Talx Corp (TALX) - Description of business
We are a leading provider of payroll-related and human resources business process outsourcing services. Our services enable our clients to automate and outsource the performance of payroll and human resources business processes that would otherwise be performed by their own in-house payroll or human resources departments. Our clients are large and mid-size organizations, including more than three-fourths of the Fortune 500 companies in a wide variety of industries, as well as a number of government agencies.
Our current services include employment and income verification and other payroll-related services, unemployment tax management services, tax credit and incentive services, and employee assessment and talent management services.
- Income Verification and Employment Services. Our employment and income verification services, which we refer to collectively as "The Work Number services," are designed to help employers save time and effort and reduce expenses associated with many of the administrative tasks required to support large workforces. These tasks include verifying employment and income information, printing and distributing pay stubs and annual W-2 forms, collecting time-reporting data, updating employee personnel records on a self-service basis, and screening job applicants. As of March 31, 2006, The Work Number database, our proprietary database of payroll and other human resources-related information, contained approximately 129.0 million employee records and had contracts to receive an additional 7.3 million records. Authorized users such as mortgage lenders, pre-employment screeners, credit issuers, social service agencies and others access The Work Number service and pay us transaction-based or monthly service fees for verification of employment and income information.
- Unemployment Tax Management Services. Through our unemployment tax management services, we provide unemployment insurance claims processing, unemployment hearing education and consultation, and unemployment tax planning and management services to a broad range of employers. These services are designed to reduce the cost of processing unemployment claims by human resources departments and to better manage the tax rate that employers are assessed for unemployment taxes.
- Tax Credit and Incentive Services. Our services in the tax credits and incentives segment include assisting employers with federal, state and local tax credits. Examples of federal tax credit services include integrating work opportunity, or "WOTC", and welfare to work, or "WtW", tax credit processing into the current hiring process, as well as processing all necessary forms to identify applicants and employees who are potential qualifiers for hiring tax credits. State and local tax credit services include assisting clients in identifying and calculating enterprise zone credits and job creation credits.
- Employee Assessment and Talent Management Services. Beginning in fiscal year 2007, through our employee assessment and talent management services, we provide testing and assessment services, as well as talent management services that are designed to enable organizations to automate and improve their human capital management business processes. With our employee assessment and talent management services, clients can electronically deliver the assessments to applicants and arrange the administering or proctoring of the assessments at pre-qualified testing centers. Using an online dashboard, clients can manage open positions and direct active applicants through the entire assessment and selection process, including external tests such as a drug test.
TALX services are enabled by our proprietary databases and applications that are designed to quickly and efficiently access and process large volumes of data. We employ web, interactive voice response, fax, document imaging and other technologies to enhance the services offered to our clients. We can interact with various payroll and human resources systems, and are virtually independent of the information technology services our clients select.
As used in this Form 10-K the terms "TALX," "we," "our," and "us" and other similar terms refer to TALX Corporation, unless we specify otherwise.
We have obtained a trademark registration for the name TALX and a trademark registration for The Work Number for Everyone, The Work Number, FasTime, UC eXpress, W-2 eXpress, Advanced HR Solutions, Performance Assessment Network, PAN, and Vital Information for Talent Assessment with the United States Patent and Trademark Office. In addition, TALXWare is our trademark, and I-9 eXpress, HireXpress and FasCast are our service marks. All other trade names, trademarks and product names in this Form 10-K are the property of their respective owners.
We are a Missouri corporation, with our principal executive offices located at 11432 Lackland Road, St. Louis, Missouri, 63146. Our telephone number is (314) 214-7000.
Our Internet website address is http://www.talx.com. We have made copies of the following reports available free of charge through our Internet website, as soon as reasonably practicable after they have been filed with or furnished to the Securities and Exchange Commission pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934: our annual report on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and amendments to those reports. Information on our website does not constitute a part of this Report.
Pursuant to an acquisition agreement dated April 20, 2005, we acquired Jon-Jay Associates, Inc., which specializes in providing unemployment cost management services as well as an employment verification service, for approximately $24 million, including transaction costs, subject to certain post-closing adjustments. Additionally, the acquisition agreement includes provisions for potential earn-out payments if certain future financial performance measures are achieved through the twelve months ending April 30, 2006 and April 30, 2007, respectively.
Pursuant to an asset purchase agreement dated April 26, 2005, we acquired substantially all of the assets and assumed certain of the liabilities of Glick & Glick Consultants, LLC, which specializes in employment-related tax credit and incentive services, for approximately $5 million, including transaction costs, subject to certain post-closing adjustments.
Pursuant to an asset purchase agreement dated November 1, 2005, we acquired the unemployment tax management businesses of Employers Unity, Inc., for approximately $30 million, including transaction costs, subject to certain post-closing adjustments.
Pursuant to an asset purchase agreement dated December 15, 2005, we acquired the tax credit and incentives business of Business Incentives, Inc., doing business as Management Insights, Inc., for approximately $24 million, including transaction costs, subject to certain post-closing adjustments.
Pursuant to an acquisition agreement dated April 6, 2006, we acquired Performance Assessment Network, Inc., or "PAN," a provider of secure, electronic-based psychometric testing and assessments, as well as comprehensive talent management services, for approximately $75 million, including transaction costs, subject to certain post-closing adjustments.
The purchase prices of the acquisitions were determined based on arms'-length negotiations, and were paid in cash financed through our Loan Agreements as discussed in Notes 8 and 20 to our consolidated financial statements and in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
As a result of recent acquisitions, in the third quarter of fiscal year 2006, we determined that we operate in four business segments:
- The Work Number services;
- unemployment tax management;
- tax credits and incentives; and
- maintenance and support services related to our former customer premises systems business.
The presentation of segment information reflects the manner in which management organizes segments for making operating decisions and assessing performance. Prior period information has been reclassified to reflect the establishment of the unemployment tax management segment and the tax credits and incentives segment, which were previously presented together as one segment.
We are assessing the impact of the April 6, 2006 acquisition of PAN on our current segment classifications. See "Recent Acquisitions" above.
THE WORK NUMBER SERVICES
The Work Number services include our employment and income verification services, W-2 management services (which include initial distribution, reissue and correction of W-2 forms), paperless pay services that enable employees to electronically receive pay statement information as well as review and change direct deposit account or W-4 information, integrated electronic time capture and reporting services, paperless new-hire services to bring new workers on board using electronic forms, and I-9 management services designed to help clients electronically comply with the immigration laws that require employers to complete an I-9 form for each new hire. The Work Number employment and income verification service is designed to help employers save time and effort and reduce expenses associated with many of the administrative tasks required to support large workforces. Additionally, all services in The Work Number suite of services provide secure web access for managers to obtain management reports, approve certain transactions and exercise important control functions.
