Item 1.
Business
Callidus Software Inc.
Incorporated in Delaware in 1996, Callidus Software Inc. is a market and technology leader in Sales Performance Management (SPM) solutions globally, to companies of every size. Organizations use SPM systems to optimize their investment in sales planning and performance, specifically in the areas of sales and channel pay for performance and incentive management. SPM solutions also provide the capability to continually monitor and analyze these business processes in order to understand what is working well, and which programs might need to be revised. Sales performance programs are key vehicles in aligning employee and channel partner goals with corporate objectives.
We recently introduced our next generation Sales Performance Management suite, the Monaco release, a multi-tenant Software-as-a-Service (SaaS) solution that delivers a comprehensive suite of sales lifecycle management solutions. These solutions provide value to customers by helping them optimize sales effectiveness from sales and channel on-boarding, to deployment, to pay for performance, to talent development. The Monaco release also offers a new focus on delivering more rapid time-to-value and ease of use for our customers. Enhancements include a new user interface, and a new self-service platform to deliver increased value to end users. In addition, we have built and delivered a library of industry-standard plans and reports, that comes pre-packaged as part of the product. These plans and reports allow customers to get up and running with a proven set of best practice resources quickly.
By facilitating effective management of sales selection and on-boarding, sales deployment and readiness management, incentive and bonus programs, and performance improvements, our products allow our customers to optimize cost efficiencies and drive sales effectiveness. While we offer our customers a range of purchasing and deployment options, from on-demand subscription SaaS to on-premise licensing, our business and revenue model is focused on recurring revenue. Our software suite is based on our proprietary technology and extensive expertise in sales performance management, and provides the flexibility and scalability required to meet the dynamic SPM requirements of global companies of every size across multiple industries.
Our software consulting services offers customers a full range of SPM solution implementations, system upgrades, compensation plan enhancements, migration assistance, reporting and integration consulting and solution architecture services.
As of December 31, 2009 over 2 million salespeople, brokers and channel representatives have their sales performance managed by our products.
Products
The Callidus product suite provides an end-to-end solution for all aspects of the SPM process. With our products, organizations gain insight into sales operations and financial performance including sales capacity and coverage, sales goal attainment and financial performance, and incentive effectiveness. Our products combine a complete web-based solution with flexible rules-based architecture, grid-based computing, reporting, analytics, and workflow functionality. While our horizontal solution is applicable to every industry, Callidus additionally provides value-added industry-specific solutions, particularly in financial services and insurance, telecommunications, life sciences, and technology. Callidus solutions are cross-platform and standards-based, enabling them to be integrated with a wide range of IT systems and processes. Callidus also provides packaged, certified integration with salesforce.com, enabling an organization’s sales team to seamlessly access Callidus applications from its Sales Force Automation/Customer Relationship Management system.
We offer our customers various options to purchase and deploy our products, primarily through on-demand, SaaS subscription and on-premise time-based term licenses. The Callidus On-Demand service delivers all the advantages of SPM. By using Callidus On-Demand, organizations gain the benefit of SPM with a rapid deployment that provides flexibility, efficiency, cost savings, security, and reliability. Callidus On-Demand can be configured with a selection of service levels and options that suit an organization’s business objectives, requirements, and resources. Callidus On-Demand customers rely on our Technical Operations services to provide the infrastructure, infrastructure operations, and software application operations layers required for SPM. In addition to Technical Operations, we make available to all customers Sales Operations services. Sales Operations provides plan and reporting administration services, which includes compensation plan maintenance, report design and maintenance, customer service, issue resolution, production support, and incentive change management. Companies selecting this service do not need to hire and train a compensation analyst or compensation administration team to design and run the system.
Customers that prefer to have our products operating on their own premises can purchase either time-based term licenses or perpetual licenses. Our time-based term license offering gives our customers the right to use our products for a period of time, typically 12 to 24 months. Fees under the time-based term licenses are generally billed annually. Thus, the up-front cost to purchase a time-based term license is significantly lower than that of a perpetual license. We started offering time-based term licenses on several of our products in the third quarter of 2009.
Our products and the deployment options currently offered are listed below.
TrueComp Manager Application
Our TrueComp Manager application automates the modeling, design, administration, reporting, and analysis of pay-for-performance programs for organizations ranging from hundreds to hundreds of thousands of sales people. Our customers use the TrueComp Manager application to design, test, and implement sales compensation plans that reward employees based on profitability of sales or customer value, team-selling, and new product introduction or geographic expansion, or other sales activities that customers wish to encourage. The TrueComp Manager application enables our customers to define flexible market goals and territories for its sales force and channels, accurately collect sales performance data, apply it to each payee’s profile and goals, and process and pay their sales force for achievement on target. The TrueComp Manager application provides a flexible, user-maintainable system that can be easily modified to align direct or indirect sales compensation with corporate goals and shareholder value. It also provides sophisticated modeling functionality to enable the finance organization to accurately forecast compensation spend, or to perform incentive and coverage modeling to understand the different incentive and/or market scenarios. This combined modeling functionality enables organizations to substantially reduce their exposure to unexpected compensation overspend.
The TrueComp Manager application serves as the business user-facing application to set-up compensation plans and incentives, territories, and goals, and to manage day-to-day operations of sales collections and payments. The solution collects and integrates multiple data feeds used to measure and process sales performance. The TrueComp grid component provides high-performance processing of compensation data and results and, together with our parallel processing functionality, enables organizations to manage global compensation. The application’s modular, date-effective approach to defining compensation plans avoids the maintenance and change problems associated with homegrown solutions. The TrueComp Manager application was initially shipped in the first quarter of 1999 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Reporting
Callidus Reporting delivers real-time production reports for detailed and summarized sales goal information. It delivers compensation statements, and order to payment tracking, enabling transparency and confidence in the sales incentive process across stakeholders, including the sales force, dealer networks, brokers and channel partners. With integrated reporting capabilities as part of the Callidus Software suite, businesses can quickly and efficiently deploy sales incentives, knowing that sales and channel partners receive up-to-date, transparent details on their performance and payments. The reports deliver at-a-glance summary snapshots for sales, and enable quick and easy navigation to the orders and events that drive their compensation. Callidus Reporting software was initially shipped in the first quarter of 2006 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Analytics
Callidus Analytics solution enables businesses to quickly deploy performance dashboards across the sales force and selling channels to monitor and indentify trends affecting sales team, product, and customer performance. The solution provides out-of-the-box dashboards for sales, finance, and sales operations roles to interactively assess and identify trends affecting selling performance across customers, products, channels, sales teams, and territories, and provides ad-hoc query capabilities for deeper analysis of root causes of performance trends.
Callidus Analytics is integrated with the TrueComp Manager solution, and is shipped with pre-packaged dashboards by role for rapid time to value. Callidus Analytics also allows integration with salesforce.com via AppExchange. Callidus Analytics software was initially shipped in the first quarter of 2006 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Producer Management
Callidus Producer Management is designed for insurance carriers with large independent distribution channels, or a large numbers of captive agents. Callidus Producer Management streamlines producer administration by helping onboard, deploy, and pay producers, while providing visibility into channel operations and financial performance. Producer management helps businesses not only realize significant hard dollar savings with better control and flexibility of incentive plans and payments to producers, but also to rapidly onboard new producers, grow producer revenue and mindshare, and ensure long-term producer loyalty. Callidus Producer Management was initially shipped in the second quarter of 2007 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Channel Management
Callidus Channel Management is designed for telecommunications companies with large independent channels that need one central location to view and update dealer information. Channel management provides businesses a comprehensive view of dealer information, essential for providing the maximum service level to dealers. It helps businesses not only realize significant savings with better control and flexibility of incentive plans and payments to dealers, but also to manage sophisticated types of hierarchies required for independent dealers. Callidus Channel Management was initially shipped in the second quarter of 2007 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Objective Management
Callidus Objective Management enables organizations to design and deploy pay-for-performance initiatives to every employee to consistently and reliably deliver and optimize results. The self-service applications empower administrators and managers to set, review, and reward objectives, and analyze objective performance, to achieve maximum impact on their key initiatives. Objective Management delivers insight to key stakeholders to understand the alignment of objectives across departments and teams. This enables businesses to spend less time juggling different systems and spreadsheets and more time to focus on execution and impact of corporate objectives. Callidus Objective Management was initially available in the fourth quarter of 2008 and is now being offered to our customers through an on-demand SaaS solution.
Callidus Quota Management
Callidus Quota Management is designed to provide sales and finance teams with a solution that ensures sales quotas are allocated fairly, in a timely manner, and are aligned with corporate revenue goals and market opportunity. Quota Management identifies opportunities to allocate and change quotas to maximize revenue based on historical performance. It helps allocate quotas effectively and quickly using sophisticated business rules, and manages the rollout and approval process across sales teams and regions in a coordinated and timely manner, enabling everyone to be brought into the process. Callidus Quota Management was initially available in the fourth quarter of 2008 and is now being offered to our customers through an on-demand SaaS solution.
Callidus Communicator
Callidus Communicator is designed to help accelerate and streamline communications with a business’ sales force and channels to help align sales behavior with corporate objectives for more consistent results. The solution can dramatically accelerate the process of rolling out compensation plans, special incentives, and strategic objective plans to the field, and helps track these documents through the inquiry, sign-off, and approval processes. The software helps expedite go-to-market for new products and services and accelerates sales readiness for new fiscal periods. Callidus Communicator was initially available in the third quarter of 2009 and is now being offered to our customers through an on-demand SaaS solution.
Callidus Business Process Management
Callidus Business Process Management (BPM) solutions provide a configurable, template-based platform to define, model, build, deploy and optimize workflows for critical sales and operational processes, such as agent onboarding and offboarding, and third party data validation and management. Callidus BPM replaces manually documented and ad-hoc processes that are challenging to implement, track, audit, and modify. Callidus BPM was initially available in the third quarter of 2009 and is now being offered to our customers through an on-demand SaaS solution, or under a time-based term or perpetual license.
Callidus Commissions Manager
Callidus Commissions Manager is a 100% native solution on the Force.com platform (developed by Salesforce.com) that delivers an easy-to-use application that can be rapidly deployed to help companies drive adoption of Salesforce CRM. With Callidus Commissions Manager, sales professionals can track their projected commissions, initiate claims for credit and payment on closed deals, file disputes on payments, and track the status and amounts of paid and pending commissions, all as part of their day-to-day opportunity management in Salesforce.com. In addition, role-based dashboards across stakeholders provide insight into sales performance and help provide transparency to sales and finance on earnings to-date as well as earnings potentials. Commissions Manager was initially available in the third quarter of 2009 and is now being offered to our customers through an on-demand SaaS solution.
Callidus Plan Communicator
Callidus Plan Communicator is a 100% native solution on the Force.com platform (developed by Salesforce.com) that accelerates the process of rolling out and communicating incentive plans across the sales force, and
obtaining acknowledgement from each sales person. With this solution, organizations can transform the sales plan deployment and approval process, accelerating new go-to-markets and fiscal period rollouts, and rolling out changes to sales strategy throughout the year. Plan Communicator was initially available in the third quarter of 2008 and is now being offered to our customers through an on-demand SaaS solution.
Services
We provide a full range of services to our customers, including professional services, maintenance and technical support services, and professional development services.
Professional Services. We provide integration and configuration services to our customers and partners. Our on-demand customers benefit from a quicker time to value than our traditional on-premise customers because our software is already up and running in our hosting facility. For these customers, professional services typically include the identification and sourcing of legacy data, configuration of application rules to create compensation plans, set up of pre-defined reports and custom reports, and the ability to interface our hosted application with other applications used by our customers. For those customers who purchase our on-premise solution, our services include the installation of our software, identification and sourcing of legacy data, configuration of the TrueComp application rules necessary to create compensation plans, creation of custom reports and integration of our software with other products, and other general testing and tuning services. Installation, configuration and other professional services related to our software can be performed by our customers, or at their discretion, by us or third-party implementation providers. We also provide services to our implementation partners to aid them in certain projects and training programs. In addition, we provide Callidus Strategic and Expert Services to help customers optimize incentive compensation business processes and management capability. The professional services we perform are generally performed on a time and materials basis.
Business Process Solutions. We provide a suite of value-added Business Process Solutions around ours and client-designed solutions. Specific solutions are available for the Callidus TrueComp Manager application, Callidus Producer Management, and Callidus Reporting & Analytics products. Each solution includes clearly defined engagement plans, rapid deployment methods, and a proven track record of delivering value to customers.
Maintenance and Technical Support Services. We have maintenance and technical support centers in the United States and India. We currently offer two levels of support, standard and premium, which are generally provided on a yearly basis. Under both levels of support, our customers are provided with online access to our customer support database, telephone, web and e-mail support, and all product enhancements and new releases. In addition, online chat is offered for clients as an alternative option. In the case of premium support, our customers are provided with access to a support engineer 24 hours a day, 7 days a week. In addition, our customers who subscribe to standard or premium support can be provided access to a remote technical account manager to assist with management and resolution of support requests.
Education and Professional Development Services. We offer a comprehensive set of over 20 performance-oriented, role-based training courses for our customers, partners, and employees. Our educational services include self-service web-based training, classroom training, remote (virtual training with off-site instructor), on-site training, and custom training. Our professional certification is available to promote standards for SPM professionals who demonstrate the ability to implement our suite of products.
Technology
Our products are written in Java. The TrueComp Manager application is based on our proprietary rules engine, which is implemented on our scalable TrueComp Grid computing architecture. This technology offers our customers high degrees of functionality and flexibility, coupled with the scalability and reliability that enables them to maximize the return on investment in their SPM systems.
Customers
While our products and services can serve the Sales Performance Management needs of all companies, we have driven particular penetration with our solutions and expertise in the telecommunications, insurance, banking,
technology, life sciences/pharmaceuticals, and retail and distribution markets. In 2009, 2008 and 2007, no customer accounted for more than 10% of our total revenues. America’s revenues represented 87%, 86% and 80% of our total revenues in 2009, 2008 and 2007, respectively. The remaining amounts of revenue in each of the past three years have been generated in Europe and the Asia Pacific region.
Now at over 200 customers, with $50 billion of incentives and compensation paid, for over 2 million payees in over 140 countries, we believe that we are the unequivocal leader in the sales performance management space.
Sales and Marketing
We sell and market our software through a direct sales force and in conjunction with our partners. In the United States, we have sales and service offices in Austin, Birmingham (Alabama), New York, San Jose (HQ), and Scottsdale. Outside the United States, we have sales and service offices in the United Kingdom and Singapore.
Sales. Our direct sales force, consisting of account development, account executives, technical pre-sales engineers and field management, is responsible for the sale of our products to global enterprises across multiple industries, and is organized into geographic and industry territories. Our account development team is responsible for generating new qualified opportunities and following up on marketing campaigns.
Marketing. Our marketing activities include product, service, field, customer, and industry marketing functions as well as marketing communications. Product marketing is responsible for defining new product requirements, managing product life cycles, and generating content for sales collateral and marketing programs. Marketing communications is focused on both primary demand generation efforts to help increase awareness of SPM, and secondary demand generation efforts to drive sales leads for our products and services. This is done through multiple channels, including advertising, webcasts, industry events, email marketing, web marketing, and telemarketing. In addition, our relaunched website is optimized to drive prospects to our solutions and generate additional sales opportunities.
Alliances and Partnerships
We actively promote and maintain strategic relationships with systems integrators, consulting organizations, independent software vendors, value-added resellers, and technology providers. These relationships provide both customer referrals and co-marketing opportunities, which have helped in expanding our customer base. On a national and global basis, we have established alliances with partners such as Accenture and salesforce.com.
In 2007, we forged a partnership with salesforce.com, specifically focused on the promotion and marketing of our On-Demand offering as an AppExchange certified partner, and in 2008 we developed our first native Force.com application, Callidus Plan Communicator. In 2009, we also launched our new native Force.com suite, featuring our new claims-based commission management solution, which enables sales professionals to manage commissions as part of Salesforce CRM. We showcased the solutions at Dreamforce ’09.
Also in 2009, we significantly expanded our global reseller network in specific geographic markets. In addition to CIS in Latin America and ICM Advisory in Poland, we added Seven Seas Technologies to resell our products in Africa, Advantech to resell our products in Israel, Ultima to resell our products in Turkey, Cognity to resell our products in Greece, Hyperintel to resell our products in Indonesia, HAND Enterprise Solutions to resell our products in China and Excel Technologies to resell our products in Asia.
Research and Development
Our research and development organization consists of experienced software engineers, software quality engineers, and technical writers. We organize the development staff along product lines, with an engineering services group providing centralized support for quality assurance, technical documentation, and advanced support. In 2009, 2008, and 2007, we recorded research and development expenses of $13.9 million, $14.6 million and $15.6 million, respectively. These expenses include stock-based compensation.
Competition
Our principal competition comes from Oracle Corporation and internally developed software solutions. We also compete with other software and consulting companies that generally focus on specific industries or sectors, including Centive (now Xactly), DSPA Software, Merced Systems, Synygy, Trilogy-Versata, Varicent, and ZS Associates. We believe that the principal competitive factors affecting our market are:
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industry-specific domain expertise;
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scalability and flexibility of solutions;
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excellent customer service;
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functionality of solutions; and
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total cost of ownership.
We believe that we compete effectively with the established enterprise software companies due to our focus, established market leadership, domain expertise, comprehensive suite and roadmap of solutions outside of core commission management, and highly scalable architecture. We believe we have more fully developed the domain expertise necessary to meet the dynamic requirements of today’s complex sales performance and incentive compensation programs.
Our On-Demand offering competes favorably in terms of speed of implementation, reliability, security, scalability, and portability to an on-premise solution. The addition of our lifecycle solutions enhanced our ability to provide a comprehensive sales management solution delivered from a single vendor. The addition of our salesforce.com solutions has also enhanced our ability to compete in the mid-market sector. While our competitors offer viable market alternatives, we believe that we have developed superior breadth and depth of functionality demanded by specific vertical markets, while providing increased operational flexibility to support more rapid deployment capability. Additionally, we have created substantial product differentiation by adding features into our products that are specific to each of our target markets, and that scale to growing business needs.
We believe that our products offer a more cost-effective and complete alternative to internally developed solutions. Internally-developed solutions are generally expensive, inflexible, and difficult to maintain for companies with increasingly complex sales performance and incentive compensation programs, thereby increasing total cost of ownership and limiting the ability to implement programs that effectively address targeted business objectives.
Although we believe that our products and services currently compete effectively with those of our competitors, the market for SPM products is rapidly evolving. Our larger competitors have significantly greater financial, technical, marketing, service, and other resources. Many of these companies also have a larger installed base of users, longer operating histories, and greater name recognition. Our competitors may also be able to respond more quickly to changes in customer requirements, or may announce new products, services, or enhancements that better meet the needs of customers or changing industry standards. In addition, if one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could adversely affect our ability to compete effectively. Increased competition may cause price reductions, reduced gross margins, and loss of market share.
Intellectual Property
Our success and ability to compete is dependent, in part, on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing upon the proprietary rights of others. We rely primarily on a combination of copyrights, trade secrets, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary information. We also have a patent registration program within the United States and have an ongoing trademark registration program pursuant to which we register some of our product names, slogans and logos in the United States and in some foreign countries. However, due to the rapidly changing nature of applicable technologies, we believe that the improvement of existing products, reliance upon trade secrets and
unpatented proprietary know-how and development of new products are generally more advantageous than patent and trademark protection.
Our agreements with customers include restrictions intended to protect and defend our intellectual property. We also require our employees, contractors and many of those with whom we have business relationships to sign non-disclosure and confidentiality agreements.
Some of our products include third-party software that we use based on rights granted under license agreements. While third-party software comprises important elements of our product offerings, it is commercially available and we believe there are other commercially available substitutes that can be integrated with our products on reasonable terms. In certain cases we also believe we could develop substitute technology to replace these products if these third-party licenses were no longer available on reasonable terms.
Employees
As of December 31, 2009, we had a total of 284 employees. Of those employees, 46 were in sales and marketing, 72 were in research and development and technical support, 84 were in professional services and training, 36 were in on-demand operations, and 46 were in general and administration. We consider our relationship with our employees to be good and have not experienced interruptions of operations due to labor disagreements.
