The Daily Magic Formula Stock for 04/03/2008 is Chordiant Software Inc. According to the Magic Formula Investing Web Site, the ebit yield is 10% and the EBIT ROIC is >100 %.
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Chordiant is an enterprise software company that delivers products and services that improve the ‚Äúcustomer experience‚ÄĚ in front-office processes for leading global companies primarily in the banking, insurance, healthcare, and telecommunications markets. Chordiant provides companies in these markets with innovative solutions that help them more effectively manage their customer interactions, offering ‚Äúnext best offers‚ÄĚ for those customers based on pre-built business rules.
Our enterprise-scale software utilizes predictive decisioning, analytical modeling, and strategy formulation in real-time for decision management and execution at the point of sale. This capability enables organizations to improve the accuracy of marketing offers for retention, up-selling, cross selling, and modeling risk scenarios such as customer churn and the likelihood of default on payments.
We believe our solutions add business value and return-on-investment for our customers by reducing operational costs, and increasing employee productivity. These improvements are realized by automating key business processes and supporting organizational decision-making associated with the servicing, selling, marketing and fulfillment of customer requests across the enterprise. We offer solutions to our clients that include software applications, business processes, tools and services that will integrate their customer information and corporate systems to produce a real-time view of customers across multiple business channels. Our solutions offer businesses additional flexibility to create and set their policies and processes to control the quality of servicing, fulfillment and marketing offers to their customers.
On December 21, 2004, we acquired KiQ Limited, a privately held United Kingdom software company or KiQ, for an aggregate purchase price of approximately $20 million, which was comprised of $9.7 million in cash, $9.4 million in our common stock and approximately $0.9 million in associated transaction costs. Through this transaction, we acquired a decision management system that advances the state of analytics by exploiting the power of predictive data mining, analytical modeling, and strategy formulation into real-time decision management and execution. Products and patented technology acquired by us in this transaction enable organizations to significantly increase the accuracy of marketing offers for retention, up-selling, cross selling, and to model risk scenarios such as customer churn and likelihood to default on payments. With the addition of KiQ‚Äôs products and patented technology we are able to deliver a range of applications for real-time recommendation, retention, risk management and recruitment.
Our products are designed for global enterprises seeking to optimize their customer experiences through effective decision analysis, marketing, selling and servicing efforts. We have designed our products to integrate customer information from different data sources and systems of record, automate business processes based on a customer‚Äôs specific profile and requests, and provide uniform service and information to customers across multiple communication channels. Our products are designed to enable companies to deliver appropriate recommendations (also known as ‚Äúnext best action‚ÄĚ), services, offers and information to a targeted customer at the time of customer need while complying with relevant business policy and industry regulatory requirements.
Our solutions are designed to address the enterprise requirements of global consumer companies serving millions of customers across multiple business channels integrating multiple lines of business. The solution suite is typically licensed as an integrated set of software products that include one or more vertical market applications running on top of a common layer of foundational technology and supporting tools. Chordiant‚Äôs software is based on open systems software standards that are widely adopted by our industry and capable of deployment throughout an enterprise‚Äôs information technology infrastructure. Chordiant software is built to be highly scalable and adaptable to a customer‚Äôs specific business requirements or technology infrastructure.
Products and Solutions
Historically, our products have been categorized into three general groups: Enterprise solutions (including the ‚ÄúCx‚ÄĚ Enterprise Foundation and Call Center and Customer Service Desktop products), Decision Management products, and the Marketing Director Suite of products. Our solutions are designed to address a variety of business needs within our four target vertical markets of banking, insurance, healthcare, and telecommunications:
Call Center and Customer Service Desktop (Call Center Advisor ‚Äď Browser Edition) : This product is a browser-based guided desktop for the effective management of customer contacts, service requests, and customer case history in the call center channel. The desktop is integrated with leading computer telephony integration products, working with our own queue-based work management to deliver ‚Äėuniversal queues‚Äô to the enterprise. This product is used by customer services professionals across all our target markets. It is designed to meet the high volume transaction and business processes common in enterprise contact centers. The desktop also acts as a delivery channel for our decision management and marketing products together with the other business applications that Chordiant offers.
Marketing Director : We provide applications for driving unified, personalized marketing campaigns and response management across multiple media types and multiple channels including email, web, phone, and mobile messaging (MMS/SMS). These products are used by marketing professionals across all our target markets to segment and target prospects and customers and deliver to them effective marketing campaigns. The Marketing Director suite of products integrates with our Decision Management products to provide an integrated campaign management system.
Recommendation Advisor : An application which provides flexible lead collection and routing in a common guided selling desktop, integrated with marketing campaigns and product fulfillment. Predictive and adaptive analytics guide staff toward best offers and ‚Äúnext best action‚ÄĚ in the context of inbound or outbound customer interactions. This product is used by sales and service professionals across our target markets to manage leads and deliver highly effective sales messages.
Credit Card Disputes, Chargebacks and Fraud : These modular applications are designed to automate and optimize customer and mid-office functions associated with credit card dispute handling and fraud investigation and recovery. The products use Chordiant technology to implement the dispute and chargeback regulatory requirements of credit card associations to assist organizations in managing their compliance of these complex regulations. This application is used by customer service professionals in the credit card segment of banking to drive more cost effective, compliant handling of disputes and fraud cases.
Teller : A guided desktop product and supporting financial transaction components for retail bank tellers/cashiers or other cash-based desktop applications. This product is used in the banking and lending sectors by customer-facing staff in bank branches or stores to effectively process cash and related financial transactions on behalf of the customer. The solution utilizes the ‚ÄúCx‚ÄĚ (Customer Experience) Enterprise Foundation (described below) in providing company-wide case management, customer history, and work management between front office and back office operations.
Lending: Solutions and services which provide a common process-driven lending infrastructure across an organization to increase efficiency of loan originations, quoting, account opening and loan risk assessment and management such as required by Basel II. Our lending solutions are used in banking and lending by a variety of users and desktop applications.
Insurance : Solutions and services which provide a common process-driven insurance infrastructure and services across an organization to increase efficiency of case management, claims processing, quoting, and risk management. Our insurance solutions and services are used in the insurance sector by a variety of users and desktop applications.
Collections : This product is designed to deliver automation and operational efficiency to debt recovery and collections professionals. The first generally available release, consisting of core collections functions, was shipped in the third fiscal quarter of 2007. The product is designed to make extensive use of Chordiant‚Äôs Decision Management (CDM) technology to deliver real-time decisioning.
Chordiant applications share a common technology platform and set of development and configuration tools through our Cx Enterprise Foundation. Chordiant technology is built to scale to tens of thousands of users and integrate seamlessly into our customer‚Äôs IT infrastructure. Chordiant technology is generally built based on standards as defined in Java 2 Enterprise Edition (J2EE). Chordiant technology works alongside third party J2EE Application Servers, such as those from International Business Machines Corporation (IBM) and BEA Systems Inc.
Chordiant technology is based on Service Oriented Architecture (SOA). This architecture provides a framework for large or growing businesses to provide multi-channel interaction and process orchestration across multiple lines of business. The Cx Enterprise Foundation framework provides a pre-integrated environment that supports the business applications required by these large scale organizations. With predictive decisioning built-in, organizations can utilize Chordiant technology to obtain customer behavioral insight and use this to drive the most appropriate business processes, guide staff through the best tasks to increase responsiveness, reduce errors, shorten cycle times, and present the most relevant offers to customers in each interaction.
Cx Enterprise Foundation: Foundation Server, Caf√©, and Tools Platform : Consisting of a family of products with enterprise-wide process orchestration and case management at its core, the Chordiant Cx Enterprise Foundation product family provides a common, highly scalable base platform for all Chordiant solutions. The product family incorporates industry standards such as J2EE, model driven development, AJAX high performance thin client desktops, Java Server Faces (JSF), and enterprise open source technologies including Hibernate, and Apache Trinidad. The products are supported by process development and administration tools that use the Eclipse integrated development environment.
The Enterprise Platform incorporates module ‚Äėservers‚Äô to deliver additional functionality as needed including business rules, decision management, telephony integration, connectivity to systems of record and interaction channel management. These allow organizations to implement only those functions that are required for their particular business requirement without interfering with future project requirements.
Decisioning : Consisting of flexible products and tools for adaptive decisioning, predictive decisioning, and rules, our Chordiant Decision Management (CDM) product family allows organizations to effectively drive application behavior based on industry or organizational models and logic. This capability allows business users advanced control over business priorities, and enables the business to refine offer and service management in real-time. CDM is a suite of products and comprises:
Chordiant Data Preparation Director‚ÄĒChordiant Data Preparation Director allows non-IT users to combine, manipulate and aggregate customer data using an easy to use visual interface.