The Work Number. Lenders, pre-employment screeners, credit issuers, social service agencies and other information verifiers often request organizations to verify employment and income information that has been provided by employees or former employees. For example, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, leading purchasers of residential mortgages in the United States, usually require independent verification of employment and income data for the past two calendar years and a current payroll period in connection with mortgages that they will purchase. The Work Number is an outsourced service that enables employers to direct the third-party verifiers to our website or to a toll-free telephone number to verify the employee's employment status and income data. We generate substantially all of The Work Number revenues from transaction-based or monthly fees charged to lenders, pre-employment screeners, credit issuers, social service agencies and other information verifiers for verification of employment and income information.
As of March 31, 2006, The Work Number database contained approximately 129.0 million employee records and had contracts to receive an additional 7.3 million records. The Work Number database is updated on a regular basis as employers transmit data electronically directly to us each payroll period. Employers contract to provide this data for specified periods, generally three years. Each employee included in our clients' payroll data represents an employment record on The Work Number database. This payroll data is uploaded to The Work Number database, updating each employee's record. If the employee is no longer employed by a client, the existing record remains intact. Thus, The Work Number database includes all our clients' current employees, as well as former employees.
W-2 eXpress. W-2 eXpress is a suite of services relating to the initial distribution (either printed or electronic), reissue and correction of W-2 wage and tax statement forms that we offer to existing clients and other large employers. Using data provided by employers, we distribute original W-2 forms (both electronically and in paper form through business alliances) to the employees of our clients and provide an automated process to enable these employees to request corrections to their W-2 forms and obtain additional copies via the web, telephone or direct download into their tax preparation software. This suite of services allows complete employee self-service, without requiring direct interaction with the employer's payroll staff. The majority of W-2 eXpress clients are billed based upon either the number of unique W-2s or the number of employees, generally pursuant to multi-year contracts.
ePayroll. ePayroll (or Paperless Pay) is a suite of payroll self-service applications that enables employees, via the web or by telephone, to receive pay statement information, access current and historical payroll information, review and change direct deposit account or paycard information, review and change W-4 (federal and state) information, update personal information, and enroll in selected paycard services chosen by their employer. Employers that send us electronic transmissions of their employees' pay stubs and direct deposit data can reduce the amount of staff required to process routine employee payroll requests as well as reduce the cost to distribute paper pay advices.
FasTime. FasTime services are integrated time capture and reporting solutions that work from any phone or the web and are used by large employers and the temporary staffing industry. For large employers, FasTime collects hours worked and exception time codes providing a user-friendly online approval and reporting for managers. FasTime is tailored to a company's business rules and processes and is designed to provide a comprehensive, paperless system for reporting time and availability and the reporting and management tools for distributed offices.
HireXpress. HireXpress is a paperless new-hire service that manages key components of the enterprise-scale hiring process, including electronic new-hire packets as well as the ability to monitor the completion process and provide approvals. Employers define their new-hire packets, and HireXpress notifies new employees and prompts them to complete their forms online using electronic signatures. Using the Web, HireXpress can automate the new-hire packet by creating electronic employee files. Information gathered from completed forms can be uploaded to the client's HR/Payroll system to provide a more complete electronic record.
I-9 eXpress. Our I-9 eXpress service is designed to help clients alleviate the difficulties involved with complying with the Immigration Reform and Control Act of 1986, which requires employers to complete an I-9 Employment Eligibility Verification form for all new employees and maintain these forms for a minimum of three years after the date of hire. Using this service, an employer can electronically generate and store I-9 forms and generate reports to monitor compliance. We expect this service to be fully implemented by the end of the first quarter of fiscal year 2007.
UNEMPLOYMENT TAX MANAGEMENT
Our unemployment tax management segment operates under the names UC eXpress, TALX Employer Services, Johnson and Associates, Jon-Jay Associates, and Employers Unity, which we refer to collectively as "UC eXpress". We offer a broad suite of services designed to reduce the cost of processing unemployment claims by human resources departments and to better manage the tax rate that employers are assessed for unemployment taxes. These services utilize optical character recognition, document imaging, web, fax and interactive voice response to speed the processing of unemployment claims, with the goal of resisting unmeritorious or illegitimate claims for unemployment compensation that have been filed with state agencies by separated employees. These services are aimed at relieving human resources departments of the administrative burden of managing unemployment claims. Following an employee separation, we respond on behalf of our client to an unemployment claim filed by the separated employee. This includes reviewing employment records to preserve the clients' rights as an employer. If an unemployment hearing is required, these services include client conferences with our hearing consultants/attorneys and, upon client request, attendance at the hearing with the employer's representative. In addition, our field-based account management team and hearing consultants bring state-specific unemployment tax knowledge to the client.
We also offer comprehensive employer tax services that encompass five service areas, including unemployment tax services, unemployment tax analysis, employment tax research and recovery, tax registrations, and employment tax consulting (withholding and unemployment). Clients who choose TALX for tax services collaborate with our tax analysts to monitor the clients' unemployment tax accounts, verify tax rates and contribution reports and identify voluntary contribution opportunities.
TAX CREDITS AND INCENTIVES
Our services in the tax credits and incentives segment include assisting employers with federal, state and local tax credits. Examples of federal tax credit services include integrating work opportunity, or "WOTC", and welfare to work, or "WtW", tax credit processing into the current hiring process, as well as processing all necessary forms to identify applicants and employees who are potential qualifiers for hiring tax credits. Through various acquisitions, we have expanded our existing tax credit services, including our capabilities to process WOTC/WtW tax credits, as well as our ability to assist clients in identifying and calculating certain other federal, state and local tax credits and incentives, such as enterprise zone credits and job creation credits.
Under current legislation, the WOTC and WtW credits were available to employers through December 31, 2005, and without further Congressional action to renew the credits, these programs have lapsed and are no longer available to our clients. We understand that Congress is currently considering the renewal of these programs. In the event that the lapsing of any of these programs should become permanent, we believe we would continue for approximately six months thereafter to earn revenues from credits in effect as of December 31, 2005. Although these programs have historically been renewed retroactively by Congress following their lapsing in accordance with their terms, Congress may not similarly renew such programs in the future. Moreover, if these programs lapse, any future renewals may not be retroactive, which means that the value of these programs to our clients could be reduced to such an extent that they no longer desire tax credit and incentive services. Any non-renewal of these tax credit programs, the renewal of such programs without retroactive effect, or other adverse change in tax legislation could adversely affect our business and results of operations.
MAINTENANCE AND SUPPORT SERVICES RELATED TO OUR FORMER CUSTOMER PREMISES SYSTEMS BUSINESS
We previously offered our products and services exclusively through licensed software specifically developed for each client, and installed these systems at the client's site. In 2000 we discontinued sales to new clients. Currently, we provide system enhancements to existing clients and client support 7-days per week, 24-hours per day, through a toll-free hotline, email and our website. We sold these systems under licenses and generate additional revenues by providing ongoing maintenance and support. During 2003, we notified our maintenance clients of our intention to discontinue all support services effective June 2005. As a result of requests from a number of clients, we have agreed to extend these support services until December 31, 2006.
