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 March 31, 2009
  OR
  o
              TRANSITION
      REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
the transition period
from         to
  Commission
File number 000-51358
  Kenexa
Corporation
 (Exact
Name of Registrant as Specified in Its
Charter)
 
 Pennsylvania
                (State
      or other jurisdiction of incorporation or organization)
              23-3024013
                (I.R.S.
      Employer Identification Number)
 
 650
      East Swedesford Road, Wayne, PA
                (Address
      of Principal Executive Offices)
              19087
                (Zip
      Code)
 
 Registrant’s
Telephone Number, Including Area Code: (610) 971-9171
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes x    No
o
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).    Yes x      No
o
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.  (Check one):
 Large
Accelerated Filer  o   Accelerated
filer  x     Non-accelerated
Filer   o    Smaller
reporting company o
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 Yes o    No
x
 
 On May 8,
2009, 22,522,844 shares of the registrant’s Common Stock, $0.01 par value, were
outstanding.
  
  
  Kenexa
Corporation and Subsidiaries
 FORM
10-Q
 Quarter
Ended March 31, 2009
 Table
of Contents
 
 PagePART I: FINANCIAL
      INFORMATIONItem
      I: Financial StatementsConsolidated
      Balance Sheets as of March 31, 2009 (unaudited) and December 31,
      2008
                            
                            3Consolidated
      Statements of Operations for the three months ended March 31, 2009 and
      2008 (unaudited)
                            
                            4Consolidated
      Statements of Shareholders’ Equity for the three months ended March
      31, 2009 (unaudited) and the year ended December 31, 2008
                            
                            5Consolidated
      Statements of Cash Flows for the three months ended March 31, 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
                            
                            42Item
      5: Other Information
                            
                            42Item
      6: Exhibits
                            
                            42Signatures
                            
                            43Exhibit
      Index
                            
                            44
  2
 
 PART
I FINANCIAL INFORMATION
 Item
1: Financial Statements
 Kenexa
Corporation and Subsidiaries
 Consolidated
Balance Sheets
 (In
thousands, except share data)
 
 March
      31,
                    2009
                  
                  
                  December
      31,
                    2008(unaudited)AssetsCurrent
      AssetsCash
      and cash equivalents
                  
                  $
                  27,045
                  
                  
                  $
                  21,742Short-term
      investments
                  
                  
                  4,142
                  
                  
                  
                  4,512Accounts
      receivable, net of allowance of doubtful accounts of $3,627 and $3,755,
      respectively
                  
                  
                  26,779
                  
                  
                  
                  33,518Unbilled
      receivables
                  
                  
                  7,077
                  
                  
                  
                  5,849Income
      tax receivable
                  
                  
                  1,201
                  
                  
                  
                  1,238Deferred
      income taxes
                  
                  
                  4,770
                  
                  
                  
                  4,615Prepaid
      expenses and other current assets
                  
                  
                  4,822
                  
                  
                  
                  3,745Total
      Current Assets
                  
                  
                  75,836
                  
                  
                  
                  75,219Long-term
      investments
                  
                  
                  15,473
                  
                  
                  
                  16,513Property
      and equipment, net of accumulated depreciation
                  
                  
                  27,537
                  
                  
                  
                  27,360Software,
      net of accumulated amortization
                  
                  
                  4,356
                  
                  
                  
                  3,840Goodwill
                  
                  
                  —
                  
                  
                  
                  32,366Intangible
      assets, net of accumulated amortization
                  
                  
                  10,919
                  
                  
                  
                  13,414Deferred
      income taxes, non-current
                  
                  
                  39,465
                  
                  
                  
                  39,465Deferred
      financing costs, net of accumulated amortization
                  
                  
                  289
                  
                  
                  
                  364Other
      long-term assets
                  
                  
                  10,545
                  
                  
                  
                  9,924Total
      assets
                  
                  $
                  184,420
                  
                  
                  $
                  218,465Liabilities
      and Shareholders’ EquityCurrent
      liabilitiesAccounts
      payable
                  
                  $
                  5,649
                  
                  
                  $
                  6,448Notes
      payable, current
                  
                  
                  41
                  
                  
                  
                  40Commissions
      payable
                  
                  
                  380
                  
                  
                  
                  559Accrued
      compensation and benefits
                  
                  
                  3,741
                  
                  
                  
                  4,010Other
      accrued liabilities
                  
                  
                  10,584
                  
                  
                  
                  10,090Deferred
      revenue
                  
                  
                  41,427
                  
                  
                  
                  38,638Capital
      lease obligations
                  
                  
                  101
                  
                  
                  
                  143Total
      current liabilities
                  
                  
                  61,923
                  
                  
                  
                  59,928Capital
      lease obligations, less current portion
                  
                  
                  91
                  
                  
                  
                  108Notes
      payable, less current portion
                  
                  
                  33
                  
                  
                  
                  41Deferred
      income taxes
                  
                  
                  1,119
                  
                  
                  
                  1,789Other
      liabilities
                  
                  
                  64
                  
                  
                  
                  63Total
      liabilities
                  
                  
                  63,230
                  
                  
                  
                  61,929Commitments
      and ContingenciesShareholders’
      EquityPreferred
      stock, par value $0.01; 100,000 shares authorized; no shares issued
      or  outstanding
                  
                  
                  —
                  
                  
                  
                  —Common
      stock, par value $0.01; 100,000,000 shares
      authorized;  22,522,844 and 22,504,924 shares issued and
      outstanding, respectively
                  
                  
                  225
                  
                  
                  
                  225Additional
      paid-in-capital
                  
                  
                  270,688
                  
                  
                  
                  269,365Accumulated
      other comprehensive loss
                  
                  
                  (4,808
                  )
                  
                  
                  (2,421
                  )Accumulated
      deficit
                  
                  
                  (144,915
                  )
                  
                  
                  (110,633
                  )Total
      shareholders’ equity
                  
                  
                  121,190
                  
                  
                  
                  156,536Total
      liabilities and shareholders’ equity
                  
                  $
                  184,420
                  
                  
                  $
                  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
                        March
      31,2009
                      
                      
                      2008Revenues:Subscription
                      
                      $
                      33,265
                      
                      
                      $
                      39,156Other
                      
                      
                      5,566
                      
                      
                      
                      9,051Total
      revenues
                      
                      
                      38,831
                      
                      
                      
                      48,207Cost
      of revenues
                      
                      
                      13,696
                      
                      
                      
                      13,105Gross
      profit
                      
                      
                      25,135
                      
                      
                      
                      35,102Operating
      expenses:Sales
      and marketing
                      
                      
                      8,705
                      
                      
                      
                      9,889General
      and administrative
                      
                      
                      10,873
                      
                      
                      
                      11,993Research
      and development
                      
                      
                      2,568
                      
                      
                      
                      4,542Depreciation
      and amortization
                      
                      
                      3,228
                      
                      
                      
                      2,151Goodwill
      impairment charge
                      
                      
                      33,329
                      
                      
                      
                      —Total
      operating expenses
                      
                      
                      58,703
                      
                      
                      
                      28,575(Loss)
      income from operations
                      
                      
                      (33,568
                      )
                      
                      
                      6,527Interest
      income, net
                      
                      
                      63
                      
                      
                      
                      641Loss
      on change in fair market value of ARS and put option, net
                      
                      
                      (295
                      )
                      
                      
                      —(Loss)
      income before income taxes
                      
                      
                      (33,800
                      )
                      
                      
                      7,168Income
      tax expense
                      
                      
                      482
                      
                      
                      
                      2,394Net
      (loss) income
                      
                      $
                      (34,282
                      )
                      
                      $
                      4,774Basic
      net (loss) income per share
                      
                      $
                      (1.52
                      )
                      
                      $
                      0.20Weighted
      average shares used to compute net (loss) income per share –
      basic
                      
                      
                      22,509,304
                      
                      
                      
                      23,413,071Diluted
      net (loss) income per share
                      
                      $
                      (1.52
                      )
                      
                      $
                      0.20Weighted
      average shares used to compute net (loss) income per share –
      diluted
                      
                      
                      22,509,304
                      
                      
                      
                      23,649,027
  See
notes to consolidated financial statements.
  4
  Kenexa
Corporation and Subsidiaries
 Consolidated
Statements of Shareholders’ Equity
 (in
thousands)
 
 Common
                    stock
                  
                  
                  Additional
                    paid-in
                    capital
                  
                  
                  Accumulated
                    deficit
                  
                  
                  Accumulated
                    other
                    comprehensive
                    income
      (loss)
                  
                  
                  Total
                    shareholders’
                    equity
                  
                  
                  Comprehensive
                    income
      (loss)Balance,
      December 31, 2007
                  
                  $
                  240
                  
                  
                  $
                  291,942
                  
                  
                  $
                  (5,941
                  )
                  
                  $
                  1,407
                  
                  
                  $
                  287,648
                  
                  
                  $
                  24,859Common
      stock repurchase
                  
                  
                  (17
                  )
                  
                  
                  (30,260
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (30,277
                  )
                  
                  
                  —Loss
      on currency translation adjustments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (3,861
                  )
                  
                  
                  (3,861
                  )
                  
                  
                  (3,861
                  )Unrealized
      gain on short-term investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  33
                  
                  
                  
                  33
                  
                  
                  
                  33Share-based
      compensation expense
                  
                  
                  —
                  
                  
                  
                  5,761
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5,761
                  
                  
                  
                  —Excess
      tax benefits from share-based payment arrangements
                  
                  
                  —
                  
                  
                  
                  169
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  169
                  
                  
                  
                  —Option
      exercises
                  
                  
                  1
                  
                  
                  
                  366
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  367
                  
                  
                  
                  —Employee
      stock purchase plan
                  
                  
                  —
                  
                  
                  
                  338
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  338
                  
                  
                  
                  —Common
      stock issuance for Straight Source earn out
                  
                  
                  1
                  
                  
                  
                  1,049
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,050
                  
                  
                  
                  —Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (104,692
                  )
                  
                  
                  —
                  
                  
                  
                  (104,692
                  )
                  
                  
                  (104,692
                  )Balance,
      December 31, 2008
                  
                  $
                  225
                  
                  
                  $
                  269,365
                  
                  
                  $
                  (110,633
                  )
                  
                  $
                  (2,421
                  )
                  
                  $
                  156,536
                  
                  
                  $
                  (108,520
                  )Loss
      on currency translation adjustments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (2,374
                  )
                  
                  
                  (2,374
                  )
                  
                  
                  (2,374
                  )Unrealized
      loss on short-term investments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (13
                  )
                  
                  
                  (13
                  )
                  
                  
                  (13
                  )Share-based
      compensation expense
                  
                  
                  —
                  
                  
                  
                  1,245
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1,245
                  
                  
                  