Chordiant Predictive Analytics Director‚ÄĒChordiant Predictive Analytics Director provides marketing professionals functionality which enables in-depth analysis of significant amounts of customer information using data-mining and predictive analytical capabilities.
Chordiant Strategy Director‚ÄĒChordiant Strategy Director allows users to design customer interaction strategies and marketing offers based on decisions and rules that reflect customer behavior, preferences, legislation, corporate policies and desired business outcomes. The resulting decision logic is executed in our campaign management solution for outbound communication or executed in real-time in multiple channels of communication.
Chordiant Decision Monitor‚ÄĒChordiant Decision Monitor provides management with insight into business results, measures data analysis effectiveness, and allows an organization to learn from current and future data models. It is a software module in which decisions are automatically logged and stored in a monitoring database together with the relevant data as well as subsequent customer information and behavior. This module can be integrated and analyzed by third party business intelligence tools.
Chordiant Deployment Manager‚ÄĒChordiant Deployment Manager provides the administrative function to prepare available data in the operational environment and implement the decision logic into production campaigns, business processes and applications.
Chordiant Real-Time Decisioning Services‚ÄĒChordiant Real-Time Decisioning Server generates a decisioning service that can be hosted in industry-standard application servers.
Chordiant Database Decisioning Services‚ÄĒThe Chordiant Database Decisioning Server provides an application for data mining, analysis, and modeling to create the optimal decision logic and the appropriate decisions outcomes.
Chordiant Mesh Collaboration
Announced in fiscal year 2006, Chordiant Mesh is a collaborative development network where customers, partners, and Chordiant staff can work together on solutions to respond to customer initiatives. Chordiant Mesh is a development infrastructure layer that allows organizations to collaborate on a wide variety of solutions, components, and tools. By applying principles from open source projects to a member-driven high-end ecosystem, Chordiant Mesh facilitates far greater collaboration, agility, speed to market, transparency, and quality than customers are accustomed to receiving from traditional high-end enterprise software providers.
Key benefits of Chordiant Mesh are:
A fabric for the maintenance of infrastructure level code and reduction of customization and cost of ownership.
A set of tools and methodologies for building applications collaboratively with Chordiant and its partners.
Enables and enhances the IT systems ‚Äúgrid‚ÄĚ to better support high value SOA ‚ąí based applications.
Enhancement of the ability of IT departments to provide support, control and flexibility.
By leveraging open-source development models, Chordiant can take code revisions submitted by community members ‚ąí customers, partners and Chordiant itself ‚ąí and allow these to be incorporated into its products when appropriate.
This new Mesh development approach enables Chordiant to be in closer collaboration with its enterprise customers.
The Company is focused on solving problems for our global accounts through helping them improve the quality of the customer experience they deliver in the banking, insurance, healthcare, and telecommunications markets. Chordiant anticipates that it will increasingly deliver business-focused applications based on an open and adaptable core information technology, or IT, infrastructure that provides high levels of business agility and fast return on investment for enterprises by allowing rapid changes to their IT systems. Within the markets above, Chordiant will continue to develop domain-level solutions for these markets, focusing on the most mission-critical business processes facing our customers.
We target global brand leaders in our core markets. Our customers include: ING, Canada, Inc., HSBC Technology and Services (USA), Inc., Capital One Services, Inc., O2 (UK) Limited, Time Warner Cable, Inc., Covad Communication Company, 21st Century Insurance, T-Mobile, Lloyds TSB Bank plc, Bank of Ireland Group, The Royal Bank of Scotland plc, Metropolitan Life Insurance Company, Signal Iduna, Deutsche Bank AG, Canadian Tire Financial Services, Canadian Imperial Bank of Commerce, Halifax plc, British Telecommunications plc, Connecticut General Life Insurance Company, Citibank Credit Services Inc. (USA), and Sky Subscribers Services Limited. As we deploy new applications, we anticipate that a certain percentage of these and new customers will adopt these new applications and expand their investment in Chordiant products. For the year ended September 30, 2007, Citicorp Credit Services Inc. and IBM accounted for 23% and 16% of our total revenues, respectively.
Chordiant‚Äôs solutions and core technology are implemented using industry standard software that includes J2EE, XML, and Web Services. This industry standard set of development specifications leverages the strengths of the Java programming language to enable software applications that are easier to develop, configure and integrate with legacy and third party information technology systems.
Chordiant‚Äôs architecture leverages J2EE and Web Services extensively to provide a services oriented architecture for use by Chordiant applications and other systems. The business services and related business components use a data persistence foundation with built-in support for Oracle and DB2 databases as well as IBM WebSphere MQ messaging. Generally, our software is easily integrated with other data sources, including those built on the Java Connector Architecture (JCA).
Chordiant‚Äôs web browser technology delivers consistent self-service and agent-driven customer interaction processes using a rich web-based application platform that provides desktop interface behavior in a browser-based technology with high performance, low maintenance costs, and flexibility to meet the differing demands of a diverse user population.
Certain of our products use technology modules from third party technology providers including IBM, BEA Systems, Sun Microsystems, and certain other non-public entities. Our enterprise platform solutions support industry standard J2EE application servers including IBM WebSphere and BEA WebLogic. Our server software runs on UNIX server platforms from Sun Microsystems, IBM and Linux.
Sales and Marketing
We license our solutions and sell services primarily through a direct sales organization that is complemented by selling and support efforts through business alliance partners such as IBM, Tata Consulting, Cap Gemini, BearingPoint, and Accenture, systems integrators and technology vendors. Our market focus is the business-to-consumer segment of the economy with a targeted effort on leading consumer focused industries and companies using multiple channels as the means of conducting business and serving customers.
The sales process generally ranges from six to eighteen months depending on the level of knowledge that prospective customers need about the use and benefits of our solutions and the involvement of systems integrators. During the sales process, we typically approach the senior management teams of the business and information technology departments of a prospective customer‚Äôs organization. We utilize sales teams consisting of sales and technical professionals who work with our systems integration partners to create company specific proposals, presentations and proof of concept demonstrations that address the needs of the business and its technology requirements.
Our corporate offices are located in Cupertino, California, and we maintain an applications development center in Bedford, New Hampshire. In Europe, we have offices in the greater metropolitan areas of London, Madrid, Amsterdam, and Munich. We have sales and support personnel in various additional locations in North America and Europe.
We offer a comprehensive set of customer services including professional consulting services and product support and training services. We believe that providing high quality customer service is critical to achieving rapid product implementation and customer success.
We provide implementation consulting and customer support services to licensed customers through our worldwide professional services organization. Our professional services consulting teams often assist customers and systems integrator partners in the configuration and implementation of our software solutions.
Our professional services organization deploys consultants as part of the project team alongside systems integration partners and members of the customer‚Äôs internal team to provide subject matter expertise, technical knowledge, business engineering, project guidance and quality assessments during the entire solution lifecycle. In the design stage, we provide a variety of professional services that help determine a customer‚Äôs business processes and the technical requirements of the solutions implementation. In the implementation stage, we use a delivery methodology to assist customers and integration partners in planning and managing the implementation. Typically, systems integrators, supported by our consultants, provide overall program management and coordinate the implementation of our products with a customer‚Äôs existing communications, applications, databases and transaction systems. In the final phases of an implementation, the systems integrators provide deployment services to enable a customer‚Äôs internal team to implement the system, train internal users and provide first-level end-user support.
Although our primary strategy is to leverage our strategic systems integration partners for implementations, our internal professional services organization is often integral in implementing our enterprise platform software solutions for our customers. We believe that our consulting services enhance the use and administration of our software solutions, facilitate the implementation of our solutions and result in sharing best business practices with client and systems integrator project teams. In addition to implementing our software, our professional services organization works closely with our internal research and development organization to enhance existing software solutions.
In addition to our internal professional services organization, in calendar 2007, we renewed for one year our agreement with Ness Technologies Inc., Ness Global Services, Inc. and Ness Technologies India, Ltd. (collectively, ‚ÄúNess‚ÄĚ), that we originally entered into in 2003. Ness provides Chordiant with resources focused on technical product support, sustaining engineering product testing and product development through their global technical resources and operations center in Bangalore, India. Ness is an independent contracting company with global technical resources. The agreement with Ness may be extended for additional one year terms at our discretion. Our agreement with Ness enables them, at our direction, to attract, train, assimilate and retain sufficient highly qualified personnel to perform technical support and certain sustaining engineering functions.