EMPLOYEE ASSESSMENTS AND TALENT MANAGEMENT
On April 6, 2006, we acquired Performance Assessment Network, Inc., or "PAN", a provider of secure, electronic-based psychometric testing and assessments, as well as comprehensive talent management services. These services can be sold together or as separate solutions.
As part of its testing and assessment services, PAN does not generate its own tests and assessments. Instead, it presents a broad variety of third-party offerings, providing one-stop shopping for its clients. PAN's service provides access to more than 650 assessments on a flexible platform and a network of thousands of testing stations. PAN's experienced psychologists consult with clients to help them determine the most appropriate assessments for aptitudes and competencies that best fit their open positions.
PAN also provides a broad range of talent management services that can be mapped to the client's current hiring process. With PAN services, clients can electronically deliver the assessments to applicants and arrange the administering or proctoring of the assessments at pre-qualified testing centers. Using an online dashboard, clients can manage open positions and direct active applicants through the entire assessment and selection process, including external tests such as a drug test. The talent management dashboard can be sold independently of the test and assessment services.
One client, the Transportation Security Administration ("TSA"), through a subcontract with CPS Human Resource Services, represented approximately 75% of PAN's revenues in fiscal year 2006. In fiscal 2005, PAN derived approximately 93% of its revenues from this relationship.
Selected financial data regarding our business segments for fiscal years 2004, 2005, and 2006 is set forth in Note 17 of Notes to Consolidated Financial Statements contained in "Item 8 - Financial Statements and Supplementary Data." For additional information, see "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview."
SALES AND MARKETING
We employ a direct sales force and also utilize strategic marketing alliances. We use our direct sales force and strategic alliances to develop relationships with large employers, typically those having over 3,500 employees. We also recently established a separate in-house sales team focusing on prospects with less than 3,500 employees. In addition, we use our strategic alliances to help us identify potential clients among small and mid-sized employers, typically those with less than 3,500 employees. We also utilize a direct sales force to market the use of The Work Number database to verifiers such as lenders and credit issuers.
DIRECT SALES FORCE
Our sales, service and marketing effort relies on a team approach consisting of approximately 260 professionals in 41 U.S. cities, including regional sales vice presidents, regional sales directors, regional client relationship directors, regional sales managers, business development representatives, client relationship managers, account managers, product managers, product consultants and marketing personnel. Our business development representatives qualify companies as viable potential clients and establish appointments for our regional sales managers. Our regional sales directors and regional sales managers are responsible for presenting our service offerings to prospective clients and negotiating for the sale of our services. Our product managers oversee product direction and provide sales assistance. Our regional client relationship directors, client relationship managers and account managers service existing clients. Product consultants provide technical assistance to regional sales managers and prospective clients during the sales process. Our marketing personnel develop market strategies and support the sales force at all levels.
Additionally we have a team of professionals that manage our alliance relationships. This team includes sales managers responsible for generating sales through the development and management of existing alliance relationships.
Finally, we have a team dedicated to marketing the use of The Work Number database to verifiers such as lenders and credit issuers. This team identifies potential new verifiers and uses of the database, as well as takes steps to promote increased utilization of the database by current verifiers.
STRATEGIC MARKETING ALLIANCES
We have established alliances with leading providers of related payroll and human resources outsourcing services with the goal of building the database of records for The Work Number and extending our services relating to employees of both large and mid-sized employers. These alliances include:
- Hewitt Associates LLC: Hewitt Associates is a global management consulting firm specializing in human resource services that has agreed to make The Work Number available to its clients. For example, The Work Number is directly accessible by employees of Hewitt's clients through an employee portal that incorporates a seamless link to our website for The Work Number. In exchange, we have agreed, among other things, to share revenue with Hewitt resulting from its referrals.
- Ceridian Corporation: Ceridian is a global human resources and payroll outsourcing company that has agreed to make The Work Number and selected tax management services available to its clients in exchange for discounted prices for tax management services and a share of the revenue generated by client records on The Work Number.
These and other strategic marketing alliances, such as ExcellerateHRO (a joint venture of EDS and Towers Perrin), Convergys Corporation, ACS, Checkpoint HR, and AON, are generally governed by non-exclusive contractual arrangements that remain in effect for specified periods. The success of these alliances generally will depend on the interest and commitment of these companies in promoting and coordinating product development and marketing efforts with us, which is entirely at their discretion. Some of these companies maintain similar relationships with some of our competitors and compete directly with us in certain applications.
We believe the principal competitive factors in our markets include:
- service and product features, quality, security and performance;
- breadth of service offerings;
- functionality and ease of use;
- company reputation for integrity and confidentiality;
- company financial strength; and
- cost of the service or product.
We have a number of competitors for our various services. Below is a summary of the more significant competitors:
We believe that we compete favorably in the key competitive factors that affect our markets for The Work Number services, our unemployment tax management services, our tax credit and incentives services, and our employee assessment and talent management services. However, our markets are still evolving, and we may not be able to compete successfully against current or future competitors. Many of our existing and potential competitors have significantly greater financial, marketing, technical and other resources than we do. In addition, many of our competitors have well-established relationships with our current and potential clients and extensive knowledge of our markets. It is possible that new competitors or alliances among competitors will emerge and rapidly acquire market share. Moreover, our competitors may consolidate with each other, or with other companies, giving them even greater capabilities with which to compete against us.
TECHNOLOGY AND PRODUCT DEVELOPMENT
Our business is based on databases we construct and applications we build or acquire to access and deliver data. Our services are run on industry standard databases from Oracle, Microsoft and IBM and internally developed applications. We use a combination of Microsoft technologies for the creation, deployment and operation of our applications, along with technologies from a number of other companies. A few of our applications utilize a proprietary integrated visual development environment and software system known as TALXWare. We also license and integrate complementary technologies into our products including speech recognition, text-to-speech, image classification, and facsimile. We license these technologies from third-party suppliers pursuant to non-exclusive license or resale agreements or purchase the technologies under open market arrangements and then integrate them into our products. Some of the PAN products license intellectual property, for varying terms, in the form of various tests which are then implemented on or integrated with the PAN platform.
We have directed our development efforts toward enhancing and developing new offerings for The Work Number services and tax management services. The most recent enhancements include:
- extending the features and capabilities of The Work Number database, through new verification types;
- W-2 eXpress, through expanded self-service capabilities;
- ePayroll paystub/direct deposit services, through the addition of electronic W-4 management;
- the addition of the I-9 eXpress service;
- the addition of new integrated and batch interfaces and the expansion of social services data;
- HireXpress, through the expansion of the automated onboarding process;
- FasTime services, through the expansion of its automated paid-time-off management capabilities; and
- enhancing and consolidating our unemployment tax in-house claims processing systems.
