Overview

We are a leading provider of on-demand compensation, performance management and competency management solutions in the human capital software-as-a-service ("SaaS") market. We offer content-rich software and services to help businesses and individuals manage pay and performance. Companies of all sizes turn to us to effectively and efficiently compensate, promote and manage their employees. With our help, companies can put the right talent in the right roles to deliver business objectives and individuals at all levels can determine their worth.

Our highly configurable software applications and proprietary content and our consulting services help executives, line managers and compensation professionals automate, streamline and optimize critical talent management processes, such as market pricing, compensation planning, performance management, competency management (a competency is a set of demonstrated behaviors, skills and proficiencies that determine performance in a given role) and succession planning. Compensation and competency content are at the core of our solutions, which deliver productive and cost-effective ways for employers to manage and inspire their most important asset-their people.

We integrate our comprehensive SaaS applications with our proprietary content to automate the essential elements of our customers' compensation and performance management processes. Our approach links pay to performance and aligns employees with corporate goals to drive business results. As a result, our solutions can significantly improve the effectiveness of our customers' compensation spending and help them become more productive in managing their employees. We enable employers of all sizes to replace or supplement inefficient and expensive traditional approaches to compensation management, including paper-based surveys, consultants, internally developed software applications and spreadsheets. Our customers report gains in productivity, reduction in personnel hours to administer pay and performance programs and improvements in employee retention.

Our data sets contain base, bonus and incentive pay data for positions held by more than 80% of U.S. employees and similar data for the top executives in more than 12,000 U.S. public companies. Our flagship offering is CompAnalyst®, a suite of on-demand compensation management applications that integrates our data, third-party survey data and a customer's own pay data with a complete analytics offering. We have expanded our CompAnalyst market data and added new geographic coverage in the Canadian market with more than 650 benchmark jobs. Our Canadian content has already attracted a diverse set of customers across multiple industries. We continue to build our IPAS® global compensation technology survey with coverage of technology jobs from clerk to chief executive officer in more than 70 countries. In addition, we are expanding our compensation data services for the consumer goods retail sectors (i.e., apparel, footwear, luxury goods and specialty retail).

Our on-demand performance management solutions offer our customers effective and measurable ways to attract and inspire employee performance. TalentManager®, our employee lifecycle performance management software suite, helps businesses automate performance reviews, streamline compensation planning, perform succession planning, and link employee pay to performance. TalentManager helps employers gain visibility into their performance cycle and drive employee engagement in the process through a configurable, easy to use interface that can be personalized by users. Using TalentManager, we believe that employers can improve their performance management systems and model the critical jobs skills they need to achieve their business goals. Our TalentManager succession planning application was named 2008 product of the year by a leading human resources industry publication.

As of September 30, 2008, our enterprise subscriber base has grown to more than 3,300 companies. We have achieved 30 consecutive quarters of revenue growth since April 2001. However, during that time, we have consistently incurred operating losses. During the three months ended September 30, 2008, we incurred an operating loss of $6.4 million compared to an operating loss of $6.3 million in the three months ended June 30, 2008. During the six months ended September 30, 2008, we experienced operating cash outflows of $3.0 million compared to operating cash inflows $0.9 million in the six months ended June 30, 2008. As of September 30, 2008, we had an accumulated deficit of $52.5 million.

As a result of the recent financial crisis in the credit markets and difficulties in the financial services sector and continuing geopolitical uncertainties, the direction and relative strength of the U.S. economy has become increasingly uncertain. We anticipate that this uncertainty could cause our current and potential customers to delay or reduce their purchases of software and consulting services, which would result in longer sales cycles and lead to a reduction in sales of our products and services.

Acquisition of Business

InfoBasis Ltd.

