UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-Q





x  QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
the quarterly period ended June 30, 2009




OR




o  TRANSITION REPORT
PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
the transition period
from         to




Commission
File number 000-51358




Kenexa
Corporation


(Exact Name of Registrant
as Specified in Its Charter)





Pennsylvania
                (State
      or other jurisdiction of incorporation or organization)
              23-3024013
                (I.R.S.
      Employer Identification
Number)





650
      East Swedesford Road, Wayne, PA
                (Address
      of Principal Executive Offices)
              19087
                (Zip
      Code)





Registrant’s
Telephone Number, Including Area Code: (610) 971-9171





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes  x  No 
o





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




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


Large
Accelerated Filer  o       Accelerated
filer  x         Non-accelerated
Filer  o       Smaller
reporting company  o





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes  o   No 
x





On August
4, 2009, 22,534,755 shares of the registrant’s Common Stock, $0.01 par value,
were outstanding.










Kenexa
Corporation and Subsidiaries


FORM
10-Q


Quarter
Ended June 30, 2009


Table
of Contents





PagePART I: FINANCIAL
      INFORMATIONItem
      I: Financial StatementsConsolidated
      Balance Sheets as of June 30, 2009 (unaudited) and December 31,
      2008
                  
                  
                  3Consolidated
      Statements of Operations for the three and six months ended June 30, 2009
      and 2008 (unaudited)
                  
                  
                  4Consolidated
      Statements of Shareholders’ Equity for the six months ended June
      30, 2009 (unaudited) and the year ended December 31, 2008
                  
                  
                  5Consolidated
      Statements of Cash Flows for the six months ended June 30, 2009 and 2008
      (unaudited)
                  
                  
                  6Notes
      to Consolidated Financial Statements (unaudited)
                  
                  
                  7Item
      2: Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                  
                  
                  26Item
      3: Quantitative and Qualitative Disclosures about Market
    Risk
                  
                  
                  39Item
      4: Controls and Procedures
                  
                  
                  39PART
      II: OTHER INFORMATIONItem
      1: Legal Proceedings
                  
                  
                  40Item
      1A: Risk Factors
                  
                  
                  40Item
      2: Unregistered Sales of Equity Securities and Use of
    Proceeds
                  
                  
                  40Item
      3: Defaults Upon Senior Securities
                  
                  
                  40Item
      4: Submission of Matters to a Vote of Security Holders
                  
                  
                  41Item
      5: Other Information
                  
                  
                  41Item
      6: Exhibits
                  
                  
                  41Signatures
                  
                  
                  42Exhibit
      Index
                  
                  
                  43


2


PART
I FINANCIAL INFORMATION


Item
1: Financial Statements


Kenexa
Corporation and Subsidiaries


Consolidated
Balance Sheets


(In
thousands, except share data)





June
      30,
                  2009
                
                
                December
      31,
                  2008(unaudited)AssetsCurrent
      AssetsCash
      and cash equivalents
                
                $
                25,368
                
                
                $
                21,742Short-term
      investments
                
                
                21,837
                
                
                
                4,512Accounts
      receivable, net of allowance of doubtful accounts of $2,631 and $3,755,
      respectively
                
                
                26,966
                
                
                
                33,518Unbilled
      receivables
                
                
                6,863
                
                
                
                5,849Income
      tax receivable
                
                
                1,155
                
                
                
                1,238Deferred
      income taxes
                
                
                4,772
                
                
                
                4,615Prepaid
      expenses and other current assets
                
                
                6,473
                
                
                
                3,745Total
      Current Assets
                
                
                93,434
                
                
                
                75,219Long-term
      investments
                
                
                —
                
                
                
                16,513Property,
      plant and equipment, net of accumulated depreciation
                
                
                19,384
                
                
                
                20,175Software,
      net of accumulated amortization
                
                
                14,659
                
                
                
                11,025Goodwill
                
                
                301
                
                
                
                32,366Intangible
      assets, net of accumulated amortization
                
                
                10,301
                
                
                
                13,414Deferred
      income taxes, non-current
                
                
                39,961
                
                
                
                39,465Deferred
      financing costs, net of accumulated amortization
                
                
                —
                
                
                
                364Other
      long-term assets
                
                
                9,207
                
                
                
                9,924Total
      assets
                
                $
                187,247
                
                
                $
                218,465Liabilities
      and Shareholders’ EquityCurrent
      liabilitiesAccounts
      payable
                
                $
                5,664
                
                
                $
                6,448Notes
      payable, current
                
                
                41
                
                
                
                40Commissions
      payable
                
                
                571
                
                
                
                559Accrued
      compensation and benefits
                
                
                4,403
                
                
                
                4,010Other
      accrued liabilities
                
                
                7,230
                
                
                
                10,090Deferred
      revenue
                
                
                42,223
                
                
                
                38,638Capital
      lease obligations
                
                
                67
                
                
                
                143Total
      current liabilities
                
                
                60,199
                
                
                
                59,928Capital
      lease obligations, less current portion
                
                
                81
                
                
                
                108Notes
      payable, less current portion
                
                
                25
                
                
                
                41Deferred
      income taxes
                
                
                1,439
                
                
                
                1,789Other
      liabilities
                
                
                6
                
                
                
                63Total
      liabilities
                
                
                61,750
                
                
                
                61,929Commitments
      and ContingenciesShareholders’
      EquityPreferred
      stock, par value $0.01; 100,000 shares authorized; no shares issued
      or  outstanding
                
                
                —
                
                
                
                —Common
      stock, par value $0.01; 100,000,000 shares
      authorized;  22,534,755 and 22,504,924 shares issued and
      outstanding, respectively
                
                
                225
                
                
                
                225Additional
      paid-in-capital
                
                
                272,233
                
                
                
                269,365Accumulated  deficit
                
                
                (143,604
                )
                
                
                (110,633
                )Accumulated
      other comprehensive loss
                
                
                (3,357
                )
                
                
                (2,421
                )Total
      shareholders’ equity
                
                
                125,497
                
                
                
                156,536Total
      liabilities and shareholders’ equity
                
                $
                187,247
                
                
                $
                218,465




See
notes to consolidated financial statements.


3


Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Operations


(In
thousands, except share and per share data)


(Unaudited)





Three
      Months Ended
                  June
      30,
                
                
                Six
      Months Ended
                  June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Revenues:Subscription
                
                $
                34,041
                
                
                $
                43,668
                
                
                $
                67,306
                
                
                $
                82,824Other
                
                
                5,424
                
                
                
                12,773
                
                
                
                10,990
                
                
                
                21,824Total
      revenues
                
                
                39,465
                
                
                
                56,441
                
                
                
                78,296
                
                
                
                104,648Cost
      of revenues
                
                
                13,637
                
                
                
                17,173
                
                
                
                27,333
                
                
                
                30,278Gross
      profit
                
                
                25,828
                
                
                
                39,268
                
                
                
                50,963
                
                
                
                74,370Operating
      expenses:Sales
      and marketing
                
                
                8,241
                
                
                
                10,988
                
                
                
                16,946
                
                
                
                20,877General
      and administrative
                
                
                9,917
                
                
                
                12,845
                
                
                
                20,790
                
                
                
                24,838Research
      and development
                
                
                2,536
                
                
                
                4,307
                
                
                
                5,104
                
                
                
                8,849Depreciation
      and amortization
                
                
                3,274
                
                
                
                3,278
                
                
                
                6,502
                
                
                
                5,429Goodwill
      impairment charge
                
                
                —
                
                
                
                —
                
                
                
                33,329
                
                
                
                —Total
      operating expenses
                
                
                23,968
                
                
                
                31,418
                
                
                
                82,671
                
                
                
                59,993Income
      (loss) from operations
                
                
                1,860
                
                
                
                7,850
                
                
                
                (31,708
                )
                
                
                14,377Interest
      (expense) income, net
                
                
                (221
                )
                
                
                320
                
                
                
                (158
                )
                
                
                961Investment
      income (loss), net
                
                
                247
                
                
                
                —
                
                
                
                (48
                )
                
                
                —Income
      (loss) before income taxes
                
                
                1,886
                
                
                
                8,170
                
                
                
                (31,914
                )
                
                
                15,338Income
      tax expense
                
                
                575
                
                
                
                2,205
                
                
                
                1,057
                
                
                
                4,599Net
      income (loss)
                
                $
                1,311
                
                
                $
                5,965
                
                
                $
                (32,971
                )
                
                $
                10,739Basic
      net income (loss) per share
                
                $
                0.06
                
                
                $
                0.26
                
                
                $
                (1.46
                )
                
                $
                0.47Weighted
      average shares used to compute net income (loss) per share –
      basic
                
                
                22,526,075
                
                
                
                22,596,510
                
                
                
                22,517,737
                
                
                
                23,004,791Diluted
      net income (loss) per share
                
                $
                0.06
                
                
                $
                0.26
                
                
                $
                (1.46
                )
                
                $
                0.46Weighted
      average shares used to compute net income (loss) per share –
      diluted
                
                
                22,743,974
                
                
                
                22,819,042
                
                
                
                22,517,737
                
                
                
                23,229,123





See
notes to consolidated financial statements.


4


Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Shareholders’ Equity


(in
thousands)





Common
                                stock
                              
                              Additional
                                paid-in
                                capital
                              
                              Accumulated
                                deficit
                              
                              Accumulated
                                other
                                comprehensive
                                income
      (loss)
                              
                              Total
                                shareholders’
                                equity
                              
                              
                              Comprehensive
                                income
      (loss)Balance,
      December 31, 2007
                              
                              $
                              240
                              
                              $
                              291,942
                              
                              $
                              (5,941
                              )
                              $
                              1,407
                              
                              $
                              287,648
                              
                              
                              $
                              24,859Common
      stock repurchase
                              
                              
                              (17
                              )
                              
                              (30,260
                              )
                              
                              —
                              
                              
                              —
                              
                              
                              (30,277
                              )
                              
                              
                              —Loss
      on currency translation adjustments
                              
                              
                              —
                              
                              
                              —
                              
                              
                              —
                              
                              
                              (3,861
                              )
                              
                              (3,861
                              )
                              
                              
                              (3,861
                              )Unrealized
      gain on short-term investments
                              
                              
                              —
                              
                              
                              —
                              
                              
                              —
                              
                              
                              33
                              
                              
                              33
                              
                              
                              
                              33Share-based
      compensation expense
                              
                              
                              —
                              
                              
                              5,761
                              
                              
                              —
                              
                              
                              —
                              
                              
                              5,761
                              
                              
                              
                              —Excess
      tax benefits from share-based payment arrangements
                              
                              
                              —
                              
                              
                              169
                              
                              
                              —
                              
                              
                              —
                              
                              
                              169
                              
                              
                              
                              —Option
      exercises
                              
                              
                              1
                              
                              
                              366
                              
                              
                              —
                              
                              
                              —
                              
                              
                              367
                              
                              
                              
                              —Employee
      stock purchase plan
                              
                              
                              —
                              
                              
                              338
                              
                              
                              —
                              
                              
                              —
                              
                              
                              338
                              
                              
                              
                              —Common
      stock issuance for Straight Source earn out
                              
                              
                              1
                              
                              
                              1,049
                              
                              
                              —
                              
                              
                              —
                              
                              
                              1,050
                              
                              
                              
                              —Net
      loss
                              
                              
                              —
                              
                              
                              —
                              
                              
                              (104,692
                              )
                              
                              —
                              
                              
                              (104,692
                              )
                              
                              
                              (104,692
                              )Balance,
      December 31, 2008
                              
                              $
                              225
                              
                              $
                              269,365
                              
                              $
                              (110,633
                              )
                              $
                              (2,421
                              )
                              $
                              156,536
                              
                              
                              $
                              (108,520
                              )Loss
      on currency translation adjustments
                              
                              
                              —
                              
                              
                              —
                              
                              
                              —
                              
                              
                              (901
                              )
                              
                              (901
                              )
                              
                              
                              (901
                              )Unrealized
      loss on short-term investments
                              
                              
                              —
                              
                              
                              —
                              
                              
                              —
                              
                              
                              (35
                              )
                              
                              (35
                              )
                              
                              
                              (35
                              )Share-based
      compensation expense
                              
                              
                              —
                              
                              
                              2,695
                              
                              
                              —
                              
                              
                              —
                              
                              
                              2,695
                              
                              
                              
                              —Option
      exercises
                              
                              
                              
                              
                              
                              15
                              
                              
                              —
                              
                              
                              —
                              
                              
                              15
                              
                              
                              
                              —Employee
      stock purchase plan
                              
                              
                              —
                              
                              
                              158
                              
                              
                              —
                              
                              
                              —
                              
                              
                              158
                              
                              
                              
                              —Net
      loss
                              
                              
                              —
                              
                              
                              —
                              
                              
                              (32,971
                              )
                              
                              —
                              
                              
                              (32,971
                              )
                              
                              
                              (32,971
                              )Balance,
      June 30, 2009 (unaudited)
                              
                              $
                              225
                              
                              $
                              272,233
                              
                              $
                              (143,604
                              )
                              $
                              (3,357
                              )
                              $
                              125,497
                              
                              
                              $
                              (33,907
                              )





See
notes to consolidated financial statements.


5


Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Cash Flows


(in
thousands)


(unaudited)





Six
      months ended June,2009
                  
                  
                  2008Cash
      flows from operating activitiesNet
      (loss) income
                  
                  $
                  (32,971
                  )
                  
                  $
                  10,739Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activitiesDepreciation
      and amortization
                  
                  
                  6,502
                  
                  
                  
                  5,429Loss
      on change in fair market value of ARS and put option, net
                  
                  
                  112
                  
                  
                  
                  —Goodwill
      impairment charge
                  
                  
                  33,329
                  
                  
                  
                  —Share-based
      compensation expense
                  
                  
                  2,695
                  
                  
                  
                  3,173Excess
      tax benefits from share-based payment arrangements
                  
                  
                  —
                  
                  
                  
                  (159
                  )Amortization
      of deferred financing costs
                  
                  
                  364
                  
                  
                  
                  150Bad
      debt recoveries (expense)
                  
                  
                  (278
                  )
                  
                  
                  1,170Deferred
      income tax (benefit) expense
                  
                  
                  (1,004
                  )
                  
                  
                  942Changes
      in assets and liabilities, net of business combinationsAccounts
      and unbilled receivables
                  
                  
                  5,672
                  
                  
                  
                  (4,030
                  )Prepaid
      expenses and other current assets
                  
                  
                  (1,304
                  )
                  
                  
                  (1,695
                  )Income
      taxes receivable
                  
                  
                  83
                  
                  
                  
                  —Other
      long-term assets
                  
                  
                  56
                  
                  
                  
                  (1,865
                  )Accounts
      payable
                  
                  
                  (838
                  )
                  
                  
                  (1,480
                  )Accrued
      compensation and other accrued liabilities
                  
                  
                  582
                  
                  
                  
                  431Commissions
      payable
                  
                  
                  12
                  
                  
                  
                  (51
                  )Deferred
      revenue
                  
                  
                  3,412
                  
                  
                  
                  3,664Other
      liabilities
                  
                  
                  (59
                  )
                  
                  
                  8Net
      cash provided by operating activities
                  
                  
                  16,365
                  
                  
                  
                  16,426Cash
      flows from investing activitiesPurchases
      of plant, equipment and software
                  
                  
                  (7,361
                  )
                  
                  
                  (11,393
                  )Purchase
      of available-for-sale securities
                  
                  
                  (3,805
                  )
                  
                  
                  (22,732
                  )Sale
      of available-for-sale securities
                  
                  
                  2,316
                  
                  
                  
                  53,785Sale
      of trading securities
                  
                  
                  1,150
                  
                  
                  
                  —Investment
      in joint venture
                  
                  
                  (1,401
                  )
                  
                  
                  —Acquisitions,
      net of cash acquired
                  
                  
                  (3,693
                  )
                  
                  
                  (21,526
                  )Net
      cash released from escrow for acquisitions
                  
                  
                  —
                  
                  
                  
                  (80
                  )Net
      cash used in investing activities
                  
                  
                  (12,794
                  )
                  
                  
                  (1,946
                  )Cash
      flows from financing activitiesRepayments
      of notes payable
                  
                  
                  (16
                  )
                  
                  
                  (25
                  )Proceeds
      from common stock issued through Employee Stock Purchase
    Plan
                  
                  
                  158
                  
                  
                  
                  174Repurchase
      of common stock
                  
                  
                  —
                  
                  
                  
                  (29,842
                  )Excess
      tax benefits from share-based payment arrangements
                  
                  
                  —
                  
                  
                  
                  159Net
      proceeds from option exercises
                  
                  
                  15
                  
                  
                  
                  273Repayment
      of capital lease obligations
                  
                  
                  (98
                  )
                  
                  
                  (114
                  )Net
      cash provided by (used in) financing activities
                  
                  
                  59
                  
                  
                  
                  (29,375
                  )Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  (4
                  )
                  
                  
                  (32
                  )Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  3,626
                  
                  
                  
                  (14,927
                  )Cash
      and cash equivalents at beginning of period
                  
                  
                  21,742
                  
                  
                  
                  38,032Cash
      and cash equivalents at end of period
                  
                  $
                  25,368
                  
                  
                  $
                  23,105Supplemental
      disclosures of cash flow informationCash
      paid during the period for:Interest
      expense
                  
                  $
                  62
                  
                  
                  $
                  87Income
      taxes
                  
                  $
                  2,727
                  
                  
                  $
                  1,686Non-cash
      investing and financing activitiesCapital
      Leases
                  
                  $
                  —
                  
                  
                  $
                  253Common
      stock issuance for earn out
                  
                  $
                  —
                  
                  
                  $
                  1,050




See
notes to consolidated financial statements


6




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements - Unaudited


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





1.
Organization





Kenexa
Corporation, and its subsidiaries (collectively the "Company" or “Kenexa”),
commenced operations in 1987 as a provider of recruiting services to a wide
variety of industries. In 1993, the Company offered its first automated talent
management system. Since 1994, the Company acquired 28 businesses that enables
it to offer comprehensive human capital management, or HCM, services integrated
with web-based technology.