Additionally, PAN's efforts have been focused on adding more test offerings and introduction of Vital Information for Talent Assessment, or "VITA," its automated talent management platform.
We incurred total product development costs of $6.3 million, $8.1 million and $9.0 million in fiscal years 2004, 2005 and 2006, respectively. As of March 31, 2006, our total product development staff consisted of approximately 80 full-time employees. After the acquisition of PAN, our total product development staff consisted of approximately 90 full-time employees. We believe that significant investments in product development are required to remain competitive.
Our success and ability to compete is dependent in part upon our ability to protect and maintain our proprietary rights to our intellectual property. We regard our trademarks and our other intellectual property as having significant value and as being important factors in the development and marketing of our products.
We currently rely on a combination of trademark, trade secret and copyright laws and restrictions on disclosure to establish and protect our intellectual property. We have obtained a trademark registration for the name TALX and a trademark registration for The Work Number for Everyone, The Work Number, FasTime, UC eXpress, W-2 eXpress, Advanced HR Solutions, Performance Assessment Network, PAN, and Vital Information for Talent Assessment with the United States Patent and Trademark Office. Additionally, TALXWare is our trademark, and I-9 eXpress, HireXpress and FasCast are our service marks. We also rely on certain patents in our employee assessment and talent management services.
We generally enter into confidentiality agreements with our officers, employees and consultants. We also generally limit access to and distribution of our source code, access to our databases, and the disclosure and use of other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances.
Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use technology that we regard as proprietary. We cannot assure you that the steps taken by us to protect our proprietary rights will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop techniques that are similar or superior to our technology. Any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of competitive advantage and decreased revenues. In addition, litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our business.
Third-parties have asserted in the past and, from time to time, may assert in the future, patent, copyright, trademark and other intellectual property rights to technologies that are important to our business. We have entered into a license agreement to use various interactive voice response and computer telephony integration technologies under which we made an initial payment and will pay future royalties. We have not conducted an exhaustive search to determine whether the technology included in our products infringes or misappropriates intellectual property held by other third-parties. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which could relate to our products. Any claims asserting that our systems infringe or may infringe proprietary rights of third-parties, if determined adversely to us, could significantly harm our business.
As of March 31, 2006, The Work Number database contained employee records from over 1,500 clients, representing approximately 129.0 million present and former employees. Additionally, as of that date, we had contracts with new clients to provide 7.3 million records of present and former employees in backlog. These clients typically employ over 1,000 employees. Our clients are large and mid-size organizations, including more than three-fourths of the Fortune 500 companies in a wide variety of industries, as well as a number of government agencies. As of March 31, 2006, our tax management business had over 9,000 clients of various sizes and operated in a broad range of industries. No client accounted for more than 10% of total revenues in any of fiscal years 2004, 2005 or 2006.
On April 6, 2006, we acquired PAN, a provider of secure, electronic-based psychometric testing and assessments, as well as comprehensive talent management services. PAN has more than 1,500 clients including individual job candidates, Global 2000 and mid-market companies, and government organizations. One client of PAN, the TSA, through a subcontract with CPS Human Resource Services, represented approximately 75% of PAN's revenues in fiscal year 2006. In fiscal 2005, PAN derived approximately 93% of its revenues from this relationship. For more information, see "Item 1A. Risk Factors - PAN derives a substantial portion of its revenues from the Federal government, which subjects us to special risks associated with government contracts and subcontracts."
As of March 31, 2006, we employed approximately 1,751 full-time and 76 part-time employees. As of April 30, 2006, after the acquisition of PAN, we employed approximately 1,819 full-time and 70 part-time employees.
We have never had a work stoppage, and no employees are represented by a labor organization. We consider our employee relations to be good.
ITEM 1A. RISK FACTORS
You should carefully consider the following factors and other information in this Form 10-K in evaluating our company:
OUR REVENUES FROM THE WORK NUMBER MAY FLUCTUATE IN RESPONSE TO CERTAIN ECONOMIC CONDITIONS SUCH AS INTEREST RATES AND EMPLOYMENT TRENDS.
A significant portion of our revenues from The Work Number depends on residential mortgage-related and employment-related activity. We charge a fee for each request from lenders, pre-employment screeners, credit issuers, social services agencies, and other verifiers to verify employment and income information. Therefore, a decrease in activity within either of these segments would reduce our overall number of transactions per record in the database. This reduction in transactions, whether due to increases in interest rates or otherwise, could cause our revenues and profitability to be harmed. As an example, during a portion of fiscal year 2004, revenues for The Work Number services were adversely affected by a slowdown in the refinancing segment of the mortgage loan market.
AS WE PERFORM LARGE-SCALE PROCESSING OF VERIFICATIONS, THERE IS AN INCREASED RISK OF BREACH OF CONFIDENTIALITY OR INAPPROPRIATE USE OF DATA, WHICH MAY RESULT IN DAMAGE CLAIMS AND LOSS OF CUSTOMERS.
As we seek to increase the use of The Work Number database by verifiers with frequent need of verification, we plan to use new methods for performing the verifications and new types of verifications. These verifiers include large mortgage lenders, pre-employment screeners, credit issuers, social service agencies, or other volume verifiers. These volume verifiers can obtain verifications in large volume or "batch" transactions using different means and requiring less proof of authorization than smaller verifiers. These volume verifiers generally enter into contracts by which they agree that they will not use the income verification service unless they have been authorized by the employee to do so, or have legal authority to obtain the information. Many of the industries that utilize The Work Number for large scale processing of verifications have high turnover which may lead to the verifier failing to terminate access privileges to The Work Number in a timely manner. We have the ability to conduct regular audits of these volume verifiers to ensure compliance with documentation requirements. However, there is a risk that the verifier may not have the requisite authority, and that there may be claims for breach of privacy or confidentiality against us, claims for damages by employees and employers and resulting loss of employer relationships, which could significantly harm our results of operations.
IF WE ARE UNABLE TO MAINTAIN THE ACCURACY, PRIVACY AND CONFIDENTIALITY OF EMPLOYEE INFORMATION IN THE WORK NUMBER AND OUR OTHER DATABASES, WE MAY FACE SIGNIFICANT CLAIMS AND OUR REPUTATION COULD BE HARMED.
The Work Number services depend on the accuracy of highly confidential employment and income history and other information, including social security numbers, which employers provide to us and which we convert for use in The Work Number and our other services. Although we have a number of protective measures in place, any inaccuracies in such information - whether in the recording of such information, the unauthorized access to information, or otherwise - or our inability to keep such information confidential, may give rise to claims against us and adversely affect our reputation or market acceptance of The Work Number and our other services. While we continue to test our data security processes for
weaknesses, we cannot assure you that we will not experience a breach in our data security, which could result in such claims. Our financial condition, results of operations and reputation may be significantly harmed if any asserted claims were ultimately decided against us.