We provide educational services to train and enable our systems integrators and customers to use our products and technologies. We offer a comprehensive series of training modules to provide the knowledge and skills to successfully deploy, use and maintain our products. These training courses focus on the technical aspects of our products as well as business issues and processes. We provide on-site customized training courses for a fee and, also, through classroom and lab instructions. In addition, we provide certification programs for our partners and customers.
We provide our customers with unspecified support and maintenance services including telephone support, web-based support and updates to our products and documentation. We believe that providing a high level of technical support is critical to customer satisfaction. We also offer training programs to our customers and other companies with which we have relationships to accelerate the implementation and adoption of our solutions by the users within a company. Fees for our training services are typically charged separately from our software license, maintenance and consulting fees.
Our customers have a choice of support and maintenance options depending on the level of service desired. Our technical support services are available to clients by telephone, over the web, by email and on-site. Additionally, we provide unspecified product enhancement releases to all customers as part of our support and maintenance contracts. We use a customer service automation system to track each customer inquiry until it is resolved. We also make use of our website and a secured customer forum to provide product information and technical support information worldwide 24 hours a day, seven days a week.
Establishing partnerships and alliances with third parties that provide additional services and resources for implementing our solutions to enhance our sales and service organizations‚Äô productivity is an important element of our strategy. These relationships and alliances fall into the following categories:
Consulting and System Integration Relationships. To enhance the productivity of our sales and service organizations, we have established relationships with systems integrators, complementary technology providers, and alternative service providers. We have established relationships and trained professionals at a number of systems integrators including: Accenture, IBM Global Services, Ness Technologies, Tata Consultancy Services, Patni Telecom Solutions (UK), LTD, and Infogain Corporation. We plan to expand these relationships to increase our capacity to license and implement our products. We believe that expanding our relationships with systems integrators and independent consulting firms will enable us to gain a greater share of our target markets.
Technology Partnerships. We make extensive use of industry platforms and embrace a number of core technologies in our solution offerings. We have formed partnerships with vendors of software and hardware technology platforms. We currently maintain technology relationships with vendors such as Avaya/Lucent, Alcatel/Genesys, BEA Systems, Cisco Systems, IBM, Oracle, and Sun Microsystems. Many of these companies voluntarily provide us with early releases of new technology platforms, education related to those platforms and limited access to their technical resources to facilitate adoption of their technology.
We have made substantial investments in research and development through internal development, acquisitions and technology licensing. Our product development efforts are focused on extending our enterprise software solutions, application components, industry specific processes and business process functionality, and continued integration of industry-specific transaction systems and services. Our product development organization is responsible for new software products, product architecture, core technologies, product testing, quality assurance and enabling the compatibility of our products with third party hardware and software platforms.
Our product development resources are organized into a number of development teams including:
Cx Enterprise Platform, which includes Foundational Server, Tools, and Decision Management Products;
Operations, which includes Mesh, Fulfillment, Performance Labs, and Release Management;
Applications, which includes our vertical and Marketing Applications;
Product Test and Quality.
Our product development teams have experience in enterprise and distributed computing, J2EE and object oriented development, data management, process and workflow engineering, transaction system interfaces, Internet and Web-Services technologies. Our research and development expenditures were $27.5 million, $25.9 million and $20.3 million for the years ended September 30, 2007, 2006, and 2005, respectively.
The market for our products is competitive, rapidly evolving, and can be affected by new product introductions and other market activities of industry participants. The competitive landscape is quickly evolving to address the need for enterprise-wide
integration of IT assets and the convergence of customer interaction applications, back-office systems and business processes. The most significant competition we face is from customers‚Äô internal development efforts, custom system integration, as well as other software providers that offer integration and development platforms.
Many of our customers and potential customers have in the past attempted to develop customer service, call center, customer relationship management and new front-office systems in-house or with the help of systems integrators. Internal information technology departments have staffed projects to build their own systems utilizing a variety of tools. In some cases, such internal development projects have been successful in satisfying the needs of an organization. The cost of internal development and total cost-of-ownership have risen to become a primary concern of the business and management. We expect that internal development will continue to be a significant source of competition.
Custom System Integration Projects
Another source of competition results from systems integrators engaged to build a custom development application. The introduction of a systems integrator typically increases the likelihood of success for the customer. The competitive factors in this area require that we demonstrate to the customer the cost savings and advantages of configurable, upgradeable and commercially supported software products developed by a dedicated professional software organization.
We frequently rely on system consulting and systems integration firms for implementation and other global services, as well as recommendations of our products during the evaluation stage of the purchase process. Many of these third parties have similar and often more established relationships with our competitors. We cannot assure that these third parties, many of whom have significantly greater resources than us, will not market software products in competition with us.
Application Software Competitors
As discussed, our primary competition is from internal development at our customers and potential customers. However, other competitors include providers of traditional, first-generation customer relationship management, enterprise resources planning, call center, marketing automation software and sales force automation software. These vendors include, among others, companies such as: Oracle Corporation, SAP, Pegasystems, Inc., Unica Corporation, SSA Global Technologies, Inc., Fidelity National Information Systems, Inc., S1 Corporation, and Amdocs Limited.
Some of these companies have longer operating histories, greater financial, marketing and other resources, greater name recognition in other markets and a larger base of customers than we do. In addition, some companies have well-established relationships with our current and potential customers. As a result, these competitors may be able to devote greater resources to the development, promotion and sale of their products than we can.
We believe that we compete favorably in the industries we serve based on the following competitive advantages: process-driven solutions for servicing and selling; real-time and transactional processes; real-time decision management and vertical processes implemented in a multi-channel architecture. The technology advantages include: Chordiant architecture providing an open services oriented architecture providing for integration with multiple legacy systems, third party applications and communication channels and advanced browser based application environment for high volume call center, mid-office and branch operations.
There is no one competitor, nor are there a small number of competitors that are dominant in our market. There are many factors that may increase competition in the enterprise customer relationship management market, including (i) entry of new competitors, (ii) mergers and alliances among existing competitors, (iii) consolidation in the software industry and (iv) technological changes or changes in the use of the Internet. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could materially and adversely affect our business, operating results and financial condition. Continuing consolidation in the software industry during 2007 may indicate that we will face new competitors in the future. Within the year Oracle announced the acquisitions of Agile Software, an enterprise solutions software maker and Hyperion Software, a business performance software maker. Also in 2007, IBM acquired Palisades, a provider of lending software to companies in the mortgage industry and SAP has made an offer to purchase Business Objects. In 2006, IBM acquired Webify, a provider of middleware to companies primarily in the insurance industry. In January 2006, Oracle acquired Siebel Systems, Inc., a maker of customer relationship management software products and acquired Portal Software, a provider of billing and revenue management solutions for the communications and media industry. Siebel Systems, Inc. was a competitor of ours. In September 2005, IBM had acquired DWL, a provider of middleware to companies in the banking, insurance, retail and telecommunications industries. In 2005, Oracle acquired I-flex Solutions, Ltd., a banking software maker headquartered in Mumbai, India. While we do not believe that Agile Software, Hyperion Software, Palisades, Webify, Portal Software, DWL, or I-flex Solutions have been significant competitors of Chordiant in the past, the acquisition of these companies by Oracle and IBM may indicate that we will face increased competition from significantly larger and more established entities in the future.
We cannot assure that we will be able to compete successfully against current and future competitors or that the competitive pressure faced by us will not materially and adversely affect our business, operating results and financial condition.
Intellectual Property and Proprietary Rights
Our success is in part dependent upon our ability to develop and protect proprietary technology and intellectual proprietary rights. We rely primarily on a combination of contractual provisions, confidentiality procedures, patents pending, trade secrets, and copyright and trademark laws to protect our intellectual property and proprietary rights.
We license our products through non-exclusive license agreements that impose restrictions on customers‚Äô ability to utilize the software. In addition, we seek to avoid disclosure of our trade secrets, including requiring employees, customers and others with access to our proprietary information to execute confidentiality agreements with us and restricting access to our source code. We also seek to protect our rights in our products, documentation and other written materials under trade secret and copyright laws. Due to rapid technological change, we believe factors such as the technological and creative skills of our personnel, new product developments and enhancements to our existing products are more important than the various legal protections of our technology to establishing and maintaining a technology leadership position.
We integrate third party software into our products. Costs associated with integrated technology provided by third parties historically accounts for approximately 2% to 5% of total license revenues. The third party software may not continue to be available on commercially reasonable terms or at all. If we cannot maintain licenses to key third party software, shipments of our products could be delayed until equivalent software is developed or licensed and integrated into our products. Moreover, although we are generally indemnified against claims if technology licensed from third parties infringes the intellectual property and proprietary rights of others, this indemnification is not always available for all types of intellectual property and proprietary rights and in some cases the scope of this indemnification is limited. There can be no assurance that infringement or invalidity claims arising from the incorporation of third party technology or claims for indemnification from our customers resulting from these claims will not be asserted or prosecuted against us. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources, in addition to potential product redevelopment costs and delays.