Executive Officers of the Company
The following table sets forth certain information with respect to our executive officers as of March 1, 2010:
Leslie J. Stretch has served as our President and CEO since December 2007. Previously, Mr. Stretch was our Senior Vice President, Global Sales, Marketing and On-Demand Business from July 2007 to November 2007, Senior Vice President, Worldwide Sales from April 2006 to July 2007, and Vice President, Worldwide Sales from November 2005 to April 2006. Prior to joining Callidus, Mr. Stretch served as interim CEO for The Hamsard Group, plc. in the United Kingdom from April 2005 to September 2005. Previously, Mr. Stretch served in a variety of roles at Sun Microsystems, most recently as Senior Vice President of Global Channel Sales from January 2005 to April 2005, UK Vice President and Managing Director from February 2003 to January 2005, and UK Sales Director from May 1996 to February 2003. Prior to joining Sun Microsystems, Mr. Stretch served in a variety of roles at Oracle Corporation, U.K. including Director of Retail and Commercial Business UK from June 1995 to June 1996, Branch Manager Western Canada from 1994 to 1995, and Branch Manager Scotland from 1989 to 1994. Mr. Stretch holds a B.A. in Economics and Economic History from the University of Strathclyde and a Postgraduate Diploma in Computer Systems Engineering from the University of Edinburgh.
Ronald J. Fior has served as our Senior Vice President, Finance and Operations and Chief Financial Officer since April 2006. Since joining us, Mr. Fior has also served as our Vice President, Finance and Chief Financial Officer from September 2002 to April 2006. From December 2001 to July 2002, Mr. Fior served as Vice President of Finance and Chief Financial Officer for Ingenuity Systems, a bioinformatics software development company. From July 1998 until October 2001, Mr. Fior served as Chief Financial Officer and Vice President of Finance and
Operations of Remedy Corporation, an enterprise software applications company. Prior to this, Mr. Fior served for 13 years as Chief Financial Officer of numerous divisions and companies within the publishing operations of The Thomson Corporation, including the ITP Education Group and the International Thomson Publishing Group. Mr. Fior holds a Bachelor of Commerce degree from the University of Saskatchewan and is a Chartered Accountant.
V. Holly Albert has served as our Senior Vice President, General Counsel and Secretary since August 2006. Previously, Ms. Albert was in private legal practice from April 2004 until August 2006. Prior to that, Ms. Albert was the Vice President, General Counsel and Corporate Secretary at Docent Inc., (now SumTotal Systems, Inc.) a provider of integrated software applications, services, and content from December 2002 to April 2004. Prior to Docent, Ms. Albert served as Vice President, General Counsel and COO at Tradenable, Inc., an Internet financial services company. Prior to Tradenable, she was the Vice President and General Counsel at infoUSA.com. Prior to infoUSA, she served in a variety of roles at Honeywell Inc. from 1983 to 2000, with her last position being the General Counsel for Honeywell-Measurex Corporation. Ms. Albert is a member of both the California and New Mexico State bars and received her J.D. from the University of Pittsburgh School Of Law. Ms. Albert also holds an M.A. from John F. Kennedy University in Psychology and a B.A. in Economics from Washington and Jefferson College.
Merritt Alberti has served as our Senior Vice President, Worldwide Client Services since April 2009. Previously, he served as our Vice President, North America Client Services from January 2008 to March 2009. From 2004 to 2008, Mr. Alberti was Vice President at Compensation Technologies, a consulting services organization specializing in the design, implementation and support of incentive compensation management programs. Prior to Compensation Technologies, he was director of technology services at The Alexander Group, Inc, a consulting organization that specializes in sales force effectiveness. Mr. Alberti holds a B.S. from the United States Military Academy at West Point, an M.S. in information systems from Tarleton State University, and an MBA from the University of Texas at Austin.
Jimmy C. Duan became our Senior Vice President, Asia Pacific and Latin America in February 2010. Previously, he served as our Senior Vice President, Mid-Market Business since October 2008. Mr. Duan also served as our Vice President, Strategic Services from October 2005 to April 2006, Managing Director, Expert Services from April 2004 to September 2005, and Managing Director, Western Area Consulting from March 2001 to March 2004. From May 2006 to October 2008, Mr. Duan was employed by Xactly Corporation, an on-demand sales compensation solution provider, in various positions, most recently as its Vice President, Products and Professional Services, Mr. Duan also served as Director of Business Intelligence and Data Warehousing at Quovera, a business consulting and technology integration provider, from May 1999 March 2001 and as Solutions Manager at Talus Solutions, a pricing and revenue management software solution provider, from October 1996 to May 1999. Mr. Duan holds a B.S. in Engineering from Central-South University in China and a Ph.D. in Industrial and Systems Engineering from Virginia Tech.
Michael L. Graves has served as our Senior Vice President, Engineering since February 2007. Previously, Mr. Graves served in a variety of roles at Oracle Corporation, an enterprise application software company, from October 1997 to February 2007, most recently as Vice President of Engineering, Oracle Applications from January 2006 to February 2007, and Senior Director of Engineering from October 1997 to January 2006. Mr. Graves holds a B.S. Finance-Economics from the University of California, Berkeley.
Lorna Heynike has served as our Senior Vice President, Marketing, since July 2009. Prior to that, Mrs. Heynike was our Vice President, Product Management from January 2009 to July 2009, and our Senior Director, Product Management from April 2007 to January 2009. Previously, Mrs. Heynike worked in a variety of product management related positions with Oracle Corporation, from April 2001 to March 2007, most recently as Director, Product Management. Mrs. Heynike holds an MBA from Heriot-Watt University in Edinburgh, Scotland; an M.Sc. from the University of Edinburgh, Scotland; and a B.A. degree with Honors from the University of California at Berkeley.
Jeffrey Saling has served as our Senior Vice President, North America and EMEA, since July 2009. Mr. Saling has also served as our Senior Vice President, Callidus On-Demand, from April 2008 to July 2009, Vice President, Managed Services, from May 2006 to April 2008, Managing Director, On-Demand Services, from December 2005 to May 2006, and Managing Director, Client Services from January 2004 to November 2005. Prior to joining
Callidus, Mr. Saling worked in a variety of roles at Chordiant Software, an enterprise application software company focused on front office solutions, including Americas Vice President of Field Operations from July 2001 to January 2004, and Consultancy Services Director/Manager from January 1998 to July 2001. Prior to Chordiant, Mr. Saling served as General Manager (Senior Manager) for Accenture’s (Andersen Consulting’s) outsourced business for Ford Motor Company from June 1997 to December 1998. Mr. Saling holds a Bachelor of Science degree in Business Administration, Production & Operations Management, from California State University, Hayward.
Available Information
We make available, free of charge, on our website (www.callidussoftware.com) our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other periodic reports as soon as reasonably practicable after we have electronically filed or furnished such materials to the Securities and Exchange Commission.
Item 1A.
Item 1A.
Risk Factors
Factors That Could Affect Future Results
We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
RISKS RELATED TO OUR BUSINESS
We have a history of losses, and we cannot assure you that we will achieve and sustain profitability.
We incurred net losses of $18.0 million, $13.8 million and $13.1 million in 2009, 2008 and 2007, respectively. Our transition to a recurring revenue model has resulted in a decline in perpetual license revenues, and we do not expect the perpetual license revenues to return to historical levels. At the same time, the decline in growth rate of our cumulative Net Annual Contract Value (ACV) for on-demand services in several previous quarters, and the absolute decline in Net ACV in the second quarter of 2009, will adversely affect our on-demand revenues in subsequent periods. As a result of the transition to a recurring revenue model and in the face of challenging macro-economic conditions, our revenue declined by 24% from 2008 to 2009. In addition, because our recurring revenue provides lower gross margin than our historical perpetual license revenues, our overall gross margin declined from 43% to 39% from 2008 to 2009. To achieve profitability, we must increase our total revenues, principally by growing our cumulative Net ACV by entering into more or larger recurring revenue transactions and maintaining or reducing the rate of existing customer cancellations. If we cannot increase our cumulative Net ACV, our future results of operations and financial condition will be adversely affected and we may be unable to achieve profitability.
To achieve profitability, we must also ensure that our cost structure is aligned to the revenue and gross margin levels of our new model. To reduce our expenses, we took a number of cost reduction steps in 2007, 2008, and 2009. These cost reductions efforts include headcount reductions, the latest of which commenced in the first quarter of 2010. In connection with the restructurings, we incurred expenses of $3.0 million in 2009, $1.6 million in 2008, and $1.5 million in 2007. We do not expect to realize the full benefits of the latest measures until the second or third quarter of 2010. We are continuing to monitor our expenses in an effort to further optimize our performance for the long-term. However, there is no assurance that these steps to manage our expenses will be adequate. Consequently, we may be required to incur additional restructuring expenses in the future and, even with these or any future actions, we cannot be sure that we will achieve or sustain profitability on a quarterly or annual basis in the future. If we cannot increase our total revenues, improve our gross margins, and control our costs, our future results of operations and financial condition will be negatively affected.
Disruptions in the financial and insurance industries or the global economic crisis may materially and adversely affect our revenues, operating results and financial condition.
Historically, a substantial portion of our revenues have been derived from sales of our products and services to customers in the financial and insurance industries. The substantial disruptions in these industries in 2008 and 2009 have resulted, and may in the future result, in these customers deferring or cancelling future planned expenditures on our products and services. Further, consolidations and business failures in these industries could result in substantially reduced demand for our products and services. In addition, the disruptions in these industries and the concurrent global financial crisis may cause other potential customers to defer or cancel future purchases of our products and services as they seek to conserve resources in the face of economic turmoil and the drastically reduced availability of capital in the equity and debt markets. Any of these developments, or the combination of these developments, may materially and adversely affect our revenues, operating results and financial condition in future periods.
If we are unable to consistently offer our on-demand offering on a profitable basis, our operating results could be adversely affected.
We have invested, and expect to continue to invest, substantial resources to expand, market, and implement our on-demand offering. We achieved positive gross margins on our on-demand offering for the first time in the first quarter of 2008. As we continue to promote our on-demand service, there is a risk of confusion in the market over the alternative ways to purchase our software, which could result in delayed sales. In addition, with our increased focus on the on-demand service, customers that might have otherwise purchased a perpetual license may opt for our on-demand service which may adversely affect our revenue and operating results in the short-term as revenues for on-demand services are recognized over the life of the agreement with each of our customers rather than upfront as they generally were recognized with perpetual licenses. In addition, the professional services associated with on-demand implementations are generally much less than those associated with perpetual licenses. This business model shift to on-demand may also have a longer term adverse effect on operating results, as our on-demand offering is expected to continue to generate much lower margins than our perpetual license sales.
Our on-demand contracts provide for payment by the customer either after the customer goes into production, as of the effective date of the contract, or when we meet the customer-specific requirements. To the extent those contracts, for which we will not recognize revenue until the customer has commenced production, become predominant, our revenue recognition will be delayed and our operating results will be adversely affected.
We cannot accurately predict customer subscription and maintenance renewal rates and the impact these renewal rates will have on our future revenues or operating results.
Our customers have no obligation to renew their subscriptions for our on-demand service or maintenance support for term or perpetual license transactions after the expiration of their initial subscription or maintenance period, which is typically 12 to 24 months, and some customers have elected not to renew. In addition, our customers may renew for fewer payees or renew for shorter contract lengths. We cannot accurately predict customer renewal rates. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their reduced spending levels, their decision to do more of the work themselves internally, or dissatisfaction with our service. If our customers do not renew their subscriptions for our on-demand services or maintenance support, our revenue will decline and our business will suffer.
Because we recognize revenue from subscriptions for our on-demand service and maintenance support over the terms of the subscription and maintenance support agreements, downturns or upturns in sales may not be immediately reflected in our operating results.
We generally recognize on-demand and maintenance revenues from customers ratably over the terms of their subscription and maintenance support agreements, which are typically 12 to 24 months, although terms can range from one to 60 months. As a result, most of the recurring revenues we report in each quarter result from the recognition of deferred revenue relating to subscription and maintenance agreements entered into during previous quarters. Consequently, a decline in new or renewed subscriptions and maintenance in any one quarter will not
necessarily be fully reflected in the revenue in that quarter but will negatively affect our revenue in future quarters. In addition, we may be unable to adjust our cost structure to reflect the changes in revenues. Accordingly, the effect of significant downturns in sales and market acceptance of our on-demand service may not be fully reflected in our results of operations until future periods. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the applicable subscription term.
Our success depends upon our ability to develop new products and enhance our existing products rapidly and cost-effectively. Failure to successfully introduce new or enhanced products may adversely affect our operating results.
The sales performance management software market is characterized by:
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Rapid technological advances in hardware and software development;
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evolving standards in computer hardware, software technology and communications infrastructure;
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changing customer needs; and
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frequent new product introductions and enhancements.
To keep pace with technological developments, satisfy increasingly sophisticated customer requirements, achieve market acceptance and effectively respond to competitive product introductions, we must quickly identify emerging trends and requirements, accurately define and design enhancements and improvements for existing products and introduce new products and services. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results. Further, any new products we develop may not be introduced in a timely manner or available in a distribution model acceptable to our target markets and may therefore not achieve the broad market acceptance necessary to generate significant revenues. For example, we recently introduced several new products that are only available through our on-demand services offering or through our relationship with salesforce.com. If one or both of these distribution options are not accepted by customers in our target markets, these new products may not succeed and our future revenues may be adversely affected. Additionally, shifting more of our new product development efforts to offshore resources will require detailed technical and logistical coordination to ensure that international resources are aware of and understand development specifications and that they can meet development timelines or, if they are not met, that any delays are not significant. If we are unable to quickly and successfully develop and distribute new products cost-effectively or enhance existing products or if we fail to position and price our products to meet market demand, our business and operating results will be adversely affected.
Our use of third-party international product development and support services may prove difficult to manage or of inadequate quality to allow us to realize our cost reduction goals and produce new products to drive growth.
We use an India-based firm to provide certain software engineering services and support and we expect to expand our use of offshore third-party technical services and support in the future. We have limited experience in managing development and support of our products by offshore contractors, and may not be able to maintain acceptable standards of quality in support or product development. If we are unable to successfully maintain product development and support quality through our efforts with international third-party service providers, our attempts to reduce costs and drive growth through new products may be negatively impacted which would adversely affect our results of operations. Additionally, if we transition too much of our development and support efforts offshore and we are not able to effectively manage these out-sourced providers, our ability to quickly respond to changing market demands and support our customers may be severely compromised which could adversely affect our business and results of operations. In addition, outsourcing development and support operation to offshore providers may expose us to misappropriation of our intellectual property, or make it more difficult to defend our rights in our technology.
The market for sales performance management software is still new and rapidly evolving and may not develop as we expect.
Our business is in the market for sales performance management software, which is an evolving market. We believe one of our key challenges is to convince prospective customers of their need for our products and services and to persuade them that they should make purchases of our products and services a higher priority relative to other projects. Our future financial performance will depend in large part on continued growth in the number of organizations adopting sales performance management software as a solution to address the problems related to sales performance management. We have only recently begun to focus our business on this market opportunity. The market for sales performance management software may not develop as we expect, or at all. Even if a market does develop, our competitors may be more successful than we are in capturing the market. In either case, our business and operating results will be adversely affected.
Our failure to effectively implement and manage the offering of our on-premise product on a time-based term license basis or the restructuring of our organizations in connection with our transition to a recurring revenue business model may harm our business and financial results.
In the third quarter of 2009, we began offering our on-premise products on a time-based term license basis. We had initial sales of our products on this basis in the third quarter of 2009, but there is no assurance when or if this new offering will achieve market acceptance. If our new on-premise time-based term license offering fails to achieve market acceptance, our business and operating results may be materially and adversely affected. In connection with our transition to a recurring revenue business model, in July 2009, we reorganized our sales organization and marketing department to more effectively focus on market opportunities and concurrently took other significant action to reduce costs. There are no guarantees that it will be successful. If these steps prove insufficient or ineffective or result in unanticipated disruption to our business, our ability to achieve or sustain profitability may be materially impaired.
Our quarterly revenues and operating results are unpredictable and are likely to continue to fluctuate substantially, which may harm our results of operations.
Although our revenue is primarily focused on recurring revenues, we anticipate doing some perpetual license revenue business which is difficult to forecast and which is likely to fluctuate significantly from quarter to quarter due to a number of factors, many of which are wholly or partially beyond our control. We expect that our ongoing focus on our on-demand business will result in lower revenues from perpetual licenses and decreased customer expenditures on professional services over historical levels.
Accordingly, we believe that period-to-period comparisons of our results of operations should not be relied upon as definitive indicators of future performance.
Factors that may cause our quarterly revenue and operating results to fluctuate include:
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Disruption in the financial and insurance industries and the global financial crisis, which may result in the deferral or cancellation of future purchases of our products and services;
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the discretionary nature of our customers’ purchase and budget cycles and changes in their budgets for software and related purchases;
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the priority our customers place on the purchase of our products as compared to other information technology and capital acquisitions;
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competitive conditions in our industry, including new product introductions, product announcements and discounted pricing or special payment terms offered by our competitors;
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varying size, timing and contractual terms of orders for our products, which may delay the recognition of revenues;
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indeterminate and often lengthy sales cycles;
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changes in the mix of revenues attributable to higher-margin product license or recurring revenues as opposed to substantially lower-margin on-demand and professional services and other revenues;
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strategic actions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;
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merger and acquisition activities among our customers, which may alter their buying patterns, or failure of potential customers, which may reduce demand for our products and services;
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the extent to which our customer’s needs for professional services are reduced as a result of product improvements as well as implementation efficiencies in our on-demand offering over traditional on-premise implementations;
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the utilization rate of our professional services personnel and the degree to which we use third-party consulting services;
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changes in the average selling prices of our products;
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the rates the market will bear for our professional services and our ability to efficiently and profitably perform such services based on those market rates; and
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increased operating expenses associated with channel sales and increased product development efforts.
Our professional services revenues declined materially in recent periods as a result of changes to our business model, and we do not expect them to recover to previous historical levels.
Historically, a significant portion of our revenues were derived from the performance of professional services, primarily implementation, configuration, training and other consulting services in connection with perpetual licenses and ongoing projects. However, given the shift in our business model to on-demand and other factors, services revenue has declined materially, and we expect services revenues to be a much smaller portion of our revenues going forward. Characteristics of our on-demand offering contributing to the decline in our service revenue include:
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The initial implementation time for our on-demand solution is substantially less than our traditional on-premise enterprise software model resulting in a decreased need for our professional services.
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Historically, our on-premise enterprise software license transactions require post-implementation professional services, typically in the form of upgrade, updates and configuration support. Under our on-demand solution model, upgrades and updates are included in our on-demand technical operations thereby further reducing customers’ professional services needs.
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The number of third party professional services providers capable of implementing, configuring and performing other consulting services related to our on-demand solutions, including our partners, continues to expand. To the extent customers use third party professional services providers, our professional services revenues may be reduced.
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In addition, certain customers may experience budget constraints causing them to delay or cancel projects, including projects in which we would have performed professional services related to our software applications. To the extent these budget constraints continue or our customers become impacted by them, our professional services revenues may be reduced. For these and other reasons, our professional service revenues may decline further in the future.
We might not be able to manage our operations efficiently or profitably.
We experienced significant growth in our overall operations in 2007 and in our on-demand operations in 2008. Since 2008, however, we have significantly reduced the size of our internal organization as we have transitioned to a recurring revenue model, expanded our offshore and third party professional services partnerships and in reaction to slowing economic activity. As we continue to optimize our operations in relation to our recurring revenue model, we expect additional adjustments in our organizational structure will continue. The actions we have taken and may take
in the future may cause disruptions in or add complexity to our operations. In addition, if we return to a period of growth in our operations, we will likely need to expand the size of our staff, grow and manage our related operations and third party partnerships and strengthen our financial and accounting controls. Any expansion may increase our expenses, and there is no assurance that our infrastructure would be sufficiently scalable to efficiently manage the growth that we may experience. If we expand our operations, our systems, procedures or controls might not be adequate to support expansion. Further, to the extent we invest in additional resources and growth in our revenues does not ensue, our operating results would be adversely affected. If we are unable to further leverage our operating cost investments as a percentage of revenues our ability to generate profits will be adversely impacted.
Our service revenues produce substantially lower gross margins than our license and recurring revenues, and periodic variations in the proportional relationship between services revenues and higher margin license and recurring revenues have harmed, and may continue to harm, our overall gross margins.
Our services revenues, which include fees for consulting, implementation and training, were 37%, 46% and 49% of our revenues for 2009, 2008 and 2007, respectively. Our services revenues have substantially lower gross margins than our license and recurring revenues.