OUR FUTURE GROWTH IS SUBSTANTIALLY DEPENDENT ON OUR ABILITY TO INCREASE THE SIZE AND RANGE OF APPLICATIONS FOR THE WORK NUMBER DATABASE.
In order to successfully grow our business, we will have to make The Work Number and related business process outsourcing services increasingly attractive to a greater number of large organizations, their employees and verifiers. To achieve this goal, we believe that we will need to increase the number of employee records contained in The Work Number database, the amount and type of information contained in those records and the number of services that make use of those records. Our strategy for increasing the size of The Work Number database is based in part on strategic alliances with several providers of payroll and human resources outsourcing services. Our success will depend on the interest and commitment of these providers, which is entirely at their discretion. Some of these companies compete with us in certain service areas. Our strategy is also based in part on strategic acquisitions of businesses with databases of employee information. If we are unable to attract and retain a sufficient number of employer clients, if we cannot persuade them to include a greater amount of information in the employee records they provide us, or if we fail to develop additional applications to use this information, we may not achieve our growth objectives.
INTERRUPTIONS TO OUR COMPUTER NETWORK OR TELEPHONE OPERATIONS COULD SIGNIFICANTLY HARM OUR REVENUES AND INDUSTRY REPUTATION.
Significant portions of our operations depend on our ability to protect our computer equipment and the information stored in our data processing centers against damage from fire, power loss, telecommunications failures, unauthorized intrusion and other events. We have data processing centers located in St. Louis, Missouri; Columbus, Ohio; Carmel, Indiana; Plano, Texas; and Ontario, Canada, which areas have historically been vulnerable to natural disasters and other risks, such as floods, earthquakes and tornadoes. We back up software and related data files regularly and store the back-up files off-site at a nearby secure facility. A portion of the data is also replicated to a secondary facility for high availability. We cannot assure you that these measures will eliminate the risk of extended interruption of our operations. We also rely on voice and data carriers to provide connectivity for our customers to gain telephone access, internet access and corporate intranet access to our services. In addition, we rely on these same providers to provide the wide area network necessary to connect our facilities across the United States to our data processing centers. We have not established an alternative disaster recovery facility, which would serve to protect us from losses of employee record information due to damage to our data storage facilities. Any damage or failure that interrupts our operations or destroys some or all of our database of employee records could have a material adverse effect on our revenues, profitability and industry reputation.
IF A COURT OR REGULATOR CONCLUDES THAT THE FAIR CREDIT REPORTING ACT OR SIMILAR LAW APPLIES TO THE WORK NUMBER SERVICES, OUR BUSINESS AND PROFITABILITY COULD BE SIGNIFICANTLY HARMED.
The Fair Credit Reporting Act, which we refer to as the FCRA, applies to "consumer reporting agencies" that engage in the practice of "assembling or evaluating" certain information relating to consumers. While we have historically taken the position that the FCRA does not apply to The Work Number services, the statutory language is subject to varying interpretation, and we are not aware of controlling legal authority to support our position. Recent public concerns relating to, among other things, data integrity, privacy and identity theft issues may increase the risk of action by consumers through litigation or by the Federal Trade Commission, or the "FTC," or state regulatory authorities, which enforce the FCRA or similar laws. If a court, the FTC, or a state regulatory authority were to determine that the FCRA or other similar law does apply, we could be subject to claims for substantial damages, penalties and attorneys' fees and may experience negative publicity and reputational harm. Additionally, compliance with the FCRA would result in some changes in the manner in which we deliver The Work Number services. As a result, while it is difficult to estimate the ultimate impact on us if a court or regulator concludes that the FCRA or similar law applies to us, our business, operations, results of operations and financial condition could be significantly harmed.
THE MARKET FOR THE WORK NUMBER DEPENDS IN PART ON THE REQUIREMENTS ESTABLISHED BY PURCHASERS IN THE SECONDARY MORTGAGE MARKET, AND OUR REVENUES AND PROFITABILITY WOULD BE SIGNIFICANTLY HARMED IF THESE REQUIREMENTS WERE RELAXED OR ELIMINATED.
We believe that residential mortgage lenders are among the most active users of The Work Number. They utilize our services to verify employment, income and related information. The demand for this verification is driven in part by the requirements of the Federal National Mortgage Association, which is also known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, which is also known as Freddie Mac, the leading purchasers of residential mortgages in the United States. These agencies currently require specific information, including independent verification of employment and income data for the past two calendar years and a current payroll period in connection with certain mortgages they purchase. Accordingly, most lenders seek this information from mortgage applicants. If Fannie Mae or Freddie Mac were to reduce the requirement for employment and income data or eliminate the requirement for independent verification thereof, our revenues and profitability would be significantly harmed.
PRIVACY LEGISLATION OR INTERPRETATIONS OF EXISTING LAWS COULD RESTRICT OUR BUSINESS.
Personal privacy has become a significant issue in the United States. Some commentators, privacy advocates and government bodies have recommended limitations on, or taken actions to limit, the use of personal information by those collecting this information. For example, the Gramm-Leach-Bliley Act contains provisions protecting the privacy of consumer non-public personal information collected by financial institutions. Additionally, federal privacy regulations issued by the Department of Health and Human Services pursuant to the Health Insurance Portability and Accountability Act of 1996, or "HIPAA," restrict the use and disclosure of individually identifiable health information. In addition, the states are taking greater interest in privacy rights on behalf of their residents, and a number of states have enacted privacy legislation. These privacy regulations could impose additional costs and could limit our use and disclosure of such information. Some states have also enacted consumer and health information privacy protection laws.
If new statutes or regulations were adopted that restricted our business, or existing statutes or regulations were deemed to apply to us, we may be required to change our activities and revise or eliminate our services, which could significantly harm our revenues and operations.
CHANGES IN ECONOMIC CONDITIONS COULD LIMIT UNEMPLOYMENT COMPENSATION CLAIMS, CAUSING EMPLOYERS TO QUESTION THE VALUE OF UNEMPLOYMENT COMPENSATION MANAGEMENT AND LIMITING OPPORTUNITIES FOR TAX PLANNING.
A difficult economic environment and consequent staff reductions could result in an increase in unemployment compensation claims. Conversely, as economic conditions improve, and claims decrease, employers may question the value of our unemployment compensation management and unemployment compensation tax planning services. As a result of the difficult economic environment in recent years, states with significant budget challenges may take legislative or regulatory steps to reduce unemployment benefits, change the way benefit charges impact employers' accounts or close tax-planning opportunities, which could reduce the opportunities for service to employers. In such situations, our revenues could be harmed. For example, during fiscal year 2005, changes in economic conditions contributed to claims activity being less than we expected. As a result, we experienced lower revenue levels in our unemployment cost management services business during fiscal year 2005.