                  —Employee
      stock purchase plan
                  
                  
                  —
                  
                  
                  
                  78
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  78
                  
                  
                  
                  —Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (34,282
                  )
                  
                  
                  —
                  
                  
                  
                  (34,282
                  )
                  
                  
                  (34,282
                  )Balance,
      March 31, 2009 (unaudited)
                  
                  $
                  225
                  
                  
                  $
                  270,688
                  
                  
                  $
                  (144,915
                  )
                  
                  $
                  (4,808
                  )
                  
                  $
                  121,190
                  
                  
                  $
                  (36,669
                  )
 
 See
notes to consolidated financial statements.
  5
  Kenexa
Corporation and Subsidiaries
 Consolidated
Statements of Cash Flows
 (in
thousands)
 (unaudited)
 
 Three
      months ended March 31,2009
                    
                    
                    2008Cash
      flows from operating activitiesNet
      (loss) income
                    
                    $
                    (34,282
                    )
                    
                    $
                    4,774Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activitiesDepreciation
      and amortization
                    
                    
                    3,228
                    
                    
                    
                    2,151Loss
      on change in fair market value of ARS and put option, net
                    
                    
                    295
                    
                    
                    
                    —Goodwill
      impairment charge
                    
                    
                    33,329
                    
                    
                    
                    —Share-based
      compensation expense
                    
                    
                    1,245
                    
                    
                    
                    1,714Excess
      tax benefits from share-based payment arrangements
                    
                    
                    —
                    
                    
                    
                    (132
                    )Amortization
      of deferred financing costs
                    
                    
                    75
                    
                    
                    
                    75Bad
      debt recoveries
                    
                    
                    (30
                    )
                    
                    
                    (475
                    )Deferred
      income tax (benefit) expense
                    
                    
                    (825
                    )
                    
                    
                    1,029Changes
      in assets and liabilities, net of business combinationsAccounts
      and unbilled receivables
                    
                    
                    5,224
                    
                    
                    
                    (2,707
                    )Prepaid
      expenses and other current assets
                    
                    
                    (1,083
                    )
                    
                    
                    (1,760
                    )Income
      taxes receivable
                    
                    
                    36
                    
                    
                    
                    1,091Other
      long-term assets
                    
                    
                    332
                    
                    
                    
                    (140
                    )Accounts
      payable
                    
                    
                    (715
                    )
                    
                    
                    (528
                    )Accrued
      compensation and other accrued liabilities
                    
                    
                    (338
                    )
                    
                    
                    (3,888
                    )Commissions
      payable
                    
                    
                    (180
                    )
                    
                    
                    (56
                    )Deferred
      revenue
                    
                    
                    2,569
                    
                    
                    
                    2,403Other
      liabilities
                    
                    
                    —
                    
                    
                    
                    8Net
      cash provided by operating activities
                    
                    
                    8,880
                    
                    
                    
                    3,559Cash
      flows from investing activitiesPurchases
      of property and equipment
                    
                    
                    (2,997
                    )
                    
                    
                    (5,619
                    )Purchase
      of available-for-sale securities
                    
                    
                    (845
                    )
                    
                    
                    (16,318
                    )Sale
      of available-for-sale securities
                    
                    
                    1,203
                    
                    
                    
                    45,105Sale
      of trading securities
                    
                    
                    1,150
                    
                    
                    
                    —Investment
      in joint venture
                    
                    
                    (1,357
                    )
                    
                    
                    —Acquisitions,
      net of cash acquired
                    
                    
                    (373
                    )
                    
                    
                    (1,248
                    )Net
      cash (used in) provided by investing activities
                    
                    
                    (3,219
                    )
                    
                    
                    21,920Cash
      flows from financing activitiesRepayments
      of notes payable
                    
                    
                    (8
                    )
                    
                    
                    (17
                    )Proceeds
      from common stock issued through Employee Stock Purchase
    Plan
                    
                    
                    78
                    
                    
                    
                    90Repurchase
      of common stock
                    
                    
                    —
                    
                    
                    
                    (24,607
                    )Excess
      tax benefits from share-based payment arrangements
                    
                    
                    —
                    
                    
                    
                    132Net
      proceeds from option exercises
                    
                    
                    —
                    
                    
                    
                    219Repayment
      of capital lease obligations
                    
                    
                    (53
                    )
                    
                    
                    (42
                    )Net
      cash provided by (used in) financing activities
                    
                    
                    17
                    
                    
                    
                    (24,225
                    )Effect
      of exchange rate changes on cash and cash equivalents
                    
                    
                    (375
                    )
                    
                    
                    92Net
      increase in cash and cash equivalents
                    
                    
                    5,303
                    
                    
                    
                    1,346Cash
      and cash equivalents at beginning of period
                    
                    
                    21,742
                    
                    
                    
                    38,032Cash
      and cash equivalents at end of period
                    
                    $
                    27,045
                    
                    
                    $
                    39,378Supplemental
      disclosures of cash flow informationCash
      paid during the period for:Interest
      expense
                    
                    $
                    15
                    
                    
                    $
                    39Income
      taxes
                    
                    $
                    925
                    
                    
                    $
                    394Income
      tax receivable applied against estimated tax payments
                    
                    $
                    —
                    
                    
                    $
                    1,091Non-cash
      investing and financing activitiesCommon
      stock issuance for earn out
                    
                    $
                    —
                    
                    
                    $
                    1,050
  See
notes to consolidated financial statements
  6
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements - Unaudited
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
 
 1.
Organization
 
 Kenexa
Corporation, and its subsidiaries (collectively the "Company" or “Kenexa”),
commenced operations in 1987 as a provider of recruiting services to a wide
variety of industries. In 1993, the Company offered its first automated talent
management system. Since 1994, the Company acquired 28 businesses that enables
it to offer comprehensive human capital management, or HCM, services integrated
with web-based technology.
 
 The
Company began its operations in August 1987 under its predecessor companies,
Insurance Services, Inc., or ISI, and International Holding
Company, Inc., or IHC. In December 1999, the Company reorganized its
corporate structure by merging ISI and IHC with and into Raymond Karsan
Associates, Inc., or RKA, a Pennsylvania corporation and a wholly owned
subsidiary of Raymond Karsan Holdings, Inc., or RKH, a Pennsylvania
corporation. Each of RKA and RKH were newly created to consolidate the
businesses of ISI and IHC. In April 2000, the Company changed its name to
TalentPoint, Inc. and changed the name of RKA to TalentPoint
Technologies, Inc. In November 2000, the Company changed its name to
Kenexa Corporation, and changed the name of TalentPoint Technologies, Inc.
to Kenexa Technology, Inc., or Kenexa Technology. Currently, Kenexa
transacts business primarily through Kenexa Technology. While the Company has
several product lines, our chief decision makers determine resource allocation
decisions and assess and evaluate periodic performance under one operating
segment.
 
 The
Company provides software, services and proprietary content that enable
organizations to more effectively recruit and retain employees.  Its
solutions are built around a suite of easily configurable software applications
that automate talent acquisition and employee performance management best
practices.  In addition, the Company offers the software applications
that form the core of its solutions on an on-demand basis, which materially
reduces the costs and risks associated with deploying traditional enterprise
applications, and is complemented by software applications with tailored
combinations of outsourcing services, consulting services and proprietary
content based on the Company’s 21 years of experience assisting clients in
addressing their human resource requirements.
 
 2.
Summary of Significant Accounting Policies
 
 The
accompanying consolidated financial statements as of March 31, 2009 and for the
three months ended March 31, 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 three
months ended March 31, 2009 and 2008 have been made.  The results for
the three months ended March 31, 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. Certain reclassifications have been made in the prior period
consolidated financial statements to conform to the current period
presentation.
 
 Principles
of Consolidation
 
 The
consolidated financial statements of the Company include the accounts of Kenexa
Corporation and its subsidiaries.  All significant intercompany
accounts and transactions have been eliminated in
consolidation.
  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)
 
 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 and
cash equivalents in foreign denominated currencies which are held in foreign
banks at March 31, 2009 and December 31, 2008 totaled $6,993 and $6,935,
respectively, and represented 25.9% and 31.9% , respectively, of our total cash
and cash equivalents balance at the end of each period.
 
 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,
2009. Certain operating cash accounts may periodically exceed the FDIC insurance
limits.
 
 Short-term
Investments
 
 Short-term
investments at March 31, 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.  Short-term investments 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.
 
 Long-term
investments
 
 Long-term
investments at March 31, 2009 and December 31, 2008 include auction rate
securities.  These investments 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.
 
 Prepaid
Expenses and Other Assets
 
 Prepaid
expenses and other current assets consist primarily of prepaid software
maintenance agreements, deferred implementation costs, insurance and other
current assets. Deferred implementation costs represent internal payroll and
other costs incurred in connection with the customization of the sites
associated with our internet hosting arrangements. These costs are deferred over
the implementation period which precedes the hosting period, typically three to
four months, and are expensed ratably when the hosting period commences,
typically four to five years.
  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)
 
 Other
Long-Term Assets
 
 Other
long-term assets primarily include cash held in escrow in connection with our
acquisitions, security deposits and deferred implementation
costs.  Other long-term assets for March 31, 2009 and December 31,
2008 are as follows:
 
 March
      31,
                          2009
                        
                        
                        December
      31,
                          2008Acquisition
      related escrow balances
                        
                        $
                        1,440
                        
                        
                        $
                        1,440Investment
      in joint ventures
                        
                        
                        1,515
                        
                        
                        
                        —Security
      deposits
                        
                        
                        1,900
                        
                        
                        
                        1,966Deferred
      implementation costs
                        
                        
                        3,693
                        
                        
                        
                        3,314Fair
      value of Put Option (“UBS Settlement Agreement”)
                        
                        
                        1,657
                        
                        
                        
                        2,219Other
      long-term assets
                        
                        
                        340
                        
                        
                        
                        985Total
      other long-term assets
                        
                        $
                        10,545
                        
                        
                        $
                        9,924
 
 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.
 
 Software
Developed for Internal Use
 
 In
accordance with EITF 00-3, "Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software Stored on
Another Entity's Hardware", the Company applies AICPA Statement of
Position No. 98-1, “Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use”. The costs
incurred in the preliminary stages of development are expensed as incurred. Once
an application has reached the development stage, internal and external costs,
if direct and incremental, are capitalized until the software is substantially
complete and ready for its intended use. Capitalization ceases upon completion
of all substantial testing. The Company also capitalizes costs related to
specific upgrades and enhancements when it is probable the expenditures will
result in additional functionality. Maintenance and training costs are expensed
as incurred. Internal use software is amortized on a straight-line basis over
its estimated useful life, generally three years. Management evaluates the
useful lives of these assets on an annual basis and tests for impairments
whenever events or changes in circumstances occur that could impact the
recoverability of these assets. There were no impairments to internal software
in any of the periods covered in these consolidated financial
statements.
 