Historically, services revenues as a percentage of total revenues have varied significantly from period to period due to a number of circumstances including fluctuations in licensing and recurring revenues, changes in the average selling prices for our products and services and the effectiveness and appeal of competitive service providers. In addition, the volume and profitability of services can depend in large part upon:
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Competitive pricing pressure on the rates that we can charge for our professional services;
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increases or decreases in the number of services projects being performed on a fixed bid or acceptance basis that may defer recognition of revenue;
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the timing and amount of any remediation services related to professional services warranty claims;
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the complexity of the customers’ information technology environments;
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the priority and resources customers place on their implementation projects; and
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the extent to which outside consulting organizations provide services directly to customers.
As an example of competitive pressure on our services offerings, many of our potential customers are outsourcing technology projects offshore to take advantage of lower labor costs. Additionally, market rates for the types of professional services we offer may be greater or less than the rates we charge domestically depending on the geographic regions where the services are performed. Moreover, as we expand our international services operations, revenues may be impacted by fluctuations in currency exchange rates. Consequently, as we extend our customer base internationally, we expect greater variation in the proportion of services revenues compared to our other higher margin license and recurring revenues, which may increase or erode margins for our service revenues and our overall gross margins.
The loss of key personnel, higher than normal employee attrition in key departments, or the inability of replacements to quickly and successfully perform in their new roles could adversely affect our business.
Our success depends to a significant extent on the abilities and effectiveness of our personnel, and in particular our president and chief executive officer and our other executive officers. All of our existing personnel, including our executive officers, are employed on an “at-will” basis. If we lose or terminate the services of one or more of our current executives or key employees or if one or more of our current or former executives or key employees joins a competitor or otherwise competes with us, it could impair our business and our ability to successfully implement our business plan. Likewise, if a number of employees from specific departments were to depart, our short-term ability to maintain business operations and implement our business plan may be impaired. For example, our announcement that we intend to move our corporate headquarters from San Jose, California to a smaller, lower cost facility in or around Pleasanton, California in the third quarter of 2010 may cause a greater than expected number of employees from departments within our corporate headquarters to depart in the coming quarters. Additionally, if we are unable to quickly hire qualified replacements for our executive, other key positions or employees within specific
departments, our ability to execute our business plan could be harmed. Even if we can quickly hire qualified replacements, we would expect to experience operational disruptions and inefficiencies during any transition.
Our products have long sales cycles, which makes it difficult to plan our expenses and forecast our results.
The sales cycles for our on-demand solutions are still evolving, and as we continue to broaden our on-demand offerings it is difficult to determine with any certainty how long our sales cycles for our on-demand solutions will be in the future. The sales cycles for perpetual licenses of our products have historically been between six and twelve months, and longer in some cases, to complete. Consequently, it remains difficult to predict the quarter in which a particular sale will close and to plan expenditures accordingly. Moreover, because sales are often completed in the final two weeks of a quarter, this difficulty may be compounded. Global economic uncertainty and corporate cost-cutting are likely to continue throughout 2010, thereby prolonging the difficulty of predicting license and on-demand sales into the foreseeable future. The period between our initial contact with a potential customer and its purchase of our products and services is relatively long due to several factors, including:
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The complex nature of our products;
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the need to educate potential customers about the uses and benefits of our products and services;
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budget cycles of our potential customers that affect the timing of purchases;
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customer requirements for competitive evaluation and internal approval before purchasing our products and services;
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potential delays of purchases due to announcements or planned introductions of new products and services by us or our competitors; and
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the lengthy approval processes of our potential customers, many of which are large organizations.
The failure to complete sales of our on-demand solution in a particular quarter will defer revenues into subsequent quarters as revenue from our on-demand services are recognized ratably over the term of the agreement.
Professional services revenues comprise a substantial portion of our revenues and, to the extent our customers choose to use other services providers, our revenues and operating results may decline.
A substantial portion of our revenues are derived from the performance of professional services, primarily implementation, configuration, training and other consulting services in connection with new product licenses and other ongoing projects. However, there are a number of third-party service providers available that offer these professional services, and we do not require that our customers use our professional services. To the extent our customers choose to use third-party service providers instead of us or perform these professional services themselves, our revenues and operating income may decline significantly.
Deployment of our products frequently requires substantial technical implementation and support by us or third-party service providers. Failure to meet these requirements could cause a decline or delay in recognition of our revenues and an increase in our expenses.
Deployments of our products frequently require a substantial degree of technical and logistical expertise for both on-demand and on-premise implementations. Moreover, whether for our on-demand or on-premise implementations, our customers can require large, enterprise-wide deployments of our products. It may be difficult for us to manage these deployments, including the timely allocation of personnel and resources by us and our customers. Failure to successfully manage the process could harm our reputation both generally and with specific customers and may cause us to lose existing customers, face potential customer disputes or limit the number of new customers that purchase our products, each of which could adversely affect our revenues and increase our technical support and litigation costs.
Our software license customers have the option to receive implementation, maintenance, training and consulting services from our internal professional services organization or from outside consulting organizations.
We may increase our use of third-party service providers to help meet our implementation and service obligations. If we use a greater number of third-party service providers than we do currently, we will be required to negotiate additional arrangements, which may result in lower gross margins for maintenance or service revenues. Moreover, third-party service providers may not be as skilled in implementing or maintaining our products as our internal professional staff.
If implementation services are not provided successfully and in a timely manner, our customers may experience increased costs and errors, which may result in customer dissatisfaction and costly remediation and litigation, any of which could adversely impact our reputation, operating results and financial condition. We make estimates of sales return reserves related to potential future requirements to provide remediation services in connection with current period service revenues, which are accounted for in the consolidated financial statements. If actual remediation services exceed our estimates we could be required to take additional charges, which could be material.
Acquisitions and investments present many risks, and we may not realize the anticipated financial and strategic goals for any such transactions.
We may in the future acquire or make investments in other complementary companies, products, services and technologies. In January 2010, we completed the acquisition of Actek, a leading provider of commissions and compliance software for complex selling environments for the insurance and financial services industries. In January 2008 we acquired Compensation Technologies LLC to expand our services offerings and improve our services related operations. We may not realize the expected benefits of acquisitions or investments we made or may make in the future. For example, after acquiring Compensation Technologies to strengthen our professional service operation, demand for our professional services declined substantially, in the face of challenging macro-economic condition, as well as our transition to a recurring revenue model, which is less service intensive. In addition, acquisitions and investments involve a number of risks, including the following:
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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;
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we may find that the acquired business or assets do not further our business strategy, or that we overpaid for the business or assets, or that economic conditions change, all of which may generate a future impairment charge;
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we may have difficulty integrating the acquired technologies or products with our existing product lines;
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there may be customer confusion where our products overlap with those of the acquired business;
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we may become exposed to liabilities associated with the sale of the acquired business’ products and services;
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our ongoing business and management’s attention may be disrupted or diverted by transition or integration issues or the complexity of managing geographically and culturally diverse locations;
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we may have difficulty maintaining uniform standards, controls, procedures and policies across locations;
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acquisitions may result in litigation from terminated employees or third-parties; and
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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. Such negotiations could result in significant diversion of management time, as well as out-of-pocket expenses.
The consideration paid in connection with an investment or acquisition also affects our financial condition and operating results. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash or incur substantial debt to
consummate such acquisitions. If we incur substantial debt, it could result in material limitations on the conduct of our business. To the extent we issue shares of stock or other rights to purchase stock, including options, existing stockholders may be diluted. In addition, acquisitions may result in the incurrence of debt, large one-time write-offs (such as acquired in-process research and development) and restructuring charges. They may also result in the acquisition of goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges.
If we are unable to hire or subcontract for and retain qualified employees, including sales, professional services, and engineering personnel, our growth may be impaired.
To expand our business successfully and maintain a high level of quality, we need to continually recruit, retain and motivate highly skilled employees and subcontractors in all areas of our business, including sales, professional services and engineering. In particular, if we are unable to hire or subcontract for and retain talented professional services personnel with the skills, and in the locations, we require, we might need to redeploy existing personnel or further increase our reliance on subcontractors to fill certain of our labor needs. As our customer base increases and as we continue to evaluate and modify our organizational structure to increase efficiency, we are likely to experience staffing constraints in connection with the deployment of trained and experienced professional services resources capable of implementing, configuring and maintaining our software for existing customers looking to migrate to more current versions of our products as well as new customers requiring installation support. Moreover, as a company focused on the development of complex products, we are often in need of additional software developers and engineers.
Our latest product features and functionality may require existing customers to migrate to more recent versions of our software. Moreover, we may choose to or be compelled to discontinue maintenance support for older versions of our software products, forcing customers to upgrade their software in order to continue receiving maintenance support. If existing customers fail to migrate or delay migration to newer versions of our software, our revenues may be harmed.
We plan to pursue sales of new product modules to existing perpetual license customers of our TrueComp software. To take advantage of new features and functionality in our latest modules, many of our perpetual license customers will need to migrate to a more current version of our products. We also expect to periodically terminate maintenance support on older versions of our products for various reasons including, without limitation, termination of support by third-party software vendors whose products complement ours or upon which we are dependent. Termination of maintenance may force our perpetual license customers to migrate to more current versions of our software. Regardless of the reason, upgrading to more current versions of our products is likely to involve additional cost, which our customers may delay or decline to incur. If a sufficient number of our customers do not migrate to newer versions of our software, our continued maintenance support opportunities and our ability to sell additional products to these customers, and as a result, our revenues and operating income, may possibly be harmed significantly.
If we do not compete effectively, our revenues may not grow and could decline.
We have experienced, and expect to continue to experience, intense competition from a number of software companies. We compete principally with vendors of Sales Performance Management (SPM) software, Enterprise Incentive Management (EIM) software, enterprise resource planning software, and customer relationship management software. Our competitors may announce new products, services or enhancements that better meet the needs of customers or changing industry standards. Increased competition may cause price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, results of operations and financial condition.
Many of our enterprise resource planning competitors and other potential competitors have significantly greater financial, technical, marketing, service and other resources. Many also have a larger installed base of users, longer operating histories or greater name recognition. Some of our competitors’ products may also be more effective at performing particular SPM or EIM system functions or may be more customized for particular customer needs in a given market. Even if our competitors provide products with less SPM or EIM system functionality than
our products, these products may incorporate other capabilities, such as recording and accounting for transactions, customer orders or inventory management data. A product that performs these functions, as well as some of the functions of our software solutions, may be appealing to some customers because it would reduce the number of software applications used to run their business.
Our products must be integrated with software provided by a number of our existing or potential competitors. These competitors could alter their products in ways that inhibit integration with our products, or they could deny or delay our access to advance software releases, which would restrict our ability to adapt our products for integration with their new releases and could result in the loss of both sales opportunities and renewals of on-demand services and maintenance.
A substantial majority of our product revenues are derived from our TrueComp®
software application and related products and services, and a decline in sales of these products and services could adversely affect our operating results and financial condition.
We derive, and expect to continue to derive, a substantial majority of our product revenues from our TrueComp application and related products and services through both our on-demand and on-premise solutions. Our on-demand solution still consists substantially of our TrueComp application. In addition, our installed base of perpetual license customers has predominantly purchased our TrueComp application, and our ability to generate maintenance revenue from these customers depends on their continued use of our TrueComp application. As a result of these factors, maintenance revenue from these customers depends on the customer use of our TrueComp application, we are particularly vulnerable to fluctuations in demand for our TrueComp application. Accordingly, if demand for our TrueComp application and related products and services decline significantly, our business and operating results will be adversely affected.
If we reduce prices, alter our payment terms or modify our products or services in order to compete successfully, our margins and operating results may be adversely affected.
The intensely competitive market in which we do business may require us to reduce our prices and/or modify our pricing strategies in ways that may adversely affect our operating results. If our competitors offer deep discounts on competitive products or services, we may be required to lower prices or offer other terms more favorable to our customers in order to compete successfully. Some of our competitors may bundle their software products that compete with ours with their other products and services for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that we can charge for our products or cause us to modify our existing market strategies for our products and services. If we cannot offset price reductions and other terms more favorable to our customers with a corresponding increase in the number of sales or decreased spending, then the reduced revenues resulting from lower prices or revenue recognition delays would adversely affect our margins and operating results.
Our products depend on the technology of third parties licensed to us that are necessary for our applications to operate and the loss or inability to maintain these licenses, errors in such software, or discontinuation or updates to such software could result in increased costs or delayed sales of our products.
We license technology from several software providers for our rules engine, analytics, web viewer and quota management application, and we anticipate that we will continue to do so for these features and from these or other providers in connection with future products. We also rely on generally available third-party software to run our applications. Any of these software applications may not continue to be available on commercially reasonable terms, if at all, or new versions may be released that are incompatible with our prior or existing software releases. Some of the products could be difficult to replace, and developing or integrating new software with our products could require months or years of design and engineering work. The loss or modification of any of these technologies could result in delays in the license of our products until equivalent technology is developed or, if available, is identified, licensed and integrated. Acquisitions of our third-party technology licenses by our competitors or otherwise may have a material adverse impact on us if the acquirer seeks to cancel or change the terms of our license.
In addition, our products depend upon the successful operation of third-party products in conjunction with our products and, therefore, any undetected errors in these products could prevent the implementation or impair the functionality of our products, delay new product introductions and/or injure our reputation. Our use of additional or alternative third-party software that requires us to enter into license agreements with third parties could result in new or higher royalty payments.
Errors in our products could be costly to correct, adversely affect our reputation and impair our ability to sell our products.
Our products are complex and, accordingly, they may contain errors, or “bugs,” that could be detected at any point in their product life cycle. While we continually test our products for errors and work with customers to identify and correct bugs, errors in our products are likely to be found in the future. Any errors could be extremely costly to correct, materially and adversely affect our reputation and impair our ability to sell our products. Further, our efforts to reduce costs by employing more subcontracting personnel to perform product development and support tasks may make it more difficult for us to timely respond to product errors. Moreover, customers relying on our products to calculate and pay incentive compensation may have a greater sensitivity to product errors and security vulnerabilities than customers for software products in general. If we incur substantial costs to correct any product errors, our operating margins would be adversely affected.
Because our customers depend on our software for their critical business functions, any interruptions could result in:
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Lost or delayed market acceptance and sales of our products;
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product liability suits against us;
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diversion of development resources; and
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substantially greater service and warranty costs.
Our revenues might be harmed by resistance to adoption of our software by information technology departments.
Some potential customers have already made a substantial investment in third-party or internally developed software designed to model, administer, analyze and report on pay-for-performance programs. These companies may be reluctant to abandon these investments in favor of our software. In addition, information technology departments of potential customers may resist purchasing our software solutions for a variety of other reasons, particularly the potential displacement of their historical role in creating and running software and concerns that packaged software products are not sufficiently customizable for their enterprises.
We may lose sales opportunities and our business may be harmed if we do not successfully develop and maintain strategic relationships to implement and sell our products.
We have relationships with third-party consulting firms, systems integrators and software vendors. These third parties may provide us with customer referrals, cooperate with us in the design, sales and/or marketing of our products, provide valuable insights into market demands and provide our customers with systems implementation services or overall program management. However, we do not have formal agreements governing our ongoing relationship with certain of these third-party providers and the agreements we do have generally do not include obligations with respect to generating sales opportunities or cooperating on future business.
We also have and are considering strategic relationships that are new or unusual for us and which can pose additional risks. While reseller arrangements offer the advantage of leveraging larger sales organizations than our own to sell our products, they also require considerable time and effort on our part to train and support our strategic partner’s personnel, and require our strategic partners to properly motivate and incentivize their sales force. Also, if the reseller agreement is an exclusive arrangement, there is risk that the exclusivity prevents us from pursuing the applicable markets ourselves, which if the reseller is not being successful there on our behalf, may adversely affect our results of operations.
Should any of these third parties go out of business or choose not to work with us; we may be forced to develop new capabilities internally, which may cause significant delays and expense, thereby adversely affecting our operating results. Any of our third-party providers may offer products of other companies, including products that compete with our products. If we do not successfully and efficiently establish, maintain, and expand our industry relationships with influential market participants, we could lose sales and service opportunities, which would adversely affect our results of operations.
Breaches of security or failure to safeguard customer data could create the perception that our services are not secure, causing customers to discontinue or reject the use of our services and potentially subject us to significant liability. Implementing, monitoring and maintaining adequate security safeguards may be costly.
Our on-demand service allows our customers to access our software and transmit confidential data, including personally identifiable individual data of their employees, agents, and customers over the Internet. We also store data provided to us by our customers on servers in a third-party data warehouse. In addition, we may have access to confidential and private individual data as part of our professional services organization activities, including implementation, maintenance and support of our software for perpetual license customers. If we do not adequately safeguard the confidential information imported into our software or otherwise provided to us by our customers, or if third parties penetrate our systems or security and misappropriate our customers’ confidential information, our reputation may be damaged and we may be sued and incur substantial damages in connection with such disclosures or misappropriations. Even if it is determined that our security measures were adequate, the damage to our reputation may cause customers and potential customers to reconsider the use of our software and services, which may have a material adverse effect on our results of operations.
Moreover, many of our customers are subject to heightened security obligations regarding the personally identifiable information of their customers. In the United States, these heightened obligations particularly affect the financial services and insurance sectors, which are subject to stringent controls over personal information under the Gramm-Leach-Bliley Act, Health Insurance Portability and Accountability Act, Health Information Technology for Economic and Clinical Health Act and other similar state and federal laws and regulations. In addition, the European Union Directive on Data Protection creates international obligations on the protection of personal data that typically exceed security requirements mandated in the United States. The security measures we have implemented and may need to implement, monitor and maintain in the future to satisfy the requirements of our customers, many of which are in the financial services and insurance sectors, may be substantial and involve significant time and effort, which are typically not chargeable to our customers.
If we fail to adequately protect our proprietary rights and intellectual property, we may lose valuable assets, experience reduced revenues and incur costly litigation to protect our rights.
Our success and ability to compete is significantly dependent on the proprietary technology embedded in our products. We rely on a combination of copyrights, patents, trademarks, service marks, trade secret laws and contractual restrictions to establish and protect our proprietary rights. We cannot protect our intellectual property if we are unable to enforce our rights or if we do not detect its unauthorized use. Despite our precautions, it may be possible for unauthorized third parties to copy and/or reverse engineer our products and use information that we regard as proprietary to create products and services that compete with ours. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we engage in international activities, our exposure to unauthorized copying and use of our products and proprietary information increases.
We enter into confidentiality or license agreements with our employees and consultants and with the customers and corporations with whom we have strategic relationships. No assurance can be given that these agreements will be effective in controlling access to and distribution of our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products. 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 one that results in a significant damage award.
From time to time, we receive claims that our products or business infringe or misappropriate the intellectual property rights of third parties and our competitors or other third parties may challenge the validity or scope of our intellectual property rights. We believe that claims of infringement are likely to increase as the functionality of our products expands and as new products are introduced. 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:
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Require costly litigation to resolve;
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absorb significant management time;
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cause us to enter into unfavorable royalty or license agreements;
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require us to discontinue the sale of all or a portion of our products;
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require us to indemnify our customers or third-party systems integrators; or
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require us to expend additional development resources to redesign our products.
Our inclusion of open source software in our products may expose us to liability or require release of our source code.
We use a limited amount of open source software in our products and may use more in the future. From time to time there have been claims challenging the ownership of open source software against companies that incorporate open source software into their products. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software. In addition, some open source software is provided under licenses that require that proprietary software, when combined in specific ways with open source software, become subject to the open source license and thus freely available. While we take steps to minimize the risk that our software, when combined with open source software, would become subject to open source licenses, few courts have interpreted open source licenses. As a result, the manner in which these licenses will be enforced is unclear. If our software were to become subject to open source licenses, our ability to commercialize our products and our operating results would be materially and adversely affected.
Uncertain economic conditions may adversely impact our business.
Our business may be adversely affected by the ongoing credit crises and adverse worldwide economic conditions. Further weakening in the global economy, or a further decline in confidence in the economy, could adversely impact our business in a number of important respects. These include (i) reduced bookings and revenues, as a result of longer sales cycles, reduced, deferred or cancelled customer purchases and lower average selling prices; (ii) increased operating losses and reduced cash flows from operations; (iii) greater than anticipated uncollectible accounts receivable and increased allowances for doubtful accounts receivable; and (iv) impairment in the value of our financial and non-financial assets resulting in non-cash impairment charges.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance consists of amounts identified for specific customers. If the financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments, additional allowances may be required, and we may be required to defer revenue recognition on sales to affected customers, any of which could adversely affect our operating results. In the future, we may have to record additional reserves or write-offs and/or defer revenue on certain sales transactions which could negatively impact our financial results.
If we do not adequately manage and evolve our financial reporting and managerial systems and processes, our ability to manage and grow our business may be harmed.