Despite our efforts to protect our proprietary rights, existing laws afford only limited protection. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. There can be no assurance that we will be able to protect our proprietary rights against unauthorized third party copying or use. Use by others of our proprietary rights could materially harm our business. Furthermore, policing the unauthorized use of our products is difficult and expensive litigation may be necessary in the future to enforce our intellectual property rights.
Third parties may claim, and have claimed, that we have infringed, or currently infringe, their current or future products. We expect that software developers will increasingly be subject to infringement claims as the number of products in different industry segments overlap. Any claims, with or without merit, can be time-consuming, result in costly litigation, prevent product shipment, cause delays, or require us to enter into royalty or licensing agreements, any of which could harm our business. Patent litigation in particular has complex technical issues and inherent uncertainties. If an infringement claim against us was successful and we could not obtain a license on acceptable terms, license a substitute technology or redesign to avoid infringement, our business could be harmed.
For fiscal year 2007, Chordiant received 2 patents from the US Patent and Trademark Office. The first patent was US Patent Number 7,178,109 for innovative user interface design, first introduced in its family of browser-based applications in 2003. The second was US Patent Number 7,194,380 covers the Decision Management Suite.
As of September 30, 2007, we employed 285 full time employees. Of that total, 85 were primarily engaged in product development, engineering or systems engineering, 85 were engaged in sales and marketing, 58 were engaged in professional services and 57 were engaged in operational, financial and administrative functions.
None of our employees are represented by a labor union and we have never experienced a work stoppage. We believe that our relations with our employees are good. We believe our future success will depend in part on our continued ability to recruit and retain highly skilled technical, sales, finance, management and marketing personnel.
Steven R. Springsteel, age 50, has been a director of ours since January 2004 and has been the Chairman of the Board of Directors since November 30, 2006. He has been our President and Chief Executive Officer since February 2006. From January 2003 to September 2005, he served as Senior Vice President of Finance and Administration and Chief Financial Officer of Verity, Inc., a public intellectual capital management software company, and from September 2005 to December 2005, its President and Chief Financial Officer, at which point Verity was purchased by Autonomy Corporation, plc. From November 2001 to January 2003, Mr. Springsteel served as the Chief Operating Officer and chief financial officer of Sagent Technology, Inc., a public business intelligence software company, whose assets were acquired by Group 1 Software, Inc. in 2003. From October 2000 to November 2001, Mr. Springsteel served as the Chief Operating Officer and Chief Financial Officer of NOCpulse, a software company (subsequently acquired by Red Hat). From November 1996 to October 2000, Mr. Springsteel served as our Executive Vice President and Chief Financial Officer. Mr. Springsteel holds a Bachelor of Arts degree in Business Administration from Cleveland State University.
Richard G. Stevens, age 61, has been a director of ours since March 2006. Mr. Stevens is the founder and managing director of Hunter Stevens, LLC, a professional services firm that Mr. Stevens founded in 1995. Prior to founding Hunter Stevens, Mr. Stevens served as a partner with both Ernst & Young LLP and Coopers & Lybrand LLP, both of which are public accounting firms. Mr. Stevens had served as the Chairman of the Audit Committee of Verity, Inc., a software firm based in Sunnyvale, CA and at Pain Therapeutics, Inc., a bio-science company in South San Francisco. Mr. Stevens holds a Bachelor of Science degree with honors from the University of San Francisco, and is a licensed Certified Public Accountant (CPA) in the state of California and a Certified Fraud Examiner.
William J. Raduchel, Ph.D. age 61, has been a director of ours since February 2003, and previously served as a director of ours between August 1998 and May 2001. Since December 2005, Dr. Raduchel has served as a director of Silicon Image, Inc., a semiconductor company and previously to that was a strategic advisor to that company from April 2003. From August 2006 he has been a director of Opera Software, a Norwegian browser company and, since June 2007, its non-executive chairman. Since February 2005, he has served as a director of Blackboard Inc., a public company that provides enterprise software and services to the education industry. From March 2004 until June 2006, he served as the Chairman and, from May 2004 to February 2006, Chief Executive Officer of Ruckus Network, a digital entertainment network for students at colleges and universities over the university network. Since 2003, Dr. Raduchel has served as director of ePals. From September 1999 through January 2001, he was Chief Technology Officer of AOL becoming chief technology officer of AOL Time Warner (now known as Time Warner Inc.) at that time, a position he held through 2002. Dr. Raduchel received his undergraduate degree in economics from Michigan State University, and earned his A.M. and Ph.D. degrees in economics at Harvard University.
David A. Weymouth, age 52, has been a director of ours since January 2005. From July 2007 he has been Group Operation and IT Director for Royal and Sun Alliance PLC a FTSE100 General Insurer. Since July 2005, Mr. Weymouth has acted as an independent consultant, including as an associate in the U.K with Deloitte & Touche LLP, a firm providing audit, tax, consulting and corporate finance services. From July 2005 to July 2007, Mr. Weymouth was an independent consultant and associate with DeWitte Consulting. From January 2005 to June 2005, Mr. Weymouth served as Corporate Responsibility Director for Barclay's Group, a U.K.-based financial services company. From February 2000 until December 2004, Mr. Weymouth served as the Group Chief Information Officer for Barclay's Group. Prior to February 2000, Mr. Weymouth held a number of senior positions with Barclay's Group, including Managing Director of Service Provision for Retail and Corporate Banking and Chief Operating Officer of Corporate Banking. Mr. Weymouth holds a Bachelors degree in French and a Masters of Business Administration from University of London.
Charles E. Hoffman, age 58, has been a director of ours since January 2005. Since June 2001, Mr. Hoffman has served as the President, Chief Executive Officer, and a Director of Covad Communications Group, Inc., a public internet communications and services company. From January 1998 to June 2001, Mr. Hoffman served as President and Chief Executive Officer of Rogers Wireless, Inc., a Canadian communications and media company. Mr. Hoffman holds a Bachelor of Science degree and a Masters of Business Administration from the University of Missouri -- St. Louis.
David R. Springett, Ph.D., age 72, has been a director of ours since January 2000. Dr. Springett has served as President of the Community College Foundation, an educational foundation, since February 1994. Dr. Springett also held various positions during his 26-year career with Xerox Corporation, retiring in 1992 as Vice President of Strategic Marketing. He is a board member of the California Vehicle Foundation and the California State Commission on Welfare Reform and Training. Dr. Springett holds degrees from the Royal Military College of Canada, the University of Toronto, Queen's University and Harvard University.
This table is based upon information supplied by officers, directors and principal stockholders and Schedules 13D and 13G filed with the Securities and Exchange Commission (the ‚ÄúSEC‚ÄĚ). Unless otherwise indicated in the footnotes to this table and subject to community property laws where applicable, the Company believes that each of the [stockholders/shareholder s] named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned. Applicable percentages are based on 33,303,036 shares outstanding on December 1, 2007, adjusted as required by rules promulgated by the SEC.
Consists of (a) 3,999 shares, (b) 4,000 shares held by two of Mr. Springsteel's children, and (c) 264,579 shares issuable upon the exercise of outstanding options that are exercisable within sixty days of December 1, 2007.
Consists of 66,768 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of (a) 7,500 shares and 92,082 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of (a) 58,702 shares which includes 6,927 shares held by his spouse, and (b) 54,682 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of 14,687 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of (a) 24,062 shares and (b) 41,000 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007 .
Consists of 31,000 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of 65,000 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of 22,916 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of 27,000 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007.
Consists of 777,977 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007 held by Directors and named executive officers in this table. Also consists of 36,248 shares issuable upon the exercise of outstanding options that are exercisable within sixty (60) days of December 1, 2007 held by other executive officers.
Chordiant appreciates that base salary is one of the basic compensation elements necessary to attract and retain talented executives and that base salary is the metric upon which bonus and severance compensation are based. With this in mind, we set base salaries for our executives primarily based on the scope of their responsibilities and the need to maintain internal pay equity among executive officers. The Compensation Committee considers peer company data to ensure that salary levels allow us to remain competitive in our efforts to build an effective executive team. Because each of these factors used by Chordiant to set base salary can change from year to year, the Compensation Committee reviews base salaries annually and makes adjustments as reasonably necessary to allow salary to continue to serve its purposes as a retention device and as the building block for other cash compensation.