 The
Company capitalized internal-use software costs for the period ended March 31,
2009 and the year ended December 31, 2008 of $2,166 and $8,137,
respectively. Amortization of capitalized internal-use software costs for the
three months ended March 31, 2009 and 2008 was $546 and $265,
respectively.
  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)
  Goodwill
 
 On
January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, “Goodwill and Other Intangible
Assets” ("SFAS 142"), which superseded Accounting Principles Board
Opinion No. 17, “Intangible Assets”. Upon
adoption of SFAS 142, the Company ceased amortization of existing goodwill
and is required to annually review the carrying value of goodwill for
impairment. Prior to 2007, the Company evaluated the carrying value of its
goodwill under two reporting units within its single segment.  During
2007, the Company combined those two reporting units into a single reporting
unit to be in alignment with its organizational and management structure which
was evaluated and restructured as part of the integration of our acquired
businesses.  As a result of the change, the Company now evaluates
goodwill at the enterprise or Company level.
  Due to
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 and a downward revision in internal projections.  These
factors signified a triggering event, which requires 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, and acquisitions, for the period ended
March 31, 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:Quorum
                      
                      
                      963Impairment
      charge
                      
                      
                      (33,329
                      )Balance
      as of March 31, 2009
                      
                      $
                      —
  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)
 
 Revenue
Recognition
 
 The
Company derives its revenue from two sources: (1) subscription revenue for
solutions, which is comprised of subscription fees from clients accessing our
on-demand software, consulting services, outsourcing services and proprietary
content, and from clients purchasing additional support beyond the standard
support that is included in the basic subscription fee; and (2) other fees
for discrete professional services. Because the Company provides its solution as
a service, the Company follows the provisions of Securities and Exchange
Commission Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial
Statements”, as amended by Staff Accounting Bulletin No. 104, “Revenue Recognition”. On
August 1, 2003, the Company adopted Emerging Issues Task Force Issue
No. 00-21, “Revenue
Arrangements with Multiple Deliverables”. The Company recognizes revenue
when all of the following conditions are met:
 
 •
              
              There
      is persuasive evidence of an arrangement;•
              
              The
      service has been provided to the client;•
              
              The
      collection of the fees is probable; and•
              
              The
      amount of fees to be paid by the client 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 client'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
clients for amounts billed in advance of subscription services being
provided.
 
 The
Company records expenses billed to clients in accordance with "Out-of-Pocket' Expenses
Incurred” ("EITF 01-14"), which requires that reimbursements received for
out-of-pocket expenses be classified as revenues and not as cost reductions.
Before the effective date of EITF 01-14, out-of-pocket reimbursements from
clients were netted with the applicable costs. These items primarily include
travel, meals and certain telecommunication costs. For the periods ended March
31, 2009 and 2008 reimbursed expenses totaled $530 and $603,
respectively.
  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)
 
 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 March 31, 2009 and
December 31, 2008, self-insurance accruals totaled $628 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.
 
 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 clients comprising the Company's client
base and their dispersion across various industries.  The Company does
not require collateral.  The clients are concentrated primarily in the
Company's U.S. market area.  At March 31, 2009, there were no clients
that represented more than 10% of the net accounts receivable balance. There
were no clients that individually exceeded 10% of the Company's
revenues.
 
 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,
2009. Certain operating cash accounts may periodically exceed the FDIC insurance
limits.
  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)
 
 (Loss)
Earnings Per Share
 
 The
Company follows SFAS 128, "Earnings Per
Share."  Under SFAS 128, companies that are publicly held
or have complex capital structures are required to present basic and diluted
earnings per share on the face of the statement of operations.  (Loss)
earnings 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 Company had a net loss applicable to
shareholders for the period ended March 31, 2009, and net income available to
shareholders for the period ended March 31, 2008.  As a result, the
common stock equivalents of stock options issued and outstanding,
totaling 2,932,056 shares at March 31, 2009, were not included in the
computation of diluted earnings per share for the period then ended as they were
antidilutive.  For the period ended March 31, 2008, the computation of
common stock equivalents excluded options to purchase 686,600 shares of common
stock, as their effect was antidilutive.  Options to purchase shares of
common stock and restricted stock included in the computation of common stock
equivalents for the period ended March 31, 2008 totaled 235,956.
 
 Basic and
diluted earnings per share are computed as follows:
 
 Three
      months ended
                      March
      31,2009
                    
                    
                    2008Numerator:Net
      (loss) income
                    
                    $
                    (34,282
                    )
                    
                    $
                    4,774Denominator:Weighted
      average shares used to compute net (loss) income per common share -
      basic
                    
                    
                    22,509,304
                    
                    
                    
                    23,413,071Effect
      of dilutive stock options
                    
                    
                    —
                    
                    
                    
                    235,956Weighted
      average shares used to compute net (loss) income per common share –
      dilutive
                    
                    
                    22,509,304
                    
                    
                    
                    23,649,027Basic
      net (loss)  income per share
                    
                    $
                    (1.52
                    )
                    
                    $
                    0.20Diluted
      net (loss)  income per share
                    
                    $
                    (1.52
                    )
                    
                    $
                    0.20
  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, we adopted SFAS No. 123R using the Modified
Prospective Approach (“MPA”). The MPA requires that compensation expense be
recorded for restricted stock and all unvested stock options as of
January 1, 2006. Following the adoption we recognized the cost of
previously granted share-based awards under the straight-line basis over the
remaining vesting period.  The compensation expense for new
share-based awards with a service condition that cliff vest, is recognized on a
straight-line basis over the award’s requisite service period.  For
those awards with a service condition that have graded vesting, compensation
expense is calculated using the graded-vesting attribution
method.   This method entails recognizing expense on a
straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.  The pool
of excess tax benefits available to absorb tax deficiencies was determined using
the alternative transition method described in FSP FAS 123(R)-3.
 
 The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that results in a factor applied to the fair
market value of the Company’s common stock on the date of the grant (measurement
date), and is recognized over a four year explicit service period using the
straight-line method.  Since the award requires both the completion of four
years of service and the share price reaching predetermined levels as defined in
the option agreement, compensation cost will be recognized over the four year
explicit service period.  If the employee terminates prior to the
four-year requisite service period, compensation cost will be reversed even if
the market condition has been satisfied by that time.
 
 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.
 
 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 March 31,
2009 and December 31, 2008 approximate fair value of these
instruments.
 
 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 $2,374 and $3,861 for the periods ended March 31, 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.
  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)
 
 Comprehensive
(Loss) Income
 
 Comprehensive
(loss) income consists of net losses on foreign currency translations and
unrealized gains and losses on available-for-sale investment securities in
addition to reported net (loss) income.
 
 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.
 
 Adoption
of new accounting pronouncements
  In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement”
(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring
fair value, and also expands disclosures about fair value measurements. SFAS 157
is effective for periods beginning after November 15, 2007. The Company
adopted this standard with respect to its financial assets effective
January 1, 2008. In February 2008, the FASB issued FASB Staff Position SFAS
No. 157-2 – “Effective
Date of FASB Statement No. 157” delaying the effective date of SFAS
157 for one year for all non financial assets and non financial liabilities,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). See Footnote 3 of the Notes
to the Consolidated Financial Statements for further detail regarding the impact
of our adoption of SFAS 157 for financial assets.
 
 In
February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an Amendment of FASB Statement
No. 115” (SFAS 159). SFAS 159 permits the Company to
choose to measure many financial instruments and certain other items at fair
value. The Company adopted SFAS 159 as of January 1, 2008. The
adoption of SFAS 159 did not impact the Company’s consolidated financial
statements on the date of adoption. However, during the fourth quarter of 2008,
the Company elected to measure at fair value the put option related to its UBS
Settlement agreement.
  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)
 
 2.
Summary of Significant Accounting Policies (Continued)
 
 New
Accounting Pronouncements
  In April
2009, the FASB issued FSP FAS 141R-1 which amends SFAS 141R by establishing a
model to account for certain pre-acquisition contingencies. Under the FSP, an
acquirer is required to recognize at fair value an asset acquired or a liability
assumed in a business combination that arises from a contingency if the
acquisition-date fair value of that asset or liability can be determined during
the measurement period. If the acquisition-date fair value cannot be determined,
then the acquirer should follow the recognition criteria in SFAS No. 5,
Accounting for
Contingencies, and FASB Interpretation No. 14, Reasonable Estimation of the Amount
of a Loss – an interpretation of FASB Statement No. 5. We are
required to adopt SFAS No. 141R and FSP FAS 141R-1 in the first quarter of
2010. We will apply the provisions of SFAS 141R and FSP FAS 141R-1 when
applicable.
  In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about
Fair Value of Financial Instruments,” which requires the fair value for all
financial instruments within the scope of SFAS No. 107, “Disclosures about Fair
Value of Financial Instruments,” to be disclosed in the interim periods as well
as in annual financial statements. This standard is effective for fiscal
quarters ending after June 15, 2009. We are currently assessing the potential
impact that adoption of this standard may have on our financial
statements.
 In May
2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting
Principles” (SFAS 162).  SFAS 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting the
principles used in the preparation of financial statements of nongovernmental
entities that are presented in conformity with GAAP. This statement shall be
effective 60 days following the Securities and Exchange Commission’s approval of
the Public Company Accounting Oversight Board Auditing amendments to AU Section
411, “The Meaning of Present Fairly in Conformity with Generally Accepted
Accounting Principles”. The Company is evaluating the impact of this standard
and does not expect the adoption of SFAS 162 to have a material impact on the
Company’s financial statements.
 
 In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement 133”
(SFAS 161).  SFAS 161 amends and expands the disclosure
requirements of SFAS 133 with the intent to provide users of financial
statements with an enhanced understanding of: (i) How and why an entity
uses derivative instruments; (ii) How derivative instruments and related
hedged items are accounted for under SFAS 133 and its related
interpretations and (iii) How derivative instruments and related hedged
items affect an entity’s financial position, financial performance and cash
flows. This statement is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008, with early
application encouraged.
 
