching programs.

 

Kenexa CareerTracker enables employees to:

 

    create individualized step-by-step development plans;

 

    align personal goals with organizational objectives;

 

    access resources for improvement in targeted competencies; and

 

    identify future opportunities within the organization.

 

Kenexa Survey Technology. We believe that our survey technology enables our clients to conduct employee surveys that are easy to administer even though the underlying organizational requirements are extremely complex. Our survey technology is comprised of:

 

    Surveys Online. A web-based survey system that has been load-tested to process more than 1 million surveys within a 24-hour period.

 

    OrgMapper. An automated software system that simplifies the process of mapping an organization to ensure appropriate recording capabilities and options.

 

    Survey Ordering System. An automated online system that accepts orders, distributes and tracks employee surveys for geographically distributed organizations.

 

    Kenexa Survey Scorecard. A software system that integrates data derived from our surveys into a secure, web-based online portal that enables managers to view survey results, identify areas for improvement, automate action-planning to address weaknesses and track progress against action-plans. It also integrates proprietary content from our HR best practices database to guide managers in the action-planning process.

 

    Kenexa Online Dynamic Reporting. A flexible, secure, web-based reporting tool for employee surveys which includes a variety of pre-designed reports as well as facilitates the design of custom reports.

 

Multi-rater surveys. These surveys combine software, proprietary content and consulting services to provide our clients with a comprehensive outsourced competency assessment service, including design, administration and reporting. The solution integrates our competency library, which contains more than 40 competencies and a broad array of assessment items designed to measure the discrete behaviors that comprise a competency, with consulting services provided by our staff psychologists who have significant experience developing, implementing and validating competency assessments.

 

Employee engagement surveys. Our consultants assist our clients in designing, administering and analyzing employee engagement surveys. We developed our Employee Engagement model through studies of organizational effectiveness and a comprehensive review of the academic literature related to employee commitment, psychological ownership, organizational pride, loyalty and satisfaction. We conduct analyses which link survey results to business metrics. By linking the survey results to clients’ performance variables, we can recommend actions for improved performance. We have documented the relationship between employee attitudes and business outcomes such as customer satisfaction, employee retention and management effectiveness. We have used this information to improve customer satisfaction, to increase efficiency and ultimately to increase our clients’ financial performance.

 

Employment Process Outsourcing

 

In concert with providing talent acquisition and employment performance management solutions that enable organizations to implement best practices in these areas, we provide our clients with the option of outsourcing to us certain aspects of their staffing operations and recruiting campaigns, including the sourcing,

 

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recruiting, screening, assessment and on-boarding of employees. Acknowledging that organizations need to retain strategic control of their HR programs, we offer our clients the ability to outsource only the tactical components and design solutions that meet each client’s specific objectives. These solutions combine our services and technology in what we believe is an integrated delivery platform that allows organizations to manage fluctuation in hiring needs and leverage shared infrastructure to reduce costs. We employ a team of experienced staffing professionals who have worked in the internal departments of some of the world’s largest companies and have completed our comprehensive proprietary training and certification program.

 

We believe our employment process outsourcing, or EPO, services enable our clients to reduce operating costs, focus on their core business, create a variable cost structure around certain non-strategic HR functions, improve the quality of certain HR functions, foster innovation and obtain access to leading technology without the corresponding investment to own the technology themselves. Clients contract for our EPO services for a pre-determined period. Generally, we will enter into service level agreements with our clients to ensure the quality of our services.

 

Our EPO services include the following:

 

    Process consulting. We perform needs analyses and advise clients on the implementation of technology and processes to optimize their talent acquisition operations.

 

    Staffing department management services. We assume all or discrete parts of the staffing function on an outsourced basis.

 

    On-site staffing professional support. We provide on-site support for ongoing staffing operations or during large scale hiring initiatives.

 

    Multi-channel sourcing strategy development and execution. We develop and execute a multi-channel sourcing strategy that allows our clients to expand their candidate pool and control costs. A multi-channel sourcing strategy may include leveraging direct recruitment, Internet mining, traditional advertising, Internet job postings, career centers, internal candidate review and career/job fairs.

 

    Employee referral program administration. We establish and administer our clients’ employee referral program, including promoting the program among employees, creating incentive strategies that further our clients’ goals, recording referrals and administering payments.