Our ability to successfully implement our business plan and comply with regulations, including the Sarbanes-Oxley Act, requires an effective planning and management process. We expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures and controls to manage our business effectively in the future. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could impair our ability to accurately forecast sales demand, manage our system integrators and other third-party service vendors and record and report financial and management information on a timely and accurate basis.
We expect to continue expanding our international operations but we do not have substantial experience in international markets, and may not achieve the expected results.
We have been expanding our international operations since 2006 and expect to continue expanding these operations in 2010. International expansion may require substantial financial resources and a significant amount of attention from our management. International operations involve a variety of risks, particularly:
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Unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
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differing abilities to protect our intellectual property rights;
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use of international resellers and compliance with the foreign corrupt practices act;
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differing labor regulations;
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greater difficulty in supporting and localizing our products;
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greater difficulty in establishing, staffing and managing foreign operations;
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possible political and economic instability; and
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fluctuating exchange rates.
We have limited experience in marketing, selling and supporting our products and services abroad. If we invest substantial time and resources to grow our international operations and fail to do so successfully and on a timely basis, our business and operating results could be seriously harmed.
RISKS RELATED TO OUR STOCK
Our stock price is likely to remain volatile.
The trading price of our common stock has in the past and may in the future be subject to wide fluctuations in response to a number of factors, including those described in this section. We receive only limited attention by securities analysts, and there frequently occurs an imbalance between supply and demand in the public trading market for our common stock due to limited trading volumes. Our stock repurchase program may increase this imbalance. Investors should consider an investment in our common stock as risky and should purchase our common stock only if they can withstand significant losses. Other factors that affect the volatility of our stock include:
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Our operating performance and the performance of other similar companies;
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significant sales or distributions by existing investors coupled with a lack of trading volume for our stock;
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announcements by us or our competitors of significant contracts, results of operations, projections, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;
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changes in our management team;
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publication of research reports about us or our industry by securities analysts; and
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developments with respect to intellectual property rights.
Additionally, some companies with volatile market prices for their securities have been subject to securities class action lawsuits filed against them. For example, in 2004 we were sued in connection with the decline in our stock price following the announcements of disappointing operating results and changes in senior management. Any future suits such as these could have a material adverse effect on our business, results of operations, financial condition and the price of our common stock.
Future sales of substantial amounts of our common stock by us or our existing stockholders could cause our stock price to fall.
Additional equity financings or other share issuances by us could adversely affect the market price of our common stock. Sales by existing stockholders of a large number of shares of our common stock in the public trading market (or in private transactions) including sales by our executive officers, directors or venture capital funds, or the perception that such additional sales could occur, could cause the market price of our common stock to drop.
Provisions in our charter documents, our stockholder rights plan and Delaware law may delay or prevent an acquisition of our company.
Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. For example, if a potential acquirer were to make a hostile bid for us, the acquirer would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms, which means that replacing a majority of our directors would require at least two annual meetings. The acquirer would also be required to provide advance notice of its proposal to replace directors at any annual meeting, and would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on the board of directors than if cumulative voting were permitted. In addition, we are a party to a stockholder rights agreement, which effectively prohibits a person from acquiring more than 15% (subject to certain exceptions) of our common stock without the approval of our board of directors. Furthermore, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. All of these factors make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders. Our board of directors could choose not to negotiate with an acquirer that it does not believe is in our strategic interests. If an acquirer is discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by these or other measures, you could lose the opportunity to sell your shares at a favorable price.
Item 2.
Item 2.
Properties
We lease our headquarters in San Jose, California which consists of approximately 53,000 square feet of office space. The lease on our San Jose headquarters expires in 2010. We are in the process of negotiating a new lease and expect to enter into the lease and relocate our headquarters to Pleasanton, California in 2010. We also lease facilities in Austin, Birmingham (Alabama), London, New York, and Scottsdale. We believe that our properties are in good operating condition and adequately serve our current business operations. We also anticipate that suitable additional or alternative space, including those under lease options, will be available at commercially reasonable terms for future expansion. See Note 7 to the Consolidated Financial Statements for information regarding our lease obligations.
Item 3.
Item 3.
Legal Proceedings
We are from time to time a party to various litigation matters and customer disputes incidental to the conduct of our business, none of which, at the present time, is likely to have a material adverse effect on our future financial results.
In accordance with accounting for contingencies, we record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We review the need for any such liability on a quarterly basis and record any necessary adjustments to reflect the effect of ongoing negotiations, contract disputes, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular
case in the period they become known. At December 31, 2009, we have not recorded any such liabilities in accordance with accounting for contingencies. We believe that we have valid defenses with respect to the contract disputes and other legal matters pending against us and that the probability of a loss under such matters is not probable.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
None
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock has been traded on the NASDAQ Global Market under the symbol “CALD” since our initial public offering in November 2003. The following table sets forth, for the periods indicated, the high and low closing sales prices reported on the NASDAQ Global Market.
As of March 1, 2010, we had 31,153,488 shares of our common stock outstanding. There were 46 stockholders of record of our common stock, and we believe a greater number of beneficial owners.
We have never declared or paid cash dividends on our capital stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.
Performance Graph
The following performance graph shall not be deemed to be incorporated by reference by means of any general statement incorporating by reference this Form 10-K into any filing under the Securities Act of 1933, as amended or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates such information by reference, and shall not otherwise be deemed filed under such acts.
The graph compares the cumulative total return of our common stock from December 31, 2004 through December 31, 2009 with the NASDAQ Composite Index and the NASDAQ Computer & Data Processing Index.
The graph assumes (i) that $100 was invested in our common stock at the closing price of our common stock on December 31, 2003, (ii) that $100 was invested in each of the NASDAQ Composite Index and the NASDAQ Computer & Data Processing Index at the closing price of the respective index on such date and (iii) that all dividends received were reinvested. To date, no cash dividends have been declared or paid on our common stock.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Callidus Software Inc., The NASDAQ Composite Index
And The NASDAQ Computer & Data Processing Index
*
$100 invested on 12/31/04 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.
*
The Company has not changed comparable indices from 2008. The NASDAQ National Market Composite Index changed its name to the NASDAQ Composite Index in June 2006.
Item 6.
Item 6.
Selected Financial Data
The following selected consolidated financial data should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations section and the Consolidated Financial Statements and Notes thereto included elsewhere in this annual report. The selected consolidated statements of operations data for each of the years in the three-year period ended December 31, 2009, and as of December 31, 2009 and 2008, are derived from our audited consolidated financial statements that have been included in this annual report. The selected consolidated statement of operations data for each of the years in the two year period ended December 31, 2006 and the selected consolidated balance sheet data as of December 31, 2007, 2006 and 2005 are derived from our audited consolidated financial statements that have not been included in this annual report.
(1)
Effective January 1, 2006, the Company adopted the provisions of accounting for share-based payment under the modified prospective method. Accordingly, for the years ended December 31, 2009, 2008, 2007 and 2006, stock-based compensation was accounted for under accounting for share-based payment, while for the years prior to January 1, 2006, stock-based compensation was accounted for under accounting for stock issued to employees. The amounts above include stock-based compensation as follows:
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview of 2009 Results
We are a market and technology leader in Sales Performance Management (SPM) software solutions designed to align internal sales resources and distribution channels with corporate strategy. Our software enhances core processes in sales management, such as the structuring of sales territories, the management of sales force talent, the establishment of sales targets and the creation and execution of sales incentive plans. Using our SPM software solutions, companies can tailor these core processes to further their strategic objectives, including coordinating sales efforts with long-range strategies regarding sales and margin targets, growth initiatives, sales force talent development, territory expansion and market penetration. Our customers can also use our SPM solutions to address more tactical objectives, such as successful new product launches and effective cross-selling strategies. Leading companies worldwide in the financial services, insurance, communications, high-technology, life sciences and retail industries rely on our solutions for their sales performance management and incentive compensation needs. Our SPM solutions can be purchased and delivered as either an on-demand service or an on-premise software solution. Our on-demand service allows customers to use our software products through a web interface rather than purchase computer equipment and install our software at their locations, and we believe the benefits of this deployment method will make our on-demand offering our most popular product choice.
We sell our products and services both directly through our sales force and in conjunction with our strategic partners. We also offer professional services, including configuration, integration and training, generally on a time-and-materials basis. We generate recurring subscription and support revenues from our on-demand service, support and maintenance agreements associated with our product licenses and, beginning in the third quarter of 2009, we introduced on-premise licenses of our software as a time-based term license arrangement, all of which is recognized ratably over the term of the related agreement.
Transition to Recurring Revenue Model Completed
In 2009, we effectively completed the transition to our recurring revenue business model from a perpetual license business model. Our financial results for 2009 reflected our progress in the transition during the past year. Recurring revenues for 2009 were $46.3 million, up 14% over 2008. As a percentage of total revenues, recurring revenues accounted for 57%, up from 38% for 2008. Our progress in the transition to a recurring revenue business model is better illustrated in the comparison between the fourth quarters of 2009 and 2008. Recurring revenues accounted for 76% of total revenues in the fourth quarter of 2009, an increase from 41% in the fourth quarter of 2008. We expect recurring revenues to run at approximately 70% of total revenues through 2010.
A key metric in our recurring revenue business model is additions to Net Annual Contract Value (ACV) generated from the sale of our on-demand and time-based term license offerings. Our Net ACV increased by $6.4 million or 25% during 2009 to $32.4 million in cumulative net ACV at the end of 2009. Because of the move to a recurring revenue model, the full impact of the ACV bookings during 2009 will generally be recognized ratably over the next year. As a result of the contractual terms in some of our customer agreements, revenue related to new ACV bookings may be deferred until a customer goes live.
Total revenues for the year were $81.1 million, down $26.1 million or 24% from the prior year. This decrease was the result of the anticipated decrease in license and services revenues related to our business model change, combined with a very challenging economic environment. Total license revenue for the year was $5.0 million, a decrease of $12.1 million from 2008. Services revenue decreased by 40% from $49.5 million in 2008 to
$29.7 million in 2009. The shift in revenue mix from perpetual license revenue to more predictable recurring revenue has also resulted in reduced services revenue as expected, as the average implementation time for a recurring revenue arrangement is significantly less than under the perpetual license model.
Alignment of Cost Base with Recurring Revenue Model
During the past year of our transition to a recurring revenue business model, we aggressively reduced our operating expenses to better align our cost base with our recurring revenue streams. Our operating expenses decreased by $10.4 million, or 17%, to $49.5 million in 2009 from $59.9 million in 2008. The significant decrease in operating expenses was primarily the result of cost saving actions including reduction in staff taken throughout 2009. As a result of reductions in workforce, we recorded charges of approximately $3.0 million in 2009 compared to $1.6 million in 2008. We expect to realize additional savings in 2010 related to these and further actions. With our plans to transfer more of our development efforts to offshore resources and relocate our headquarters in 2010, we will make further progress toward aligning our cost base with our recurring revenue streams and achieving profitability.
Immaterial Adjustments to Previously Released Financial Results
Subsequent to the filing of our Form 8K on January 28, 2010, which included our press release containing our December 31, 2009 unaudited financial statements, we made immaterial adjustments to our fiscal 2009 financial statements which had the effect of increasing net loss by approximately $320,000. These adjustments are not material to either the annual or fourth quarter financial statements for the period ended December 31, 2009.
Other Business Highlights
On January 1, 2010, we completed the acquisition of Actek. Under the terms of the agreement, we paid Actek’s owner $2.1 million in a combination of cash and stock and assumed debt of $0.9 million. In addition, we may pay up to approximately $1 million in the form of cash, restricted stock units and stock options, depending on the achievement of specified operational milestones on January 1, 2011. Because this consideration is contingent on the achievement of the milestones, we are required to revalue the consideration at each subsequent reporting date until January 1, 2011 under the acquisition accounting guidance. Actek is a leading provider of commissions and compliance software for complex selling environments for the insurance and financial services industries.
Challenges and Risks
In response to market demand, we shifted our primary business focus from the sale of perpetual licenses for our products to the provision of our software as a service through our on-demand offering. Our SaaS model also provides more predictable quarterly revenues for us. In 2009, as our on-demand business has begun to mature and we faced challenging macro economic conditions, the growth rate of our new on-demand ACV bookings has slowed and we have begun to experience some attrition. As a result, the overall net ACV growth rate in 2009 was lower than in prior years. As a further step in our transition to a recurring revenue business model, in the third quarter of 2009 we began offering our on-premise products as a time-based term license arrangement. We believe this offering will better address the needs of our customers that prefer our on-premise solution, and provide us with more predictable revenue streams than perpetual on-premise licenses. While we have sold on-premise time-based term licenses during the second half of 2009, there is no assurance that this new offering will achieve market acceptance. If we are unable to significantly grow our recurring revenue business or continue to provide our on-demand services on a consistently profitable basis in the future, our business and operating results may be materially and adversely affected.
Costs associated with supporting our on-demand offering are generally higher than the cost of maintenance related to our on-premise customers. In addition to providing customer support that is included in our maintenance offering, we are responsible for the full operation of the software that the customer has contracted for in our hosting facility. Additionally, some of our on-demand customers subscribe to additional services available through our business operations offering that result in additional costs.
Our transition to a recurring revenue model has accelerated the anticipated decline in services revenues, as implementations of our on-demand offering generally are faster and require lower customer investment than our on-premise business. We do not expect our services revenues and margins to return to historical levels, and have taken steps to better align our costs to anticipated revenues. However, there is no assurance that the steps we have taken, or may take in the future, will be adequate. If they are not, our overall gross margins and our ability to achieve or sustain profitability will be adversely affected.
In July 2009 in connection with our transition to a recurring revenue business model, we reorganized our sales organization and marketing department to more effectively focus on our market opportunity and at the same time took other significant actions to reduce costs. If these steps prove insufficient or ineffective or result in unanticipated disruption to our business, our ability to achieve or sustain profitability may be materially impaired.
From a business perspective, we have a number of sales opportunities in process and additional opportunities coming from our sales pipeline; however, we continue to experience wide variances in the timing and size of our transactions and the timing of revenue recognition resulting from greater flexibility in contract terms. We believe one of our major remaining challenges is increasing prospective customers’ prioritization of purchasing our products and services over competing IT projects. To address this challenge, we have set goals that include expanding our sales efforts, promoting our on-demand services, and continuing to develop new products and enhancements to our suite of products.
Historically, a substantial portion of our revenues has been derived from sales of our products and services to customers in the financial and insurance industries. The recent substantial disruptions in these industries have resulted and may in the future result in these customers deferring or cancelling future planned expenditures on our products and services. Further, consolidations and business failures in these industries could result in substantially reduced demand for our products and services. In addition, the disruptions in these industries and the concurrent international financial crisis may cause other potential customers to defer or cancel future purchases of our products and services as they seek to conserve resources in the face of economic turmoil and the drastically reduced availability of capital in the equity and debt markets. Any of these developments, or the combination of these developments, may materially and adversely affect our revenues, operating results and financial condition in future periods.
If we are unable to grow our revenues, we may be unable to achieve and sustain profitability. In addition to these risks, our future operating performance is subject to the risks and uncertainties described in “Risk Factors” in Section 1A of this annual report on Form 10-K.
Application of Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations which follows is based upon our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The application of GAAP requires our management to make assumptions, judgments and estimates that affect our reported amounts of assets, liabilities, revenues and expenses, and the related disclosure regarding these items. We base our assumptions, judgments and estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation of our financial condition or results of operations will be affected. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with our Audit Committee of the Board of Directors.
We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, allowance for doubtful accounts and service remediation reserve, stock-based compensation, goodwill impairment, long-lived asset impairment and income taxes have the greatest potential impact on our consolidated financial statements. These areas are key components of our results of operations and are based on complex rules which require us to make judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially
from actual results. For a more detailed discussion of these accounting policies and our use of estimates, please refer to Note 1 to our Consolidated Financial Statements included in this report.
Revenue Recognition
We recognize revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists, we have delivered the product or performed the service, the fee is fixed or determinable and collection is deemed probable. Determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we report. Changes in assumptions or judgments or changes to the elements in a software arrangement could cause a material increase or decrease in the amount of revenue that we report in a particular period.
Allowance for Doubtful Accounts and Service Remediation Reserve
We must make estimates of the uncollectability of accounts receivable. We record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Management specifically analyzes accounts receivable and historical bad debt experience, customer creditworthiness, current economic trends, international situations (such as currency devaluation) and changes in our customer payment history when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management will also change, which could affect the level of our future provision for doubtful accounts. Specifically, if the financial condition of our customers were to deteriorate, affecting their ability to make payments, an additional provision for doubtful accounts may be required and such provision may be material.
We generally warrant that our services will be performed in accordance with the criteria agreed upon in a statement of work, which we generally execute with each applicable customer prior to commencing work. Should these services not be performed in accordance with the agreed upon criteria, we typically provide remediation services until such time as the criteria are met. Management must use judgments and make estimates of service remediation reserves related to potential future requirements to provide remediation services in connection with current period service revenues. When providing for service remediation reserves, we analyze historical experience of actual remediation service claims as well as current information on remediation service requests as they are the primary indicators for estimating future service claims. Material differences may result in the amount and timing of our revenues if, for any period, actual remediation claims differ from management’s judgments or estimates.
Stock-based Compensation
Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the requisite service period, which is generally the vesting period. We currently use the Black-Scholes-Merton option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include: the expected term of the options, taking into account projected exercises; our expected stock price volatility over the expected term of the awards; the risk-free interest rate; estimated forfeitures and expected dividends, which we determine as follows:
•
Expected term is determined based on historical experience, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.
•
Expected volatility is based on the historical volatility over the expected term.
•
Risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equivalent to the expected term.
•
Estimated forfeitures are based on voluntary termination behavior as well as analysis of actual option forfeitures.
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Expected dividends are estimated at zero based on our history and intentions of not declaring and paying dividends.
Changes in these variables could materially affect the estimate of fair value of stock-based compensation and thus could materially affect our operating results.
Goodwill Impairment
We complete our goodwill impairment test on an annual basis, during the fourth quarter of our fiscal year, or more frequently, if changes in facts and circumstances indicate that an impairment in the value of goodwill recorded on our balance sheet may exist. In order to estimate the fair value of goodwill, we typically estimate future revenue, consider market factors and estimate our future cash flows. Based on these key assumptions, judgments and estimates, we determine whether we need to record an impairment charge to reduce the value of the asset carried on our balance sheet to its estimated fair value. Assumptions, judgments and estimates about future values are complex and often subjective. They can be affected by a variety of external and internal factors, including industry and economic trends and changes in our business strategy or our internal forecasts. Although we believe the assumptions, judgments and estimates we have made in the past have been reasonable and appropriate, different assumptions, judgments and estimates could materially affect our reported financial results.
We completed our annual impairment test in the fourth quarter of fiscal 2009 and determined there was no impairment. We currently believe that there is no significant risk of future material goodwill impairment.
Long-Lived Asset Impairment
We evaluate impairment of our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. We assess the recoverability of the assets to be held and used based on the undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized equal to the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Upon classification of long lived assets as “held for sale,” such assets are measured at the lower of their carrying amount or fair value less cost to sell and we cease further depreciation or amortization.
Accounting for Income Taxes
Income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. Management must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset.
Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of potential tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions,
judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (“FASB”) issued new revenue recognition standards for arrangements with multiple deliverables, where certain of those deliverables are non-software related. The new standards permit entities to initially use management’s best estimate of selling price to value individual deliverables when those deliverables do not have VSOE of fair value or when third-party evidence is not available. Additionally, these new standards modify the manner in which the transaction consideration is allocated across the separately identified deliverables by no longer permitting the residual method of allocating arrangement consideration. These new standards are effective for annual periods ending after June 15, 2010, however early adoption is permitted. The Company is currently evaluating the impact of adopting these new standards on our consolidated financial position, results of operations and cash flows, including possible early adoption.
See Note 1 of our Notes to Consolidated Financial Statements for information regarding the effect of newly adopted accounting pronouncements on our financial statements.
Results of Operations
Comparison of the Years Ended December 31, 2009 and 2008
Revenues, Cost of Revenues and Gross Profit
The table below sets forth the changes in revenue, cost of revenue and gross profit from 2009 to 2008 (in thousands, except percentage data):
Revenues
Recurring Revenues. Recurring revenues, consisting of on-demand arrangements, time-based on-premise arrangements and maintenance revenues, increased by $5.8 million, or 14%, in 2009 compared to 2008. The increase was primarily the result of an increase of $6.7 million in subscription revenues related to on-demand and business operations services in 2009. This increase was attributable to the increase in the number of existing on-demand customers for which we recognized revenue as all elements of the related customer contracts began to be performed during 2009 compared to 2008. We introduced our time-based term license offering in the third quarter of 2009. Total revenue generated from this new offering was $0.2 million during 2009. Support revenues for maintenance services decreased by $1.1 million in 2009 compared to 2008, which was primarily a result of a number of on-premise customers converting to our on-demand service and decreased perpetual license sales to new customers.
