**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, D.C.20549

**FORM 10-Q**

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

**For the quarterly periodended June 30, 2007**

**OR**

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

**For the transitionperiod from                 to                 **

**Commission File number 000-51358**

**Kenexa Corporation** (Exact Name of Registrant as Specified in Its Charter)
| **Pennsylvania**                                                | ** ** | **23-3024013**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification Number) |
|                                                            |       |                                     |
| **650  East Swedesford Road, Wayne, PA**                        | ** ** | **19087**                                |
| (Address of  Principal Executive Offices)                       |       | (Zip Code)                               |

 

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

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o               Acceleratedfiler x               Non-acceleratedfiler o

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

On August 6, 2007, 25,454,365 shares of the registrant’sCommon Stock, $0.01 par value, were outstanding.

 

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**KenexaCorporation and SubsidiariesFORM 10-QQuarter Ended June 30, 2007Table of Contents**
| PART I: FINANCIAL INFORMATION                                                                             |
|-----------------------------------------------------------------------------------------------------------|
| Item  1: Financial Statements (unaudited)                                                                 |
| Consolidated Balance Sheets as of June 30, 2007 and  December 31, 2006                                    |
| Consolidated Statements of Operations for the three  and six months ended June 30, 2007 and June 30, 2006 |
| Consolidated Statements of Shareholders’ Equity as of  June 30, 2007 and December 31, 2006           |
| Consolidated Statements of Cash Flows for the six  months ended June 30, 2007 and June 30, 2006           |
| Notes to Consolidated Financial Statements                                                                |
| Item 2: Management’s Discussion and Analysis of  Financial Condition and Results of Operations       |
| Item 3: Quantitative and Qualitative Disclosures about  Market Risk                                       |
| Item  4: Controls and Procedures                                                                          |
| PART  2: OTHER INFORMATION                                                                                |
| Item  1: Legal Proceedings                                                                                |
| Item  1A: Risk Factors                                                                                    |
| Item 2: Unregistered Sales of Equity Securities and  Use of proceeds                                      |
| Item 3: Defaults upon Senior Securities                                                                   |
| Item 4: Submission of matters to a vote of security  holders                                              |
| Item  5: Other Information                                                                                |
| Item 6:  Exhibits                                                                                         |
| Signatures                                                                                                |
| Exhibit Index                                                                                             |

 

2

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**PART I FINANCIAL INFORMATION**

**Item 1:Financial Statements**

**Kenexa Corporation and SubsidiariesConsolidated Balance Sheets**

(In thousands, except share data)

 
| ** **                                                                                                                            | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                            | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                            |       |                    |       |                        |       |
| Current assets                                                                                                                        |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                            |       | $                       | 29,180     |                        | $          | 42,502 |   |
| Short term  investments                                                                                                               |       | 79,360                  |       | —                      |       |
| Accounts  receivable, net of allowance for doubtful accounts of $1,300 and $975                                                       |       | 34,382                  |       | 31,493                      |       |
| Unbilled  receivables                                                                                                                 |       | 2,051                   |       | 1,005                       |       |
| Deferred income  taxes                                                                                                                |       | 12,611                  |       | 8,093                       |       |
| Prepaid expenses  and other current assets                                                                                            |       | 3,275                   |       | 3,578                       |       |
| **Total current assets**                                                                                                              |       | 160,859                 |       | 86,671                      |       |
|                                                                                                                                  |       |                    |       |                        |       |
| Property and  equipment, net of accumulated depreciation                                                                              |       | 11,540                  |       | 8,469                       |       |
| Software, net of  accumulated amortization                                                                                            |       | 1,566                   |       | 2,122                       |       |
| Goodwill                                                                                                                              |       | 172,386                 |       | 161,329                     |       |
| Intangible  assets, net of accumulated amortization                                                                                   |       | 4,213                   |       | 4,570                       |       |
| Deferred income  taxes, non-current                                                                                                   |       | —                  |       | 1,430                       |       |
| Deferred  financing costs, net of accumulated amortization                                                                            |       | 813                     |       | 1,295                       |       |
| Other assets                                                                                                                          |       | 1,905                   |       | 1,573                       |       |
| **Total assets**                                                                                                                      |       | $                       | 353,282    |                        | $          | 267,459 |   |
| ** **                                                                                                                            |       |                    |       |                        |       |
| **Liabilities and Shareholders’  Equity**                                                                                        |       |                    |       |                        |       |
| Current liabilities                                                                                                                   |       |                    |       |                        |       |
| Accounts payable                                                                                                                      |       | $                       | 6,180      |                        | $          | 5,672 |   |
| Line of credit                                                                                                                        |       | —                  |       | 20,000                      |       |
| Notes payable,  current                                                                                                               |       | 320                     |       | 138                         |       |
| Commissions  payable                                                                                                                  |       | 1,406                   |       | 1,674                       |       |
| Accrued  compensation and benefits                                                                                                    |       | 7,073                   |       | 9,878                       |       |
| Other accrued  liabilities                                                                                                            |       | 8,201                   |       | 6,086                       |       |
| Deferred revenue                                                                                                                      |       | 32,007                  |       | 31,251                      |       |
| Capital lease  obligations                                                                                                            |       | 175                     |       | 229                         |       |
| **Total current liabilities**                                                                                                         |       | 55,362                  |       | 74,928                      |       |
|                                                                                                                                  |       |                    |       |                        |       |
| Term loan                                                                                                                             |       | —                  |       | 45,000                      |       |
| Capital lease  obligations, less current portion                                                                                      |       | 92                      |       | 145                         |       |
| Notes payable,  less current portion                                                                                                  |       | 88                      |       | 111                         |       |
| Deferred income taxes                                                                                                                 |       | 825                     |       | —                      |       |
| Other  liabilities                                                                                                                    |       | —                  |       | 114                         |       |
| **Total liabilities**                                                                                                                 |       | 56,367                  |       | 120,298                     |       |
| ** **                                                                                                                            |       |                    |       |                        |       |
| Commitments and  Contingencies                                                                                                        |       |                    |       |                        |       |
|                                                                                                                                  |       |                    |       |                        |       |
| **Shareholders’ equity**                                                                                                         |       |                    |       |                        |       |
| Preferred stock,  par value $0.01; 100,000 shares authorized; no shares issued or outstanding                                         |       | —                  |       | —                      |       |
| Common stock,  $0.01 par value; 100,000,000 shares authorized; 25,451,425 and 20,897,777  shares issued and outstanding, respectively |       | 255                     |       | 209                         |       |
| Additional  paid-in capital                                                                                                           |       | 315,247                 |       | 176,345                     |       |
| Accumulated  other comprehensive income                                                                                               |       | 393                     |       | 96                          |       |
| Accumulated  deficit                                                                                                                  |       | (18,980                 | )          | (29,489                     | )          |
| **Total shareholders’ equity**                                                                                                   |       | 296,915                 |       | 147,161                     |       |
| **Total liabilities and  shareholders’ equity**                                                                                  |       | $                       | 353,282    |                        | $          | 267,459 |   |

 

*See notes to consolidated financial statements.*

3

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**KenexaCorporation and SubsidiariesConsolidated Statements of Operations**

(In thousands,except share and per share data)

(Unaudited)
| ** **                                                                   | ** ** | **Three months Ended  June 30,** | ** ** | **Six months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenue                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Subscription revenue                                                         |       | $                                               | 37,009     |                                          | $          | 19,947 |   | $ | 71,696 |   | $ | 37,540 |   |
| Other revenue                                                                |       | 8,155                                           |       | 4,760                                         |       | 15,685 |   | 10,182 |   |
| Total revenue                                                                |       | 45,164                                          |       | 24,707                                        |       | 87,381 |   | 47,722 |   |
| Cost of revenue                                                              |       | 12,600                                          |       | 6,672                                         |       | 24,032 |   | 13,026 |   |
| Gross profit                                                                 |       | 32,564                                          |       | 18,035                                        |       | 63,349 |   | 34,696 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Sales and marketing                                                          |       | 9,094                                           |       | 5,717                                         |       | 17,324 |   | 11,445 |   |
| General and administrative                                                   |       | 9,765                                           |       | 5,914                                         |       | 19,436 |   | 11,201 |   |
| Research and development                                                     |       | 4,297                                           |       | 1,815                                         |       | 8,620 |   | 3,351 |   |
| Depreciation and amortization                                                |       | 1,477                                           |       | 768                                           |       | 2,907 |   | 1,490 |   |
| Total operating  expenses                                                    |       | 24,633                                          |       | 14,214                                        |       | 48,287 |   | 27,487 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations                                                      |       | 7,931                                           |       | 3,821                                         |       | 15,062 |   | 7,209 |   |
| Interest income,  net                                                        |       | 974                                             |       | 682                                           |       | 1,097 |   | 802 |   |
| Income from  operations before income taxes                                  |       | 8,905                                           |       | 4,503                                         |       | 16,159 |   | 8,011 |   |
| Income tax  expense                                                          |       | 3,092                                           |       | 1,223                                         |       | 5,650 |   | 1,452 |   |
| Net income                                                                   |       | $                                               | 5,813      |                                          | $          | 3,280 |   | $ | 10,509 |   | $ | 6,559 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Basic net income  per share                                                  |       | $                                               | 0.23       |                                          | $          | 0.16 |   | $ | 0.43 |   | $ | 0.34 |   |
| Weighted average  shares used to compute net income per share — basic   |       | 25,326,997                                      |       | 20,250,790                                    |       | 24,690,936 |   | 19,239,983 |   |
|                                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Diluted net  income per share                                                |       | $                                               | 0.23       |                                          | $          | 0.16 |   | $ | 0.42 |   | $ | 0.33 |   |
| Weighted average shares  used to compute net income per share — diluted |       | 25,743,996                                      |       | 21,056,536                                    |       | 25,116,145 |   | 19,972,040 |   |

 

*See notes to consolidated financial statements.*

4

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**KenexaCorporation and SubsidiariesConsolidated Statements of Shareholders’ Equity**

(in thousands)
| ** **                                                                       | ** ** | **Common  stock** | ** ** | **Additional  paid-in  capital** | ** ** | **Accumulated  (deficit)** | ** ** | **Accumulated  other  comprehensive  (loss) income** | ** ** | **Deferred  compensation** | ** ** | **Note  receivable  on common  stock** | ** ** | **Total  stockholders’  equity** | ** ** | **Comprehensive  income** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|----------------------------|------------|-----------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|
| Balance, December  31, 2005                                                      |       | $                 | 174        |                             | $          | 97,140                     |       | $                                                         | (45,382    | )                          | $          | (30                                         | )          | $                                     | (1,040     | )                         | $          | (120 | ) | $ | 50,742 |   | $ | 5,967 |   |
| Payments received on notes receivable for  class A common stock             |       | —            |       | —                           |       | —                     |       | —                                                    |       | —                     |       | 120                                         |       | 120                                   |       | —                    |       |
| Gain on currency exchange                                                        |       | —            |       | —                           |       | —                     |       | 126                                                       |       | —                     |       | —                                      |       | 126                                   |       | 126                       |       |
| Reclassification of deferred compensation balance to  additional paid-in capital |       | —            |       | (1,040                           | )          | —                     |       | —                                                    |       | 1,040                      |       | —                                      |       | —                                |       | —                    |       |
| Share-based compensation                                                         |       | —            |       | 3,076                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 3,076                                 |       | —                    |       |
| Income tax benefits realized from activity in  employee stock plans              |       | —            |       | 2,762                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 2,762                                 |       | —                    |       |
| Option exercises                                                                 |       | 4                 |       | 4,360                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 4,364                                 |       | —                    |       |
| Conversion of class B, D & E warrants                                        |       | 3                 |       | (3                               | )          | —                     |       | —                                                    |       | —                     |       | —                                      |       | —                                |       | —                    |       |
| Public stock offering, net                                                       |       | 26                |       | 66,255                           |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 66,281                                |       | —                    |       |
| Common Stock Issuance for Gantz Wiley Research  Acquisition                      |       | 2                 |       | 3,168                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 3,170                                 |       | —                    |       |
| Common Stock Issuance for Psychometrics Services Ltd.  Acquisition               |       | —            |       | 627                              |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 627                                   |       | —                    |       |
| Net Income                                                                       |       |              |       |                             |       | 15,893                     |       |                                                      |       |                       |       |                                        |       | 15,893                                |       | 15,893                    |       |
| Balance, December  31, 2006                                                      |       | $                 | 209        |                             | $          | 176,345                    |       | $                                                         | (29,489    | )                          | $          | 96                                          |       | $                                     | —     |                      | $          | — |   | $ | 147,161 |   | $ | 16,019 |   |
| Gain on currency translation adjustment                                          |       | —            |       | —                           |       | —                     |       | 387                                                       |       | —                     |       | —                                      |       | 387                                   |       | 387                       |       |
| Unrealized loss on short term investments                                        |       | —            |       | —                           |       | —                     |       | (90                                                       | )          | —                     |       | —                                      |       | (90                                   | )          | (90                       | )          |
| Share-based compensation expense                                                 |       | —            |       | 1,784                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 1,784                                 |       | —                    |       |
| Excess tax benefits from Share-based payment  arrangements                       |       | —            |       | 1,326                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 1,326                                 |       | —                    |       |
| Option exercises                                                                 |       | 2                 |       | 1,523                            |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 1,525                                 |       | —                    |       |
| Employee stock purchase plan                                                     |       | —            |       | 91                               |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 91                                    |       | —                    |       |
| Public stock offering, net                                                       |       | 43                |       | 130,355                          |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 130,398                               |       | —                    |       |
| Common Stock Issuance for Jack Wiley earn out                                    |       | —            |       | 650                              |       | —                     |       | —                                                    |       | —                     |       | —                                      |       | 650                                   |       | —                    |       |
| Common Stock Issuance for Straight Source Acquisition                            |       | 1                 |       | 3,173                            |       |                       |       |                                                      |       |                       |       |                                        |       | 3,174                                 |       | —                    |       |
| Net income                                                                       |       | —            |       | —                           |       | 10,509                     |       | —                                                    |       | —                     |       | —                                      |       | 10,509                                |       | 10,509                    |       |
| Balance, June 30, 2007  (unaudited)                                              |       | $                 | 255        |                             | $          | 315,247                    |       | $                                                         | (18,980    | )                          | $          | 393                                         |       | $                                     | —     |                      | $          | — |   | $ | 296,915 |   | $ | 10,806 |   |

 

*See notes to consolidated financial statements.*

5

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**KenexaCorporation and SubsidiariesConsolidated Statements of Cash Flows**

(In thousands)

(Unaudited)
| ** **                                                                        | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
|                                                                              |       |                                          |       |   |   |
| **Cash  flows from operating activities**                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                        |       | $                                             | 10,509     |   | $ | 6,559 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities |       |                                          |       |   |   |
| Depreciation and amortization                                                     |       | 2,907                                         |       | 1,489 |   |
| Non-cash interest expense                                                         |       | 9                                             |       | — |   |
| Share-based compensation expense                                                  |       | 1,784                                         |       | 1,341 |   |
| Excess tax benefits from share-based payment  arrangements                        |       | (1,326                                        | )          | (767 | ) |
| Amortization of deferred financing costs                                          |       | 584                                           |       | 66 |   |
| Bad debt expense                                                                  |       | 70                                            |       | (62 | ) |
| Deferred income taxes                                                             |       | (1,874                                        | )          | (1,388 | ) |
| **Changes  in assets and liabilities**                                            | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Accounts and unbilled receivables                                                 |       | (1,817                                        | )          | (5,227 | ) |
| Prepaid expenses and other current assets                                         |       | 410                                           |       | (277 | ) |
| Other assets                                                                      |       | (335                                          | )          | 87 |   |
| Accounts payable                                                                  |       | 331                                           |       | 278 |   |
| Accrued compensation and other accrued liabilities                                |       | 591                                           |       | 1,060 |   |
| Commissions payable                                                               |       | (268                                          | )          | 13 |   |
| Deferred revenue                                                                  |       | 730                                           |       | (823 | ) |
| Other liabilities                                                                 |       | (115                                          | )          | (23 | ) |
| **Net  cash provided by operating activities**                                    |       | 12,190                                        |       | 2,326 |   |
| ** **                                                                        |       |                                          |       |   |   |
| **Cash  flows from investing activities**                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                               |       | (4,610                                        | )          | (2,085 | ) |
| Purchases of available-for-sale securities                                        |       | (79,450                                       | )          | — |   |
| Acquisitions, net of cash acquired                                                |       | (10,049                                       | )          | (34,629 | ) |
| **Net  cash used in investing activities**                                        |       | (94,109                                       | )          | (36,714 | ) |
| ** **                                                                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Cash  flows from financing activities**                                         | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Repayments under line of credit                                                   |       | (65,000                                       | )          | — |   |
| Repayments of notes payable                                                       |       | (58                                           | )          | (139 | ) |
| Collections of notes receivable                                                   |       | —                                        |       | 120 |   |
| Share issuance from Employee Stock Purchase Plan                                  |       | 91                                            |       | — |   |
| Excess tax benefits from share-based payment  arrangements                        |       | 1,326                                         |       | 767 |   |
| Net proceeds from public offering                                                 |       | 130,471                                       |       | 66,514 |   |
| Deferred financing costs                                                          |       | (102                                          | )          | (123 | ) |
| Net proceeds from option exercises                                                |       | 1,525                                         |       | 1,208 |   |
| Repayments of capital lease obligations                                           |       | (115                                          | )          | (225 | ) |
| **Net  cash provided by financing activities**                                    |       | 68,138                                        |       | 68,122 |   |
|                                                                              |       |                                          |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                     |       | 459                                           |       | (302 | ) |
| Net (decrease)  increase in cash and cash equivalents                             |       | (13,322                                       | )          | 33,432 |   |
| Cash and cash  equivalents at beginning of year                                   |       | 42,502                                        |       | 43,499 |   |
|                                                                              |       |                                          |       |   |   |
| **Cash  and cash equivalents at end of period**                                   |       | $                                             | 29,180     |   | $ | 76,931 |   |
| ** **                                                                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| **Supplemental  disclosures of cash flow information**                            | ** ** | ** **                                    | ** ** | ** ** | ** ** |
|                                                                              |       |                                          |       |   |   |
| Cash paid during  the period for:                                                 |       |                                          |       |   |   |
| Interest expense                                                                  |       | $                                             | 692        |   | $ | 387 |   |
| Income taxes                                                                      |       | $                                             | 1,550      |   | $ | 975 |   |
|                                                                              |       |                                          |       |   |   |
| **Non-cash  investing and financing activities**                                  | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Capital lease obligations                                                         |       | $                                             | 19         |   | $ | 114 |   |
| Common Stock Issuance for Jack Wiley earn out                                     |       | $                                             | 650        |   | — |   |
| Common Stock  Issuance for Straight Source Acquisition                            |       | $                                             | 3,174      |   | — |   |

 

*See notes to consolidated financial statements.*

6

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**KenexaCorporation and Subsidiaries****Notes to Consolidated Financial Statements -Unaudited**

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

**1.Organization**

Kenexa Corporation and its subsidiaries (collectively,the “Company”) commenced operations in 1987 as a provider of recruitingservices to a wide variety of industries. In 1993, the Company offered itsfirst automated talent management system. Between 1994 and 2007, the Companyacquired 26 businesses that enabled it to offer comprehensive human capitalmanagement, or HCM, services integrated with web-based technology.

The Company began its operations in 1987 under its predecessorcompanies, Insurance Services, Inc., or ISI, and International HoldingCompany, Inc., or IHC, in 1987. In December 1999, the Companyreorganized its corporate structure by merging ISI and IHC with and intoRaymond Karsan Associates, Inc., or RKA, a Pennsylvania corporation and awholly owned subsidiary of Raymond Karsan Holdings, Inc., or RKH, aPennsylvania corporation. Each of RKA and RKH were newly created to consolidatethe businesses of ISI and IHC. In April 2000, the Company changed its nameto TalentPoint, Inc. and changed the name of RKA to TalentPointTechnologies, Inc. In November 2000, the Company changed its name toKenexa Corporation and changed the name of TalentPoint Technologies, Inc.to Kenexa Technology, Inc., or Kenexa Technology. Currently, Kenexatransacts business primarily through Kenexa Technology. The Company operates inone segment.

The Company providessoftware, services and proprietary content that enable organizations to moreeffectively recruit and retain employees. Its solutions are built around asuite of easily configurable software applications that automate talentacquisition and employee performance management best practices. In addition,the Company offers the software applications that form the core of itssolutions on an on-demand basis, which materially reduces the costs and risksassociated with deploying traditional enterprise applications, and iscomplemented by software applications with tailored combinations of outsourcingservices, consulting services and proprietary content based on the Company’s 20years of experience assisting clients in addressing their human resourcerequirements.

Since its initial public offering in June 2005, theCompany has completed seven acquisitions and two follow-on offerings, raisingover $200,000 in the process.

**2.Summary of Significant Accounting Policies**

The accompanying financial statements for the three and six months endedJune 30, 2007 and 2006 have been prepared by the Company without audit.  In the opinion of management, all adjustments(which include only normal recurring adjustments) necessary to present fairlythe financial position and the results of operations and cash flows for thethree and six months ended June 30, 2007 and 2006 have been made.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed or eliminated.  The results forthe six months ended June 30, 2007 are not necessarily indicative of theresults to be expected for the year ended December 31, 2007 or for any otherinterim period.

**Principlesof Consolidation**

Theconsolidated financial statements of the Company include the accounts of KenexaCorporation and its subsidiaries.  Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.

**Cash andCash Equivalents**

Cash and cash equivalentsconsist of highly liquid investments with remaining maturities of three monthsor less at the time of purchase.

**Financial Instruments**

Short term investmentsconsist of investments with original maturities of greater than three monthsand remaining maturities of less than one year. Investments with maturities beyond one year are classified as short-termbased on their highly liquid nature and because such marketable securitiesrepresent the investment in cash that is available for current operations.  All cash and short term investments areclassified as available for sale and are recorded at market value; unrealized gainsand losses (excluding other-than-temporary impairments) are reflected in othercomprehensive income.   Short terminvestments consist of tax free municipal bonds with credit ratings of AA orhigher.

**PrepaidExpenses and Other Assets**

Prepaid expenses andother current assets consist primarily of prepaid software maintenanceagreements, deferred implementation costs, insurance and other currentassets.  Deferred implementation costsrepresent internal payroll and other costs incurred in connection with thecustomization of the sites associated with internet hosting arrangements.  These costs are deferred over theimplementation period, typically three to four months, and are expensed ratablyover the subscription period, typically one to three years.  These amounts aggregated $840 and $985 atJune 30, 2007 and December 31, 2006, respectively.  The current portion of these deferred costsof $318 and $636 at June 30, 2007 and December 31, 2006, respectively, isincluded in other current assets and the non-current portion of $522 and $349at June 30, 2007 and December 31, 2006, respectively, is included in otherassets in the accompanying consolidated balance sheets.

7

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**SoftwareDeveloped for Internal Use**

In accordance with EITF 00-3, “Application of AICPAStatement of Position 97-2 to Arrangements That Include the Right to UseSoftware Stored on Another Entity’s Hardware”, the Company applies AICPAStatement of Position No. 98-1, *Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use*.The costs incurred in the preliminary stages of development are expensed asincurred. Once an application has reached the development stage, internal andexternal costs, if direct and incremental, will be capitalized until thesoftware is substantially complete and ready for its intended use.Capitalization ceases upon completion of all substantial testing. The Companyalso capitalizes costs related to specific upgrades and enhancements when it isprobable the expenditures will result in additional functionality. Maintenanceand training cost are expensed as incurred. Internal use software is amortizedon a straight-line basis over its estimated useful life, generally three years.Management evaluates the useful lives of these assets on an annual basis andtests for impairments whenever events or changes in circumstances occur thatcould impact the recoverability of these assets. There were no impairments tointernal software in any of the periods covered in this report.

The Companycapitalized internal-use software costs for the three and six months ended June30, 2007 and the year ended December 31, 2006 of $467, $708 and $1,954,respectively.  Amortization ofcapitalized internal-use software costs for the three and six months ended June30, 2007 and the year ended December 31, 2006 were $308, $627 and $1,291,respectively.

**RevenueRecognition**

The Company derives itsrevenue from two sources: (1) subscription revenue for solutions, which iscomprised of subscription fees from clients accessing our on-demand software,consulting services, outsourcing services and proprietary content, and fromclients purchasing additional support beyond the standard support that isincluded in the basic subscription fee; and (2) other fees for discreteprofessional services. Because the Company provides its solution as a service,the Company follows the provisions of Securities and Exchange Commission StaffAccounting Bulletin No. 101, *RevenueRecognition in Financial Statements,* as amended by Staff AccountingBulletin No. 104, *Revenue Recognition.*On August 1, 2003, the Company adopted Emerging Issues Task Force IssueNo. 00-21, *Revenue Arrangements withMultiple Deliverables.* The Company recognizes revenue when all ofthe following conditions are met:

·              There is persuasive evidence of anarrangement;

 

·              The service has been provided tothe client;

 

·              The collection of the fees isprobable; and

 

·              The amount of fees to be paid bythe client is fixed or determinable.

 

Subscription feesand support revenues are recognized ratably on a monthly basis over the hostingperiod. Amounts that have been invoiced are recorded in accounts receivable andin deferred revenue or revenue, depending on whether the revenue recognitioncriteria have been met.

Discreteprofessional services and other revenues, when sold with subscription andsupport offerings, are accounted for separately since these services have valueto the customer on a stand-alone basis and there is objective and reliableevidence of fair value of the delivered elements. The Company’s arrangements donot contain general rights of return. Additionally, when professional servicesare sold with other elements, the consideration from the revenue arrangement isallocated among the separate elements based upon the relative fair value.Professional services and other revenues are recorded as follows: Consultingrevenues are recognized upon completion of the contracts that are of shortduration (generally less than 60 days) and as the services are renderedfor contracts of longer duration.

In determiningwhether revenues from professional services can be accounted for separatelyfrom subscription revenue, the Company considers the following factors for eachagreement: availability from other vendors, whether objective and reliableevidence of fair value exists of the undelivered elements, the nature and thetiming of when the agreement was signed in comparison to the subscriptionagreement start date and the contractual dependence of the subscription serviceon the client’s satisfaction with the other services. If the professionalservice does not qualify for separate accounting, the Company recognizes therevenue ratably over the remaining term of the subscription contract. In thesesituations the Company defers the direct and incremental costs of theprofessional service over the same period as the revenue is recognized.

Deferred revenuerepresents payments received or accounts receivable from the Company’s clientsfor amounts billed in advance of subscription services being provided.

8

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The Companyrecords “*Out-of-Pocket” Expenses Incurred*(“EITF 01-14”), which requires that reimbursements received for out-of-pocketexpenses be classified as revenues and not as cost reductions. Before theeffective date of EITF 01-14, out-of-pocket reimbursements from clients werenetted with the applicable costs. These items primarily include travel, mealsand certain telecommunication costs.  Forthe three and six months ended June 30, 2007 and 2006, reimbursed expenses totaled$1,071, $1,493, $328 and $592, respectively.

**Self-Insurance**

The Company isself-insured for the majority of its health insurance costs, including claimsfiled and claims incurred but not reported subject to certain stop-lossprovisions. The Company estimated the liability based upon management’sjudgment and historical experience. At June 30, 2007 and December 31,2006, self-insurance accruals totaled $386 and $340, respectively.  Management continuously reviews the adequacyof the Company’s stop-loss insurance coverage. Material differences may resultin the amount and timing of insurance expense if actual experience differssignificantly from management’s estimates.

**Concentrationof Credit Risk**

Financialinstruments which potentially expose the Company to concentration of creditrisk consist primarily of accounts receivable. Credit risk arising fromreceivables is mitigated due to the large number of clients comprising theCompany’s client base and their dispersion across various industries.  The clients are concentrated primarily in theCompany’s U.S. market area.  At June 30,2007, there were no clients that represented more than 10% of the net accountsreceivable balance. For the six months ended June 30, 2007, there were noclients that individually exceeded 10% of the Company’s revenues.

Cash balances aremaintained at several banks. Accounts located in the United States are insuredby the Federal Deposit Insurance Corporation (“FDIC”) up to $100. Certainoperating cash accounts may exceed the FDIC limits.

**EarningsPer Share**

The Company follows SFAS 128, “Earnings PerShare.” Under SFAS 128, companies that are publicly held or have complexcapital structures are required to present basic and diluted earnings per shareon the face of the statement of operations. Earnings per share are based on the weighted average number of sharesand common stock equivalents outstanding during the period.  In the calculation of diluted earnings pershare, shares outstanding are adjusted to assume conversion of the Company’snon-interest bearing convertible stock and the exercise of options and warrantsif they are dilutive.  In the calculationof basic earnings per share, weighted average numbers of shares outstanding areused as the denominator.  The computationof common stock equivalents excluded 308,400 and 498,400 options, for the threeand six months ended June 30, 2007 as their effect was antidilutive.  Options included in computation of commonstock equivalents for the three and six months ended June 30, 2007 totaled1,343,135 and 1,153,135 options.  Basicand diluted earnings per share is computed as follows:
| ** **                                                                         | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Numerator:                                                                         |       |                                                |       |                                              |       |   |   |   |   |
| Net income                                                                         |       | $                                                   | 5,813      |                                              | $          | 3,280 |   | $ | 10,509 |   | $ | 6,559 |   |
|                                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Denominator:                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  shares used to compute net income per share - basic              |       | 25,326,997                                          |       | 20,250,790                                        |       | 24,690,936 |   | 19,239,983 |   |
| Effect of  dilutive stock options and warrants                                     |       | 416,999                                             |       | 805,746                                           |       | 425,209 |   | 732,057 |   |
|                                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  shares used to compute net income per share — dilutive |       | 25,743,996                                          |       | 21,056,536                                        |       | 25,116,145 |   | 19,972,040 |   |
|                                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Basic net income  per share                                                        |       | $                                                   | 0.23       |                                              | $          | 0.16 |   | $ | 0.43 |   | $ | 0.34 |   |
|                                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Diluted net income per  share                                                      |       | $                                                   | 0.23       |                                              | $          | 0.16 |   | $ | 0.42 |   | $ | 0.33 |   |

 

9

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**Share-basedcompensation**

On January 1,2006, we adopted SFAS No. 123R using the Modified Prospective Approach (“MPA”).The MPA requires that compensation expense be recorded for restricted stock andall unvested stock options as of January 1, 2006. Since the adoption we continueto recognize the cost of previously granted share-based awards on astraight-line basis and recognize the cost for new share-based awards on astraight-line basis over the requisite service period.

**RecentAccounting Pronouncements**

On January 1,2007, we 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 taxpositions recognized in financial statements and requires the impact of a taxposition to be recognized in the financial statements if that position is morelikely than not of being sustained by the taxing authority.  As of December31, 2006 and June 30, 2007, we had an insignificant amount of unrecognized taxbenefits, none of which would materially affect our effective tax rate ifrecognized.  We do not expect that the amount of unrecognized tax benefitswill significantly increase or decrease within the next twelve months. Our policy is to recognize interest and penalties on unrecognized tax benefitsin provision for income taxes in the consolidated statements ofoperations.  The amount of interest and penalties for the six months endedJune 30, 2007 was insignificant.  Tax years beginning in 2004 are subjectto examination by taxing authorities, although net operating loss and creditcarryforwards from all years are subject to examinations and adjustments for atleast three years following the year in which the attributes are used.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair-value hierarchy that prioritizes the information used todevelop those assumptions. Under SFAS No. 157, fair-value measurements would beseparately disclosed by level within the fair-value hierarchy. SFAS No. 157 iseffective for fiscal years beginning after November 15, 2007.  We do notbelieve the adoption of SFAS No. 157 will have a material impact on ourconsolidated financial position, results of operations or cash flows.

In November 2005, the FASB issued FSP FAS123(R)-3, Transition Election Related to Accounting for the Tax Effects ofShare-Based Payment Awards, to provide an alternative approach of accountingfor the tax effects of employee share-based awards. We have elected to adoptthe alternative transition method provided in FSP FAS 123(R)-3 for calculatingthe tax effects of share-based compensation pursuant to SFAS 123(R). Thealternative transition method includes simplified methods to establish thebeginning balance of the additional paid-in capital pool (APIC pool) related tothe tax effects of employee share-based compensation, and to determine thesubsequent impact on the APIC pool and consolidated statements of cash flows ofthe tax effects of employee share-based compensation awards that areoutstanding upon the adoption of SFAS 123(R).

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”(SFAS 123R). SFAS 123R requires that the cost resulting from all share-based paymenttransactions be recognized in the financial statements. SFAS 123R alsoestablishes fair value as the measurement method in accounting for share-basedpayments. The FASB required the provisions of SFAS 123R be adopted for interimor annual periods beginning after June 15, 2005. In April 2005, the SEC adopteda new rule amending the compliance dates for SFAS 123R for public companies. Inaccordance with this rule, we adopted SFAS 123R effective January 1, 2006 usingthe modified prospective transition method. We did not modify the terms of anypreviously granted options in anticipation of the adoption of SFAS 123R.

The application of the provisions of SFAS 123Rresulted in a pretax expense of approximately $1,784 for the six months endedJune 30, 2007. Based on the same assumptions used to value our 2006compensation expense, we estimate our pretax expense associated with ourshare-based compensation plans will approximate $4,139 in 2007 and $4,142 in2008.

**Use ofEstimates**

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

10

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**FairValue of Financial Instruments**

The carryingamounts of the Company’s financial assets and liabilities, including cash,accounts receivable and accounts payable at June 30, 2007 and 2006 approximatefair value of these instruments.

**3.Acquisitions**

**StraightSource**

On June 8, 2007, theCompany acquired all of the outstanding stock of Straight OutsourcingCorporation (“StraightSource”), a provider of recruitment process outsourcingservices, based in Dallas, Texas, for a purchase price of approximately $9,000in cash and $3,174 in stock consideration.  In connection with the acquisition, $1,200 of the cash portion of thepurchase price was deposited into an escrow account to cover any claims forindemnification made by the Company against StraightSource under theacquisition agreement.   The escrow agreementwill remain in place for three years from the acquisition date.  Any funds remaining in the escrow account onDecember 7, 2009, except for $250 which shall be held for an additional sixmonths, will be distributed to the former stockholders of StraightSource.  The purchase price has been allocated on apreliminary basis to the assets acquired and liabilities assumed based uponmanagement’s best estimate of fair value with any excess over the net tangibleand intangible assets acquired allocated to goodwill.    In accordancewith Statement of Financial Accounting Standard No. 141 the purchase price andrelated purchase price allocation may be updated to reflect changes such as anyadditional transaction fees or the valuation of certain assets acquired orliabilities assumed.

**Psychometric Services**

On November 20,2006, the Company acquired all of the outstanding stock of PsychometricServices, Ltd., a provider of user friendly psychometric tests, based inHarrow, United Kingdom, for a purchase price of approximately $7,459 in cashand $627 in stock consideration.  Thetotal cost of the acquisition, including legal, accounting, and otherprofessional fees of $296, was approximately $8,383.  In connection with the acquisition, $758 ofthe cash portion of the purchase price was deposited into an escrow account tocover any claims for indemnification made by the Company against PsychometricsServices under the acquisition agreement.  The escrow agreement will remain in place for one year from theacquisition date, and any funds remaining in the escrow account at the end ofthe one year period will be distributed to the former stockholders ofPsychometric Services Ltd.  The purchaseprice has been allocated on a preliminary basis to the assets acquired andliabilities assumed based upon management’s best estimate of fair value withany excess over the net tangible and intangible assets acquired allocated togoodwill.    In accordance with Statement of FinancialAccounting Standard No. 141 the purchase price and related purchase priceallocation may be updated to reflect changes such as any additional transactionfees or the valuation of certain assets acquired or liabilities assumed.

**BrassRing**

On November 13, 2006, theCompany acquired BrassRing, LLC, a provider of talent management solutions,combining innovative technology, consulting, and outsourcing with recruitmentexpertise to build successful workforces to meet the specific needs of clients,for approximately $114,708 in cash.  Thetotal cost of the acquisition, including legal, accounting, and otherprofessional fees of $3,080, was approximately $117,788.  On the date of close, approximately$11,500 or 10% of the aggregate purchase price was deposited into anescrow account to cover any claims for indemnification made by the Companyagainst BrassRing under the acquisition agreement.  Assuming there are no indemnification claims,this amount will be released to the former stockholders of BrassRing on orabout May 13, 2008.

BrassRing’s results of operations were included in theCompany’s consolidated financial statements beginning on November 13,2006.

 

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The purchase price wasallocated as follows:
| **Description**                            | ** ** | **Amount** | ** ** | **Amortization  period** | ** ** |
|--------------------------------------------|------------|------------|------------|--------------------------|------------|
| Assets acquired                            |       |       |       |                     |       |
| Cash and cash  equivalents                 |       | $          | 10,567     |                     |       |   |
| Accounts  receivable                       |       | 6,495      |       |                     |       |
| Prepaid expenses  and other current assets |       | 1,500      |       |                     |       |
| Property &  equipment                  |       | 1,776      |       |                     |       |
| Other long-term  assets                    |       | 520        |       |                     |       |
| Technology-related  assets                 |       | 368        |       | 1.5  years               |       |
| Contract-related  assets                   |       | 416        |       | 5  years                 |       |
| Goodwill                                   |       | 105,862    |       | Indeterminable           |       |
| Other  intangibles, net                    |       | 24         |       |                     |       |
| Deferred income  taxes                     |       | 3,383      |       | 5  years                 |       |
|                                       |       |       |       |                     |       |
| Less: Liabilities  assumed                 |       |       |       |                     |       |
| Accounts payable                           |       | 3,875      |       |                     |       |
| Accrued salary                             |       | 1,283      |       |                     |       |
| Deferred federal  income taxes             |       | 21         |       |                     |       |
| Deferred revenue                           |       | 7,445      |       |                     |       |
| Deferred rent                              |       | 499        |       |                     |       |
| Total cash purchase  price                 |       | $          | 117,788    |                     |       |   |

 

The purchase pricehas been allocated on a preliminary basis to the assets acquired andliabilities assumed based upon management’s best estimate of fair value withany excess over the net tangible and intangible assets acquired allocated togoodwill.    In accordance with Statement of FinancialAccounting Standard No. 141, the purchase price and related purchase priceallocation may be updated to reflect changes such as any additional transactionfees or the valuation of certain assets acquired or liabilities assumed.  The estimated fair values of the intangiblesassets are further described below. Contract-related assets, technology-related assets, and net operatingloss tax attributes are being amortized over their estimated useful lives.   Goodwill is not amortized but is periodicallyevaluated for impairment.

The valuation ofcontract-related assets in the amount of $416, which relates to BrassRing’scurrent customer portfolio, was determined based upon estimated discountedincremental future cash flow to be received as a result of these relationships.

Goodwill from the acquisition resulted from our beliefthat the recruiter products developed by BrassRing will be complementary to ourKenexa Recruiter product offerings and will help us remain competitive in thetalent acquisition market.  The goodwillfrom the BrassRing acquisition will not be deductible for tax purposes.

If the BrassRingacquisition had occurred on January 1, 2006, the unaudited pro forma results ofoperations for the three and six months ended June 30, 2006 would have been:
| ** **                          | ** ** | **For the three  months ended  June 30, 2006** | ** ** | **For the six  months ended  June 30, 2006** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
|                                |       |                                                               |       |                                                             |       |
| Revenue                             |       | $                                                                  | 34,452     |                                                             | $          | 67,120 |   |
| Net income                          |       | $                                                                  | 2,242      |                                                             | $          | 5,686 |   |
| Net income per share —  basic  |       | $                                                                  | 0.11       |                                                             | $          | 0.30 |   |
| Net income per share — diluted |       | $                                                                  | 0.11       |                                                             | $          | 0.28 |   |

 

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**Gantz Wiley Research**

On August 14,2006, the Company, through its wholly-owned subsidiary, KenexaTechnology, Inc., acquired all of the outstanding stock of Gantz WileyResearch, an employee and customer research firm based in Minneapolis,Minnesota, for a purchase price including contingent consideration ofapproximately $3,302 in cash and $3,820 in stock consideration.  The total cost of the acquisition, includingestimated legal, accounting, other professional fees of $46, was approximately$7,168.  The payment of additionalconsideration by the Company was based upon the annual revenues of Gantz WileyResearch through December 31, 2006. Based upon the results, contingent consideration of $1,300 was paid incash and equity during the first quarter of 2007 to the former shareholder ofGantz Wiley Research.  The relatedliability has been reflected in the financial statements at December 31, 2006and is included in the total cost of the acquisition.  In connection with the acquisition, $600 ofthe cash portion of the purchase price was deposited into an escrow account tocover any claims for indemnification made by the Company against Gantz WileyResearch under the acquisition agreement.  The escrow agreement will remain in place for one year from theacquisition date, and any funds remaining in the escrow account at the end ofthe one year period will be distributed to the former stockholder of Gantz WileyResearch.   The purchase price has beenallocated on a preliminary basis to the assets acquired and liabilities assumedbased upon management’s best estimate of fair value with any excess over thenet tangible and intangible assets acquired allocated to goodwill.   In accordance with Statement of Financial Accounting StandardNo. 141 the purchase price and related purchase price allocation may be updatedto reflect changes such as any additional transaction fees or the valuation ofcertain assets acquired or liabilities assumed.

**KnowledgeWorkers**

On April 10, 2006,the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc.,and Kenexa Acquisition Corp., a wholly-owned subsidiary of Kenexa Technology,acquired all of the outstanding stock of Knowledge Workers, Inc., a humancapital consulting and technology firm based in Denver, Colorado, for apurchase price of approximately $2,476 in cash. The total cost of the acquisition, including estimated legal,accounting, and other professional fees of $104, was approximately $2,580.  In connection with the acquisition, theCompany deposited $100 into an escrow account to cover any claims forindemnification made by the Company against Knowledge Workers, Inc. under theacquisition agreement.   The escrowagreement will remain in place for two years from the acquisition date.  The purchase price has been allocated to theassets acquired and liabilities assumed based upon management’s best estimateof fair value with any excess over the net tangible and intangible assetsacquired allocated to goodwill.    In accordance with Statementof Financial Accounting Standard No. 141, the purchase price and relatedpurchase price allocation may be updated to reflect changes such as any additionaltransaction fees or the valuation of certain assets acquired or liabilitiesassumed.

**Webhire**

On January 13, 2006,the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc.,and Kenexa Acquisition Corp., a wholly-owned subsidiary of Kenexa Technology,completed its acquisition of Webhire, Inc. (“Webhire”) for approximately$34,395 in cash. The total cost of the acquisition, including legal,accounting, and other professional fees of $666, was approximately$35,061.  In July 2007, approximately$5,000, or 14.3% of the aggregate purchase price, held in an escrow wasreleased to the former stockholders of Webhire. There were no claims for indemnification made by the Company againstWebhire under the acquisition agreement.

Webhire’s results ofoperations were included in the Company’s consolidated financial statementsbeginning on January 1, 2006.

 

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**4.Property, Equipment and Software**

A summary ofproperty, equipment and software and related accumulated depreciation as ofJune 30, 2007 and December 31, 2006 is as follows: 

|                                                 | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                                            |       |                        |       |                            |       |
| Equipment                                       |       | $                           | 10,991     |                            | $          | 8,914 |   |
| Software                                        |       | 10,116                      |       | 9,934                           |       |
| Office furniture  and fixtures                  |       | 1,329                       |       | 1,225                           |       |
| Leasehold  improvements                         |       | 1,484                       |       | 1,282                           |       |
| Land                                            |       | 708                         |       | 708                             |       |
| Building  construction in progress              |       | 1,176                       |       | 430                             |       |
| Software in  development                        |       | 874                         |       | 237                             |       |
|                                            |       | 26,678                      |       | 22,730                          |       |
| Less accumulated  depreciation and amortization |       | 13,572                      |       | 12,139                          |       |
|                                            |       | $                           | 13,106     |                            | $          | 10,591 |   |

 

Equipment, officefurniture and fixtures included capital leases totaling $2,518 and $2,499 atJune 30, 2007 and December 31, 2006, respectively.  Depreciation and amortization expense,including amortization of assets under capital leases, was $2,544 and $3,312for the period ended June 30, 2007 and December 31, 2006, respectively.

**5. OtherAccrued Liabilities**

Other accrued liabilitiesconsist of the following:

|                                       | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Accrued  professional fees            |       | $                           | 161        |                            | $          | 361 |   |
| Straight line  rent accrual           |       | 1,290                       |       | 1,405                           |       |
| Other taxes  payable (non-income tax) |       | 351                         |       | 666                             |       |
| Income taxes  payable                 |       | 5,333                       |       | 740                             |       |
| Other  liabilities                    |       | 1,066                       |       | 1,614                           |       |
| Contingent  purchase price            |       | —                      |       | 1,300                           |       |
| Total other accrued  liabilities      |       | $                           | 8,201      |                            | $          | 6,086 |   |

 

**6. Lineof Credit**

On March 26, 2007, the Company entered into a FirstAmendment to Credit Agreement (the “Amendment”) with PNC Bank, N.A.   TheAmendment increased the maximum amount available under the revolving creditfacility portion of the Credit Agreement from $25,000 to $50,000, including asublimit of up to $2,000 for letters of credit.  In connection with the Amendment the Companywrote off deferred financing fees of $447. The Amendment provides that the Credit Agreement will terminate, and allborrowings will become due and payable, on March 26, 2010.  The Companyand each of the U.S. subsidiaries of Kenexa Technology are guarantors of theobligations of Technology under the Credit Agreement, as amended by theAmendment.

In January 2007, the Company repaid the balance of itsobligations relating to the term loan portion of the Credit Agreement with thenet proceeds from the Company’s public offering of its common stock in January2007.

On November 13, 2006, the Company entered into anew secured credit agreement with PNC Bank, N.A., as administrative agent, inconnection with its acquisition of BrassRing (the “Credit Agreement”).   The new Credit Agreement increased themaximum amount available under the facility from $25,000 to $75,000, consistingof (i) a $25,000 revolving credit facility, including a sublimit of up to$2,000 for letters of credit, and (ii) a $50,000 term loan.  Borrowings under the Credit Agreement aresecured by substantially all of the Company’s assets and the assets of itssubsidiaries.   This credit facilityreplaced the prior $25,000 revolving credit facility also with PNC Bank, N.A.  As of December 31, 2006, the Company had outstandingborrowings of $65,000 from the credit facility with a weighted averageinterest rate of 7.9% per annum.

 

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The Company’sborrowings under the credit agreement bear interest at tiered rates based uponthe ratio of Net Funded Debt to Modified EBITDA Ratio as defined in the CreditAgreement. The Company may also elect interest rates on its borrowingscalculated by reference to  (i) thehigher of PNC’s prime rate or the current Federal Funds rate plus 1⁄2% (the “BaseRate”), or (ii) the Eurodollar rate (the “Eurodollar Rate”), in either caseplus a margin based upon the ratio of the Company and its consolidatedsubsidiaries Net Funded Debt to EBITDA ratio.  Interest is payable quarterly for Base Rate loans and at the end of theapplicable interest period for Eurodollar Rate loans.   Eurodollar Rate advances will be availablefor periods of 1, 2, 3, 6 or, if available to all lenders under the CreditAgreement, 9 or 12 months.   EurodollarRate pricing will be adjusted for any statutory reserves.

Repayment of amounts outstanding under certain notespayable and all issued or issuable shares of common and preferred stock aresubordinated to the rights of the lender under terms of the Credit Agreement.The Credit Agreement contains various terms and covenants that provide forrestrictions on capital expenditures, payment of dividends, dispositions ofassets, investments and acquisitions and require the Company, among otherthings, to maintain minimum levels of tangible net worth, net income and fixedcharge coverage.  The Company wascompliant with all such covenants at June 30, 2007.

**7.Commitments and Contingencies**

**Litigation**

We are involved inclaims which arise in the ordinary course of business. In the opinion ofmanagement, we have made adequate provision for potential liabilities, if any,arising from any such matters.  However,litigation is inherently unpredictable, and the costs and other effects ofpending or future litigation, governmental investigations, legal andadministrative cases and proceedings (whether civil or criminal), settlements,judgments and investigations, claims and changes in any such matters, anddevelopments or assertions by or against us relating to intellectual propertyrights and intellectual property licenses, could have a material adverse effecton our business, financial condition and operating results.

**8.Equity**

OnJanuary 18, 2007, the Company completed a public offering of 3,750,000 sharesof its common stock at a price to the public of $31.86 per share. Net proceedsto the Company aggregated approximately $113,371 after payment of all offeringfees and underwriters’ commission and offering expenses of $5,475.  OnJanuary 24, 2007, the underwriters exercised their over-allotment option underthe terms of the underwriting agreement to purchase 562,500 additional sharesof common stock. Net proceeds to the Company following the sale of theoverallotment shares were $17,100.

**9.Stock Plans**

The Company’s 2005 Equity Incentive Plan (the “2005Option 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 thediscretion of the Board or a committee of the Board.  The 2005 Option Plan replaced the Company’s2000 Stock Option Plan (the “2000 Option Plan”).  The purpose of stock options is to recognizepast services rendered and to provide additional incentive in furthering thecontinued success of the Company.  Stockoptions granted under both the 2005 Option Plan and the 2000 Stock Option Planexpire between the fifth and tenth anniversary of the date of grant andgenerally vest on the third anniversary of the date of grant.  Unexercised stock options may expire up to90 days after an employee’s termination.

15

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As of June 30, 2007, there were options to purchase1,651,535 shares of common stock outstanding under the 2005 Option Plan.  The Company is authorized to issue up to anaggregate of 4,842,910 shares of its common stock pursuant to stock optionsgranted under the 2005 Option Plan.  Asof June 30, 2007, there were a total of 2,655,446 shares of common stock notsubject to outstanding options and available for issuance under the 2005 OptionPlan.

SFAS 123R requirescompanies to estimate the fair value of share-based payment awards on the dateof grant using an option-pricing model. In 2007 and 2006, the fair value of each grant was estimated using theBlack-Scholes valuation model.  Expectedvolatility was based upon a weighted average of peer companies, comparableindices, and the Company’s stock volatility. The expected life was determined based upon an average of thecontractual life and vesting period of the options.  The estimated forfeiture rate was based uponan analysis of historical data.   Therisk-free rate was based on U.S. Treasury zero coupon bond yields at the timeof grant.  The following table providesthe assumptions used in determining the fair value of the share-based awardsfor the quarters ended June 30, 2007 and March 31, 2007 and the year endedDecember 31, 2006, respectively.

|                           | ** ** | **June 30, 2007** | ** ** | **March 31, 2007** | ** ** | **Year ended  December 31, 2006** | ** ** |
|---------------------------|------------|-----------------------------|------------|------------------------------|------------|--------------------------------------------------|------------|
|                      |       |                        |       |                         |       |                                             |       |
| Expected  volatility      |       | 47.26                       | %          | 47.70                        | %          | 39.5 - 41.98                                     | %          |
| Expected  dividends       |       | 0                           |       | 0                            |       | 0                                                |       |
| Expected term  (in years) |       | 4 - 5                       |       | 4                            |       | 4 - 5                                            |       |
| Risk-free rate            |       | 4.60                        |       | 4.46                         |       | 4.6 - 5.1                                        | %          |

 

Asummary of the status of the Company’s stock options as of June 30, 2007 andDecember 31, 2006 and changes during the period then ended is as follows:
| ** **                         | ** ** | **Options Outstanding**          | ** ** | **Options Exercisable** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Shares  available for  grant** | ** ** | **Shares**                   | ** ** | **Wtd. avg.  exercise  price** | ** ** | **Shares** | ** ** | **Wtd. avg.  exercise  price** | ** ** |
| Balance at  December 31, 2005 |       | 3,265,859                             |       | 1,562,181                    |       | $ | 11.74 |   | 638,781 |   | $ | 12.08 |   |
| Granted                            |       | (316,333                              | )          | 316,333                      |       | $ | 25.24 |   | — |   | — |   |
| Exercised                          |       | —                                |       | (387,986                     | )          | $ | 11.25 |   | — |   | — |   |
| Forfeited or expired               |       | 188,520                               |       | (188,520                     | )          | $ | 15.47 |   | — |   | — |   |
| Balance at  December 31, 2006 |       | 3,138,046                             |       | 1,302,008                    |       | $ | 14.63 |   | 321,208 |   | $ | 14.26 |   |
| Granted                            |       | (516,400                              | )          | 516,400                      |       | $ | 35.60 |   |   |   |   |   |
| Exercised                          |       | —                                |       | (133,073                     | )          | $ | 11.45 |   |   |   |   |   |
| Forfeited or expired               |       | 33,800                                |       | (33,800                      | )          | $ | 26.06 |   |   |   |   |   |
| Balance at June 30,  2007     |       | 2,655,446                             |       | 1,651,535                    |       | $ | 21.21 |   | 244,935 |   | $ | 14.89 |   |

 

The total intrinsic value of options outstanding,exercisable and exercised as of and for the period ended June 30, 2007 was$27,253, $5,590 and $3,344, respectively.  The weighted average fair value of options granted during the six monthsended June 30, 2007 and December 31, 2006 was $15.11 and $11.05, respectively.

A summary of the statusof the Company’s nonvested share options as of December 31, 2006 and for theperiod ended June 30, 2007 is presented below:

| Nonvested Shares           | ** ** | **Shares** | ** ** | **Wtd. Avg. Grant  Date Fair Value** | ** ** |
|---------------------------------|------------|------------|------------|----------------------------------------------------------|------------|
| Nonvested at  December 31, 2005 |       | 923,400    |       | $                                                        | 8.10       |   |
| Granted                         |       | 316,333    |       | $                                                        | 11.05      |   |
| Vested                          |       | (76,333    | )          | $                                                        | 15.31      |   |
| Forfeited or expired            |       | (182,600   | )          | $                                                        | 7.23       |   |
| Nonvested at  December 31, 2006 |       | 980,800    |       | $                                                        | 8.65       |   |
| Granted                         |       | 516,400    |       | $                                                        | 15.11      |   |
| Vested                          |       | (56,800    | )          | $                                                        | 13.26      |   |
| Forfeited or expired            |       | (33,800    | )          | $                                                        | 10.76      |   |
| Nonvested at June 30,  2007     |       | 1,406,600  |       | $                                                        | 10.78      |   |

 

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Between January 1, 2007and June 30, 2007, the Company granted options to certain employees to purchasean aggregate of 516,400 shares of the Company’s common stock at a weightedexercise price of $35.60 per share. The Company granted the options at prevailingmarket prices ranging from $31.94 to $36.87 per share.

Between January 1, 2006and December 31, 2006, the Company granted options to certain employees topurchase an aggregate of 316,333 shares of the Company’s common stock at aweighted exercise price of $25.24 per share. The Company granted the options atprevailing market prices ranging from $21.10 to $32.69 per share.

As of June 30, 2007, there was $10,819 of totalunrecognized compensation cost related to nonvested share-based compensation arrangementsgranted under the 2005 Option Plan and the 2000 Option Plan.  That cost is expected to be recognized over aweighted-average period of 3 years.

SFAS No. 123R also requires us to change theclassification of any tax benefits realized upon exercise of stock options inexcess of that which is associated with the expense recognized for financialreporting purposes. These amounts are presented as a financing cash inflow anda corresponding operating cash outflow in our consolidated statement of cashflows.

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

The following table shows total share-basedcompensation expense included in the Consolidated Statement of Operations:
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                      |       |                                                |       |                                              |       |   |   |   |   |
| Cost of revenue                           |       | $                                                   | 38         |                                              | $          | 124 |   | $ | 215 |   | $ | 240 |   |
| Sales and  marketing                      |       | 273                                                 |       | 139                                               |       | 452 |   | 340 |   |
| General and  administrative               |       | 700                                                 |       | 470                                               |       | 1,021 |   | 690 |   |
| Research and  development                 |       | 58                                                  |       | 36                                                |       | 96 |   | 71 |   |
| Pre-tax  share-based compensation expense |       | 1,069                                               |       | 769                                               |       | 1,784 |   | 1,341 |   |
| Income tax  benefit                       |       | 369                                                 |       | 295                                               |       | 647 |   | 511 |   |
| Share-based  compensation expense, net    |       | $                                                   | 700        |                                              | $          | 474 |   | $ | 1,137 |   | $ | 830 |   |

 

**EmployeeStock Purchase Plan**

The Employee StockPurchase Plan, which was approved May 2006, enables substantially all of theCompany’s U.S. and foreign employees to purchase shares of our common stock ata discounted offering price.  Theoffering price is 95% of the closing market price of our common stock on theNASDAQ National Market, LLC on the offering date.  500,000 common shares are available to ouremployees for purchase under the Plan. The Plan is not considered acompensatory plan in accordance with SFAS 123 (r) and requires no compensationexpense to be recognized.  2,600 sharesof our common stock were purchased under the employee stock purchase planduring the six months ended June 30, 2007.

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**10. Related Party**

Oneof the Company’s directors, Barry M. Abelson, is a partner in the law firm ofPepper Hamilton LLP. This firm has represented the Company since 1997. For the threeand six months ended June 30, 2007 and 2006, the Company paid Pepper HamiltonLLP, net of insurance coverage, $1,009, $1,285, $432 and $1,354, respectively,for general legal matters.  Theamount payable to Pepper Hamilton as of June 30, 2007 was $13.

**11.  Income Taxes**

The Company’s tax provisionfor interim periods is determined using an estimate of its annual effectiverate.  The 2007 effective tax rate isestimated to be lower than the 35% statutory rate primarily due to anticipatedearnings in subsidiaries outside the U.S. in jurisdictions where the effectiverate is lower than in the U.S.

Effective January 1, 2007,the Company adopted the provisions of FASB Interpretation No. 48 “Accounting forUncertainty in Income Taxes,” (“FIN 48”). As of January 1, 2007 unrecognized tax benefits totaled $234 which wasrecorded as a purchase price adjustment and an increase to goodwill.  As a result of the implementation of FIN 48,our tax liabilities increased $5 which was expensed to tax expense for sixmonths ended June 30, 2007.

We recognize interest andpenalties related to our tax liabilities as other tax expense.  Our January 1, 2007, tax liabilities include$89 of interest related to the adoption of FIN 48.

It is not expected that theamount of unrecognized tax benefits will change in the next 12 months, however,the Company does not expect any change to have a significant impact on theresults of operations or financial position of the Company.

**12. Geographic Information**

The following table summarizes the distribution ofrevenue by geographic region as determined by billing address for the three andsix months ended June 30, 2007.
| ** **                | ** ** | **Revenue for the  three months ended  June 30, 2007** | ** ** | **Revenue as a  percentage of  total revenue** | ** ** | **Revenue for the  six months ended  June 30, 2007** | ** ** | **Revenue as a  percentage of  total revenue** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| United States             |       | $                                                                                    | 39,346     |                                                               | 87.1       | %                                                                                  | $          | 76,163                                                             |       | 87.2 | % |
| United Kingdom            |       | 2,832                                                                                |       | 6.3                                                                | %          | 5,818                                                                              |       | 6.7                                                                | %          |
| Other                     |       | 667                                                                                  |       | 1.5                                                                | %          | 1,265                                                                              |       | 1.4                                                                | %          |
| The Netherlands           |       | 816                                                                                  |       | 1.8                                                                | %          | 1,358                                                                              |       | 1.6                                                                | %          |
| Other European  Countries |       | 1,503                                                                                |       | 3.3                                                                | %          | 2,777                                                                              |       | 3.1                                                                | %          |
| Total                     |       | $                                                                                    | 45,164     |                                                               | 100.0      | %                                                                                  | $          | 87,381                                                             |       | 100.0 | % |

 

The following table summarizes the distribution ofassets by geographic region for the period ended June 30, 2007.

| **Country**    | ** ** | **Assets as of  June 30, 2007** | ** ** | **Assets as a  percentage of  total assets** | ** ** |
|----------------|------------|---------------------------------|------------|----------------------------------------------|------------|
| United States  |       | $                               | 329,151    |                                         | 93.2       | % |
| United Kingdom |       | $                               | 16,427     |                                         | 4.6        | % |
| India          |       | $                               | 5,232      |                                         | 1.5        | % |
| Other          |       | $                               | 2,472      |                                         | 0.7        | % |
| Total          |       | $                               | 353,282    |                                         | 100.0      | % |

 

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**Item 2:Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

This QuarterlyReport on Form 10-Q, including the following Management’s Discussion andAnalysis of Financial Condition and Results of Operations, containsforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, asamended, and the Private Securities Litigation Reform Act of 1995, that involvea number of risks and uncertainties. Such statements are based on currentexpectations of future events that involve a number of risks and uncertaintiesthat may cause the actual events to differ materially from those discussed herein.In addition, such forward-looking statements are necessarily dependent uponassumptions, estimates and dates that may be incorrect or imprecise and involveknown and unknown risks and other factors. Accordingly, any forward-lookingstatements included herein do not purport to be predictions of future events orcircumstances and may not be realized. Forward-looking statements can beidentified by, among other things, the use of forward-looking terminology suchas “believes,” “expects,” “may,” “could,” “will,” “should,” “seeks,” “potential,”“anticipates,” “predicts,” “plans,” “estimates,” or “intends,” or the negativeof any thereof, or other variations thereon or comparable terminology, or bydiscussions of strategy or intentions. Given these uncertainties, readers arecautioned not to place undue reliance on such forward-looking statements.Forward-looking statements should be considered in light of various importantfactors, including those set forth in this report under Part I, Item 1A “RiskFactors” in Kenexa Corporation’s Annual Report on Form 10-K for the year endedDecember 31, 2006 filed with the Securities and Exchange Commission. Allforward-looking statements, and reasons why results may differ, that areincluded in this report are made as of the date of this report, and except asrequired by law, we disclaim any obligations to update any such factors or topublicly announce the results of any revisions to any of the forward-lookingstatements contained herein or reasons why results might differ to reflectfuture events or developments. References herein to “Kenexa,” “we,” “our,” and “us”collectively refer to Kenexa Corporation, a Pennsylvania corporation, and allof its direct and indirect U.S., U.K., Canada, India, and other foreignsubsidiaries.

**1. Overview**

Weprovide software, services and proprietary content that enable organizations tomore effectively recruit and retain employees. Our solutions are built around asuite of easily configurable software applications that automate talent acquisitionand employee performance management best practices. We offer the softwareapplications that form the core of our solutions on an on-demand basis, whichmaterially reduces the costs and risks associated with deploying traditionalenterprise applications. We complement our software applications with tailoredcombinations of outsourcing services, consulting services and proprietarycontent based on our 20 years of experience assisting clients in addressingtheir human resource requirements. Together, our software applications andservices form solutions that we believe enable our clients to improve theeffectiveness of their talent acquisition programs, increase employeeproductivity and retention, measure key HR metrics and make their talentacquisition and employee performance management programs more efficient.

Since1999, we have focused on providing talent acquisition and employee performancemanagement solutions on a subscription basis and currently generate asignificant portion of our revenue from these subscriptions. For the six monthsended June 30, 2007 and 2006, revenue from these subscriptions comprisedapproximately 82.0% and 78.7%, respectively, of our total revenue. We generatethe remainder of our revenue from discrete professional services that are notprovided as part of an integrated solution on a subscription basis. Thesesubscription-based solutions provide us with a recurring revenue stream and webelieve represent a more compelling opportunity in terms of growth andprofitability than discrete professional services.  As a result, since 1999 discrete professionalservices have represented a consistently decreasing percentage of ourrevenue.  We expect that trend tocontinue.

Wesell our solutions to large and medium-sized organizations through our directsales force.  As of December 31,2006, we had a client base of approximately 3,000 companies, includingapproximately 166 companies on the Fortune 500 list published inApril 2006. Our client base includes companies that we billed for servicesduring the year ended December 31, 2006 and does not necessarily indicatean ongoing relationship with each such client. Our top 80 clients contributedapproximately $45.5 million, or 52.1%, of our total revenue for the six monthsended June 30, 2007.

**2. Recent Events**

On June 8, 2007, weacquired StraightSource, a provider of recruitment process outsourcingservices, based in Dallas, Texas, for a purchase price of approximately $9.0million in cash and $3.0 million in stock consideration.  Thetotal cost of the acquisition was approximately $12.0 million.  We expect that the acquisition ofStraightSource will provide additional efficiency to our exempt and non-exemptrecruitment offering and expand our distribution capabilities in the Southwestmarket.

On March 26, 2007, we entered into a First Amendmentto Credit Agreement with PNC Bank.   The amendment increased themaximum amount available under the revolving credit facility portion of theCredit Agreement from $25 million to $50 million, including a sublimit of up to$2 million for letters of credit.   The amendment provides that thecredit agreement will terminate, and all borrowings will become due andpayable, on March 26, 2010.

On January 18, 2007, we completed a public offering of3,750,000 shares of our common stock at a price to the public of $31.86 pershare.  We also sold an additional 562,500 shares of our common stock tocover over-allotments of shares.  Our net 

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proceeds from the offering, after payment of alloffering expenses and commissions, aggregated approximately $131.0million. We repaid all of the outstanding borrowings under our creditfacility with a portion of the net proceeds from the offering.

OnNovember 20, 2006, we acquired Psychometric Services Limited (“PSL”), aprovider of online and paper-based assessment products, training andconsultancy based in the United Kingdom, for approximately $7.5 million in cashand $0.6 million in stock consideration. The total cost of theacquisition, including legal, accounting, and other professional fees of $0.3million, was approximately $8.4 million. The strategic rationale foracquiring PSL was to add PSL’s library of content and team of psychologists toextend Kenexa’s value proposition and to further differentiate Kenexa from adomain expertise perspective.  In addition, we believe that theacquisition of PSL advances Kenexa’s efforts to build its internationalinfrastructure, while adding an attractive customer list of commercial andgovernment entities in the UK.

On November 13,2006, we entered into a new secured credit facility with PNC Bank, N.A., asadministrative agent, in connection with our acquisition of BrassRing. Ourobligations under the new credit facility are secured by substantially all ofour assets and the assets of our subsidiaries. This credit facility replacedour prior $25 million revolving credit facility with PNC Bank. Under the termsof the credit facility, we borrowed $75 million on November 13, 2006 to fundour acquisition of BrassRing.

On November 13, 2006, weacquired BrassRing Inc. and BrassRing LLC (“BrassRing”), a provider of talentmanagement solutions, for approximately $114.7 million in cash.  The totalcost of the acquisition, including legal, accounting, and other professionalfees of $3.1 million, was approximately $117.8 million.  Thestrategic rationale for acquiring BrassRing included expansion of opportunities with large, global customers, expansion ofglobal infrastructure and product capabilities, and creation of cross-marketing opportunitieswith our existing suite of products and services. Additionally,management’s industry expertise and experience were also important factors forthe acquisition of Brass Ring.

On August 14, 2006, we acquired Gantz-Wiley ResearchConsulting Group, Inc., an employee and customer survey data analysis firmbased in Minneapolis, Minnesota, for a purchase price including contingentconsideration of approximately $3.3 million in cash and $3.8 million in stockconsideration.  The total cost of the acquisition, including estimatedlegal, accounting, and other professional fees, was approximately $7.2million.  In addition, the payment of $1.3 million in cash and equityduring the first quarter of 2007 to the former shareholder of Gantz-Wiley ofadditional consideration by the Company was based upon the annual revenues ofGantz-Wiley Research through December 31, 2006.  The $1.3 millionliability is reflected in the financial statements at December 31, 2006.

On April 10, 2006, we acquired Knowledge Workers Inc.,a human capital consulting and technology firm based in Denver Colorado, forapproximately $2.5 million in cash.  Thetotal cost of the acquisition, including estimated legal, accounting, and otherprofessional fess of $0.1 million, was approximately $2.6 million.

On January 13, 2006,the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc.,and Kenexa Acquisition Corp., a wholly-owned subsidiary of Kenexa Technology,completed its acquisition of Webhire, Inc. (“Webhire”) for approximately $34.4 millionin cash. The total cost of the acquisition, including legal, accounting, andother professional fees of $0.7 million, was approximately $35.1 million.  In July 2007, approximately $5.0 million,or 14.3% of the aggregate purchase price, held in an escrow was released to theformer stockholders of Webhire.  Therewere no claims for indemnification made by the Company against Webhire underthe acquisition agreement.    Webhire’sresults of operations were included in the Company’s consolidated financialstatements beginning on January 1, 2006.

**3.****Sources of Revenue**

Wederive revenue primarily from two sources: (1) subscription revenue for oursolutions, which is comprised of subscription fees from clients accessing ouron-demand software, consulting services, outsourcing services and proprietarycontent, and from clients purchasing additional support that is not included inthe basic subscription fee; and (2) fees for discrete professional services.

Ourclients primarily purchase renewable subscriptions for our solutions. Thetypical term is one to three years, with some terms extending up to fiveyears.  The majority of our subscriptionagreements are not cancelable for convenience although our clients have theright to terminate their contracts for cause if we fail to provide the agreedupon services or otherwise breach the agreement. A client does not generallyhave a right to a refund of any advance payments if the contract is cancelled.We expect that we will maintain our renewal rate of approximately 90.0% of theaggregate contract value up for renewal for 2007 and 2008. The revenue derivedfrom subscription fees is recognized ratably over the term of the subscriptionagreement. We generally invoice our clients in advance in monthly or quarterlyinstallments and typical payment terms provide that our clients pay us within30 days of invoice. Amounts that have been invoiced are recorded in accountsreceivable prior to the receipt of payment and in deferred revenue to theextent revenue recognition criteria have not been met. As the subscriptioncomponent of our revenue has grown and clients’ willingness to pay us inadvance for their subscriptions has increased, the amount of deferred revenueon our balance sheet has grown at a higher rate than our revenue. As of June30, 2007, deferred revenue increased to $32.0 million from $31.3 million atDecember 31, 2006.  We generally priceour solutions based on the number of software applications and servicesincluded and the number of client employees. Accordingly, subscription fees aregenerally greater for larger organizations and for those that subscribe for abroader array of software applications and services.

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Asmall portion of our clients purchase discrete professional services. Theseservices primarily consist of consulting and training services. In addition, werecognize a small amount of revenue from sales of perpetual software licenses.The revenue from these services and licenses is recognized differently dependingon the type of service or license provided as described in greater detail belowunder “Critical Accounting Policies and Estimates.”

Wegenerate substantially all of our revenue from within the United States. Forthe three and six months ended June 30, 2007, approximately 87% of our totalrevenue was derived from sales in the United States.  Revenue generated from clients in TheNetherlands and the United Kingdom for the three and six months ended June 30,2007 aggregated to approximately 8.1% and 8.3%, respectively. Revenue fromother clients amounted to 4.9% and 4.7% for the three and six months ended June30, 2007.

**4. KeyPerformance Indicators**

The followingtables summarize the key performance indicators that we consider to be materialin managing our business, in thousands:
| ** **                                             | ** ** | **For the three months ended  June 30,** | ** ** | **For the six months ended  June 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2007**                                                          | ** ** | **2006**                                                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                             | ** ** | **(unaudited)**                                                   | ** ** | **(unaudited)**                                                 | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Total Revenue                                          |       | $                                                                 | 45,164     |                                                            | $          | 24,707 |   | $ | 87,381 |   | $ | 47,722 |   |
|                                                   |       |                                                              |       |                                                            |       |   |   |   |   |
| Subscription  revenue as a percentage of total revenue |       | 81.9                                                              | %          | 80.7                                                            | %          | 82.0 | % | 78.7 | % |
| Income from  operations                                |       | $                                                                 | 7,931      |                                                            | $          | 3,821 |   | $ | 15,062 |   | $ | 7,209 |   |
|                                                   |       |                                                              |       |                                                            |       |   |   |   |   |
| Net cash  provided by operating activities             |       | $                                                                 | 6,023      |                                                            | $          | 1,424 |   | $ | 12,190 |   | $ | 2,326 |   |

 
| ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **As of June 30,** | ** ** |
|------------------|------------|------------|------------|------------|------------|--------------------|------------|
| ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **2007**           | ** ** | **2006** | ** ** |
| ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **(unaudited)**    | ** ** | **(unaudited)** | ** ** |
| Deferred revenue |       |       |       |       |       | $                  | 32,007     |   | $ | 17,078 |   |
|                  |            |            |            |            |            |                    |            |  |  |  |  |

 

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

***Subscription revenue as a percentage of total revenue****.* Subscription revenue as a percentage oftotal revenue can be derived from our consolidated statement of operations.This performance indicator illustrates the evolution of our business towardssubscription-based solutions, which provide us with a recurring revenue streamand which we believe to be a more compelling revenue growth and profitabilityopportunity. We expect that the percentage of subscription revenue will be inthe range of 76-80% of our total revenues through at least 2007.

***Net cash provided by operating activities****.* Net cash provided by operatingactivities is taken from our consolidated statement of cash flows andrepresents the amount of cash generated by our operations that is available forinvesting and financing activities. Historically, our net cash provided byoperating activities has exceeded our net income primarily due to the positiveimpact of deferred revenue. We expect this trend to continue because of theadvance payment structure of our subscription agreements and because as oursales increase, we expect incremental costs to decline.

***Deferred revenue****.* We generate revenue primarily frommulti-year subscriptions for our on-demand talent acquisition and employeeperformance management solutions. We recognize revenue from these subscriptionagreements ratably over the hosting period, which are typically one to threeyears. We generally invoice our clients in quarterly or monthly installments inadvance. Deferred revenue, which is included in our consolidated balancesheets, is the amount of invoiced subscriptions in excess of the amountrecognized as revenue. Deferred revenue represents, in part, the amount that wewill record as revenue in our consolidated statements of operations in futureperiods. As the subscription component of our revenue has grown and customerwillingness to pay us in advance for their subscriptions has increased, theamount of deferred revenue on our balance sheet has grown at a higher rate thanour revenue growth rate. We expect this trend to continue.

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The following tablereconciles 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,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                             | ** ** | **2007**                                                      | ** ** | **2006**                                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | ** **                                           | ** ** | **(unaudited)**                                               | ** ** | **(unaudited)**                                             | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Deferred revenue at the  beginning of the period |       | $                                                    | 12,588     |                                                          | $          | 31,655                                                      |       | $ | 16,164 |   | $ | 31,251 |   | $ | 12,558 |   |
| Total invoiced  subscriptions during period      |       | 95,087                                               |       | 37,334                                                        |       | 20,861                                                      |       | 72,425 |   | 36,747 |   |
| Deferred revenue from  acquisitions              |       | 14,046                                               |       | 27                                                            |       |                                                        |       | 27 |   | 5,313 |   |
| Subscription revenue  recognized during period   |       | (90,470                                              | )          | (37,009                                                       | )          | (19,947                                                     | )          | (71,696 | ) | (37,540 | ) |
| Deferred revenue at end of period                |       | $                                                    | 31,251     |                                                          | $          | 32,007                                                      |       | $ | 17,078 |   | $ | 32,007 |   | $ | 17,078 |   |

** **

**5.Results of Operations**

**Six months ended June 30, 2007 compared to six months endedJune 30, 2006**

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

Kenexa CorporationConsolidated Statements of Operations(In thousands)(Unaudited)
| ** **                                  | ** ** | **For the  Three Months Ended  June 30,** | ** ** | **For the  Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                                      | ** ** | **2006**                                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **Amount**                                                    | ** ** | **Percent of  Revenues**                               | ** ** | **Amount** | ** ** | **Percent of  Revenues** | ** ** | **Amount** | ** ** | **Percent of  Revenues** | ** ** | **Amount** | ** ** | **Percent of  Revenues** | ** ** |
| Revenue:                                    |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Subscription revenue                        |       | 37,009                                                        |       | 81.9                                                        | %          | 19,947 |   | 80.7 | % | 71,696 |   | 82.0 | % | 37,540 |   | 78.7 | % |
| Other revenue                               |       | 8,155                                                         |       | 18.1                                                        | %          | 4,760 |   | 19.3 | % | 15,685 |   | 18.0 | % | 10,182 |   | 21.3 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenue                               |       | 45,164                                                        |       | 100.0                                                       | %          | 24,707 |   | 100.0 | % | 87,381 |   | 100.0 | % | 47,722 |   | 100.0 | % |
| Cost of revenue                             |       | 12,600                                                        |       | 27.9                                                        | %          | 6,672 |   | 27.0 | % | 24,032 |   | 27.5 | % | 13,026 |   | 27.3 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross profit                                |       | 32,564                                                        |       | 72.1                                                        | %          | 18,035 |   | 73.0 | % | 63,349 |   | 72.5 | % | 34,696 |   | 72.7 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating expenses:                         |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                         |       | 9,094                                                         |       | 20.1                                                        | %          | 5,717 |   | 23.1 | % | 17,324 |   | 19.8 | % | 11,445 |   | 24.0 | % |
| General and  administrative                 |       | 9,765                                                         |       | 21.6                                                        | %          | 5,914 |   | 23.9 | % | 19,436 |   | 22.2 | % | 11,201 |   | 23.5 | % |
| Research and development                    |       | 4,297                                                         |       | 9.5                                                         | %          | 1,815 |   | 7.3 | % | 8,620 |   | 9.9 | % | 3,351 |   | 7.0 | % |
| Depreciation and  amortization              |       | 1,477                                                         |       | 3.3                                                         | %          | 768 |   | 3.1 | % | 2,907 |   | 3.3 | % | 1,490 |   | 3.1 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total operating expenses                    |       | 24,633                                                        |       | 54.5                                                        | %          | 14,214 |   | 57.5 | % | 48,287 |   | 55.3 | % | 27,487 |   | 57.6 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income from operations                      |       | 7,931                                                         |       | 17.6                                                        | %          | 3,821 |   | 15.5 | % | 15,062 |   | 17.2 | % | 7,209 |   | 15.1 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income, net                        |       | 974                                                           |       | 2.2                                                         | %          | 682 |   | 2.8 | % | 1,097 |   | 1.3 | % | 802 |   | 1.7 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Income from operations  before income taxes |       | 8,905                                                         |       | 19.7                                                        | %          | 4,503 |   | 18.2 | % | 16,159 |   | 18.5 | % | 8,011 |   | 16.8 | % |
| Income tax expense                          |       | 3,092                                                         |       | 6.8                                                         | %          | 1,223 |   | 4.9 | % | 5,650 |   | 6.5 | % | 1,452 |   | 3.0 | % |
|                                        |       |                                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                  |       | 5,813                                                         |       | 12.9                                                        | %          | 3,280 |   | 13.3 | % | 10,509 |   | 12.0 | % | 6,559 |   | 13.7 | % |

 

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***Revenues***

Total revenue increased $20.5 million or 82.8% and$39.7 million or 83.1% during the three and six months ended June 30, 2007,respectively, compared to the same periods in 2006 to $45.2 million and $87.4million, respectively. Our subscription revenue increased by $17.1 million or85.5% and $34.2 million or 91.0% during the three and six months ended June 30,2007, respectively, compared to the same periods in 2006 to $37.0 million and$71.7 million, respectively. Subscription revenue represented approximately82.0% of our revenues for three and six months ended June 30, 2007. Theincrease in revenues is attributable to an increase in sales volumes of ourtalent management solutions and the continued acceptance of our on-demandmodel.  The acquisitions of StraightSource,BrassRing, Gantz-Wiley, Psychometrics and Knowledge Workers comprisedapproximately 60% of the increase in our total revenue for the three and sixmonths ended June 30, 2007, respectively. Our other revenue increased by $3.4 million or 71.3% and $5.5 million or54.0% to $8.2 million and $15.7 million for the three and six months ended June30, 2007, respectively, compared to the same periods in 2006.   The year- to-date increase was due toprimarily to an increase in demand for our consulting services resulting from anincrease in our subscription-based revenues. For the remainder of the year, we expect subscription based and otherrevenue to increase from the prior year due to customer acquisitions andadditional sales to existing customers as well as the impact of our recentacquisitions.

***Cost of Revenue***

Ourcost of revenue primarily consists of compensation, employee benefits andtravel-related expenses for our employees and independent contractors whoprovide consulting or other professional services to our clients. Additionally,our application hosting costs, amortization of third-party license royaltycosts, technical support personnel costs, allocated overhead and reimbursedexpenses are also recorded as cost of revenue. Many factors affect our cost ofrevenue, including changes in the mix of products and services, pricing trends,changes in the amount of reimbursed expenses and fluctuations in our clientbase. Because cost as a percentage of revenue is higher for professionalservices than for software products, an increase in the services component ofour solutions or an increase in discrete professional services as a percentageof our total revenue would reduce gross profit as a percentage of totalrevenue. As our business expands, we expect that third-party license royaltycosts and personnel costs associated with the delivery of our solutions willcontinue to fall within a range of approximately 26% to 30% of revenues.

Costof revenue increased by $5.9 million or 88.8% and $11.0 million or 84.5% forthe three and six months ended June 30, 2007, respectively, compared to thesame periods in 2006 to $12.6 million and $24.0 million, respectively. As apercentage of revenue, cost of revenue increased by 1.0% to 27.9% for the threemonths ended June 30, 2007, compared to the same periods in 2006, and wasrelatively the same for the six months ended June 30, 2007 and the prior yearat approximately 27%.  The addition of215 employees brought on by our recent acquisitions contributed approximately$3.6 million to the cost of revenue increase for the three months ended June30, 2007 versus the prior year. Additionally, other consulting and external services needed to supportour customer’s requirements added approximately $2.3 million to the increaseduring the quarter ended June 30, 2007

***Sales and Marketing (“S&M”) expense***

S&Mexpense primarily consists of personnel and related costs for employees engagedin sales and marketing, including salaries, commissions and other variablecompensation, travel expenses and costs associated with trade shows,advertising and other marketing efforts and allocated overhead. We expense oursales commissions at the time the related revenue is recognized, and werecognize revenue from our subscription agreements ratably over the term of theagreements. Investment in sales and marketing commencing in 2003 resulted in significantrevenue growth during 2004 through 2006. We intend to continue to invest insales and marketing to pursue new clients and expand relationships withexisting clients. As a result, although we expect S&M expense to increasein total dollars, we also expect S&M to continue to decrease as apercentage of revenue for the next twelve months.

S&M expense increased $3.4 million or 59.1% and$5.9 million or 51.4% for the three and six months ended June 30, 2007,respectively, compared to the same periods in 2006 to $9.1 million and $17.3million, respectively. Increased staff related expense including performancebonuses and commissions and bad debt expense contributed approximately $2.1million and $0.5 million, respectively, to the increase in S&M expenseduring the quarter ended June 30, 2007 from the prior year. In addition,increased travel and other expense added approximately $0.3 million and $0.5million to the increase in S&M expense during the quarter ended June 30,2007 from the prior year.  The increasein compensation and travel expense was attributable to the addition of 43employees hired in connection with our acquisitions in the prior year.

For the six months ended June 30, 2007, increasedstaff related expense including performance bonuses and commissions and travelexpense contributed of $4.1 million and $0.7 million, respectively, to theincrease in S&M expense from the prior year.  In addition, bad debt and other expense contributedapproximately $0.5 million each to the increase in S&M expense for the sixmonths ended June 30, 2007 over the comparable period in the prior year.  As a percentage of revenues, S&M expensedecreased from 23.1% to 20.1%, and 24.0% to 19.8%, respectively, for the threeand six months ended June 30, 2007, compared to the same periods in 2006 due toincreased revenues.

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***General and Administrative (“G&A”) expense***

G&Aexpense primarily consists of personnel and related costs for our executive,finance, human resources and administrative personnel, professional fees andother corporate expenses and allocated overhead. As we expand our business andincur additional expenses associated with being a public company, including thecosts of compliance with the Sarbanes-Oxley Act of 2002 and other regulations governingpublic companies, we believe that G&A expense will increase in dollaramount and may increase as a percentage of revenue in 2007 and future periods.

G&Aexpense increased by $3.9 million or 65.1% and $8.2 million and 73.5% for thethree and six months ended June 30, 2007, respectively compared to the sameperiod in 2006 to $9.8 million and $19.4 million, respectively. The $3.9million increase for the quarter ended June 30, 2007 was due primarily to anincrease in staff related expenses of $2.0 million related to the addition of32 employees hired in connection with our acquisitions in the prior year aswell as 15 employees needed to support our organic growth.  In addition, rent expense, professional feesand office supplies contributed $0.6 million, $0.5 million and $0.2 million,respectively, to the increase in G&A expense for the three months endedJune 30, 2007 versus the comparable period in the prior year.  The remainder of the increase of $0.6 millionwas attributable to increases in infrastructure expenses such as phone,supplies, utilities, insurance and other.

The$8.2 million increase for the six months ended June 30, 2007 was due in part toan increase in staff related expense of $3.7 million related to the addition of32 employees from our 2006 acquisitions. In addition, rent expense, professional fees and office suppliescontributed of $1.1 million, $1.4 million and $0.6 million, respectively, tothe increase in G&A expense for the six months ended June 30, 2007 versusthe comparable period in the prior year. The remainder of the increase of $1.4 million was attributable toincreases in infrastructure expenses such as phone, supplies, utilities,insurance and other.  As a percentage ofrevenues, G&A expense decreased from 23.9% to 21.6%, and 23.5% to 22.2%,respectively, for the three and six months ended June 30, 2007, compared to thesame periods in 2006 due to increased revenues.

***Research and Development (“R&D”) expense***

R&Dexpense primarily consists of personnel and related costs, including salariesand employee benefits for software engineers, quality assurance engineers,product managers, technical sales engineers and management information systemspersonnel.  Our R&D efforts have beendevoted primarily to new product offerings and incidental enhancements andupgrades to our existing products.  Ourcapitalized software includes a small percentage of our R&D expense.  Capitalized R&D expense totaled $0.5 millionand $0.3 million for the six months ended June 30, 2007 and 2006,respectively. The remaining R&D expense has been expensed as incurred. Weexpect R&D expense to increase in the future as we employ more personnel tosupport enhancements of our solutions and new solutions offerings. However, weexpect R&D expense to decrease as a percentage of revenue primarily due toincreased efficiencies from our global development center.

R&D expense increased by $2.5 million or 136.7%and $5.3 million or 157.2% for the three and six months ended June 30, 2007,respectively compared to the same period in 2006 to $4.3 million and $8.6million, respectively.  The $2.5 millionand $5.3 million increase in R&D for the three and six months ended June30, 2007, respectively, was due primarily to the addition of 78 developershired in connection with our acquisitions in the prior year as well as 27developers needed to support our broadening and deepening solution suite.  As a percentage of revenues, R&D expenseincreased from 7.3% to 9.5%, for the three months ended June 30, 2007 andincreased from 7.0% to 9.9%, for the six months ended June 30, 2007, comparedto the same periods in 2006.

***Depreciation and Amortization***

Depreciationand amortization expense increased by $0.7 million and $1.4 million orapproximately 92.3% and 95.1% for the three and six months ended June 30, 2007,respectively, compared to the same periods in 2006 to $1.5 million and $2.9million, respectively.  In the future, weexpect depreciation and amortization expense to increase due to recent capitalpurchases.

***Incometax expense***

Income tax expense onoperations increased by $1.9 million and $4.2 million or approximately 152.8%and 289.1% for the three and six months ended June 30, 2007, respectively,compared to the same periods in 2006 to $3.1 million and $5.6 million,respectively.  The increase in expensewas due to increased taxable income.

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***Interest Income***

Interestincome increased $0.3 million for the three and six months ended June 30,2007.  The $0.3 million or 43% increasefor the three months ended June 30, 2007 is due to and commensurate with theincrease in cash and short term investments over the prior year.   The $0.3 million increase for the six monthsended June 30, 2007 is also due to an increase in cash and short investmentsfor the six month period ended June 30, 2007 versus the prior period and is netof $0.4 million in interest expense associated with the write-off of a portionof our deferred financing fees from our amended credit facility.

**6. Liquidity and Capital Resources**

Sincewe were formed in 1987, we have financed our operations primarily throughinternally generated cash flows, our line of credit and the issuance of preferredand common stock. As of June 30, 2007, we had cash and cash equivalents of$29.2 million and short term investments of $79.4 million. In addition, we had$0.3 million in capital equipment leases.

Ourcash provided from operations was $12.2 million and $2.3 million for the sixmonths ended June 30, 2007 and 2006, respectively.  Cash used in investing activities was $94.1million and $36.7 million for the six months ended June 30, 2007 and 2006,respectively.  Cash provided by financingactivities was $68.1 million for the six months ended June 30, 2007 and 2006.  For the six months ended June 30, 2007 ournet decrease in cash and cash equivalents was $13.3 million, resultingprimarily from the investment in short term investments, and for the six monthsended June 30, 2006 our net increase in cash and cash equivalents was $33.4million resulting from our net proceeds of $66.5 million from our publicoffering completed in March 2006.  Weexpect this positive cash flow to continue in future periods.

On January 18, 2007, we completed a public offering of3,750,000 shares of our common stock at a price to the public of $31.86 pershare.  We also sold an additional 562,500 shares of our common stock tocover over-allotments of shares.  Our net proceeds from the offering,after payment of all offering expenses and commissions, aggregatedapproximately $130.5 million.

In January 2007 we repaid the balance of ourobligations relating to the term loan portion of the Credit Agreement with thenet proceeds from our public offering of common stock in January 2007.

OnMarch 26, 2007, we entered into a First Amendment to Credit Agreement withPNC Bank, N.A.   The Amendment increased the maximum amount availableunder the revolving credit facility portion of the Credit Agreement from $25million to $50 million, including a sublimit of up to $2 million for letters ofcredit.  The Amendment provides that the Credit Agreement will terminate,and all borrowings will become due and payable, on March 26, 2010.

***Operating Activities***

Net cash provided byoperating activities was $12.2 million and $2.3 million for the six monthsended June 30, 2007 and 2006, respectively. Net cash provided by operating activities for the six months ended June30, 2007 primarily resulted from net income of approximately $10.5 million,non-cash charges to net income of $5.4 million and net changes in workingcapital of $1.2 million, partially offset by an increase in accounts andunbilled receivables of $1.8 million, deferred tax benefit of $1.9 million, anda $1.3 million reduction for excess tax benefits from share basedarrangements.  Net cash provided byoperating activities for the six months ended June 30, 2006 primarily resultedfrom net income of approximately $6.6 million, non-cash charges to netincome of $2.8 million and net changes in working capital of $0.3 millionpartially offset by an increase in accounts and unbilled receivables of$5.2 million, an increase in deferred taxes of $1.4 million, and a $0.8 millionreduction for excess tax benefits from share based arrangements.

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***Investing Activities***

Netcash used in investing activities was $94.1 million and $36.7 million for thesix months ended June 30, 2007 and 2006, respectively.  Cash flows from investing activities for thesix months ended June 30, 2007 and 2006 consisted of the following:

|                                               | ** ** | **Six months June 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                    | ** ** | **2007**                               | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | **(In millions)**                 | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                        | ** ** |
| Webhire acquisition                           |       | —                                 |       | $ | 32.0 |   |
| Knowledge Workers                             |       |                                   |       | $ | 2.6 |   |
| Psychometrics  acquisition                    |       | $                                      | 0.3        |   | — |   |
| Gantz Wiley Research  acquisition             |       | $                                      | 0.6        |   | — |   |
| Brassring acquisition                         |       | $                                      | 0.1        |   | — |   |
| StraightSource  acquisition                   |       | $                                      | 9.0        |   |   |   |
| Purchases of property  and equipment          |       | $                                      | 4.6        |   | $ | 2.1 |   |
| Purchases of available  for sale investments  |       | $                                      | 79.5       |   |   |   |
| Total Cash flows used in investing activities |       | $                                      | 94.1       |   | $ | 36.7 |   |

 

In thefuture, we expect our capital expenditures to increase as revenues increase andbusiness needs arise.

***Financing Activities***

Netcash provided by financing activities was $68.1 million for the six monthsended June 30, 2007 and 2006.  For thesix months ended June 30, 2007, net cash provided by financing activityconsisted of net proceeds from our follow-on public offering of $130.5 million,net proceeds from stock option exercises of $1.5 million and excess tax benefitsfrom share-based payment arrangements of $1.3 million, partially offset by therepayment of our credit facility of $65.0 million, capital lease obligations of$0.1 million and deferred financing costs of $0.1 million.   For the six months ended June 30, 2006, netcash provided by financing activity consisted of net proceeds from ourfollow-on public offering of $66.5 million, net proceeds from stock optionexercises of $1.2 million and excess tax benefits from share-based paymentarrangements of $0.8 million, partially offset by the repayment of notespayable of $0.1 million, capital lease obligations of $0.2 million anddeferred financing costs of $0.1 million.

Webelieve that our cash and cash equivalent balances and cash flows fromoperations will be sufficient to satisfy our working capital and capitalexpenditure requirements for at least the next 12 months.  We intend to continue to invest our cash inexcess of current operating requirements in interest-bearing, investment-gradesecurities. Changes in our operating plans, lower than anticipated revenue,increased expenses or other events, may cause us to seek additional debt orequity financing. Financing may not be available on acceptable terms, or atall, and our failure to raise capital when needed could negatively impact ourgrowth plans and our financial condition and consolidated results ofoperations. Additional equity financing would be dilutive to the holders of ourcommon stock, and debt financing, if available, may involve significant cashpayment obligations and covenants or financial ratios that restrict our abilityto operate our business.

**CriticalAccounting Policies and Estimates**

Ourdiscussion and analysis of our financial condition and consolidated results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with generally accepted accounting principles inthe United States. The preparation of our consolidated financial statementsrequires us to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenue and expenses and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to uncollectible accounts receivable and accruedexpenses. We base these estimates on historical experience and various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Ouractual results may differ from these estimates.

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

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***Revenue Recognition***

Wederive our revenue from two sources: (1) subscription revenues for solutions,which are comprised of subscription fees from clients accessing our on-demandsoftware, consulting services, outsourcing services and proprietary content,and from clients purchasing additional support beyond the standard support thatis included in the basic subscription fee; and (2) other fees for discreteprofessional services. Because we provide our solutions as a service, we followthe provisions of Securities and Exchange Commission Staff Accounting BulletinNo. 101,*Revenue Recognition in FinancialStatements,* 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:

·              Thereis persuasive evidence of an arrangement;

·              Theservice has been provided to the client;

·              Thecollection of the fees is probable; and

·              Theamount of fees to be paid by the customer is fixed or determinable.

Subscriptionfees and support revenues are recognized on a monthly basis over the terms ofthe contracts. Amounts that have been invoiced are recorded in accountsreceivable and in deferred revenue or revenue, depending on whether the revenuerecognition criteria have been met.

Discreteprofessional services, when sold with subscription and support offerings, areaccounted for separately since these services have value to the customer on astand-alone basis and there is objective and reliable evidence of fair value ofthe delivered elements. Our arrangements do not contain general rights ofreturn. Additionally, when professional services are sold with other elements,the consideration from the revenue arrangement is allocated among the separateelements based upon the relative fair value. Revenues from professionalservices are recognized as the services are rendered.

Indetermining whether revenues from professional services can be accounted forseparately from subscription revenue, we consider the following factors foreach agreement: availability of professional services from other vendors,whether objective and reliable evidence of the fair value exists of theundelivered elements, the nature and the timing of the agreement execution incomparison to the subscription agreement start date and the contractualdependence of the subscription service on the customer’s satisfaction with theother services. If the professional service does not qualify for separateaccounting, we recognize the revenue ratably over the remaining term of thesubscription contract. In these situations we defer the direct and incrementalcosts of the professional service over the same period as the revenue isrecognized.

Werecord out-of-pocket expenses incurred in accordance with EITF issue 01-14, “IncomeStatement Characterization of Reimbursements Received for ‘Out-of-Pocket’Expenses Incurred,” which requires that reimbursements received forout-of-pocket expenses be classified as revenue and not as cost reductions.Before the December 15, 2001 effective date of EITF Issue 01-14, out-of-pocketreimbursements from clients were netted with the applicable costs.  These items primarily include travel, mealsand certain telecommunication costs. For the six months ended June 30,2007, reimbursed expenses totaled $1.2 million.

***Allowance for Doubtful Accounts***

Wemaintain an allowance for doubtful accounts for estimated losses resulting fromclients’ inability to pay us. The provision is based on our historicalexperience and for specific clients that, in our opinion, are likely to defaulton our receivables from them. In order to identify these clients, we performongoing reviews of all clients that have breached their payment terms, as wellas those that have filed for bankruptcy or for whom information has becomeavailable indicating a significant risk of non-recoverability. In addition, wehave experienced significant growth in number of clients, and we have lesspayment history to rely upon with these clients. We rely on historical trendsof bad debt as a percentage of total revenue and apply these percentages to theaccounts receivable associated with new clients and evaluate these clients overtime. To the extent that our future collections differ from our assumptionsbased on historical experience, the amount of our bad debt and allowancerecorded may be different.

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***Capitalized Software Research and Development Costs***

Inaccordance with EITF Issue 00-3, “Application of AICPA Statement of Position97-2 to Arrangements That Include the Right to Use Software Stored on AnotherEntity’s Hardware,” we apply AICPA Statement of Position No. 98-1, Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use. Thecosts incurred in the preliminary stages of development are expensed asincurred. Once an application has reached the development stage, internal andexternal costs, if direct and incremental, will be capitalized until thesoftware is substantially complete and ready for its intended use.Capitalization ceases upon completion of all substantial testing. We alsocapitalize costs related to specific upgrades and enhancements when it isprobable the expenditures will result in additional functionality. Maintenanceand training cost are expensed as incurred. Internal use software is amortizedon a straight-line basis over its estimated useful life, generally three years.Management evaluates the useful lives of these assets on an annual basis andtests for impairments whenever events or changes in circumstances occur thatcould impact the recoverability of these assets. There were no impairments tointernal software in any of the periods covered in this report.

***Goodwill and Other Identified Intangible Asset Impairment***

OnJanuary 1, 2002, we adopted SFAS No. 142,*Goodwill and Other Intangible Assets* which superseded AccountingBoard Opinion No. 17,*Intangible Assets.*Upon adoption of SFAS No. 142, we ceased amortization of existing goodwill andare required to review the carrying value of goodwill for impairment. Ifgoodwill becomes impaired, some or all of the goodwill could be written off asa charge to operations. This comparison is performed annually or more frequentlyif circumstances indicate that the carrying value may not be recoverable. Wehave reviewed the carrying values of goodwill of each business unit bycomparing the carrying values to the estimated fair values of the businesscomponents. The fair value is based on management’s estimate of the futurediscounted cash flows to be generated by the respective business components andcomparable company multiples. Such cash flows consider factors such as futureoperating income, historical trends, as well as demand and competition.Comparable company multiples are based upon public companies in sectorsrelevant to our business based on our knowledge of the industry. Changes in theunderlying business could affect these estimates, which in turn could affectthe recoverability of goodwill.  ThroughJune 30, 2007, we have not observed any changes to our business units whichwould lead us to believe that our goodwill or other identified intangibles’carrying value exceeds their fair values.

***Accounting for Stock-Based Compensation***

We use a Black-Scholesoption-pricing model to calculate the fair value of our stock awards. Thecalculation of the fair value of the awards using the Black-Scholesoption-pricing model is affected by our stock price on the date of grant aswell as assumptions regarding the following:

·                                          Volatilityis a measure of the amount by which the stock price is expected to fluctuateeach year during the expected life of the award and is based on a weightedaverage of peer companies, comparable indices and our stock volatility. Anincrease in the volatility would result in an increase in our expense.

·                                          Theexpected term represents the period of time that awards granted are expected tobe outstanding and is currently based upon an average of the contractual lifeand the vesting period of the options. With the passage of time actualbehavioral patterns surrounding the expected term will replace the currentmethodology. Changes in the future exercise behavior of employees or in thevesting period of the award could result in a change in the expected term. Anincrease in the expected term would result in an increase to our expense.

·                                          Therisk-free interest rate is based on the U.S. Treasury yield curve in effect attime of grant. An increase in the risk-free interest rate would result in anincrease in our expense.

Stock-based compensationexpense recognized during the period is based on the value of the number ofawards that are expected to vest. In determining the stock-based compensationexpense to be recognized, a forfeiture rate is applied to the fair value of theaward. This rate represents the number of awards that are expected to beforfeited prior to vesting and is based on Kenexa’s employee historicalbehavior. Changes in the future behavior of employees could impact this rate. Adecrease in this rate would result in an increase in our expense.

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***Accounting for Income Taxes***

Weaccount for income taxes in accordance with FASB Statement No. 109, “Accountingfor Income Taxes,” or SFAS 109, which requires that deferred tax assets andliabilities be recognized using enacted tax rates for the effect of temporarydifferences between the book and tax basis of recorded assets and liabilities.SFAS 109 also requires that deferred tax assets be reduced by a valuation allowanceif it is more likely than not that some portion of all of the deferred taxasset will not be realized.

Therealization of the deferred tax assets is evaluated quarterly by assessing thevaluation allowance and by adjusting the amount of the allowance, if necessary.The factors used to assess the likelihood of realization are the forecast offuture taxable income and available tax planning strategies that could beimplemented to realize the net deferred tax assets. We have used tax-planningstrategies to realize or renew net deferred tax assets in order to avoid thepotential loss of future tax benefits.

Inaddition, we operate within multiple taxing jurisdictions and are subject toaudit in each jurisdiction. These audits can involve complex issues that mayrequire an extended period of time to resolve. In our opinion, adequateprovisions for income taxes have been made for all periods.

***Self-Insurance***

We areself-insured for the majority of our health insurance costs, including claimsfiled and claims incurred but not reported subject to certain stop lossprovisions. We estimate our liability based upon management’s judgment andhistorical experience. We also rely on the advice of consulting administratorsin determining an adequate liability for self-insurance claims. For the sixmonths ended June 30, 2007 our self-insurance accrual totaled $0.4 million. Wecontinuously review the adequacy of our insurance coverage. Materialdifferences may result in the amount and timing of insurance expense if actual experiencediffers significantly from management’s estimates.

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**Item3: Quantitative and Qualitative Disclosures about Market Risk**

Marketrisk represents the risk of loss that may impact our financial position due toadverse changes in financial market prices and rates. Our market risk exposureis primarily a result of fluctuations in interest rates and foreign currencyexchange rates. We do not hold or issue financial instruments for tradingpurposes.

***Foreign Currency Exchange Risk***

Forthe six months ended June 30, 2007, approximately 87.2 of our total revenue wascomprised of sales to clients in the United States. A key component of ourbusiness strategy is to expand our international sales efforts, which willexpose us to foreign currency exchange rate fluctuations. A 10% change in thevalue of the U.S. dollar relative to each of the currencies of ournon-U.S-generated sales would not have resulted in a material change to ourresults. As of June 30, 2007, we werenot engaged in any foreign currency hedging activities.

Thefinancial position and operating results of our United Kingdom and Indiaoperations are consolidated using the local currency as the functionalcurrency. Local currency assets and liabilities are translated at the rate ofexchange to the U.S. dollar on the balance sheet date, and the local currencyrevenue and expenses are translated at average rates of exchange to the U.S.dollar during the period. The related translation adjustments was approximately$0.5 million at June 30, 2007, or $0.4 million for the six monthsended and is included in accumulated other comprehensive income**.** The foreign currency translation adjustment is notadjusted for income taxes as it relates to an indefinite investment in anon-U.S. subsidiary.

***Interest Rate Risk***

Theprimary objective of our investment activities is to preserve principal whilemaximizing income without significantly increasing risk. Some of the securitiesin which we invest may be subject to market risk. This means that a change inprevailing interest rates may cause the principal amount of the investment tofluctuate. To minimize this risk in the future, we intend to maintain ourportfolio of cash equivalents and short-term investments in a variety ofsecurities, including commercial paper, money market funds, government andnon-government debt securities and certificates of deposit. Our cashequivalents, which consist solely of money market funds, are not subject tomarket risk because the interest paid on these funds fluctuates with theprevailing interest rate. We do not believe that a 10% change in interest rateswould have a significant effect on our interest income.

**Item4: Controls and Procedures**

Under thesupervision of and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934 as of the end of the period covered by thisreport, or the Evaluation Date. Based upon the evaluation, our principalexecutive officer and principal financial officer concluded that our disclosurecontrols and procedures were effective as of the Evaluation Date. Disclosurecontrols are controls and procedures designed to reasonably ensure thatinformation required to be disclosed in our reports filed under the ExchangeAct, such as this report, is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms. Disclosure controlsinclude controls and procedures designed to reasonably ensure that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate to allowtimely decisions regarding required disclosure.

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

 

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**PART II: OTHER INFORMATION**

**Item 1:Legal Proceedings**

We areinvolved in claims, which arise in the ordinary course of business. In theopinion of management, we have made adequate provision for potentialliabilities, if any, arising from any such matters.  However, litigation is inherentlyunpredictable, 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, claimsand changes in any such matters, and developments or assertions by or againstus relating to intellectual property rights and intellectual property licenses,could have a material adverse effect on our business, financial condition andoperating results.

**Item 1A: Risk Factors**

In addition to the otherinformation set forth in this Form 10-Q, you should carefully consider thefactors discussed in Part I, Item 1A “Risk Factors” of our Annual Report onForm 10-K for the year ended December 31, 2006 which could materially affectour business, financial condition or future results of operations.  The risks described in our Annual Report onForm 10-K for the year ended December 31, 2006 are not the only risks that weface.  Additional risks and uncertaintiesnot currently known to us or that we currently deem to be immaterial may alsomaterially adversely affect our business, financial condition and futureresults of operations.  There have beenno material changes from the risk factors previously disclosed in Item IA ofour Annual Report on Form 10-K for the year ended December 31, 2006.

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

On June 13, 2007,as partial consideration for the Company’s acquisition of all of theoutstanding stock of StraightSource, the Company issued 87,235 shares of theCompany’s common stock to the former shareholders of StraightSource.  These shares were issued without registrationunder the Securities Act of 1933, as amended, or the securities laws of certainstates, in reliance on the exemptions provided by Section 4(2) of theSecurities Act and similar exemptions under applicable state laws.

**Item 3:Defaults Upon Senior Securities**

Notapplicable.

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

We held our annualmeeting of shareholders on May 8, 2007 (the “Annual Meeting”).

At the Annual Meeting,Joseph A. Konen and Richard J. Pinola were each nominated for, and elected bythe shareholders to, our Board of Directors (the “Board”).  The number ofvotes cast for, and withheld with respect to, each nominee is set forth below:

|                   | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-------------------|------------|------------|------------|--------------|------------|
| Joseph A. Konen   |       | 17,201,164 |       | 1,750,590    |       |
| Richard J. Pinola |       | 17,224,234 |       | 1,727,520    |       |

 

At the Annual Meeting,Rebecca J. Maddox was re-elected to our Board. The number of votes cast for, and withheld with respect to  her re-election is set forth below:

|                   | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-------------------|------------|------------|------------|--------------|------------|
| Rebecca J. Maddox |       | 18,206,604 |       | 745,150      |       |

 

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

**Item 5:Other Information**

Notapplicable.

**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 AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

August 9, 2007Kenexa Corporation
|          | * * | */s/*    | * * | *Nooruddin S. Karsan*                               | * * | * * |
|----------|----------|----------|----------|-----------------------------------------------------|----------|----------|
| * * | * * | * * | * * | *Nooruddin S. Karsan*                               | * * | * * |
| * * | * * | * * | * * | *Chairman of the Board and Chief Executive Officer* |
| * * | * * | */s/*    | * * | *Donald F. Volk*                                    | * * | * * |
| * * | * * | * * | * * | *Donald F. Volk*                                    | * * | * * |
| * * | * * | * * | * * | *Chief Financial Officer*                           | * * | * * |

 

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**EXHIBIT INDEX**

Exhibit Number andDescription
| 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. |

 

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