The
Company began its operations in August 1987, under its predecessor companies,
Insurance Services, Inc., or ISI, and International Holding
Company, Inc., or IHC. In December 1999, the Company reorganized its
corporate structure by merging ISI and IHC with and into Raymond Karsan
Associates, Inc., or RKA, a Pennsylvania corporation and a wholly owned
subsidiary of Raymond Karsan Holdings, Inc., or RKH, a Pennsylvania
corporation. Each of RKA and RKH were newly created to consolidate the
businesses of ISI and IHC. In April 2000, the Company changed its name to
TalentPoint, Inc. and changed the name of RKA to TalentPoint
Technologies, Inc. In November 2000, the Company changed its name to
Kenexa Corporation, and changed the name of TalentPoint Technologies, Inc.
to Kenexa Technology, Inc., or Kenexa Technology. Currently, Kenexa
transacts business primarily through Kenexa Technology. While the Company has
several product lines, its chief decision makers determine resource allocation
decisions and assess and evaluate periodic performance under one operating
segment.





The
Company provides business solutions for human resources. The Company’s solutions
include a comprehensive suite of On-Demand software applications and
complementary services, including outsourcing services and consulting, to help
global organizations recruit high performing individuals and to foster optimal
work environments to increase employee productivity and retention. The Company
employs a large force of organizational and industrial psychologists and
statisticians who study the science of human behavior and its impact on business
outcomes. This research is the foundation of the Company’s suite of software
applications and supporting services that enable companies to improve business
results through human resources.





2.
Summary of Significant Accounting Policies





The
accompanying consolidated financial statements as of June 30, 2009 and for the
three and six months ended June 30, 2009 and 2008 have been prepared by the
Company without audit.  In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position and the results of operations and cash flows for the six
months ended June 30, 2009 and 2008 have been made.  The results for
the three and six months ended June 30, 2009 are not necessarily indicative of
the results to be expected for the year ended December 31, 2009 or for any other
interim period.  Certain information and footnote disclosures normally
included in the Company’s annual consolidated financial statements have been
condensed or omitted and, accordingly, the accompanying financial information
should be read in conjunction with the consolidated financial statements and
notes thereto contained in the Company’s Annual Report on Form 10-K, filed with
the United States Securities and Exchange Commission for the year ended December
31, 2008.





Principles
of Consolidation





The
consolidated financial statements of the Company include the accounts of Kenexa
Corporation and its subsidiaries.  All significant intercompany
accounts and transactions have been eliminated in consolidation.





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates, and such
differences may be material to the Company’s consolidated financial
statements.


7





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Reclassifications





Certain
reclassifications have been made to the prior period consolidated financial
statements to conform to the current period
presentation.  Reclassifications to the December 31, 2008 consolidated
balance sheet include a transfer of $7,185 relating to software in development
from property and equipment to software.  Reclassifications to the
June 30, 2008 consolidated statement of cash flows include a transfer of $965
from accounts and unbilled receivables to bad debt expense.





Fair
Value of Financial Instruments





The
carrying amounts of the Company’s financial assets and liabilities, including
cash and cash equivalents, accounts receivable and accounts payable at June 30,
2009 and December 31, 2008 approximate fair value of these
instruments.





Concentration
of Credit Risk





Financial
instruments which potentially expose the Company to concentration of credit risk
consist primarily of accounts receivable. Credit risk arising from receivables
is mitigated due to the large number of customers comprising the Company's
customer base and their dispersion across various industries.  The
Company does not require collateral.  The customers are concentrated
primarily in the Company's U.S. market area.  At June 30, 2009 and
December 31, 2008, there were no customers that represented more than 10% of the
net accounts receivable balance.   For the three and six months
ended June 30, 2009 and 2008, there were no customers that individually exceeded
10% of the Company's revenues.





Cash
and Cash Equivalents





Cash and
cash equivalents consist of highly liquid investments with remaining maturities
of three months or less at the time of purchase.  Cash which is
restricted for lease deposits is included in other assets.   Cash
balances are maintained at several banks. Accounts located in the United States
are insured by the Federal Deposit Insurance Corporation ("FDIC") up to
$100,000, which has been temporarily increased to $250,000 through December 31,
2013. Certain operating cash accounts of the Company may periodically exceed the
FDIC insurance limits.





Cash and
cash equivalents in foreign denominated currencies which are held in foreign
banks at June 30, 2009 and December 31, 2008 totaled $7,451 and $6,935,
respectively, and represented 29.4% and 31.9%, respectively, of our total cash
and cash equivalents balance at the end of each period.





Foreign
Currency Translation





The
financial position and operating results of the Company’s foreign operations are
consolidated using the local currency as the functional currency. Local currency
assets and liabilities are translated at the rate of exchange to the U.S. dollar
on the balance sheet date, and the local currency revenues and expenses are
translated at average rates of exchange to the U.S. dollar during the period.
The related translation adjustments are reported in the shareholders’ equity
section of the consolidated balance sheet and resulted in a net reduction in
shareholders’ equity of $901 and $3,861 for the periods ended June 30, 2009 and
December 31, 2008, respectively.  The foreign currency translation
adjustment is not adjusted for income taxes as it relates to an indefinite
investment in a non-U.S. subsidiary.





Comprehensive
income (loss)





Comprehensive
income (loss) consists of net changes on foreign currency translations and
unrealized gains and losses on available-for-sale investment securities in
addition to reported net loss.


8





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Software
Developed for Internal Use





In
accordance with EITF 00-3, "Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software Stored on
Another Entity's Hardware", the Company applies AICPA Statement of
Position No. 98-1, “Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use”. The costs
incurred in the preliminary stages of development are expensed as incurred. Once
an application has reached the development stage, internal and external costs,
if direct and incremental, are capitalized until the software is substantially
complete and ready for its intended use. Capitalization ceases upon completion
of all substantial testing. The Company also capitalizes costs related to
specific upgrades and enhancements when it is probable the expenditures will
result in additional functionality. Maintenance and training costs are expensed
as incurred. Internal use software is amortized on a straight-line basis over
its estimated useful life, generally three years. Management evaluates the
useful lives of these assets on an annual basis and tests for impairments
whenever events or changes in circumstances occur that could impact the
recoverability of these assets. There were no impairments to internal software
in any of the periods covered in these consolidated financial
statements.





The
Company capitalized internal-use software costs for the six month period of June
30, 2009 and the year ended December 31, 2008 of $5,526 and $8,137,
respectively. Amortization of capitalized internal-use software costs for the
six months ended June 30, 2009 and 2008 was $1,711 and $492,
respectively.





Investments





Investments
at June 30, 2009 and December 31, 2008 include floating rate letter of credit
backed securities and municipal bonds.  The maturities of these
securities range from one day to one year and are rated A to AAA by various
rating agencies.  The floating rate letter of credit backed securities
and municipal bonds are recorded at fair value based on current market rates and
are classified as available-for-sale.  Changes in the fair value are
included in accumulated other comprehensive loss in the accompanying
consolidated financial statements.





Investments
at June 30, 2009 and December 31, 2008 also include auction rate securities
which were originally purchased with ratings ranging from A to AAA by various
rating agencies.  The auction rate securities are recorded at fair
value using the discounted cash flow model and are classified as trading
securities.  Changes in the fair value are included in the statement
of operations in the accompanying consolidated financial
statements.  Both the cost and realized gains and losses of these
securities are calculated using the specific identification method.





Investment
income (loss)





Investment
income (loss) as presented in the following table includes changes in the fair
value of auction rate securities and put option related to the UBS Settlement
Agreement, net and investment in joint ventures:





Three
      months ended
                      June
      30, 2009
                    
                    
                    Six
      months ended
                      June
      30,2009Gain
      (loss) on auction rate securities and put option, net
                    
                    $
                    183
                    
                    
                    $
                    (112
                    )Income
      from investment in joint venture
                    
                    
                    64
                    
                    
                    
                    64Investment
      income (loss), net
                    
                    $
                    247
                    
                    
                    $
                    (48
                    )


9





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Prepaid
Expenses and Other Current Assets





Prepaid
expenses and other current assets consist primarily of prepaid software
maintenance agreements, deferred implementation costs, UBS Settlement
Agreement and other current assets. Deferred implementation costs represent
internal payroll and other costs incurred in connection with the customization
of the sites associated with our internet hosting arrangements. These costs are
deferred over the implementation period which precedes the hosting period,
typically three to four months, and are expensed ratably when the hosting period
commences, typically four to five years.





Other
Long-Term Assets





Other
long-term assets for June 30, 2009 and December 31, 2008 are as
follows:





June
      30,
                    2009
                  
                  
                  December
      31,
                    2008Acquisition
      related escrow balances (1)
                  
                  $
                  1,440
                  
                  
                  $
                  1,440Investment
      in joint ventures
                  
                  
                  1,449
                  
                  
                  
                  —Security
      deposits
                  
                  
                  1,662
                  
                  
                  
                  1,966Deferred
      implementation costs
                  
                  
                  4,376
                  
                  
                  
                  3,314Fair
      value of put option (“UBS Settlement Agreement”)
                  
                  
                  —
                  
                  
                  
                  2,219Other
      long-term assets
                  
                  
                  280
                  
                  
                  
                  985Total
      other long-term assets
                  
                  $
                  9,207
                  
                  
                  $
                  9,924





(1)
            Upon
      completion of the escrow term and settlement of any outstanding claims,
      all remaining escrow balances are reclassified to additional purchase
      consideration for the respective
acquisition.





Self-Insurance





The
Company is self-insured for the majority of its health insurance costs,
including claims filed and claims incurred but not reported subject to certain
stop loss provisions. The Company estimated the liability based upon
management's judgment and historical experience. At June 30, 2009 and
December 31, 2008, self-insurance accruals totaled $497 and $560,
respectively.  Management continuously reviews the adequacy of the
Company's stop loss insurance coverage. Material differences may result in the
amount and timing of health insurance expense if actual experience differs
significantly from management's estimates.


10





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Goodwill





On
January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, “Goodwill and Other Intangible
Assets” ("SFAS 142"), which superseded Accounting Principles Board
Opinion No. 17, “Intangible Assets”. Upon
adoption of SFAS 142, the Company ceased amortization of existing goodwill
and is required to annually review the carrying value of goodwill for
impairment. Prior to 2007, the Company evaluated the carrying value of its
goodwill under two reporting units within its single segment.  During
2007, the Company combined those two reporting units into a single reporting
unit to be in alignment with its organizational and management structure which
was evaluated and restructured as part of the integration of our acquired
businesses.  As a result of the change, the Company now evaluates
goodwill at the enterprise or Company level.




Due to a
downward revision in internal projections and continued adverse changes in the
economic climate, the Company experienced a 32.5% decline in its market
capitalization from December 31, 2008 through March 31,
2009 which signified a triggering event and required the determination
as to whether and to what extent the Company’s goodwill may have been impaired
as of March 31, 2009.  The Company completed its goodwill impairment
analysis during the quarter ended March 31, 2009.




The first
step of this analysis requires the estimation of fair value of the Company and
is calculated primarily based on the observable market capitalization with a
range of estimated control premiums as well as discounted future estimated cash
flows. This step yielded an estimated fair value of the Company which was less
than the Company’s carrying value (including goodwill) at March 31, 2009. The
next step entails performing an analysis to determine whether the carrying
amount of goodwill on the Company’s balance sheet exceeds its implied fair
value. The implied fair value of the Company’s goodwill for this step was
determined in a similar manner as goodwill recognized in a business combination.
That is, the estimated fair value of the Company was allocated to its assets and
liabilities, including any unrecognized identifiable intangible assets, as if
the Company had been acquired in a hypothetical business combination with the
estimated fair value of the Company representing the price paid to acquire it.
The allocation process performed on the test date was only for purposes of
determining the implied fair value of goodwill with no assets or liabilities
written up or down, nor any additional unrecognized identifiable intangible
assets recorded as part of this process. Based on the analysis, management
recorded a goodwill impairment charge of $33,329 for the quarter ended March 31,
2009 to write off the remaining balance of its goodwill. The goodwill impairment
charge had no effect on the Company’s cash balances.





The
changes in the carrying amount of goodwill, which include adjustments for
earnouts, taxes and escrow adjustments, acquisitions and impairment charges, for
the period ended June 30, 2009 and the year ended December 31, 2008 are as
follows:





Balance
      as of December 31, 2007
                    
                    $
                    173,502Acquisitions
      or adjustments:ScottWorks
                    
                    
                    85Webhire
                    
                    
                    311Knowledge
      Workers
                    
                    
                    100Gantz
      Wiley Research
                    
                    
                    398BrassRing
                    
                    
                    (121
                    )Psychometrics
      Services Ltd.
                    
                    
                    3,383StraightSource
                    
                    
                    6,051HRC
      Human Resources Consulting GmbH
                    
                    
                    330Quorum
      (2008 acquisition)
                    
                    
                    15,338Impairment
      charge
                    
                    
                    (167,011
                    )Balance
      as of December 31, 2008
                    
                    $
                    32,366Acquisitions
      or adjustments:StraightSource
                    
                    
                    125HRC
      Human Resources Consulting GmbH
                    
                    
                    195Quorum
                    
                    
                    944Impairment
      charge
                    
                    
                    (33,329
                    )Balance
      as of June 30, 2009
                    
                    $
                    301


11


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Revenue
Recognition





The
Company derives its revenue from two sources: (1) subscription revenue for
solutions, which is comprised of subscription fees from customers accessing the
Company’s on-demand software, consulting services, outsourcing services and
proprietary content, and from customers purchasing additional support beyond the
standard support that is included in the basic subscription fee; and
(2) other fees for discrete professional services. Because the Company
provides its solution as a service, the Company follows the provisions of
Securities and Exchange Commission Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial
Statements”, as amended by Staff Accounting Bulletin No. 104, “Revenue Recognition”. On
August 1, 2003, the Company adopted Emerging Issues Task Force Issue
No. 00-21, “Revenue
Arrangements with Multiple Deliverables”. The Company recognizes revenue
when all of the following conditions are met:





•
            There
      is persuasive evidence of an
arrangement;





•
            The
      service has been provided to the
customer;





•
            The
      collection of the fees is probable;
and





•
            The
      amount of fees to be paid by the customer is fixed or
      determinable.





Subscription
fees and support revenues are recognized on a monthly basis over the lives of
the contracts. Amounts that have been invoiced are recorded in accounts
receivable and in deferred revenue or revenue, depending on whether the revenue
recognition criteria have been met.





Discrete
professional services and other revenues, when sold with subscription and
support offerings, are accounted for separately since these services have value
to the customer on a stand-alone basis and there is objective and reliable
evidence of fair value of the delivered elements. The Company's arrangements do
not contain general rights of return.  Additionally, when professional
services are sold with other elements, the consideration from the revenue
arrangement is allocated among the separate elements based upon the relative
fair value.  Professional services and other revenues are recorded as
follows: Consulting revenues are recognized upon completion of the contracts
that are of short duration (generally less than 60 days) and as the
services are rendered for contracts of longer duration.





In
determining whether revenues from professional services can be accounted for
separately from subscription revenue, the Company considers the following
factors for each agreement: availability from other vendors, whether objective
and reliable evidence of fair value exists of the undelivered elements, the
nature and the timing of when the agreement was signed in comparison to the
subscription agreement start date and the contractual dependence of the
subscription service on the customer's satisfaction with the other services. If
the professional service does not qualify for separate accounting, the Company
recognizes the revenue ratably over the remaining term of the subscription
contract. In these situations the Company defers the direct and incremental
costs of the professional service over the same period as the revenue is
recognized.





Deferred
revenue represents payments received or accounts receivable from the Company's
customers for amounts billed in advance of subscription services being
provided.





The
Company records expenses billed to customers in accordance with Emerging Issues
Task Force Issue No. 01-14 "Out-of-Pocket' Expenses
Incurred”, which requires that reimbursements received for out-of-pocket
expenses be classified as revenues and not as cost reductions.  These
items primarily include travel, meals and certain telecommunication costs. For
the three and six months ended June 30, 2009 and 2008 reimbursed expenses
totaled $537 and $1,067 and $1,518 and $2,121, respectively.