On August 21, 2008, we acquired the share capital of InfoBasis Limited ("InfoBasis"). InfoBasis, located in the United Kingdom, is a provider of competency-based learning and development software. Under the terms of the agreement, we paid the former owners of InfoBasis $5.2 million in cash of which $0.5 million of the cash paid will be held in escrow until one year from the anniversary of the closing. The escrow fund will be available to compensate us for any losses that we may incur as a result of any breach of the representations or warranties by the former owners of InfoBasis contained in the purchase agreement, and certain liabilities arising out of the ownership or operation of InfoBasis prior to the acquisition. The former employee owners of InfoBasis will also be eligible to earn additional consideration based on meeting certain performance targets during each of the five twelve month periods ending August 31, 2009, 2010, 2011, 2012 and 2013. The additional consideration, if earned, consists of cash payments of a maximum of $200,000 per year for five years, allocated proportionately amongst the former employee owners. The total cash paid for the acquisition was approximately $5.4 million, which includes approximately $0.2 million of direct acquisition costs plus approximately $1.1 million of net liabilities assumed. The results of operations include the impact of this acquisition since August 22, 2008.

Sources of Revenues

We derive our revenues primarily from subscription fees and, to a lesser extent, through advertising on our website. For the three months ended September 30, 2008 and 2007, subscription revenues accounted for 93% and 92%, respectively, of our total revenues and for the three months ended September 30, 2008 and 2007, advertising revenues accounted for 7% and 8%, respectively, of our total revenues.

Subscription revenues are comprised primarily of subscription fees from enterprise and small business customers who pay a bundled fee for our on-demand software applications and data products and implementation services related to our subscription products, as well as syndication fees from our website partners and premium membership subscriptions sold primarily to individuals. Subscription revenues are primarily recognized ratably over the contract period as they are earned. Our subscription agreements for our enterprise subscription customer base are typically one to five years in length, and as of September 30, 2008, approximately 50% of our contracts were more than one year in length. We generally invoice our customers annually in advance of their subscription (for both new sales and renewals), with the majority of the payments typically due upon receipt of invoice. Deferred revenue consists primarily of billings or payments received in advance of revenue recognition from our subscription agreements and is recognized over time as the revenue recognition criteria are met. Deferred revenue does not include the unbilled portion of multi-year customer contracts, which is held off the balance sheet. Changes in deferred revenue generally indicate the trend for subscription revenues over the following year as the current portion of deferred revenue is expected to be recognized as revenue within 12 months. To a lesser extent, subscription revenues also include fees for professional services which are not bundled with our subscription products, revenues from sales of job competency models and related implementation services and revenue from the sale of our Compensation Market Study and Salary.com Survey products, which are not sold on a subscription basis.

Advertising revenues are comprised of revenues that we generate through agreements to display third party advertising on our website for a fixed period of time or fixed number of impressions. Advertising revenues are recognized as the advertising is displayed on the website.

Cost of Revenues and Operating Expenses

Cost of Revenues. Cost of revenues consists primarily of costs for data acquisition and data development, fees paid to our network provider for the hosting and managing of our servers, related bandwidth costs, compensation costs for the support and implementation of our products, compensation costs related to our consulting and professional services business and amortization of capitalized software costs. As we continue to implement and support our new and existing products and expand our data sets, we expect that over the next few years cost of revenues will continue to increase as a percentage of revenue and on an absolute dollar basis. Over the longer term, we expect our cost of revenues to decrease as a percentage of revenue as our business grows and our new data products gain market acceptance.

Research and Development. Research and development expenses consist primarily of compensation for our software and data application development personnel. We have historically focused our research and development efforts on improving and enhancing our existing on-demand software and data offerings as well as developing new features, functionality and products. We expect that in the future, research and development expenses will increase on an absolute dollar basis as we upgrade and extend our service offerings and develop new technologies.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation for our sales and marketing personnel, including sales commissions, as well as the costs of our marketing programs. The direct sales commissions for our subscription sales are capitalized at the time a subscription agreement is executed by a customer and we recognize the initial year sales commission expense ratably over one year. In the case of multi-year agreements, upon billing the customer for each additional year, we incur a subsequent sales commission and recognize the expense for such commission over the applicable year. Typically, a majority of the sales commission is recognized in the initial year of the subscription term. In order to add new customers and increase sales to our existing customers, we plan to continue to invest heavily in our sales efforts by increasing the number of direct sales personnel. We also plan to expand our marketing activities in order to extend brand awareness and generate additional leads for our sales staff. As a result, we expect that our sales and marketing expenses will increase on an absolute dollar basis as we grow our business.

General and Administrative. General and administrative expenses consist of compensation expenses for executive, finance, accounting, human resources, administrative and management information systems personnel, professional fees and other corporate expenses, including rent and depreciation expense.