Services Revenues. Services revenues decreased by $19.8 million or 40% in 2009 compared to 2008. The decrease was primarily a result of combined effect of shorter on-demand implementation time, the challenging economic environment and reduced on-premise license sales. Services revenue for 2008 benefitted from a one-time fee of approximately $1.2 million paid to us by two of our customers that were acquired and subsequently terminated our services.
License Revenues. Perpetual license revenues decreased $12.1 million, or 71%, in 2009 compared to 2008. The decrease was primarily attributable to our transition from a perpetual license business to a recurring revenue SaaS-oriented company. As a result, our license business diminished in importance in the past year and we do not expect perpetual license revenue to return to historical levels.
Cost of Revenues and Gross Margin
Cost of Recurring Revenues. Cost of recurring revenues increased by $6.4 million or 39% in 2009 compared to 2008. The increase was primarily due to increased cost of fulfilling higher level of customer orders resulting from the increase in on-demand subscription revenue, increased amortization of intangible assets resulting from higher cost of third-party technology used in our products, the allocation of a relatively greater portion of such amortization expense to the cost of recurring revenues as such revenues compose a greater portion of total revenues and, in certain periods, increased labor and infrastructure costs associated with customers going live with our on-demand offering. The costs associated with supporting our on-demand offering are generally higher than the cost of maintenance related to our on-premise customers, as we are responsible for the full operation of the software that the customer has contracted for in our hosting facility.
Cost of Services Revenues. Cost of services revenues decreased by $18.4 million or 41% in 2009 compared to 2008. The decrease was attributable to the decrease in related services revenues as discussed above and decreases in personnel and subcontractor costs.
Cost of License Revenues. Cost of license revenues decreased by $0.1 million or 16% in 2009 compared to 2008. The decrease was primarily the result of our transition to a recurring revenue business. As a result of the transition, we have allocated to the cost of license revenues a lower portion of the amortization expense for intangible assets comprised of third-party technology used in our products.
Gross Margin. Our overall gross margin decreased to 39% in 2009 from 43% in 2008. This was primarily a result of our business model shifting to on-demand from perpetual license sales, which historically has had a higher margin.
Our recurring revenue gross margin declined from 60% in 2008 to 51% in 2009. The decrease was primarily due to the increase in higher cost on-demand revenue and additional costs, including the amortization expense for intangible assets comprised of third party technology used in our products and costs associated with customers going live, as discussed above. We expect our overall recurring revenue margin to fluctuate, but trend upwards in future periods as we realize the full quarter benefit of our recent cost cutting actions as well as anticipated efficiencies over the longer term.
Services gross margin increased from 10% in 2008 to 12% in 2009. The increase was primarily due to the progress we made during the first half of the year to improve utilization. Services gross margin was adversely impacted during the fourth quarter of 2009 as a result of lower-than-planned utilization and a decrease in our average billing rate. While we expect improvement in our services margin in 2010, we do not expect it to return to the levels it was under our perpetual license model.
License gross margin decreased from 95% in 2008 to 85% in 2009. The decrease in license gross margin reflects the lower license revenue offset against the fixed cost of license generated by the amount of intangible assets amortization allocated to license sales.
Operating Expenses
The table below sets forth the changes in operating expenses from 2009 to 2008 (in thousands, except percentage data):
Sales and Marketing. Sales and marketing expenses decreased $9.1 million, or 31%, in 2009 compared to 2008. The decrease was primarily attributable to decreases in personnel costs of $4.9 million due to reductions in headcount and a decrease in commission payments of $0.7 million resulting from decreased perpetual license sales. The decrease was also driven by a decrease in partner selling fees of $1.1 million, a decrease in travel costs of $1.2 million, and a decrease in stock-based compensation as discussed below. The reductions in commission expenses are, in part, reflective of the shift of our business focus to our on-demand offering and away from the license model. For financial reporting purposes, commission expenses associated with on-demand arrangements are deferred and then amortized over the non-cancelable term of the contract as the related revenue is recognized; whereas commission expenses related to perpetual license sales are incurred in the period the transaction occurs. Commission expenses associated with the new time-based licenses will have the same treatment as commission expenses associated with on-demand arrangements.
Research and Development. Research and development expenses decreased $0.7 million, or 5%, in 2009 compared to 2008. The decrease was primarily due to a decrease in personnel costs of $0.7 million due to the reductions in headcount and a decrease in stock-based compensation as discussed below, partially offset by an increase in professional fees of $0.3 million for costs related to our offshore resource center.
General and Administrative. General and administrative expenses decreased $1.9 million, or 14%, in 2009 compared to 2008. The decrease in 2009 was primarily due to a decrease in bad debt expenses, which included $0.5 million in 2008 resulting from one customer that filed for bankruptcy, a decrease in professional fees of $0.3 million, and a decrease in stock-based compensation as discussed below.
Restructuring. Restructuring charges were $3.0 million in 2009 compared to $1.6 million in 2008, in connection with severance and termination-related costs, most of which were severance-related cash expenditures. As of December 31, 2009, accrued restructuring charges were $0.1 million.
Stock-Based Compensation
The following table sets forth a summary of our stock-based compensation expenses for 2009 and 2008 (in thousands, except percentage data).
Total stock-based compensation expenses decreased $3.4 million or 44% in 2009 compared to 2008. The overall decreases were primarily attributable to the decrease in our stock price over the past two years and to employees with unvested options and awards leaving the Company due to reductions in workforce. See Note 8 - Stock-based Compensation for additional discussion.
Other Items
The table below sets forth the changes in other items from 2009 to 2008 (in thousands, except percentage data):
Interest and Other Income, Net
Interest and other income, net decreased $0.4 million or 56% in 2009 compared to 2008. The decrease was primarily attributable to the $0.9 million decrease in interest income generated on our investments as a result of a lower average investments balance and lower interest rates in 2009 compared to 2008. The decrease was partially offset by $0.5 million related to changes in fair value of our auction rate securities.
Provision for Income Taxes
Provision for income taxes was $0.4 million for 2009 and $0.2 million for 2008. The increase was primarily attributable a change in the deferred tax assets of one of the Company’s foreign subsidiaries in 2009.
Comparison of the Years Ended December 31, 2008 and 2007
Revenues, Cost of Revenues and Gross Profit
The table below sets forth the changes in revenue, cost of revenue and gross profit from 2008 to 2007 (in thousands, except percentage data):
*
Less than 1%
Revenues
Recurring Revenues. Recurring revenues increased by $16.6 million, or 70%, in 2008 compared to 2007. The increase is primarily the result of an increase of $14.9 million in on-demand subscription revenues in 2008. This increase is attributable to the increase in the number of on-demand customers for which we recognized revenue in 2008 compared to 2007. Support revenues for maintenance services increased by $1.7 million in 2008 compared to 2007, which was a result of license sales to new customers and continued renewal of maintenance support by our existing customers.
Services Revenues. Services revenues remained essentially flat in 2008 as compared to 2007, increasing by $0.4 million or 1%. Included in services revenues for 2008 were one-time fees aggregating approximately $1.2 million paid to us by two of our customers. These customers were acquired by another company, and as a result stated their intentions to terminate our services. Excluding these one-time fees, services revenues decreased in 2008 as compared to 2007. The decrease was due to a number of factors, including deferrals of services and other revenues as a result of project delays and the completion of a number of projects during 2008 that were not immediately replaced.
License Revenues. License revenues decreased $10.9 million, or 39%, in 2008 compared to 2007. The decrease was attributable to the shift of our primary business focus from the sale of perpetual licenses for our products to the provision of our software as a service through our on-demand offering. Our average license revenue
per transaction for 2008 was $0.6 million compared to $0.7 million in 2007. We had three transactions in 2008 with a license value over $1.0 million compared to eight such transactions in 2007.
Cost of Revenues and Gross Margin
Cost of Recurring Revenues. Cost of recurring revenues increased by $5.1 million or 46% in 2008 compared to 2007. The increase was due to the investment we made to grow our on-demand business as well as the increase in related recurring revenues discussed above. As a percentage of related revenues, cost of recurring revenues improved to 40% in 2008 compared to 46% in 2007. This improvement is primarily attributable to economies of scale achieved as a result of the increase in the number of on-demand customers for which we recognized revenue during 2008 as discussed above.
Cost of Services Revenues. Cost of services revenues increased by $1.1 million or 2% in 2008 compared to 2007. The increase was attributable to a loss on a contract of $1.6 million related to a customer dispute and acquisition-related amortization costs of $1.4 million, partially offset by a decrease in subcontractor costs.
Cost of License Revenues. Cost of license revenues increased by $13,000 or 1% in 2008 compared to 2007. The increase was primarily the result of amortization expense for additional purchases of intangible assets comprised of third-party software licenses used in our products.
Gross Margin. Our overall gross margin decreased to 43% in 2008 from 45% in 2007. The decrease in our gross margin is primarily attributable to the shift in revenue mix away from higher margin license revenues, which represented 16% of our total revenues in 2008 compared to 28% in 2007. The effect of the revenue mix shift was partially offset by the improvement in our gross margin for recurring revenues. Recurring gross margin improved from 54% in 2007 to 60% in 2008 as we continued to achieve operational scale in our on-demand business. Services gross margin decreased from 11% in 2007 to 10% in 2008 as a result of the loss related to a customer dispute, acquisition-related amortization costs and the increase in stock-based compensation. License gross margin decreased from 97% in 2007 to 95% in 2008 due to increased amortization expense from additional purchases of intangible assets.
Operating Expenses
The table below sets forth the changes in operating expenses from 2008 to 2007 (in thousands, except percentage data):
Sales and Marketing. Sales and marketing expenses decreased $1.3 million, or 4%, for 2008 compared to 2007. The decrease was primarily attributable to decreases in personnel costs of $1.7 million due to reductions in headcount and a decrease in commission payments resulting from decreased license sales. The decrease was also driven by a decrease in advertising expenses of $0.1 million. The decrease was partially offset by an increase in acquisition-related amortization costs of $0.5 million and an increase in stock-based compensation as discussed below. The reduction in commission expense is, in part, reflective of the shift in our business focus to our on-demand offering and away from the perpetual license model. Commission expenses associated with on-demand arrangements are deferred and then amortized over the non-cancelable term of the contract as the related revenue is recognized; whereas commission expenses related to license sales are incurred in the period the transaction occurs.
Research and Development. Research and development expenses decreased $1.0 million, or 6%, for 2008 compared to 2007. The decrease was primarily due to decreases in personnel costs of $1.7 million resulting from headcount reductions, partially offset by an increase in professional fees of $0.7 million for costs related to our new offshore resource center. The offshore resource center has helped us reduce overall engineering costs, and the cost to headcount ratio for an onshore engineer versus an offshore engineer is 3 to 1. As such, we have been able to maintain the same level of engineering support and development while controlling our costs. The decrease was also partially offset by an increase in stock-based compensation as discussed below.
General and Administrative. General and administrative expenses increased $0.2 million, or 2%, for 2008 compared to 2007. The increase was primarily due to an increase in bad debt expense related to one of our customers that recently filed for bankruptcy. The increase also included an increase in stock-based compensation as discussed below.
Restructuring. Restructuring charges increased $0.2 million, or 13%, for 2008 compared to 2007. We recorded restructuring charges of $1.2 million in the fourth quarter of 2008 and $0.4 million in the first quarter of 2008 in connection with severance and termination-related costs, most of which were severance-related cash expenditures. This 2008 cost savings program was substantially completed in the fourth quarter of 2008 and will be fully completed in the early part of 2009. As of December 31, 2008, accrued restructuring charges were $0.8 million.
Stock-Based Compensation
The following table sets forth a summary of our stock-based compensation expenses for 2008 and 2007 (in thousands, except percentage data).
Total stock-based compensation expenses increased $2.7 million or 55% for 2008 compared to 2007. The overall increase was primarily attributable to restricted stock units vesting for the full 2008 year versus one quarter in 2007 and newly granted stock options and restricted stock units for current employees and employees acquired as part of the Compensation Technologies acquisition. See Note 8 - Stock-based Compensation for additional discussion.
Other Items
The table below sets forth the changes in other items from 2008 to 2007 (in thousands, except percentage data):
Interest and Other Income, Net
Interest and other income, net decreased $2.1 million or 75% for 2008 compared to 2007. The decrease was primarily attributable to the $1.5 million decrease in interest income generated on our investments as a result of a lower average investments balance in 2008 compared to 2007 and lower interest rates in 2008 compared to 2007. The decrease also included the other than temporary impairment of $0.8 million recorded on our auction rate securities partially offset by the corresponding put option gain of $0.5 million and a $0.3 million increase in loss on foreign currency transactions as a result of a stronger US dollar.
Provision (Benefit) for Income Taxes
Provision for income taxes was $0.2 million for 2008, while we had a benefit from income taxes of $0.3 million for 2007. The provision in 2008 was primarily the result of $0.4 million in foreign withholding taxes partially offset by a $0.2 million refund of research and development and alternative minimum tax credits, which we elected to accelerate in lieu of bonus depreciation, in accordance with the Housing and Economic Recovery Act of 2008. Under this act, corporations eligible for 50% bonus depreciation on property placed in service during the period April 1 through December 31, 2008 may elect to claim a special refundable credit amount in lieu of bonus depreciation. In making the election, we will receive a cash benefit from the current utilization of carry forward credits, in exchange for deferring deductions until future years otherwise generated by bonus depreciation. See Note 10 - Income Taxes for further discussion.
Liquidity and Capital Resources
As of December 31, 2009, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $33.6 million and accounts receivable of $12.7 million.
The following table summarizes, for the periods indicated, selected items in our condensed consolidated statements of cash flows (in thousands):
Net Cash Used in / Provided by Operating Activities. The $10 million adverse change in 2009 operating cash flow compared to 2008 was primarily due to an $18.4 million decrease in cash collections resulting from the decrease in revenue, partially offset by a $9.7 million decrease in payroll related costs as a result of workforce reduction programs in 2009. The $9.3 million improvement in operating cash flow in 2008 compared to 2007 was due to a $4.5 million decrease in professional services expense due to the decreased use of outside contractors in our professional services organization, a $4.3 million increase in cash collections resulting from the increase in revenue and the timing of accounts receivable collections, and a $4.4 million decrease in employee expense reports and other costs, partially offset by a $2.9 million increase in payroll related costs due to an increase in headcount and a $1.0 million increase in restructuring payments
Net Cash Used in / Provided by Investing Activities. Net cash used in investing activities during 2009 was primarily related to purchases of investments of $29 million, purchases of property and equipment of $2.0 million and purchases of intangible assets of $1.6 million, partially offset by maturity and sales of investments of $11.7 million. Net cash provided by investing activities during 2008 was primarily due to proceeds from the maturities and sale of investments of $36.8 million, partially offset by purchases of investments of $13.9 million, payments for the Compensation Technologies acquisition of $9.4 million, purchases of property and equipment of $2.4 million and purchases of intangible assets of $0.4 million. Net cash provided by investing activities during 2007 was primarily due to proceeds from the maturities and sale of investments of $59.4 million and change in restricted cash of $0.1 million, partially offset by purchases of investments of $46.7 million, purchases of property and equipment of $2.7 million and purchases of intangible assets of $1.9 million.
Net Cash Used in / Provided by Financing Activities. In 2009, net cash provided by financing activities was primarily related to net cash received from the exercise of stock options and shares purchased under our employee stock purchase plan of $1.8 million, partially offset by repurchases of stock of $0.7 million and cash used to repurchase common stock from employees for payment of taxes of $0.4 million on vesting of restricted stock units. In 2008, net cash received from the exercise of stock options and shares purchased under our employee stock purchase plan was $4.8 million. In 2007, net cash received from the exercise of stock options and shares purchased under our employee stock purchase plan was $4.7 million.
Auction Rate Securities
See Note 5 - Investments of our Notes to Consolidated Financial Statements for information regarding our auction rate securities.
Contractual Obligations and Commitments
The following table summarizes our contractual cash obligations (in thousands) at December 31, 2009. Contractual cash obligations that are cancelable upon notice and without significant penalties are not included in the table. In addition, to the extent that payments for unconditional purchase commitments for goods and services are based, in part, on volume or type of services required by us, we included only the minimum volume or purchase commitment in the table below.
(1)
Included in the unconditional purchase commitments is approximately $211,000 of unrecognized tax benefits.
For our New York, New York and San Jose, California offices, we have two certificates of deposit totaling approximately $232,000 and $434,000, as of December 31, 2009 and 2008, respectively, pledged as collateral to secure letters of credit required by our landlords for security deposits.
Our future capital requirements will depend on many factors, including revenues we generate, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, market acceptance of our on-demand service offering, our ability to offer on-demand service on a consistently profitable basis and the continuing market acceptance of our other products. However, based on our current business plan and revenue projections, we believe our existing cash and investment balances will be sufficient to meet our anticipated cash requirements as well as the contractual obligations listed above for the next twelve months.
Off-Balance Sheet Arrangements
With the exception of the above contractual cash obligations, we have no material off-balance sheet arrangements that have not been recorded in our consolidated financial statements.
Related Party Transactions
For information regarding related party transactions, see Note 14 of Notes to Consolidated Financial Statements and Part III, Item 12, Certain Relationships and Related Transactions, and Director Independence included in this Annual Report on Form 10-K and incorporated by reference here.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
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 also a result of fluctuations in interest rates and foreign exchange rates. See Note 5 - Investments of our Notes to Consolidated Financial Statements for information regarding our auction rate securities.
We do not hold or issue financial instruments for trading purposes except for certain auction rate securities, and we invest in investment grade securities. We limit our exposure to interest rate and credit risk by establishing and monitoring clear policies and guidelines for our investment portfolios, which is approved by our board of directors. The guidelines also establish credit quality standards, limits on exposure to any one security issue, limits on exposure to any one issuer and limits on exposure to the type of instrument.
Financial instruments that potentially subject us to market risk are short-term investments, long-term investments and trade receivables denominated in foreign currencies. We mitigate market risk by monitoring ratings, credit spreads and potential downgrades for all bank counterparties on at least a quarterly basis. Based on our on-going assessment of counterparty risk, we will adjust our exposure to various counterparties.
Interest Rate Risk. We invest our cash in a variety of financial instruments, consisting primarily of investments in money market accounts, certificates of deposit, high quality corporate debt obligations, United States government obligations, auction rate securities and the related put option asset.
Investments in both fixed-rate and floating-rate interest earning instruments carry a degree of interest rate risk. The fair market value of fixed-rate securities may be adversely affected by a rise in interest rates, while floating rate securities, which typically have a shorter duration, may produce less income than expected if interest rates fall. Due in part to these factors, our investment income may decrease in the future due to changes in interest rates. At December 31, 2009, the average maturity of our investments was approximately 9 months, and all investment securities other than auction rate securities had maturities of less than 24 months. The following table presents certain information about our financial instruments except for auction rate securities at December 31, 2009 that are sensitive to changes in interest rates (in thousands, except for interest rates):
Our exposure to interest rate risk also relates to the increase or decrease in the amount of interest expense we must pay on our outstanding debt instruments. As of December 31, 2009, we had no outstanding indebtedness for borrowed money. Therefore, we currently have no exposure to interest rate risk related to debt instruments. To the extent we enter into or issue debt instruments in the future, we will have interest rate risk.
Foreign Currency Exchange Risk. Our revenues and our expenses, except those related to our non-United States operations, are generally denominated in United States dollars. For our operations outside the United States, we transact business generally in various other currencies. For 2009, approximately 12% of our total revenue was denominated in foreign currency. At December 31, 2009, approximately 12% of our total accounts receivable was denominated in foreign currency. Our exchange risks and foreign exchange losses have been minimal to date. The overall decrease in revenue for 2009 as compared to 2008 reflects a $1.6 million adverse effect due to currency exchange rate fluctuations. We expect to continue to transact a majority of our business in U.S. dollars.
Occasionally, we may enter into forward exchange contracts to reduce our exposure to currency fluctuations on our foreign currency transactions. The objective of these contracts is to minimize the impact of foreign currency exchange rate movements on our operating results. We do not use these contracts for speculative or trading purposes.
As of December 31, 2009, we had an aggregate of $0.5 million (notional amount) of outstanding short-term foreign currency forward exchange contracts related to customer payments denominated in Mexican Pesos (MXN).