Guarantees





The
Company’s software license agreements typically provide for indemnifications of
customers for intellectual property infringement claims.  The Company
also warrants to customers, when requested, that the Company’s software products
operate substantially in accordance with standard specifications for a limited
period of time.  The Company has not incurred significant obligations
under customer indemnification or warranty provisions historically, and does not
expect to incur significant obligations in the future.  Accordingly,
the Company does not maintain accruals for potential customer indemnification or
warranty-related obligations.


12


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Earnings
(Loss) Per Share





The
Company follows SFAS 128, "Earnings Per
Share."  Under SFAS 128, companies that are publicly held
or have complex capital structures are required to present basic and diluted
earnings per share on the face of the statement of operations.  Earnings
(loss) per share is based on the weighted average number of shares and
common stock equivalents outstanding during the period.  In the
calculation of diluted earnings per share, shares outstanding are adjusted to
assume conversion of the Company's non-interest bearing convertible stock and
the exercise of options if they are dilutive.  In the calculation of
basic earnings per share, weighted average numbers of shares outstanding are
used as the denominator.  The common stock equivalents of stock
options issued and outstanding were not included in the computation of diluted
earnings per share for the period then ended as they were antidilutive and are
presented in the table below.




Basic and
diluted earnings (loss) per share are computed as follows:





Three
      months ended
                      June
      30,
                    
                    
                    Six
      months ended
                      June
      30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Numerator:Net
      income (loss)
                    
                    $
                    1,311
                    
                    
                    $
                    5,965
                    
                    
                    $
                    (32,971
                    )
                    
                    $
                    10,739Denominator:Weighted
      average shares used to compute net income (loss) per common share -
      basic
                    
                    
                    22,526,075
                    
                    
                    
                    22,596,510
                    
                    
                    
                    22,517,737
                    
                    
                    
                    23,004,791Effect
      of dilutive stock options
                    
                    
                    217,899
                    
                    
                    
                    222,532
                    
                    
                    
                    —
                    
                    
                    
                    224,332Weighted
      average shares used to compute net income (loss) per common share –
      dilutive
                    
                    
                    22,743,974
                    
                    
                    
                    22,819,042
                    
                    
                    
                    22,517,737
                    
                    
                    
                    23,229,123Basic
      net income (loss) per share
                    
                    $
                    0.06
                    
                    
                    $
                    0.26
                    
                    
                    $
                    (1.46
                    )
                    
                    $
                    0.47Diluted
      net income (loss) per share
                    
                    $
                    0.06
                    
                    
                    $
                    0.26
                    
                    
                    $
                    (1.46
                    )
                    
                    $
                    0.46Total
      antidilutive stock options issued and outstanding
                    
                    
                    1,968,056
                    
                    
                    
                    308,400
                    
                    
                    
                    2,525,056
                    
                    
                    
                    498,400


13





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





2.
Summary of Significant Accounting Policies (Continued)





Share-based
Compensation Expense





On
January 1, 2006, the Company adopted SFAS No. 123R, “Share-based payment” (“SFAS
123R”) using the Modified Prospective Approach (“MPA”). The MPA requires that
compensation expense be recorded for restricted stock and all unvested stock
options as of January 1, 2006.  Following the adoption the Company
recognized the cost of previously granted share-based awards under the
straight-line basis over the remaining vesting period.  The
compensation expense for new share-based awards with a service condition that
cliff vest, is recognized on a straight-line basis over the award’s requisite
service period.  For those awards with a service condition that have
graded vesting, compensation expense is calculated using the graded-vesting
attribution method.   This method entails recognizing expense on
a straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.  The pool
of excess tax benefits available to absorb tax deficiencies was determined using
the alternative transition method described in FSP FAS 123(R)-3.





The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that results in a factor applied to the fair
market value of the Company's common stock on the date of the grant (measurement
date), and is recognized over a four year explicit service period using the
straight-line method.  Since the award requires both the completion of four
years of service and the share price reaching predetermined levels as defined in
the option agreement, compensation cost will be recognized over the four year
explicit service period.  If the employee terminates prior to the
four-year requisite service period, compensation cost will be reversed even if
the market condition has been satisfied by that time.




Adoption
of new accounting pronouncements





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement”
(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring
fair value, and also expands disclosures about fair value measurements. SFAS 157
is effective for periods beginning after November 15, 2007. The Company
adopted this standard with respect to its financial assets effective
January 1, 2008. In February 2008, the FASB issued FASB Staff Position SFAS
No. 157-2 – “Effective
Date of FASB Statement No. 157” delaying the effective date of SFAS
157 for one year for all nonfinancial assets and nonfinancial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). See Footnote 3 of the Notes
to the Consolidated Financial Statements for further detail regarding the impact
of our adoption of SFAS 157 for financial assets.





In
February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an Amendment of FASB Statement
No. 115” (“SFAS 159”). SFAS 159 permits the Company to
choose to measure many financial instruments and certain other items at fair
value. The Company adopted SFAS 159 as of January 1, 2008. The
adoption of SFAS 159 did not impact the Company’s consolidated financial
statements on the date of adoption.  However, during the fourth
quarter of 2008, the Company elected to measure at fair value the put option
related to its UBS Settlement Agreement.


14




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)




2.
Summary of Significant Accounting Policies (Continued)





New
Accounting Pronouncements





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events”
(“SFAS 165”). SFAS 165 is intended to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. It
requires the disclosure of the date through which an entity has evaluated
subsequent events and the basis for selecting that date, that is, whether that
date represents the date the financial statements were issued or were available
to be issued. SFAS 165 is effective for interim or annual financial periods
ending after June 15, 2009. The Company has evaluated SFAS 165 and has
determined that it will not have a significant impact on the determination or
reporting of our financial results.




In April
2009, the FASB issued FSP FAS 141R-1 which amends SFAS 141R by establishing a
model to account for certain pre-acquisition contingencies. Under the FSP, an
acquirer is required to recognize at fair value an asset acquired or a liability
assumed in a business combination that arises from a contingency if the
acquisition-date fair value of that asset or liability can be determined during
the measurement period. If the acquisition-date fair value cannot be determined,
then the acquirer should follow the recognition criteria in SFAS No. 5,
“Accounting for
Contingencies”, and FASB Interpretation No. 14, “Reasonable Estimation of the Amount
of a Loss – an interpretation of FASB Statement
No. 5”. In the first quarter of 2009 we adopted SFAS
No. 141R and FSP FAS 141R-1 and will apply the provisions of SFAS 141R
and FSP FAS 141R-1 when applicable.




In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value
of Financial Instruments,” which requires the fair value for all
financial instruments within the scope of SFAS No. 107, “Disclosures about Fair Value of
Financial Instruments,” to be disclosed in the interim periods as well as
in annual financial statements. This standard is effective as and for the
quarter ending June 30, 2009.





In May
2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”).  SFAS 162 is intended
to improve financial reporting by identifying a consistent framework, or
hierarchy, for selecting the principles used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with
GAAP. This statement shall be effective 60 days following the Securities
and Exchange Commission’s approval of the Public Company Accounting Oversight
Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles”. The Company is
evaluating the impact of this standard and does not expect the adoption of
SFAS 162 to have a material impact on the Company’s financial
statements.





In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement 133”
(“SFAS 161”).  SFAS 161 amends and expands the disclosure
requirements of SFAS 133 with the intent to provide users of financial
statements with an enhanced understanding of: (i) How and why an entity
uses derivative instruments; (ii) How derivative instruments and related
hedged items are accounted for under SFAS 133 and its related
interpretations and (iii) How derivative instruments and related hedged
items affect an entity’s financial position, financial performance and cash
flows. This statement is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early
application encouraged.





In
December 2007, the FASBissued SFAS No.
141(R),“Business
Combinations”("FAS 141(R)")and SFAS No. 160,“Accounting and Reporting of
Noncontrolling Interests in Consolidated Financial Statements, an amendment of
Accounting Research Bulletin No. 51” ("FAS 160"). Changes for business
combination transactions pursuant to FAS 141(R) include, among others, expensing
of acquisition-related transaction costs as incurred, the recognition of
contingent consideration arrangements at their acquisition date fair value and
capitalization of in-process research and development assets acquired at their
acquisition date fair value. Changes in accounting for noncontrolling (minority)
interests pursuant to FAS 160 include, among others, the classification of
noncontrolling interest as a component of consolidated shareholders’ equity and
the elimination of "minority interest" accounting in results of operations. FAS
141(R) and FAS 160 are required to be adopted simultaneously and are effective
for fiscal years beginning on or after December 15, 2008. The adoption of FAS
141(R) will impact the accounting for the Company's future
acquisitions.  The adoption of FAS 160 did not have a material impact
on our consolidated financial position, results of operations or cash
flows.


15





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





3.  Investments





Short-term
investments for the period ended June 30, 2009 and December 31, 2009 consisted
of the following securities:





June
      30,
                      2009
                    
                    
                    December
      31,
                      2008Municipals
      securities
                    
                    $
                    5,967
                    
                    
                    $
                    4,512Auction
      rate securities
                    
                    
                    15,870
                    
                    
                    
                    —Total
      short-term investments
                    
                    $
                    21,837
                    
                    
                    $
                    4,512





During
the six months ended June 30, 2009, the Company continued to experience failed
auctions for thirteen tax exempt auction rate securities (“ARS”) issues
representing principal of $15,870.  Nine of these ARS are guaranteed by the
Family Federal Educational Loan Program with the remainder being insured by
private issuers. Due to the ability to liquidate its ARS issues, in accordance
with the arrangement discussed below, within the next twelve months, the Company
has reclassified these investments to short-term assets as of June 30,
2009.  These securities will continue to accrue interest at the contractual
rate and will be auctioned at preset intervals.




The ARS,
which have a par value of $17,425 at June 30, 2009, were acquired through UBS
AG. Due to the failure of the auction rate market in early 2008, UBS AG and
other major banks entered into discussions with government agencies to provide
liquidity to owners of auction rate securities. In November 2008, we entered
into an agreement (the “UBS Settlement Agreement”) with UBS AG which provides
(1) the Company with a “no net cost” loan up to the par value of Eligible ARS
until June 30, 2010, and  (2) the Company the right to sell these
auction rate securities back to UBS AG at par, at the Company’s sole discretion,
any time during the period from June 30, 2010 through July 2, 2012,
and (3) UBS AG the right to purchase these auction rate securities or sell
them on the Company’s behalf at par anytime through July 2,
2012.   As a result of the execution of the USB Settlement Agreement,
the Company determined that it no longer had the intent and ability to hold the
ARS until maturity or until the ARS market would recover.  Based on this
unusual circumstance related to the signing of the UBS Settlement Agreement, the
Company transferred these investments from available–for-sale to trading
securities and began recording the change in fair value of the ARS as gains or
losses in current period operations.




Also,
during the fourth quarter of 2008, the Company elected to measure the value of
its option to put the securities (“put option”) to UBS AG under the fair value
option of SFAS No. 159.   As a result, at December 31, 2008, the
Company recorded a non-operating gain representing the estimated fair value of
the put option and a corresponding long-term asset of approximately
$2,219.   At June 30, 2009, the put option’s estimated fair value
decreased to $1,444, resulting in a non-operating loss of $214 during the
quarter.  The estimated fair value of the put option as of June 30, 2009
was based in part on an expected life of twelve months and a discount rate of
2.81%.   As a result of the transfer of the ARS from
available-for-sale to trading investment securities noted above, the Company
also recorded a non-operating gain during the three and six months ended June
30, 2009 representing an increase in their estimated fair value of approximately
$397 and $664, respectively.   The recording of the gain relating to
the increase in the fair value of the ARS and the recognition of the loss on the
put option resulted in an overall net gain of approximately $183 for the three
months ended June 30, 2009 and a net loss of approximately $112 for the six
months ended June 30, 2009.




The
Company adjusted the fair value of its ARS investment portfolio using a
discounted cash flow model to determine the estimated fair value of its ARS
investments as of June 30, 2009.  The assumptions used in preparing the
discounted cash flow model include level three inputs, as defined in SFAS No.
157, Fair Value Measurements, and are presented in the following
table:





AmountsMaximum
      auction rate (interest rate)
                  
                  
                  2.19
                  %Liquidity
      risk premium
                  
                  
                  5.00
                  %Probability
      of earned maximum rate until maturity
                  
                  
                  0.17
                  %Probability
      of default
                  
                  
                  21.39
                  %





Based on
the results of the discounted cash flow analysis, the Company determined that
the fair value of its investment in its ARS should be discounted from par value
by approximately $1,555 to $15,870 at June 30, 2009.


16





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





3.  Investments (Continued)





The
Company adopted the provisions of SFAS 157 effective January 1, 2008. Under
this standard, fair value is defined as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.  The Company has investments
that are valued in accordance with the provisions of SFAS 157.  SFAS 157
establishes a hierarchy for inputs used in measuring fair value that maximizes
the use of observable inputs and minimizes the use of unobservable inputs by
requiring that the most observable inputs be used when available. The hierarchy
is broken down into three levels based on the reliability of inputs as
follows:





Level 1 -
Valuations based on quoted prices in active markets for identical assets that
the Company has the ability to access.





Level 2 -
Valuations based inputs on other than quoted prices included within Level 1, for
which all significant inputs are observable, either directly or
indirectly.





Level 3 -
Valuations based on inputs that are unobservable and significant to the overall
fair value measurement.




The fair
value for the Company’s municipal investments on June 30, 2009 and December 31,
2008 of $5,967 and $4,512, respectively, was determined based upon quoted prices
in active markets for identical assets or Level 1 inputs.  The fair
value of the Company’s auction rates securities on June 30, 2009 and December
31, 2008 of $15,870 and $16,513, respectively, was determined based upon
significant unobservable inputs or Level 3 inputs.





A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
June 30, 2009 is presented below:





Auction
      rate
                      securitiesBalance
      at December 31, 2008
                    
                    $
                    16,513Total
      net realized gainsIncluded
      in earnings
                    
                    
                    664Settlements
                    
                    
                    (1,307
                    )Balance
      at June 30, 2009
                    
                    $
                    15,870





A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
June 30, 2008 is presented below:





Auction
      rate
                      securitiesBalance
      at December 31, 2007
                    
                    $
                    29,900Total
      net realized lossesIncluded
      in earnings
                    
                    
                    603Included
      in accumulated other comprehensive loss
                    
                    
                    (1,268
                    )Settlements
                    
                    
                    (8,369
                    )Balance
      at June 30, 2008
                    
                    $
                    20,866





Based on
the size of this investment, the Company’s ability to access cash and other
short-term investments, and expected operating cash flows, the Company does not
anticipate the illiquidity of this investment will affect its
operations.


17


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





4. Acquisitions





Quorum
International Holdings Limited





On April
2, 2008, the Company acquired all of the outstanding stock of Quorum
International Holdings Limited (“Quorum”), a provider of recruitment process
outsourcing services based in London, England, for a purchase price of
approximately $27,950, in cash, of which $19,753 was paid in April 2008 and
$8,197 was paid in July 2008.  The total cost of the acquisition,
including legal, accounting, and other fees of $1,037, was approximately
$28,987, including acquired intangibles of $8,633, with estimated useful lives
between 3 and 10 years.  In addition, the acquisition agreement
contains an earn out provision which provides for the payment of additional
consideration by the Company based upon the gross profit of Quorum for the
twelve month periods ending June 30, 2009 and June 30, 2010. 
Formulaically, the earnout is 3.86 times Quorum’s gross profit less the amount
of base consideration, as defined in the agreement.  Pursuant to SFAS No
141, “Business
Combinations,” the Company accrues contingent purchase consideration when
the outcome of the contingency is determinable beyond a reasonable
doubt.  Based upon the results for the twelve month period through
June 30, 2009, it was determined that no earnout payment was due to the former
shareholders of Quorum for the June 2009 payment.  In addition, as of
June 30, 2009, the June 30, 2010 earnout amount was substantially uncertain,
and, as such, the estimated earn out range is not possible to
disclose.  The Company evaluates the earnout provisions contained in
the acquisition agreement at each financial statement reporting date.  In
connection with the acquisition, $780 of the purchase price was deposited into
an escrow account and recorded in other long-term assets, to cover any claims
for indemnification made by the Company against Quorum under the acquisition
agreement.  The escrow agreement will remain in place for
approximately two years from the acquisition date, and any funds remaining in
the escrow account at the end of the two year period will be distributed to the
former stockholders of Quorum.  The Company expects that the
acquisition of Quorum will broaden our presence in the global recruitment
market.  The purchase price and related purchase price allocations
have been allocated to the assets acquired and liabilities assumed based upon
management’s best estimate of fair value with any excess over the net tangible
and intangible assets acquired allocated to goodwill.  Quorum’s
results of operations were included in the Company’s consolidated financial
statements beginning on April 2, 2008.