Results of Operations

The following table sets forth our total deferred revenue and net cash (used in)
provided by operating activities for each of the periods indicated.



                                                        Three Months Ended        Six Months Ended
                                                           September 30             September 30
                                                         2008          2007       2008         2007
                                                          (in thousands)           (in thousands)
Total deferred revenue at end of period               $   23,953     $ 18,262   $ 23,953     $ 18,262
Net cash (used in) provided by operating activities         (865 )        569     (2,960 )      3,106

Three Months Ended September 30, 2008 compared to Three Months Ended September 30, 2007

Revenues. Revenues for the second quarter of fiscal 2009 were $10.5 million, an increase of $2.0 million, or 25%, compared to revenues of $8.5 million for the second quarter of fiscal 2008. Subscription revenues were $9.9 million for the second quarter of fiscal 2009, an increase of $2.1 million, or 27%, compared to subscription revenues of $7.8 million for the second quarter of fiscal 2008. The growth in subscription revenues was due primarily to an increase of $1.3 million in recognized revenue of our core compensation and talent management products sold by our professional services sales team. Revenues from our acquisitions during the second half of fiscal 2008 led to an increase in revenue of $0.7 million. Advertising revenues were $688,000 for the second quarter of fiscal 2009 compared to advertising revenues of $687,000 for the second quarter of fiscal 2008. Total deferred revenue as of September 30, 2008 was $24.0 million, representing an increase of $5.7 million, or 31%, compared to total deferred revenue of $18.3 million as of September 30, 2007.

Cost of Revenues. Cost of revenues for the second quarter of fiscal 2009 was $3.1 million, an increase of $1.2 million, or 66%, compared to cost of revenues of $1.9 million for the second quarter of fiscal 2008. The increase in cost of revenues was primarily due to a $0.4 million increase in payroll and benefit related costs due to the addition of personnel to our compensation and professional service teams in the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008, a $0.4 million increase in amortization of intangible assets primarily from data acquisition costs and a $0.2 million increase in stock-based compensation expense. As a percent of total revenues, cost of revenues increased to 30% in the second quarter of fiscal 2009 compared to 22% in the second quarter of fiscal 2008. The percentage increase was primarily the result of an increase in professional services personnel needed to support our changing business mix which now includes a more substantial consulting component.

Research and Development Expenses. Research and development expenses for the second quarter of fiscal 2009 were $2.3 million, an increase of $1.1 million, or 87%, compared to research and development expenses of $1.2 million for the second quarter of fiscal 2008. The increase in research and development expenses was primarily due to a $0.4 million increase in stock-based compensation expense, a $0.3 million increase in payroll and related expenses due to the addition of research and development personnel since the second quarter of fiscal 2008 and a $0.2 million increase in equipment expenses to support the increased headcount. Research and development expenses increased to 22% of total revenues in the second quarter of fiscal 2009 compared to 14% of total revenues in the second quarter of fiscal 2008 primarily as a result of the increased headcount to support planned product introductions.

Sales and Marketing Expenses. Sales and marketing expenses for the second quarter of fiscal 2009 were $7.2 million, an increase of $2.7 million, or 62%, compared to sales and marketing expenses of $4.4 million for the second quarter of fiscal 2008. The increase was primarily due to a $1.3 million increase in payroll and benefit related costs due to the addition of sales and marketing personnel since the second quarter of fiscal 2008, a $0.6 million increase in expenses from outside service providers, a $0.3 million increase in stock-based compensation expense and a $0.4 million increase in advertising and trade show expenses. Sales and marketing expenses increased to 68% of total revenues in the second quarter of fiscal 2009 compared to 52% of total revenues in the second quarter of fiscal 2008.

General and Administrative Expenses. General and administrative expenses for the second quarter of fiscal 2009 were $3.9 million, an increase of $0.3 million, or 9%, compared to general and administrative expenses of $3.6 million for the second quarter of fiscal 2008. The increase in general and administrative expenses was primarily due to a $0.5 million increase in payroll and benefit related costs due to the addition of administrative personnel. Also contributing to the increase in general and administrative expenses was a $0.4 million increase in stock-based compensation expense and an incremental $0.3 million of administrative expenses related to the acquisition of InfoBasis in August 2008. The increase in general and administrative expenses was somewhat offset by a decrease in legal expense of $0.5 million, a decrease in recruiting expense of $0.2 million and a decrease in accounting fees of $0.1 million. General and administrative expenses decreased to 37% of total revenues in the second quarter of fiscal 2009 compared to 43% in the second quarter of fiscal 2008.