We had $0.2 million of losses related to forward exchange contracts for 2009. We do not anticipate any material adverse effect on our consolidated financial condition, results of operations or cash flows resulting from the use of these instruments in the immediate future. However, we cannot provide any assurance that our foreign exchange rate contract investment strategies will be effective or that transaction losses can be minimized or forecasted accurately. In particular, generally, we hedge only a portion of our foreign currency exchange exposure. We cannot assure you that our hedging activities will eliminate foreign exchange rate exposure. Failure to do so could have an adverse effect on our business, financial condition, and results of operations or cash flows.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this Annual Report on Form 10-K beginning on page.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
N/A.
Item 9A.
Item 9A.
Controls and Procedures
(a)
Disclosure Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this annual report, have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.
(b)
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Our management has concluded that, as of December 31, 2009, our internal control over financial reporting is effective based on these criteria.
(c)
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth quarter of 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
PART III
Certain information required by Part III of Form 10-K is omitted from this Annual Report on Form 10-K because we will file a definitive proxy statement within 120 days after the end of our fiscal year pursuant to Regulation 14A for our annual meeting of stockholders, currently scheduled for June 1, 2010, and the information included in the proxy statement shall be incorporated herein by reference when it is filed with the Securities and Exchange Commission.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)
Consolidated financial statements, consolidated financial statements schedule and exhibits
1. Consolidated financial statements. The consolidated financial statements as listed in the accompanying “Index to Consolidated Financial Information” are filed as part of this Annual Report on Form 10-K.
2. All schedules not listed in the accompanying index have been omitted as they are either not required or not applicable, or the required information is included in the consolidated financial statements or the notes thereto.
3. Exhibits. The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Annual Report on Form 10-K.
INDEX TO EXHIBITS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on March 9, 2010.
CALLIDUS SOFTWARE INC.
By:
/s/ RONALD J. FIOR
Ronald J. Fior,
Chief Financial Officer,
Senior Vice President, Finance and Operations
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated below.
CALLIDUS SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Callidus Software Inc.
We have audited the accompanying consolidated balance sheets of Callidus Software Inc. (the Company) and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2009. We also have audited the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying management’s report on internal control over financial reporting appearing under Item 9A(b). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Callidus Software Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, Callidus Software Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by COSO.
As discussed in note 5 to the consolidated financial statements, the Company changed its method of accounting for other than temporary impairments of available for sale investments during the year ended December 31, 2009 included in Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 320, Investments - Debt and Equity Securities. Also, as discussed in note 10 to the consolidated financial statements, the Company changed its method of accounting for uncertainty in income taxes during the year ended December 31, 2007, due to the adoption of new accounting principles included in FASB ASC Topic 740, Income Taxes.
/s/ KPMG LLP
Mountain View, California
March 9, 2010
CALLIDUS SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements.
CALLIDUS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Notes to Consolidated Financial Statements.
CALLIDUS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
Years Ended December 31, 2009, 2008 and
See accompanying Notes to Consolidated Financial Statements.
CALLIDUS SOFTWARE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements.
CALLIDUS SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -
The Company and Significant Accounting Policies
Description of Business
The Company is a provider of Sales Performance Management (SPM) software and services to global companies. Enterprises use SPM systems to optimize their investment in sales planning and performance, specifically in the areas of incentive compensation, quota and goal management, and territory alignment. SPM solutions also provide the capability to continually monitor and analyze these business processes in order to understand what is working well and which programs might need to be revised. Sales performance and incentive compensation management programs are key vehicles in aligning employee and channel partner goals with corporate objectives. The Company’s suite of products enables companies to access applicable transaction data, allocate compensation credit to appropriate employees and business partners, determine relevant compensation measurements, payment amounts and timing, and accurately report on compensation results. By facilitating effective management of complex incentive and sales performance programs, the Company’s products allow its customers to align sales and incentive strategies with corporate objectives to increase sales revenue, make better use of their sales and incentive budgets, and drive productivity improvements. The Company’s software suite is based on its proprietary technology and extensive expertise in sales performance programs, and provides the flexibility and scalability required to meet the dynamic SPM requirements of small, medium, and large businesses across multiple industries. The Company’s products drive sales strategies toward desired business outcomes.
Principles of Consolidation
The consolidated financial statements include the accounts of Callidus Software Inc. and its wholly owned subsidiaries (collectively, the Company), which include wholly-owned subsidiaries in Australia, Canada, Germany, Hong Kong, Singapore and the United Kingdom. All intercompany transactions and balances have been eliminated in the consolidation.
Certain Risks and Uncertainties
The Company’s products and services are concentrated in the software industry, which is characterized by rapid technological advances and changes in customer requirements. A critical success factor is management’s ability to anticipate or to respond quickly and adequately to technological developments in its industry and changes in customer requirements. Any significant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business and operating results.
Historically, a substantial portion of the Company’s revenues have been derived from sales of its products and services to customers in the financial and insurance industries. The substantial disruptions in these industries under the current economy may result in these customers deferring or cancelling future planned expenditures on the Company’s products and services. The Company is also subject to fluctuations in sales for the TrueComp product, and its revenues are typically dependent on a small volume of transactions. Continued macroeconomic weakness may keep potential customers from purchasing the Company’s products.
Use of Estimates
Preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission (SEC) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, the reported amounts of revenues and expenses during the reporting period and the accompanying notes. Estimates are used for, but not limited to, the allocation of the value of purchase consideration for business acquisitions, uncertain tax liabilities, valuation of certain investments, allowances for doubtful accounts and service remediation reserves, the useful lives of fixed assets and intangible assets, goodwill and intangible asset impairment charges, accrued
liabilities and other contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates such estimates and assumptions on an ongoing basis using historical experience and considers other factors, including the current economic environment, for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such evaluation. Illiquid credit markets, volatile equity and foreign currency markets and declines in IT spending by companies have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ materially from those estimates. Changes in those estimates, if any, resulting from continuing changes in the economic environment, will be reflected in the financial statements in future periods.
Foreign Currency Translation
The functional currencies of the Company’s foreign subsidiaries are their respective local currencies. Accordingly, the foreign currencies are translated into U.S. dollars using exchange rates in effect at period end for assets and liabilities and average rates during each reporting period for the results of operations. Adjustments resulting from the translation of the financial statements of the foreign subsidiaries are reported as a separate component of accumulated other comprehensive income (loss). Foreign currency transaction gains and losses are included in interest and other income, net in the accompanying consolidated statements of operations.
Cash and Cash Equivalents and Investments
The Company considers all highly liquid instruments with an original maturity on the date of purchase of three months or less to be cash equivalents. Cash equivalents as of December 31, 2009 and 2008 consisted of money market funds. The Company determines the appropriate classification of investment securities at the time of purchase and re-evaluates such designation as of each balance sheet date. As of December 31, 2009 and 2008, all investment securities, except for certain auction rate securities that are classified as trading, are designated as “available for sale.” The Company considers all investments that are available for sale, except for certain auction rate securities, that have a maturity date longer than three months to be short-term investments, including those investments with a maturity date of longer than one year that are highly liquid and for which the Company does not have a positive intent to hold to maturity. These securities are carried at estimated fair value based on quoted market prices or other readily available market information, with the unrealized gains (losses) reported as a separate component of stockholders’ equity. Gains are recognized when realized in our Consolidated Statements of Operations. Losses are recognized as realized. When the Company has determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in earnings. Gains and losses are determined using the specific identification method.
All of the auction rate securities carry AAA credit ratings from one or more of the major credit rating agencies. These investments are education municipal securities substantially collateralized by the U.S. Department of Education Federal Family Education Loan program guarantee. None of the auction rate securities held by the Company are mortgage-backed debt obligations. Liquidity for these securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals, usually every 28 days. However, as a result of liquidity issues in the global credit and capital markets, the auctions for all of the Company’s ARS failed beginning in February 2008, when sell orders exceeded buy orders. The failures of these auctions do not affect the value of the collateral underlying the ARS, and the Company continues to earn and receive interest on the Company’s ARS at contractually set rates. As of December 31, 2009, there continues to be no auction market for the Company’s ARS. In the absence of a liquid market to value these securities, the Company has used a discounted cash flow model to estimate the fair value of its investments in ARS as of December 31, 2009.
In connection with certain of the auction rate securities, in October 2008, one financial institution where the Company holds auction rate securities issued certain put option rights to the Company, which entitles the Company to sell its auction rate securities to the financial institution for a price equal to the par value plus any accrued and unpaid interest. These rights to sell the securities are exercisable at any time during the period from June 30, 2010 to July 2, 2012, after which the rights will expire. See Note 5 - Investments for additional discussion.
Fair Value of Financial Instruments and Concentrations of Credit Risk
The fair value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximate their respective carrying value due to their short maturity. See Note 5 - Investments for discussion regarding the valuation of the Company’s investments. Financial instruments that potentially subject the Company to concentrations of credit risk are short-term investments, long-term investments and trade receivables. The Company mitigates concentration of risk by monitoring ratings, credit spreads and potential downgrades for all bank counterparties on at least a quarterly basis. Based on the Company’s on-going assessment of counterparty risk, the Company will adjust its exposure to various counterparties.
The Company’s customer base consists of businesses throughout the Americas, Europe Middle East Africa and Asia-Pacific. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. As of December 31, 2009 and December 31, 2008, the Company had no customers comprising greater than 10% of net accounts receivable. See Note 13 for information regarding revenues from significant customers.
Reserve Accounts
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company reduces gross trade accounts receivable with its allowance for doubtful accounts and service remediation reserve. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days are reviewed individually for collectability. Account balances are charged against the allowance after reasonable means of collection have been exhausted and the potential for recovery is considered remote.
The Company must make estimates of the uncollectability of accounts receivable. The Company records an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Management specifically analyzes accounts receivable and historical bad debt experience, customer creditworthiness, current economic trends, international situations (such as currency devaluation) and changes in customer payment history when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management will also change, which could affect the level of the Company’s future provision for doubtful accounts. Specifically, if the financial condition of customers were to deteriorate, affecting their ability to make payments, an additional provision for doubtful accounts may be required and such provision may be material. The allowance for doubtful accounts, which is netted against accounts receivable on the consolidated balance sheets, totaled approximately $307,000 and $550,000 at December 31, 2009 and December 31, 2008, respectively.
The service remediation reserve is the Company’s best estimate of the probable amount of remediation services it will have to provide for ongoing professional service arrangements. Provisions to the allowance for doubtful accounts are recorded in general and administrative expenses, while provisions for service remediation reduce services revenues.
The Company generally warrants that its services will be performed in accordance with the criteria agreed upon in a statement of work, which the Company generally executes with each applicable customer prior to commencing work. Should these services not be performed in accordance with the agreed upon criteria, the Company typically provides remediation services until such time as the criteria are met. Management must use judgments and make estimates of service remediation reserves related to potential future requirements to provide remediation services in connection with current period service revenues. When providing for service remediation reserves, the Company analyzes historical experience of actual remediation service claims as well as current information on remediation service requests as they are the primary indicators for estimating future service claims. Material differences may result in the amount and timing of revenues if, for any period, actual remediation claims differ from management’s judgments or estimates. The service remediation reserve balance, which is netted against accounts receivable on the consolidated balance sheets, was approximately $256,000 and $399,000 at December 31, 2009 and December 31, 2008, respectively.
Below is a summary of the changes in the Company’s reserve accounts for 2009, 2008 and 2007 (in thousands):
The decrease in allowance for doubtful accounts and service remediation reserve from 2008 to 2009 was primarily attributable to the decrease of revenue in 2009 and the transition of our business model from on-premise to on-demand services. The increase in allowance for doubtful accounts from 2007 to 2008 was primarily attributable to one customer that filed for bankruptcy, which resulted in approximately $223,000 of bad debt expense. The remaining increase was comprised of smaller amounts reserved in the normal course of our analysis of uncollectible amounts.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the lesser of the assets’ estimated useful lives or the related lease terms. Expenditures for maintenance and repairs are charged to expense as incurred. Cost and accumulated depreciation of assets sold or retired are removed from the respective property accounts and the gain or loss is reflected in the consolidated statements of operations.
Restricted Cash
Included in prepaid and other current assets and deposits and other assets in the consolidated balance sheets at December 31, 2009 and 2008 is restricted cash totaling $232,000 and $434,000, respectively, related to security deposits on leased facilities for our New York, New York and San Jose, California offices. The restricted cash represents investments in certificates of deposit required by landlords to meet security deposit requirements for the leased facilities. Restricted cash is included in prepaid and other current assets and deposits and other assets based on the contractual term for the release of the restriction.
Goodwill and Acquired Intangible Assets
The Company reviews its goodwill for impairment in November annually, or more frequently, if facts and circumstances warrant a review. In order to estimate the fair value of goodwill, the Company estimates future revenue, considers market factors and estimates its future cash flows. The Company has one reporting unit and evaluates goodwill for impairment by comparing the carrying amount of the reporting unit, including the associated goodwill, to its estimated undiscounted future cash flows.
Intangible assets with finite lives are amortized over their estimated useful lives of one to five years. Generally, amortization is based on the pattern in which the economic benefits of the intangible asset will be consumed.
As of December 31, 2009, the Company noted no indications of impairment of its goodwill or acquired intangible assets.
Impairment of Long-Lived Assets
The Company assesses impairment of its long-lived assets in accordance with the provisions of accounting for the impairment or disposal of long-lived assets. Long-lived assets, such as property and equipment and purchased intangibles subject to amortization are required to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized equal to the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.
Research and Development Costs
Software development costs associated with new products and enhancements to existing products are expensed as incurred until technological feasibility, in the form of a working model, is established, at which time any additional development costs would be capitalized in accordance with accounting guidance for computer software to be sold, leased, or otherwise marketed. Costs eligible for capitalization were not material to our consolidated financial statements.
Stock-Based Compensation
The Company measures and recognizes compensation expense for all stock-based awards made to employees and directors including employee stock options, restricted stock units (“RSUs”), and employee stock purchases under the Company’s Employee Stock Purchase Plan based on estimated fair values on the date of grant using the Black-Scholes-Merton option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in the Company’s Consolidated Statements of Operations.
Foreign Currency
The Company transacts business in foreign countries in U.S. dollars and in various foreign currencies. Occasionally, the Company may enter into forward exchange contracts to reduce its exposure to currency fluctuations on its foreign currency exposures. The objective of these contracts is to minimize the impact of foreign currency exchange rate movements on the Company’s operating results. These contracts are carried at fair value with changes recorded in interest and other income. The Company does not use these contracts for speculative or trading purposes.
Income Taxes
The Company is subject to income taxes in both the United States and foreign jurisdictions and the Company uses estimates in determining its provision for income taxes. This process involves estimating actual current tax assets and liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the consolidated balance sheets. Net deferred tax assets are recorded to the extent the Company believes that these assets will more likely than not be realized. In making such determination, all available positive and negative evidence is considered, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. With the exception of the net deferred tax assets of one of the Company’s foreign subsidiaries, the Company maintained a full valuation allowance against its net deferred tax assets at December 31, 2009 because the Company believes that it is not more-likely-than-not that the gross deferred tax assets will be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event the Company were to determine that it would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax assets would increase net income in the period such determination was made.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well
as operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
In July 2006, the FASB issued guidance on accounting for uncertainty in income taxes, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with accounting for income taxes. A tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. The Company adopted the provisions of accounting for uncertainty in income taxes on January 1, 2007. As a result of applying the provisions of the accounting guidance, the Company recognized approximately $0.1 million in the liability for unrecognized tax benefits as well as incremental penalties and interest net of deductions of $41,000, the sum of which was accounted for as an increase to the January 1, 2007 beginning balance of accumulated deficit. The Company’s unrecognized tax benefits at December 31, 2007 related to various foreign jurisdictions.
Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of accounting for uncertainty in income taxes and in subsequent periods. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet.
Revenue Recognition
The Company generates revenues by providing its software application as a service through its on-demand subscription and time-based term license offering and providing related professional services to its customers, as well as by licensing software on a perpetual basis and providing related software support. The Company presents revenue net of sales taxes and any similar assessments.
The Company recognizes revenues in accordance with accounting standards for software and service companies. The Company will not recognize revenue until persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is deemed probable. The Company evaluates each of these criteria as follows:
Evidence of an Arrangement. The Company considers a non-cancelable agreement signed by it and the customer to be evidence of an arrangement.
Delivery. In on-demand arrangements, the Company considers delivery to have occurred as the service is provided to the customer, and they have access to the hosting environment. In both perpetual and time-based term licensing arrangements, the Company considers delivery to have occurred when media containing the licensed programs is provided to a common carrier, or in the case of electronic delivery, the customer is given access to the licensed programs. The Company’s typical end-user license agreement does not include customer acceptance provisions.
Fixed or Determinable Fee. The Company considers the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within its standard payment terms. The Company considers payment terms greater than 90 days to be beyond its customary payment terms. If the fee is not fixed or determinable, the Company recognizes the revenue as amounts become due and payable.
In perpetual licensing arrangements where the customer is obligated to pay at least 90% of the license amount within normal payment terms and the remaining 10% is to be paid within a year from the contract effective date, the Company will recognize the license revenue for the entire arrangement upon delivery assuming all other revenue recognition criteria have been met. This policy is effective as long as the Company
continues to maintain a history of providing similar terms to customers and collecting from those customers without providing any contractual concessions.
Collection is Deemed Probable. The Company conducts a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the customer. Collection is deemed probable if the Company expects that the customer will be able to pay amounts under the arrangement as payments become due. If the Company determines that collection is not probable, the Company defers the recognition of revenue until cash collection.
Recurring Revenue
Recurring revenues include on-demand revenues, time-based term license revenues and maintenance revenues. On-demand revenues are principally derived from technical operation fees earned through the Company’s services offering of the on-demand TrueComp suite, as well as revenues generated from business operations services. Time based term license revenues are derived from fees earned through the licensing of our software bundled with maintenance for a specified period of time. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Company’s licensed software. Customers that own perpetual licenses can receive the benefits of upgrades, updates, and support from either subscribing to the Company’s on-demand services or maintenance services.
On-Demand Revenue. In arrangements where the Company provides its software applications as a service, the Company has considered accounting guidance for arrangements that include the right to use software stored on another entity’s hardware and non-software deliverables in an arrangement containing more-than-incidental software, and has concluded that these transactions are considered service arrangements and fall outside of the scope of software revenue recognition guidance. Accordingly, the Company follows the provisions of SEC Staff Accounting Bulletin No. 104, Revenue Recognition, and accounting guidance for revenue arrangements with multiple deliverables. Customers will typically prepay for the Company’s on-demand services, which amounts the Company defers and recognizes ratably over the non-cancelable term of the customer contract. In addition to the on-demand services, these arrangements may also include implementation and configuration services, which are billed on a time-and-materials basis and recognized as revenues as the services are performed. In determining whether the consulting services can be accounted for separately from on-demand revenues, the Company considers the following factors for each consulting agreement: availability of the consulting services from other vendors; whether objective and reliable evidence of fair value exists for the undelivered elements; the nature of the consulting services; the timing of when the consulting contract is signed in comparison to the on-demand service contract and the contractual dependence of the consulting work on the on-demand service.
For all of the arrangements where the elements qualify for separate units of accounting, the on-demand revenues are recognized ratably over the non-cancelable contract term, which is typically 12 to 24 months, beginning on the date the on-demand services begin to be performed. Implementation and configuration services, when sold with the on-demand offering, are recognized as the services are rendered for time-and-materials contracts. The majority of our implementation and configuration services for on-demand arrangements are accounted for in this manner. If implementation and configuration services associated with an on-demand arrangement do not qualify as a separate unit of accounting, the Company will recognize the revenue from implementation and configuration services ratably over the remaining non-cancelable term of the subscription contract once the implementation is complete. For arrangements with multiple deliverables, the Company allocates the total contractual arrangement to the separate units of accounting based on their relative fair values, as determined by the fair value of the undelivered and delivered items.
In addition, the Company will defer the direct costs of the implementation and configuration services and amortize those costs over the same time period as the related revenue is recognized. The deferred costs on the Company’s consolidated balance sheets for these consulting arrangements totaled $1.8 million and $2.6 million at December 31, 2009 and 2008, respectively. As of December 31, 2009 and 2008, $1.4 million and $2.0 million, respectively, of the deferred costs are included in prepaid and other current assets, with the remaining amount included in deposits and other assets in the consolidated balance sheets.