5.
Joint Venture Agreement





On
January 20, 2009, the Company entered into an ownership interest transfer
agreement with Shanghai Runjie Management Consulting Company, (“R and J”) in
Shanghai, China for $1,357.  The initial investment provided the
Company with a 46% ownership in the new entity Shanghai Kenexa Human Resources
Consulting Co., Ltd., (the “joint venture”) and a presence in China’s growing
human capital management market.  Based upon the adjusted EBITDA, as
defined in the agreement, for each of the years ended 2008, 2009 and 2010, the
Company will acquire an additional 1% ownership per year for each of the years
ended 2009, 2010 and 2011 in the joint venture.





The
additional ownership in the joint venture in 2009 will be determined as the
greater of 1) the amount of registered capital attributable to a 1% ownership or
2) an amount denominated in Chinese Yuan Renminbi (“RMB¥”) equal to the result
of 47% times four and one half times the Adjusted EBITDA of the joint venture
for the calendar year ended December 31, 2008, plus 1% of the joint venture’s
free cash flow as of March 31, 2008, minus the amount of the initial investment
or RMB¥ 8,145.  The additional ownership investment for 2010 and 2011
is determined formulaically the same as above and adjusted only for any increase
in ownership.





18





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





6.
Property, Plant, Equipment and Software





A summary
of property, plant, equipment and software and related accumulated depreciation
and amortization as of June 30, 2009 and December 31, 2008 is as
follows:





June
      30, 2009
                    
                    
                    December
      31, 2008Equipment
                    
                    $
                    15,781
                    
                    
                    $
                    15,112Purchased
      Software
                    
                    
                    5,516
                    
                    
                    
                    5,099Software
      in development
                    
                    
                    2,468
                    
                    
                    
                    7,185Software
      developed
                    
                    
                    18,214
                    
                    
                    
                    8,900Office
      furniture and fixtures
                    
                    
                    2,421
                    
                    
                    
                    2,370Leasehold
      improvements
                    
                    
                    2,743
                    
                    
                    
                    2,744Land
                    
                    
                    680
                    
                    
                    
                    643Building
                    
                    
                    7,360
                    
                    
                    
                    6,77155,183
                    
                    
                    
                    48,824Less
      accumulated depreciation and amortization
                    
                    
                    21,140
                    
                    
                    
                    17,624$
                    34,043
                    
                    
                    $
                    31,200





Depreciation
and amortization expense is excluded from cost of revenues.





Equipment
and office furniture and fixtures included assets under capital leases totaling
$2,612 at June 30, 2009 and December 31, 2008. Depreciation and amortization
expense, including amortization of assets under capital leases, was $4,360 and
$3,090 for the six months ended June 30, 2009 and 2008,
respectively.




Pursuant
to SFAS No. 144, the Company reviewed its fixed assets and determined that the
fair value exceeded the carrying value, and therefore did not record any fixed
asset impairment.





7.
Other Accrued Liabilities





Other
accrued liabilities consist of the following:





June
      30, 2009
                      
                      
                      December
      31, 2008Accrued
      professional fees
                      
                      $
                      200
                      
                      
                      $
                      131Straight
      line rent accrual
                      
                      
                      1,957
                      
                      
                      
                      1,904Other
      taxes payable (non-income tax)
                      
                      
                      704
                      
                      
                      
                      450Income
      taxes payable
                      
                      
                      3,541
                      
                      
                      
                      3,549Other
      liabilities
                      
                      
                      828
                      
                      
                      
                      1,056Contingent
      purchase price
                      
                      
                      —
                      
                      
                      
                      3,000Total
      other accrued liabilities
                      
                      $
                      7,230
                      
                      
                      $
                      10,090





8.
Line of Credit





On May
21, 2009, based upon its current liquidity needs, the Company elected not
to renew its secured credit agreement with PNC Bank, as administrative
agent, and several other lenders named therein (the “Credit Agreement”). The
Credit Agreement, which became effective November 13, 2006, provided (i) a $50
million revolving credit facility, including a sublimit of up to $2 million for
letters of credit and (ii) a $50 million term loan.  The Company and
each of its U.S. subsidiaries guaranteed the obligations of the Company under
the Credit Agreement.  The Credit Agreement also required the Company
to pay a monthly commitment fee based on the unused portion of the revolving
credit facility.  At May 21, 2009, the Company had no outstanding
balance on the Credit Agreement. Unless renewed, the Credit Agreement would have
expired on its own terms on March 26, 2010.  No early termination
penalties were incurred in connection with the termination of the Credit
Agreement.  In connection with the termination of the Credit
Agreement, the Company wrote off $289 of deferred financing fees during the
quarter ended June 30, 2009.  As a result of the termination of the
Credit Agreement, the Company does not have a revolving credit facility or other
debt financing arrangement.


19


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





9.
Commitments and Contingencies





Litigation





On June
11, 2009 and July 16, 2009, two putative class actions were filed against us and
our Chief Executive Officer and Chief Financial Officer in the United States
District Court for the Eastern District of Pennsylvania, purportedly on behalf
of a class of our investors who purchased our publicly traded securities between
May 8, 2007 and November 7, 2007.  The complaints in these actions
generally allege violations of Section 10(b) of the Securities Exchange Act of
1934 (“Exchange Act”), Rule 10b-5 promulgated thereunder and Section 20(a) of
the Exchange Act in connection with various public statements made by
us.  Pursuant to the Private Securities Litigation Reform Act, any
member of the purported class who wishes to be appointed “lead plaintiff” must
file a motion seeking such designation on or before August 10,
2009.  According to the Court’s current scheduling order, a hearing
regarding the appointment of lead plaintiff will take place on September 9,
2009; whoever is appointed lead plaintiff will have until September 30, 2009 to
file an amended complaint; and defendants will have until October 21, 2009 to
file their response to the complaint.  We intend to vigorously defend
these actions.  The potential impact of these actions, which seek
unspecified damages, attorneys fees and expenses, is uncertain.





The
Company is also involved in claims, including those identified above, which
arise in the ordinary course of business. In the opinion of management, the
Company has made adequate provision for potential liabilities, if any, arising
from any such matters.





Litigation
is inherently unpredictable, and the costs and other effects of pending or
future litigation, governmental investigations, legal and administrative cases
and proceedings (whether civil or criminal), settlements, judgments and
investigations, claims and changes in any such matters, could have a material
adverse effect on the Company’s business, financial condition and operating
results.





10.
Equity





Rollforward
of Shares





The
Company’s common shares issued and repurchased for the six months ended June 30,
2009 and the year ended December 31, 2008 are as follows:





Class
      A
                      Common
      SharesDecember
      31, 2007 ending balance
                    
                    
                    24,032,446Repurchase
      of common shares
                    
                    
                    (1,677,560
                    )Stock
      option exercises
                    
                    
                    67,021Employee
      stock purchase plan
                    
                    
                    27,141Shares
      issued for acquisition
                    
                    
                    55,876December
      31, 2008 ending balance
                    
                    
                    22,504,924Stock
      option exercises
                    
                    
                    3,200Employee
      stock purchase plan
                    
                    
                    26,631June
      30, 2009 ending balance
                    
                    
                    22,534,755





Refer to
the accompanying consolidated statements of shareholders’ equity and this note
for further discussion.


20





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





10.
Equity (continued)





Authorized
but not issued shares





On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3,000,000 shares of the Company’s common
stock, of which 1,125,651 shares were repurchased at an aggregate cost of
$20,429 as of June 30, 2009.  These shares were restored to original
status prior to December 31, 2008 and accordingly are presented as authorized
but not issued.  The timing, price and volume of repurchases were
based on market conditions, relevant securities laws and other
factors.  As of June 30, 2009, the amount of shares available for
repurchase under the stock repurchase plan was 1,874,349.




On
November 8, 2007, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 2,000,000 shares of our common stock,
of which 1,448,091 shares were repurchased at an aggregate cost of $25,482 as of
December 31, 2007. These shares were restored to original status and
accordingly are presented as authorized but not issued.  In
January 2008, the remaining 551,909 shares available for repurchase under
this stock repurchase plan were repurchased at an aggregate cost of
$9,848.





11.
Stock Plans





Stock
Option Plan





The
Company’s 2005 Equity Incentive Plan (the “2005 Option Plan”), which was adopted
by the Company’s Board of Directors (the “Board”) in March 2005 and was approved
by the Company’s shareholders in June 2005, provides for the granting of stock
options to employees and directors at the discretion of the Board or a committee
of the Board.  The 2005 Option Plan replaced the Company’s 2000 Stock
Option Plan (the “2000 Option Plan”).





As of
June 30, 2009, there were options to purchase 3,177,454 shares of common stock
outstanding under the 2000 and 2005 Option Plans.  The Company is
authorized to issue up to an aggregate of 4,842,910 shares of its common stock
pursuant to stock options granted under the 2005 Option Plan.  As of June
30, 2009, there was a total of 1,039,506 shares of common stock not subject to
outstanding options and available for issuance under the 2005 Option
Plan.  The purpose of stock options is to recognize past services
rendered and to provide additional incentive in furthering the continued success
of the Company.  Stock options granted under both the 2000 and 2005
Option Plans generally expire between the fifth and tenth anniversary of
the date of grant and generally vest on the third anniversary of the date of
grant.  Unexercised stock options may expire up to 90 days after
an employee's termination for options granted under the 2000 Option
Plan.





SFAS 123R
requires companies to estimate the fair value of share-based payment awards on
the date of grant using an option-pricing model.  In 2009 and 2008,
the fair value of each grant was estimated using the Black-Scholes valuation
model.  Expected volatility was based upon a weighted average of peer
companies and the Company’s stock volatility.  The expected life was
determined based upon an average of the contractual life and vesting period of
the options.  The estimated forfeiture rate was based upon an analysis
of historical data.   The risk-free rate was based on U.S.
Treasury zero coupon bond yields at the time of grant.





Compensation
expense, for awards with a service condition that cliff vest, is recognized on a
straight-line basis over the award’s requisite service
period.   For those awards with a service condition that have a
graded vest, compensation expense is calculated using the graded-vesting
attribution method.   This method entails recognizing expense on
a straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.





The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that simulates various potential outcomes of
the option grant and values each outcome using the Black-Scholes valuation model
which yields a fair market value of the Company's common stock on the date of
the grant (measurement date).  This amount is recognized over the
vesting period, using the straight-line method. Since the award requires both
the completion of 4 years of service and the share price reaching predetermined
levels as defined in the option agreement, compensation cost will be recognized
over the 4 year explicit service period.  If the employee terminates
prior to the four-year requisite service period, compensation cost will be
reversed even if the market condition has been satisfied by that time. The total
grant date fair value of the options granted during 2008 using the Monte Carlo
valuation model was $1,026.


21





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





11.
Stock Plans (continued)





The
following table provides the assumptions used in determining the fair value of
the market and service based awards for the six months ended June 30, 2009 and
the year ended December 31, 2008, respectively.





Six months
                    ended
                    June 30, 2009
                    Service based
                    awards
                  
                  
                  Year ended
                    December 31, 2008
                    Service based
                    awards
                  
                  
                  Year ended
                    December 31, 2008
                    Market based
                    awardsExpected
      volatility
                  
                  
                  63.56-69.38
                  %
                  
                  
                  56.23 – 57.52
                  %
                  
                  
                  60.98
                  %Expected
      dividends
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  0Expected
      term (in years)
                  
                  
                  3-6.25
                  
                  
                  
                  3.75
                  
                  
                  
                  10Risk-free
      rate
                  
                  
                  1.36-3.04
                  %
                  
                  
                  1.87
      – 2.77
                  %
                  
                  
                  3.45
                  %





A summary
of the status of the Company’s vested and non-vested stock options as of and for
the periods ended June 30, 2009 and December 31, 2008 and changes during the
periods then ended is as follows:





Options & Restricted Stock Outstanding
                          
                          
                          Options ExercisableShares
                            Available for
                            Grant
                          
                          
                          Shares
                          
                          
                          Wtd. Avg.
                            Exercise
                            Price
                          
                          
                          Shares
                          
                          
                          Wtd. Avg.
                            Exercise
                            PriceBalance
      at December 31, 2007
                          
                          
                          2,702,346
                          
                          
                          
                          1,601,035
                          
                          
                          $
                          21.18
                          
                          
                          
                          241,335
                          
                          
                          $
                          14.96Granted
      – options
                          
                          
                          (1,084,600
                          )
                          
                          
                          1,084,600
                          
                          
                          
                          11.87
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
      options and vested restricted stock
                          
                          
                          —
                          
                          
                          
                          (83,221
                          )
                          
                          
                          4.41
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
      or expired
                          
                          
                          114,760
                          
                          
                          
                          (114,760
                          )
                          
                          
                          29.28
                          
                          
                          
                          —
                          
                          
                          
                          —Balance
      at December 31, 2008
                          
                          
                          1,732,506
                          
                          
                          
                          2,487,654
                          
                          
                          $
                          17.33
                          
                          
                          
                          447,854
                          
                          
                          $
                          14.01Granted
      – options
                          
                          
                          (713,000
                          )
                          
                          
                          713,000
                          
                          
                          
                          5.76
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
                          
                          
                          —
                          
                          
                          
                          (3,200
                          )
                          
                          
                          4.62
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
      or expired
                          
                          
                          20,000
                          
                          
                          
                          (20,000
                          )
                          
                          
                          20.16
                          
                          
                          
                          —
                          
                          
                          
                          —Balance
      at June 30, 2009
                          
                          
                          1,039,506
                          
                          
                          
                          3,177,454
                          
                          
                          $
                          14.73
                          
                          
                          
                          657,154
                          
                          
                          $
                          16.42





The total
intrinsic value of options outstanding, exercisable and exercised for and during
the six months ended June 30, 2009 was $8,406, $642 and $15,
respectively.  The weighted average fair value for options granted
during the six months ended June 30, 2009 and the year ended December 31, 2008
was $3.27 and $5.67, respectively.  The weighted average
remaining contractual term of options outstanding and exercisable at June 30,
2009 was 5.96 and 3.56 years, respectively.





Between
January 1, 2009 and June 30, 2009, the Company granted to certain employees,
officers and non-employee directors options to purchase an aggregate of 713,000
shares of the Company's common stock at prevailing market prices ranging from
$4.74 to $9.38 per share.





Between
January 1, 2008 and December 31, 2008, the Company granted to certain
employees, officers and non-employee directors options to purchase an aggregate
of 1,084,600 shares of the Company's common stock at a weighted exercise price
of $11.87 per share. The Company granted the options at prevailing market prices
ranging from $5.11 to $21.80 per share.


22


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





11.
Stock Plans (continued)





A summary
of the status of the Company’s nonvested share options as of June 30, 2009 and
December 31, 2008 is presented below:





Nonvested Shares
                    
                    Shares
                    
                    
                    Wtd. Avg.
                      Grant Date
                      Fair ValueNonvested
      at December 31, 2007
                    
                    
                    1,359,700
                    
                    
                    $
                    10.73Granted
      - options
                    
                    
                    1,084,600
                    
                    
                    
                    5.67Vested
                    
                    
                    (293,000
                    )
                    
                    
                    8.98Forfeited
      or expired
                    
                    
                    (111,500
                    )
                    
                    
                    12.31Nonvested
      at December 31, 2008
                    
                    
                    2,039,800
                    
                    
                    $
                    8.24Granted
      - options
                    
                    
                    713,000
                    
                    
                    
                    3.27Vested
                    
                    
                    (222,500
                    )
                    
                    
                    8.52Forfeited
      or expired
                    
                    
                    (10,000
                    )
                    
                    
                    13.59Nonvested
      at June 30, 2009
                    
                    
                    2,520,300
                    
                    
                    $
                    6.49





SFAS
No. 123R also requires us to change the classification of any tax benefits
realized upon exercise of stock options in excess of that which is associated
with the expense recognized for financial reporting purposes. These amounts are
presented as a financing cash inflow rather than as a reduction of income taxes
paid in our consolidated statement of cash flows.





In
accordance with Staff Accounting Bulletin No. 107, we classified share-based
compensation within cost of revenues, sales and marketing, general and
administrative expenses and research and development corresponding to the same
line as the cash compensation paid to respective employees, officers and
non-employee directors.