 

    Direct sourcing. We maintain off-site teams of recruiting professionals at our offices in Wayne, Pennsylvania and Hyderabad, India. These professionals support major hiring initiatives for our clients and handle recruiting projects on an ongoing basis. We believe that our investment in technology and productivity tools offers our clients efficiency and reduced costs over other available sourcing options.

 

    Project Outsourcing. We help our clients to develop effective, cost-efficient strategies to conduct large and small scale recruitment campaigns. These strategies can be executed either by our clients’ internal HR department or outsourced to a team of our professionals, or a combination of both. Project Outsourcing programs include evaluating the talent acquisition mission and business objectives, mapping recruitment processes and execution strategies, engaging hiring management and key stakeholders in defining deliverables, creating a detailed definition of a qualified candidate for each hiring manager, executing candidate sourcing, screening and assessment, managing the candidate interview, selection, hiring and communication process, providing comprehensive weekly and monthly reports which detail current progress against pre-established performance measures and metrics and concluding the assignment with a project summary and “lessons learned” to facilitate knowledge transfer. Executive candidate sourcing is the practice of identifying, contacting and soliciting individuals for the purpose of screening and selecting for hire.

 

Our EPO services are provided in concert with our talent acquisition and employee performance management solutions and we have developed proprietary technology for large volume sourcing performed by our sourcing center in Hyderabad, India, enabling us to provide these services in an efficient and scalable manner.

 

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Customer Support

 

We believe that superior customer support is critical to our clients. Our customer support group assists our clients by answering questions and troubleshooting our solutions. Customer support is available 24 hours a day, 7 days a week by telephone, email and over the Internet from a member of our customer support team. Each member of our customer support team receives comprehensive training and orientation to ensure that our clients receive high-quality support and service. Each of our clients is assigned a single point of contact. When an issue is reported to us, our customer support personnel follow a clearly defined escalation process to ensure that mission-critical issues are resolved to the satisfaction of the client. We believe that our customer service model has materially contributed to our client retention rate. During the year ended December 31, 2004, we renewed approximately 89.6% of the aggregate contract value subject to renewal.

 

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 March 31, 2005, our customer support group consisted of 27 employees, 18 of whom are located in Lincoln, Nebraska and 9 of whom are located in Hyderabad, India.

 

Technology, Development and Operations

 

Technology

 

Our integrated suite of talent acquisition and employee performance management solutions is built on a multi-tier, platform independent Java 2 Platform, Enterprise Edition, or J2EE, architecture using our Core Application Framework, which consists of open source components, commercially available products and our own proprietary tools. The Core Application Framework consists of the following components:

 

    User Layer. The user layer consists of a commonly used web browser. We use Java Server Pages and a Servlet-based server-side application to support the browser-based interface.

 

    Business Layer. Our Business Object Framework supports the business logic of our applications as well as providing comprehensive auditing functionality, security, multi-threading and component pooling.

 

    Integration Layer. Our integration tier provides integration with a wide range of third-party tools, job boards and applications, such as Oracle (PeopleSoft), SAP, Siebel Systems and Lawson, to support the needs of our clients. We are dedicated to the development and promotion of a standard suite of XML specifications to enable e-business and the automation of human resources-related data exchanges. The HR-XML consortium has recognized and certified Kenexa in this regard.

 

    Data Layer. Our Data Access Framework supports collection pooling, session management and optimization of data retrieval.

 

Our software is designed to support easy-to-use features such as dynamic workflows, job templates and user configuration that enable clients 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.

 

We provide our clients with two options to use our solutions. Most of our clients use our solutions on an on-demand basis, with only a limited number of our clients implementing our solutions on-site.

 

Development

 

Innovation is an important part of our business. We believe that three primary factors drive our innovation: our employees, our domain experts and our clients. 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

 

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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 client feedback.

 

We follow a development methodology that we believe allows us to develop projects quickly and then proceed on a predictable, low risk path for high-quality results. We conduct our product development through our global development center, which consists of three locations: Hyderabad, India, Lincoln, Nebraska and Wayne, Pennsylvania. Product development is primarily conducted at our highly efficient facility in India, which we established in 2003. As of March 31, 2005, we employed approximately 70 developers in India, 28 in Nebraska and 31 in Pennsylvania. Our development process is ISO 9001:2000 certified.