Amortization of Intangible Assets. Amortization of intangible assets for the second quarter of fiscal 2009 was $444,000 compared to $281,000 in the second quarter of fiscal 2008. The increase in amortization was primarily due to the amortization of intangible assets acquired as part of the acquisition of ITG Competency Group, Inc ("ITG") in August 2007, Schoonover Associates, Inc. in December 2007 and InfoBasis in August 2008.

Interest Income. Interest income for the second quarter of fiscal 2009 was $206,000 compared to $514,000 in the second quarter of fiscal 2008. The decrease in interest income was due to a decrease in invested cash balances as well as a decrease in interest rates in the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008.

Provision for Income Taxes. The provision for income taxes for the second quarter of fiscal 2009 was $56,000 compared to $89,000 in the second quarter of fiscal 2008. The provision for income taxes consisted primarily of a deferred tax liability arising from timing differences between book and tax income related to goodwill and intangible asset amortization related to our business acquisitions.

Six Months Ended September 30, 2008 compared to Six Months Ended September 30, 2007

Revenues. Revenues for the six months ended September 30, 2008 were $20.2 million, an increase of $4.2 million, or 26%, compared to revenues of $16.0 million for the same period a year ago. Subscription revenues were $18.8 million for the six months ended September 30, 2008, an increase of $4.3 million, or 30%, compared to subscription revenues of $14.5 million for the year earlier period. The increase in subscription revenues was due primarily to an increase of $2.8 million in recognized revenue of our core compensation and talent management products sold by our professional services sales team. Revenues from the acquisitions we made during the second half of fiscal 2008 and the second quarter of fiscal 2009 increased revenues by $1.8 million. Advertising revenues were $1.3 million for the six months ended September 30, 2008 compared to advertising revenues of $1.5 million for the same period a year ago. The decrease in advertising revenues was primarily due to a reduction of advertising revenue from job boards.

Cost of Revenues. Cost of revenues for the six months ended September 30, 2008 was $6.4 million, an increase of $2.9 million, or 82%, compared to cost of revenues of $3.5 million for the same period a year ago. The increase in cost of revenues was primarily due to a $1.1 million increase in payroll and benefit related costs due to the addition of personnel to our compensation and professional service teams in the six months ended September 30, 2008 compared to the year earlier period, a $0.8 million increase in amortization of intangible assets primarily from data acquisition costs and a $0.5 million increase in stock-based compensation expense. As a percent of total revenues, cost of revenues increased to 32% in the six months ended September 30, 2008 compared to 22% in the same period a year ago. The percentage increase was primarily the result of an increase in professional services personnel needed to support our changing business mix which now includes a more substantial consulting component.

Research and Development Expenses. Research and development expenses for the six months ended September 30, 2008 were $4.1 million, an increase of $2.0 million, or 95%, compared to research and development expenses of $2.1 million for the same period a year ago. The increase in research and development expenses was primarily due to a $0.7 million increase in stock-based compensation expense, a $0.5 million increase in payroll and related expenses due to the addition of research and development personnel since the second quarter of fiscal 2008, a $0.3 million increase in equipment expenses to support the increased headcount and an increase of $0.1 of rent expense related to the expansion of the China facility. Research and development expenses increased to 20% of total revenues in the six months ended September 30, 2008 compared to 13% of total revenues in the same period a year ago, primarily as a result of the increased headcount to support planned product introductions.

Sales and Marketing Expenses. Sales and marketing expenses for the six months ended September 30, 2008 were $13.6 million, an increase of $5.3 million, or 64%, compared to sales and marketing expenses of $8.3 million for the same period a year ago. The increase was primarily due to a $2.3 million increase in payroll and benefit related costs due to the addition of sales and marketing personnel since the second quarter of fiscal 2008, a $0.9 million increase in stock-based compensation expense, a $0.8 million increase in marketing, advertising and trade show expenses, an increase of $0.3 million in commissions expense and a $0.3 million increase in travel expenses. The remainder of the increase is due to an overall increase in sales and marketing expenses related to supporting the increase in headcount and the previously announced sales and marketing initiatives. Sales and marketing expenses increased to 68% of total revenues in the six months ended September 30, 2008 compared to 52% of total revenues in the same period a year ago.