Included in the deferred costs for on-demand arrangements is the deferral of commission payments to the Company’s direct sales force, which the Company amortizes over the non-cancelable term of the contract as the related revenue is recognized. The commission payments are a direct and incremental cost of the revenue arrangements. The deferral of commission expenditures related to the Company’s on-demand offering was $1.0 million and $0.8 million at December 31, 2009 and 2008, respectively.
Time-Based Term License. The Company introduced on-premise licenses of our software as a time-based term license arrangement in the third quarter of 2009. Such arrangements typically include an initial fee, which covers the time-based term license for a specified period and the maintenance and support for the first year of the arrangement. If a customer wishes to receive maintenance after the first year, then the customer must pay the maintenance fee for each year they wish to receive maintenance.
For a Single-Year Time-based Term License that is sold with multiple elements the entire arrangement fee is recognized ratably. In these arrangements, both the time-based term licenses and the maintenance agreements have duration of one year; therefore the fair value of the bundled maintenance services is not reliably measured by reference to a maintenance renewal rate. As a result, revenue cannot be allocated to the various elements of the arrangement and it will be recognized ratably over the longer of the maintenance term or over the period during which the services are expected to be performed.
Multi-Year Time-based Term License arrangements often include multiple elements (e.g., software technology, maintenance, training, consulting and other services). The Company allocates revenue to each element of the arrangement based on vendor-specific objective evidence of each element’s fair value when the Company can demonstrate that sufficient evidence exists of the fair value for the undelivered elements. The fair value of each element in multiple element arrangements is determined based on either (i) in the case of maintenance, providing the customer with the ability during the term of the arrangement to renew maintenance at a substantive renewal rate or (ii) selling the element on a stand-alone basis.
In Multi-Year Time-based Term License arrangements that include multiple elements and for which fair value of VSOE cannot be established for the undelivered elements the entire arrangement fee is recognized ratably upon delivery. All of our multi-year time-based term license arrangements are accounted for in this manner.
Similar to certain on-demand arrangements as described above, the Company will defer the direct costs, and amortize those costs over the same time period as the related revenue is recognized. The deferred costs on the Company’s consolidated balance sheets for these arrangements totaled $0.1 million and are included in prepaid and other current assets at December 31, 2009.
Maintenance Revenue. Under perpetual software license arrangements, a customer typically pre-pays maintenance for the first twelve months, and the related revenues are deferred and recognized ratably over the term of the initial maintenance contract. Maintenance is renewable by the customer on an annual basis thereafter. Rates for maintenance, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.
Services Revenue
Professional Service Revenue. Professional service revenues primarily consist of integration services related to the installation and configuration of the Company’s products as well as training. The Company’s installation and configuration services do not involve customization to, or development of, the underlying software code. Generally, the Company’s professional services arrangements are on a time-and-materials basis. Reimbursements, including those related to travel and out-of-pocket expenses, are included in services revenues, and an equivalent amount of reimbursable expenses is included in cost of services revenues. For professional service arrangements with a fixed fee, the Company recognizes revenue utilizing the proportional performance method of accounting. The Company estimates the proportional performance on fixed-fee contracts on a monthly basis, if possible, utilizing hours incurred to date as a percentage of total estimated hours to complete the project. If the Company does not have a sufficient basis to measure progress toward completion, revenue is recognized upon completion of performance. To the extent the Company enters into a fixed-fee services contract, a loss will be recognized any time the total estimated project cost exceeds project revenues.
In certain arrangements, the Company has provided for unique acceptance criteria associated with the delivery of consulting services. In these instances, the Company has recognized revenue in accordance with the provisions of SAB 104. To the extent there is contingent revenue in these arrangements, the Company will defer the revenue until the contingency has lapsed.
Perpetual License Revenue
The Company’s perpetual software license arrangements typically include: (i) an end-user license fee paid in exchange for the use of its products, generally based on a specified number of payees, and (ii) a maintenance arrangement that provides for technical support and product updates, generally over renewable twelve month periods. If the Company is selected to provide integration and configuration services, then the software arrangement will also include professional services, generally priced on a time-and-materials basis. Depending upon the elements in the arrangement and the terms of the related agreement, the Company recognizes license revenues under either the residual or the contract accounting method.
Certain arrangements result in the payment of customer referral fees to third parties that resell the Company’s software products. In these arrangements, license revenues are recorded, net of such referral fees, at the time the software license has been delivered to a third-party reseller and an end-user customer has been identified.
Residual Method. Perpetual license fees are recognized upon delivery whether licenses are sold separately from or together with integration and configuration services, provided that (i) the criteria described above have been met, (ii) payment of the license fees is not dependent upon performance of the integration and configuration services, and (iii) the services are not otherwise essential to the functionality of the software. The Company recognizes these license revenues using the residual method pursuant to the requirements of accounting guidance for software revenue recognition. Under the residual method, revenues are recognized when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e., professional services and maintenance), but does not exist for one or more of the delivered elements in the arrangement (i.e., the software product). Each license arrangement requires careful analysis to ensure that all of the individual elements in the license transaction have been identified, along with the fair value of each undelivered element.
The Company allocates revenue to each undelivered element based on its fair value, with the fair value determined by the price charged when that element is sold separately. For a certain class of transactions, the fair value of the maintenance portion of the Company’s arrangements is based on substantive stated renewal rates rather than stand-alone sales. The fair value of the professional services portion of the arrangement is based on the hourly rates that the Company charges for these services when sold independently from a software license. If evidence of fair value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue from the arrangement is deferred until evidence of fair value can be established, or until the items for which evidence of fair value cannot be established are delivered. If the only undelivered element is maintenance, then the entire amount of revenue is recognized over the maintenance delivery period.
Contract Accounting Method. For arrangements where services are considered essential to the functionality of the software, such as where the payment of the license fees is dependent upon performance of the services, both the license and services revenues are recognized in accordance with the provisions of accounting for performance of construction-type and certain production-type contracts. The Company generally uses the percentage-of-completion method because the Company is able to make reasonably dependable estimates relative to contract costs and the extent of progress toward completion. However, if the Company cannot make reasonably dependable estimates, the Company uses the completed-contract method. If total cost estimates exceed revenues, the Company accrues for the estimated loss on the arrangement at the time such determination is made.
In certain arrangements, the Company has provided for unique acceptance criteria associated with the delivery of consulting services. In these instances, the Company has recognized revenue in accordance with the provisions of accounting for performance of construction-type and certain production-type contracts. To the extent there is contingent revenue in these arrangements, the Company measures the level of profit that is expected based on the non-contingent revenue and the total expected project costs. If the Company is assured of a certain level of profit excluding the contingent revenue, the Company recognizes the non-contingent revenue on a percentage-of-completion basis and recognizes the contingent revenue upon final acceptance.
Cost of Revenues
Cost of recurring revenues consists primarily of salaries, benefits, allocated overhead costs related to on-demand operations and technical support personnel, as well as allocated amortization of purchased technology. Cost of license revenues consists primarily of amortization of purchased technology. Cost of services revenues consists primarily of salaries, benefits, travel and allocated overhead costs related to consulting, training and other professional services personnel, including cost of services provided by third-party consultants engaged by the Company.
Advertising Costs
The Company expenses advertising costs in the period incurred. Advertising expense was $29,000, $53,000, and $117,000 for 2009, 2008 and 2007, respectively.
Net Loss Per Share
Basic net loss per share is calculated by dividing net loss for the period by the weighted average common shares outstanding during the period, less shares subject to repurchase. Diluted net loss per share is calculated by dividing the net loss for the period by the weighted average common shares outstanding, adjusted for all dilutive potential common shares, which includes shares issuable upon the exercise of outstanding common stock options, the release of restricted stock, and purchases of employee stock purchase plan (ESPP) shares to the extent these shares are dilutive. For 2009, 2008 and 2007, the diluted net loss per share calculation was the same as the basic net loss per share calculation as all potential common shares were anti-dilutive.
Diluted net loss per share does not include the effect of the following potential weighted average common shares because to do so would be anti-dilutive for the periods presented (in thousands):
The weighted average exercise price of stock options excluded for 2009, 2008 and 2007 was $4.70, $5.13 and $4.99, respectively.
Comprehensive Income
Comprehensive income is the total of net income, unrealized gains and losses on investments and foreign currency translation adjustments. Unrealized gains and losses on investments and foreign currency translation adjustment amounts are excluded from net loss and are reported in accumulated other comprehensive income in the accompanying consolidated financial statements.
The following table sets forth the components of accumulated other comprehensive income as of December 31, 2009 and 2008 (in thousands):
Recent Accounting Pronouncements
In June 2009, the FASB issued the FASB Accounting Standards Codification (the “Codification”) for financial statements issued for interim and annual periods ending after September 15, 2009, which was effective for us beginning in the third quarter of fiscal 2009. The Codification became the single authoritative source for GAAP. Accordingly, previous references to GAAP accounting standards are no longer used in our disclosures, including these Notes to the Consolidated Financial Statements. The Codification does not affect our consolidated financial position, cash flows, or results of operations.
In May 2009, the FASB issued new standards for subsequent events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new standards are effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the new standards during the second quarter of fiscal 2009 and, as the pronouncement only requires additional disclosures, the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.
In April 2009, the FASB issued new standards for the recognition and measurement of other-than-temporary impairments for debt securities which replaced the pre-existing “intent and ability” indicator. These new standards specify that if the fair value of a debt security is less than its amortized cost basis, an other-than-temporary impairment is triggered in circumstances where (1) an entity has an intent to sell the security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the security (that is, a credit loss exists). Other-than-temporary impairments are separated into amounts representing credit losses which are recognized in earnings and amounts related to all other factors which are recognized in other comprehensive income (loss). The Company adopted these standards in the second quarter of fiscal 2009. See Note 5 - Investments for additional discussion.
In April 2009, the FASB issued new standards to enhance consistency in financial reporting by increasing the frequency of fair value disclosures. These new standards relate to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet of companies at fair value. Prior to issuing these standards, fair values of these assets and liabilities were only disclosed once a year. These new standards now require these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The Company adopted these standards in the second quarter of 2009 and the adoption did not have an impact on our condensed consolidated financial statements.
In April 2009, the FASB issued new standards which provide guidance on how to determine the fair value of assets and liabilities when the volume and level of activity for the asset or liability has significantly decreased. These new standards also provide guidance on identifying circumstances that indicate a transaction is not orderly. In addition, the Company is required to disclose in interim as well as annual reporting periods the inputs and valuation techniques used to measure fair value and discussion of changes in valuation techniques. The Company adopted these standards in the second quarter of fiscal 2009 and they did not have a material effect on our consolidated financial position, results of operations or cash flows.
Note 2 -
Restructuring
On November 27, 2007, the Company’s Board of Directors approved a cost savings program to reduce the Company’s workforce by approximately 8%. The Company recorded restructuring charges of approximately $1.5 million in the fourth quarter of 2007 and $0.4 million in the first quarter of 2008, which were the total amounts incurred in connection with severance and termination-related costs, most of which were severance-related cash expenditures. The cost savings program was completed in the first quarter of 2008.
During 2008, management approved and initiated plans to restructure certain operations by reducing the Company’s workforce to eliminate redundant costs resulting from the acquisition made at the beginning of the year (see Note 3 below) and improve efficiencies in operations. The Company incurred restructuring charges of $1.6 million in 2008 and $0.2 million in the first quarter of 2009 in connection with severance and termination-
related costs, most of which are severance-related cash expenditures. These cost savings program was substantially completed during 2008 and was fully completed in the first half of 2009.
In 2009, management approved additional cost savings programs to further reduce the Company’s workforce. The Company incurred restructuring charges of $3.0 million in 2009 in connection with severance and termination related costs, most of which are severance related cash expenditures. The 2009 cost saving programs were substantially completed during 2009.
Total costs for all programs approved to date of $6.1 million include restructuring charges of $1.5 million in 2007, $1.6 million in 2008, and $3.0 million in 2009.
The following table sets forth a summary of accrued restructuring charges for 2009 and 2008 (in thousands):
Note 3 -
Acquisition
The Company did not have any acquisitions in the year ended December 31, 2009.
In 2008, the Company acquired Compensation Technologies LLC (“CT”) and Compensation Management Services LLC (“CMS”). CT provides business process redesign support, business analytics solutions, business case development and compensation administration management while CMS provides software-as-a-service to a number of customers. The acquisition of CT and CMS provided the Company with additional customers, experienced management and employee resources and augmented the Company’s portfolio of service offerings.
The acquisition has been accounted for under the purchase method of accounting. Assets acquired and liabilities assumed were recorded at their estimated fair values as of January 14, 2008. The results of operations of CT and CMS since January 14, 2008 were included in the Company’s consolidated statement of operations. The acquisition was not material to the Company’s consolidated balance sheet and results of operations.
The total purchase price for CT and CMS, which was an all cash transaction and includes the $1.9 million contingent payment discussed below, was approximately $10.4 million and is comprised of the following (in thousands):
The initial purchase price was allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values at the acquisition date and resulted in excess purchase consideration over the net tangible assets and identifiable intangible assets acquired of $3.7 million.
The acquisition included contingent payments of up to $4.8 million that were not accounted for in the initial purchase price as of the acquisition date. The contingent payments include $1.9 million that was paid on December 31, 2008 to all of the former shareholders of CT and CMS in proportion to their ownership based on achievement of a retention objective. Based on the Company’s evaluation of accounting for contingent consideration paid to the shareholders of an acquired enterprise in a purchase business combination, the contingent payment of $1.9 million was accounted for in the total purchase price of $10.4 million. The contingent consideration led to an increase in goodwill when the contingency was resolved on December 31, 2008.
Goodwill of $5.7 million, representing the excess of the purchase price over the estimated fair value of tangible and identifiable intangible assets acquired in the acquisition, will not be amortized, but is instead tested for impairment at least annually, consistent with the accounting guidance for goodwill and other intangible assets. The $5.7 million of goodwill is expected to be deductible for tax purposes. In addition, a portion of the purchase price was allocated to the following identifiable intangible assets (in thousands, except years):
Customer backlog and relationships represent the underlying customer support contracts and related relationships with CT and CMS’s existing customers.
Note 4 -
Goodwill and Intangible Assets
Goodwill as of December 31, 2009 and 2008 was $5.5 million and $5.7 million, respectively. The change is due to an adjustment to the previous estimates for the lease liability valuation associated with the CT acquisition as a result of actual operating costs.
Intangible assets consisted of the following as of December 31, 2009 and 2008 (in thousands):
Intangible assets include third-party software licenses used in our products and acquired assets related to the CT acquisition. Costs incurred to renew or extend the term of a recognized intangible asset are expensed in the period incurred. The $1.8 million added in 2009 is for purchases of third-party software licenses used in our products. Amortization expense related to intangible assets was $2.1 million, $2.9 million and $0.5 million in 2009, 2008 and 2007, respectively, and was charged to cost of revenues for purchased technology and customer backlog and sales and marketing expense for customer relationships. The Company’s intangible assets are amortized over their estimated useful lives of one to five years. Total future expected amortization is as follows (in thousands):
Note 5 -
Financial Instruments
The Company classifies debt and marketable equity securities based on the liquidity of the investment and management’s intention on the date of purchase and re-evaluates such designation as of each balance sheet date. Except for certain auction rate securities that are classified as trading, debt and marketable equity securities are classified as available for sale and carried at estimated fair value, which is determined based on the inputs discussed below. Those securities that are classified as trading are designated as short-term investments due to a contractual agreement that allows the Company to sell the securities at par value beginning June 30, 2010. The total estimated fair value of such trading securities at December 31, 2009 was $3.6 million, which includes losses on investments of $0.1 million as compared to par value.
The Company considers all highly liquid instruments with an original maturity on the date of purchase of three months or less to be cash equivalents. The Company considers all investments that are available for sale that have a
maturity date of longer than three months to be short-term investments, including those investments with a maturity date of longer than one year that are highly liquid and for which the Company does not have a positive intent to hold to maturity. The auction rate security classified as available for sale is designated as a long-term investment due to the maturity date being longer than one year and the security not being liquid in the current market.
Interest is included in interest and other income, net, in the accompanying consolidated financial statements. Realized gains and losses are calculated using the specific identification method. The components of the Company’s debt and marketable equity securities classified as available-for-sale were as follows for December 31, 2009 (in thousands):
For investments in securities classified as available-for-sale, market value and the amortized cost of debt securities have been classified in accordance with the following maturity groupings based on the contractual maturities of those securities as of December 31, 2009 (in thousands).
The components of the Company’s debt and marketable equity securities classified as available-for-sale were as follows for December 31, 2008 (in thousands):
For investments in securities classified as available-for-sale, market value and the amortized cost of debt securities have been classified in accordance with the following maturity groupings based on the contractual maturities of those securities as of December 31, 2008 (in thousands).
The Company had no realized gains or losses on the sales of investments in 2009. The Company had no realized gains and realized losses on sales of investments of $22,000 in 2008. There were no realized gains or losses on the sales of investments in 2007. The Company had proceeds of $11.7 million from maturities and sales of investments for 2009. All proceeds from sales and maturities of investments were equal to the par value of the securities.
The Company measures financial assets at fair value on a recurring basis. The estimated fair value of the Company’s financial assets was determined using the following inputs at December 31, 2009 and 2008 (in thousands):
(1)
Included in cash and cash equivalents on the consolidated balance sheet.
(2)
Except as indicated in (3), included in short-term investments on the consolidated balance sheet.
(3)
$892K included in long-term investments on the consolidated balance sheet.
(4)
Included in prepaid and other current assets on the consolidated balance sheet.
(5)
Included in long-term investments on the consolidated balance sheet.
(1)
Included in cash and cash equivalents on the consolidated balance sheet.
(2)
Included in long-term investments on the consolidated balance sheet.
(3)
Included in short-term investments on the consolidated balance sheet.
(4)
Included in deposits and other assets on the consolidated balance sheet.
The table below presents the changes during the period related to balances measured using significant unobservable inputs (Level 3) (in thousands):
Valuation of Investments, Put Option and Warrants
Level 1 and Level 2
The Company’s available-for-sale securities include certificate of deposits, corporate notes and obligations, and U.S. government and agency obligations at December 31, 2009 and corporate notes and obligations at December 31, 2008. The Company values these securities using a pricing matrix from a reputable pricing service, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that observable either directly or indirectly (Level 2 inputs). However, the Company classifies all its available-for-sale securities, except for certain auction rated securities, as having Level 2 inputs. The Company validates the estimated fair value received from the reputable pricing service on a quarterly basis.
In December 2009, the Company executed a “Subscription Agreement for Units” (“the Agreement”) with ForceLogix Technologies, Inc. (“ForceLogix”). ForceLogix is a Canada-based public company that delivers on-demand sales management process optimization solutions for sales organizations. Pursuant to the Agreement, the Company purchased 2,639,000 units of ForceLogix for an aggregate of $250,000. Each unit consists of one common share and three quarters (3/4) of one common share purchase warrant of ForceLogix. The Company owns approximately 5% of the outstanding common shares of ForceLogix as of December 31, 2009 and does not have the ability to exercise significant influence. The Company valued the investment in the common stock using observable inputs (Level 1 inputs) and the related warrants using unobservable inputs (Level 3 inputs).
Level 3
The Company valued its auction rate securities using unobservable inputs (Level 3). The Company utilized the income approach applying assumptions for interest rates using current market trends and an estimated term based on expectations from brokers for liquidity in the market and redemption periods agreed to by other broker-dealers. The Company also applied an adjustment for the lack of liquidity to the value determined by the income approach utilizing a put option model. As a result of the valuation assessment, the Company recorded a gain on auction rate securities classified as trading securities of $484,000 for 2009 and an unrealized gain on auction rate securities classified as available for sale of $144,000 for 2009. As a result of the adoption of recognition and presentation of other-than-temporary impairments accounting guidance, the Company recorded a cumulative effect adjustment of $0.2 million to increase the second quarter 2009 beginning unrealized loss on auction rate securities classified as available for sale and to decrease the second quarter 2009 beginning accumulated deficit. See further discussion below.
In connection with certain of the auction rate securities, in October 2008, one financial institution where the Company holds auction rate securities issued certain put option rights to the Company, which entitles the Company to sell its auction rate securities to the financial institution for a price equal to the par value plus any accrued and unpaid interest. These rights to sell the securities are exercisable at any time during the period from June 30, 2010 to July 2, 2012, after which the rights will expire. As a result of the valuation assessment, the Company recorded a loss on the put option of $0.4 million 2009. The auction rate securities to which the put option applies were recorded as short-term investments and the asset associated with the put option was recorded as prepaid and other current assets as of December 31, 2009, as the put may be exercised beginning June 30, 2010. These auction rate securities were recorded as long-term investments and the asset associated with the put option was recorded as deposits and other assets on the consolidated balance sheets as of December 31, 2008.