The
following table shows total share-based compensation expense included in the
Consolidated Statement of Operations:





Three
      months ended
                    June
      30,
                  
                  
                  Six
      months ended
                    June
      30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Cost
      of revenue
                  
                  $
                  112
                  
                  
                  $
                  87
                  
                  
                  $
                  222
                  
                  
                  $
                  171Sales
      and marketing
                  
                  
                  313
                  
                  
                  
                  284
                  
                  
                  
                  552
                  
                  
                  
                  568General
      and administrative
                  
                  
                  885
                  
                  
                  
                  961
                  
                  
                  
                  1,693
                  
                  
                  
                  2,208Research
      and development
                  
                  
                  140
                  
                  
                  
                  127
                  
                  
                  
                  228
                  
                  
                  
                  226Pre-tax
      share-based compensation
                  
                  
                  1,450
                  
                  
                  
                  1,459
                  
                  
                  
                  2,695
                  
                  
                  
                  3,173Income
      tax benefit
                  
                  
                  389
                  
                  
                  
                  481
                  
                  
                  
                  729
                  
                  
                  
                  969Share-based
      compensation expense, net
                  
                  $
                  1,061
                  
                  
                  $
                  978
                  
                  
                  $
                  1,966
                  
                  
                  $
                  2,204





Employee
Stock Purchase Plan





The
Employee Stock Purchase Plan, which was approved in May 2006, enables
substantially all U.S. and foreign employees to purchase shares of our common
stock at a 5% discounted offering price off the closing market price of our
common stock on the NASDAQ National Market, LLC on the offering
date.  We have granted rights to purchase up to 500,000 shares of
common stock to our employees under the Plan. The Plan is not considered a
compensatory plan in accordance with SFAS 123(R) and requires no compensation
expense to be recognized.  Shares of our common stock purchased under
the employee stock purchase plan were 26,631 and 27,141 for the periods ended
June 30, 2009 and December 31, 2008, respectively.


23





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





12.  Related
Party Transactions





One of
the Company's Board of Directors, Barry M. Abelson, is a partner in the law firm
of Pepper Hamilton LLP. This firm has represented the Company since 1997. For
the three and six months ended June 30, 2009 and 2008, the Company paid Pepper
Hamilton LLP, $162, $189, $38 and $75, respectively, for general legal
matters.  The amounts payable to Pepper Hamilton as of June 30, 2009
and December 31, 2008 were $17 and $75, respectively.





13.  Income
Taxes





The
Company’s tax provision for interim periods is determined using an estimate of
its annual effective tax rate.  The 2009 effective tax rate is
estimated to be lower than the 35% statutory U.S. Federal rate primarily due to
anticipated earnings in subsidiaries outside the U.S. in jurisdictions where the
effective rate is lower than in the U.S. and tax exempt interest
income.





On
January 1, 2007, the Company adopted the Financial Accounting Standard Board’s
Interpretation No. 48, “Accounting for Income Tax
Uncertainties” (“FIN 48”).  FIN 48 clarifies the accounting for
uncertain income tax positions recognized in financial statements and requires
the impact of a tax position to be recognized in the financial statements if
that position is more likely than not of being sustained by the taxing
authority.  We do not expect that the amount of unrecognized tax benefits
will significantly increase or decrease within the next twelve months.  The
Company’s policy is to recognize interest and penalties on unrecognized tax
benefits in the provision for income taxes in the consolidated statements of
operations.  Tax years beginning in 2005 are subject to examination by
taxing authorities, although net operating loss and credit carryforwards from
all years are subject to examinations and adjustments for at least three years
following the year in which the attributes are used.





The
Company recorded a partial valuation allowance as management determined, based
on the weight of available evidence, it is more likely than not that some or all
of the deferred tax asset will not be realized.




24


Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


(All
amounts in thousands, except share and per share data, unless noted
otherwise)





14.
Geographic Information





The
following table summarizes the distribution of revenue and as a percentage of
total revenue by geographic region as determined by billing address for the
three and six months ended June 30, 2009 and 2008.





For the three months ended June 30,
                                        
                                        
                                        For the six months ended June 30,2009
                                        
                                        2008
                                        
                                        
                                        2009
                                        
                                        
                                        2008Country
                                        
                                        Amount
                                        
                                        Percent of
                                          Revenues
                                        
                                        Amount
                                        
                                        Percent of
                                          Revenues
                                        
                                        
                                        Amount
                                        
                                        Percent of
                                          Revenues
                                        
                                        
                                        Amount
                                        
                                        
                                        Percent of
                                          RevenuesUnited
      States
                                        
                                        
                                        30,905
                                        
                                        
                                        78.3
                                        %
                                        
                                        41,812
                                        
                                        
                                        74.1
                                        %
                                        
                                        
                                        63,425
                                        
                                        
                                        81.0
                                        %
                                        
                                        
                                        79,582
                                        
                                        
                                        
                                        76.0
                                        %United
      Kingdom
                                        
                                        
                                        3,137
                                        
                                        
                                        7.9
                                        %
                                        
                                        5,979
                                        
                                        
                                        10.6
                                        %
                                        
                                        
                                        5,375
                                        
                                        
                                        6.9
                                        %
                                        
                                        
                                        10,066
                                        
                                        
                                        
                                        9.6
                                        %Germany
                                        
                                        
                                        970
                                        
                                        
                                        2.5
                                        %
                                        
                                        2,964
                                        
                                        
                                        5.2
                                        %
                                        
                                        
                                        1,898
                                        
                                        
                                        2.4
                                        %
                                        
                                        
                                        3,991
                                        
                                        
                                        
                                        3.8
                                        %The
      Netherlands
                                        
                                        
                                        417
                                        
                                        
                                        1.1
                                        %
                                        
                                        806
                                        
                                        
                                        1.4
                                        %
                                        
                                        
                                        889
                                        
                                        
                                        1.1
                                        %
                                        
                                        
                                        1,272
                                        
                                        
                                        
                                        1.2
                                        %Other
      European Countries
                                        
                                        
                                        2,077
                                        
                                        
                                        5.3
                                        %
                                        
                                        3,096
                                        
                                        
                                        5.5
                                        %
                                        
                                        
                                        3,654
                                        
                                        
                                        4.7
                                        %
                                        
                                        
                                        5,208
                                        
                                        
                                        
                                        5.0
                                        %Canada
                                        
                                        
                                        689
                                        
                                        
                                        1.7
                                        %
                                        
                                        654
                                        
                                        
                                        1.2
                                        %
                                        
                                        
                                        730
                                        
                                        
                                        0.9
                                        %
                                        
                                        
                                        1,640
                                        
                                        
                                        
                                        1.6
                                        %Other
                                        
                                        
                                        1,270
                                        
                                        
                                        3.2
                                        %
                                        
                                        1,130
                                        
                                        
                                        2.0
                                        %
                                        
                                        
                                        2,325
                                        
                                        
                                        3.0
                                        %
                                        
                                        
                                        2,889
                                        
                                        
                                        
                                        2.8
                                        %Total
                                        
                                        
                                        39,465
                                        
                                        
                                        100.0
                                        %
                                        
                                        56,441
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        78,296
                                        
                                        
                                        100.0
                                        %
                                        
                                        
                                        104,648
                                        
                                        
                                        
                                        100.0
                                        %





The
following table summarizes the distribution of assets by geographic region as of
June 30, 2009 and December 31, 2008.  The assets by geographic region
as of December 31, 2008 have been reclassified to reflect the effects of the
goodwill impairment had in each of the corresponding geographic
region.





June
      30, 2009
                          
                          
                          December
      31, 2008Country
                          
                          Assets
                          
                          
                          Assets
      as a
                            percentage
      of
                            total
      assets
                          
                          
                          Assets
                          
                          
                          Assets
      as a
                            percentage
      of
                            total
      assetsUnited
      States
                          
                          $
                          148,536
                          
                          
                          
                          79.3
                          %
                          
                          $
                          172,272
                          
                          
                          
                          78.9
                          %United
      Kingdom
                          
                          
                          16,337
                          
                          
                          
                          8.7
                          %
                          
                          
                          22,381
                          
                          
                          
                          10.2
                          %India
                          
                          
                          10,959
                          
                          
                          
                          5.9
                          %
                          
                          
                          9,099
                          
                          
                          
                          4.1
                          %Germany
                          
                          
                          5,152
                          
                          
                          
                          2.7
                          %
                          
                          
                          6,911
                          
                          
                          
                          3.2
                          %Canada
                          
                          
                          2,774
                          
                          
                          
                          1.5
                          %
                          
                          
                          3,004
                          
                          
                          
                          1.4
                          %Poland
                          
                          
                          386
                          
                          
                          
                          0.2
                          %
                          
                          
                          1,056
                          
                          
                          
                          0.5
                          %Other
                          
                          
                          3,103
                          
                          
                          
                          1.7
                          %
                          
                          
                          3,742
                          
                          
                          
                          1.7
                          %Total
                          
                          $
                          187,247
                          
                          
                          
                          100.0
                          %
                          
                          $
                          218,465
                          
                          
                          
                          100.0
                          %





15.
Subsequent Events





The
Company has evaluated all subsequent events through August 10, 2009, which
represents the filing date of this Form 10-Q with the Securities and Exchange
Commission, to ensure that this Form 10-Q includes appropriate disclosure of
events both recognized in the financial statements as of June 30, 2009, and
events which occurred subsequent to June 30, 2009, but were not recognized in
the financial statements. As of August 10, 2009, there were no subsequent events
which required recognition or disclosure.


25


Item
2: Management's Discussion and Analysis of Financial Condition and Results of
Operations





This Quarterly Report on Form 10-Q,
including the following Management’s Discussion and Analysis of Financial
Condition and Results of Operations, contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, Section
21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995, that involve a number of risks and
uncertainties. These forward-looking statements include, but are not limited to,
plans, objectives, expectations and intentions and other statements contained
herein that are not historical facts and statements identified by words such as
“expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates”
or words of similar meaning. These statements may contain, among other things,
guidance as to future revenue and earnings, operations, prospects of the
business generally, intellectual property and the development of
products.  These statements are based on our current beliefs or
expectations and are inherently subject to various risks and uncertainties,
including those set forth under the caption “Risk Factors” in our most recent
Annual Report on Form 10-K as filed with the Securities and Exchange Commission,
as amended and supplemented under the caption “Risk Factors” in our subsequent
Quarterly Reports on Form 10-Q filed with the Securities and Exchange
Commission, including this Quarterly Report on Form 10-Q.  Actual
results may differ materially from these expectations due to changes in global
political, economic, business, competitive, market and regulatory factors, our
ability to implement business and acquisition strategies or to complete or
integrate acquisitions.  We do not undertake any obligation to update
any forward-looking statements contained herein as a result of new information,
future events or otherwise. References herein to “Kenexa,” “we,” “our,” and “us”
collectively refer to Kenexa Corporation, a Pennsylvania corporation, and all of
its direct and indirect U.S., U.K., Canada, India, and other foreign
subsidiaries.





1.
Overview





We
provide business solutions for human resources. Our solutions include a
comprehensive suite of On-Demand software  applications and
complementary services, including outsourcing services and consulting, to help
global organizations recruit high performing individuals and to foster optimal
work environments to increase employee productivity and retention. We employ a
large force of organizational and industrial psychologists and statisticians who
study the science of human behavior and its impact on business outcomes. This
research is the foundation of our suite of software applications and supporting
services that enable our customers to improve business results through human
resources.





Since
1999, we have focused on providing talent acquisition and employee performance
management solutions on a subscription basis and currently generate a
significant portion of our revenue from these subscriptions. For the six months
ended June 30, 2009 and 2008, revenue from these subscriptions comprised
approximately 86.0% and 79.1%, respectively, of our total revenue. We generate
the remainder of our revenue from discrete professional services that are not
provided as part of an integrated solution on a subscription basis. These
subscription-based solutions provide us with a recurring revenue stream and we
believe represent a more compelling opportunity in terms of growth and
profitability than discrete professional services. Since 2005, subscription
revenue has represented approximately 80% of our total revenue; we expect that
trend to continue.





We sell
our solutions to large and medium-sized organizations through our direct sales
force. As of December 31, 2008, we had a customer base of approximately 4,400
companies, including approximately 180 companies on the Fortune 500 list
published in April 2008. Our customer base includes companies that we
billed for services during the year ended December 31, 2008 and does not
necessarily indicate an ongoing relationship with each such customer. Our top 80
customers contributed approximately $44.5 million, or 56.8%, of our total
revenue for the six months ended June 30, 2009.





Over the
past nine months, as a result of the adverse financial conditions, growth levels
of the global economy have slowed to near historic lows as measured by most
indices.  Unemployment in the United States was at a 20 year high of 9.5%
in June 2009.  As the economy continues to deteriorate, economists
have increased their joblessness estimates to reach double digits nationwide by
late 2009 or early 2010.  During the second quarter of 2009, gross domestic
product contracted at a 1.0% annual rate.  However, the extent or
degree to which we may be affected by these events is extremely difficult to
predict.   The uncertain economic prospects being experienced by our
customers will likely translate into slower growth, or contraction, for us,
since a substantial portion of our business is dependent upon our customers’
hiring and human capital needs.  However, we believe that, by optimizing
our internal resources for the current business conditions, we can minimize
these adverse effects and emerge from this economic crisis with a stronger and
more efficient operating model.





26


Although
our compound annual growth of revenue for the three year period ending December
31, 2008 was 45.9% and our customers have historically renewed their
subscriptions at an approximately 90% rate each year, some of our customers,
facing uncertainty and cost pressures in their own businesses during the current
economic downturn, have indicated that they are waiting to purchase our products
and are otherwise increasingly seeking purchasing terms and conditions that are
less favorable to us. As a result of this trend, we experienced lower renewal
rates during the second half of fiscal 2008, resulting in a renewal rate by
aggregate value of multi-year subscriptions for the year ended December 31, 2008
of approximately 75% and as a result we have forecasted lower business levels
for 2009.





Due to
the decline in our stock price and market capitalization, expected reductions in
projected future net income, reduced future cash flow estimates and predicted
slower growth rates in our industry, we recorded an impairment charge totaling
$167.0 million for the year ended December 31, 2008, representing a portion
of our acquired goodwill.  During the quarter ended March 31, 2009, we
recorded an additional impairment charge totaling $33.3 million, representing
the remaining acquired goodwill.





On May
21, 2009, we elected not to renew our secured credit agreement with PNC
Bank.  We believe that our cash and short-term investments, our UBS
Settlement Agreement for our auction rate securities and our projected cash from
operations will be sufficient to meet our liquidity needs for at least the next
twelve months.





2.
Recent Events





During
the three months ended March 31, 2009, due to a 32.5% decline in our stock price
and market capitalization from the previous quarter, lower projected net income,
cash flow estimates and slower projected growth rates in our industry, we
reevaluated our goodwill impairment analysis.  Our analysis was
performed to determine the implied fair value of our goodwill with neither the
write up or write down of any assets or liabilities, nor recording any
additional unrecognized identifiable intangible assets.  Based upon
our analysis we recorded a goodwill impairment charge of $33.3 million during
the quarter ended March 31, 2009. This goodwill impairment charge had no effect
on our cash balances.





In
response to the challenging macroeconomic environment, the strengthening U.S.
dollar relative to other currencies of countries in which we do business, and
the slowing or delaying of a number of projects by our customers, we announced
during the fourth quarter 2008, a restructuring program involving staff
reductions of approximately 12% of our workforce which included one-time
severance, outplacement benefits and certain legal fees totaling approximately
$2.0 million.  As a result of the continued deterioration in the
economic environment during the first quarter of 2009, we executed an additional
reduction in force resulting in the elimination of 159 employees, as a result we
incurred one-time severance and outplacement benefit costs totaling $1.2
million.





On April
2, 2008, we acquired Quorum International Holdings Limited (“Quorum”), a
provider of recruitment process outsourcing services based in London, England,
for a purchase price of approximately $27.9 million, in cash.  The
total cost of the acquisition, including legal, accounting, and other fees of
$1.1 million, was approximately $29.0 million.  In addition, the
acquisition agreement contains an earn out provision which provides for the
payment of additional consideration by us based upon the gross profit of Quorum
for the twelve month period ending June 30, 2009 and June 30, 2010. 
Formulaically, the earnout is 3.86 times Quorum’s gross profit less the amount
of base consideration, as defined in the agreement. Based upon our results for
the twelve month period ending June 30, 2009, no earnout is due to the former
shareholders of Quorum.  We believe that our acquisition of Quorum
broadened our presence in the global recruitment market.





On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3.0 million shares of our common stock, of
which 1.1 million shares were repurchased at an aggregate cost of $20.4 million
as of December 31, 2008.  These shares were restored to original
status and accordingly are presented as authorized but not
issued.  The timing, price and volume of repurchases were based on
market conditions, relevant securities laws and other factors.  As of
March 31, 2009, the amount of shares available for repurchase under the stock
repurchase plan was 1.9 million.  In addition, in January 2008, we
repurchased 0.5 million shares under a previously authorized stock repurchase
plan for an aggregate cost of $9.8 million.


27


3.
Sources of Revenue




We derive
revenue primarily from two sources: (1) subscription revenue for our
solutions, which is comprised of subscription fees from customers accessing our
on-demand software, consulting services, outsourcing services and proprietary
content, and from customers purchasing additional support that is not included
in the basic subscription fee; and (2) fees for discrete professional
services.





