Overview

We are a leading provider of on-demand human resource management systems ("HRMS")/payroll, compensation, performance management and competency management solutions in the human capital software-as-a-service ("SaaS") market. We offer software and services that are tightly integrated with our proprietary data sets 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, 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 employees and top executives in thousands of 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. In 2008, we expanded our CompAnalyst market data and added new geographic coverage in the Canadian market. Our Canadian content continues to attract a diverse set of customers across multiple industries. We continue to build our IPAS ®global compensation technology survey with coverage of technology jobs in more than 80 countries.

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.

With our fiscal 2009 acquisitions of InfoBasis Limited, now known as Salary.com Limited, and Genesys Software Systems, Inc. (Genesys), we further expanded our addressable market. Salary.com Limited provides customers with competency-based learning and development software and Genesys offers a broad range of on-demand and licensed human resources management systems and payroll solutions, including benefits and tax filing services. These acquisitions have also given us the ability to offer our customers a bundled package that includes our HR data and point solution tools for compensation and competency management, our strategic talent management solutions for performance management, compensation and succession planning, and learning and development and our transactional HR solutions for payroll, tax, benefits, HRMS and employee self service. We are working to further leverage the synergies among our different products by developing a single, integrated product suite that will contain all of these elements. We believe that an integrated product suite will offer a cost effective way to automate performance and develop a strong internal pipeline of leaders beyond what can be achieved through bundling our products.

We were organized as a Delaware corporation in 1999. As of June 30, 2009, our enterprise subscriber base has grown to more than 3,500 companies who spend from $2,000 to more than $100,000 annually. We have achieved 33 consecutive quarters of revenue growth since April 2001. During the three months ended June 30, 2009, we incurred an operating loss of $5.0 million compared to an operating loss of $8.6 million in the three months ended March 31, 2009. During the three months ended June 30, 2009, we experienced operating cash inflows of $0.1 million compared to operating cash outflows $1.4 million in the three months ended March 31, 2009. As of June 30, 2009, we had an accumulated deficit of $71.6 million.

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 June 30, 2009 and 2008, subscription revenues accounted for 92% and 93%, respectively, of our total revenues and for the three months ended June 30, 2009 and 2008, advertising revenues accounted for 8% and 7%, 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, sales of payroll perpetual licenses, maintenance and hosting services including related implementation and consulting services, 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 June 30, 2009, 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. Although we took significant expense-reducing measures in fiscal 2009, we continue to implement and support our new and existing products and expand our data sets and 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 our addition of HRMS/payroll solutions to our line of products will require us to focus additional research and development efforts on creating a single integrated product suite that encompasses all of our solutions. 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 fiscal 2009, we invested substantially in sales and marketing, which resulted in increased sales and marketing expenses. We do not expect to make similar expenditures in the near-term and, as a result, we expect that our sales and marketing expenses will decrease in the upcoming fiscal year.

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 provided
by (used in) operating activities for each of the periods indicated.



                                                            Three Months Ended
                                                                 June 30
                                                             2009         2008
                                                              (in thousands)
    Total deferred revenue at end of period               $    29,296   $ 23,268
    Net cash provided by (used in) operating activities            88     (2,095 )

Three Months Ended June 30, 2009 compared to Three Months Ended June 30, 2008

Revenues. Revenues for the first quarter of fiscal 2010 were $11.4 million, an increase of $1.8 million, or 19%, compared to revenues of $9.6 million for the first quarter of fiscal 2009. Subscription revenues were $10.4 million for the first quarter of fiscal 2010, an increase of $1.4 million, or 16%, compared to subscription revenues of $9.0 million for the first quarter of fiscal 2009. The growth in subscription revenues was due primarily to our acquisitions during fiscal 2009. Advertising revenues were $913,000 for the first quarter of fiscal 2010 compared to advertising revenues of $625,000 for the first quarter of fiscal 2009. Total deferred revenue as of June 30, 2009 was $29.3 million, representing an increase of $6.0 million, or 26%, compared to total deferred revenue of $23.3 million as of June 30, 2008.