 In
December 2007, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 141(R), “Business
Combinations” ("FAS 141(R)")and SFAS No. 160,“Accounting and Reporting of
Noncontrolling Interests in Consolidated Financial Statements, an amendment of
Accounting Research Bulletin No. 51” ("FAS 160"). Changes for business
combination transactions pursuant to FAS 141(R) include, among others, expensing
of acquisition-related transaction costs as incurred, the recognition of
contingent consideration arrangements at their acquisition date fair value and
capitalization of in-process research and development assets acquired at their
acquisition date fair value. Changes in accounting for noncontrolling (minority)
interests pursuant to FAS 160 include, among others, the classification of
noncontrolling interest as a component of consolidated shareholders’ equity and
the elimination of "minority interest" accounting in results of operations. FAS
141(R) and FAS 160 are required to be adopted simultaneously and are effective
for fiscal years beginning on or after December 15, 2008. The adoption of FAS
141(R) will impact the accounting for the Company's future
acquisitions.  The adoption of FAS 160 did not have a
material impact on our consolidated financial position, results of operations or
cash flows.
  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.  Long-term
investments
 
 During
the three months ended March 31, 2009, the Company continued to experience
failed auctions for thirteen tax exempt auction rate securities (“ARS”) issues
representing principal of $15,473.  Nine of these ARS are guaranteed by the
Family Federal Educational Loan Program with the remainder being insured by
private issuers. Due to the uncertainty surrounding the ability to liquidate its
ARS issues over the next twelve months, the Company has continued to classify
these investments as long-term assets as of March 31, 2009.  These
securities will continue to accrue interest at the contractual rate and will be
auctioned at preset intervals.
  The ARS,
which have a par value of $17,425 at March 31, 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 “Agreement”) with UBS AG which provides (1) us with a “no
net cost” loan up to the par value of Eligible ARS until June 30, 2010,
and  (2) us 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) UBS AG the right to
purchase these auction rate securities or sell them on our behalf at par any
time through July 2, 2012.   As a result of the execution of this
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 Agreement, the
Company transferred these investments from available–for-sale to trading
securities and began recording the change in fair value of the ARS in as gains
or losses in current period earnings.
  Also,
during the fourth quarter of 2008, the Company elected to measure the value of
its option to put the securities (“put option”) to UBS AG under the fair value
option of SFAS No. 159.   As a result, at December 31, 2008, the
Company recorded non-operating gain representing the estimated fair value of the
put option and a corresponding long-term asset of approximately
$2,219.   At March 31, 2009, the put option’s estimated fair value
decreased to $1,657, resulting in a non-operating loss of $562 during the
quarter.  The estimated fair value of the put option as of March 31, 2009
was based in part on an expected life of fifteen months and a discount rate of
4.36%.   As a result of the transfer of the ARS from
available-for-sale to trading investment securities noted above, the Company
also recorded a non-operating gain during the quarter representing an increase
in their estimated fair value of approximately $267.   The recording
of the gain relating to the increase in the fair value of the ARS and the
recognition of the loss on the put option resulted in an overall loss of
approximately $295 for the quarter ended March 31, 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 March 31, 2009.  The assumptions used in preparing the
discounted cash flow model include level three inputs, as defined in SFAS No.
157, Fair Value Measurements, and are presented in the following
table:
 
 AmountsMaximum
      auction rate (interest rate)
                    
                    
                    1.45
                    %Liquidity
      risk premium
                    
                    
                    5.50
                    %Probability
      of earned maximum rate until maturity
                    
                    
                    0.01
                    %Probability
      of default
                    
                    
                    9.80
                    %
 
 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 their par
value by approximately $1,952 to $15,473 at March 31, 2009.
 
 The
Company adopted the provisions of SFAS 157 effective January 1, 2008. Under
this standard, fair value is defined as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.
  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)
 
 3.  Long-term
investments (Continued)
 
 The
Company has investments that are valued in accordance with the provisions of
SFAS 157. SFAS 157 establishes a hierarchy for inputs used in measuring fair
value that maximizes the use of observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when
available. The hierarchy is broken down into three levels based on the
reliability of inputs as follows:
 
 Level
      1 - Valuations based on quoted prices in active markets for identical
      assets that the Company has the ability to
  access.
  Level
      2 - Valuations based inputs on other than quoted prices included within
      level 1, for which all significant inputs are observable, either directly
      or indirectly.
  Level
      3 - Valuations based on inputs that are unobservable and significant to
      the overall fair value measurement.
  The fair
value for the Company’s municipal investments on March 31, 2009 and December 31,
2008 of $4,142 and $4,512, respectively, was determined based upon quoted prices
in active markets for identical assets or level 1 inputs.  The fair
value of the Company’s auction rates securities on March 31, 2009 and December
31, 2008 of $15,473 and $16,513, respectively, was determined based upon
significant unobservable inputs or level 3 inputs.
 
 A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
March 31, 2009 is presented below:
 
 Auction
      rate
                          securitiesBalance
      at December 31, 2008
                        
                        $
                        16,513Total
      net realized gainsIncluded
      in earnings
                        
                        
                        267Settlements
                        
                        
                        (1,307
                        )Balance
      at March 31, 2009
                        
                        $
                        15,473
 
 A
reconciliation of the beginning and ending balances for the auction rate
securities using significant unobservable inputs (Level 3) for the period ended
March 31, 2008 is presented below:
 
 Auction
      rate
                        securitiesBalance
      at December 31, 2007
                      
                      $
                      29,900Total
      net realized lossesIncluded
      in earnings
                      
                      
                      329Included
      in accumulated other comprehensive loss
                      
                      
                      (979
                      )Settlements
                      
                      
                      (7,987
                      )Balance
      at March 31, 2008
                      
                      $
                      21,263
 
 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.
  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)
 
 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 professional fees of $1,037, was
approximately $28,987, including acquired intangibles of $8,633, with estimated
useful lives between 3 and 10 years.  In addition, the acquisition
agreement contains an earn out provision which provides for the payment of
additional consideration by the Company based upon the gross profit of Quorum
for the twelve month periods ending June 30, 2009 and June 30, 2010. 
Formulaically, the earnout is 3.86 times Quorum’s gross profit less the amount
of base consideration, as defined in the agreement.  Pursuant to SFAS No
141., “Business
Combinations,” the Company accrues contingent purchase consideration when
the outcome of the contingency is determinable beyond a reasonable
doubt.  Based upon the results for the nine month period through March
31, 2009, no earnout was accrued to the former shareholders of Quorum for the
June 2009 payment.  In addition, as of March 31, 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 has been allocated on a
preliminary basis 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.  In accordance
with SFAS No. 141, the purchase price and related purchase price allocation may
be updated to reflect changes such as any additional transaction fees or the
finalization of the valuation of assets acquired or liabilities
assumed.  Quorum’s results of operations were included in the
Company’s consolidated financial statements beginning on April 2,
2008.
 
 5.
Property, Equipment and Software
 
 A summary
of property, equipment and software and related accumulated depreciation and
amortization as of March 31, 2009 and December 31, 2008 is as
follows:
 
 March
      31,
                            2009
                          
                          
                          December
      31,
                            2008Equipment
                          
                          $
                          15,294
                          
                          
                          $
                          15,112Purchased
      Software
                          
                          
                          5,323
                          
                          
                          
                          5,099Software
      in development
                          
                          
                          8,262
                          
                          
                          
                          7,185Software
      developed
                          
                          
                          9,962
                          
                          
                          
                          8,900Office
      furniture and fixtures
                          
                          
                          2,336
                          
                          
                          
                          2,370Leasehold
      improvements
                          
                          
                          2,730
                          
                          
                          
                          2,744Land
                          
                          
                          630
                          
                          
                          
                          643Building
                          
                          
                          6,756
                          
                          
                          
                          6,77151,293
                          
                          
                          
                          48,824Less
      accumulated depreciation and amortization
                          
                          
                          19,400
                          
                          
                          
                          17,624$
                          31,893
                          
                          
                          $
                          31,200
 
 Depreciation
and amortization expense is excluded from cost of revenues.
 
 Equipment
and office furniture and fixtures included assets under capital leases totaling
$2,612 at March 31, 2009 and December 31, 2008. Depreciation and amortization
expense, including amortization of assets under capital leases, was $2,145 and
$1,362 for the three months ended March 31, 2009 and 2008,
respectively.
  Contemporaneous
with its goodwill impairment analysis, as a result of the Company’s market
capitalization being less than stockholders’ equity at March 31, 2009, the
Company also reviewed its fixed assets and determined that the fair value
exceeded the carrying value, pursuant to SFAS No. 144, and therefore did not
record any fixed asset impairment.
  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.
Other Accrued Liabilities
 
 Other
accrued liabilities consist of the following:
 
 March
      31,
                            2009
                          
                          
                          December
      31,
                            2008Accrued
      professional fees
                          
                          $
                          235
                          
                          
                          $
                          131Straight
      line rent accrual
                          
                          
                          1,922
                          
                          
                          
                          1,904Other
      taxes payable (non-income tax)
                          
                          
                          279
                          
                          
                          
                          450Income
      taxes payable
                          
                          
                          3,977
                          
                          
                          
                          3,549Other
      liabilities
                          
                          
                          1,171
                          
                          
                          
                          1,056Contingent
      purchase price
                          
                          
                          3,000
                          
                          
                          
                          3,000Total
      other accrued liabilities
                          
                          $
                          10,584
                          
                          
                          $
                          10,090
 
 7.
Line of Credit
  As a
result of its goodwill impairment charges, the Company has not been in
compliance with certain financial covenants under its line of credit.  The
Company is currently evaluating the cost of a waiver agreement and is
considering renegotiating the credit facility for an additional term.  If
the Company is unable to negotiate a satisfactory agreement for the credit
facility waiver, the Company will lose its credit facility and all access to
previously available credit under the line of credit facility.  This could
negatively impact our financial condition and liquidity in the
future.
 
 On
November 13, 2006, the Company entered into a secured credit agreement with
PNC Bank, N.A. (the “Credit Agreement”), as administrative agent, in connection
with its acquisition of BrassRing.   The secured Credit Agreement
increased the maximum amount available under the credit facility from $25,000 to
$75,000, including a sublimit of up to $2,000 for letters of
credit.  Borrowings under the new credit facility are secured by
substantially all of the Company’s assets and the assets of its
subsidiaries.  This Credit Agreement replaced the prior $25,000
revolving Credit Agreement with PNC Bank.  In connection with this
agreement, the Company borrowed $65,000, under the credit facility, for the
acquisition of BrassRing in November 2006.
 
 In
January 2007, the Company repaid the balance of its obligations relating to the
term loan portion of the Credit Agreement with the net proceeds from the
Company’s public offering of its common stock.  The Amendment provides that
the Credit Agreement will terminate, and all borrowings will become due and
payable, on March 26, 2010.  The Company and each of the U.S. subsidiaries
of Kenexa Technology are guarantors of the obligations of Technology under the
Credit Agreement, as amended by the Amendment.
 
 On March
26, 2007, the Company entered into a First Amendment to Credit Agreement (the
“Amendment”) with PNC Bank, N.A.  The Amendment increased the maximum
amount available under the revolving credit facility portion of the Credit
Agreement from $25,000 to $50,000, including a sublimit of up to $2,000 for
letters of credit.
 
