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Building Trades United Pension Trust Fund v. Kenexa Corp.

September 27, 2010

BUILDING TRADES UNITED PENSION TRUST FUND
v.
KENEXA CORPORATION, ET AL.



The opinion of the court was delivered by: Juan R. Sánchez, J.

MEMORANDUM

Building Trades United Pension Trust Fund (BTUPTF) brings this consolidated securities fraud class action on behalf of all persons who purchased the common stock of Kenexa Corporation (Kenexa) between May 8, 2007, and November 7, 2007 (the Class Period). The Plaintiff class asserts claims against Kenexa, CEO Nooruddin "Rudy" Karsan, and CFO Donald Volk for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and SEC Rule 10b-5.

Defendants ask this Court to dismiss Plaintiffs' claims, arguing: (1) Plaintiffs have failed to adequately plead scienter; (2) Plaintiffs cannot hold Defendants liable for omissions related to future losses; and (3) the safe harbor provision of the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-5(c), protects Defendants' forward-looking written or oral statements. Because Plaintiffs have not met the heightened standard for pleading scienter as set forth in Tellabs, Inc. v. Makor, 551 U.S. 308 (2007), this Court will grant Defendants' Motion to Dismiss.

Also before this Court is Plaintiffs' Motion to Strike Exhibit 36 of Defendants' Motion to Dismiss, or, in the alternative, to convert Defendants' motion into a motion for summary judgment, which shall be granted.*fn1

FACTS

Kenexa and its subsidiaries operate in the Human Capital Market (HCM) industries, providing software, content, and services to help human resources departments hire and retain employees. Kenexa provides "talent acquisition" services, which involves finding and recruiting employees, and outsourcing services known as Employment Process Outsourcing (EPO). Kenexa earns revenue by charging subscription fees for its services and by charging fees for additional support or any other discrete professional services. At the beginning of the Class Period, Kenexa had 13 EPO accounts, which collectively constituted about 15-20% of Kenexa's total revenue. The revenue generated by the EPO accounts was divided evenly between subscription fees and discrete services fees.

In June 2005, during Kenexa's initial public offering (IPO), the company sold 5.75 million shares of common stock at $12 per share. Kenexa grew quickly during the following years, acquiring seven other companies from January 2006 through August 2007.

On May 8, 2007, Kenexa reported its results for the first quarter of 2007 (Q1), stating a total revenue of $42.2 million (an 83% increase from the first quarter of 2006). Kenexa asserted it earned $34.7 million in subscription revenue and $7.5 million of other revenue, including professional services. Defendant Karsan stated interest in Kenexa was "strong" and the company was benefitting from the trend towards hiring HCM firms because of Kenexa's "proven ability to deliver tangible business benefits for [its] customers and growing brand awareness." Compl. ¶ 60. Karsan stated he anticipated Kenexa's revenues for 2007 would be $186-189 million. In a conference call later the same day, Karsan expressed similar optimism, telling investors the company's acquisitions were expected to boost profitability. Karsan stated the company's 35% annual growth was unlikely to decrease.

In response to this positive forecast, the price of Kenexa stock rose from $31.94 on May 8, 2007, to $32.96 on May 9, 2007, and continued to climb for the remainder of May 2007. During that month, Defendant Karsan sold 127,400 shares of Kenexa stock for proceeds of more than $4.6 million. Defendant Volk sold 20,000 shares of stock in May 2007 for proceeds of approximately $764,000. Non-defendant board member Troy Kanter, Kenexa's President and Chief Operating Officer, sold 62,096 shares of stock for proceeds of $2.25 million.

Plaintiffs allege the May 8, 2007, forecast was materially false because at the time Karsan made his statements, Kenexa officers knew the company was poised to lose one of its largest EPO clients, a biotechnology firm referred to as "Client B."*fn2 Client B, a pharmaceutical company, was a subscription client whose account generated approximately $6 million annually for Kenexa.

During early 2007, Kenexa reduced the number of employees who worked at Client B because Kenexa knew Client B was experiencing difficulties related to certain pharmaceutical products. Given these problems, Plaintiffs allege it was unreasonable for Defendants to include the $6 million value of Client B's contract in Kenexa's 2007 forecast. Plaintiffs also argue the forecast was false because Karsan knew EPO sales had slowed and Kenexa's international businesses were reporting revenue in a method which was not in conformity with U.S. Generally Accepted Accounting Principles (GAAP), in violation of SEC requirements.*fn3 Plaintiffs further argue Defendants engaged in insider trading during the Class Period, thereby profiting from their misrepresentations and omissions.

On August 8, 2007, following its acquisition of StraightSource, a provider of recruitment process outsourcing services, Kenexa updated its 2007 revenue estimate to $188-192 million. This slightly increased projection was troublesome, according to Plaintiffs, because the $2-3 million increase was less than the $4-7 million in projected StraightSource revenue. During the conference call reporting results from the second quarter of 2007 (Q2), Karsan reassured investors that organic growth was "solid," estimating a growth rate of 30-35% for the remainder of the year. By August 9, 2007, stock prices had dropped from $41 to $33.85. Plaintiffs assert the latter price was still artificially inflated because the August forecast was materially false.

Kenexa performed poorly in the third quarter of 2007 (Q3), with preliminary reports $2 million short of its projections. As a result, the company revised its revenue estimate for 2007 downward by $7 million. Kenexa informed investors on November 7, 2007, that there were problems with Client B, slow EPO sales, and problems with its foreign acquisitions' accounting. Stock prices immediately plummeted, declining 40% by the following day.

A month before the November disclosure, Karsan sold 37,500 shares of stock for a gain of $1.2 million. These sales were made pursuant to a Rule 10b5-1 trading plan put in place after the commencement of the Class Period. Of the five Kenexa officers, Karsan was the only one to sell stock between May 30, 2007, and the end of the Class Period, November 7, 2007.

Plaintiffs identify several non-forward looking statements made in response to Kenexa's Q1 and Q2 results which they believe create liability for Defendants. This Court finds the following statements made on May 8, 2007, or portions thereof,*fn4 to be non-forward looking:

(1) "Market demand is strong . . . ." Compl. ¶ 60 (citing Kenexa's Q1 press release).

(2) "Kenexa is benefitting from these trends [toward growing interest in talent management firms] due to our differentiated value proposition, proven ability to deliver tangible business benefits for our customers . . . ." Id. (citing Kenexa's Q1 press release).

(3) "[O]ur revenue continues to be highly visible as a result of our diverse customer base, long-term contracts, renewal rates that continue to be in the 90%-plus range, and the growing number of new customers that we are adding to our overall customer base." Compl.¶ 62 (citing Kenexa's Q1 conference call).

Plaintiffs also point to several forward-looking statements made on May 7, 2007, which they contend fall outside the scope of the PSLRA safe harbor provision so as to create liability for Defendants:

(1) "[I]nterest is growing . . . ." Compl.¶ 60 (citing Kenexa's Q1 press release).

(2) "[W]e are currently ahead of where we would target at this point in the year, and as such we will be primarily focused on optimizing sales productivity in the near term."*fn5 Compl.¶ 62 (citing Kenexa's Q1 conference call).

(3) "For the full year 2007, we are slightly increasing our revenue and profitability guidance. We now expect the following: Total revenue of $186 million to $189 million, subscription revenue to be $149 million to $152 million; non-GAAP ...


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