With respect to base salary decisions for fiscal 2007, prior to the Compensation Committee‚Äôs meetings to determine executive compensation for fiscal 2007, the Company‚Äôs management team asked that they not be given increases to their base salaries as the Company was not then profitable. The Compensation Committee considered the request of the management team and how it reflected upon the executive team‚Äôs commitment to the Company. The Compensation Committee also reviewed peer company data to form its own conclusions on the appropriateness of maintaining salary levels given the challenges the Company faced in the prior year, the challenges the Company faced in the upcoming year and the need to retain its executive team in tact to meet those challenges. The Compensation Committee determined that base salaries for fiscal 2006 remained competitive with compensation paid by peer companies. As a result of such review, the Compensation Committee did not increase the base salary for any of the named executive officers for fiscal 2007 except for Mr. Norman.
Mr. Norman joined Chordiant‚Äôs Finance department in 2004 as Director of Finance and on March 8, 2006 was appointed as Vice President, Chief Financial Officer and Chief Accounting Officer with an annual base salary of $230,000. In setting this initial salary, the Compensation Committee reviewed peer company data provided by Hewitt for executives in similar positions. The Compensation Committee set Mr. Norman‚Äôs base salary at this time below the median salary from the peer data, reflecting Mr. Norman‚Äôs lack of prior experience as a Chief Financial Officer of a publicly traded company. In February of 2007, the Board increased Mr. Norman‚Äôs base salary from $230,000 to $250,000 per year in recognition of his efforts and leadership in successfully restating the Company‚Äôs financial statements after the Audit Committee reached a conclusion that incorrect measurement dates were used for financial accounting purposes for stock option grants in certain prior periods. In making this adjustment, the Compensation Committee again reviewed peer data provided by Hewitt and set the salary within the median of such data.
Executive Incentive Plan or Bonus Compensation
Chordiant uses its cash-based Executive Incentive Bonus Plan and other bonus compensation to focus our executives on, and reward our executives for, achieving key corporate goals in the short term ‚Äď generally a one year performance period. The Compensation Committee sets target performance bonuses as a percentage of base salary, allowing compensation to be earned in excess of such targets amounts for exceptional performance. Target bonus levels are not generally pegged to a specific range within peer company data, as the Compensation Committee considers more important the historic levels of bonus targets, the overall cash compensation target for the executive, the role a specific executive is expected to play in the upcoming year in meeting the Company‚Äôs specific business objectives, and the challenges faced in that role. However, the Committee does look at peer group percentages as one factor it considers.
2007 Executive Plan
As noted above, the Company uses its compensation program in part to align executives to focus executives on achieving goals that are necessary for sustained Company performance. Therefore, in establishing performance goals under the non-equity incentive plan, the Compensation Committee starts from the operating plan developed by management and approved by the Board for the upcoming fiscal year.
In November 2006, the adoption of the Chordiant Fiscal Year 2007 Executive Incentive Bonus Plan (the ‚Äú2007 Executive Plan‚ÄĚ) was recommended by the Compensation Committee and approved by the Board of Directors in connection with the approval of our 2007 financial plan. Our bonus compensation programs are designed primarily to reward the achievement of certain financial goals and metrics which we believe are the best indicators of the success of our business. Since we believe that a growing, profitable company creates shareholder value, the design of our executive compensation program emphasized the achievement of various measures of profitability and growth in fiscal year 2007. Messrs. Springsteel, Norman and St. Jean are participants in the 2007 Executive Plan. Mr. Springsteel‚Äôs bonus target amount under the 2007 Executive Plan was 80% of his base salary, which remained unchanged from the prior year. The bonus percentage from 2006 was established based on an analysis by the Compensation Committee of the challenges faced by the Company and the role Mr. Springsteel was expected to play in meeting these challenges, and as a result of individual negotiations with Mr. Springsteel. In reviewing the Company‚Äôs goals for 2007, and Mr. Springsteel‚Äôs achievements in 2006, the Compensation Committee determined that that no change to the target bonus was appropriate and that 80% was an appropriate level to encourage continued superior performance by Mr. Springsteel. Messrs. Norman‚Äôs and St. Jean‚Äôs bonus target amounts under the 2007 Executive Plan were established at 60% of their base salaries based on the determination by the Compensation Committee that such targets were consistent with levels of compensation provided by peer companies and based on the importance of the role each officer was expected to play in fiscal 2007. Messrs. Witte and Karnik each participated in bonus plans where at least 50% of their potential bonus was determined using the goals and metrics of the 2007 Executive Plan, as further described below. In addition to the goals of the 2007 Executive Plan, Mr. Witte‚Äôs plan was designed to emphasize his role in monitoring the Company‚Äôs compliance with the law and the policies adopted by the Board and Mr. Karnik‚Äôs plan was designed to emphasize the profitability of the Company‚Äôs professional services business.
The Compensation Committee and Board of Directors felt the best way to maximize value for stockholders would be to motivate officers to increase our revenue, increase bookings of new transactions which result in revenue in future periods, and manage expenses. Consequently the bonuses payable under the 2007 Executive Plan were calculated as a function of Company performance relative to the 2007 financial plan against three separate financial goals: revenue, bookings and expenses, with expense and bookings each weighted more than revenue. Because much of Chordiant‚Äôs revenue is attributable to customer contracts signed in previous periods and recognized under the percentage of completion method of accounting, the revenue goal received a lower weighting than those associated with the booking of new contractual commitments and expense control.
Additionally, 10% of the bonus payable under the Executive Plan to each officer other than the CEO was determined as a function of each executive‚Äôs accomplishment of individual goals. Mr. Normans‚Äô goals related primarily to remedying certain material weaknesses reported by the Company in 2006. Mr. St. Jean‚Äôs goals related primarily to product development commitments for 2007. Mr. Karnik‚Äôs goals under the Executive Plan related primarily to revising the Company‚Äôs organization model for professional services and closing certain contracts. Mr. Witte‚Äôs goals under the Executive Plan related primarily to improving the efficiency of the administration of the Board and its committees. The Compensation Committee determined that each officer achieved 100% of his individual performance goals.
The revenue goal in the 2007 Executive Plan had two components ‚Äď revenue as recognized under Generally Accepted Accounting Principles (‚ÄúGAAP‚ÄĚ) on the Company‚Äôs quarterly financial statements and deferred revenue as reflected on the Company‚Äôs balance sheet. The bookings goal in the 2007 Executive Plan was calculated as a function of the payment commitments from customers under contracts signed in the period. The expense goal in the 2007 Executive Plan was based upon pro-forma operating expenses incurred by the sales, marketing, research and development, and general and administrative functions and excluding expenses for stock-based compensation, amortization of purchased intangible assets, restructuring expenses and infrequent charges.
2007 VP Services Plan
In November 2006, in connection with adopting the 2007 Executive Plan, the Compensation Committee recommended and the Board approved the Chordiant Fiscal Year 2007 VP of Services Bonus Plan (the ‚Äú2007 VP Services Plan‚ÄĚ) under which Mr. Karnik is the only participant. Mr. Karnik‚Äôs total bonus opportunity was 60% of his base salary, with a maximum bonus opportunity equal to twice his target bonus opportunity. The 2007 VP Services Plan provides that 50% of Mr. Karnik‚Äôs eligible bonus target will be calculated under the 2007 Executive Plan. The other 50% of Mr. Karnik‚Äôs eligible bonus target will be calculated based on the actual worldwide cumulative professional services direct controllable contribution margin percentage (‚ÄúPS Margin‚ÄĚ) calculated as a function of Company performance relative to the PS Margin target of 19.1% in the 2007 financial plan. The Compensation Committee determined that it was in the best interests of the Company to tie a significant portion of Mr. Karnik‚Äôs bonus opportunity to the profitability of the professional services group for which he is responsible. The Compensation Committee believed that cumulative professional services direct controllable contribution margin percentage was a good measure of such profitability.
MANAGEMENT DISCUSSION FROM LATEST 10K
The following discussion and analysis contains forward-looking statements. These statements are based on our current expectations, assumptions, estimates and projections about our business and our industry, and involve known and unknown risks, uncertainties and other factors that may cause our or our industry‚Äôs results, levels of activity, performance or achievement to be materially different from any future results, levels of activity, performance or achievements expressed or implied in or contemplated by the forward-looking statements. Words such as ‚Äúbelieve,‚ÄĚ ‚Äúanticipate,‚ÄĚ ‚Äúexpect,‚ÄĚ ‚Äúintend,‚ÄĚ ‚Äúplan,‚ÄĚ ‚Äúwill,‚ÄĚ ‚Äúmay,‚ÄĚ ‚Äúshould,‚ÄĚ ‚Äúestimate,‚ÄĚ ‚Äúpredict,‚ÄĚ ‚Äúguidance,‚ÄĚ ‚Äúpotential,‚ÄĚ ‚Äúcontinue‚ÄĚ or the negative of such terms or other similar expressions, identify forward-looking statements. Our actual results and the timing of events may differ significantly from those discussed in the forward-looking statements as a result of various factors, including but not limited to, those discussed in Item 1 of this Form 10-K under the caption ‚ÄúRisk Factors‚ÄĚ and those discussed elsewhere in this Annual Report and in our other filings with the Securities and Exchange Commission. Chordiant undertakes no obligation to update any forward-looking statement to reflect events after the date of this report.
Reverse Stock Split
On December 13, 2006, Chordiant‚Äôs Board of Directors approved a reverse two and a half to one stock split. On February 15, 2007 at a special meeting, stockholders approved the reverse stock split such that each outstanding two and one half (2.5) shares of common stock were combined into and became one (1) share of common stock. The reverse stock split was effective February 20, 2007. All share and per share amounts in this form 10-K has been retroactively adjusted to reflect the reverse stock split for all periods presented.
As an enterprise software vendor, we generate substantially all of our revenues from the banking, insurance, healthcare, telecommunications, and retail industries. Our customers typically fund purchases of our software and services out of their lines of business and information technology budgets. As a result, our revenues are heavily influenced by our customers‚Äô long-term business outlook and willingness to invest in new enterprise information systems and business applications.
In fiscal year 2007, we recorded revenue of $124.5 million. In fiscal year 2007, we generated $6.0 million of net income and ended the fiscal year with over $90.1 million in cash, cash equivalents and marketable securities as compared to $45.3 million for the year ended September 30, 2006.
Total revenue for the year ended September 30, 2007 increased 28% to $124.5 million from $97.5 million of the prior year. The growth in revenue was evenly distributed between license and service revenue, each increasing by $13.5 million. The increase in license revenue was primarily driven by an increase in the transaction size of license transactions in excess of $1 million as compared to the prior year. The increase in service revenue was primarily composed of an increase in consulting revenue of $5.2 million, an increase in support and maintenance revenue of $8.9 million and an increase of $0.5 million in expense reimbursement revenue offset by a decrease in training revenue of $1.0 million.
In the past an increase in license revenue has resulted in a related increase in consulting revenue as our customers request us to assist with their implementation efforts. The increase in support and maintenance revenue is expected to continue if we are able to add new licenses to our existing base of licenses at a rate greater than customers opting not to renew their annual support and maintenance contracts.
Software Industry Consolidation and Possible Increased Competition
The software industry in general is continuing to undergo a period of consolidation, and there has been recent consolidation in sectors of the software industry in which we operate. Within the year Oracle announced the acquisitions of Agile Software, an enterprise solutions software maker and Hyperion Software, a business performance software maker. Also in 2007, IBM acquired Palisades, a provider of lending software to companies in the mortgage industry and SAP has made an offer to purchase Business Objects. In 2006, IBM acquired Webify, a provider of middleware to companies primarily in the insurance industry. In January 2006, Oracle acquired Siebel Systems, Inc., a maker of customer relationship management software products and acquired Portal Software, a provider of billing and revenue management solutions for the communications and media industry. Siebel Systems, Inc. was a competitor of ours. In September 2005, IBM had acquired DWL, a provider of middleware to companies in the banking, insurance, retail and telecommunications industries. In 2005, Oracle acquired I-flex Solutions, Ltd., a banking software maker headquartered in Mumbai, India. While we do not believe that Agile Software, Hyperion Software, Palisades, Webify, Portal Software, DWL, or I-flex Solutions have been significant competitors of Chordiant in the past, the acquisition of these companies by Oracle and IBM may indicate that we will face increased competition from larger and more established entities in the future.
Backlog . An increasingly material portion of our revenues have been derived from large customer transactions. For some of these transactions, the associated professional services provided to the customer can span over a period greater than one year. If the services delivery period is over a prolonged period of time, it will cause the associated backlog to be recognized as revenue over a similar period of time. As of September 30, 2007 and 2006, we had approximately $75.4 million and $36.0 million in backlog, respectively, which we define as contractual commitments by our customers through purchase orders or contracts. This increase in backlog is partially reflected in the growth of deferred revenue recorded on our balance sheet. For the period ended September 30, 2006 to September 30, 2007 deferred revenue increased $38.4 million due to an increase of $20.6 million in short-term deferred revenue and a $17.8 million increase in long-term deferred revenue. The increase in long-term deferred revenue was primarily driven by entering into multi-year support and maintenance contracts with our customers. Backlog is comprised of:
software license orders for which the delivered products have not been accepted by customers or have not otherwise met all of the required criteria for revenue recognition. This component includes billed amounts classified as deferred revenue;
deferred revenue from customer support contracts;
consulting service orders representing the unbilled remaining balances of consulting contracts not yet completed or delivered, plus deferred consulting revenue where we have not otherwise met all of the required criteria for revenue recognition.
Backlog is not necessarily indicative of revenues to be recognized in a specified future period. There are many factors that would impact Chordiant‚Äôs conversion of backlog as recognizable revenue, such as Chordiant‚Äôs progress in completing projects for its customers, Chordiant‚Äôs customers‚Äô meeting anticipated schedules for customer-dependent deliverables and customers increasing the scope or duration of a contract causing license revenue to be deferred for a longer period of time.
Chordiant provides no assurances that any portion of its backlog will be recognized as revenue during any fiscal year or at all, or that its backlog will be recognized as revenues in any given period. In addition, it is possible that customers from whom we expect to derive revenue from backlog will default, and as a result, we may not be able to recognize expected revenue from backlog.
For the year ended September 30, 2007, we entered into several large customer orders resulting in a significant portion of our near term license revenues being recognized under the percentage-of-completion method of accounting such that our deferred revenue balance increased. These orders will require consulting services that are essential to the functionality of the respective licenses.
Implementation by Third Parties. Over time, as our products mature and system integrators become more familiar with our products, our involvement with implementations has diminished on some projects. If this trend continues to evolve, certain agreements with customers may transition from a contract accounting model (SOP 81-1) to a more traditional revenue model whereby revenues are recorded upon delivery.
Service R evenues. Service revenues as a percentage of total revenues were 57%, 58%, and 62% for the years ended September 30, 2007, 2006, and 2005, respectively. We expect that service revenues will represent between 50% and 60% of our total revenues in the foreseeable future.
Revenues from I nternational C ustomers versus North America . For all periods presented, revenues were principally derived from customer accounts in North America and Europe. For the years ended September 30, 2007, 2006, and 2005, international revenues were $58.8 million, $37.5 million, and $42.0 million or approximately 47%, 38%, and 50% of our total revenues, respectively. We believe international revenues will continue to represent a significant portion of our total revenues in future periods. The significant increase in international revenue for year ended September 30, 2007, as compared to the prior fiscal year was due to an improved economy for the region as well as an improved sales production for the region resulting from the new management team that was put in place over the past several quarters. International revenues were favorably impacted for the year ended September 30, 2007, as compared to the year ended September 30, 2006, as both the British Pound and the Euro increased in average value by approximately 9% and 8%, respectively, as compared to the U.S. Dollar. International revenues were negatively impacted for the year ended September 30, 2006, as compared to the year ended September 30, 2005, as both the British Pound and the Euro decreased in average value by less than 1% and approximately 3%, respectively, as compared to the U.S. Dollar.
For the years ended September 30, 2007, 2006, and 2005, North America revenues were $65.7 million, $60.0 million, and $41.7 million or approximately 53%, 62%, and 50% of our total revenues, respectively. As the U.S. economy has remained strong, we have seen an increase in North America revenues. Large customers have become more willing to invest in new enterprise infrastructure projects. We believe North America revenues will continue to represent 50% to 60% of our total revenues in the future.
Gross margins. Management focuses on license and service gross margin in evaluating our financial condition and operating performance. Gross margins on license revenues were 97%, 96%, and 97% for the years ended September 30, 2007, 2006, and 2005, respectively. The changes in gross margins are primarily related to the amortization expense associated with capitalized software development costs pertaining to a banking product. We expect license gross margin on current products to range from 95% to 97% in the foreseeable future. The margin will fluctuate with the mix of products sold. Historically, the enterprise solution products have higher associated third party royalty expense than the marketing solution products and decision management products.
Gross margins on service revenues were 57%, 46%, and 42% for the years ended September 30, 2007, 2006, and 2005, respectively. The increase in gross margins for the year ended September 30, 2007 is primarily due to improved consulting services utilization rates and increased support and maintenance revenue. We expect that gross margins on service revenue to range between 55% and 60% in the foreseeable future. Margins can be negatively impacted during, and immediately following, periods in which professional service department headcounts increase, as resources are not immediately billable.