 The
Company's borrowings under the Credit Agreement bear interest at tiered rates
based upon the ratio of Net Funded Debt to EBITDA as defined in the Third
Amendment. The Company may also elect interest rates on its borrowings
calculated by reference to LIBOR plus a margin based upon the ratio of its Net
Funded Debt to EBITDA ratio. Interest on LIBOR borrowings is calculated on an
actual/360 day basis and is paid on the last day of each interest period.
LIBOR advances are available for periods of 1,2,3 or 6 months. LIBOR
pricing is adjusted for any statutory reserves.
 
 Borrowings
under the Revolver are collateralized generally by all of the Company's assets,
including a pledge of the capital stock of its subsidiaries. The Credit
Agreement contains various terms and covenants that provide for restrictions on
capital expenditures, payment of dividends, dispositions of assets, investments
and acquisitions and require the Company, among other things, to maintain
minimum levels of tangible net worth, net income and fixed charge
coverage.  As of and for the three months ended March 31, 2009 the
Company had no borrowings or the ability to borrow under this Credit
Agreement.
  20
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
 
 8.
Commitments and Contingencies
 
 Litigation
 
 The
Company is involved in claims, including those identified above, which arise in
the ordinary course of business. In the opinion of management, the Company has
made adequate provision for potential liabilities, if any, arising from any such
matters.  However, 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, and developments or assertions by or against the Company relating
to intellectual property rights and intellectual property licenses, could have a
material adverse effect on the Company’s business, financial condition and
operating results.
 
 9.
Equity
 
 Rollforward
of Shares
 
 The
Company’s common shares issued and repurchased for the three months ended March
31, 2009 and the year ended December 31, 2008 are as follows:
 
 Common
      SharesClass
      ADecember
      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
                            
                            
                            22,504,924Employee
      stock purchase plan
                            
                            
                            17,920March
      31, 2009 ending balance
                            
                            
                            22,522,844
 
 Refer to
the accompanying consolidated statements of shareholders’ equity and this note
for further discussion.
 
 Authorized
but not issued shares
 
 On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3,000,000 shares of the Company’s common
stock, of which 1,125,651 shares were repurchased at an aggregate cost of
$20,429 as of March 31, 2009.  These shares were restored to original
status prior to December 31, 2008 and accordingly are presented as authorized
but not issued.  The timing, price and volume of repurchases were
based on market conditions, relevant securities laws and other
factors.  As of March 31, 2009, the amount of shares available for
repurchase under the stock repurchase plan was 1,874,349.
  On
November 8, 2007, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 2,000,000 shares of our common stock,
of which 1,448,091 shares were repurchased at an aggregate cost of $25,482 as of
December 31, 2007. These shares were restored to original status and
accordingly are presented as authorized but not issued.  In
January 2008, the remaining 551,909 shares available for repurchase under
this stock repurchase plan were repurchased at an aggregate cost of
$9,848.
 
 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.
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 March 31, 2009, there
were options to purchase 3,034,054 shares of common stock outstanding under the
2005 Option Plan.  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 March 31, 2009, there was a total of
1,186,106 shares of common stock not subject to outstanding options and
available for issuance under the 2005 Option Plan.  The purpose of
stock options is to recognize past services rendered and to provide additional
incentive in furthering the continued success of the Company.  Stock
options granted under both the 2005 Option Plan and the 2000 Stock Option
Plan generally expire between the fifth and tenth anniversary of the date
of grant and generally vest on the third anniversary of the date of
grant.  Unexercised stock options may expire up to 90 days after
an employee's termination for options granted under the 2000 Option
Plan.
 
 SFAS 123R
requires companies to estimate the fair value of share-based payment awards on
the date of grant using an option-pricing model.  In 2009 and 2008,
the fair value of each grant was estimated using the Black-Scholes valuation
model.  Expected volatility was based upon a weighted average of peer
companies and the Company’s stock volatility.  The expected life was
determined based upon an average of the contractual life and vesting period of
the options.  The estimated forfeiture rate was based upon an analysis
of historical data.   The risk-free rate was based on U.S.
Treasury zero coupon bond yields at the time of grant.
 
 Compensation
expense, for awards with a service condition that cliff vest, is recognized on a
straight-line basis over the award’s requisite service
period.   For those awards with a service condition that have a
graded vest, compensation expense is calculated using the graded-vesting
attribution method.   This method entails recognizing expense on
a straight-line basis over the requisite service period for each separately
vesting portion as if the grant consisted of multiple awards, each with the same
service inception date but different requisite service periods.  This
method accelerates the recognition of compensation expense.
 
 The fair
value of market based, performance vesting share awards granted is calculated
using a Monte Carlo valuation model that simulates various potential outcomes of
the option grant and values each outcome using the Black-Scholes valuation model
which yields a fair market value of the Company's common stock on the date of
the grant (measurement date).  This amount is recognized over the
vesting period, using the straight-line method. Since the award requires both
the completion of 4 years of service and the share price reaching predetermined
levels as defined in the option agreement, compensation cost will be recognized
over the 4 year explicit service period.  If the employee terminates
prior to the four-year requisite service period, compensation cost will be
reversed even if the market condition has been satisfied by that time. The total
grant date fair value of the options granted during 2008 using the Monte Carlo
valuation model was $1,026.
 
 The
following table provides the assumptions used in determining the fair value of
the market and service based awards for the period ended March 31, 2009 and the
year ended December 31, 2008, respectively.
 
 Quarter
      ended
                        March
      31, 2009
                        Service
      based
                        awards
                      
                      
                      Year
      ended
                        December
      31,
                        2008
                        Service
      based
                        awards
                      
                      
                      Year
      ended
                        December
      31,
                        2008
                        Market
      based
                        awardsExpected
      volatility
                      
                      
                      63.56
                      %
                      
                      
                      56.23
      – 57.52
                      %
                      
                      
                      60.98
                      %Expected
      dividends
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      0Expected
      term (in years)
                      
                      
                      6.25
                      
                      
                      
                      3.75
                      
                      
                      
                      10Risk-free
      rate
                      
                      
                      2.53
                      %
                      
                      
                      1.87
      – 2.77
                      %
                      
                      
                      3.45
                      %
  22
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
 
 10.
Stock Plans (continued)
 
 A summary
of the status of the Company’s vested and non-vested stock options as of and for
the period periods ended March 31, 2009 and December 31, 2008 and changes during
the periods then ended is as follows:
 
 Options
      & Restricted Stock Outstanding
                              
                              Options
      ExercisableShares
                                Available for
                                Grant
                              
                              Shares
                              
                              
                              Wtd. Avg.
                                Exercise
                                Price
                              
                              Shares
                              
                              Wtd. Avg.
                                Exercise
                                PriceBalance
      at December 31, 2007
                              2,702,346
                              
                              1,601,035
                              
                              
                              $
                              21.18
                              
                              241,335
                              
                              $
                              14.96Granted
      – options
                              (1,084,600
                              )
                              1,084,600
                              
                              
                              
                              11.87
                              
                              —
                              
                              
                              —Exercised
      options and vested restricted stock
                              —
                              
                              (83,221
                              )
                              
                              
                              4.41
                              
                              —
                              
                              
                              —Forfeited
      or expired
                              114,760
                              
                              (114,760
                              )
                              
                              
                              29.28
                              
                              —
                              
                              
                              —Balance
      at December 31, 2008
                              1,732,506
                              
                              2,487,654
                              
                              
                              $
                              17.33
                              
                              447,854
                              
                              $
                              14.01Granted
      – options
                              (557,000
                              )
                              557,000
                              
                              
                              
                              4.74
                              
                              —
                              
                              
                              —Exercised
                              —
                              
                              —
                              
                              
                              
                              —
                              
                              —
                              
                              
                              —Forfeited
      or expired
                              10,600
                              
                              (10,600
                              )
                              
                              
                              28.09
                              
                              —
                              
                              
                              —Balance
      at March 31, 2009
                              1,186,106
                              
                              3,034,054
                              
                              
                              $
                              14.98
                              
                              574,154
                              
                              $
                              15.21
 
 The total
intrinsic value of options outstanding and exercisable for the period ended
March 31, 2009 was $597 and $79, respectively.  The weighted average
fair value for options granted during the three months ended March 31, 2009 and
the year ended December 31, 2008 was $2.87 and $5.67,
respectively.  The weighted-average remaining contractual term of
options outstanding and exercisable at March 31, 2009 was 6.19 and 3.85
years, respectively.
 
 Between
January 1, 2009 and March 31, 2009, the Company granted options to certain
employees to purchase an aggregate of 557,000 shares of the Company's common
stock at prevailing market price of $4.74 per share.
 
 Between
January 1, 2008 and December 31, 2008, the Company granted options to
certain employees 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)
 
 10.
Stock Plans (continued)
 
 A summary
of the status of the Company’s nonvested share options as of March 31, 2009 and
December 31, 2008 is presented below:
 
 Nonvested
      Shares
                    
                    Shares
                    
                    
                    Wtd. Avg.
                      Grant
      Date
                      Fair
      ValueNonvested
      at December 31, 2007
                    
                    1,359,700
                    
                    
                    $
                    10.73Granted
      - options
                    
                    1,084,600
                    
                    
                    
                    5.67Vested
                    
                    (293,000
                    )
                    
                    
                    8.98Forfeited
      or expired
                    
                    (111,500
                    )
                    
                    
                    12.31Nonvested
      at December 31, 2008
                    
                    2,039,800
                    
                    
                    $
                    8.24Granted
      - options
                    
                    557,000
                    
                    
                    
                    2.87Vested
                    
                    (128,500
                    )
                    
                    
                    8.18Forfeited
      or expired
                    
                    (8,400
                    )
                    
                    
                    13.21Nonvested
      at March 31, 2009
                    
                    2,459,900
                    
                    
                    $
                    6.
      71
 
 SFAS
No. 123R also requires us to change the classification of any tax benefits
realized upon exercise of stock options in excess of that which is associated
with the expense recognized for financial reporting purposes. These amounts are
presented as a financing cash inflow rather than as a reduction of income taxes
paid in our consolidated statement of cash flows.
 
 In
accordance with Staff Accounting Bulletin No. 107, we classified share-based
compensation within cost of revenues, sales and marketing, general and
administrative expenses and research and development corresponding to the same
line as the cash compensation paid to respective employees, officers and
non-employee directors.
 