 

Operations

 

Our data center in Wayne, Pennsylvania serves as the primary hosting facility for our on-demand solutions. We also have a secondary data center in Lincoln, Nebraska. We adhere to industry standards and best practices in our global operations. We have entered into service level agreements with many of our clients. We have a comprehensive load balanced environment for optimal performance and server redundancy to avoid single points of application failure. The environment is shared across clients to reduce costs for each individual client. Each client’s data is stored in a separate logical partition in the database, allowing increased security and maintenance efficiency in backing up data or exporting data to the client when requested.

 

Our data center personnel are 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, 24 hours a day, 7 days a week. Our data centers have built-in power redundancy, with two uninterrupted power supplies backed up by an industrial strength generator to provide uninterrupted service to our clients. We have documented our network, server and database management procedures including backup and recovery.

 

Clients

 

As of March 31, 2005, we had a base of approximately 2,100 active clients over a number of industries, including financial services and banking, manufacturing, life sciences, biotechnology and pharmaceuticals, retail, healthcare, hospitality, call centers, and education. Our client base includes companies that we billed for services during the 12 months ended March 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. For the year ended December 31, 2004, we provided our talent acquisition and employee performance management solutions on a subscription basis to 2,015 clients, with an average subscription term of two years. Other than a small number of perpetual license sales, the remainder of our clients in 2004 engaged us to provide discrete professional services and may not engage us for future services once a project is completed. Our clients include approximately 90 of the organizations included in the Fortune 500 list published in April 2005. No single client accounted for more than 10% of our revenue in the year ended December 31, 2004.

 

Sales and Marketing

 

Our target clients are large- and medium-sized organizations with complex talent acquisition and employee performance management needs. We sell our solutions to both new and existing clients primarily through our direct sales force, which is comprised of inside sales, telesales and field sales personnel. As of March 31, 2005, we had 65 sales and marketing representatives. Our marketing strategy focuses on generating qualified sales leads and building our brand. We generate sales leads through a combination of the marketing efforts described below and a third-party lead generation service. We have sales offices located in Wayne, Pennsylvania, Philadelphia, Pennsylvania, Lincoln, Nebraska, London, England and Hyderabad, India.

 

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We believe that our client relationships provide us with a meaningful opportunity to cross-sell additional solutions to our existing clients and to achieve greater penetration with the organization. We have established a program intended to increase cross-selling into our largest clients, and we expect to continue to create innovative programs designed to incent our employees and maximize the value from each of our clients.

 

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, trade shows and industry events;

 

    direct mail and email campaigns;

 

    advertising in trade magazines;

 

    distribution of HCM white papers, case studies and thought pieces; and

 

    using our website to provide product and company information.

 

We have focused our public relations efforts on building our brand. In 2004, we were recognized by the League of American Communication Professionals as the Gold winner of the 2004 Magellan Awards in the Publicity Campaign Competition for our media campaign that created awareness of Kenexa Selector, our pre-employment assessment offering.

 

Intellectual Property

 

Our intellectual property rights are important to our business. We rely on a combination of copyright, trade secret, trademark 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. We currently have one pending patent application.

 

Although we rely primarily on copyright, trade secret and trademark law, written agreements and common law, we believe that the following factors are more essential to establishing and maintaining a competitive advantage:

 

    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. 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

 

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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.

 

Competition

 

We have experienced, and expect to continue to experience, intense competition from a number of companies. We compete with niche point solution vendors such as Authoria, Inc., BrassRing, LLC, Deploy Solutions, Inc., iCIMS, Inc., Integrated Performance Systems, Inc., InScope Corporation, PeopleClick, Inc., Performix Technologies, Inc., Pilat HR Solutions, Inc., Qwiz, Inc., Recruitmax Software, SHL Group plc, Success Factors, Inc., Taleo Corporation, Unicru, Inc., Virtual Edge Corporation, Webhire, Inc. and Workstream Software, Inc. that offer products that compete with one or more applications in our suite of solutions. In some aspects of our business, we also compete with established vendors of enterprise resource planning software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG, Siebel Systems, Inc. and Lawson, Inc. To a lesser extent, we compete with vendors of employment process outsourcing services and survey services such as Accolo, The Gallup Organization, Hyrian, LLC and Recruitment Enhancement Services.

 

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.

 

We may face future competition in the talent acquisition and employee performance management market from large, established companies, such as Oracle and SAP, as well as from emerging companies. Barriers to entry into our industry are relatively low, new software products are frequently introduced and existing products are continually enhanced. In addition, we expect that there is likely to be consolidation in our industry, which would 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 and could reduce our gross margins and operating income.