Our
customers primarily purchase renewable subscriptions for our solutions. The
typical term is one to three years, with some terms extending up to five years.
The majority of our subscription agreements are not cancelable for convenience
although our customers have the right to terminate their contracts for cause if
we fail to provide the agreed upon services or otherwise breach the agreement. A
customer does not generally have a right to a refund of any advance payments if
the contract is cancelled.   Due to the current economic
slowdown, a greater number of our customers are delaying or seeking to revise
the terms and conditions of our service agreements.  As a result, we
experienced for the quarter ended June 30, 2009 lower than expected renewal
rates in the range of 70% - 80% of the aggregate value of multi-year
subscriptions for our on-demand talent acquisition and performance management
solution contracts rather than our historical renewal rate of more than
90%.  We expect this trend to continue through the end of
2009.





Consistent
with our historical practices, revenue derived from subscription fees is
recognized ratably over the term of the subscription agreement. We generally
invoice our customers in advance in monthly or quarterly installments and
typical payment terms provide that our customers pay us within 30 days of
invoice. Amounts that have been invoiced are recorded in accounts receivable
prior to the receipt of payment and in deferred revenue to the extent revenue
recognition criteria have not been met. As a result of cyclical annual
subscription renewals and an increase in the sales volume of our bundled
arrangements,, the amount of deferred revenue on our balance sheet has
increased.  As of June 30, 2009, deferred revenue increased to $42.2
million from $38.6 million at December 31, 2008. We generally price our
solutions based on the number of software applications and services included and
the number of customer employees. Accordingly, subscription fees are generally
greater for larger organizations and for those that subscribe for a broader
array of software applications and services.





We derive
other revenue from the sale of discrete professional services, and translation
services as well as from out-of-pocket expenses. The majority of our other
revenue is derived from discrete professional services, which primarily consist
of consulting and training services. This revenue is recognized differently
depending on the type of service provided as described in greater detail below
under “Critical Accounting Policies and Estimates.”





For the
quarter ended June 30, 2009, approximately 78.3% of our total revenue was
derived from sales in the United States. Revenue that we generated from
customers in the United Kingdom and Germany was approximately 7.9% and 2.5%,
respectively, for the quarter ended June 30, 2009. Revenue for all other
countries amounted to an aggregate of 11.3%. Other than the countries listed, no
other country represented more than 2.0% of our total revenue for the quarter
ended June 30, 2009.





4.
Key Performance Indicators




The following tables summarize the key
performance indicators that we consider to be material in managing our business,
in thousands (other than percentages):





For
      the three months ended
                  June
      30,
                
                
                For
      the six months ended
                  June
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008(unaudited)
                
                
                (unaudited)
                
                
                (unaudited)
                
                
                (unaudited)Total
      Revenue
                
                $
                39,465
                
                
                $
                56,441
                
                
                $
                78,296
                
                
                $
                104,648Subscription
      revenue as a percentage of total revenue
                
                
                86.3
                %
                
                
                77.4
                %
                
                
                86.0
                %
                
                
                79.1
                %Non-GAAP
      income from operations
                
                $
                4,369
                
                
                $
                10,886
                
                
                $
                8,301
                
                
                $
                19,969Net
      cash provided by operating activities
                
                $
                7,485
                
                
                $
                12,867
                
                
                $
                16,365
                
                
                $
                16,426


28


The
following is a discussion of significant terms used in the tables
above.





Non-GAAP income
from operations.Non-GAAP income from operations is derived
from income (loss) from operations adjusted for noncash or nonrecurring
expenses.  We believe that measuring our operations, using non-GAAP
income from operations depicts more accurately our ongoing results.





For
      the three months ended
                    June
      30,
                  
                  
                  For
      the six months ended
                    June
      30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008(unaudited)
                  
                  
                  (unaudited)
                  
                  
                  (unaudited)
                  
                  
                  (unaudited)Income
      (loss) from operations
                  
                  $
                  1,860
                  
                  
                  $
                  7,850
                  
                  
                  $
                  (31,708
                  )
                  
                  $
                  14,377Stock-based
      compensation expense
                  
                  
                  1,450
                  
                  
                  
                  1,459
                  
                  
                  
                  2,695
                  
                  
                  
                  3,173Amortization
      of intangibles associated with acquisitions
                  
                  
                  1,059
                  
                  
                  
                  1,577
                  
                  
                  
                  2,142
                  
                  
                  
                  2,419Restructuring
      charges
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,156
                  
                  
                  
                  —Goodwill
      impairment charge
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  33,329
                  
                  
                  
                  —Professional
      fees associated with joint ventures
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  687
                  
                  
                  
                  —Non-GAAP
      income from operations
                  
                  $
                  4,369
                  
                  
                  $
                  10,886
                  
                  
                  $
                  8,301
                  
                  
                  $
                  19,969




Subscription
revenue as a percentage of total revenue. Subscription revenue as a
percentage of total revenue can be derived from our consolidated statements of
operations. This performance indicator illustrates the evolution of our business
towards subscription-based solutions, which provide us with a recurring revenue
stream and which we believe to be a more compelling revenue growth and
profitability opportunity. While subscription revenue as a percentage of total
revenue increased to 86%, due to a decrease in other revenue, we expect that the
percentage of subscription revenue will remain above our target range of 78% to
82% of our total revenues for the remainder of 2009.




Net cash provided
by operating activities. Net cash provided by
operating activities is taken from our consolidated statement of cash flows and
represents the amount of cash generated by our operations that is available for
investing and financing activities. Generally, our net cash provided by
operating activities has exceeded our operating income primarily due to the
positive impact of deferred revenue and more recently due to the collection of
accounts receivables. It is possible that this trend may vary as business
conditions change.





Deferred
revenue. We generate revenue primarily from multi-year subscriptions for
our on-demand talent acquisition and employee performance management solutions.
We recognize revenue from these subscription agreements ratably over the hosting
period, which is typically one to three years. We generally invoice our
customers in quarterly or monthly installments in advance. Deferred revenue,
which is included in our consolidated balance sheets, is the amount of invoiced
subscriptions in excess of the amount recognized as revenue. Deferred revenue
represents, in part, the amount that we will record as revenue in our
consolidated statements of operations in future periods. As the subscription
component of our revenue has grown and customer willingness to pay us in advance
for their subscriptions has increased, the amount of deferred revenue on our
balance sheet has grown.  It is possible that this trend may vary as
business conditions change.




The
following table reconciles beginning and ending deferred revenue for each of the
periods shown, in thousands:




For the
                                                  year ended
                                                  December 31,
                                                
                                                For the
                                                  three months ended
                                                  June 30,
                                                
                                                
                                                For the
                                                  six months ended
                                                  June 30,2008
                                                
                                                2009
                                                
                                                2008
                                                
                                                
                                                2009
                                                
                                                
                                                2008(unaudited)
                                                
                                                (unaudited)
                                                
                                                
                                                (unaudited)
                                                
                                                
                                                (unaudited)Deferred
      revenue at the beginning of the period
                                                
                                                $
                                                35,076
                                                
                                                $
                                                41,427
                                                
                                                $
                                                37,481
                                                
                                                
                                                $
                                                38,638
                                                
                                                
                                                $
                                                35,076Total
      invoiced subscriptions during period
                                                
                                                
                                                166,982
                                                
                                                
                                                34,837
                                                
                                                
                                                44,928
                                                
                                                
                                                
                                                70,891
                                                
                                                
                                                
                                                86,489Subscription
      revenue recognized during period
                                                
                                                
                                                (163,420
                                                )
                                                
                                                (34,041
                                                )
                                                
                                                (43,668
                                                )
                                                
                                                
                                                (67,306
                                                )
                                                
                                                
                                                (82,824
                                                )Deferred
      revenue at end of period
                                                
                                                $
                                                38,638
                                                
                                                $
                                                42,223
                                                
                                                $
                                                38,741
                                                
                                                
                                                $
                                                42,223
                                                
                                                
                                                $
                                                38,741


29


5.
Results of Operations




Three
and six months ended June 30, 2009 compared to three and six months ended June
30, 2008




The
following table sets forth for the periods indicated, the amount and percentage
of total revenues represented by certain items reflected in our unaudited
consolidated statements of operations:




Kenexa
Corporation Consolidated Statements of Operations


(In
thousands)


(Unaudited)




For the three months ended June 30,
                                  
                                  For the six months ended June 30,2009
                                  
                                  2008
                                  
                                  2009
                                  
                                  
                                  2008Amount
                                  
                                  Percent of
                                    Revenues
                                  
                                  Amount
                                  
                                  Percent of
                                    Revenues
                                  
                                  Amount
                                  
                                  Percent of
                                    Revenues
                                  
                                  
                                  Amount
                                  
                                  
                                  Percent of
                                    RevenuesRevenue:Subscription
                                  
                                  
                                  34,041
                                  
                                  
                                  86.3
                                  %
                                  $
                                  43,668
                                  
                                  
                                  77.4
                                  %
                                  
                                  67,306
                                  
                                  
                                  86.0
                                  %
                                  
                                  $
                                  82,824
                                  
                                  
                                  
                                  79.1
                                  %Other
                                  
                                  
                                  5,424
                                  
                                  
                                  13.7
                                  %
                                  
                                  12,773
                                  
                                  
                                  22.6
                                  %
                                  
                                  10,990
                                  
                                  
                                  14.0
                                  %
                                  
                                  
                                  21,824
                                  
                                  
                                  
                                  20.9
                                  %Total
      revenue
                                  
                                  
                                  39,465
                                  
                                  
                                  100.0
                                  %
                                  
                                  56,441
                                  
                                  
                                  100.0
                                  %
                                  
                                  78,296
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  104,648
                                  
                                  
                                  
                                  100.0
                                  %Cost
      of revenue
                                  
                                  
                                  13,637
                                  
                                  
                                  34.6
                                  %
                                  
                                  17,173
                                  
                                  
                                  30.4
                                  %
                                  
                                  27,333
                                  
                                  
                                  34.9
                                  %
                                  
                                  
                                  30,278
                                  
                                  
                                  
                                  28.9
                                  %Gross
      profit
                                  
                                  
                                  25,828
                                  
                                  
                                  65.4
                                  %
                                  
                                  39,268
                                  
                                  
                                  69.6
                                  %
                                  
                                  50,963
                                  
                                  
                                  65.1
                                  %
                                  
                                  
                                  74,370
                                  
                                  
                                  
                                  71.1
                                  %Operating
      expenses:Sales
      and marketing
                                  
                                  
                                  8,241
                                  
                                  
                                  20.9
                                  %
                                  
                                  10,988
                                  
                                  
                                  19.5
                                  %
                                  
                                  16,946
                                  
                                  
                                  21.6
                                  %
                                  
                                  
                                  20,877
                                  
                                  
                                  
                                  19.9
                                  %General
      and administrative
                                  
                                  
                                  9,917
                                  
                                  
                                  25.1
                                  %
                                  
                                  12,845
                                  
                                  
                                  22.8
                                  %
                                  
                                  20,790
                                  
                                  
                                  26.6
                                  %
                                  
                                  
                                  24,838
                                  
                                  
                                  
                                  23.7
                                  %Research
      and development
                                  
                                  
                                  2,536
                                  
                                  
                                  6.4
                                  %
                                  
                                  4,307
                                  
                                  
                                  7.6
                                  %
                                  
                                  5,104
                                  
                                  
                                  6.5
                                  %
                                  
                                  
                                  8,849
                                  
                                  
                                  
                                  8.5
                                  %Depreciation
      and amortization
                                  
                                  
                                  3,274
                                  
                                  
                                  8.3
                                  %
                                  
                                  3,278
                                  
                                  
                                  5.8
                                  %
                                  
                                  6,502
                                  
                                  
                                  8.3
                                  %
                                  
                                  
                                  5,429
                                  
                                  
                                  
                                  5.2
                                  %Goodwill
      impairment charge
                                  
                                  
                                  —
                                  
                                  
                                  —
                                  %
                                  
                                  —
                                  
                                  
                                  —
                                  %
                                  
                                  33,329
                                  
                                  
                                  42.6
                                  %
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  %Total
      operating expenses
                                  
                                  
                                  23,968
                                  
                                  
                                  60.7
                                  %
                                  
                                  31,418
                                  
                                  
                                  55.7
                                  %
                                  
                                  82,671
                                  
                                  
                                  105.6
                                  %
                                  
                                  
                                  59,993
                                  
                                  
                                  
                                  57.3
                                  %Income
      from operations
                                  
                                  
                                  1,860
                                  
                                  
                                  4.7
                                  %
                                  
                                  7,850
                                  
                                  
                                  13.9
                                  %
                                  
                                  (31,708
                                  )
                                  
                                  (40.5
                                  )
      %
                                  
                                  
                                  14,377
                                  
                                  
                                  
                                  13.7
                                  %Interest
      (expense) income, net
                                  
                                  
                                  (221
                                  )
                                  
                                  (0.6
                                  )
      %
                                  
                                  320
                                  
                                  
                                  0.6
                                  %
                                  
                                  (158
                                  )
                                  
                                  (0.2
                                  )
      %
                                  
                                  
                                  961
                                  
                                  
                                  
                                  0.9
                                  %Investment
      income (loss), net
                                  
                                  
                                  247
                                  
                                  
                                  0.6
                                  %
                                  
                                  —
                                  
                                  
                                  —
                                  %
                                  
                                  (48
                                  )
                                  
                                  (0.1
                                  )
      %
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  %Income
      (loss) before income taxes
                                  
                                  
                                  1,886
                                  
                                  
                                  4.7
                                  %
                                  
                                  8,170
                                  
                                  
                                  14.5
                                  %
                                  
                                  (31,914
                                  )
                                  
                                  (40.8
                                  )
      %
                                  
                                  
                                  15,338
                                  
                                  
                                  
                                  14.7
                                  %Income
      tax expense
                                  
                                  
                                  575
                                  
                                  
                                  1.5
                                  %
                                  
                                  2,205
                                  
                                  
                                  3.9
                                  %
                                  
                                  1,057
                                  
                                  
                                  1.4
                                  %
                                  
                                  
                                  4,599
                                  
                                  
                                  
                                  4.4
                                  %Net
      income (loss)
                                  
                                  
                                  1,311
                                  
                                  
                                  3.2
                                  %
                                  $
                                  5,965
                                  
                                  
                                  10.6
                                  %
                                  
                                  (32,971
                                  )
                                  
                                  (42.2
                                  )
      %
                                  
                                  $
                                  10,739
                                  
                                  
                                  
                                  10.3
                                  %


30




Revenue





Total
revenue decreased $16.9 million or 30.0% to $39.5 million, subscription revenue
decreased $9.6 million or 22.0% to $34.0 million and other revenue decreased by
$7.3 million or 57.0% to $5.5 million for the three months ended June 30,
2009, compared to the same periods in 2008.  Subscription revenue
represented approximately 86.3% of our total revenue for the three months ended
June 30, 2009. Total revenue decreased $26.3 million or 25.1% to $78.3
million, subscription revenue decreased $15.5 million or 18.7% to $67.3 million
and other revenue decreased by $10.8 million or 49.5% to $11.0 million for the
six months ended June 30, 2009, compared to the same periods in 2008.
Subscription revenue represented approximately 86.0% of our total revenue for
the six months ended June 30, 2009.





The
decrease in our revenue for the three months ended June 30, 2009, as
compared to the same period in 2008, is primarily attributable to the effects
arising from the global economic recession, increased pricing pressures, high
unemployment, and reduced demand for our products and services.  Based
upon the current market conditions, we expect our subscription-based and other
revenues to decrease in 2009 over the prior year due to a greater number of
customers delaying or looking to revise the terms and conditions of our service
agreements, the strengthening US dollar relative to other currencies of
countries in which we do business, the loss of RPO customers, and a loss of
consulting engagements.




Cost
of Revenue





Our cost
of revenue primarily consists of compensation, employee benefits and
out-of-pocket travel-related expenses for our employees and independent
contractors who provide consulting or other professional services to our
customers. Additionally, our application hosting costs, amortization of
third-party license royalty costs, technical support personnel costs, overhead
allocated based on headcount and reimbursed expenses are also recorded as cost
of revenue. Many factors affect our cost of revenue, including changes in the
mix of products and services, the number of initial implementations versus
recurring engagements, pricing trends, changes in the amount of reimbursed
expenses and fluctuations in our customer base. Because cost as a percentage of
revenue is higher for professional services than for software products, an
increase in the services component of our solutions or an increase in discrete
professional services as a percentage of our total revenue would reduce gross
profit as a percentage of total revenue.  As our overall revenue
declines, we expect our cost of revenue to decline, subject to pricing pressure
related to economic conditions and  influenced by the mix of services and
software.




Cost of
revenue decreased by $3.6 million or 20.9% to $13.6 million and $3.0 million or
9.9% to $27.3 million during the three and six month period ended June 30,
2009, respectively, compared to the same periods in 2008. As a percentage of
revenue cost of revenue increased by 4.2% to 34.6% and 6.0% to 34.9% for the
three and six months ended June 30, 2009, compared to the same periods in
2008.  The $3.6 million decrease for the three months ended June 30,
2009 was due primarily to reduced staff expense of $2.2 million in connection
with reduced headcount of 124 employees from the prior year, mainly from our
U.S. operations.  Additionally lower third party fees and decreased
reimbursable expenses contributed $0.4 million and $1.0 million, respectively,
to the decrease for the quarter ended June 30, 2009 compared to the prior
year.   The $3.0 million decrease for the six months ended June
30, 2009 was due to reduced staff expense of $2.2 million, an increase in third
party fees, including marketing and agency costs, of approximately $0.3 million
and reduced reimbursable expense of $1.1 million for the period ended June 30,
2009, compared to the prior year.