CHANGES IN TAX LAW, INCLUDING THE WORK OPPORTUNITY, OR "WOTC," AND WELFARE TO WORK, OR "WTW," TAX CREDITS, COULD ADVERSELY IMPACT OUR BUSINESS AND RESULTS OF OPERATIONS.
Certain of our revenues and profits from continuing operations are derived from our tax services businesses. At any time, the tax laws or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations could adversely affect us. For example, the WOTC and WtW tax credits expired on January 1, 2006. Accordingly, these tax credits are no longer available to our clients. Federal legislation, however, has been introduced that would combine the WOTC and the WtW tax credits and extend the combined credit for one year. The proposal would be effective for wages paid or incurred by employers hiring qualified individuals who begin work for an employer after December 31, 2005 and before January 1, 2007. While Congress historically has renewed retroactively these credits following their expiration, we cannot assure you that Congress will renew such credits in the future. Any non-renewal of these tax credits, renewal of such credits without retroactive effect, or other adverse changes in tax legislation, could adversely affect our business and results of operations.
If new statutes or regulations were adopted that restricted our business or the ability of others to provide us with payroll and human resources information, or existing statutes or regulations were deemed to apply to us or such third parties, we may be required to change our activities and revise or eliminate our services, which could significantly harm our revenues and operations.
OUR FUTURE PERFORMANCE WILL BE DEPENDENT ON SUCCESSFUL INTEGRATION OF ACQUISITIONS.
We expect a portion of our growth to come from business acquisitions which we recently consummated or which we may consummate in the future. Such acquisitions involve certain operational, legal and financial risks. Operational risks include the possibility that an acquisition does not ultimately provide the benefits originally anticipated by our management, while we continue to incur operating expenses to provide the services formerly provided by the acquired company. Legal risks involve contract and regulatory issues. For example, some employers may not consent to the transfer of ownership of their contracts by which the services are provided, and some states' unemployment insurance agencies may require changes to powers of attorney by which the employer authorizes representation in employment matters. In the event of any loss of employer-customers or our inability to appear before state unemployment insurance agencies, our business and results of operations may be materially adversely affected. Financial risks involve the incurrence of indebtedness as a result of the acquisitions and the consequent need to service that indebtedness. In addition, in the event we were to issue stock in connection with any acquisitions, we would dilute the voting power and could dilute the economic interests of existing shareholders. In carrying out our acquisition strategy, we attempt to minimize the risk of unexpected liabilities and contingencies associated with acquired businesses through planning, investigation and negotiation, but there can be no assurance that we will be successful in identifying attractive acquisition candidates or completing additional acquisitions on favorable terms.
PAN DERIVES A SUBSTANTIAL PORTION OF ITS REVENUES FROM THE FEDERAL GOVERNMENT, WHICH SUBJECTS US TO SPECIAL RISKS ASSOCIATED WITH GOVERNMENT CONTRACTS AND SUBCONTRACTS.
TALX and PAN have a number of prime and sub-contracts with the Federal government, which we refer to collectively as "government contracts". For example, one client, the Transportation Security Administration, or "TSA", represented approximately 75% of PAN's revenues in fiscal year 2006. In fiscal 2005, PAN derived approximately 93% of its revenues from this relationship. Following our acquisition of PAN in April 2006, we have increased exposure to special risks that result from doing business with the United States Federal government and some of its agencies, including acquisition integration risks. Termination of these arrangements, or material deterioration in PAN'S relations with the government, would have an adverse affect on our business, financial condition and results of operations.
Among the factors that could materially adversely affect our government contracting business are:
- budgetary constraints affecting Federal government spending generally, or specific departments or agencies in particular, and changes in fiscal policies or available funding;
- changes in U.S. Federal government programs or requirements;
- the adoption of new laws or regulations;
- delays in the payment of our invoices by government payment offices and, where PAN is a subcontractor, as in the case with our TSA contract, possible resulting delays in payments by the prime contractors that are its customers; and
- where PAN is a subcontractor, dependence on the performance by and actions of the prime contractor.
In addition to these appropriations, economic and political factors, which we cannot control, Federal government agencies have special rights to reduce their purchases under contracts, to audit and review performance, to terminate contracts or not to extend contracts, any of which could have an adverse affect on our financial condition and operating results. Failure to comply with technical requirements or procurement-related laws and regulations could subject us to penalties or liabilities, or result in termination of the government contracts or a deterioration in the relationship. For example in the case of the TSA, PAN has specified qualification standards and key personnel provisions that we must satisfy. If we are acting as a subcontractor, we may be liable to the prime contractor for costs they are unable to recover or damages they incur as a consequence of any improperly allocated costs by us or our failure to make a required disclosure during negotiations. If a government audit or other review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines, and suspension or debarment from doing business with the Federal government either as a prime contractor or as a subcontractor. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us. Any of the foregoing could have a material adverse affect on our business, financial results or results of operations.
IF THE SUTA DUMPING PREVENTION ACT OF 2004 APPLIES TO OUR TAX PLANNING SERVICES, OUR BUSINESS AND REVENUES COULD BE HARMED.
On August 9, 2004 the President signed the "SUTA Dumping Prevention Act of 2004." In the past, some employers found ways to manipulate state experience rating systems so that these employers paid lower state employment compensation taxes than their unemployment experience alone would have otherwise allowed. This practice is referred to as "SUTA dumping." "SUTA" refers to state unemployment tax acts, but has also been referred to as "state unemployment tax avoidance." Most frequently these avoidance tactics involved mergers, acquisitions or corporate restructurings, the legality of which depended upon state laws. The SUTA Dumping Prevention Act of 2004 established a nationwide minimum standard to curb SUTA dumping. The law also established penalties for employers and their advisors who knowingly violate those state law provisions.
Our tax management services include advising clients with respect to unemployment compensation taxes. We fully support the measures enacted in the SUTA dumping legislation, and we believe the advice we have given since the enactment of this legislation does not include advice to clients to take any action which would be prohibited under the legislation. However, there can be no assurance that we have not and will not provide advice to clients or that our clients have not taken or will not take action which runs afoul of the SUTA Dumping Prevention Act of 2004. We could be subject to "meaningful civil and criminal penalties," as the statute provides, for violations of the law. We could also be subject to negative publicity, harm to our reputation, and strained relationships with state agencies which are important to our business if we were accused of advising clients to take actions in violation of the SUTA dumping guidelines, or if clients took such actions at a time when we were providing advice on unemployment compensation taxes.
OUR QUARTERLY AND ANNUAL OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE SIGNIFICANTLY.
Our revenues, margins and results from operations have fluctuated in the past, and may continue to fluctuate in the future due to a number of factors.