 

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Employees

 

As of March 31, 2005, we had 533 employees, consisting of 70 employees in sales and marketing, 129 in development, 272 in delivery of our solutions and 62 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.

 

Facilities

 

We lease our headquarters in Wayne, Pennsylvania, which consists of approximately 31,000 square feet. The table below provides additional information concerning our principal facilities, including the approximate square footage of each facility and the lease expiration date. We also lease facilities in Philadelphia, Pennsylvania, Lincoln, Nebraska, Hyderabad, India and London, England. 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.

 

Location


  

Approximate

Square Footage


   Monthly Rent

  

Lease

Expiration


Wayne, Pennsylvania

   31,000    $     70,805    May 13, 2013

Lincoln, Nebraska

   33,000    $ 39,875    October 31, 2009

Philadelphia, Pennsylvania

   4,400    $ 3,872    September 30, 2007
(month-to-month)

Hyderabad, India

   4,900    $ 2,245    August 1, 2009

London, England

   5,000    $ 20,355    September 23, 2005

 

Legal Proceedings

 

On October 31, 2000, Gallup, Inc., which conducts its business under the name The Gallup Organization, filed suit against us in United States District Court for the Eastern District of Pennsylvania seeking unspecified damages and injunctive relief, alleging that we unlawfully raided Gallup’s employees and tortiously interfered with Gallup’s relationships with former employees and customers, infringed on Gallup’s copyrighted survey language and falsely advertised aspects of our employee survey services. In November 2001, the District Court granted our motion to dismiss Gallup’s claim that we conducted an unlawful raid of Gallup’s employees. In December 2002, the District Court granted our motion for summary judgment on the false advertising claim. In January 2003, the District Court granted our motion for summary judgment on the claims regarding our alleged tortious interference with Gallup’s relationships with its former employees and its customers. Gallup did not appeal any of these rulings.

 

In November 2004, the District Court granted our motion for summary judgment on the copyright claim. Gallup has appealed that ruling to the United States Court of Appeals for the Third Circuit. Although we believe that our ownership of the survey language at issue in this case is an important intellectual property asset to our business, we do not believe that an adverse ruling on the copyright claim would have a material adverse effect on our results of operation or financial position.

 

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, and developments or assertions by or against us relating to intellectual property rights and intellectual property licenses, could have a material adverse effect on our business, financial condition and operating results.

 

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MANAGEMENT

 

Executive Officers, Directors and Key Employees

 

The following table sets forth information concerning our executive officers, directors and key employees as of June 3, 2005:

 

Name


   Age

  

Position


Executive officers and directors:

         

Nooruddin (Rudy) S. Karsan

   47    Chairman of the Board and Chief Executive Officer

Elliot H. Clark

   43    Chief Operating Officer and Director

Troy A. Kanter

   37    President, Human Capital Management

Donald F. Volk

   55    Chief Financial Officer

Sarah M. Teten

   32    Chief Marketing Officer

Ramarao V. Velpuri

   41    Chief Technology Officer

Other key employees:

         

Bill L. Erickson

   56    Vice Chairman and Director

Kevin T. Hudson

   50    Senior Vice President—Talent Acquisition Services

P. Grant Parker

   47    Executive Vice President

Raghuveer Sakuru

   38    Senior Vice President—Global Development Center

Non-management directors:

         

Barry M. Abelson

   59    Director

Joseph A. Konen

   57    Director

John A. Nies

   36    Director

Richard J. Pinola

   59    Director

John C. Rutherford

   55    Director

 

Nooruddin (Rudy) S. Karsan co-founded our predecessor company in 1987 and has served as the Chairman of our board of directors since 1997 and as our Chief Executive Officer since 1991. Prior to that, Mr. Karsan headed Marketing Actuarial for the Mercantile & General Insurance Company in Toronto, Canada. Mr. Karsan received a B Math in Actuarial Science from the University of Waterloo. Mr. Karsan holds the designation of Fellow of the Society of Actuaries.

 

Elliot H. Clark joined us in 1991 and has served as a member of our board of directors and our Secretary and Treasurer since 1997 and as our Chief Operating Officer since 1999. From 1992 to 1999, Mr. Clark served as general manager of our talent acquisition division. Prior to his employment with us, Mr. Clark served as a sales manager for a regional HR recruiting ad consulting firm. Mr. Clark received a B.S. in Economics from the Wharton School of Finance and Commerce of the University of Pennsylvania with a major in human resources. Mr. Clark’s legal name is Eliot H. Chack, but he uses for business purposes and is known in the industry as Elliot H. Clark.