Acquisition of KiQ Limited. On December 21, 2004, we acquired KiQ Limited, a privately-held United Kingdom software company with branch offices in the Netherlands, or KiQ, specializing in the development and sales of decision management systems. The year ended September 30, 2005 includes the revenue and expense of KiQ from the acquisition date, December 21, 2004, through the end of the fiscal year, September 30, 2005. The years ended September 30, 2007 and 2006 include the revenues and expenses of KiQ for the entire fiscal year.
Costs R elated to C ompliance with the Sarbanes-Oxley Act of 2002. Significant professional service expenses are included in general and administrative costs relating to efforts to comply with the Sarbanes-Oxley Act of 2002. For the years ended September 30, 2007, 2006, and 2005, these costs were $1.0 million, $1.8 million, and $4.5 million, respectively. While these costs are expected to continue into the next fiscal year, the decline in amount and timing of the costs through fiscal year 2008 is uncertain as compared to the costs incurred for the year ended September 30, 2007.
Costs R elated to S tock O ption I nvestigation. Significant outside professional services are included in general and administrative costs associated with the Company‚Äôs stock option investigation which began in July 2006 and was completed during the quarter ended March 31, 2007. This issue is more fully described in the in Note 3, ‚ÄúRestatement of Previously Issued Consolidated Financial Statements‚ÄĚ in Notes to Consolidated Financial Statements of the Annual Report on Form 10-K for the fiscal year ended September 30, 2006. For the year ended September 30, 2007 and 2006, these costs were $1.8 and $1.2 million, respectively. We have not incurred any additional costs since the quarter ended March 31, 2007 and do not expect to incur such costs in future periods.
Cost to Amend Eligible Options. In July 2006, our Board of Directors (the ‚ÄúBoard‚ÄĚ) initiated a review of our historical stock option grant practices and appointed the Audit Committee to oversee the investigation. The Audit Committee determined that the correct measurement dates for a number of stock option grants made by us during the period 2000 to 2006, or Review Period, differ from the measurement dates previously used to account for such option grants. The Audit Committee identified errors related to the determination of the measurement dates for grants of options where the price of our common stock on the selected grant date was lower than the price on the actual grant date which would permit recipients to exercise these options at a lower exercise price. As such, these affected stock options are deemed, for accounting purposes, to have been granted at a discount. Based on the determination made for accounting purposes, the discounted options (for accounting purposes) may now be deemed to have been granted at a discount for tax purposes, which may expose the holders of these impacted stock option grants to potentially adverse tax treatment under Section 409A of the Internal Revenue Code and state law equivalents. As more fully described on Form SC TO-I filed with the SEC on March 29, 2007, Chordiant offered certain optionees the opportunity to increase the exercise price of the discounted options to limit the potential adverse personal tax consequences that may apply to those stock options under Section 409A of the Internal Revenue Code and state law equivalents. On April 26, 2007, eligible optionees finalized their elections under the offer and were awarded a future cash payment equal to the price differential of the Amended Options. These payments will be treated as bonus payments. These cash payments will be approximately $0.3 million and will be paid out in January 2008. The cost of these bonus payments were fully accrued as of September 30, 2007.
Reduction in W orkforce. In October 2006, the Company initiated a restructuring plan intended to align its resources and cost structure with expected future revenues. The restructuring plan included a balancing of services resources worldwide, an elimination of duplicative functions internationally, and a shift in the U.S. field organization toward a focus on domain-based sales and pre-sales teams.
Results of Operations
Comparison of the Year Ended September 30, 2007 to the Year Ended September 30, 2006
License R evenue. The increase or decrease of license revenue occurring within the three different product groups is dependent on the timing of when a sales transaction is completed and whether a license transaction was sold with essential consulting services. Products licensed with essential consulting services are generally recognized as revenue under the percentage-of-completion method of accounting. The timing and amount of revenue for those transactions being recognized under the percentage-of-completion is influenced by the progress of work performed relative to the project length of customer contracts and the dollar value of such contracts.
Total license revenue increased $13.5 million, or 33%, for the year ended September 30, 2007 compared to the same period of the prior year. A significant portion of this increase is attributable to a single customer that purchased a perpetual product license as part of a $20.0 million agreement. The value of this agreement has been allocated as follows: $12.2 million to license fees, $7.1 million to support and maintenance fees expected to be recognized over the next five year period, and $0.7 million to consulting fees. The license amount was recorded as deferred license revenue at the inception of the agreement and is being recognized on a percentage-of-completion basis due to the essential services required for the functionality of the software. For the year ended September 30, 2007, $11.3 million of license revenue has been recognized in connection with this agreement.
In addition to the revenue contribution from the aforementioned customer, the increase in license revenue for the year ended September 30, 2007 was primarily due to the growth in the absolute dollar size of transactions in excess of $1 million as compared to the same period of the prior year.
Service R evenue . Service revenue is primarily composed of consulting implementation and integration, consulting customization, training, post-contract customer support services, or PCS, and certain reimbursable out-of-pocket expenses. The increase or decrease of service revenue within the three different product emphases is primarily due to the timing of when license transactions are completed, whether or not the license was sold with essential consulting services, the sophistication of the customer‚Äôs application, and the expertise of the customer‚Äôs internal development team. For other service transactions, service revenue will lag in timing compared to the period of when the license revenue is recognized.
Total service revenue increased $13.5 million or 24% for the year ended September 30, 2007 compared to the same period of the prior year. The $13.5 million increase is primarily related to increases of $8.9 million in PCS revenue, $5.2 million in consulting revenue, $0.5 million in reimbursement of out-of-pocket expense revenue offset by a decrease of $1.0 million in training revenue. The increase in PCS revenue is a function of the growth in new license bookings sold with PCS agreements combined with the renewal of existing PCS customers at a rate in excess of existing customers, declining the service in the year of renewal. The increase in consulting revenue is a direct result of the growth in license revenue as the majority of our customers will use some form of our consulting services in connection with their project.
Cost of Revenues
License . Cost of license revenues includes third party software royalties and amortization of capitalized software development costs. Royalty expenses can vary depending upon the mix of products sold within the period. The capitalized software development costs pertain to a banking product that was completed and available for general release in August 2005 and the third party costs associated with the porting of a product to a new platform. The porting project was completed in August 2007 and the aggregate costs capitalized were $0.5 million. Amortization expense for the banking product and porting project for the year ended September 30, 2007 were $0.9 million and less than $0.1 million, respectively. Amortization costs for the banking product are expected through 2008 and amortization costs of the porting project are expected through 2010.
Cost of license revenues increased $0.1 million or 7% for the year ended September 30, 2007 as compared to the same period of the prior year. The primary reason for the increase was due to the growth of license revenue year-over-year leading to an increase in third party royalty costs.
Service. Cost of service revenues consists primarily of personnel, third party consulting, facility and travel costs incurred to provide consulting implementation and integration, consulting customization, training, PCS support services.
Cost of service revenue decreased by $0.2 million or 1% for the year ended September 30, 2007 as compared to the same period of the prior year. This change is primarily due to a decrease in personnel and related costs of $2.5 million associated with a decrease in headcount which was offset by an increase in third party consulting costs of $2.1 million and third party PCS costs of $0.1 million. Service costs were able to remain constant while service revenue increased due to improved utilization of our internal consultant teams, replacing full time employees with third party consultants (converting a fixed cost to a variable cost) and increasing PCS revenue, which to a limited degree is not based on a variable cost model, so there is not a direct relationship of revenue to costs.
Amortization of I ntangible A ssets ( i ncluded in C ost of R evenues). Amortization of intangible assets cost consists primarily of the amortization of amounts paid for developed technologies, customer lists and trade-names resulting from business acquisitions.
These costs are solely related to the $6.1 million of intangible assets associated with the acquisition of KiQ in December 2004. We expect amortization expense for intangible assets to be $1.2 million in fiscal year 2008, $1.2 million in fiscal year 2009 and $0.3 million in fiscal year 2010.
Sales and Marketing. Sales and marketing expenses is composed primarily of costs associated with selling, promoting and advertising our products, product demonstrations and customer sales calls. These costs consist primarily of employee salaries, commissions and bonuses, benefits, facilities, travel expenses and promotional and advertising expenses.
Sales and marketing expenses decreased $1.0 million or 3% for the year ended September 30, 2007 as compared to the same period of the prior year. The primary reason for the decrease was due to a decrease of $1.5 million in personnel related costs and a decrease of $0.4 million in travel costs offset by an increase of $0.7 million in sales and marketing program costs. The decrease in personnel costs is mainly attributed to a 22% decrease in average headcount year-over-year.