 The
following table shows total share-based compensation expense included in the
Consolidated Statement of Operations:
 
 Three
      months ended
                      March
      31,2009
                    
                    
                    2008Cost
      of revenue
                    
                    $
                    110
                    
                    
                    $
                    84Sales
      and marketing
                    
                    
                    239
                    
                    
                    
                    284General
      and administrative
                    
                    
                    808
                    
                    
                    
                    1,247Research
      and development
                    
                    
                    88
                    
                    
                    
                    99Pre-tax
      share-based compensation
                    
                    
                    1,245
                    
                    
                    
                    1,714Income
      tax benefit
                    
                    
                    —
                    
                    
                    
                    488Share-based
      compensation expense, net
                    
                    $
                    1,245
                    
                    
                    $
                    1,226
  24
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
 
 10.
Stock Plans (continued)
 
 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 common shares
to our employees under the Plan. The Plan is not considered a compensatory plan
in accordance with SFAS 123(R) and requires no compensation expense to be
recognized.  Shares of our common stock purchased under the employee
stock purchase plan were 17,920 and 27,141 for the periods ended March 31, 2009
and December 31, 2008, respectively.
 
 11.  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 months ended March 31, 2009 and 2008, the Company paid Pepper Hamilton
LLP, $27 and $37, respectively, for general legal matters.  The
amounts payable to Pepper Hamilton as of March 31, 2009 and December 31, 2008
were $56 and $75, respectively.
 
 12.  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, we adopted the Financial Accounting Standard Board’s
Interpretation No. 48, “Accounting for Income Tax
Uncertainties” (“FIN 48”).  FIN 48 clarifies the accounting for
uncertain income 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.  Our
policy is to recognize interest and penalties on unrecognized tax benefits in
the provision for income taxes in the consolidated statements of
operations.  Tax years beginning in 2005 are subject to examination by
taxing authorities, although net operating loss and credit carryforwards from
all years are subject to examinations and adjustments for at least three years
following the year in which the attributes are used.
  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 three months ended March 31, 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)
 
 13.
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 months ended March 31, 2009 and 2008.
 
 For
      the three months ended
                          March
      31,
                        
                        
                        For
      the three months ended
                          March
      31,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008United
      States
                        
                        $
                        32,520
                        
                        
                        $
                        37,770
                        
                        
                        
                        83.7
                        %
                        
                        
                        78.4
                        %United
      Kingdom
                        
                        
                        2,238
                        
                        
                        
                        4,087
                        
                        
                        
                        5.8
                        %
                        
                        
                        8.5
                        %Germany
                        
                        
                        928
                        
                        
                        
                        1,027
                        
                        
                        
                        2.4
                        %
                        
                        
                        2.1
                        %The
      Netherlands
                        
                        
                        472
                        
                        
                        
                        466
                        
                        
                        
                        1.2
                        %
                        
                        
                        1.0
                        %Other
      European Countries
                        
                        
                        1,577
                        
                        
                        
                        2,112
                        
                        
                        
                        4.1
                        %
                        
                        
                        4.4
                        %Canada
                        
                        
                        41
                        
                        
                        
                        986
                        
                        
                        
                        0.1
                        %
                        
                        
                        2.0
                        %Other
                        
                        
                        1,055
                        
                        
                        
                        1,759
                        
                        
                        
                        2.7
                        %
                        
                        
                        3.6
                        %Total
                        
                        $
                        38,831
                        
                        
                        $
                        48,207
                        
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %
 
 The
following table summarizes the distribution of assets by geographic region as of
March 31, 2009 and December 31, 2008.
 
 March
      31, 2009
                                
                                
                                December
      31, 2008Country
                                
                                Assets
                                
                                
                                Assets
      as a
                                  percentage
      of
                                  total
      assets
                                
                                
                                Assets
                                
                                
                                Assets
      as a
                                  percentage
      of
                                  total
      assetsUnited
      States
                                
                                $
                                114,540
                                
                                
                                
                                62.1
                                %
                                
                                $
                                146,850
                                
                                
                                
                                67.2
                                %United
      Kingdom
                                
                                
                                43,113
                                
                                
                                
                                23.4
                                %
                                
                                
                                43,634
                                
                                
                                
                                20.0
                                %India
                                
                                
                                10,335
                                
                                
                                
                                5.6
                                %
                                
                                
                                9,099
                                
                                
                                
                                4.1
                                %Germany
                                
                                
                                9,426
                                
                                
                                
                                5.1
                                %
                                
                                
                                9,976
                                
                                
                                
                                4.6
                                %Canada
                                
                                
                                3,184
                                
                                
                                
                                1.7
                                %
                                
                                
                                3,332
                                
                                
                                
                                1.5
                                %Poland
                                
                                
                                1,464
                                
                                
                                
                                0.8
                                %
                                
                                
                                2,139
                                
                                
                                
                                1.0
                                %Other
                                
                                
                                2,358
                                
                                
                                
                                1.3
                                %
                                
                                
                                3,435
                                
                                
                                
                                1.6
                                %Total
                                
                                $
                                184,420
                                
                                
                                
                                100.00
                                %
                                
                                $
                                218,465
                                
                                
                                
                                100.0
                                %
 
 14.
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 capital contribution provided
the Company with a 46% ownership in the new entity Shanghai Kenexa Human
Resources Consulting Co., Ltd, (the “joint venture”) and a presence in China’s
growing human capital management market.  Based upon
the adjusted EBITDA, as defined in the agreement, for each of the years ended
2008, 2009 and 2010, the Company will acquire an additional 1% ownership per
year for each of the years ended 2009, 2010 and 2011 in the joint
venture.
 
 The
additional ownership in the joint venture in 2009 will be determined as the
greater of 1) the amount of registered capital attributable to a 1% ownership or
2) an amount denominated in Chinese Yuan Renminbi (“RMB¥”) equal to the result
of 47% times four and one half times the Adjusted EBITDA of the joint venture
for the calendar year ended December 31, 2008, plus 1% of the joint venture’s
free cash flow as of March 31, 2008, minus the amount of the initial investment
or RMB¥ 8,145.  The additional ownership investment for 2010 and 2011
is determined formulaically the same as above and adjusted only for any increase
in ownership
 
 Pursuant to APB No. 18, “The Equity Method of Accounting for
Investment in Common Stock”, paragraph 6(b), the Company recorded its
investment in the joint venture at cost and will periodically adjust the
carrying amount of the investment to recognize its share of the earnings or
losses of the joint venture following the acquisition.  The amount of
this adjustment will be included in the Company’s statement of operations and
will continue to be adjusted as its underlying share ownership
changes.  Since the Company holds more than 20% of the outstanding
stock and has control or influence in the joint venture the equity method will
be used to account for its activity.
  26
  Kenexa
Corporation and Subsidiaries
 Notes
to Consolidated Financial Statements (Continued)
 (All
amounts in thousands, except share and per share data, unless noted
otherwise)
 
 Item
2: Management's Discussion and Analysis of Financial Condition and Results of
Operations
 
 This Quarterly Report on Form 10-Q,
including the following Management’s Discussion and Analysis of Financial
Condition and Results of Operations, contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, Section
21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995, that involve a number of risks and
uncertainties. These forward-looking statements include, but are not limited to,
plans, objectives, expectations and intentions and other statements contained
herein that are not historical facts and statements identified by words such as
“expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates”
or words of similar meaning. These statements may contain, among other things,
guidance as to future revenue and earnings, operations, prospects of the
business generally, intellectual property and the development of
products.  These statements are based on our current beliefs or
expectations and are inherently subject to various risks and uncertainties,
including those set forth under the caption “Risk Factors” in our most recent
Annual Report on Form 10-K as filed with the Securities and Exchange Commission,
as amended and supplemented under the caption “Risk Factors” in our subsequent
Quarterly Reports on Form 10-Q filed with the Securities and Exchange
Commission, including this Quarterly Report on Form 10-Q.  Actual
results may differ materially from these expectations due to changes in global
political, economic, business, competitive, market and regulatory factors, our
ability to implement business and acquisition strategies or to complete or
integrate acquisitions.  We do not undertake any obligation to update
any forward-looking statements contained herein as a result of new information,
future events or otherwise. References herein to “Kenexa,” “we,” “our,” and “us”
collectively refer to Kenexa Corporation, a Pennsylvania corporation, and all of
its direct and indirect U.S., U.K., Canada, India, and other foreign
subsidiaries.
 
 1.
Overview
 
 We
provide software, services and proprietary content that enable organizations to
more effectively recruit and retain employees. Our solutions are built around a
suite of easily configurable software applications that automate talent
acquisition and employee performance management best practices. We offer the
software applications that form the core of our solutions on an on-demand basis,
which materially reduces the costs and risks associated with deploying
traditional enterprise applications. We complement our software applications
with tailored combinations of outsourcing services, consulting services and
proprietary content based on our 21 years of experience assisting clients in
addressing their human resource requirements. Together, our software
applications and services form solutions that we believe enable our clients to
improve the effectiveness of their talent acquisition programs, increase
employee productivity and retention, measure key HR metrics and make their
talent acquisition and employee performance management programs more
efficient.
 
 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 three
months ended March 31, 2009 and 2008, revenue from these subscriptions comprised
approximately 85.7% and 81.2%, 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 client base of approximately 4,400
companies, including approximately 180 companies on the Fortune 500 list
published in April 2008. Our client 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 client. Our top 80
clients contributed approximately $22.4 million, or 57.7%, of our total revenue
for the three months ended March 31, 2009.
  27
 
 Over the
past six months, as a result of the deteriorating financial conditions, growth
levels of the global economy have slowed to near historic lows as measured by
most indices.  Unemployment in the United States was at a 20 year high of
8.5% in March 2009.  As the economy continues to deteriorate,
economists have increased their joblessness estimates from 9.3% to over 10%
nationwide by late 2009 or early 2010.  During the first quarter of 2009,
gross domestic product contracted at an annualized 6.1% rate, a rate not
experienced in the United States since the 1982 recession, and much faster than
previous government forecasts.   Globally, the outlook was similar as
the Organization for Economic Cooperation and Development's leading indicator
edged closer to lows recorded during the oil shock of the early 1970s. 
Taken together, all of these factors (i.e. high unemployment, slower domestic
growth and global recession) will likely adversely affect our business in 2009
and perhaps beyond.  However, the extent or degree to which we may be
affected by these events is extremely difficult to predict.   The
uncertain economic prospects being experienced by our clients will likely
translate into slower growth, or contraction, for us, since a substantial
portion of our business is dependent upon our clients’ hiring and human capital
needs.  However, we believe that, by optimizing our internal resources for
the current business conditions, we can minimize these adverse effects and
emerge from this economic crisis with a stronger and more efficient operating
model.
 
 Although
our compound annual growth of revenue for the three year period ending December
31, 2008 was 45.9% and our clients have historically renewed their subscriptions
at an approximately 90% rate each year, some of our customers, facing
uncertainty and cost pressures in their own businesses during the current
economic downturn, have indicated that they are waiting to purchase our products
and are otherwise increasingly seeking purchasing terms and conditions that are
less favorable to us. As a result of this trend, we experienced lower renewal
rates during the second half of fiscal 2008, resulting in a renewal rate by
aggregate value of multi-year subscriptions for the year ended December 31, 2008
of approximately 75% and as a result we have forecasted lower business levels
for 2009.
 
 Due to
the decline in our stock price and market capitalization, expected reductions in
projected future net income, reduced future cash flow estimates and predicted
slower growth rates in our industry, we recorded an impairment charge totaling
$167.0 million for the year ended December 31, 2008, representing a portion
of our acquired goodwill.  During the quarter ended March 31, 2009, we
recorded an additional impairment charge totaling $33.3 million, representing
the remaining acquired goodwill.
 
 Although,
in the intermediate term, our liquidity was adversely affected by the downturn
in the credit markets and our credit facility may be affected by our non-cash
goodwill impairment charge recognized in the fourth quarter 2008 and first
quarter of 2009, we believe that the UBS settlement agreement for our auction
rate securities, cash and short-term investments on hand and our projected cash
from operations will be sufficient to meet our liquidity needs for at least the
next twelve months.
 
 2.
Recent Events
 
 During
the quarter ended March 31, 2009, due to a 32.5% decline in our stock price and
market capitalization from the previous quarter, lower projected net income,
cash flow estimates and slower projected growth rates in our industry, we
reevaluated our goodwill impairment analysis.  Our analysis was
performed to determine the implied fair value of our goodwill with neither the
write up or write down of any assets or liabilities, nor recording any
additional unrecognized identifiable intangible assets.  Based upon
our analysis we recorded a goodwill impairment charge of $33.3 million during
the quarter ended March 31, 2009. This goodwill impairment charge had no effect
on our cash balances.
 
 In
response to the challenging macroeconomic environment, the strengthening U.S.
dollar relative to other currencies of countries in which we do business, and
the resulting slowing or delaying of a number of project implementations we
announced, during the fourth quarter 2008, a restructuring program involving
staff reductions of approximately 12% of our workforce which included one-time
severance and outplacement benefit 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 and incurring $
1.2 million in one-time severance and outplacement benefits.
 
 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
professional 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 the
Company 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 period through March 31, 2009, we do
not believe an earnout will be due to the former shareholders of Quorum for the
period through June 2009.  The acquisition of Quorum broadened our
presence in the global recruitment market.
  28
 
 On
February 20, 2008, our board of directors authorized a stock repurchase plan
providing for the repurchase of up to 3.0 million shares of our common stock, of
which 1.1 million shares were repurchased at an aggregate cost of $20.4 million
as of December 31, 2008.  These shares were restored to original
status and accordingly are presented as authorized but not
issued.  The timing, price and volume of repurchases were based on
market conditions, relevant securities laws and other factors.  As of
March 31, 2009, the amount of shares available for repurchase under the stock
repurchase plan was 1.9 million.  In addition, in January 2008, we
repurchased 0.5 million shares under a previously authorized stock repurchase
plan for an aggregate cost of $9.8 million.
 
 3. Sources of
Revenue
  We derive
revenue primarily from two sources: (1) subscription revenue for our
solutions, which is comprised of subscription fees from clients accessing our
on-demand software, consulting services, outsourcing services and proprietary
content, and from clients purchasing additional support that is not included in
the basic subscription fee; and (2) fees for discrete professional
services.
 
 Our
clients 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 clients have the right to terminate their contracts for cause if we
fail to provide the agreed upon services or otherwise breach the agreement. A
client 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 March 31, 2009 lower than expected renewal
rates in the range of 70% - 80% of the aggregate value of multi-year
subscriptions for our on-demand talent acquisition and performance management
solution contracts rather than our historical renewal rate of approximately
90%.  We expect this trend to continue through the end of
2009.  Consistent with our historical practices, revenue derived from
subscription fees is recognized ratably over the term of the subscription
agreement. We generally invoice our clients in advance in monthly or quarterly
installments and typical payment terms provide that our clients pay us within 30
days of invoice. Amounts that have been invoiced are recorded in accounts
receivable prior to the receipt of payment and in deferred revenue to the extent
revenue recognition criteria have not been met. As a result of cyclical annual
subscription renewals and the addition of one large customer payment during the
first quarter of 2009, the amount of deferred revenue on our balance sheet has
increased.  As of March 31, 2009, deferred revenue increased to $41.4
million from $38.6 million at December 31, 2008. We generally price our
solutions based on the number of software applications and services included and
the number of client 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 March 31, 2009, approximately 83.7% of our total revenue was
derived from sales in the United States. Revenue that we generated from clients
in United Kingdom, Germany, and Netherlands was approximately 5.8%, 2.4%, 1.2%,
respectively, for the quarter ended March 31, 2009. Revenue for all other
countries amounted to an aggregate of 6.9%. Other than the countries listed, no
other country represented more than 2.0% of our total revenue for the quarter
ended March 31, 2009.
  29
  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 year
                                          ended
                                          December 31,
                                        
                                        
                                        For the three months ended
                                          March 31,2008
                                        
                                        
                                        2009
                                        
                                        
                                        2008(unaudited)
                                        
                                        
                                        (unaudited)Total
      Revenue
                                        $
                                        203,732
                                        
                                        
                                        $
                                        38,831
                                        
                                        
                                        $
                                        48,207Subscription
      revenue as a percentage of total revenue
                                        
                                        80.2
                                        %
                                        
                                        
                                        85.7
                                        %
                                        
                                        
                                        81.2
                                        %Non-gaap
      income from operations
                                        $
                                        36,563
                                        
                                        
                                        $
                                        3,932
                                        
                                        
                                        $
                                        9,083Net
      cash provided by operating activities
                                        $
                                        32,465
                                        
                                        
                                        $
                                        8,880
                                        
                                        
                                        $
                                        3,559As
      of March 31,2009
                                        
                                        
                                        2008(unaudited)
                                        
                                        
                                        (unaudited)Deferred
      revenue
                                        $
                                        38,638
                                        
                                        
                                        $
                                        41,427
                                        
                                        
                                        $
                                        37,481
  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 from operations adjusted for noncash or nonrecurring
expenses.  We believe that measuring our operations, using non-gaap
income from operations depicts more accurately our ongoing results.
 
 For
      the year
                      ended
                      December 31,
                    
                    
                    For the three months ended
                      March 31,2008
                    
                    
                    2009
                    
                    
                    2008(unaudited)
                    
                    
                    (unaudited)
                    
                    
                    (unaudited)(Loss)
      income from operations
                    
                    $
                    (144,158
                    )
                    
                    $
                    (33,568
                    )
                    
                    $
                    6,527Stock-based
      compensation expense
                    
                    
                    5,761
                    
                    
                    
                    1,245
                    
                    
                    
                    1,714Amortization
      of intangibles associated with acquisitions
                    
                    
                    5,456
                    
                    
                    
                    1,083
                    
                    
                    
                    842Restructuring
      charges
                    
                    
                    1,979
                    
                    
                    
                    1,156
                    
                    
                    
                    —Legal
      fees related to restructuring charges
                    
                    
                    514
                    
                    
                    
                    —
                    
                    
                    
                    —Goodwill
      impairment charge
                    
                    
                    167,011
                    
                    
                    
                    33,329
                    
                    
                    
                    —Professional
      fees associated with joint ventures
                    
                    
                    —
                    
                    
                    
                    687
                    
                    
                    
                    —Non-gaap
      income from operations
                    
                    $
                    36,563
                    
                    
                    $
                    3,932
                    
                    
                    $
                    9,083
  Subscription
revenue as a percentage of total revenue. Subscription revenue as a
percentage of total revenue can be derived from our consolidated statements of
operations. This performance indicator illustrates the evolution of our business
towards subscription-based solutions, which provide us with a recurring revenue
stream and which we believe to be a more compelling revenue growth and
profitability opportunity. While subscription revenue as a percentage of total
revenue increased to 85.7%, due to a decrease in other revenue, we expect that
the percentage of subscription revenue will be in the range of 78% to 82% of our
total revenues for the year ended 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. We expect this trend to continue because of the advance
payment structure of our subscription agreements.
  30
  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 clients
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 reasonably 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
                                                            March 31,2008
                                                          
                                                          2009
                                                          
                                                          
                                                          2008(unaudited)
                                                          
                                                          
                                                          (unaudited)Deferred
      revenue at the beginning of the period
                                                          $
                                                          35,076
                                                          
                                                          $
                                                          38,638
                                                          
                                                          
                                                          $
                                                          35,076Total
      invoiced subscriptions during period
                                                          
                                                          166,982
                                                          
                                                          
                                                          36,054
                                                          
                                                          
                                                          
                                                          41,561Subscription
      revenue recognized during period
                                                          
                                                          (163,420
                                                          )
                                                          $
                                                          (33,265
                                                          )
                                                          
                                                          $
                                                          (39,156
                                                          )Deferred
      revenue at end of period
                                                          $
                                                          38,638
                                                          
                                                          
                                                          41,427
                                                          
                                                          
                                                          
                                                          37,481
  31
  5.
Results of Operations
  Three
months ended March 31, 2009 compared to three months ended March 31,
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
                                                                March 31,2009
                                                              
                                                              
                                                              2008Amount
                                                              
                                                              Percent of
                                                                Revenues
                                                              
                                                              
                                                              Amount
                                                              
                                                              Percent of
                                                                RevenuesRevenue:Subscription
      revenue
                                                              
                                                              $
                                                              33,265
                                                              
                                                              85.7
                                                              %
                                                              
                                                              $
                                                              39,156
                                                              
                                                              81.2
                                                              %Other
      revenue
                                                              
                                                              
                                                              5,566
                                                              
                                                              14.3
                                                              %
                                                              
                                                              
                                                              9,051
                                                              
                                                              18.8
                                                              %Total
      revenue
                                                              
                                                              
                                                              38,831
                                                              
                                                              100.0
                                                              %
                                                              
                                                              
                                                              48,207
                                                              
                                                              100.0
                                                              %Cost
      of revenue
                                                              
                                                              
                                                              13,696
                                                              
                                                              35.3
                                                              %
                                                              
                                                              
                                                              13,105
                                                              
                                                              27.2
                                                              %Gross
      profit
                                                              
                                                              
                                                              25,135
                                                              
                                                              64.7
                                                              %
                                                              
                                                              
                                                              35,102
                                                              
                                                              72.8
                                                              %Operating
      expenses:Sales
      and marketing
                                                              
                                                              
                                                              8,705
                                                              
                                                              22.4
                                                              %
                                                              
                                                              
                                                              9,889
                                                              
                                                              20.5
                                                              %General
      and administrative
                                                              
                                                              
                                                              10,873
                                                              
                                                              28.0
                                                              %
                                                              
                                                              
                                                              11,993
                                                              
                                                              24.9
                                                              %Research
      and development
                                                              
                                                              
                                                              2,568
                                                              
                                                              6.6
                                                              %
                                                              
                                                              
                                                              4,542
                                                              
                                                              9.4
                                                              %Depreciation
      and amortization
                                                              