 

Troy A. Kanter joined us in 1997 and has served as our President, Human Capital Management since 2003. From 1997 to 2003, Mr. Kanter served as our Executive Vice President—Sales and Business Development. From 1997 to 1999, he managed our HCM Consulting, Retention Services operations. From 1995 to 1997, Mr. Kanter was the president of Human Resources Innovations, Inc., a company he co-founded that provided employee survey research and consulting and which we acquired in 1997. From 1990 to 1994, Mr. Kanter was employed by The Gallup Organization, a provider of research, survey and HCM services, most recently serving as its vice president of client services. Mr. Kanter received a B.A. in Corporate Communications from Doane College.

 

Donald F. Volk has served as our Chief Financial Officer since 1996. Prior to joining us, Mr. Volk was a partner in the accounting firm of Brinker, Simpson, Nicastro & Volk. He received a B.S. in Accounting from Villanova University and an M.S. in Taxation from the Villanova University School of Law. Mr. Volk has been a Certified Public Accountant since 1974.

 

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Sarah M. Teten joined us in 1999 and has served as our Chief Marketing Officer since 2004. From 2002 to 2004, Ms. Teten served as our Director of Marketing and was one of our sales executives from 1999 until 2002. Prior to joining Kenexa, Ms. Teten served as a marketing manager for Kaplan Educational Centers, a provider of educational services. Ms. Teten received a Bachelor of Journalism and Mass Communications degree from the University of Nebraska at Lincoln.

 

Ramarao V. Velpuri has served as our Chief Technology Officer since 2003. From 1999 to 2003, Mr. Velpuri served as the chief executive officer of Oracle’s technology product development company, Oramasters Software India Private Limited, which provides Oracle database support services on a worldwide basis. From 1988 to 1999, Mr. Velpuri was employed by Oracle Corporation, a software company. Mr. Velpuri received a B.S. in Electronics and Communications Engineering from Andhra University and an M.S. in Electrical and Computer Engineering from Louisiana State University. Mr. Velpuri is the author of nine technology books including the most recent, Oracle OCP Oracle9i Database: Fundamentals II Exam Guide.

 

Bill L. Erickson has served as the Vice Chairman of our board of directors since 1997. From 1997 to 2004, Mr. Erickson also served as our Executive Vice President. From 1995 to 1997, Mr. Erickson was chief executive officer of Human Resource Innovations, Inc., a provider of employee survey research and consulting services of which he co-founded and which we acquired in 1997. Prior to his tenure with Human Resources Innovations, Inc., Mr. Erickson was employed by The Gallup Organization, a provider of research, survey and HCM services, most recently serving as executive vice president of its management research division. Mr. Erickson received a B.A. in Psychology from the University of Nebraska at Lincoln.

 

Kevin T. Hudson joined us in 1993 and has served as Senior Vice President—Talent Acquisition Services since 1998. From 1993 to 1998, Mr. Hudson led the technology and staffing solutions components of our talent acquisition and recruitment services operations. From 1990 to 1993, Mr. Hudson served as director of human resources and director of staffing for Arco Chemical, a division of Atlantic Richfield, a producer of petroleum and chemical products. Mr. Hudson received a B.A. in Psychology from the University of Delaware.

 

P. Grant Parker joined us in 1988 and has served as our Executive Vice President since 1999. From 1996 to 1999, Mr. Parker served as managing partner of our financial services search practice. From 1991 until 1996, Mr. Parker was a partner in our executive search practice and from 1988 until 1991 he served as one of our consultants.

 

Raghuveer Sakuru joined us in 1996 and has served as our Senior Vice President—Global Development Center since 2003. From 1996 to 2002, Mr. Sakuru served as our Vice President—Consulting. From 1984 until 1996, Mr. Sakuru was a managing principal of Pragma, Inc., a provider of e-business and information technology consulting which he co-founded and which we acquired in December of 1995. Mr. Sakuru received a Bachelor of Technology degree in Mechanical Engineering from Jawaharlal Nehu Technological University.

 

Barry M. Abelson has been a member of our board of directors since 2000. Since 1992, Mr. Abelson has been a partner in the law firm of Pepper Hamilton LLP, which has provided legal services to us since 1997. Mr. Abelson received an A.B. in Sociology from Dartmouth College and a J.D. from the University of Pennsylvania Law School.

 

Joseph A. Konen has been a member of our board of directors since 2000. Mr. Konen, who is now retired, has held a number of executive positions, most recently serving from 1994 to 1999 as the president and chief operating officer of Ameritrade Holding Corporation, a provider of brokerage services. Mr. Konen received a B.A. in Economics and an M.B.A. in Finance and Management from Indiana University at Bloomington.

 

John A. Nies has been a member of our board of directors since 2002. Mr. Nies has served as a principal of Sage River Partners, LLC, private equity investment firm, since January 2005. From 2002 to January 2005, Mr. Nies served as a principal of Maplegate Holdings, LLC, a private equity firm. From 2001 to 2002, Mr. Nies

 

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worked for Parthenon Capital, Inc., a private equity investment firm, most recently serving as managing director, operations, a position in which he was responsible for post-transaction performance of portfolio companies. From 1991 to 2001, Mr. Nies worked for The Parthenon Group, a management consulting firm. Mr. Nies received an A.B. in Economics from Dartmouth College and an M.B.A. from Harvard Business School.

 

Richard J. Pinola was elected to our board of directors in 2005. From 1992 to 2004, Mr. Pinola served as the chairman and chief executive officer of Right Management Consultants, a human resources consulting firm. From 1989 to 1991, Mr. Pinola served as the chief operating officer of Penn Mutual Life Insurance Company. Mr. Pinola also serves as a director of K-Tron International, Inc., a manufacturer of material handling equipment and systems, Bankrate, Inc., an Internet financial services provider, and Nobel Learning Communities, Inc., a for-profit provider of education and educational services. Mr. Pinola received a B.S. in Accounting from King’s College.

 

John C. Rutherford has been a member of our board of directors since 1999. Mr. Rutherford is a founder and co-chief executive officer of Parthenon Capital, Inc., a private equity investment firm formed in 1998 and an affiliate of two of our shareholders, Parthenon Investors, L.P. and PCIP Investors. Mr. Rutherford is also a co-founder and former Chairman of The Parthenon Group, a strategic advisory consulting and investment firm. Prior to founding The Parthenon Group in 1991, Mr. Rutherford served as a Director of Bain & Company. He has over 25 years experience as a management consultant and private equity investor. Mr. Rutherford received a B.E. from the University of Canterbury, an M.S. in Computer Science from the University of Connecticut and an M.B.A. from Harvard Business School. Mr. Rutherford currently serves as a member of our board of directors as a representative, and is an affiliate, of Parthenon Investors, L.P. and PCIP Investors. See “Board Composition” and “Certain Relationships and Related Party Transactions.”

 

Executive officers are appointed by our board of directors and serve until their successors have been duly elected and qualified. There are no family relationships among any of our directors, officers or key employees.

 

Board Composition

 

Our board of directors consists of eight members who are divided into three classes of directors as follows:

 

    the Class I directors are Bill L. Erickson and John C. Rutherford, whose terms will expire at the annual meeting of shareholders to be held in 2006;

 

    the Class II directors are Elliot H. Clark, Joseph A. Konen and Richard J. Pinola, whose terms will expire at the annual meeting of shareholders to be held in 2007; and

 

    the Class III directors are Barry M. Abelson, Nooruddin S. Karsan and John A. Nies, whose terms will expire at the annual meeting of shareholders to be held in 2008.

 

A classified board of directors may have the effect of deterring or delaying any attempt by any person or group to obtain control of us by a proxy contest since such third party would be required to have its nominees elected at two separate annual meetings of our board of directors in order to elect a majority of the members of our board of directors. See “Risk Factors—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.”

 

Our board of directors will observe all applicable criteria for independence established by The Nasdaq Stock Market and other governing laws and applicable regulations. No director will be deemed to be independent unless our board of directors determines that the director has no relationship which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

 

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Under our existing second amended and restated stockholders agreement, which will terminate upon the completion of this offering, Parthenon Investors, L.P. and PCIP Investors have the right to nominate two individuals for membership on our board of directors. Mr. Rutherford is the current designee of Parthenon Investors, L.P. and PCIP Investors. See “Certain Relationships and Related Party Transactions—Stockholders Agreement.”