For The Work Number services, these factors include residential mortgage activity and interest rate levels. Revenues generated from our W-2 eXpress service are affected by seasonality, as revenues are primarily earned in our fourth fiscal quarter. The non-renewal of certain tax credit programs, such as WOTC or WtW, the renewal of such programs without retroactive effect, or other adverse changes in tax legislation would cause fluctuations in our tax credit and incentive services business. For all of our service offerings, other factors that can cause our operating results to fluctuate include:
- new product introductions or announcements by us or our competitors;
- market acceptance of new services;
- pricing pressure;
- the hiring and training of additional staff;
- the length of the sales cycle; and
- general economic conditions.
We cannot assure you that we will be able to sustain our level of total revenues or our historical rate of revenue growth on a quarterly or annual basis. It is likely that, in some future quarters, our operating results will fall below our targets and the expectations of stock market analysts and investors. In such event, the price of our common stock could decline significantly.
IF WE ARE UNABLE TO SUCCESSFULLY INTRODUCE NEW BUSINESS PROCESS OUTSOURCING SERVICES AND ENHANCED FUNCTIONALITY TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES THAT CHARACTERIZE OUR MARKETS, OUR RESULTS OF OPERATIONS WOULD BE SIGNIFICANTLY HARMED.
The business process outsourcing industry is characterized by rapidly changing technology, and our future success will depend upon our ability to keep pace with technological developments. In particular, the market for self-service applications through the web and corporate intranets using browser software is rapidly evolving.
To remain competitive, we must continually change and improve our services in response to changes in operating systems, application software, computer and telephony hardware, communications, database and networking systems, programming tools and computer language technology. Additionally, we must also introduce new business process outsourcing services and add functionality to existing services in response to changing market conditions and client demand.
The development of new, technologically advanced services is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technology and market trends.
If we are unable, for technical or other reasons, to develop and market new business process outsourcing services or enhancements to existing services in a timely and cost-effective manner, or if new business process outsourcing services do not achieve market acceptance, we could lose revenues and our competitive position could suffer.
WE DEPEND ON THIRD-PARTY SOFTWARE, HARDWARE, AND SERVICE, WHICH EXPOSES US TO DISRUPTION IF THOSE PRODUCTS OR SERVICES ARE NO LONGER OFFERED, SUPPORTED OR DEVELOP DEFECTS.
Our services involve integration with operating systems and products developed by others and services provided by others. If any third-party software, hardware or service, such as Microsoft Windows server products, Microsoft database software and development tools, Oracle database software, Sun Solaris, IBM (Informix) database software, Intel Media processing hardware, Sybase Power Builder development tools, and testing products provided by third parties and utilized by PAN, become unavailable for any reason, fail to integrate with our products or fail to be supported by their respective vendors or to operate properly, we would have to redesign our products or, in the case of PAN, attempt to locate replacement testing products. We cannot assure you that we could accomplish any redesign or obtain any replacements in a cost-effective or timely manner. Further, if third-parties release new versions of these systems or products before we develop products compatible with such new releases, demand for our services and products might decline, thereby harming our revenues and profitability.
We believe that if any supplier agreement expires or is canceled or otherwise terminated, or if a third-party supplier refuses to sell to us, in most cases, we could locate one or more alternate suppliers. In some instances it may be either impossible or impractical to find an alternate source for certain products. It would require a significant amount of time to integrate the relevant technology from the new supplier, which would result in a significant delay in our ability to offer the particular enhancement. We could also experience difficulties integrating the new supplier's technology with our services. We cannot assure you we could accomplish any such integration in a cost-effective manner. Significant delays in the offering of service enhancements due to integration of technology from new suppliers could significantly harm our revenues and profitability.
OUR SERVICES MAY CONTAIN DEFECTS OR LACK ADEQUATE SECURITY WHICH MAY CAUSE US TO INCUR SIGNIFICANT COSTS, DIVERT OUR ATTENTION FROM PRODUCT DEVELOPMENT EFFORTS AND RESULT IN A LOSS OF CUSTOMERS.
As a result of their complexity, business process outsourcing services and hardware and software products may contain undetected errors or failures when first introduced or as new versions are released. We cannot assure you that, despite testing by us and our clients, errors will not occur in services and systems after implementation. The occurrence of such errors could result in potential security issues, delivery of incorrect results which could harm an employee, employer, verifier, or other users of our services, or loss or delay in market acceptance of our services, which could significantly harm our revenues and our reputation.
Web or other users could access without authorization or otherwise disrupt our web and corporate intranet services. Such unauthorized access and other disruptions could jeopardize the security of information stored in and transmitted through the computer systems of our clients, which could result in significant liability to us, could cause the loss of existing clients and could discourage potential new clients.
THE LOSS OF KEY MANAGEMENT WOULD ADVERSELY AFFECT OUR BUSINESS.
Our success depends in large part upon the retention of key management, especially William W. Canfield, the Chairman of our Board of Directors and our President and Chief Executive Officer, who has served in that capacity for more than 15 years. We would likely undergo a difficult transition period if we were to lose the services of our key management, including Mr. Canfield, which would materially and adversely affect our business and prospects.
BECAUSE OF INTENSE COMPETITION FOR TRAINED PERSONNEL, WE MAY NOT BE ABLE TO RECRUIT OR RETAIN NECESSARY PERSONNEL ON A COST-EFFECTIVE BASIS.
Our success depends in large part upon our ability to identify, hire, retain and motivate highly-skilled employees. Competition for highly-skilled employees in our industry is intense. In addition, employees may leave our company and subsequently compete against us. Our failure to attract and retain these qualified employees could significantly harm our ability to develop
new services and maintain customer relationships.
Moreover, companies in our industry whose employees accept positions with competitors frequently claim that those competitors have engaged in unfair hiring practices. We may be subject to such claims as we seek to retain or hire qualified personnel, some of whom may currently be working for our competitors. Some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits. Such claims could also discourage potential employees who currently work for our competitors from joining us.
CLAIMS THAT WE INFRINGE THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS COULD RESULT IN SIGNIFICANT EXPENSES OR RESTRICTIONS ON OUR ABILITY TO SELL OUR SERVICES.
Other parties have asserted in the past, and may assert in the future, patent, copyright, trademark and other intellectual property rights to technologies that are important to our business. For example, we have entered into a license to use various interactive voice response and computer telephony technologies that required us to make an initial payment and to pay future royalties. Further, we have not conducted an exhaustive search to determine whether the technology we have in our services infringes or misappropriates intellectual property held by other third parties. We cannot provide assurance that others will not claim that we are infringing their intellectual property rights or that we do not in fact infringe those intellectual property rights.
Any claims asserting that our services infringe or may infringe proprietary rights of third-parties, if determined adversely to us, could significantly harm our results of operations. Any claims, with or without merit, could:
- be time-consuming;
- result in costly litigation;
- divert the efforts of our technical and management personnel;
- require us to develop alternative technology, thereby resulting in delays and the loss or deferral of revenues;
- require us to cease marketing business process outsourcing services containing the infringing intellectual property;
- require us to pay substantial damage awards;
- damage our reputation; or
- require us to enter into royalty or licensing agreements which may not be available on acceptable terms, if at all.