Sales
and Marketing (“S&M”) Expense





S&M
expense primarily consists of personnel and related costs for employees engaged
in sales and marketing, including salaries, commissions and other variable
compensation, travel expenses and costs associated with trade shows, advertising
and other marketing efforts and allocated overhead.  We expense our
sales commissions at the time the related revenue is recognized, and we
recognize revenue from our subscription agreements ratably over the term of the
agreements.   Based on recent economic conditions we have reduced
our sales and marketing expenditures to adjust for expected lower rates of
growth projections.  However, consistent with our past practice, we
intend to continue to invest in sales and marketing to pursue new customers and
expand relationships with existing customers at levels we deem appropriate given
our current economic conditions.   Although our S&M expense
decreased in absolute terms and increased as a percentage of total revenue, we
expect our S&M expense to increase, mainly due to our investment in
branding.




S&M
expense decreased $2.7 million or 24.5% to $8.3 million during the three month
period ended June 30, 2009, compared to the same periods in 2008. The $2.7
million decrease for the three months ended June 30, 2009 was due primarily
to decreased staff and commission expense of $0.6 million each, reduced bad
debt, travel and marketing expense of $0.9 million, $0.3 million and $0.3
million, respectively, compared to the same periods in 2008.   As
a percentage of revenue, S&M expense increased from 19.5% to 20.9%, for the
three months ended June 30, 2009.


31




S&M
expense decreased $3.9 million or 18.7% to $17.0 million during the six month
period ended June 30, 2009, compared to the same periods in 2008. The $3.9
million decrease for the six months ended June 30, 2009 was due primarily
to reduced bad debt, commission, travel and benefits expense of $1.5 million,
$1.4 million, $0.8 million and $0.2 million, respectively, compared to the same
periods in 2008.  As a percentage of revenue, S&M expense
increased from 19.9% to 21.6%, for the six months ended June 30, 2009.




General
and Administrative (“G&A”) Expense





G&A
expense primarily consists of personnel and related costs for our executive,
finance, human resources and administrative personnel, professional fees and
other corporate expenses and allocated overhead.  Based upon the
current state of the economy, we believe that general and administrative
expenses will remain the same or slightly increase in dollar amount and remain
constant as a percentage of total revenue in 2009.




G&A
expense decreased $2.9 million or 22.7% to $9.9 million during the three month
period ended June 30, 2009, compared to the same period in 2008. The $2.9
million decrease for the three months ended June 30, 2009 was due primarily
to a decrease in staff related expense, travel, and rent of $1.6 million, $0.4
million, and $0.2 million respectively, during the three months ended
June 30, 2009, compared to the same period in 2008.  In addition
professional fees and other expense contributed $0.2 million and $0.5 million to
the decrease for the three months ended June 30, 2009, compared to the prior
year.  As a percentage of revenue, G&A expense increased from
approximately 22.8% to 25.1% for the three months ended June 30, 2009,
compared to the same period in 2008.




G&A
expense decreased $4.0 million or 16.1% to $20.8 million during the six month
period ended June 30, 2009, compared to the same period in 2008. The $4.0
million decrease for the six months ended June 30, 2009, was due primarily
to a decrease in staff related expense, travel and entertainment, and temporary
help expense of $ 2.8 million, $1.0 million and $0.2 million, respectively,
during the six months ended June 30, 2009, compared to the same period in
2008.   As a percentage of revenue, G&A expense increased
from 23.7% to 26.6% for the six months ended June 30, 2009, compared to the
same period in 2008.




Research
and Development (“R&D”) Expense





R&D
expense primarily consists of personnel and related costs, including salaries
and employee benefits for software engineers, quality assurance engineers,
product managers, technical sales engineers and management information systems
personnel and third party consultants.  Our R&D efforts have been
devoted primarily to new product offerings and enhancements and upgrades to our
existing products.  As a result of these ongoing development efforts,
we have capitalized software costs of $2.8 million, $5.0 million, $1.4 million
and $3.7 million for the three and six months ended June 30, 2009 and 2008,
respectively.  The remaining R&D activities have been expensed as
incurred.




R&D
expense decreased $1.8 million or 41.9% to $2.5 million during the three month
period ended June 30, 2009, compared to the same period in
2008.   The decrease was attributable to a reduction in staff and
consulting expense of $1.6 million and $0.2 million, respectively, compared to
the same period in 2008.  As a percentage of revenue, R&D expense
decreased from approximately 7.6% to 6.4% for the three months ended
June 30, 2009, compared to the same period in 2008.




R&D
expense decreased $3.7 million or 42.0% to $5.1 million during the six month
period ended June 30, 2009, compared to the same period in
2008.   The decrease was attributable to a reduction in staff and
consulting expense of $3.4 million and $0.3 million, respectively, compared to
the same period in 2008.  As a percentage of revenue, R&D expense
decreased from approximately 8.5% to 6.5% for the three months ended
June 30, 2009, compared to the same period in 2008.




Depreciation
and Amortization




Depreciation
and amortization expense remained the same at $3.3 million for the three month
period ended June 30, 2009 and increased $1.1 million or 20.4% to $6.5 million
during the six month period ended June 30, 2009, compared to the same
period in 2008. In the future, we expect depreciation and amortization expense
to increase due to additional capital purchases, increased software
capitalization, and to a lesser extent the full period effect of our acquired
intangibles .




Income
tax expense from operations




Income
tax expense from operations decreased by $1.6 million or 72.7% to $0.6 million
and $3.5 million or 76.1% to $1.1 million during the three and six month periods
ended June 30, 2008, respectively, compared to the same periods in 2008.
The decrease in expense was due to a larger portion of our taxable income being
generated in jurisdictions with lower effective tax rates and decreasing in
jurisdictions with higher tax rates.


32




6.
Liquidity and Capital Resources





Since we
were formed in 1987, we have financed our operations primarily through
internally generated cash flows, our revolving credit facilities and the
issuance of equity. As of June 30, 2009, we had cash and cash equivalents of
$25.4 million and investments of $21.8 million . In addition, we had
no debt and approximately $0.2 million in capital equipment
leases.





Our cash
provided from operations was $16.4 million for the six months ended June 30,
2009 and 2008.  Cash used in investing activities was $12.8 million
for the six months ended June 30, 2009 and $1.9 million for the six months ended
June 30, 2008.  Cash provided by financing activities was less than
$0.1 million for the six months ended June 30, 2009 and cash used in financing
activities was $29.4 million for the six months ended June 30,
2008.  Our net increase in cash and cash equivalents was $3.6 million
for the six months ended June 30, 2009, resulting primarily from our operating
activities, and our net decrease in cash and cash equivalents was $14.9 million
for the six months ended June 30, 2008, resulting primarily from our financing
activities.   We expect positive cash flow to continue in future
periods.





As of
June 30, 2009, we held auction rate securities with a fair value of $15.9
million and par value of $17.4 million. Our auction rate securities portfolio
includes investments rated A and AAA and comprised of federally and privately
insured student loans. However, the auction rate securities we hold have failed
to trade at recent auctions due to insufficient bids from buyers. This limits
the short-term liquidity of these instruments and may limit our ability to
liquidate and fully recover the carrying value of our auction rate securities if
we needed to convert some or all to cash in the near term. We believe that based
upon our current cash and cash equivalent balances, the current lack of
liquidity in the auction rate securities market will not have a material impact
on our liquidity or our ability to fund our operations.





Our
auction rate securities were acquired through UBS AG.  Due to the
failure of the auction rate market in early 2008, UBS and other major banks
entered into agreements with governmental agencies to provide liquidity to
owners of auction rate securities. In November 2008, we entered into an
agreement with UBS which provides us (1) with a “no net cost” loan up to the par
value of Eligible ARS until June 30, 2010, (2) the right to sell these
auction rate securities back to UBS AG at par, at our sole discretion, anytime
during the period from June 30, 2010 through July 2, 2012, and
(3) provides UBS AG the right to purchase these auction rate securities or
sell them on our behalf at par anytime through July 2, 2012. (See Note 3 to
our Consolidated Financial Statements included in this Quarterly Report on Form
10-Q for more information).





On May
21, 2009, we elected not to renew our secured credit agreement with our
bank and as a result, no longer have a revolving credit facility or other debt
financing arrangement.  We believe that our cash and short-term
investments, our UBS Settlement Agreement for our auction rate securities and
our projected cash from operations will be sufficient to meet our liquidity
needs for at least the next twelve months





In
connection with our November 8, 2007 and February 20, 2008 stock repurchase
plans we repurchased 1.3 million shares of our common stock at an average price
of $18.66 per share and an aggregate cost of $24.6 million for the six months
ended June 30, 2008.




33




Operating
Activities




Our
largest source of operating cash flows is cash collections from our customers
following the purchase and renewal of their software subscriptions. Payments
from customers for subscription agreements are generally received near the
beginning of the contract term, which can vary from one to six years in length.
We also generate significant cash from our recruitment services and to a lesser
extent our consulting services. Our primary uses of cash from operating
activities are for personnel related expenditures as well as payments related to
taxes and leased facilities.





Net cash
provided by operating activities was $16.4 million for the six months ended June
30, 2009 and 2008.  Net cash provided by operating activities for the
six months ended June 30, 2009 resulted primarily from a net loss of
approximately $33.0 million, increase in deferred tax benefits of $1.0 million
and changes in working capital of $1.4 offset by non-cash charges to net income
of $9.4 million, a non-cash goodwill impairment charge of $33.3 million, an
increase in deferred revenue of $3.4 million, and a decrease in accounts
receivables of approximately $5.7 million.  Net cash provided by
operating activities for the six months ended June 30, 2008 resulted primarily
from net income of approximately $10.7 million, non-cash charges to net income
of $9.9 million, an increase in deferred revenue of $3.7 million and a deferred
taxes of $0.9 million, partially offset by changes in working capital of $4.6
million, an increase in accounts receivable of $4.0 million and a reduction in
taxes payable resulting from the excess tax benefits from share based payments
of $0.2 million.





Investing
Activities





Net cash
used in investing activities was $12.8 million and $1.9 million for the six
months ended June 30, 2009 and 2008, respectively, and consisted of the
following, in millions:





For the six
                    months ended
                    June 30, 2009
                  
                  
                  For the six
                    months ended
                    June 30, 2008Scottworks
      acquisition
                  
                  $
                  —
                  
                  
                  $
                  (
      0.1
                  )StraightSource
      acquisition
                  
                  
                  (3.1
                  )
                  
                  
                  (1.1
                  )Knowledge
      Workers acquisition
                  
                  
                  —
                  
                  
                  
                  (0.1
                  )Gantz
      Wiley Research acquisition
                  
                  
                  —
                  
                  
                  
                  (0.6
                  )HRC
      acquisition
                  
                  
                  (0.2
                  )
                  
                  
                  (0.3
                  )Quorum
      acquisition
                  
                  
                  (0.4
                  )
                  
                  
                  (19.4
                  )Capitalized
      software and purchases of computer hardware
                  
                  
                  (7.4
                  )
                  
                  
                  (11.4
                  )Purchases
      of available-for-sale securities
                  
                  
                  (3.8
                  )
                  
                  
                  (22.7
                  )Sales
      of available-for-sale securities
                  
                  
                  2.3
                  
                  
                  
                  53.8Sales
      of trading securities
                  
                  
                  1.2
                  
                  
                  
                  —Investment
      in joint venture
                  
                  
                  (1.4
                  )
                  
                  
                  —Total
      cash flows (used in) and provided by investing activities
                  
                  $
                  (12.8
                  )
                  
                  $
                  1.9





In the
future, we expect our capital expenditures to increase as business needs
arise.





Financing
Activities





Net cash
provided by and used in financing activities was less than $0.1 million and
$29.4 million for the six months ended June 30, 2009 and 2008,
respectively.  For the six months ended June 30, 2008, net cash used
in financing activities consisted of repurchases of our common shares of $29.8
million and repayments of our capital lease obligations of $0.1 million,
partially offset by net proceeds from stock option exercises of $0.3 million,
excess tax benefits from share-based payment arrangements of $0.1 million and
proceeds from our employee stock purchase plan of $0.1 million.




We
believe that our cash and cash equivalent balances and cash flows from
operations will be sufficient to satisfy our working capital and capital
expenditure requirements for at least the next 12 months.  We intend
to continue to invest our cash in excess of current operating requirements in
interest-bearing, investment-grade securities. Changes in our operating plans,
lower than anticipated revenue, increased expenses or other events, may cause us
to seek additional debt or equity financing. Financing may not be available on
acceptable terms, or at all, and our failure to raise capital when needed could
negatively impact our growth plans and our financial condition and consolidated
results of operations. Additional equity financing would be dilutive to the
holders of our common stock, and debt financing, if available, may involve
significant cash payment obligations and covenants or financial ratios that
restrict our ability to operate our business.


34


Critical
Accounting Policies and Estimates





Our
discussion and analysis of our financial condition and consolidated results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of our consolidated financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to uncollectible accounts receivable and accrued expenses. We base
these estimates on historical experience and various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Our actual results may differ
from these estimates.





We
believe that the following critical accounting policies affect our more
significant estimates and judgments used in the preparation of our consolidated
financial statements:




Revenue
Recognition





We derive
our revenue from two sources: (1) subscription revenues for solutions,
which are comprised of subscription fees from customers accessing our on-demand
software, consulting services, outsourcing services and proprietary content, and
from customers purchasing additional support beyond the standard support that is
included in the basic subscription fee; and (2) other fees for professional
services, translation services and reimbursed out-of-pocket expenses. Because we
provide our solutions as a service, we follow the provisions of Staff Accounting
Bulletin No. 101, “Revenue Recognition in Financial
Statements”, as amended by Staff Accounting Bulletin No. 104, “Revenue Recognition”. On
August 1, 2003, we adopted Emerging Issues Task Force Issue No. 00-21,
“Revenue Arrangements with
Multiple Deliverables”. We recognize revenue when all of the following
conditions are met:




•
            there is persuasive evidence of
      an arrangement;





•
            the service has been provided to
      the customer;





•
            the collection of the fees is
      probable; and





•
            the amount of fees to be paid by
      the customer is fixed or
determinable.





Subscription Fees and Support
Revenues. Subscription fees and support revenues are recognized ratably
over the lives of the contracts. Amounts that have been invoiced are recorded in
accounts receivable and in deferred revenue or revenue, depending on whether the
revenue recognition criteria have been met.





Other Revenue. Other revenue
consists of discrete professional services, translation services and
reimbursable out-of-pocket expenses. Discrete professional services, when sold
with subscription and support offerings, are accounted for separately since
these services have value to the customer on a stand-alone basis and there is
objective and reliable evidence of fair value of the delivered elements. Our
arrangements do not contain general rights of return. Additionally, when
professional services are sold with other elements, the consideration from the
revenue arrangement is allocated among the separate elements based upon the
relative fair value. Revenues from professional services are recognized as the
services are rendered.





In
determining whether revenues from professional services can be accounted for
separately from subscription revenue, we consider the following factors for each
agreement: availability of professional services from other vendors, whether
objective and reliable evidence of the fair value exists of the undelivered
elements, the nature and the timing of when the agreement was signed in
comparison to the subscription agreement start date and the contractual
dependence of the subscription service on the customer's satisfaction with the
other services. If the professional service does not qualify for separate
accounting, we recognize the revenue ratably over the remaining term of the
subscription contract. In these situations we defer the direct and incremental
costs of the professional service over the same period as the revenue is
recognized.




In
accordance with EITF 01-14, “Out-of-Pocket Expenses Incurred”we record reimbursements received for out-of-pocket expenses as revenue
and not netted with the applicable costs.  These items primarily
include travel, meals and certain telecommunication costs.  Reimbursed
expenses totaled $0.5 million, $1.1 million, $1.5 million, and $2.1 million for
the three and six months ended June 30, 2009 and 2008,
respectively.


35


Allowance
for Doubtful Accounts





We
maintain an allowance for doubtful accounts for estimated losses resulting from
customers’ inability to pay us. The provision is based on our historical
experience and for specific customers that, in our opinion, are likely to
default on our receivables from them. In order to identify these customers, we
perform ongoing reviews of all customers that have breached their payment terms,
as well as those that have filed for bankruptcy or for whom information has
become available indicating a significant risk of non-recoverability. In
addition, we have experienced significant growth in number of customers, and we
have less payment history to rely upon with these customers. We rely on
historical trends of bad debt as a percentage of total revenue and apply these
percentages to the accounts receivable associated with new customers and
evaluate these customers over time. To the extent that our future collections
differ from our assumptions based on historical experience, the amount of our
bad debt and allowance recorded may be different.