Cost of Revenues. Cost of revenues for the first quarter of fiscal 2010 was $3.6 million, an increase of $0.4 million, or 13%, compared to cost of revenues of $3.2 million for the first quarter of fiscal 2009. The increase in cost of revenues was primarily due to a $1.5 million increase of costs attributable to fiscal 2009 acquisitions, partially offset by decreases of $0.5 million and $0.2 million in payroll and benefit related costs and stock-based compensation, respectively, due to the reduction in workforce implemented in the fourth quarter of fiscal 2009, a $0.3 million decrease in incentive compensation charges and a $0.1 million decrease in consulting costs during the first quarter of fiscal 2010. As a percent of total revenues, cost of revenues remained fairly consistent at 33% in the first quarter of fiscal 2010 compared to 34% in the first quarter of fiscal 2009.

Research and Development Expenses. Research and development expenses for the first quarter of fiscal 2010 were $2.3 million, an increase of $0.5 million, or 28%, compared to research and development expenses of $1.8 million for the first quarter of fiscal 2009. The increase in research and development expenses was primarily due to a $0.4 million increase of costs attributable to fiscal 2009 acquisitions and a $0.1 million increase in payroll and related expenses due to the addition of research and development personnel since the first quarter of fiscal 2009. Research and development expenses increased to 20% of total revenues in the first quarter of fiscal 2010 compared to 19% of total revenues in the first quarter of fiscal 2009.

Sales and Marketing Expenses. Sales and marketing expenses for the first quarter of fiscal 2010 were $5.7 million, a decrease of $0.8 million, or 12%, compared to sales and marketing expenses of $6.5 million for the first quarter of fiscal 2009. The decrease was primarily due to a decrease of $0.4 million in advertising and trade show expenses and decreases of $0.2 million and $0.1 million in payroll and benefit related costs and stock-based compensation, respectively, due to the reduction in workforce implemented in the fourth quarter of fiscal 2009, a $0.3 million decrease in incentive compensation charges, partially offset by a $0.3 million increase of costs attributable to fiscal 2009 acquisitions. Sales and marketing expenses decreased from 68% of total revenues in the first quarter of fiscal 2009 to 50% of total revenues in the first quarter of fiscal 2010.

General and Administrative Expenses. General and administrative expenses were $4.0 million for the first quarter of fiscal 2010 and 2009. General and Administrative costs remained consistent primarily due to a $0.4 million increase of costs attributable to fiscal 2009 acquisitions, a $0.3 million increase in accounting and legal costs, offset by decreases of $0.3 million and $0.2 million in payroll and benefit related costs and stock-based compensation, respectively, due to the reduction in workforce implemented in the fourth quarter of fiscal 2009 and a $0.2 million decrease in incentive compensation charges during the first quarter of fiscal 2010. General and administrative expenses decreased to 36% of total revenues in the first quarter of fiscal 2010 compared to 42% in the first quarter of fiscal 2009.

Amortization of Intangible Assets. Amortization of intangible assets for the first quarter of fiscal 2010 was $738,000 compared to $379,000 in the first quarter of fiscal 2009. The increase in amortization was primarily due to the amortization of intangible assets acquired as part of the acquisition of Salary.com Limited in August 2008 and Genesys in December 2008.

Interest Income. Interest income for the first quarter of fiscal 2010 was $7,000 compared to $250,000 in the first quarter of fiscal 2009. The decrease in interest income was due to a decrease in invested cash balances as well as a decrease in interest rates in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009.

Other Expense. Other expense for the first quarter of fiscal 2010 consisted primarily of $69,000 non-income taxes incurred during the current quarter and interest expense of $37,000 primarily due to borrowings against our revolving credit facility previously used to fund the acquisition of Genesys.

Provision for Income Taxes. The provision for income taxes for the first quarter of fiscal 2010 was $26,000 compared to $86,000 in the first quarter of fiscal 2009. 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.