 

Board Committees

 

The standing committees of our board of directors include the audit committee, the compensation committee and the nominating and corporate governance committee. These committees are described below. Our board of directors may also establish various other committees to assist it in its responsibilities.

 

Audit Committee

 

Our audit committee oversees our corporate accounting and financial reporting process. Our audit committee:

 

    evaluates the qualifications, independence and performance of our independent registered auditors;

 

    determines the engagement of our independent auditors;

 

    approves the retention of our independent auditors to perform any proposed permissible non-audit services;

 

    ensures the rotation of the partners of our independent auditors on our engagement team as required by law;

 

    reviews our systems of internal controls established for finance, accounting, legal compliance and ethics;

 

    reviews our accounting and financial reporting processes;

 

    provides for effective communication between our board of directors, our senior and financial management and our independent auditors;

 

    discusses with management and our independent auditors the results of our annual audit and the review of our quarterly financial statements;

 

    reviews the audits of our financial statements; and

 

    implements a pre-approval policy for certain audit and non-audit services performed by our independent auditors.

 

The audit committee is comprised of Messrs. Konen (chair), Nies and Pinola. Our board of directors has determined that each of Messrs. Konen and Pinola is an “audit committee financial expert” as currently defined under the SEC rules implementing Section 407 of the Sarbanes-Oxley Act of 2002. We believe that the composition and functioning of our audit committee complies with all applicable requirements of the Sarbanes-Oxley Act of 2002, The Nasdaq Stock Market and SEC rules and regulations, including those regarding the independence of our audit committee members. We intend to comply with future requirements to the extent that they become applicable to us.

 

Compensation Committee

 

Our compensation committee reviews and recommends policy relating to the compensation and benefits of our executive officers. Our compensation committee:

 

    reviews and approves corporate goals and objectives relevant to the compensation and the benefits of our Chief Executive Officer and our other executive officers;

 

    evaluates the performance of these officers in light of those goals and objectives; and

 

    sets compensation of these officers based on such evaluations.

 

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Our compensation committee or a designated subcommittee administers the issuance of stock options and other awards under our 2005 Equity Incentive Plan. The compensation committee is comprised of Messrs. Abelson, Nies and Rutherford (chair). We believe that the composition and functioning of our compensation committee complies with all applicable requirements of the Sarbanes-Oxley Act of 2002, The Nasdaq Stock Market and SEC rules and regulations, including those regarding the independence of our compensation committee members. We intend to comply with future requirements to the extent that they become applicable to us.

 

Nominating and Corporate Governance Committee

 

The nominating and corporate governance committee’s responsibilities includes the selection of potential candidates for our board of directors. It also makes recommendations to our board of directors concerning the structure and membership of the other board committees. The nominating and corporate governance committee is responsible for implementing policies and procedures with regard to consideration of any director candidates recommended by our shareholders. The nominating and corporate governance committee is comprised of Messrs. Abelson, Nies (chair) and Pinola. We believe that the composition of our nominating and corporate governance committee complies with any applicable requirements of the Sarbanes-Oxley Act of 2002, The Nasdaq Stock Market and SEC rules and regulations, including those regarding the independence of our nominating and corporate governance committee members. We intend to comply with future requirements to the extent that they become applicable to us.

 

Compensation Committee Interlocks and Insider Participation

 

The current members of our compensation committee are Messrs. Abelson, Nies and Rutherford. None of these individuals was at any time during fiscal year 2004 an officer or employee of ours. In addition, none of our executive officers serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee. Mr. Abelson is a partner in the law firm of Pepper Hamilton LLP, which has provided legal services to us since 1997.

 

Director Compensation

 

We pay each member of our board of directors, other than those who are our employees or employees or partners of our affiliates, an annual retainer of $15,000 for service on the board. The chair of each of the compensation committee and the nominating and corporate governance committee receives an additional annual fee of $2,500, while each other member of those committees receives an annual fee of $1,250 for each committee upon which the member serves. In addition, the audit committee chair receives an additional annual fee of $5,000 and each other member of the audit committee receives an additional annual fee of $2,500.

 

Upon the closing of this offering, we will grant an option to purchase 10,000 shares of our common stock to each of Messrs. Abelson, Konen, Nies and Pinola with an exercise price equal to the initial public offering price. In the future, each person newly elected to our board of directors, other than those who are our employees or employees or partners of our affiliates, will receive an option to purchase 10,000 shares of our common stoc