Capitalized
Software Research and Development Costs





In
accordance with EITF Issue 00-3, “Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software Stored on
Another Entity's Hardware”, we apply AICPA Statement of Position
No. 98-1, “Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use”.
The costs incurred in the preliminary stages of development are expensed as
incurred. Once an application has reached the development stage, internal and
external costs, if direct and incremental, will be capitalized until the
software is substantially complete and ready for its intended use.
Capitalization ceases upon completion of all substantial testing. We also
capitalize costs related to specific upgrades and enhancements when it is
probable the expenditures will result in additional functionality. Maintenance
and training cost are expensed as incurred. Internal use software is amortized
on a straight-line basis over its estimated useful life, generally three years.
Management evaluates the useful lives of these assets on an annual basis and
tests for impairments whenever events or changes in circumstances occur that
could impact the recoverability of these assets. There were no impairments to
internal software in any of the periods covered in this report.





Goodwill
and Other Identified Intangible Asset Impairment





On
January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible
Assets”,which superseded Accounting Board Opinion No. 17, “Intangible Assets”. Upon
adoption of SFAS No. 142, we ceased amortization of existing goodwill and
are required to review the carrying value of goodwill for impairment. If
goodwill becomes impaired, some or all of the goodwill could be written off as a
charge to operations. This comparison is performed annually or more frequently
if circumstances change that would more likely than not reduce the fair value of
the reporting unit below its carry amount.





During
the three months ended March 31, 2009 and December 31, 2008 we reviewed the
carrying values of goodwill by comparing the carrying values to the estimated
fair values of the enterprise. The fair value is based on management’s estimate
of the future discounted cash flows to be generated by the enterprise and our
market capitalization. Such cash flows consider factors such as future operating
income, historical trends, as well as demand and competition. Comparable company
multiples are based upon public companies in sectors relevant to our business
based on our knowledge of the industry. Changes in the underlying business could
affect these estimates, which in turn could affect our assessment of the
recoverability of goodwill.





Based on
the analysis, a goodwill impairment charge of $33.3 million and $167.0 million
for the three months ended June 30, 2009 and December 31, 2008, respectively,
was recorded. The goodwill impairment charge had no effect on our cash
balances.


36


Classification
and Fair Value Measurement of Auction Rate Securities





We hold
investments in auction rate securities having contractual maturities of greater
than one year and interest rate reset features of between 7 and 35 days. These
auction rate securities were priced and subsequently traded as short-term
investments because of the interest rate reset feature. Consequently, we have
historically classified our auction rate securities as available for sale
short-term investments at par.





During
2008, as a result of the deterioration in the credit markets, our auction rate
securities failed to trade at recent auctions due to insufficient bids from
buyers. These events have led to uncertainty surrounding the short-term
liquidity of our auction rate security investments.   Due to our
ability to liquidate these securities within the next twelve months, we have
reclassified our auction rate securities to short-term investments on our
Consolidated Balance Sheet as of June 30, 2009.





Our
auction rate securities, which have a par value of $17.4 million at June 30,
2009, were acquired through UBS AG. Due to the failure of the auction rate
market in early 2008, UBS AG and other major banks entered into discussions with
government agencies to provide liquidity to owners of auction rate securities.
In November 2008, we entered into an agreement (the “UBS Settlement Agreement”)
with UBS AG which provides us (1)  with a “no net cost” loan up to the
par value of Eligible ARS until June 30, 2010, (2)  the right to sell these
auction rate securities back to UBS AG at par, at our sole discretion, anytime
during the period from June 30, 2010 through July 2, 2012, and
provides UBS AG the right to purchase these auction rate securities or sell
them on our behalf at par anytime through July 2, 2012. (See Note 3 to the
Consolidated Financial Statements).  As a result of the execution of
the UBS Settlement Agreement, we determined that we no longer had the intent and
ability to hold the ARS until maturity or until the ARS market would
recover.  Based on this unusual circumstance related to the signing of the
USB Settlement Agreement, we transferred these investments from
available–for-sale to trading securities and began recording the change in fair
value of the ARS in as gains or losses in current period earnings.




During
the fourth quarter of 2008, we elected to measure the value of our option to put
the securities (“put option”) to UBS AG under the fair value option of SFAS
No. 159.   As a result, at December 31, 2008, we recorded
non-operating gain representing the estimated fair value of the put option and a
corresponding long-term asset of approximately $2,219.   At June 30,
2009, the put option’s estimated fair value decreased to $1,444, resulting in a
non-operating loss of $214 during the quarter.  The estimated fair value of
the put option as of June 30, 2009 was based in part on an expected life of
twelve months and a discount rate of 2.81%.   As a result of the
transfer of the ARS from available-for-sale to trading investment securities
noted above, we also recorded a non-operating gain during the three and six
months ended June 30, 2009 representing an increase in their estimated fair
value of approximately $397 and $664, respectively.   The recording of
the gain relating to the increase in the fair value of the ARS and the
recognition of the loss on the put option resulted in an overall net gain of
approximately $183 for the three months ended June 30, 2009 and a net loss of
approximately $112 for the six months ended June 30, 2009.





We
anticipate that any future changes in the fair value of our put option under the
UBS Settlement Agreement will partially be offset by the changes in the fair
value of the related auction rate securities and may result in a material net
impact to our consolidated statement of operations. Our option to put the
securities under the UBS Settlement Agreement will continue to be measured at
fair value utilizing Level 3 inputs as defined by SFAS 157 until the earlier of
its maturity or exercise.





The fair
values of our auction rate securities are estimated utilizing a discounted cash
flow analysis or other types of valuation models as of June 30, 2009 rather than
at par. These analyses are highly judgmental and consider, among other items,
the likelihood of redemption, credit quality, duration, insurance wraps and
expected future cash flows. These securities were also compared, when possible,
to other observable market data with similar characteristics to the securities
held by us. Any changes in fair value for our auction rate securities, which we
attribute to market liquidity issues rather than credit issues, are recorded in
our statement of operations.


37





Accounting
for Share-Based Compensation





We use a
Black-Scholes option-pricing model to calculate the fair value of our
share-based awards. The calculation of the fair value of the awards using the
Black-Scholes option-pricing model is affected by our stock price on the date of
grant as well as assumptions regarding the following:




•
            Volatility is a measure of the
      amount by which the stock price is expected to fluctuate each year during
      the expected life of the award and is based on a weighted average of peer
      companies, comparable indices and our stock volatility. An increase in the
      volatility would result in an increase in our
    expense.


•
              The expected term represents the
      period of time that awards granted are expected to be outstanding and is
      currently based upon an average of the contractual life and the vesting
      period of the options. With the passage of time actual behavioral patterns
      surrounding the expected term will replace the current methodology.
      Changes in the future exercise behavior of employees or in the vesting
      period of the award could result in a change in the expected term. An
      increase in the expected term would result in an increase to our
      expense.


•
              The risk-free interest rate is
      based on the U.S. Treasury yield curve in effect at time of grant. An
      increase in the risk-free interest rate would result in an increase in our
      expense.


•
              The estimated forfeiture rate is
      the rate at which awards are expected to expire before they become fully
      vested and exercisable. An increase in the forfeiture rate would result in
      a decrease to our
expense.





Share-based compensation expense
recognized during the period is based on the value of the number of awards that
are expected to vest. In determining the share-based compensation expense to be
recognized, a forfeiture rate is applied to the fair value of the award. This
rate represents the number of awards that are expected to be forfeited prior to
vesting and is based on our historical employee behavior. Changes in the future
behavior of employees could impact this rate. A decrease in this rate would
result in an increase in our expense.





In
certain instances where market based, performance share awards are granted, we
use the Monte Carlo valuation model to calculate the fair value.  This
approach utilizes a two-stage process, which first simulates potential outcomes
for our shares using the Monte Carlo simulation and then employs the
Black-Scholes model to value the various outcomes predicted by the Monte Carlo
simulation.   The resulting fair value, on the date of the grant
(measurement date), is being recognized over the vesting period using the
straight-line method.





The
stage-one Monte Carlo simulation requires a variety of assumptions about both
the statistical properties of our shares as well as potential reactions to such
share price movements by management.  Such assumptions include the
natural logarithm of our stock price, a random log-difference using the Russell
2000 stock index and a random variable using the specific deviations of our
returns relative to the returns dictated by the Capital asset pricing
model.





Accounting
for Income Taxes





We
account for income taxes in accordance with FASB Statement No. 109, “Accounting for Income
Taxes,” (“SFAS No. 109”), which requires that deferred tax
assets and liabilities be recognized using enacted tax rates for the effect of
temporary differences between the book and tax basis of recorded assets and
liabilities. SFAS No. 109 also requires that deferred tax assets be
reduced by a valuation allowance if it is more likely than not that some portion
or all of the deferred tax asset will not be realized.





The
realization of the deferred tax assets is evaluated quarterly by assessing the
valuation allowance and by adjusting the amount of the allowance, if necessary.
The factors used to assess the likelihood of realization are the forecast of
future taxable income and available tax planning strategies that could be
implemented to realize the net deferred tax assets. We have used tax-planning
strategies to realize or renew net deferred tax assets in order to avoid the
potential loss of future tax benefits.  In addition, we operate within
multiple taxing jurisdictions and are subject to audit in each jurisdiction.
These audits can involve complex issues that may require an extended period of
time to resolve. In our opinion, adequate provisions for income taxes have been
made for all periods.





Self-Insurance





We are
self-insured for the majority of our health insurance costs, including claims
filed and claims incurred but not reported subject to certain stop loss
provisions. We estimate our liability based upon management’s judgment and
historical experience. We also rely on the advice of consulting administrators
in determining an adequate liability for self-insurance claims. As of June 30,
2009 and December 31, 2008, self-insurance accruals totaled approximately
$0.5 million and $0.6 million, respectively. We continuously review
the adequacy of our insurance coverage. Material differences may result in the
amount and timing of insurance expense if actual experience differs
significantly from management's estimates.


38


Item
3: Quantitative and Qualitative Disclosures about Market Risk





Market
risk represents the risk of loss that may impact our financial position due to
adverse changes in financial market prices and rates.  Our market risk
exposure is primarily a result of fluctuations in interest rates and foreign
currency exchange rates. We do not hold or issue financial instruments for
trading purposes.





Foreign
Currency Exchange Risk





A key
component of our business strategy is to expand our international sales efforts,
which will expose us to foreign currency exchange rate fluctuations. A 10%
change in the value of the U.S. dollar relative to each of the currencies of our
non-U.S. generated sales would have not resulted in a material change to our
results.  As of June 30, 2009 we were not involved in any foreign
currency hedging activities.




The
financial position and operating results of our foreign operations are
consolidated using the local currency as the functional currency. Local currency
assets and liabilities are translated at the rate of exchange to the U.S. dollar
on the balance sheet date, and the local currency revenue and expenses are
translated at average rates of exchange to the U.S. dollar during the period.
The related translation adjustments to shareholders’ equity were a decrease of
$0.9 million and $3.9 million for the six months ended June 30, 2009 and
year ended December 30, 2008, respectively, and are included in other
comprehensive income. The foreign currency translation adjustment is not
adjusted for income taxes as it relates to an indefinite investment in a
non-U.S. subsidiary.





Interest
Rate Risk





The
primary objective of our investment activities is to preserve principal while
maximizing income without significantly increasing risk. Some of the securities
in which we invest may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. To minimize this risk in the future, we intend to maintain our
portfolio of cash equivalents and short-term investments in a variety of
securities, money market funds, government and non-government debt securities
and certificates of deposit. Our cash equivalents, which consist solely of money
market funds, are not subject to market risk because the interest paid on these
funds fluctuates with the prevailing interest rate. We believe that a 10% change
in interest rates would not have a significant effect on our interest income for
the three and six months ended June 30, 2009 and 2008.





Item
4: Controls and Procedures





Under the
supervision of and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 as of the end of the period covered by this
report, or the Evaluation Date.  Based upon the evaluation, our
principal executive officer and principal financial officer concluded that our
disclosure controls and procedures were effective as of the Evaluation
Date.  Disclosure controls are controls and procedures designed to
reasonably ensure that information required to be disclosed in our reports filed
under the Exchange Act, such as this report, is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and
forms.  Disclosure controls include controls and procedures designed
to reasonably ensure that such information is accumulated and communicated to
our management, including our chief executive officer and chief financial
officer, as appropriate to allow timely decisions regarding required
disclosure.





In
connection with this evaluation, our management identified no changes in our
internal control over financial reporting that occurred during the most recent
fiscal quarter that materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.


39


PART
II: OTHER INFORMATION





Item
1: Legal Proceedings





On June
11, 2009 and July 16, 2009, two putative class actions were filed against us and
our Chief Executive Officer and Chief Financial Officer in the United States
District Court for the Eastern District of Pennsylvania, purportedly on behalf
of a class of our investors who purchased our publicly traded securities between
May 8, 2007 and November 7, 2007.  The complaints in these actions
generally allege violations of Section 10(b) of the Securities Exchange Act of
1934 (“Exchange Act”), Rule 10b-5 promulgated thereunder and Section 20(a) of
the Exchange Act in connection with various public statements made by
us.  Pursuant to the Private Securities Litigation Reform Act, any
member of the purported class who wishes to be appointed “lead plaintiff” must
file a motion seeking such designation on or before August 10,
2009.  According to the Court’s current scheduling order, a hearing
regarding the appointment of lead plaintiff will take place on September 9,
2009; whoever is appointed lead plaintiff will have until September 30, 2009 to
file an amended complaint; and defendants will have until October 21, 2009 to
file their response to the complaint.  We intend to vigorously defend
these actions.  The potential impact of these actions, which seek
unspecified damages, attorneys fees and expenses, is uncertain.




We also
are involved from time to time in claims which arise in the ordinary course of
business.  In the opinion of management, we have made adequate
provision for potential liabilities, if any, arising from any such
matters.




Litigation
is inherently unpredictable, and the costs and other effects of pending or
future litigation, governmental investigations, legal and administrative cases
and proceedings (whether civil or criminal), settlements, judgments and
investigations, claims and changes in any such matters, could have a material
adverse effect on our business, financial condition and operating
results.





Item
1A: Risk Factors





In
addition to the other information set forth in this Form 10-Q, you should
carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of
our Annual Report on Form 10-K for the year ended December 31, 2008 which could
materially affect our business, financial condition or future results of
operations.  The risks described in our Annual Report on Form 10-K for
the year ended December 31, 2008 are not the only risks that we
face.  Additional risks and uncertainties not currently known to us or
that we currently deem to be immaterial may also materially adversely affect our
business, financial condition and future results of operations.  There
have been no material changes from the risk factors previously disclosed in Item
1A of our Annual Report on Form 10-K for the year ended December 31,
2008.





Item
2: Unregistered Sales of Equity Securities and Use of Proceeds





Not
applicable.





Item
3: Defaults Upon Senior Securities





Not
applicable.


40


Item
4: Submission of Matters to a Vote of Security Holders





We held
our annual meeting of shareholders on May 20, 2009 (the “Annual
Meeting”).




At the
Annual Meeting, Troy A. Kanter, Renee B. Booth and Rebecca J. Maddox were each
nominated for, and reelected by the shareholders to, our Board of Directors (the
“Board”).  The number of votes cast for, and withheld with respect to, each
nominee is set forth below:




For
                
                
                WithheldTroy
      A. Kanter
                
                
                19,347,356
                
                
                
                916,481Renee
      B. Booth
                
                
                18,982,472
                
                
                
                1,281,365Rebecca
      J. Maddox
                
                
                18,982,472
                
                
                
                1,281,365




Troy A.
Kanter, Renee B. Booth and Rebecca J. Maddox will continue to serve on our Board
along with Joseph A. Konen, Richard J. Pinola, Barry M. Abelson, Nooruddin S.
Karsan and John A. Nies, each of whose terms continued after the Annual
Meeting.





Also at
the Annual Meeting, the selection of Grant Thornton LLP as our independent
registered public accounting firm for 2009 was ratified.  The number of
votes cast for, against and abstentions and the number of broker non-votes with
respect to the selection is set forth below:




For
                
                
                Against
                
                
                Abstain
                
                
                Broker
      Non-
                  VotesRatification
      of Grant Thornton LLP
                
                
                20,262,842
                
                
                
                —
                
                
                
                995
                
                
                
                —





Item
5: Other Information





Not
applicable.





Item
6:  Exhibits





The
following exhibits are filed herewith:





31.1    Certification
by Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).





31.2    Certification
by Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).





32.1    Certification
Furnished Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.


41


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.





August
10, 2009


Kenexa
Corporation





/s/ Nooruddin S. KarsanNooruddin
      S. KarsanChairman
      of the Board and Chief Executive Officer/s/ Donald F. VolkDonald
      F. VolkChief
      Financial Officer


42


EXHIBIT
INDEX





Exhibit
Number and Description




Exhibit
31.1    Certification by Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).





Exhibit
31.2    Certification by Chief Financial Officer Pursuant to
Rule 13a-14(a)/15d-14(a).





Exhibit
32.1    Certification Furnished Pursuant to 18 U.S.C.
Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.


43