Acquisition of Business

Genesys Software Systems, Inc.

On December 17, 2008, we acquired all issued and outstanding shares of Genesys, a leading provider of on-demand and licensed human resources management systems and payroll solutions. Under the terms of the agreement, we paid the former owners of Genesys $6.0 million, net of cash acquired and converted approximately $1.1 million of options to purchase Genesys common stock into options to purchase approximately 519,492 shares of our common stock. In addition, the former Genesys security holders are eligible to earn additional consideration of up to $2,000,000 which would be paid in cash or shares of our common stock, at our option, based on Genesys meeting certain performance targets during the eighteen months after the closing of the acquisition. As of June 30, 2009, the $2.0 million of additional consideration had been earned and recorded as additional goodwill. The purchase price to be allocated for financial accounting purposes was approximately $9.4 million, which includes $1.1 million of options to purchase our common stock and approximately $1.9 million of net liabilities assumed. Accordingly, the preliminary purchase price was allocated based upon the fair value of assets acquired and liabilities assumed in accordance with SFAS 141. We preliminarily allocated $4.1 million of the purchase price to goodwill based upon the estimated fair value of the assets acquired in the acquisition. Goodwill from the acquisition resulted from our belief that the products and services offered by Genesys will be complementary to our on-demand software suites. The allocation of the purchase price is preliminary and subject to change. The results of operations include the impact of this acquisition since December 17, 2008.

Liquidity and Capital Resources

At June 30, 2009, our principal sources of liquidity were cash and cash equivalents totaling $17.0 million and accounts receivable, net of allowance for doubtful accounts of $5.9 million, compared to cash and cash equivalents of $21.1 million and accounts receivable, net of allowance for doubtful accounts of $6.0 million at March 31, 2009. Our working capital as of June 30, 2009 was a negative $17.4 million compared to negative working capital of $11.6 million as of March 31, 2009. The reduction in our working capital was primarily due to cash outflows related our fiscal 2009 acquisitions and payments related to our stock repurchase program of $1.8 million. During the first quarter of fiscal 2010, we borrowed against our revolving credit facility and, as of June 30, 2009, we had an outstanding balance of $6.0 million against our line.

Cash provided by operating activities for the three months ended June 30, 2009 was $0.1 million. This amount resulted from a net loss of $5.1 million, adjusted for non-cash charges of $3.5 million and a $1.7 million net increase in working capital accounts. Non-cash items primarily consisted of $0.5 million of depreciation and amortization of property, equipment and software, $1.2 million of amortization of intangible assets and $1.5 million of stock-based compensation. The net increase in working capital of $1.7 million was primarily comprised of increases in accounts payable of $0.9 million and deferred revenue of $0.8 million. The increase in accounts payable was primarily due to additional billings subsequently received related to services received in fiscal 2009 and timing of payments to vendors. The increase in deferred revenue is primarily the result of increased invoicing less revenue recognition from our subscription customers for quarter ended June 30, 2009. 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 deferred revenue. 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 within 12 months. The decreases in accounts payable, accrued expenses and other current liabilities are due primarily to the timing of payments to vendors.

Cash provided by investing activities was $10.5 million and consisted primarily of a decrease of $10.6 million of funds obtained from payroll customers to be used in satisfying related obligations partially offset by $0.1 million paid for purchases of data sets and property, equipment and software. We intend to continue to invest in our content data sets, software development and network infrastructure to ensure our continued ability to enhance our existing software, expand our data sets, introduce new products, and maintain the reliability of our network.

Cash used in financing activities was $14.5 million, which consisted primarily of $9.1 million of repayments of our revolving line of credit, $1.8 million of repurchases of our stock, $10.6 million related to decreases in payroll customer related obligations, partially offset by borrowings of $7.0 million against our line of credit.

On December 30, 2006, we entered into an agreement with a vendor to obtain additional data sets that runs for an initial one year term following the date of the initial delivery. The fee for the initial term was $1.5 million. At the end of the initial term, November 17, 2008, the agreement automatically renewed in accordance with the terms of the agreement for the first of up to six subsequent one year renewal terms, the remainder of such subsequent renewal terms are terminable by us. In December 2008, we extended the initial term of the agreement to June 30, 2009. On June 30, 2009, we terminated the agreement.

On August 3, 2007, we acquired the assets of ITG. Under the terms of the agreement, the former owners of ITG are eligible to earn up to $1.0 million in additional consideration based on meeting certain performance targets during the first two years after the closing of the acquisition, and can earn additional consideration if these targets are exceeded. The additional consideration will be paid 75% in cash and 25% in common stock. As of June 30, 2009, all $1.0 million of the additional consideration has been earned and recorded as additional goodwill and recorded as compensation expense.

On December 21, 2007, we acquired the assets of Schoonover Associates, Inc. Schoonover will be eligible to earn additional consideration based on meeting certain performance targets during the first five fiscal years after March 31, 2008. The additional consideration, if earned, consists of cash payments of no more than $100,000 per year for 5 years and 112,646 newly issued shares of common stock valued at $1.5 million, which are eligible to vest ratably over such five-year period. As of June 30, 2009, $100,000 of the additional consideration has been earned.

On April 17, 2008, we entered into a leaseline agreement (Leaseline #4) with a maximum available commitment of $350,000. The lease term began on July 1, 2008 and runs for a term of 36 months. As of June 30, 2009, we had leased approximately $173,000 of equipment under the terms of this leaseline. On July 24, 2008, we entered into a leaseline agreement (Leaseline #5) with a maximum available commitment of $200,000. The lease term began on October 1, 2008 and runs for a term of 36 months. In addition, at June 30, 2009, we had approximately $1.1 million in a restricted cash account as collateral for equipment with a value of approximately $1.1 million in accordance with all of its master lease agreements.

In June 2008, we entered into an agreement with a vendor to finance the purchase of perpetual software licenses in the amount of approximately $738,000. We will make quarterly payments of approximately $64,000 for a term of 36 months.

On August 8, 2008, we entered into a modification of our existing credit facility with Silicon Valley Bank to modify certain of the financial covenants and extend the term of the agreement to September 23, 2008. On September 17, 2008, we entered into a second modification of our credit facility to extend the term of the agreement to October 8, 2008. On October 8, 2008, we entered into a third modification of our credit facility to extend the term of this credit facility two years to October 8, 2010 and increased the line of credit from $5,000,000 to $10,000,000. On March 16, 2009, we entered into a fourth modification of our agreement, which added Genesys as a guarantor to our obligations under the credit facility. As of March 31, 2009, there was $8.1 million outstanding under the credit facility. On April 27, 2009, we paid all of the outstanding amounts due under our credit facility.

On June 29, 2009, we entered into a Fifth Loan Modification Agreement with Silicon Valley Bank. The agreement modifies our existing credit facility with Silicon Valley Bank to, among other things:

• Increase the interest rate payable by us on advances from our revolving line of credit, so that our borrowings bear interest at the greater of the bank's prime rate and 4% or, if our unrestricted cash balance falls below $20 million, at the bank's prime rate plus 0.5%;

• Increase the fee payable on the unused portion of our revolving line of credit to 0.5%;

• Amend certain financial covenants to be based upon our adjusted earnings before interest, taxes, depreciation and amortization ("adjusted EBITDA") rather than our domestic invoices; and

• Increasing the amount of stock we can repurchase under our repurchase plans to $2.25 million.

On August 10, 2009, the Company entered into a Consent with Silicon Valley Bank regarding its existing credit facility to (i) exclude $300 thousand of stock repurchase made during June 2009 from the calculation of EBITDA for the three months ended June 30, July 31, and August 31, 2009 and (ii) to increase the limit on stock repurchases from $2.25 million to $2.45 million. . . .