The Company valued the ForceLogix warrants using the Black-Scholes-Merton option pricing model. At December 31, 2009, the fair value of the warrants is insignificant.
Adoption of Recognition and Presentation of Other-Than-Temporary Impairments Guidance
In the second quarter of 2009, the Company reclassified a cumulative effect adjustment of $0.2 million to increase the second quarter 2009 beginning unrealized loss on investments and decrease the second quarter 2009 beginning accumulated deficit. This adjustment to beginning accumulated other comprehensive loss reclassifies the impairment previously recognized in 2008 as the Company does not intend to sell its auction rate security and it is not more-likely-than-not that the Company will be required to sell that security before recovery. The cumulative effect adjustment relates to the Company’s one auction rate security classified as available for sale with an estimated fair value of $0.9 million, and was measured based on the discounted cash flows as of April 1, 2009.
Changes in value of the Company’s auction rate securities since June 30, 2009 were allocated between credit loss factors and other factors. The Company considered the following factors when determining credit loss:
•
Adverse conditions specifically related to the security, industry, or geographic area (i.e., financial condition of the issuer, financial condition of the underlying assets, changes to the underlying business, and changes in the quality of the underlying assets);
•
the historical and implied volatility of the security;
•
the payment structure of the debt security (i.e., the increased/decreased probability of repayment);
•
failure of the issuer to make payments or default on obligations;
•
changes to the rating of the security; and
•
declines in value of the underlying assets.
As the Company concluded that there was no other-than-temporary-impairment as of December 31, 2008 when using the modified definitions in the recognition and presentation of other-than-temporary impairments guidance, the Company recorded the full impairment as an adjustment to opening accumulated deficit. In addition, the Company evaluated the credit loss and determined it was immaterial.
Note 6 -
Property and Equipment, Net
Property and equipment consisted of the following (in thousands):
Depreciation and amortization expense for 2009, 2008 and 2007 was $2.8 million, $2.5 million and $1.9 million, respectively. Included in depreciation and amortization expense was amortization of purchased software, which totaled $1.2 million, $0.9 million, and $0.7 million for 2009, 2008 and 2007, respectively.
Note 7 -
Commitments and Contingencies
Contingencies
The Company is from time to time a party to various litigation matters and customer disputes incidental to the conduct of its business. At the present time, the Company believes that none of these matters is likely to have a material adverse effect on the Company’s future financial results.
The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews the need for any such liability on a quarterly basis and records any necessary adjustments to reflect the effect of ongoing negotiations, contract disputes, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case in the period they become known. At December 31, 2009, the Company has not recorded any such liabilities in accordance with accounting for contingencies. The Company believes that it has valid defenses with respect to the legal matters pending against the Company and that the probability of a loss under such matters is not probable.
Other Contingencies
The Company generally warrants that its products shall perform to its standard documentation. Under the Company’s standard warranty, should a product not perform as specified in the documentation within the warranty period, the Company will repair or replace the product or refund the license fee paid. Such warranties are accounted for in accordance with accounting for contingencies. To date, the Company has not incurred any costs related to warranty obligations for its software product.
The Company’s product license and on-demand agreements typically include a limited indemnification provision for claims by third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. To date, the Company has not incurred and therefore has not accrued for any costs related to such indemnification provisions.
Commitments
The Company leases its facilities under several non-cancelable operating lease agreements that expire at various dates through 2016. For leases with escalating rent payments, rent expense is amortized on a straight-line basis over the life of the lease. The Company had deferred rent related to leases with such escalating payments of $351,000 and $482,000 as of December 31, 2009 and 2008, respectively. Rent expense for 2009, 2008 and 2007 was $2.9 million, $3.0 million and $2.8 million, respectively. In addition, the Company, in the normal course of business, enters into unconditional purchase commitments for supplies and services.
For each of the next five years and beyond, noncancelable long-term operating lease obligations and unconditional purchase commitments are as follows (in thousands):
Included in prepaid and other current assets and deposits and other assets in the consolidated balance sheets at December 31, 2009 and 2008 is restricted cash of $232,000 and $434,000, respectively, related to security deposits on leased facilities for our New York, New York and San Jose, California offices. The restricted cash represents investments in certificates of deposit and secured letters of credit required by landlords to meet security deposit requirements for the leased facilities. Restricted cash is included in either prepaid and other current assets or deposits and other assets based on the remaining contractual term for the release of the restriction.
Note 8 -
Stock-Based Compensation
Expense Summary
Stock-based compensation expense of $4.3 million was recorded for 2009 in the consolidated statement of operations. Of the total stock-based compensation expense, approximately $1.6 million was related to stock options, $0.8 million was related to purchases of common stock under the ESPP, and $1.9 million was related to restricted stock units. For 2008, $7.7 million of stock-based compensation expense was recorded. Of the total stock-based compensation expense, approximately $2.4 million was related to stock options, $1.0 million was related to purchases of common stock under the ESPP, and $4.3 million was related to restricted stock units. For 2007, $5.0 million of stock-based compensation expense was recorded. Of the total stock-based compensation expense, approximately $3.8 million was related to stock options, $0.8 million was related to purchases of common stock under the ESPP, and $0.4 million was related to restricted stock units.
As of December 31, 2009, there was $4.1 million, $3.3 million and $0.1 million of total unrecognized compensation expense related to stock options, restricted stock units and the ESPP, respectively. This expense related to stock options, restricted stock units and the ESPP is expected to be recognized over a weighted average period of 2.64 years, 1.86 years and 0.30 years, respectively.
The table below sets forth the functional classification of stock-based compensation expense for 2009, 2008 and 2007 (in thousands):
Determination of Fair Value
The fair value of each restricted stock unit is estimated based on the market value of the Company’s stock on the date of grant. The fair value of each option award is estimated on the date of grant and the fair value of the ESPP is estimated on the beginning date of the offering period using the Black-Scholes-Merton valuation model and the assumptions noted in the following table.
Stockholder-Approved Stock Option and Incentive Plans
The Company has two stock option and incentive plans approved by stockholders, the 1997 Stock Option Plan and the 2003 Stock Incentive Plan.
The incentive and nonstatutory options to purchase the Company’s common stock granted to employees under the 1997 Stock Option Plan generally vest over 4 years with a contractual term of 10 years. The vesting period generally equals the requisite service period of the individual grantees. Since the Company’s initial public offering, no options to purchase shares under the 1997 Stock Option Plan have been granted and all shares that remained available for future grant under this plan became available for issuance under the 2003 Stock Incentive Plan, as described below.
The 2003 Stock Incentive Plan became effective upon the completion of the Company’s initial public offering in November 2003. As of December 31, 2009, the Company was authorized to issue approximately 10,050,161 shares of common stock under the plan. Under the plan, the Company’s Board of Directors (or an authorized subcommittee) may grant stock options or other types of stock-based awards, such as restricted stock, restricted stock units, stock bonus awards or stock appreciation rights. Incentive stock options may be granted only to the Company’s employees. Nonstatutory stock options and other stock-based awards may be granted to employees, consultants or non-employee directors. These options vest as determined by the Board of Directors (or an authorized subcommittee), generally over 4 years. Formerly, the Company’s Board of Directors had approved a contractual term of 10 years, but effective April 24, 2006, the Board of Directors approved a reduction of the contractual term to 5 years for all future grants. The restricted stock units also vest as determined by the Board, generally over 3 years. The vesting period generally equals the requisite service period of the individual grantees. On July 1 of each year, the aggregate number of shares reserved for issuance under this plan increases automatically by a number of shares equal to the lesser of (i) 5% of the Company’s outstanding shares, (ii) 2,800,000 shares, or (iii) a lesser number of shares approved by the Board of Directors.
A summary of the Company’s shares available for grant and the status of options and awards under the 1997 Stock Option Plan and the 2003 Stock Incentive Plan are as follows:
Shares Available for Grant
Stock Options
Restricted Stock Units
Restricted stock units are not considered outstanding at the time of grant, as the holders of these units are not entitled to dividends and voting rights. Unvested restricted stock units are not considered outstanding in the computation of basic net loss per share.
As of December 31, 2009, the range of exercise prices and weighted average remaining contractual life of outstanding options under the 1997 Stock Option Plan and the 2003 Stock Incentive Plan are as follows:
The weighted-average fair value of stock options and restricted stock units granted during 2009 was $1.31 and $2.66 per share, respectively. For 2008, the weighted-average fair value of stock options and restricted stock units granted was $1.61 and $4.99 per share, respectively. For 2007, the weighted-average fair value of stock options and restricted stock units granted was $3.00 and $7.80 per share, respectively. The total intrinsic value of stock options exercised was $0.2 million, $1.4 million and $3.9 million for 2009, 2008 and 2007, respectively. The total cash
received from employees as a result of stock option exercises was $0.1 million, $2.5 million and $2.4 million for 2009, 2008 and 2007, respectively.
Employee Stock Purchase Plan
In August 2003, the Board of Directors adopted the Employee Stock Purchase Plan (ESPP), which became effective upon the completion of the Company’s initial public offering and is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. The ESPP is designed to enable eligible employees to purchase shares of the Company’s common stock at a discount on a periodic basis through payroll deductions. Each offering period under the ESPP will be for 12 months and will consist of two consecutive six-month purchase periods. The purchase price for shares of common stock purchased under the ESPP will be 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable offering period and the fair market value of the Company’s common stock on the last day of each purchase period. The Company issued approximately 788,000 shares during 2009 under the ESPP. The weighted-average fair value of stock purchase rights granted under the ESPP during 2009 was $1.24 per share. During 2008, the Company issued approximately 532,000 shares under the ESPP. The weighted-average fair value of stock purchase rights granted under the ESPP in 2008 was $1.74 per share. During 2007, the weighted-average fair value of stock purchase rights granted under the ESPP was $2.23 per share.
Other Plan Awards
On May 31, 2005, the Company granted its former chief executive officer, Robert H. Youngjohns, an option to purchase 1,000,000 shares of its common stock with an exercise price of $3.45 per share, which was the fair market value of the Company’s common stock on the date of grant. The option had a contractual term of 10 years and vested over four years, with 25% of the shares subject to the option vesting on the first anniversary of the grant date and 1/48th vesting each month thereafter. The vesting period equals the requisite service period of the grant. A summary of the status of this option for 2009 is as follows:
The agreements granting both the 28,000 shares of restricted stock and the option to purchase 1,000,000 shares were approved by the Company’s Compensation Committee, which is made up entirely of independent directors. Upon his resignation as chief executive officer on November 30, 2007, Mr. Youngjohns’ unvested shares terminated. As a continuing member of the Company’s Board of Directors, his vested shares did not terminate.
Note 9 -
Stockholders’ Equity
Convertible Preferred Stock
Upon completion of the Company’s initial public offering, the Company amended its certificate of incorporation and authorized 5,000,000 shares of undesignated preferred stock with a par value of $0.001. None of these shares were outstanding as of December 31, 2009 or 2008.
Repurchase Program
On November 27, 2007, the Company’s Board of Directors authorized a one-year program for the repurchase of up to $10 million of the Company’s outstanding common stock. On October 21, 2008, the Company’s Board of Directors re-authorized the program for the repurchase of up to $5 million of its outstanding common stock, which represented the unused balance of the program initially approved in 2007. During 2008 under these repurchase programs the Company executed the repurchase of 1,994,000 shares for a total cost of approximately $8.0 million. During 2009 under these repurchase programs the Company executed the repurchase of 248,000 shares for a total cost of approximately $0.7 million. The repurchased shares have been constructively retired for accounting purposes. The Company’s Board of Directors suspended the repurchase program in the first quarter of 2009.
Note 10 -
Income Taxes
The following is a geographical breakdown of consolidated loss before income taxes by income tax jurisdiction (in thousands):
The provision (benefit) for income taxes for 2009, 2008 and 2007 consists of the following (in thousands):
The provision (benefit) for income taxes differs from the expected tax benefit computed by applying the statutory federal income tax rates to consolidated loss before income taxes as follows (in thousands):
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Net deferred tax assets consist of the following (in thousands):
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the level of historical taxable income and projections for future taxable income over the period in which the temporary differences are deductible, the Company has recorded a valuation allowance against the deferred tax assets for which it believes it is not more likely than not to be realized. As of December 31, 2009, a valuation allowance has been recorded on all deferred tax assets, except the deferred tax assets related to one of its foreign subsidiaries, based on the analysis of profitability for that subsidiary.
The net changes for valuation allowance for years ended December 31, 2009 and 2008 was an increase of $5.6 million and $2 million, respectively.
As of December 31, 2009, the Company had net operating loss carryforwards for federal and California income tax purposes of approximately $76 million and $25 million, respectively, available to reduce future income
subject to income taxes. The federal net operating loss carryforwards, if not utilized, will expire over 20 years beginning in 2019. The California net operating loss carryforward, if not utilized, will expire beginning in 2010.
The Company also has research credit carryforwards for federal and California income tax purposes of approximately $5.7 million and $5.9 million, respectively, available to reduce future income taxes. The federal research credit carryforward, if not utilized, will expire over 20 years beginning in 2017. The California research credit carries forward indefinitely.
Federal and California tax laws impose restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an ownership change, as defined in Section 382 of the Internal Revenue Code. The Company’s ability to utilize its net operating loss and tax credit carryforwards are subject to limitations under these provisions.
Not included in the deferred income tax asset balance at December 31, 2009 is approximately $1.5 million, which pertains to certain net operating loss carryforwards resulting from the exercise of employee stock options. When recognized, the tax benefit of these losses will be accounted for as a credit to additional paid-in capital rather than a reduction of the income tax provision.
In fiscal 2009, the Company recognized approximately $0.1 million in the liability for unrecognized tax benefits as well as incremental penalties and interest net of deductions of $41,000. The Company’s unrecognized tax benefits at December 31, 2009 relate to various foreign jurisdictions.
The activity related to the Company’s unrecognized tax benefits is set forth below (in thousands):
(1)
$2.0 million is included as a reserve against deferred tax assets and $0.2 million is included in accrued expenses on the consolidated balance sheet.
If recognized, the unrecognized tax benefits at December 31, 2009 would reduce the Company’s annual effective tax rate. The Company also accrued potential penalties and interest of $8,000 related to these unrecognized tax benefits during 2009, and in total, as of December 31, 2009, the Company has recorded a liability for potential penalties and interest of $86,000. The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. The Company has classified the unrecognized tax benefits as long term, as it does not expect them to be realized over the next 12 months. The Company also does not expect its unrecognized tax benefits to change significantly over the next 12 months.
The Company files U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. All tax years generally remain subject to examination by federal and most state tax authorities. In foreign jurisdictions, the 2001 through 2008 tax years generally remain subject to examination by their respective tax authorities.
Note 11 -
Stockholders’ Rights Plan
On August 31, 2004, the Company’s Board of Directors approved the adoption of a Stockholder Rights Plan (the “Rights Plan”) and reserved 100,000 shares of participating, non-redeemable preferred stock for issuance upon exercise of the rights. The number of shares of preferred stock reserved for issuance may be increased by resolution of the Board of Directors without shareholder approval. The Rights Plan was amended on September 28, 2004.
Under the Rights Plan each common stockholder at the close of business on September 10, 2004 received a dividend of one preferred stock purchase right (a “Right” or “Rights”) for each share of common stock held. Each Right entitles the holder to purchase from the Company one one-thousandth of a share of a new series of participating preferred stock at an initial purchase price of $23.00. The Rights will become exercisable and will detach from the common stock a specified period of time after any person (the “Acquiring Person”) has become the beneficial owner of 15% or more of the Company’s common stock or commences a tender or exchange offer which, if consummated, would result in any person becoming the beneficial owner of 15% or more of the common stock. The Rights held by an Acquiring Person would become null and void upon the occurrence of such an event.
Further, if an Acquiring Person becomes the beneficial owner of 15% or more of the Company’s common stock, upon the exercise of each Right, the holder will be entitled to receive, in lieu of preferred stock, common stock having a market value equal to two times the purchase price of the right. However, if the number of shares of common stock which are authorized by the Company’s certificate of incorporation are not sufficient to issue such common shares, then the Company shall issue such number of one one-thousandths of a share of preferred stock as are then equivalent in value to the common shares. In addition, if, following an acquisition of 15% or more of the Company’s common stock, the Company is involved in certain mergers or other business combinations, each Right will entitle the holder to purchase a number of shares of common stock of the other party to such transaction equal in value to two times the purchase price of the Right.
The Company may exchange all or part of the Rights for shares of common stock at an exchange ratio of one share of common stock per Right any time after a person has acquired 15% or more (but before any person has acquired more than 50%) of the Company’s common stock.
The Company may redeem the Rights at a price of $0.001 per Right at any time prior to a specified period of time after a person has become the beneficial owner of 15% or more of its common stock. The Rights will expire on September 2, 2014, unless earlier exchanged or redeemed.
Note 12 -
Employee Benefit Plan
In 1999, the Company established a 401(k) tax-deferred savings plan, whereby eligible employees may contribute a percentage of their eligible compensation up to the maximum allowed under IRS rules. Company contributions are discretionary. No such Company contributions have been made since the inception of this plan.
Note 13 -
Segment, Geographic and Customer Information
The accounting principles guiding disclosures about segments of an enterprise and related information establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method of determining which information is reported is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision maker is considered to be the Company’s chief executive officer (CEO). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. By this definition, the Company operates in one business segment, which is the development, marketing and sale of enterprise software and related services. The Company’s TrueComp Suite is its only product line, which includes all of its software application products.
The following table summarizes revenues for 2009, 2008 and 2007 by geographic areas (in thousands):
Substantially all of the Company’s long-lived assets are located in the United States. Long-lived assets located outside the United States are not significant.
In 2009, 2008 and 2007, no customer accounted for more than 10% of our total revenues.
Note 14 -
Related Party Transactions
In 2005, the Company entered into a service agreement with Saama Technologies, Inc. for software consulting services. William Binch, who was appointed to the Company’s Board of Directors in April 2005, is also currently a member of Saama’s board of directors. The Company incurred expenses of $0, approximately $227,000 and $831,000 for services rendered by Saama for 2009, 2008 and 2007, respectively.
In 2007, CT entered into an operating lease agreement with CCT Properties LLC for its office space. Robert Conti, who was appointed as Senior Vice President, Client Services, in January 2008 in connection with the acquisition of CT, is also a part owner of CCT Properties LLC. The Company incurred rent expense for the office space owned by CCT Properties of approximately $153,000 and $202,000 for 2009 and 2008, respectively. Mr. Conti resigned from his position with the Company effective March 31, 2009.
Subsequent to the acquisition of CT in 2008, the Company continued its service agreement with The Alexander Group, Inc. for software consulting services. Robert Conti, who was appointed as Senior Vice President, Client Services, in January 2008 in connection with the acquisition of CT, is also a part owner of The Alexander Group and continues to serve as its Senior Vice President and CFO. The Company incurred expenses of approximately $147,000 and $553,000 for services rendered by The Alexander Group for 2009 and 2008, respectively.
Subsequent to the acquisition of CT in 2008, the Company continued to purchase hosting services from Level 3 Communications, Inc. Michele Vion, who was appointed to the Company’s Board of Directors in September 2005, was the Senior Vice President, Human Resources, at Level 3 Communications through January 2010. The Company incurred expenses of approximately $95,000 and $86,000 for hosting services rendered by Level 3 Communications for 2009 and 2008, respectively.
The Company believes all of these agreements represent arm’s length transactions.
Note 15 -
Subsequent Events
Subsequent to year-end, the Company completed the acquisition of Actek, a leading provider of commissions and compliance software for complex selling environments for the insurance and financial services industries. Under the terms of the agreement, the Company paid Actek’s owner $2.1 million in a combination of cash and stock and assumed debt of $0.9 million. In addition, the Company may pay up to approximately $1 million in the form of cash, restricted stock units and stock options, depending on the achievement of specified operational milestones on January 1, 2011. Because this consideration is contingent on the achievement of the milestones, the Company is required to revalue the consideration at each subsequent reporting date until January 1, 2011 under the acquisition accounting guidance.
In February 2010, management approved a cost savings program to reduce the Company’s workforce. The Company expects to incur restructuring charges of $0.7 million in the first quarter of 2010 in connection with severance and termination-related costs, most of which are severance-related cash expenditures. The February 2010 cost savings program will be fully completed in the first quarter of 2010.
Note 16 -
Quarterly Financial Data (Unaudited) (in thousands, except for per share amounts)