In the event a claim against us were successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our services to avoid infringement, our revenues, results of operations and competitive position would be harmed.
OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY MAY SIGNIFICANTLY HARM OUR RESULTS OF OPERATIONS AND REPUTATION.
Our success and ability to compete is dependent in part on our ability to protect and maintain our proprietary rights to our intellectual property. We currently rely on a combination of trade secret, trademark and copyright laws to establish and protect our intellectual property.
We generally enter into confidentiality agreements with our officers, employees and consultants. We also generally limit access to and distribution of our source code, access to our databases and the disclosure and use of our other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have procured signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances. Further, we have not included copyright notices on all of our copyrightable intellectual property. Efforts to address any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar services, potentially resulting in the loss of one or more competitive advantages and decreased revenues.
Despite our efforts to protect our proprietary rights, existing trade secret, copyright, patent and trademark laws afford us only limited protection. Others may attempt to copy or reverse engineer aspects of our services or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technologies or to deter others from developing similar technologies. Further, monitoring the unauthorized use of our products and other proprietary rights is difficult. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our results of operations and reputation.
WE FACE COMPETITION FROM A BROAD RANGE OF COMPANIES.
The markets for our services are extremely competitive and subject to rapid technological change.
We consider the primary competitor to The Work Number to be large employers and outsourcers who manage employment verification through a call center or through internal automated systems. We believe the primary competitors to other complementary Work Number services are ADP, Paychex, Inc., and Ceridian Corporation. We consider the primary competitor to our unemployment tax management services to be ADP, as well as smaller regional firms that offer similar services. We consider the primary competitors to our tax credit and incentive services to be ADP and First Advantage, as well as smaller regional firms that offer similar services. We consider the primary competitors to our employee assessment and talent management services to be Previsor, Inc., Development Dimensions International, Brainbench, Inc., Devine Group, Inc., Hogan Assessments Systems, Inc., and SHL Group plc, as well as human resources consulting firms such as AON Corporation, Watson Wyatt Worldwide, Inc., and Right Management Consulting, a subsidiary of Manpower, Inc. Our competitors may have more resources than we do.
Increased competition could result in price reductions, reduced gross margins and loss of market share, any of which could significantly harm our results of operations. Additionally, we may be required to increase spending in response to competition in order to pursue new market opportunities or to invest in research and development efforts, and, as a result, our operating results in the future may be adversely affected. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures we face will not significantly harm our results of operations.
PROVISIONS OF OUR ARTICLES OF INCORPORATION AND BYLAWS AND MISSOURI LAW MAY MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, DESPITE THE POSSIBLE BENEFITS TO OUR SHAREHOLDERS.
A number of provisions of our articles of incorporation and bylaws and Missouri law could make it difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of us. These provisions:
- provide for a classified Board of Directors;
- limit the right of shareholders to remove directors or change the size of the Board of Directors;
- limit the right of shareholders to fill vacancies on the Board of Directors;
- limit the right of shareholders to call a special meeting of shareholders or propose other actions;
- require unanimity for shareholders to act by written consent, in accordance with Missouri law;
- require a higher percentage of shareholders than would otherwise be required under Missouri law to amend, alter, change or repeal certain provisions of our articles of incorporation;
- provide that the bylaws may be amended only by the majority vote of the Board of Directors and shareholders will not be able to amend the bylaws without first amending the articles of incorporation;
- authorize the issuance of preferred stock with any voting powers, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions of such rights as may be specified by our Board of Directors, without shareholder approval; and
- restrict specified types of "business combinations" and "control share acquisitions," as well as regulate some tender offers.
These provisions may:
- have the effect of delaying, deferring or preventing a change in our control despite possible benefits to our shareholders;
- discourage bids at a premium over the market price of our common stock; and
- harm the market price of our common stock and the voting and other rights of our shareholders.
OUR STOCK PRICE IS VOLATILE AND COULD DROP UNEXPECTEDLY.
The market price of our common stock has been volatile. The price could continue to be subject to wide fluctuations due to factors including:
- actual or anticipated variations in our operating results;
- announcements of technological innovations or new services or contracts by us or our competitors;
- our ability to successfully integrate acquisitions;
- developments with respect to patents, copyrights or proprietary rights;
- changes in financial estimates by securities analysts;
- concerns regarding the security of our database;
- conditions and trends in outsourcing of tax management, human resources and payroll services; and general economic and market conditions.
The stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many technology companies. Often these fluctuations have been unrelated or disproportionate to the operating performances of those companies.
Broad market and industry factors may significantly affect the market price of our common stock, regardless of our actual operating performance. Declines in the market price of our common stock could also harm employee morale and retention, our access to capital and other aspects of our business.
BECAUSE OUR SHARE PRICE IS VOLATILE, WE MAY BE THE TARGET OF SECURITIES LITIGATION, WHICH IS COSTLY AND TIME-CONSUMING TO DEFEND.
In the past, following periods of volatility in the market price of a company's securities, shareholders have often instituted class action securities litigation against those companies. In January 2004, we restated our consolidated financial statements as a result of adjustments to our customer premises systems business. The restatement affected the fiscal years ended March 31, 1999 through 2003 and the first two quarters of fiscal year 2004. In fiscal year 2005 we settled class action litigation, as discussed in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Other Matters" of our 2005 Annual Report on Form 10-K, and settled an SEC enforcement action, as described below. Such litigation could result in substantial costs and a diversion of management attention and resources, which would significantly harm our profitability and reputation. These market fluctuations, as well as general economic, political and market conditions such as recessions, may adversely affect the market price of our common stock.
We are subject to a cease and desist order issued by the Securities and Exchange Commission and a U.S. District Court court order and are required to advance expenses to one of our former officers in satisfaction of indemnification obligations in connection with a related case against that former officer.
As previously reported, on March 3, 2005, we agreed with the SEC, without admitting or denying any liability, to pay one dollar in disgorgement and, pursuant to a court order, to pay a $2.5 million civil penalty, and not to violate certain provisions of the federal securities laws in the future pursuant to the SEC cease and desist order. Our agreement resolved the SEC's investigation into our accounting for certain items. The cease and desist order enjoins us from committing or causing future violations of specified securities laws. Any further violation of these laws could result in civil penalties, including sanctions, fines and penalties, which may be more severe than if the violation had occurred without our having entered into the order.
Our former chief financial officer is currently defending a related SEC civil action, and any future related litigation costs for his defense will be borne by us and not by insurance. In addition, to the extent that we are required to indemnify him against any fines or penalties assessed against him, those amounts would be borne by us and will not be covered by insurance. Any such costs, fines or penalties borne by us could harm our business and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS.