UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-Q





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





For
the quarterly period ended September 30, 2009




OR




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





For
the transition period
from         to




Commission
File number 000-51358




Kenexa
Corporation


(Exact Name of Registrant
as Specified in Its Charter)





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





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





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





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


Yes  x  No    ̈





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




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


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





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


Yes   ̈   No  x





On
November 9, 2009, 22,553,686 shares of the registrant’s Common Stock, $0.01 par
value, were outstanding.








Kenexa
Corporation and Subsidiaries


FORM
10-Q


Quarter
Ended September 30, 2009


Table
of Contents




PagePART I: FINANCIAL
      INFORMATIONItem
      I: Financial StatementsConsolidated
      Balance Sheets as of September 30, 2009 (unaudited) and December 31,
      2008
                    
                    3Consolidated
      Statements of Operations for the three and nine months ended September 30,
      2009 and 2008 (unaudited)
                    
                    4Consolidated
      Statements of Shareholders’ Equity for the nine months
      ended September 30, 2009 (unaudited) and the year ended December 31,
      2008
                    
                    5Consolidated
      Statements of Cash Flows for the nine months ended September 30, 2009 and
      2008 (unaudited)
                    
                    6Notes
      to Consolidated Financial Statements (unaudited)
                    
                    7Item
      2: Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                    
                    27Item
      3: Quantitative and Qualitative Disclosures about Market
    Risk
                    
                    41Item
      4: Controls and Procedures
                    
                    41PART
      II: OTHER INFORMATIONItem
      1: Legal Proceedings
                    
                    42Item
      1A: Risk Factors
                    
                    42Item
      2: Unregistered Sales of Equity Securities and Use of
    Proceeds
                    
                    42Item
      3: Defaults Upon Senior Securities
                    
                    42Item
      4: Submission of Matters to a Vote of Security Holders
                    
                    43Item
      5: Other Information
                    
                    43Item
      6: Exhibits
                    
                    43Signatures
                    
                    44Exhibit
      Index
                    
                    45




2




PART
I FINANCIAL INFORMATION


Item
1: Financial Statements


Kenexa
Corporation and Subsidiaries


Consolidated
Balance Sheets


(In
thousands, except share data)


September 30,
                  2009
                
                
                December 31,
                  2008(unaudited)AssetsCurrent
      AssetsCash
      and cash equivalents
                
                $
                28,224
                
                
                $
                21,742Short-term
      investments
                
                
                22,000
                
                
                
                4,512Accounts
      receivable, net of allowance for doubtful accounts of $2,235 and $3,755,
      respectively
                
                
                29,809
                
                
                
                33,518Unbilled
      receivables
                
                
                5,613
                
                
                
                5,849Income
      tax receivable
                
                
                1,155
                
                
                
                1,238Deferred
      income taxes
                
                
                4,778
                
                
                
                4,615Prepaid
      expenses and other current assets
                
                
                7,183
                
                
                
                3,745Total
      Current Assets
                
                
                98,762
                
                
                
                75,219Long-term
      investments
                
                
                —
                
                
                
                16,513Property,
      plant and equipment, net of accumulated depreciation
                
                
                19,437
                
                
                
                20,175Software,
      net of accumulated amortization
                
                
                16,188
                
                
                
                11,025Goodwill
                
                
                314
                
                
                
                32,366Intangible
      assets, net of accumulated amortization
                
                
                9,392
                
                
                
                13,414Deferred
      income taxes, non-current
                
                
                39,901
                
                
                
                39,465Deferred
      financing costs, net of accumulated amortization
                
                
                —
                
                
                
                364Other
      long-term assets
                
                
                9,835
                
                
                
                9,924Total
      assets
                
                $
                193,829
                
                
                $
                218,465Liabilities
      and Shareholders’ EquityCurrent
      liabilitiesAccounts
      payable
                
                $
                6,922
                
                
                $
                6,448Notes
      payable, current
                
                
                12
                
                
                
                40Commissions
      payable
                
                
                709
                
                
                
                559Accrued
      compensation and benefits
                
                
                5,041
                
                
                
                4,010Other
      accrued liabilities
                
                
                6,149
                
                
                
                10,090Deferred
      revenue
                
                
                44,192
                
                
                
                38,638Capital
      lease obligations
                
                
                214
                
                
                
                143Total
      current liabilities
                
                
                63,239
                
                
                
                59,928Capital
      lease obligations, less current portion
                
                
                310
                
                
                
                108Notes
      payable, less current portion
                
                
                —
                
                
                
                41Deferred
      income taxes
                
                
                1,202
                
                
                
                1,789Other
      liabilities
                
                
                86
                
                
                
                63Total
      liabilities
                
                
                64,837
                
                
                
                61,929Commitments
      and ContingenciesShareholders’
      EquityPreferred
      stock, par value $0.01; 10,000,000 shares authorized; no shares issued
      or  outstanding
                
                
                —
                
                
                
                —Common
      stock, par value $0.01; 100,000,000 shares
      authorized;  22,553,686 and 22,504,924 shares issued and
      outstanding, respectively
                
                
                226
                
                
                
                225Additional
      paid-in-capital
                
                
                273,758
                
                
                
                269,365Accumulated  deficit
                
                
                (142,006
                )
                
                
                (110,633
                )Accumulated
      other comprehensive loss
                
                
                (3,093
                )
                
                
                (2,421
                )Total
      Kenexa Corporation shareholders’ equity
                
                
                128,885
                
                
                
                156,536Non-controlling
      interest
                
                
                107
                
                
                
                —Total
      shareholders’ equity
                
                
                128,992
                
                
                
                156,536Total
      liabilities and shareholders’ equity
                
                $
                193,829
                
                
                $
                218,465




See
notes to consolidated financial statements.




3




Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Operations


(In
thousands, except share and per share data)


(Unaudited)





Three Months Ended
                  September 30,
                
                
                Nine Months Ended
                  September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Revenues:Subscription
                
                $
                33,221
                
                
                $
                43,031
                
                
                $
                100,527
                
                
                $
                125,855Other
                
                
                7,093
                
                
                
                10,995
                
                
                
                18,083
                
                
                
                32,819Total
      revenues
                
                
                40,314
                
                
                
                54,026
                
                
                
                118,610
                
                
                
                158,674Cost
      of revenues
                
                
                13,129
                
                
                
                16,461
                
                
                
                40,462
                
                
                
                46,739Gross
      profit
                
                
                27,185
                
                
                
                37,565
                
                
                
                78,148
                
                
                
                111,935Operating
      expenses:Sales
      and marketing
                
                
                9,083
                
                
                
                10,298
                
                
                
                26,029
                
                
                
                31,175General
      and administrative
                
                
                10,182
                
                
                
                12,649
                
                
                
                30,972
                
                
                
                37,487Research
      and development
                
                
                2,453
                
                
                
                3,756
                
                
                
                7,557
                
                
                
                12,605Depreciation
      and amortization
                
                
                3,582
                
                
                
                3,337
                
                
                
                10,084
                
                
                
                8,766Goodwill
      impairment charge
                
                
                —
                
                
                
                —
                
                
                
                33,329
                
                
                
                —Total
      operating expenses
                
                
                25,300
                
                
                
                30,040
                
                
                
                107,971
                
                
                
                90,033Income
      (loss) from operations
                
                
                1,885
                
                
                
                7,525
                
                
                
                (29,823
                )
                
                
                21,902Interest
      (expense) income, net
                
                
                (28
                )
                
                
                255
                
                
                
                (186
                )
                
                
                1,216Investment
      income (loss), net
                
                
                102
                
                
                
                —
                
                
                
                54Income
      (loss) before income taxes
                
                
                1,959
                
                
                
                7,780
                
                
                
                (29,955
                )
                
                
                23,118Income
      tax expense
                
                
                361
                
                
                
                2,356
                
                
                
                1,418
                
                
                
                6,955Net
      income (loss)
                
                $
                1,598
                
                
                $
                5,424
                
                
                $
                (31,373
                )
                
                $
                16,163Basic
      net income (loss) per share
                
                $
                0.07
                
                
                $
                0.24
                
                
                $
                (1.39
                )
                
                $
                0.71Weighted
      average shares used to compute net income (loss) per share –
      basic
                
                
                22,539,717
                
                
                
                22,551,225
                
                
                
                22,525,144
                
                
                
                22,852,499Diluted
      net income (loss) per share
                
                $
                0.07
                
                
                $
                0.24
                
                
                $
                (1.39
                )
                
                $
                0.70Weighted
      average shares used to compute net income (loss) per share –
      diluted
                
                
                22,920,935
                
                
                
                22,788,468
                
                
                
                22,525,144
                
                
                
                23,084,524




See
notes to consolidated financial statements.




4




Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Shareholders’ Equity


(in
thousands)





Nine months ended September 30, 2009 and year ended December 31, 2008Common
                      stock
                    
                    
                    Additionalpaid-incapital
                    
                    
                    Accumulateddeficit
                    
                    
                    Accumulatedothercomprehensive
                      income (loss)
                    
                    
                    Total
                      shareholders’
                      equity
                    
                    
                    Non-controllinginterest
                    
                    
                    Comprehensiveincome (loss)Balance,
      December 31, 2007
                    
                    $
                    240
                    
                    
                    $
                    291,942
                    
                    
                    $
                    (5,941
                    )
                    
                    $
                    1,407
                    
                    
                    $
                    287,648
                    
                    
                    $
                    —
                    
                    
                    $
                    24,859Common
      stock repurchase
                    
                    
                    (17
                    )
                    
                    
                    (30,260
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (30,277
                    )
                    
                    
                    —
                    
                    
                    
                    —Loss
      on currency translation adjustments
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (3,861
                    )
                    
                    
                    (3,861
                    )
                    
                    
                    —
                    
                    
                    
                    (3,861
                    )Unrealized
      gain on short-term investments
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    33
                    
                    
                    
                    33
                    
                    
                    
                    —
                    
                    
                    
                    33Share-based
      compensation expense
                    
                    
                    —
                    
                    
                    
                    5,761
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    5,761
                    
                    
                    
                    —
                    
                    
                    
                    —Excess
      tax benefits from share-based payment arrangements
                    
                    
                    —
                    
                    
                    
                    169
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    169
                    
                    
                    
                    —
                    
                    
                    
                    —Option
      exercises
                    
                    
                    1
                    
                    
                    
                    366
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    367
                    
                    
                    
                    —
                    
                    
                    
                    —Employee
      stock purchase plan
                    
                    
                    —
                    
                    
                    
                    338
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    338
                    
                    
                    
                    —
                    
                    
                    
                    —Common
      stock issuance for Straight Source earn out
                    
                    
                    1
                    
                    
                    
                    1,049
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1,050
                    
                    
                    
                    —
                    
                    
                    
                    —Net
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (104,692
                    )
                    
                    
                    —
                    
                    
                    
                    (104,692
                    )
                    
                    
                    —
                    
                    
                    
                    (104,692
                    )Balance,
      December 31, 2008
                    
                    $
                    225
                    
                    
                    $
                    269,365
                    
                    
                    $
                    (110,633
                    )
                    
                    $
                    (2,421
                    )
                    
                    $
                    156,536
                    
                    
                    $
                    —
                    
                    
                    $
                    (108,520
                    )Loss
      on currency translation adjustments
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (604
                    )
                    
                    
                    (604
                    )
                    
                    
                    —
                    
                    
                    
                    (604
                    )Unrealized
      loss on short-term investments
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (68
                    )
                    
                    
                    (68
                    )
                    
                    
                    —
                    
                    
                    
                    (68
                    )Share-based
      compensation expense
                    
                    
                    —
                    
                    
                    
                    4,080
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    4,080
                    
                    
                    
                    —
                    
                    
                    
                    —Option
      exercises
                    
                    
                    1
                    
                    
                    
                    69
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    70
                    
                    
                    
                    —
                    
                    
                    
                    —Employee
      stock purchase plan
                    
                    
                    —
                    
                    
                    
                    244
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    244
                    
                    
                    
                    —
                    
                    
                    
                    —Non-controlling
      interest
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    107
                    
                    
                    
                    —Net
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (31,373
                    )
                    
                    
                    —
                    
                    
                    
                    (31,373
                    )
                    
                    
                    —
                    
                    
                    
                    (31,373
                    )Balance,
      September 30, 2009 (unaudited)
                    
                    $
                    226
                    
                    
                    $
                    273,758
                    
                    
                    $
                    (142,006
                    )
                    
                    $
                    (3,093
                    )
                    
                    $
                    128,885
                    
                    
                    $
                    107
                    
                    
                    $
                    (32,045
                    )





See
notes to consolidated financial statements.





5




Kenexa
Corporation and Subsidiaries


Consolidated
Statements of Cash Flows


(in
thousands)


(unaudited)





Nine months ended September,2009
                  
                  
                  2008Cash
      flows from operating activitiesNet
      (loss) income
                  
                  $
                  (31,373
                  )
                  
                  $
                  16,163Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activitiesDepreciation
      and amortization
                  
                  
                  10,084
                  
                  
                  
                  8,766Loss
      on change in fair market value of ARS and put option, net
                  
                  
                  9
                  
                  
                  
                  —Goodwill
      impairment charge
                  
                  
                  33,329
                  
                  
                  
                  —Share-based
      compensation expense
                  
                  
                  4,080
                  
                  
                  
                  4,430Excess
      tax benefits from share-based payment arrangements
                  
                  
                  —
                  
                  
                  
                  (192
                  )Amortization
      of deferred financing costs
                  
                  
                  364
                  
                  
                  
                  224Bad
      debt (recoveries) expense
                  
                  
                  (471
                  )
                  
                  
                  1,293Deferred
      income tax (benefit) expense
                  
                  
                  (1,118
                  )
                  
                  
                  1,213Changes
      in assets and liabilities, net of business combinationsAccounts
      and unbilled receivables
                  
                  
                  4,272
                  
                  
                  
                  (3,705
                  )Prepaid
      expenses and other current assets
                  
                  
                  (1,907
                  )
                  
                  
                  (462
                  )Income
      taxes receivable
                  
                  
                  83
                  
                  
                  
                  —Other
      long-term assets
                  
                  
                  (903
                  )
                  
                  
                  (2,659
                  )Accounts
      payable
                  
                  
                  336
                  
                  
                  
                  584Accrued
      compensation and other accrued liabilities
                  
                  
                  180
                  
                  
                  
                  (2,424
                  )Commissions
      payable
                  
                  
                  149
                  
                  
                  
                  (64
                  )Deferred
      revenue
                  
                  
                  5,433
                  
                  
                  
                  1,919Other
      liabilities
                  
                  
                  (34
                  )
                  
                  
                  8Net
      cash provided by operating activities
                  
                  
                  22,513
                  
                  
                  
                  25,094Cash
      flows from investing activitiesCapitalized
      software and purchases of property, plant and equipment
                  
                  
                  (10,923
                  )
                  
                  
                  (16,609
                  )Purchase
      of available-for-sale securities
                  
                  
                  (4,765
                  )
                  
                  
                  (25,195
                  )Sale
      of available-for-sale securities
                  
                  
                  2,572
                  
                  
                  
                  57,931Sale
      of trading securities
                  
                  
                  1,650
                  
                  
                  
                  —Acquisitions
      and joint ventures, net of cash acquired
                  
                  
                  (4,795
                  )
                  
                  
                  (29,747
                  )Net
      cash released from escrow for acquisitions
                  
                  
                  —
                  
                  
                  
                  (80
                  )Net
      cash used in investing activities
                  
                  
                  (16,261
                  )
                  
                  
                  (13,700
                  )Cash
      flows from financing activitiesRepayments
      of notes payable
                  
                  
                  (73
                  )
                  
                  
                  (33
                  )Proceeds
      from common stock issued through Employee Stock Purchase
    Plan
                  
                  
                  244
                  
                  
                  
                  255Repurchase
      of common stock
                  
                  
                  —
                  
                  
                  
                  (29,842
                  )Excess
      tax benefits from share-based payment arrangements
                  
                  
                  —
                  
                  
                  
                  192Net
      proceeds from option exercises
                  
                  
                  70
                  
                  
                  
                  366Repayment
      of capital lease obligations
                  
                  
                  (237
                  )
                  
                  
                  (174
                  )Net
      cash provided by (used in) financing activities
                  
                  
                  4
                  
                  
                  
                  (29,236
                  )Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  226
                  
                  
                  
                  (692
                  )Net
      increase (decrease) in cash and cash equivalents
                  
                  
                  6,482
                  
                  
                  
                  (18,534
                  )Cash
      and cash equivalents at beginning of period
                  
                  
                  21,742
                  
                  
                  
                  38,032Cash
      and cash equivalents at end of period
                  
                  $
                  28,224
                  
                  
                  $
                  19,498Supplemental
      disclosures of cash flow informationCash
      paid during the period for:Interest
      expense
                  
                  $
                  190
                  
                  
                  $
                  138Income
      taxes
                  
                  $
                  4,634
                  
                  
                  $
                  2,987Non-cash
      investing and financing activitiesCapital
      Leases
                  
                  $
                  513
                  
                  
                  $
                  260Common
      stock issuance for earn out
                  
                  $
                  1,050
                  
                  
                  $
                  1,050




See
notes to consolidated financial statements





6




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements - Unaudited


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





1.
Organization





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





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





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





2.
Summary of Significant Accounting Policies




In June
2009, the FASB issued ASU 2009-01, Amendments based on Statement of
Financial Accounting Standards No. 168—TheFASB Accounting Standards
CodificationTM and the
Hierarchy of Generally Accepted Accounting Principles, to codify in ASC
105, Generally Accepted
Accounting Principles, FASB Statement 168, TheFASB Accounting Standards
CodificationTM and the
Hierarchy of Generally Accepted Accounting Principles, which was issued
to establish the Codification as the sole source of authoritative U.S. GAAP
recognized by the FASB, excluding SEC guidance, to be applied by nongovernmental
entities. The guidance in ASC 105 is effective for financial statements issued
for interim and annual periods ending after September 15, 2009. The Company
has revised its references to pre-Codification GAAP and noted no impact on the
financial condition or results of operations of the
Company.


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





Principles
of Consolidation





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





Use
of Estimates





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





7




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Reclassifications





Certain
reclassifications have been made to the prior period consolidated financial
statements to conform to the current period
presentation.  Reclassifications to the December 31, 2008 consolidated
balance sheet include a transfer of $7,185 relating to software in development
from property and equipment to software.  Reclassifications to the
September 30, 2008 consolidated statement of cash flows include a transfer of
$1,147 from accounts and unbilled receivables to bad debt expense.





Fair
Value of Financial Instruments





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





Concentration
of Credit Risk





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





Cash
and Cash Equivalents





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





Cash and
cash equivalents in foreign denominated currencies which are held in foreign
banks at September 30, 2009 and December 31, 2008 totaled $7,776 and $6,935,
respectively, and represented 27.6% and 31.9%, respectively, of our total cash
and cash equivalents balance at the end of each period.





Foreign
Currency Translation





The
financial position and operating results of the Company’s foreign operations are
consolidated using the local currency as the functional currency. Local currency
assets and liabilities are translated at the rate of exchange to the U.S. dollar
on the balance sheet date, and the local currency revenues and expenses are
translated at average rates of exchange to the U.S. dollar during the period.
The related translation adjustments are reported in the shareholders’ equity
section of the consolidated balance sheet and resulted in a net reduction in
shareholders’ equity of $604 and $3,861 for the periods ended September 30, 2009
and December 31, 2008, respectively.  The foreign currency translation
adjustment is not adjusted for income taxes as it relates to an indefinite
investment in a non-U.S. subsidiary.





Comprehensive
income (loss)





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




8




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Software
Developed for Internal Use





In
accordance with Financial Accounting Standards Board Accounting Standards
Classification (“FASB ASC”) 605, Revenue Recognition-Multiple Element
Arrangements, the Company applies FASB ASC 350, Intangibles-Goodwill and Other,
Internal-Use Software.  The costs incurred in the preliminary
stages of development are expensed as incurred. Once an application has reached
the development stage, internal and external costs, if direct and incremental,
are capitalized until the software is substantially complete and ready for its
intended use. Capitalization ceases upon completion of all substantial testing.
The Company also capitalizes costs related to specific upgrades and enhancements
when it is probable the expenditures will result in additional
functionality.  Maintenance and training costs are expensed as
incurred. Internal use software is amortized on a straight-line basis over its
estimated useful life, generally three years.  Management evaluates
the useful lives of these assets on an annual basis and tests for impairments
whenever events or changes in circumstances occur that could impact the
recoverability of these assets. There were no impairments to internal software
in any of the periods covered in these consolidated financial
statements.





The
Company capitalized internal-use software costs for the nine month period of
September 30, 2009 and the year ended December 31, 2008 of $7,335 and
$8,137, respectively. Amortization of capitalized internal-use software costs
for the nine months ended September 30, 2009 and 2008 was $1,882 and $951,
respectively.





Investments





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





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





Investment
income





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





Three months ended
                        September 30, 2009
                      
                      
                      Nine months ended
                        September 30, 2009Gain
      (loss) on auction rate securities and put option, net
                      
                      $
                      102
                      
                      
                      $
                      (10
                      )Other
      income
                      
                      
                      —
                      
                      
                      
                      64Investment
      income, net
                      
                      $
                      102
                      
                      
                      $
                      54





9




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Prepaid
Expenses and Other Current Assets





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





Other
Long-Term Assets





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





September 30,2009
                    
                    
                    December 31,
                      2008Acquisition
      related escrow balances (1)
                    
                    $
                    1,440
                    
                    
                    $
                    1,440Security
      deposits
                    
                    
                    1,703
                    
                    
                    
                    1,966Deferred
      implementation costs
                    
                    
                    5,347
                    
                    
                    
                    3,314Fair
      value of put option (“UBS Settlement Agreement”)
                    
                    
                    —
                    
                    
                    
                    2,219Other
      long-term assets
                    
                    
                    1,345
                    
                    
                    
                    985Total
      other long-term assets
                    
                    $
                    9,835
                    
                    
                    $
                    9,924





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




Self-Insurance





The
Company is self-insured for the majority of its health insurance costs,
including claims filed and claims incurred but not reported subject to certain
stop loss provisions. The Company estimated the liability based upon
management's judgment and historical experience. At September 30, 2009 and
December 31, 2008, self-insurance accruals totaled $510 and $560,
respectively.  Management continuously reviews the adequacy of the
Company's stop loss insurance coverage. Material differences may result in the
amount and timing of health insurance expense if actual experience differs
significantly from management's estimates.




10





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Goodwill





Since
2002, the Company has recorded goodwill in accordance with the provisions of
FASB ASC, 350, Intangibles-Goodwill and Other,which discontinued the amortization of existing goodwill and instead
requires the Company to annually review the carrying value of goodwill for
impairment. Prior to 2007, the Company evaluated the carrying value of its
goodwill under two reporting units within its single segment.  During
2007, the Company combined those two reporting units into a single reporting
unit to be in alignment with its organizational and management structure which
was evaluated and restructured as part of the integration of our acquired
businesses.  As a result of the change, the Company now evaluates
goodwill at the enterprise or Company level.




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




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





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





Balance
      as of December 31, 2007
                      
                      $
                      173,502Acquisitions
      or adjustments:ScottWorks
                      
                      
                      85Webhire
                      
                      
                      311Knowledge
      Workers
                      
                      
                      100Gantz
      Wiley Research
                      
                      
                      398BrassRing
                      
                      
                      (121
                      )Psychometrics
      Services Ltd.
                      
                      
                      3,383StraightSource
                      
                      
                      6,051HRC
      Human Resources Consulting GmbH
                      
                      
                      330Quorum
      (2008 acquisition)
                      
                      
                      15,338Impairment
      charge
                      
                      
                      (167,011
                      )Balance
      as of December 31, 2008
                      
                      $
                      32,366Acquisitions
      or adjustments:StraightSource
                      
                      
                      125HRC
      Human Resources Consulting GmbH
                      
                      
                      195Quorum
                      
                      
                      957Impairment
      charge
                      
                      
                      (33,329
                      )Balance
      as of September 30, 2009
                      
                      $
                      314





11





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Revenue
Recognition





The
Company derives its revenue from two sources: (1) subscription revenue for
solutions, which is comprised of subscription fees from customers accessing the
Company’s on-demand software, consulting services, outsourcing services and
proprietary content, and from customers purchasing additional support beyond the
standard support that is included in the basic subscription fee; and
(2) other fees for discrete professional services. Because the Company
provides its solution as a service, the Company follows the provisions of FASB
ASC 605, Revenue
Recognition-Multiple Element Arrangements.The Company recognizes revenue
when all of the following conditions are met:





•
                    There
      is persuasive evidence of an
arrangement;
 
 •
                    The
      service has been provided to the
customer;
 
 •
                    The
      collection of the fees is probable;
and
 
 •
                    The
      amount of fees to be paid by the customer is fixed or
      determinable.





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





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





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





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





The
Company records expenses billed to customers in accordance with FASB ASC,
605Revenue
Recognition-Principal Agent Considerations, which requires that
reimbursements received for out-of-pocket expenses be classified as revenues and
not as cost reductions.  These items primarily include travel, meals
and certain telecommunication costs. For the three and nine months ended
September 30, 2009 and 2008 reimbursed expenses totaled $526 and $1,593 and
$1,343 and $3,464, respectively.





Guarantees





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




12




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Earnings
(Loss) Per Share





The
Company follows FASB ASC 260, Earnings Per Share,which
requires companies that are publicly held or have complex capital structures to
present basic and diluted earnings per share on the face of the statement of
operations.  Earnings (loss) per share is based on the weighted
average number of shares and common stock equivalents outstanding during the
period.  In the calculation of diluted earnings per share, shares
outstanding are adjusted to assume conversion of the Company's non-interest
bearing convertible stock and the exercise of options if they are
dilutive.  In the calculation of basic earnings per share, weighted
average numbers of shares outstanding are used as the
denominator.  The common stock equivalents of stock options issued and
outstanding were not included in the computation of diluted earnings per share
for the period then ended as they were antidilutive and are presented in the
table below.





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





Three months ended
                    September 30,
                  
                  
                  Nine months ended
                    September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Numerator:Net
      income (loss)
                  
                  $
                  1,598
                  
                  
                  $
                  5,424
                  
                  
                  $
                  (31,373
                  )
                  
                  $
                  16,163Denominator:Weighted
      average shares used to compute net income (loss) per common share -
      basic
                  
                  
                  22,539,717
                  
                  
                  
                  22,551,225
                  
                  
                  
                  22,525,144
                  
                  
                  
                  22,852,499Effect
      of dilutive stock options
                  
                  
                  381,218
                  
                  
                  
                  237,243
                  
                  
                  
                  —
                  
                  
                  
                  232,025Weighted
      average shares used to compute net income (loss) per common share –
      dilutive
                  
                  
                  22,920,935
                  
                  
                  
                  22,788,468
                  
                  
                  
                  22,525,144
                  
                  
                  
                  23,084,524Basic
      net income (loss) per share
                  
                  $
                  0.07
                  
                  
                  $
                  0.24
                  
                  
                  $
                  (1.39
                  )
                  
                  $
                  0.71Diluted
      net income (loss) per share
                  
                  $
                  0.07
                  
                  
                  $
                  0.24
                  
                  
                  $
                  (1.39
                  )
                  
                  $
                  0.70Total
      antidilutive stock options issued and outstanding
                  
                  
                  1,894,956
                  
                  
                  
                  764,400
                  
                  
                  
                  1,966,056
                  
                  
                  
                  764,400





13




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





Share-based
Compensation Expense





On
January 1, 2006, the Company adopted FASB ASC 718, Compensation-Stock
Compensation using the Modified Prospective Approach (“MPA”). The
MPA requires that compensation expense be recorded for restricted stock and all
unvested stock options as of January 1, 2006.  Following the adoption
the Company recognized the cost of previously granted share-based awards under
the straight-line basis over the remaining vesting period.  The
compensation expense for new share-based awards with a service condition that
cliff vest, is recognized on a straight-line basis over the award’s requisite
service period.  For those awards with a service condition that have
graded vesting, compensation expense is calculated using the graded-vesting
attribution method.   This method entails recognizing expense on
a straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.  In
accordance with FASB ASC 18, the pool of excess tax benefits available to absorb
tax deficiencies was determined using the alternative transition
method.





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





Adoption
of new accounting pronouncements




In May
2009, the FASB issued ASC 855, “Subsequent Events”. ASC 855
is intended to establish general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. It requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for
selecting that date, that is, whether that date represents the date the
financial statements were issued or were available to be issued. ASC 855 is
effective for interim or annual financial periods ending after September 15,
2009. The Company has evaluated ASC 855 and has determined that it will not have
a significant impact on the determination or reporting of our financial results
for the period ended September 30, 2009.
 
 In April
2009, the FASB issued ASC 805 “Business Combinations,” which amends ASC 805 by
establishing a model to account for certain pre-acquisition contingencies. Under
ASC 805, an acquirer is required to recognize at fair value an asset acquired or
a liability assumed in a business combination that arises from a contingency if
the acquisition-date fair value of that asset or liability can be determined
during the measurement period. If the acquisition-date fair value cannot be
determined, then the acquirer should follow the recognition criteria in ASC 450,
“Contingencies”. In the
first quarter of 2009, we adopted ASC 805 and will apply its provisions when
applicable.


In
September 2006, the FASB issued FASB ASC 820, Fair Value Measurements and Disclosureswhich
defines fair value, establishes a framework for measuring fair value, and also
expands disclosures about fair value measurements. FASB ASC 820 is
effective for periods beginning after November 15, 2007. The Company
adopted this standard with respect to its financial assets effective
January 1, 2008. In February 2008, the FASB amended certain provisions of
ASC 820 delaying its effective date for one year for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually). See
Footnote 3 of the Notes to the Consolidated Financial Statements for further
detail regarding the impact of our adoption of ASC 820 for financial
assets.





In
February 2007, the FASB issued FASB ASC 825, FinancialInstrumentswhich permits
the Company to choose to measure many financial instruments and certain other
items at fair value. The Company adopted ASC 825 as of January 1, 2008. The
adoption did not impact the Company’s consolidated financial statements on the
date of adoption.  However, during the fourth quarter of 2008, the
Company elected to measure at fair value the put option related to its UBS
Settlement Agreement.


14




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





2.
Summary of Significant Accounting Policies (Continued)





New
Accounting Pronouncements





In
October 2009, the FASB issued Accounting Standards Update (“ASU”)
No. 2009-13, Revenue
Recognition: Multiple-Deliverable Revenue Arrangements—a consensus of the FASB
Emerging Issues Task Force, which eliminates the use of the residual
method for allocating consideration, as well as the criteria that requires
objective and reliable evidence of fair value of undelivered elements in order
to separate the elements in amultiple-element
arrangement. By removing the criterion requiring the use of objective and
reliable evidence of fair value in separately accounting for deliverables, the
recognition of revenue will more closely align with certain revenue
arrangements. The standard also will replace the term "fair value" in the
revenue allocation guidance with "selling price" to clarify that the allocation
of revenue is based on entity-specific assumptions rather than assumptions of a
marketplace participant. ASU No. 2009-13 is effective for revenue
arrangements entered or materially modified in fiscal years beginning on or
after June 15, 2010, however companies may adopt as early as interim
periods ended September 30, 2009. The Company is currently assessing the
potential impact of this standard, but does not expect the adoption of the
standard will have a material impact on the financial condition or results of
operations of the Company.





In June
2009, the FASB issued new accounting guidance for variable interest entities.
The new guidance includes: (1) the elimination of the exemption from
consolidation for qualifying special purpose entities, (2) a new approach for
determining the primary beneficiary of a variable interest entity (“VIE”), which
requires that the primary beneficiary have both (i) the power to control the
most significant activities of the VIE and (ii) either the obligation to absorb
losses or the right to receive benefits that could potentially be significant to
the VIE, and (3) the requirement to continually reassess who should consolidate
a VIE. The new guidance is effective for annual reporting periods that begin
after November 15, 2009 and applies to all existing and new VIEs. The Company is
currently evaluating the impact of adopting this new guidance.








15





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





3.  Investments





Short-term
investments as of September 30, 2009 and December 31, 2008 consisted of the
following securities:





September 30,2009
                        
                        
                        December 31,
                          2008Municipal
      securities
                        
                        $
                        6,638
                        
                        
                        $
                        4,512Auction
      rate securities
                        
                        
                        15,362
                        
                        
                        
                        —Total
      short-term investments
                        
                        $
                        22,000
                        
                        
                        $
                        4,512





During
the nine months ended September 30, 2009, the Company continued to experience
failed auctions for thirteen tax exempt auction rate securities (“ARS”) issues
representing principal of $15,362.  Nine of these ARS are guaranteed by the
Family Federal Educational Loan Program with the remainder being insured by
private issuers. Due to the ability to liquidate its ARS issues, in accordance
with the arrangement discussed below, within the next twelve months, the Company
has reclassified these investments to short-term assets as of September 30,
2009.  These securities will continue to accrue interest at the contractual
rate and will be auctioned at preset intervals.




As of
September 30, 2009 the ARS, which were acquired through UBS AG, had a par value
of $16,925. Due to the failure of the auction rate market in early 2008, UBS AG
and other major banks entered into discussions with government agencies to
provide liquidity to owners of auction rate securities. In November 2008, the
Company entered into an agreement (the “UBS Settlement Agreement”) with UBS AG
which provides (1) the Company with a “no net cost” loan up to the par value of
Eligible ARS until June 30, 2010, and  (2) the Company the right to
sell these auction rate securities back to UBS AG at par, at the Company’s sole
discretion, any time during the period from June 30, 2010 through
July 2, 2012, and (3) UBS AG the right to purchase these auction rate
securities or sell them on the Company’s behalf at par anytime through
July 2, 2012.  As a result of the execution of the UBS Settlement
Agreement, the Company determined that it no longer had the intent and ability
to hold the ARS until maturity or until the ARS market would recover. 
Based on this unusual circumstance related to the signing of the UBS Settlement
Agreement, the Company transferred these investments from available–for-sale to
trading securities and began recording the change in fair value of the ARS as
gains or losses in current period operations.




Also,
during the fourth quarter of 2008, the Company elected to measure the value of
its option to put the securities (“put option”) to UBS AG under the fair value
option of FASB ASC 825, Financial
Instruments.   As a result, at December 31, 2008, the Company
recorded a non-operating gain representing the estimated fair value of the put
option and a corresponding long-term asset of approximately $2,219.  At
September 30, 2009, the put option’s estimated fair value increased to $1,553,
resulting in a non-operating gain of $109 during the quarter.  The
estimated fair value of the put option as of September 30, 2009 was based in
part on an expected life of twelve months and a discount rate of 1.73%.  As
a result of the transfer of the ARS from available-for-sale to trading
investment securities noted above, the Company also recorded a non-operating
loss during the three months ended September 30, 2009 of approximately $7 and
also recorded a non-operating gain during the nine months ended September 30,
2009 representing an increase in the estimated fair value of ARS of
approximately $656.   The recording of the loss relating to the
decrease in the fair value of the ARS and the recognition of the gain on the put
option resulted in an overall net gain of approximately $102 for the three
months ended September 30, 2009 and a net loss of approximately $9 for the nine
months ended September 30, 2009.




The
Company adjusted the fair value of its ARS investment portfolio using a
discounted cash flow model to determine the estimated fair value of its ARS
investments as of September 30, 2009.  The assumptions used in preparing
the discounted cash flow model include level three inputs, as defined in FASB
ASC 820, Fair Value
Measurements and Disclosure, and are presented in the following
table:





AmountsMaximum
      auction rate (interest rate)
                  
                  
                  1.48
                  %Liquidity
      risk premium
                  
                  
                  5.00
                  %Probability
      of earned maximum rate until maturity
                  
                  
                  0.18
                  %Probability
      of default
                  
                  
                  21.14
                  %





Based on
the results of the discounted cash flow analysis, the Company determined that
the fair value of its investment in its ARS should be discounted from par value
by approximately $1,563 to $15,362 at September 30, 2009.




16




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





3.  Investments (Continued)





The
Company has investments that are valued in accordance with the provisions of
FASB ASC 820, Fair Value
Measurements and Disclosure. Under this standard, fair value is defined
as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.  FASB ASC 820, Fair Value Measurements and
Disclosure establishes a hierarchy for inputs used in measuring fair
value that maximizes the use of observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when
available. The hierarchy is broken down into three levels based on the
reliability of inputs as follows:





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





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





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




The
estimated fair value of the Company’s municipal investments on September 30,
2009 and December 31, 2008 of $6,638 and $4,512, respectively, was determined
based upon quoted prices in active markets for identical assets or Level 1
inputs.  The estimated fair value of the Company’s auction rate
securities on September 30, 2009 and December 31, 2008 of $15,362 and $16,513,
respectively, was determined based upon significant unobservable inputs or Level
3 inputs.





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





Auction ratesecuritiesBalance at
      December 31, 2008
                    
                    $
                    16,513Total
      net realized gainsIncluded
      in earnings
                    
                    
                    656Settlements
                    
                    
                    (1,807
                    )Balance
      at September 30, 2009
                    
                    $
                    15,362





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





Auction ratesecuritiesBalance at
      December 31, 2007
                      
                      $
                      29,900Total
      net realized lossesIncluded
      in earnings
                      
                      
                      816Included
      in accumulated other comprehensive loss
                      
                      
                      (1,293
                      )Settlements
                      
                      
                      (11,603
                      )Balance
      at September 30, 2008
                      
                      $
                      17,820





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




17




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





4.
Acquisitions





Quorum
International Holdings Limited





On April
2, 2008, the Company acquired all of the outstanding stock of Quorum
International Holdings Limited (“Quorum”), a provider of recruitment process
outsourcing services based in London, England, for a purchase price of
approximately $27,950, in cash, of which $19,753 was paid in April 2008 and
$8,197 was paid in July 2008.  The total cost of the acquisition,
including legal, accounting, and other fees of $1,050, was approximately
$29,000, including acquired intangibles of $8,633, with estimated useful lives
between 3 and 10 years.  In addition, the acquisition agreement
contains an earn out provision which provides for the payment of additional
consideration by the Company based upon the gross profit of Quorum for the
twelve month periods ending June 30, 2009 and June 30, 2010. 
Formulaically, the earnout is 3.86 times Quorum’s gross profit less the amount
of base consideration, as defined in the agreement.  Pursuant to FASB ASC
805, Business
Combinations, the Company accrues contingent purchase consideration when
the outcome of the contingency is determinable beyond a reasonable
doubt.  Based upon the results for the twelve month period through
June 30, 2009, it was determined that no earnout payment was due to the former
shareholders of Quorum for the June 2009 payment.  In addition, as of
September 30, 2009, the June 30, 2010 earnout amount was substantially
uncertain, and, as such, the estimated earn out range is not possible to
disclose.  The Company evaluates the earnout provisions contained in
the acquisition agreement at each financial statement reporting date.  In
connection with the acquisition, $780 of the purchase price was deposited into
an escrow account and recorded in other long-term assets, to cover any claims
for indemnification made by the Company against Quorum under the acquisition
agreement.  The escrow agreement will remain in place for
approximately two years from the acquisition date, and any funds remaining in
the escrow account at the end of the two year period will be distributed to the
former stockholders of Quorum.  The Company expects that the
acquisition of Quorum will broaden our presence in the global recruitment
market.  The purchase price and related purchase price allocations
have been allocated to the assets acquired and liabilities assumed based upon
management’s best estimate of fair value with any excess over the net tangible
and intangible assets acquired allocated to goodwill.  Quorum’s
results of operations were included in the Company’s consolidated financial
statements beginning on April 2, 2008.





18




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





5.
Joint Venture Agreement





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





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





Under the
terms of the Joint Venture agreement the Company has the right to acquire R and
J’s remaining interest in the Joint Venture at any time after the earlier of the
termination of the general manager’s employment by the Joint Venture or during
the first three months of any calendar year beginning on or after January 1,
2013.  The purchase price for the remaining ownership interest is
based upon the outstanding ownership interest multiplied by the sum of the
amount of free cash flow plus four and one half times the Adjusted EBITDA, as
defined.  R and J may also require the Company to purchase its
interest in the Joint Venture at any time after the earlier of the Company’s
acquisition of more than fifty percent of the Joint Venture or January 1,
2011.





In
accordance ASC 810, “Variable Interest
Entities,” the Joint
Venture qualified for consolidation as the Joint Venture was determined to be a
variable interest entity and the Company as its primary
beneficiary.  The equity interests of R and J not owned by the Company
are reported as a non-controlling interest in the Company’s September 30, 2009
balance sheet.





The
determination of the primary beneficiary was based, in part, upon a qualitative
assessment which included the Company’s commitment to finance the Joint
Venture’s operations, the level of involvement in the Joint Venture’s
operations, the use of the Company’s brand by the Joint Venture, and
the lack of equity “at risk” by R and J given its put option.  The Joint
Venture is consolidated with the Company’s subsidiaries because of the
Company’s commitment to provide required financing and as well as its
significant involvement in the day-to-day operations.  All inter-company
transactions are eliminated (see Note 2 – Summary of Significant Accounting
Policies.)





The Joint
Venture was financed with $307 in initial equity contributions from the Company
and R and J, and has no borrowings for which its assets would be used as
collateral.  On
September 30, 2009 the Company provided $160 of financing for the Joint
Venture.The creditors of the Joint Venture do not have recourse to
other assets of the Company.





19




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements – Unaudited (Continued)


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





6.
Property, Plant, Equipment and Software





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





September 30, 2009
                      
                      
                      December 31, 2008Equipment
                      
                      $
                      16,708
                      
                      
                      $
                      15,112Purchased
      Software
                      
                      
                      5,690
                      
                      
                      
                      5,099Software
      in development
                      
                      
                      4,226
                      
                      
                      
                      7,185Software
      developed
                      
                      
                      18,904
                      
                      
                      
                      8,900Office
      furniture and fixtures
                      
                      
                      2,426
                      
                      
                      
                      2,370Leasehold
      improvements
                      
                      
                      2,724
                      
                      
                      
                      2,744Land
                      
                      
                      640
                      
                      
                      
                      643Building
                      
                      
                      7,434
                      
                      
                      
                      6,77158,752
                      
                      
                      
                      48,824Less
      accumulated depreciation and amortization
                      
                      
                      23,127
                      
                      
                      
                      17,624$
                      35,625
                      
                      
                      $
                      31,200





Depreciation
and amortization expense is excluded from cost of revenues.





Equipment
and office furniture and fixtures included assets under capital leases totaling
$2,714 and $2,612 at September 30, 2009 and December 31, 2008, respectively.
Depreciation and amortization expense, including amortization of assets under
capital leases, was $6,902 and $4,945 for the nine months ended September 30,
2009 and 2008, respectively.




Pursuant
to FASB ASC 360, Property
Plant and Equipment, the Company reviewed its fixed assets and determined
that the fair value exceeded the carrying value, and therefore did not record
any fixed asset impairment.





7.
Other Accrued Liabilities





Other
accrued liabilities consist of the following:





September
      30, 2009
                        
                        
                        December
      31, 2008Accrued
      professional fees
                        
                        $
                        376
                        
                        
                        $
                        131Straight
      line rent accrual
                        
                        
                        2,144
                        
                        
                        
                        1,904Other
      taxes payable (non-income tax)
                        
                        
                        798
                        
                        
                        
                        450Income
      taxes payable
                        
                        
                        2,137
                        
                        
                        
                        3,549Other
      liabilities
                        
                        
                        694
                        
                        
                        
                        1,056Contingent
      purchase price
                        
                        
                        —
                        
                        
                        
                        3,000Total
      other accrued liabilities
                        
                        $
                        6,149
                        
                        
                        $
                        10,090




8.
Line of Credit





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





20





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





9.
Commitments and Contingencies





Litigation





On June
11, 2009 and July 16, 2009, two putative class actions were filed against the
Company and its Chief Executive Officer and Chief Financial Officer in the
United States District Court for the Eastern District of Pennsylvania,
purportedly on behalf of a class of the Company's investors who purchased the
Company's publicly traded securities between May 8, 2007 and November 7, 2007.
The complaint filed on July 16, 2009 has since been voluntarily dismissed. In
the pending action, the initial complaint generally alleged violations of
Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), Rule
10b-5 promulgated thereunder and Section 20(a) of the Exchange Act in connection
with various public statements made by the Company.  Pursuant to the
Private Securities Litigation Reform Act, any member of the purported class who
wished to be appointed "lead plaintiff" was required to file a motion seeking
such designation on or before August 10, 2009.  In accordance with the
Court's scheduling order, a hearing regarding the appointment of lead plaintiff
took place on September 9, 2009 and a lead plaintiff was appointed. Pursuant to
the court's amended scheduling order; the lead plaintiff filed an amended
complaint on October 26, 2009, and defendants will have until December 14, 2009
to file their motion to dismiss the complaint. The Company intends to vigorously
defend these actions. The potential impact of these actions, which seek
unspecified damages, attorneys fees and expenses, is uncertain.




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




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





10.
Equity





Rollforward
of Shares





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





Class A
                      Common SharesDecember
      31, 2007 ending balance
                    
                    
                    24,032,446Repurchase
      of common shares
                    
                    
                    (1,677,560
                    )Stock
      option exercises
                    
                    
                    67,021Employee
      stock purchase plan
                    
                    
                    27,141Shares
      issued for acquisition
                    
                    
                    55,876December
      31, 2008 ending balance
                    
                    
                    22,504,924Stock
      option exercises
                    
                    
                    14,747Employee
      stock purchase plan
                    
                    
                    34,015September
      30, 2009 ending balance
                    
                    
                    22,553,686





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





21




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





10.
Equity (continued)





Authorized
but not issued shares





On
February 20, 2008, the Company’s board of directors authorized a stock
repurchase plan providing for the repurchase of up to 3,000,000 shares of the
Company’s common stock, of which 1,125,651 shares were repurchased at an
aggregate cost of $20,429 as of December 31, 2008.  These shares were
restored to original status prior to December 31, 2008 and accordingly are
presented as authorized but not issued.  The timing, price and volume
of repurchases were based on market conditions, relevant securities laws and
other factors.  As of September 30, 2009, the amount of shares
available for repurchase under the stock repurchase plan was
1,874,349.  For the nine months ended September 30, 3009, there have
been no repurchases under the stock repurchase plan.




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





11.
Stock Plans





Stock
Option Plan





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





As of
September 30, 2009, there were options to purchase 3,164,107 shares of common
stock outstanding under the 2000 and 2005 Option Plans.  The Company
is authorized to issue up to an aggregate of 4,842,910 shares of its common
stock pursuant to stock options granted under the 2005 Option Plan.  As of
September 30, 2009, there was a total of 1,041,306 shares of common stock not
subject to outstanding options and available for issuance under the 2005 Option
Plan.  The Company grants stock options to recognize and reward those
individuals whose contributions have, or the Company expects will have, a
significant impact on its long-term performance.  Stock options
granted under both the 2000 and 2005 Option Plans generally expire between
the fifth and tenth anniversary of the date of grant and generally vest on the
third anniversary of the date of grant.  Unexercised stock options may
expire up to 90 days after an employee's termination for options granted
under the 2000 Option Plan.





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





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





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




22




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





11.
Stock Plans (continued)





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





Nine months ended
                      September 30, 2009
                      Service based awards
                    
                    
                    Year endedDecember 31, 2008
                      Service basedawards
                    
                    
                    Year endedDecember 31, 2008
                      Market basedawardsExpected
      volatility
                    
                    
                    63.56-69.38
                    %
                    
                    
                    56.23
      – 57.52
                    %
                    
                    
                    60.98
                    %Expected
      dividends
                    
                    
                    0
                    
                    
                    
                    0
                    
                    
                    
                    0Expected
      term (in years)
                    
                    
                    3-6.25
                    
                    
                    
                    3.75
                    
                    
                    
                    10Risk-free
      rate
                    
                    
                    1.36-3.09
                    %
                    
                    
                    1.87
      – 2.77
                    %
                    
                    
                    3.45
                    %




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





Options & Restricted Stock Outstanding
                          
                          
                          Options ExercisableSharesAvailable forGrant
                          
                          
                          Shares
                          
                          
                          Wtd. Avg.ExercisePrice
                          
                          
                          Shares
                          
                          
                          Wtd. Avg.ExercisePriceBalance
      at December 31, 2007
                          
                          
                          2,702,346
                          
                          
                          
                          1,601,035
                          
                          
                          $
                          21.18
                          
                          
                          
                          241,335
                          
                          
                          $
                          14.96Granted
      – options
                          
                          
                          (1,084,600
                          )
                          
                          
                          1,084,600
                          
                          
                          
                          11.87
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
      options and vested restricted stock
                          
                          
                          —
                          
                          
                          
                          (83,221
                          )
                          
                          
                          4.41
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
      or expired
                          
                          
                          114,760
                          
                          
                          
                          (114,760
                          )
                          
                          
                          29.28
                          
                          
                          
                          —
                          
                          
                          
                          —Balance
      at December 31, 2008
                          
                          
                          1,732,506
                          
                          
                          
                          2,487,654
                          
                          
                          $
                          17.33
                          
                          
                          
                          447,854
                          
                          
                          $
                          14.01Granted
      – options
                          
                          
                          (725,000
                          )
                          
                          
                          725,000
                          
                          
                          
                          5.88
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
                          
                          
                          —
                          
                          
                          
                          (14,747
                          )
                          
                          
                          4.72
                          
                          
                          
                          —
                          
                          
                          
                          —Forfeited
      or expired
                          
                          
                          33,800
                          
                          
                          
                          (33,800
                          )
                          
                          
                          22.24
                          
                          
                          
                          —
                          
                          
                          
                          —Balance
      at September 30, 2009
                          
                          
                          1,041,306
                          
                          
                          
                          3,164,107
                          
                          
                          $
                          14.72
                          
                          
                          
                          658,007
                          
                          
                          $
                          16.73





The total
intrinsic value of options outstanding, exercisable and exercised for and during
the nine months ended September 30, 2009 was $11,580, $820 and $116,
respectively.  The weighted average fair value for options granted
during the nine months ended September 30, 2009 and the year ended December 31,
2008 was $3.35 and $5.67, respectively.  The weighted average
remaining contractual term of options outstanding and exercisable at September
30, 2009 was 5.74 and 3.30 years, respectively.





Between
January 1, 2009 and September 30, 2009, the Company granted to certain
employees, officers and non-employee directors options to purchase an aggregate
of 725,000 shares of the Company's common stock at prevailing market prices
ranging from $4.74 to $13.38 per share.





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




23




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





11.
Stock Plans (continued)





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





Nonvested
      Shares
                    
                    Shares
                    
                    
                    Wtd. Avg.Grant
      DateFair ValueNonvested
      at December 31, 2007
                    
                    
                    1,359,700
                    
                    
                    $
                    10.73Granted
      - options
                    
                    
                    1,084,600
                    
                    
                    
                    5.67Vested
                    
                    
                    (293,000
                    )
                    
                    
                    8.98Forfeited
      or expired
                    
                    
                    (111,500
                    )
                    
                    
                    12.31Nonvested
      at December 31, 2008
                    
                    
                    2,039,800
                    
                    
                    $
                    8.24Granted
      - options
                    
                    
                    725,000
                    
                    
                    
                    3.35Vested
                    
                    
                    (237,000
                    )
                    
                    
                    8.59Forfeited
      or expired
                    
                    
                    (21,700
                    )
                    
                    
                    12.53Nonvested
      at September 30, 2009
                    
                    
                    2,506,100
                    
                    
                    $
                    6.46




In
accordance with FASB ASC 718, Compensation-Stock
Compensation  excess tax benefits, associated with the expense
recognized for financial reporting purposes, realized upon the exercise of stock
options are presented as a financing cash inflow rather than as a reduction of
income taxes paid in our consolidated statement of cash
flows.   In addition,  the Company classifies
share-based compensation within cost of revenues, sales and marketing, general
and administrative expenses and research and development corresponding to the
same line as the cash compensation paid to respective employees, officers and
non-employee directors.





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





Three months ended
                    September 30,
                  
                  
                  Nine months ended
                    September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Cost
      of revenue
                  
                  $
                  59
                  
                  
                  $
                  96
                  
                  
                  $
                  281
                  
                  
                  $
                  267Sales
      and marketing
                  
                  
                  286
                  
                  
                  
                  68
                  
                  
                  
                  838
                  
                  
                  
                  636General
      and administrative
                  
                  
                  902
                  
                  
                  
                  985
                  
                  
                  
                  2,595
                  
                  
                  
                  3,193Research
      and development
                  
                  
                  137
                  
                  
                  
                  107
                  
                  
                  
                  365
                  
                  
                  
                  333Pre-tax
      share-based compensation
                  
                  
                  1,384
                  
                  
                  
                  1,256
                  
                  
                  
                  4,079
                  
                  
                  
                  4,429Income
      tax benefit
                  
                  
                  355
                  
                  
                  
                  414
                  
                  
                  
                  1,084
                  
                  
                  
                  1,383Share-based
      compensation expense, net
                  
                  $
                  1,029
                  
                  
                  $
                  842
                  
                  
                  $
                  2,995
                  
                  
                  $
                  3,046




Employee
Stock Purchase Plan





The
Employee Stock Purchase Plan, which was approved in May 2006, enables
substantially all U.S. and foreign employees to purchase shares of our common
stock at a 5% discounted offering price off the closing market price of our
common stock on the NASDAQ National Market, LLC on the offering
date.  We have granted rights to purchase up to 500,000 shares of
common stock to our employees under the Plan. The Plan is not considered a
compensatory plan in accordance with FASB ASC 718, Compensation-Stock
Compensation and requires no compensation expense to be
recognized.  Shares of our common stock purchased under the employee
stock purchase plan were 34,015 and 27,141 for the periods ended September 30,
2009 and December 31, 2008, respectively.  As of September 30, 2009
the shares of common stock available to purchase under the employee stock
purchase plan were 428,692.





24




Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





12.  Related
Party Transactions





One of
the Company's Directors, Barry M. Abelson, is a partner in the law firm of
Pepper Hamilton LLP. This firm has represented the Company since 1997. For the
three and nine months ended September 30, 2009 and 2008, the Company paid Pepper
Hamilton LLP, $42, $231, $52 and $127, respectively, for general legal
matters.  The amounts payable to Pepper Hamilton as of September 30,
2009 and December 31, 2008 were $29 and $75, respectively.





13.  Income
Taxes





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





On
January 1, 2007, the Company adopted certain provisions under FASB ASC 740,
Income Taxes, which
clarifies the accounting for uncertain income tax positions recognized in
financial statements and requires the impact of a tax position to be recognized
in the financial statements if that position is more likely than not of being
sustained by the taxing authority.  We do not expect that the amount of
unrecognized tax benefits will significantly increase or decrease within the
next twelve months.  The Company’s policy is to recognize interest and
penalties on unrecognized tax benefits in the provision for income taxes in the
consolidated statements of operations.  Tax years beginning in 2006
are subject to examination by taxing authorities, although net operating loss
and credit carry forwards from all years are subject to examinations and
adjustments for at least three years following the year in which the attributes
are used.





Given the
continued deterioration in the economy, the declining operating margins and the
difficulty in forecasting the Company’s ability to utilize existing tax
benefits, the Company did not record a deferred tax benefit associated with the
loss in the U.S. for the nine months ended September 30,
2009.  Rather, the Company recorded a partial valuation allowance as
management determined, based on the weight of available evidence, it is more
likely than not that some or all of the deferred tax asset will not be
realized.




25





Kenexa
Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Continued)


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





14.
Geographic Information





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





For
      the three months ended September 30,
                          
                          
                          For
      the nine months ended September 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Country
                          
                          Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent
      of
                            RevenuesUnited
      States
                          
                          
                          30,918
                          
                          
                          
                          76.7
                          %
                          
                          
                          38,780
                          
                          
                          
                          71.8
                          %
                          
                          
                          94,343
                          
                          
                          
                          79.5
                          %
                          
                          
                          118,490
                          
                          
                          
                          74.7
                          %United
      Kingdom
                          
                          
                          2,912
                          
                          
                          
                          7.2
                          %
                          
                          
                          4,183
                          
                          
                          
                          7.7
                          %
                          
                          
                          8,287
                          
                          
                          
                          7.0
                          %
                          
                          
                          14,184
                          
                          
                          
                          8.9
                          %Germany
                          
                          
                          1,363
                          
                          
                          
                          3.4
                          %
                          
                          
                          3,013
                          
                          
                          
                          5.6
                          %
                          
                          
                          3,261
                          
                          
                          
                          2.7
                          %
                          
                          
                          7,666
                          
                          
                          
                          4.8
                          %The
      Netherlands
                          
                          
                          425
                          
                          
                          
                          1.1
                          %
                          
                          
                          1,404
                          
                          
                          
                          2.6
                          %
                          
                          
                          1,314
                          
                          
                          
                          1.1
                          %
                          
                          
                          2,663
                          
                          
                          
                          1.7
                          %Other
      European Countries
                          
                          
                          1,774
                          
                          
                          
                          4.4
                          %
                          
                          
                          3,501
                          
                          
                          
                          6.5
                          %
                          
                          
                          5,428
                          
                          
                          
                          4.6
                          %
                          
                          
                          7,950
                          
                          
                          
                          5.0
                          %Canada
                          
                          
                          1,085
                          
                          
                          
                          2.7
                          %
                          
                          
                          982
                          
                          
                          
                          1.8
                          %
                          
                          
                          1,815
                          
                          
                          
                          1.5
                          %
                          
                          
                          2,638
                          
                          
                          
                          1.7
                          %Other
                          
                          
                          1,837
                          
                          
                          
                          4.6
                          %
                          
                          
                          2,163
                          
                          
                          
                          4.0
                          %
                          
                          
                          4,162
                          
                          
                          
                          3.5
                          %
                          
                          
                          5,083
                          
                          
                          
                          3.2
                          %Total
                          
                          
                          40,314
                          
                          
                          
                          100.0
                          %
                          
                          
                          54,026
                          
                          
                          
                          100.0
                          %
                          
                          
                          118,610
                          
                          
                          
                          100.0
                          %
                          
                          
                          158,674
                          
                          
                          
                          100.0
                          %




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





September
      30, 2009
                            
                            
                            December
      31, 2008Country
                            
                            Assets
                            
                            
                            Assets
      as apercentage oftotal assets
                            
                            
                            Assets
                            
                            
                            Assets
      as apercentage oftotal assetsUnited
      States
                            
                            $
                            153,049
                            
                            
                            
                            79.0
                            %
                            
                            $
                            172,272
                            
                            
                            
                            78.9
                            %United
      Kingdom
                            
                            
                            14,363
                            
                            
                            
                            7.4
                            %
                            
                            
                            22,381
                            
                            
                            
                            10.2
                            %India
                            
                            
                            10,968
                            
                            
                            
                            5.7
                            %
                            
                            
                            9,099
                            
                            
                            
                            4.1
                            %Germany
                            
                            
                            5,461
                            
                            
                            
                            2.8
                            %
                            
                            
                            6,911
                            
                            
                            
                            3.2
                            %Canada
                            
                            
                            3,322
                            
                            
                            
                            1.7
                            %
                            
                            
                            3,004
                            
                            
                            
                            1.4
                            %Ireland
                            
                            
                            2,343
                            
                            
                            
                            1.2
                            %
                            
                            
                            1,133
                            
                            
                            
                            0.5
                            %Other
                            
                            
                            4,323
                            
                            
                            
                            2.2
                            %
                            
                            
                            3,665
                            
                            
                            
                            1.7
                            %Total
                            
                            $
                            193,829
                            
                            
                            
                            100.0
                            %
                            
                            $
                            218,465
                            
                            
                            
                            100.0
                            %




15.
Subsequent Events





The
Company has evaluated all subsequent events through November 9, 2009, which
represents the filing date of this Form 10-Q with the Securities and Exchange
Commission, to ensure that this Form 10-Q includes appropriate disclosure of
events both recognized in the financial statements as of September 30, 2009, and
events which occurred subsequent to September 30, 2009, but were not recognized
in the financial statements. As of November 9, 2009, there were no subsequent
events which required recognition or disclosure.




26




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





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





1.
Overview





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





Since
1999, we have focused on providing talent acquisition and employee performance
management solutions on a subscription basis and currently generate a
significant portion of our revenue from these subscriptions. For the nine months
ended September 30, 2009 and 2008, revenue from these subscriptions comprised
approximately 84.8% and 79.3%, respectively, of our total revenue. We generate
the remainder of our revenue from discrete professional services that are not
provided as part of an integrated solution on a subscription basis. These
subscription-based solutions provide us with a recurring revenue stream and we
believe represent a more compelling opportunity in terms of growth and
profitability than discrete professional services. Since 2005, subscription
revenue has represented approximately 80% of our total revenue; we expect that
trend to continue.





We sell
our solutions to large and medium-sized organizations through our direct sales
force. As of December 31, 2008, we had a customer base of approximately 4,400
companies, including approximately 180 companies on the Fortune 500 list
published in April 2008. Our customer base includes companies that we
billed for services during the year ended December 31, 2008 and does not
necessarily indicate an ongoing relationship with each such customer. Our top 80
customers contributed approximately $65.7 million, or 55.4%, of our total
revenue for the nine months ended September 30, 2009.





As of
September 2009, unemployment in the United States continued to increase and was
at a 20 year high of 9.8% while gross domestic product rose at a seasonally
annual adjusted rate of 3.4% during the third quarter of 2009.  The
extent or degree to which we may be affected by these events is extremely
difficult to predict.  The uncertain economic prospects being experienced
by our customers will likely translate into slower growth, or contraction, for
us, since a substantial portion of our business is dependent upon our customers’
hiring and human capital needs.  However, we believe that, by optimizing
our internal resources for the current business conditions, we can minimize
these adverse effects and emerge from this economic crisis with a return to our
historic operating margins.





27





Although
our compound annual growth of revenue for the three year period ending December
31, 2008 was 45.9% and our historic subscription renewal rate has been
approximately 90% each year, some of our customers, facing uncertainty and cost
pressures in their own businesses during the current economic downturn, have
indicated that they are delaying the purchase of our products and increasingly
seeking purchasing terms and conditions that are less favorable to us. As a
result of this trend, we experienced lower renewal rates during the second half
of fiscal 2008, resulting in a renewal rate by aggregate value of multi-year
subscriptions for the year ended December 31, 2008 of approximately 70% - 80%
and as a result we have experienced lower business levels for 2009.





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





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





2.
Recent Events





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





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





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





On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3.0 million shares of our common stock, of
which 1.1 million shares were repurchased at an aggregate cost of $20.4 million
as of December 31, 2008.  These shares were restored to original
status and accordingly are presented as authorized but not
issued.  The timing, price and volume of repurchases were based on
market conditions, relevant securities laws and other factors.  As of
September 30, 2009, the amount of shares available for repurchase under the
stock repurchase plan was 1.9 million.  For the nine months ended
September 30, 3009, there were no repurchases under the stock repurchase
plan.  In addition, in January 2008, we repurchased 0.5 million shares
under a previously authorized stock repurchase plan for an aggregate cost of
$9.8 million.


28





3.
Sources of Revenue




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




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





Consistent
with our historical practices, revenue derived from subscription fees is
recognized ratably over the term of the subscription agreement. We generally
invoice our customers in advance in monthly or quarterly installments and
typical payment terms provide that our customers pay us within 30 days of
invoice. Amounts that have been invoiced are recorded in accounts receivable
prior to the receipt of payment and in deferred revenue to the extent revenue
recognition criteria have not been met.  As of September 30, 2009,
deferred revenue increased by $5.6 million or 14.4% to $44.2 million from $38.6
million at December 31, 2008.  The increase in deferred revenue
is a result of the increase in sales of our multiple elements or bundled
arrangements.  We generally price our solutions based on the number of
software applications and services included and the number of customer
employees. Accordingly, subscription fees are generally greater for larger
organizations and for those that subscribe for a broader array of software
applications and services.





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





For the
quarter ended September 30, 2009, approximately 76.7% of our total revenue was
derived from sales in the United States. Revenue that we generated from
customers in the United Kingdom, Germany and Canada was approximately 7.2%,
3.4%, and 2.7%, respectively, for the quarter ended September 30, 2009. Revenue
for all other countries amounted to an aggregate of 10.0%. Other than the
countries listed, no other country represented more than 2.0% of our total
revenue for the quarter ended September 30, 2009.





4.
Key Performance Indicators




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





For the three months ended
                  September 30,
                
                
                For the nine months ended
                  September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008(unaudited)
                
                
                (unaudited)
                
                
                (unaudited)
                
                
                (unaudited)Total
      Revenue
                
                $
                40,314
                
                
                $
                54,026
                
                
                $
                118,610
                
                
                $
                158,674Subscription
      revenue as a percentage of total revenue
                
                
                82.4
                %
                
                
                79.6
                %
                
                
                84.8
                %
                
                
                79.3
                %Non-GAAP
      income from operations
                
                $
                4,310
                
                
                $
                10,307
                
                
                $
                12,611
                
                
                $
                30,276Net
      cash provided by operating activities
                
                $
                6,148
                
                
                $
                8,668
                
                
                $
                22,513
                
                
                $
                25,094


29




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





Non-GAAP income
from operations.Non-GAAP income from operations is derived
from income (loss) from operations adjusted for noncash or nonrecurring
expenses.  We believe that measuring our operations, using non-GAAP
income from operations provides more useful information to management and
investors regarding certain financial and business trends relating to our
financial condition and ongoing results.  We use these measures for
purposes of determining executive compensation, and for budget and planning
purposes.





For the three months ended
                  September 30,
                
                
                For the nine months ended
                  September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008(unaudited)
                
                
                (unaudited)
                
                
                (unaudited)
                
                
                (unaudited)Income
      (loss) from operations
                
                $
                1,885
                
                
                $
                7,525
                
                
                $
                (29,823
                )
                
                $
                21,902Stock-based
      compensation expense
                
                
                1,384
                
                
                
                1,256
                
                
                
                4,079
                
                
                
                4,429Amortization
      of intangibles associated with acquisitions
                
                
                1,041
                
                
                
                1,526
                
                
                
                3,183
                
                
                
                3,945Restructuring
      charges
                
                
                —
                
                
                
                —
                
                
                
                1,156
                
                
                
                —Goodwill
      impairment charge
                
                
                —
                
                
                
                —
                
                
                
                33,329
                
                
                
                —Professional
      fees associated with joint ventures
                
                
                —
                
                
                
                —
                
                
                
                687
                
                
                
                —Non-GAAP
      income from operations
                
                $
                4,310
                
                
                $
                10,307
                
                
                $
                12,611
                
                
                $
                30,276




Subscription
revenue as a percentage of total revenue. Subscription revenue as a
percentage of total revenue can be derived from our consolidated statements of
operations. This performance indicator illustrates the evolution of our business
towards subscription-based solutions, which provides us with a recurring revenue
stream and which we believe to be a more compelling revenue growth and
profitability opportunity. While subscription revenue as a percentage of total
revenue increased to 82.4%, due to a decrease in other revenue, we expect that
the percentage of subscription revenue will remain above our target range of 78%
to 82% of our total revenues for the remainder of 2009.




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





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




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




For
      the
                                            year
      ended
                                            December 31,
                                          
                                          
                                          For
      the
                                            three
      months ended
                                            September
      30,
                                          
                                          
                                          For
      the
                                            nine
      months ended
                                            September
      30,2008
                                          
                                          
                                          2009
                                          
                                          
                                          2008
                                          
                                          
                                          2009
                                          
                                          
                                          2008(unaudited)
                                          
                                          
                                          (unaudited)
                                          
                                          
                                          (unaudited)
                                          
                                          
                                          (unaudited)Deferred
      revenue at the beginning of the period
                                          
                                          $
                                          35,076
                                          
                                          
                                          $
                                          42,223
                                          
                                          
                                          $
                                          38,741
                                          
                                          
                                          $
                                          38,638
                                          
                                          
                                          $
                                          35,076Total
      invoiced subscriptions during period
                                          
                                          
                                          166,982
                                          
                                          
                                          
                                          35,190
                                          
                                          
                                          
                                          41,286
                                          
                                          
                                          
                                          106,081
                                          
                                          
                                          
                                          127,775Subscription
      revenue recognized during period
                                          
                                          
                                          (163,420
                                          )
                                          
                                          
                                          (33,221
                                          )
                                          
                                          
                                          (43,031
                                          )
                                          
                                          
                                          (100,527
                                          )
                                          
                                          
                                          (125,855
                                          )Deferred
      revenue at end of period
                                          
                                          $
                                          38,638
                                          
                                          
                                          $
                                          44,192
                                          
                                          
                                          $
                                          36,996
                                          
                                          
                                          $
                                          44,192
                                          
                                          
                                          $
                                          36,996




30





5.
Results of Operations




Three
and nine months ended September 30, 2009 compared to three and nine months ended
September 30, 2008




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




Kenexa
Corporation Consolidated Statements of Operations


(In
thousands)


(Unaudited)




For the three months ended September 30,
                          
                          
                          For the nine months ended September 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent of
                            Revenues
                          
                          
                          Amount
                          
                          
                          Percent of
                            RevenuesRevenue:Subscription
                          
                          
                          33,221
                          
                          
                          
                          82.4
                          %
                          
                          $
                          43,031
                          
                          
                          
                          79.6
                          %
                          
                          
                          100,527
                          
                          
                          
                          84.8
                          %
                          
                          $
                          125,855
                          
                          
                          
                          79.3
                          %Other
                          
                          
                          7,093
                          
                          
                          
                          17.6
                          %
                          
                          
                          10,995
                          
                          
                          
                          20.4
                          %
                          
                          
                          18,083
                          
                          
                          
                          15.2
                          %
                          
                          
                          32,819
                          
                          
                          
                          20.7
                          %Total
      revenue
                          
                          
                          40,314
                          
                          
                          
                          100.0
                          %
                          
                          
                          54,026
                          
                          
                          
                          100.0
                          %
                          
                          
                          118,610
                          
                          
                          
                          100.0
                          %
                          
                          
                          158,674
                          
                          
                          
                          100.0
                          %Cost
      of revenue
                          
                          
                          13,129
                          
                          
                          
                          32.6
                          %
                          
                          
                          16,461
                          
                          
                          
                          30.5
                          %
                          
                          
                          40,462
                          
                          
                          
                          34.1
                          %
                          
                          
                          46,739
                          
                          
                          
                          29.5
                          %Gross
      profit
                          
                          
                          27,185
                          
                          
                          
                          67.4
                          %
                          
                          
                          37,565
                          
                          
                          
                          69.5
                          %
                          
                          
                          78,148
                          
                          
                          
                          65.9
                          %
                          
                          
                          111,935
                          
                          
                          
                          70.5
                          %Operating
      expenses:Sales
      and marketing
                          
                          
                          9,083
                          
                          
                          
                          22.5
                          %
                          
                          
                          10,298
                          
                          
                          
                          19.1
                          %
                          
                          
                          26,029
                          
                          
                          
                          21.9
                          %
                          
                          
                          31,175
                          
                          
                          
                          19.6
                          %General
      and administrative
                          
                          
                          10,182
                          
                          
                          
                          25.3
                          %
                          
                          
                          12,649
                          
                          
                          
                          23.4
                          %
                          
                          
                          30,972
                          
                          
                          
                          26.1
                          %
                          
                          
                          37,487
                          
                          
                          
                          23.6
                          %Research
      and development
                          
                          
                          2,453
                          
                          
                          
                          6.1
                          %
                          
                          
                          3,756
                          
                          
                          
                          7.0
                          %
                          
                          
                          7,557
                          
                          
                          
                          6.4
                          %
                          
                          
                          12,605
                          
                          
                          
                          7.9
                          %Depreciation
      and amortization
                          
                          
                          3,582
                          
                          
                          
                          8.9
                          %
                          
                          
                          3,337
                          
                          
                          
                          6.2
                          %
                          
                          
                          10,084
                          
                          
                          
                          8.5
                          %
                          
                          
                          8,766
                          
                          
                          
                          5.5
                          %Goodwill
      impairment charge
                          
                          
                          —
                          
                          
                          
                          —
                          %
                          
                          
                          —
                          
                          
                          
                          —
                          %
                          
                          
                          33,329
                          
                          
                          
                          28.1
                          %
                          
                          
                          —
                          
                          
                          
                          —
                          %Total
      operating expenses
                          
                          
                          25,300
                          
                          
                          
                          62.8
                          %
                          
                          
                          30,040
                          
                          
                          
                          55.7
                          %
                          
                          
                          107,971
                          
                          
                          
                          91.0
                          %
                          
                          
                          90,033
                          
                          
                          
                          56.6
                          %Income
      from operations
                          
                          
                          1,885
                          
                          
                          
                          4.7
                          %
                          
                          
                          7,525
                          
                          
                          
                          13.8
                          %
                          
                          
                          (29,823
                          )
                          
                          
                          (25.1
                          )
      %
                          
                          
                          21,902
                          
                          
                          
                          13.8
                          %Interest
      (expense) income, net
                          
                          
                          (28
                          )
                          
                          
                          (0.1
                          )
      %
                          
                          
                          255
                          
                          
                          
                          0.5
                          %
                          
                          
                          (186
                          )
                          
                          
                          (0.2
                          )
      %
                          
                          
                          1,216
                          
                          
                          
                          0.8
                          %Investment
      income, net
                          
                          
                          102
                          
                          
                          
                          0.3
                          %
                          
                          
                          —
                          
                          
                          
                          —
                          %
                          
                          
                          54
                          
                          
                          
                          0.0
                          %
                          
                          
                          —
                          
                          
                          
                          —
                          %Income
      (loss) before income taxes
                          
                          
                          1,959
                          
                          
                          
                          4.9
                          %
                          
                          
                          7,780
                          
                          
                          
                          14.4
                          %
                          
                          
                          (29,955
                          )
                          
                          
                          (25.3
                          )
      %
                          
                          
                          23,118
                          
                          
                          
                          14.6
                          %Income
      tax expense
                          
                          
                          361
                          
                          
                          
                          0.9
                          %
                          
                          
                          2,356
                          
                          
                          
                          4.4
                          %
                          
                          
                          1,418
                          
                          
                          
                          1.2
                          %
                          
                          
                          6,955
                          
                          
                          
                          4.4
                          %Net
      income (loss)
                          
                          
                          1,598
                          
                          
                          
                          4.0
                          %
                          
                          $
                          5,424
                          
                          
                          
                          10.0
                          %
                          
                          
                          (31,373
                          )
                          
                          
                          (26.5
                          )
      %
                          
                          $
                          16,163
                          
                          
                          
                          10.2
                          %


31




Revenue





Total
revenue decreased $13.7 million or 25.4% to $40.3 million, subscription revenue
decreased $9.8 million or 22.8% to $33.2 million and other revenue decreased
$3.9 million or 35.5% to $7.1 million for the three months ended September 30,
2009, compared to the same periods in 2008.  Subscription revenue
represented approximately 82.4% of our total revenue for the three months ended
September 30, 2009. Total revenue decreased $40.0 million or 25.2% to $118.6
million, subscription revenue decreased $25.3 million or 20.1% to $100.5 million
and other revenue decreased $14.7 million or 44.9% to $18.1 million for the nine
months ended September 30, 2009, compared to the same periods in 2008.
Subscription revenue represented approximately 84.8% of our total revenue for
the nine months ended September 30, 2009.





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




Cost
of Revenue





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




Cost of
revenue decreased by $3.4 million or 20.2% to $13.1 million during the three
months ended September 30, 2009, compared to the same period in 2008. As a
percentage of revenue cost of revenue increased by 2.1% to 32.6% for the three
months ended September 30, 2009, compared to the same period in
2008.  The $3.4 million decrease for the three months ended September
30, 2009 was due primarily to reduced staff expense and reimbursable expenses of
$2.9 million and $0.8 million, respectively, partially offset by $0.3 million
increase in third party fees, compared to the same period in 2008.




Cost of
revenue decreased by $6.4 million or 13.4% to $40.4 million during the nine
months ended September 30, 2009, compared to the same period in 2008. As a
percentage of revenue cost of revenue increased by 4.6% to 34.1% for the nine
months ended September 30, 2009, compared to the same period in
2008.  The $6.4 million decrease for the nine months ended
September 30, 2009 was due to reduced staff expense, reimbursable expense
and third party fees, including marketing and agency costs, of approximately
$3.9 million, $1.9 million and $0.6 million, respectively, compared to the same
period in 2008.


32





Sales
and Marketing (“S&M”) Expense





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




S&M
expense decreased $1.2 million or 11.8% to $9.1 million during the three months
ended September 30, 2009, compared to the same period in 2008. The $1.2
million decrease for the three months ended September 30, 2009 was due primarily
to decreased staff, bonus and commission expense of $0.6 million, $0.2 million
and $0.4 million, respectively.  In addition,  reduced bad
debt and marketing expense of $0.3 million and $0.3 million, respectively, was
offset by an increase in share-based compensation expense and third party
consultants of $0.2 million and $0.4 million, respectively, compared to the same
period in 2008.  As a percentage of revenue, S&M expense increased
from 19.1% to 22.5%, for the three months ended September 30,
2009.




S&M
expense decreased $5.1 million or 16.5% to $26.1 million during the nine months
ended September 30, 2009, compared to the same period in 2008. The $5.1 million
decrease for the nine months ended September 30, 2009 was due primarily to
reduced bonus, commission, travel and bad debt expense of $0.6 million, $1.8
million, $1.0 million and $1.7 million, respectively, compared to the same
period in 2008.  As a percentage of revenue, S&M expense increased
from 19.6% to 21.9%, for the nine months ended September 30, 2009.




General
and Administrative (“G&A”) Expense





G&A
expense primarily consists of personnel and related costs for our executive,
finance, human resources and administrative personnel, professional fees and
other corporate expenses and allocated overhead.  In the short term,
we expect G&A to increase as we incur additional professional fees in
connection with our patent infringement matter, however, in the longer term
based upon the current state of the economy, we believe that general and
administrative expenses will remain the same or slightly decrease in dollar
amount and remain constant as a percentage of total revenue in
2009.




G&A
expense decreased $2.5 million or 19.5% to $10.1 million during the three months
ended September 30, 2009, compared to the same period in 2008. The $2.5
million decrease for the three months ended September 30, 2009 was due
primarily to a decrease in staff related expense, rent, travel and other
expenses of $0.9 million, $0.2 million, $0.6 million and $0.8 million,
respectively, during the three months ended September 30, 2009, compared to
the same period in 2008.  As a percentage of revenue, G&A expense
increased from approximately 23.4% to 25.3% for the three months ended
September 30, 2009, compared to the same period in 2008.




G&A
expense decreased $6.5 million or 17.4% to $30.9 million during the nine months
ended September 30, 2009, compared to the same period in 2008. The $6.5
million decrease for the nine months ended September 30, 2009, was due
primarily to a decrease in staff related expense, travel and entertainment and
share-based compensation expense of $3.7 million, $1.7 million and $0.6 million,
respectively.  Temporary help, office supplies and other expenses also
contributed $0.2 million, $0.3 and $0.4 million, respectively, to the decrease
and was partially offset by an increase of $0.4 in professional fees during the
nine months ended September 30, 2009, compared to the same period in
2008.   As a percentage of revenue, G&A expense increased
from 23.6% to 26.1% for the nine months ended September 30, 2009, compared
to the same period in 2008.


33




Research
and Development (“R&D”) Expense





R&D
expense primarily consists of personnel and related costs, including salaries
and employee benefits for software engineers, quality assurance engineers,
product managers, technical sales engineers and management information systems
personnel and third party consultants.  Our R&D efforts have been
devoted primarily to new product offerings and enhancements and upgrades to our
existing products.  As a result of these ongoing development efforts,
we have capitalized software costs of $2.3 million, $7.3 million, $2.4 million
and $6.1 million for the three and nine months ended September 30, 2009 and
2008, respectively.  The remaining R&D activities have been
expensed as incurred.




R&D
expense decreased $1.3 million or 34.7% to $2.5 million during the three months
ended September 30, 2009, compared to the same period in
2008.   The decrease was attributable to a reduction in staff
expense of $1.3 million compared to the same period in 2008.  As a
percentage of revenue, R&D expense decreased from approximately 7.0% to 6.1%
for the three months ended September 30, 2009, compared to the same period in
2008.




R&D
expense decreased $5.0 million or 40.4% to $7.6 million during the nine months
ended September 30, 2009, compared to the same period in
2008.   The decrease was attributable to a reduction in staff and
consulting expense of $4.8 million and $0.2 million, respectively, compared to
the same period in 2008.  As a percentage of revenue, R&D expense
decreased from approximately 7.9% to 6.4% for the three months ended
September 30, 2009, compared to the same period in 2008.




Depreciation
and Amortization




Depreciation
and amortization expense increased $0.3 million or 7.3% to $3.6 million and $1.4
million or 15.0% to $10.1 million during the three and nine months ended
September 30, 2009, compared to the same period in 2008.  In the
future, we expect depreciation and amortization expense to increase due to
additional capital purchases, increased software capitalization, and to a lesser
extent the full period effect of our acquired intangibles.




Income
tax expense from operations




Income
tax expense from operations decreased by $2.1 million or 84.7% to $0.3 million
and $5.6 million or 79.6% to $1.4 million during the three and nine month period
ended September 30, 2009, respectively, compared to the same periods in
2008. The decrease in income tax expense was due to lower taxable income and a
larger portion of our taxable income being generated in jurisdictions with lower
effective tax rates and also decreasing in jurisdictions with higher tax
rates.


34




6.
Liquidity and Capital Resources





Since we
were formed in 1987, we have financed our operations primarily through
internally generated cash flows, our revolving credit facilities and the
issuance of equity. As of September 30, 2009, we had cash and cash equivalents
of $28.2 million and investments of $22.0 million. In addition, we had
no debt and approximately $0.5 million in capital equipment
leases.





Our cash
provided from operations was $22.5 million and $25.1 million for the nine months
ended September 30, 2009 and 2008.  Cash used in investing
activities was $16.3 million and $13.7 million for the nine months ended
September 30, 2009 and 2008.  Cash provided by financing
activities was less than $0.1 million for the nine months ended
September 30, 2009 and cash used in financing activities was $29.3 million
for the nine months ended September 30, 2008.  Our net increase in
cash and cash equivalents was $6.5 million for the nine months ended
September 30, 2009, resulting primarily from our operating activities, and
our net decrease in cash and cash equivalents was $18.5 million for the nine
months ended September 30, 2008, resulting primarily from our financing
activities.   We expect positive cash flow to continue in future
periods.





As of
September 30, 2009, we held auction rate securities with a fair value of $15.4
million and par value of $16.9 million. Our auction rate securities portfolio
includes investments rated A and AAA and comprised of federally and privately
insured student loans. However, the auction rate securities we hold have failed
to trade at recent auctions due to insufficient bids from buyers. This limits
the short-term liquidity of these instruments and may limit our ability to
liquidate and fully recover the carrying value of our auction rate securities if
we needed to convert some or all to cash in the near term. We believe that based
upon our current cash and cash equivalent balances, the current lack of
liquidity in the auction rate securities market will not have a material impact
on our liquidity or our ability to fund our operations.





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





On May
31, 2009, we elected not to renew our secured credit agreement with our bank and
as a result, no longer have a revolving credit facility or other debt financing
arrangement.  We believe that our cash and short-term investments, our
UBS Settlement Agreement for our auction rate securities and our projected cash
from operations will be sufficient to meet our liquidity needs for at least the
next twelve months.





In
connection with our November 8, 2007 and February 20, 2008 stock repurchase
plans, we repurchased 1.7 million shares of our common stock at an average price
of $18.01 per share and an aggregate cost of $30.3 million for the year ended
December 30, 2008.  For the nine months ended September 30, 2009, there
have been no repurchases under the stock repurchase plans.