Research and Development. Research and development expenses is composed primarily of costs associated with the development of new products, enhancements of existing products and quality assurance activities. These costs consist primarily of employee salaries and benefits, facilities, the cost of software and development tools and equipment and consulting costs, including costs for offshore consultants.
Research and development expense increased $1.7 million or 7% for the year ended September 30, 2007 as compared to the same period of the prior year. The primarily reason for the increase was due to a $3.4 million increase in personnel related expense offset by a decrease of $1.6 million in third party consulting costs and a decrease of $0.2 million in travel costs. The increase in personnel costs was driven by a 13% increase in average headcount for the comparative periods. Third party consulting costs decreased as the result of the completion of a large co-development project in September 2006 that utilized a large number of outside consultants.
General and A dministrative. General and administrative expenses is composed primarily of costs associated with our executive and administrative personnel (e.g. the CEO, legal, human resources and finance personnel). These costs consist primarily of employee salaries, bonuses, stock compensation expense, benefits, facilities, professional fees, including costs for Sarbanes-Oxley Act of 2002 (SOX) consultants and the recently concluded stock option review.
General and administrative expense decreased $0.5 million or 3% for the year ended September 30, 2007 as compared to the same period of the prior year. This decrease is primarily due to a decrease of $0.6 million in professional fees and a decrease of $0.3 million in personnel and related costs offset by an increase of $0.4 million in other miscellaneous costs of which $0.2 million of the miscellaneous costs were related to U.S. state franchise taxes.
Restructuring Expense. In October 2006, we initiated a restructuring plan that included an immediate reduction in positions of slightly more than ten percent of the Company's workforce, consolidation of our European facilities, and the closure of our French office. A majority of the positions eliminated were in Europe. We recorded a pre-tax cash restructuring expense of $6.1 million as calculated using the net present value of the related costs as required by SFAS 146. The expense was composed of $1.8 million for severance costs and $4.4 million for exiting excess facilities of which $1.0 million of the excess facility expense is associated with non-cash charges for the write-off of leasehold improvements and the reversal of a favorable purchase price adjustment related to the France office lease. We anticipated that $5.1 million of the expense would result in cash expenditures. As of September 30, 2007, we have paid $2.7 million in cash payments and expect to pay the remaining $2.5 million during the first six months of fiscal year 2008.
During fiscal year 2002, we restructured several areas of the Company to reduce expenses and improve revenues. As part of this restructuring, we closed an office facility in Boston, Massachusetts and recorded an expense associated with the long term lease which expires in January 2011. During 2007, we completed a new sublease for this facility with a new sub-tenant for the remaining term of our lease at a rate lower than that which was forecasted when the original restructuring expense was recorded in 2002. This change in estimate resulted in an additional $0.4 million in restructuring expenses for the year ended September 30, 2007.
Stock-based C ompensation ( i ncluded i n individual O perating E xpense and C ost of R evenue C ategories).
For the year ended September 30, 2007, the aggregate stock-based compensation cost included in cost of revenues and in operating expenses was $3.0 million which is a combination of $2.8 million related to stock options and $0.2 million associated with restricted stock awards. For the year ended September 30, 2006, the aggregate stock-based compensation cost included in cost of revenues and in operating expenses was $4.7 million which was a combination of $2.7 million related to stock options and $2.0 million associated with restricted stock awards. The decrease in total compensation expense of $1.7 million year-over-year is primarily attributed to a reduction in restricted stock expense of $1.8 million, of which $1.0 million of the reduction is due to the restricted stock associated with the KIQ acquisition which became fully amortized during 2007. The remaining decrease is the result of restricted stock cancellations granted in prior years to two key executives who left the company in the quarter ending December 2006.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
The following table sets forth, in dollars (in thousands) and as a percentage of total revenues, unaudited Condensed Consolidated Statements of Operations data for the periods indicated.
Comparison of the Three Months Ended December 31, 200 7 and 200 6 (Unaudited)
Total revenues increased $ 6.2 million, or 27 %, to $ 29.1 million for the three months ended December 31, 200 7 as compared to the same period of the prior year. This increase was primarily due to a 23% increase in license revenue and a 29 % inc rease in service revenue.
The following summarizes the components of our total revenues:
License R evenue
The increase or decrease of license revenue occurring within the three different product groups is dependent on the timing of when a sales transaction is completed and whether a license transaction was sold with essential consulting services. Products licensed with essential consulting services are generally recognized as revenue under the percentage-of-completion method of accounting. The timing and amount of revenue for those transactions being recognized under the percentage-of-completion method is influenced by the progress of work performed relative to the project length of customer contracts and the dollar value of such contracts.
Total license revenue increased by $1. 6 million or 2 3 % f or the three months ended December 31, 200 7 as compared to the same period of the prior year . The increase is attributed to the number of projects and the degree of progress associated with percentage-of-completion transactions.
Service R evenue
Service revenue is primarily composed of consulting implementation and integration, consulting customization, training, post-contract customer support services , or PCS , and certain reimbursable out-of-pocket expenses. The increase or decrease of service revenue within the three different product emphases is primarily due to the timing of when license transactions are completed, whether or not the license was sold with essential consulting services, the sophistication of the customer‚Äôs application, and the expertise of the customer‚Äôs internal development team. For other service transactions, service revenue will lag in timing compared to the period of when the license revenue is recognized.
Total service revenue increased $4.6 million or 29 % for the three months ended December 31, 2007, as compared to the same period of the prior year. The $ 4.6 million increase is primarily related to increases of $ 3.0 million in PCS revenue, $ 1.2 million in consulting revenue, $ 0.3 million in training revenue and $0.1 million in reimbursement of out-of-pocket expense revenue . The increase in PCS revenue is a function of the growth in new license transactions sold with PCS agreements combined with the renewal of existing PCS customers at a rate in excess of existing customers declining PCS at some point in time after the first year. The increase in consulting revenue is a direct result of the growth in license revenue as the majority of our customers will use some form of our consulting services in connection with their project.
Cost of R evenue
Cost of license revenues includes third party software royalties and amortization of capitalized software development costs. Royalty expenses can vary depending upon the mix of products sold within the period. The capitalized software development costs primarily pertain to a banking product that was completed and available fo r general release in August 2005 and the third party costs associated with the porting of a product to a new platform . The porting project was completed in August 2007 and the aggregate costs capitalized were $0.5 million. A mortization expense for the banking product and porting project for the three months ended December 31, 2007 were $ 0.2 million and less than $0.1 million, respectively. Amortization costs for the banking product are expected through 2008 and amortization costs of the porting project are expected through 2010.
Cost of license revenue decreased by $0.1 million or 26 % from the three months ended December 31, 2006 as compared to the same period of the prior year. The decrease is primary due to the reduction in royalty expense associated with third party technology included in our products.
Cost of service revenues consists primarily of personnel, third party consulting, facility and travel costs incurred to provide consulting implementation and integration, consulting customization, training, PCS support services.
Cost of service revenue increased $1.0 million or 14 % for the three months ended December 31, 2007, as compared to the same period of the prior year. This change is primarily due to a n increase in third party consulting costs of $1.2 million offset by a decrease in personnel and related costs of $0.2 million associated with a decrease in headcount. Service costs increased at a lower rate as compared to the increase in service revenue due to improved utilization of our internal consultant teams, replacing full time employees with third party consultants (converting a fixed cost to a variable cost) and increasing PCS revenue, which to a limited degree is not based on a variable cost model, so there is not a direct relationship of revenue to costs.
Amortization of I ntangible A ssets
Amortization of intangible assets cost consists primarily of the amortization of amounts paid for developed technologies, customer lists and trade-names resulting from business acquisitions.
We expect amortization expense for intangible assets to be $ 0.3 million for each of the three remaining quarters in fiscal year 2008 , $1.2 million in fiscal year 2009 and $0. 3 million in fiscal year 2010.
Operating E xpenses
Sales and M arketing
Sales and marketing expense is attributed to activities associated with selling, promoting and advertising our products, product demonstrations and customer sales calls. These costs consist primarily of employee salaries, commissions and bonuses, benefits, facilities, travel expenses and promotional and advertising expenses.
Sales and marketing expense increased by $1.6 million or 23 % f or the three months ended December 3 1 , 200 7 as compared to the same period of the prior year. The increase is primarily due to increases of $1.0 million in sales and marketing program costs, $0.4 million in personnel and related costs and $0.2 million in consultant costs . The increase in sales and marketing program costs was mainly attributed to two annual worldwide sales events: Sales Kick Off and Presidents Club. In the prior year, these events occurred in the March 2007 quarter.