UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

 

Commission file number: 000-50463

Callidus Software Inc.

(Exact name of registrant as specified in its charter)

 

 

160 West Santa Clara Street, Suite 1500

San Jose, CA 95113

(Address of principal executive offices, including zip code)

 

(408) 808-6400

(Registrant’s Telephone Number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.  Yes o     No þ

 

The aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant, based on the closing sale price of the Registrant’s common stock on June 30, 2009, as reported on the NASDAQ Global Market, was approximately $85.4 million. Shares of common stock held by each executive officer and director and by each person who may be deemed to be an affiliate of the Registrant have been excluded from this computation. The determination of affiliate status for this purpose is not necessarily a conclusive determination for other purposes. As of March 1, 2010, the Registrant had 31,153,488 shares of its common stock, $0.001 par value, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The Registrant is incorporating by reference into Part III of this Annual Report on Form 10-K portions of its Proxy Statement for its 2010 Annual Meeting of Stockholders to be held on June 1, 2010.

 

 

CALLIDUS SOFTWARE INC.
ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2009

 

TABLE OF CONTENTS

 

 

^© 1998-2010 Callidus Software Inc. All rights reserved. Callidus Software, the Callidus Software logo, and TrueComp Manager are trademarks, servicemarks, or registered trademarks of Callidus Software Inc. in the United States and other countries. All other brand, service or product names are trademarks or registered trademarks of their respective companies or owners.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in Item 6 of this report, and other materials accompanying this Annual Report on Form 10-K contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will,” and similar expressions and the negatives thereof identify forward-looking statements, which generally are not historical in nature. These forward-looking statements include, but are not limited to, statements concerning the following: changes in and expectations with respect to license revenues and gross margins, future operating expense levels, the impact of quarterly fluctuations of revenue and operating results, levels of recurring revenues, staffing and expense levels, the impact of foreign exchange rate fluctuations and the adequacy of our capital resources to fund operations and growth. As and when made, management believes that these forward-looking statements are reasonable. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made and may be based on assumptions that do not prove to be accurate. Our Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, occurring after the date of this Annual Report on Form 10-K. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our Company’s historical experience and our present expectations or projections. For a detailed discussion of these risks and uncertainties, see the “Business” and “Risk Factors” sections in Items 1 and 1A of this Annual Report on Form 10-K.

 

 

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:

 

 

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.

 

 

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:

 

 

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:

 

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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:

 

 

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.

 

 

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.

 

 

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.

 

 

None

 

 

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

 

 

 

 

 

 

 

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.

 

 

 

 

 

 

 

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:

 

 

 

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):

 

 

 

 

 

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):