35




Operating
Activities




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





Net cash
provided by operating activities was $22.5 million and $25.1 million for the
nine months ended September 30, 2009 and 2008.  Net cash provided by
operating activities for the nine months ended September 30, 2009 resulted
primarily from non-cash charges to net income of $14.1 million, a non-cash
goodwill impairment charge of $33.3 million, an increase in deferred revenue of
$5.4 million, and a decrease in accounts receivables of approximately $4.3
million offset by a net loss of approximately $31.4 million, increase in
deferred tax benefits of $1.1 million and changes in working capital of $2.1
million.  Net cash provided by operating activities for the nine
months ended September 30, 2008 resulted primarily from net income of
approximately $16.2 million, non-cash charges to net income of $14.7 million, an
increase in deferred revenue of $1.9 million and deferred taxes of $1.2 million,
partially offset by changes in working capital of $5.5 million, an increase in
accounts receivable of $3.7 million and a reduction in taxes payable resulting
from the excess tax benefits from share based payments of $0.2
million.




Investing
Activities





Net cash
used in investing activities was $16.3 million and $13.7 million for the nine
months ended September 30, 2009 and 2008, respectively, and consisted of the
following, in millions:




For the nine
                    months ended
                    September 30,
                    2009
                  
                  
                  For the nine
                    months ended
                    September 30,
                    2008Scottworks
      acquisition
                  
                  $
                  —
                  
                  
                  $
                  0.1StraightSource
      acquisition
                  
                  
                  3.1
                  
                  
                  
                  1.1Knowledge
      Workers acquisition
                  
                  
                  —
                  
                  
                  
                  0.1Gantz
      Wiley Research acquisition
                  
                  
                  —
                  
                  
                  
                  0.6HRC
      acquisition
                  
                  
                  0.2
                  
                  
                  
                  0.3Quorum
      acquisition
                  
                  
                  0.4
                  
                  
                  
                  27.6Capitalized
      software and purchases of property, plant and equipment
                  
                  
                  10.9
                  
                  
                  
                  16.6Purchases
      of available-for-sale securities
                  
                  
                  4.8
                  
                  
                  
                  25.2Sales
      of available-for-sale securities
                  
                  
                  (2.6
                  )
                  
                  
                  (57.9
                  )Sales
      of trading securities
                  
                  
                  (1.6
                  )
                  
                  
                  —Investment
      in joint venture
                  
                  
                  1.1
                  
                  
                  
                  —Total
      cash flows used in by investing activities
                  
                  $
                  16.3
                  
                  
                  $
                  13.7




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





Financing
Activities





Net cash
provided by and used in financing activities was less than $0.1 million and
$29.2 million for the nine months ended September 30, 2009 and 2008,
respectively.  For the nine months ended September 30, 2008, net cash
used in financing activities consisted of repurchases of our common shares of
$29.8 million and repayments of our capital lease obligations of $0.2 million,
partially offset by net proceeds from stock option exercises of $0.4 million,
excess tax benefits from share-based payment arrangements of $0.2 million and
proceeds from our employee stock purchase plan of $0.2 million.




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


36


Critical
Accounting Policies and Estimates





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





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




Revenue
Recognition





We derive
our revenue from two sources: (1) subscription revenues for solutions,
which are comprised of subscription fees from customers accessing our on-demand
software, consulting services, outsourcing services and proprietary content, and
from customers purchasing additional support beyond the standard support that is
included in the basic subscription fee; and (2) other fees for professional
services, translation services and reimbursed out-of-pocket expenses. Because we
provide our solutions as a service, we follow the provisions FASB ASC 605-10,
Revenue Recognition and
FASB ASC 605-25 Multiple
Elements. We recognize revenue when all of the following conditions are
met:




•
              there is persuasive evidence of
      an arrangement;





•
              the service has been provided to
      the customer;





•
              the collection of the fees is
      probable; and





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





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





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





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




In
accordance with FASB ASC 605-45 Principal Agent
Considerations we record reimbursements received for out-of-pocket
expenses as revenue and not netted with the applicable costs.  These
items primarily include travel, meals and certain telecommunication
costs.  Reimbursed expenses totaled $0.5 million, $1.6 million, $1.3
million, and $3.5 million for the three and nine months ended September 30, 2009
and 2008, respectively.


37





Allowance
for Doubtful Accounts





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





Capitalized
Software Research and Development Costs





In
accordance with FASB ASC 985, Software and FASB ASC 350,
Assets-Intangibles-Goodwill
and Other,costs incurred in the preliminary stages of a development
project are expensed as incurred. Once an application has reached the
development stage, internal and external costs, if direct and incremental, will
be capitalized until the software is substantially complete and ready for its
intended use. Capitalization ceases upon completion of all substantial testing.
We also capitalize costs related to specific upgrades and enhancements when it
is probable the expenditures will result in additional functionality.
Maintenance and training cost are expensed as incurred. Internal use software is
amortized on a straight-line basis over its estimated useful life, generally
three years. Management evaluates the useful lives of these assets on an annual
basis and tests for impairments whenever events or changes in circumstances
occur that could impact the recoverability of these assets. There were no
impairments to internal software in any of the periods covered in this
report.





Goodwill
and Other Identified Intangible Asset Impairment





Since
2002, we have recorded goodwill in accordance with the provisions of FASB ASC,
350, Intangibles-Goodwill and
Other,which disallows the amortization of existing goodwill and instead
requires us to annually review the carrying value of goodwill for
impairment.   If goodwill becomes impaired, some or all of the
goodwill could be written off as a charge to operations. This comparison is
performed annually or more frequently if circumstances change that would more
likely than not reduce the fair value of the reporting unit below its carry
amount.





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





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


38





Classification
and Fair Value Measurement of Auction Rate Securities





We hold
investments in auction rate securities having contractual maturities of greater
than one year and interest rate reset features of between 7 and 35 days. These
auction rate securities were priced and initially traded as short-term
investments because of the interest rate reset feature.  During 2008,
as a result of the deterioration in the credit markets, our auction rate
securities failed to trade at auctions due to insufficient bids from
buyers.  The credit market crisis led to uncertainty surrounding the
liquidity of our auction rate security investments and required us to reclassify
our auction rate securities to long-term investments.   In June
2009, due to our ability to liquidate these securities within the next twelve
months, we reclassified our auction rate securities to short-term investments on
our Consolidated Balance Sheet as of September 30, 2009.





Our
auction rate securities, which have a par value of $16.9 million at September
30, 2009, were acquired through UBS AG. Due to the failure of the auction rate
market in early 2008, UBS AG and other major banks entered into discussions with
government agencies to provide liquidity to owners of auction rate securities.
In November 2008, we entered into an agreement (the “UBS Settlement Agreement”)
with UBS AG which provides us (1)  with a “no net cost” loan up to the
par value of Eligible ARS until June 30, 2010, (2)  the right to sell these
auction rate securities back to UBS AG at par, at our sole discretion, anytime
during the period from June 30, 2010 through July 2, 2012, and
provides UBS AG the right to purchase these auction rate securities or sell
them on our behalf at par anytime through July 2, 2012 (See Note 3 to the
Consolidated Financial Statements).  As a result of the execution of
the UBS Settlement Agreement, we determined that we no longer had the intent and
ability to hold the ARS until maturity or until the ARS market would
recover.  Based on this unusual circumstance related to the signing of the
UBS Settlement Agreement, we transferred these investments from
available–for-sale to trading securities and began recording the change in fair
value of the ARS as gains or losses in current period earnings.




During
the fourth quarter of 2008, we elected to measure the value of our option to put
the securities (“put option”) to UBS AG under the fair value option of FASB ASC
825, Financial
Instruments.   As a result, at December 31, 2008, we recorded
non-operating gain representing the estimated fair value of the put option and a
corresponding long-term asset of approximately $2,219.   At September
30, 2009, the put option’s estimated fair value increased to $1,553, resulting
in a non-operating gain of $109 during the quarter.  The estimated fair
value of the put option as of September 30, 2009 was based in part on an
expected life of twelve months and a discount rate of 1.73%.   As a
result of the transfer of the ARS from available-for-sale to trading investment
securities noted above, we also recorded a non-operating loss during the three
months of less than $7 and a non-operating gain during the nine months ended
September 30, 2009 representing an increase in the estimated fair value of ARS
of approximately $656.   The recording of the loss relating to the
increase in the fair value of the ARS and the recognition of the gain on the put
option resulted in an overall net gain of approximately $102 for the three
months ended September 30, 2009 and a net loss of approximately $9 for the nine
months ended September 30, 2009.





We
anticipate that any future changes in the fair value of our put option under the
UBS Settlement Agreement will partially be offset by the changes in the fair
value of the related auction rate securities. Our option to put the securities
under the UBS Settlement Agreement will continue to be measured at fair value
utilizing Level 3 inputs as defined by FASB ASC 820, Fair Value Measurement and
Disclosure until the earlier of its maturity or exercise.





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


39





Accounting
for Share-Based Compensation





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




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





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





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





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





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





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





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





Accounting
for Income Taxes





We
account for income taxes in accordance with FASB ASC 740, Income
Taxes,which requires that deferred tax assets and
liabilities be recognized using enacted tax rates for the effect of temporary
differences between the book and tax basis of recorded assets and liabilities.
In addition, any deferred tax assets are reduced by a valuation allowance if it
is more likely than not that some portion or all of the deferred tax asset will
not be realized.





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





Self-Insurance





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


40


Item
3: Quantitative and Qualitative Disclosures about Market Risk





Market
risk represents the risk of loss that may impact our financial position due to
adverse changes in financial market prices and rates.  Our market risk
exposure is primarily a result of fluctuations in interest rates and foreign
currency exchange rates.





Foreign
Currency Exchange Risk





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




The
financial position and operating results of our foreign operations are
consolidated using the local currency as the functional currency. Local currency
assets and liabilities are translated at the rate of exchange to the U.S. dollar
on the balance sheet date, and the local currency revenue and expenses are
translated at average rates of exchange to the U.S. dollar during the period.
The related translation adjustments to shareholders’ equity were a decrease of
$0.6 million and $3.9 million for the nine months ended September 30, 2009
and year ended December 30, 2008, respectively, and are included in other
comprehensive income. The foreign currency translation adjustment is not
adjusted for income taxes as it relates to an indefinite investment in a
non-U.S. subsidiary.





Interest
Rate Risk





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





Item
4: Controls and Procedures





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





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


41


PART
II: OTHER INFORMATION





Item
1: Legal Proceedings





On June
11, 2009 and July 16, 2009, two putative class actions were filed against us and
our Chief Executive Officer and Chief Financial Officer in the United States
District Court for the Eastern District of Pennsylvania, purportedly on behalf
of a class of our investors who purchased our publicly traded securities between
May 8, 2007 and November 7, 2007. The complaint filed on July 16, 2009 has since
been voluntarily dismissed. In the pending action, the initial complaint
generally alleged violations of Section 10(b) of the Securities Exchange Act of
1934 ("Exchange Act"), Rule 10b-5 promulgated thereunder and Section 20(a) of
the Exchange Act in connection with various public statements made by us.
Pursuant to the Private Securities Litigation Reform Act, any member of the
purported class who wished to be appointed "lead plaintiff" was required to file
a motion seeking such designation on or before August 10, 2009.  In
accordance with the Court's scheduling order, a hearing regarding the
appointment of lead plaintiff took place on September 9, 2009 and a lead
plaintiff was appointed. Pursuant to the court's amended scheduling order; the
lead plaintiff filed an amended complaint on October 26, 2009, and defendants
will have until December 14, 2009 to file their motion to dismiss the complaint.
We intend to vigorously defend these actions. The potential impact of these
actions, which seek unspecified damages, attorneys fees and expenses, is
uncertain.




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




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





Item
1A: Risk Factors





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





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





Not
applicable.





Item
3: Defaults Upon Senior Securities





Not
applicable.


42





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





Not
applicable.





Item
5: Other Information





Not
applicable.





Item
6:  Exhibits





The
following exhibits are filed herewith:





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





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





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


43





SIGNATURES





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





November
9, 2009


Kenexa
Corporation





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


44





EXHIBIT
INDEX





Exhibit
Number and Description




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





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





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


45