General and Administrative Expenses. General and administrative expenses for the six months ended September 30, 2008 were $7.9 million, an increase of $1.4 million, or 21%, compared to general and administrative expenses of $6.5 million for the same period a year ago. The increase in general and administrative expenses was primarily due to a $1.0 million increase in payroll and benefit related costs due to the addition of administrative personnel. Also contributing to the increase in general and administrative expenses was a $0.6 million increase in stock-based compensation expense, an increase of $0.3 million in Board of Directors fees, and an incremental $0.3 million of administrative expenses related to the acquisition of InfoBasis in August 2008. The increase in general and administrative expenses was somewhat offset by a decreases in legal expense of $0.6 million, a decrease in recruiting expense of $0.3 million and a decrease in accounting fees of $0.1 million. General and administrative expenses decreased to 39% of total revenues in the six months ended September 30, 2008 compared to 41% in the same period a year ago.

Amortization of Intangible Assets. Amortization of intangible assets for the six months ended September 30, 2008 was $823,000 compared to $415,000 in the same period a year ago. The increase in amortization was primarily due to the amortization of intangible assets acquired as part of the acquisition of ITG in August 2007, Schoonover Associates, Inc. in December 2007 and InfoBasis in August 2008.

Interest Income. Interest income for the six months ended September 30, 2008 was $0.5 million compared to $1.1 million in the same period a year ago. The decrease in interest income was due to a decrease in invested cash balances as well as a decrease in interest rates in the six months ended September 30, 2008 compared to the year earlier period.

Provision for Income Taxes. The provision for income taxes for the six months ended September 30, 2008 was $143,000 compared to $89,000 in the same period a year ago. The provision for income taxes consisted primarily of a deferred tax liability arising from timing differences between book and tax income related to goodwill and intangible asset amortization related to our business acquisitions. The increase in the provision for income taxes is due primarily due to the incremental impact of intangible assets acquired from business acquisitions since the second quarter of fiscal year 2008.

Liquidity and Capital Resources

At September 30, 2008, our principal sources of liquidity were cash and cash equivalents totaling $28.0 million and accounts receivable, net of allowance for doubtful accounts of $5.1 million, compared to cash and cash equivalents of $37.7 million and accounts receivable, net of allowance for doubtful accounts of $4.7 million at March 31, 2008. Our working capital as of September 30, 2008 was $4.9 million compared to working capital of $16.0 million as of March 31, 2008. The reduction in our working capital was primarily due to our acquisition of Infobasis, which was funded by our working capital.

Cash used in operating activities for the six months ended September 30, 2008 was $3.0 million. This amount resulted from a net loss of $12.5 million, adjusted for net non-cash charges of $6.6 million and a $2.9 million net increase in working capital accounts. Non-cash items primarily consisted of $0.6 million of depreciation and amortization of property, equipment and software, $1.6 million of amortization of intangible assets and $4.5 million of stock-based compensation. The net increase in working capital of $2.9 million was primarily comprised of increases in prepaid and other current assets of $0.2 million, accounts payable of $0.4 million, accrued expenses and other current liabilities of $1.3 million and deferred revenue of $1.3 million. The increase in prepaid expenses and other current assets is due to the timing of payments to vendors. The increase in accounts payable is due both to an increased level of expenses related to our headcount growth, our increased sales and marketing spending and the timing of payments to vendors. The increase in accrued expenses is primarily due to an increase in accrued compensation. The increase in deferred revenue is primarily due to increased invoicing less revenue recognition from our subscription customers in the six months ended September 30, 2008. The growth in the invoicing was primarily due to increased subscription renewals and increased sales to existing customers. Currently, payment for the majority of our subscription agreements is due upon invoicing. Because revenue is generally recognized ratably over the subscription period, payments received at the beginning of the subscription period result in an increase to accounts receivable and deferred revenue. Changes in deferred . . .