                                                              
                                                              3,228
                                                              
                                                              8.3
                                                              %
                                                              
                                                              
                                                              2,151
                                                              
                                                              4.5
                                                              %Goodwill
      impairment charge
                                                              
                                                              
                                                              33,329
                                                              
                                                              85.8
                                                              %
                                                              
                                                              
                                                              —
                                                              
                                                              —Total
      operating expenses
                                                              
                                                              
                                                              58,703
                                                              
                                                              151.2
                                                              %
                                                              
                                                              
                                                              28,575
                                                              
                                                              59.3
                                                              %(Loss)
      income from operations
                                                              
                                                              
                                                              (33,568
                                                              )
                                                              (86.4
                                                              )%
                                                              
                                                              
                                                              6,527
                                                              
                                                              13.5
                                                              %Interest
      income, net
                                                              
                                                              
                                                              63
                                                              
                                                              0.2
                                                              %
                                                              
                                                              
                                                              641
                                                              
                                                              1.3
                                                              %Loss
      on change in fair market value of ARS and put option, net
                                                              
                                                              
                                                              (295
                                                              )
                                                              0.8
                                                              %
                                                              
                                                              
                                                              —
                                                              
                                                              —(Loss)
      income from operations before income taxes
                                                              
                                                              
                                                              (33,800
                                                              )
                                                              (87.0
                                                              )%
                                                              
                                                              
                                                              7,168
                                                              
                                                              14.9
                                                              %Income
      tax expense
                                                              
                                                              
                                                              482
                                                              
                                                              1.2
                                                              %
                                                              
                                                              
                                                              2,394
                                                              
                                                              5.0
                                                              %Net
      (loss) income
                                                              
                                                              $
                                                              (34,282
                                                              )
                                                              (88.3
                                                              )%
                                                              
                                                              $
                                                              4,774
                                                              
                                                              9.9
                                                              %
  Revenue
 
 Our total
revenue decreased $9.4 million or 19.5% to $38.8 million, subscription revenue
decreased $5.9 million or 15.1% to $33.3 million and other revenue decreased by
$3.5 million or 38.9% to $5.5 million for the three months ended March 31, 2009,
compared to the same periods in 2008, respectively.  Subscription and
other revenue represented approximately 85.7% and 14.3% of our total revenue,
respectively, for the three months ended March 31, 2009 as compared to
81.2% and 18.8%, respectively, for the three month period ended March 31,
2008.  The decrease in our revenues for the three months ended March
31, 2009 from the prior period is primarily attributable to the effects arising
from the global economic recession, increased pricing pressures, high
unemployment, and reduced demand for our products and services.  Based
upon the current market conditions, we expect 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.
  32
 
 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
clients. 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, pricing trends, changes in the amount of
reimbursed expenses and fluctuations in our client base. Because cost as a
percentage of revenue is higher for professional services than for software
products, an increase in the services component of our solutions or an increase
in discrete professional services as a percentage of our total revenue would
reduce gross profit as a percentage of total revenue.  As our overall
revenue begins to decline, we expect our cost of revenue to decline
proportionately, subject to pricing pressure related to economic conditions and
slightly influenced by the mix of services and software.
 
 Cost of
revenue increased by $0.6 million or 4.6% to $13.7 million for the three months
ended March 31, 2009 compared to the same period in 2008. Decreased salary
expense of $0.7 million was offset by an increase in severance expense recorded
during the quarter ended March 31, 2009.   The $0.6 million
increase was due to increased third party fees, including marketing and agency
costs, of approximately $0.3 million and an increase in overhead expense due to
the addition of 30 employees needed to support our foreign customer’s
business requirements as part of our Quorum acquisition of approximately
$0.3 million.  As a percentage of revenue, cost of revenue increased
from 27.2% to 35.3% for the three months ended March 31, 2009, compared to the
same period in 2008 primarily due to decreased revenues.
 
 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 clients and
expand relationships with existing clients 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 decrease, mainly due to reduced commission expense
partially offset by increased branding expense, as business conditions
dictate.
 
 S&M
expense decreased by $1.2 million or 12.1% to $8.7 million for the three months
ended March 31, 2009 compared to the same period in 2008. The $1.2 million
decrease was due primarily to decreased commission, bonus, travel and bad debt
expenses of $0.8 million, $0.1 million, $0.5 million and $0.6 million,
respectively, partially offset by an increase in salary and marketing
expenses of $0.6 million and $0.2 million, respectively. The increase in salary
expense was attributable to the addition of 23 employees to support our
increased sales efforts. As a percentage of revenues, S&M expense
increased from 20.5% to 22.4% for the three months ended March 31, 2009,
compared to the same period in 2008 due to decreased revenues.
 
 General and
Administrative(“G&A”)
expense
 
 G&A
expense primarily consists of personnel and related costs for our executive,
finance, human resources and administrative personnel, professional fees and
other corporate expenses and allocated overhead.  Based upon the
current state of the economy, we believe that general and administrative
expenses will remain the same or decrease in dollar amount and increase as a
percentage of total revenue in 2009.
 
 G&A
expense decreased $1.1 million or 9.2% to $10.9 million for the three
months ended March 31, 2009 compared to the same period in 2008. The $1.1
million decrease for the quarter ended March 31, 2009 was due primarily to
reduced staff related expenses including bonus and stock compensation expense of
$1.1 million and $0.4 million, respectively.  The decrease in these
expenses was partially offset by an increase in rent expense from the Quorum
acquisition which contributed $0.4 million to the increase during the quarter
ended March 31, 2009, compared to the prior year.  As a percentage of
revenues, G&A expense increased from 24.9% to 28.0% for the three months
ended March 31, 2009, compared to the same period in 2008 due to decreased
revenues.
  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 $2.2 million and $2.3 million for the
three months ended March 31, 2009 and 2008, respectively.  The
remaining R&D activities have been expensed as incurred.
 
 R&D
expense decreased $1.9 million or 42.2% to $2.6 million, for the three months
ended March 31, 2009 compared to the same period in 2008.  The $1.9
million decrease for the quarter ended March 31, 2009 was due primarily to
reduced staff expense and overhead in connection with the consolidation of three
of our India offices as well as an improvement in the efficiency of our
technology strategy..  Also contributing to the decline in R&D
expense was a decrease of $0.3 million of relocation expense, incurred during
the first quarter of 2008, for our India R&D operations and the effect
of more favorable foreign exchange rates which contributed approximately 25% to
the decrease.   Finally, a small portion of our R&D expense
relates to the efforts of our Kenexa Research Institute scientists, which is
more fixed in nature. This cost structure will result in future R&D expense
being more constant and also a greater percentage of revenue as our revenue
decreases.  We expect research and development expenses to remain flat
or increase slightly as we continue to execute on our strategies which include
furthering the common services enterprise architecture, introducing Kenexa 2x
modules, and continuing to develop feature enhancements.
 
 Depreciation and
Amortization
  Depreciation
and amortization expense increased by $1.1 million or 52.4% to $3.2 million for
the three months ended March 31, 2009, compared to the same period in
2008. The $1.1 million increase was due in part to increased amortization
expense associated with acquisitions and increased depreciation expense
associated with our capitalized software and our capital purchases including our
building in Vizag, India.  In the year ended December 31, 2009, we
expect depreciation and amortization expense to increase due to recent capital
purchases.
 
 Goodwill
Impairment
  Due to
continued adverse changes in the economic climate, we experienced a 32.5%
decline in our market capitalization from December 31, 2008 through March 31,
2009 and a downward revision in internal projections.  Pursuant to
SFAS No. 142, “Goodwill
and Other Intangible Assets”, these factors signified a triggering event,
which requires the determination as to whether and to what extent our 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 our 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 we had an estimated fair value that was less than our carrying
value (including goodwill) at March 31, 2009. The next step entails performing
an analysis to determine whether the carrying amount of goodwill on our balance
sheet exceeds our implied fair value. Our implied fair value of our goodwill for
this step was determined in a similar manner as goodwill recognized in a
business combination. That is, our estimated fair value was allocated to our
assets and liabilities, including any unrecognized identifiable intangible
assets, as if we had been acquired in a hypothetical business combination with
our estimated fair value representing the price paid to acquire us. 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, we recorded
a goodwill impairment charge of $33.3 million for the quarter ended March 31,
2009 to write off the remaining balance of our goodwill. The goodwill impairment
charge had no effect on our cash balances.
 
 Income
tax expense on operations
 
 Income tax expense on operations
decreased by $1.9 million or 79.2% to $0.5 million for the three months ended
March 31, 2009 compared to the same periods in 2008.  The decrease in
expense was due to continued global expansion and related increase in taxable
income recognized in jurisdictions with relatively lower effective tax rates
than from the prior periods.
 
 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 March 31, 2009, we had cash and cash equivalents
of $27.0 million, short-term investments of $4.1 million and long-term
investments of $15.5 million. In addition, we had no debt and approximately
$0.2 million in capital equipment leases.
 
 Our cash
provided from operations was $8.9 million and $3.6 million for the three months
ended March 31, 2009 and 2008, respectively.  Cash used in investing
activities was $3.2 million for the three months ended March 31, 2009 and cash
provided by investing activities was $21.9 million for the three months ended
March 31, 2008.  Cash provided by financing activities was less than
$0.1 million for the three months ended March 31, 2009 and cash used in
financing activities was $24.2 million for the three months ended March 31,
2008.  Our net increase in cash and cash equivalents was $5.3 million
for the three months ended March 31, 2009, resulting primarily from our
operating activities, and our net increase in cash and cash equivalents was $1.3
million for the three months ended March 31, 2008, resulting primarily from our
cash from operations.   We expect positive cash flow to continue
in future periods.
 
 As of
March 31, 2009, we held auction rate securities with a fair value of $15.5
million and par value of $17.4 million. Our auction rate securities portfolio
includes solely AA- and AAA-rated investments, comprised of federally 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 other 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 to (1) us a “no net cost” loan up to the par
value of Eligible ARS until June 30, 2010, (2) us 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) UBS AG the right to purchase these auction rate securities or sell them
on the 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).
 
 As a
result of our goodwill impairment charge in the fourth quarter of 2008 and the
first quarter of 2009, we are no longer in compliance with certain financial
covenants under our line of credit.  We are currently evaluating the
cost of a waiver agreement and are considering renegotiating the credit facility
for an additional term.  If we are unable to negotiate a satisfactory
agreement for the credit facility waiver, we will lose our credit facility and
all access to previously available credit from the
facility.   This could negatively impact our financial condition
and liquidity.
 
 Although,
in the intermediate term, our liquidity was adversely affected by the downturn
in the credit markets and our credit facility may be affected by our non-cash
goodwill impairment charges recognized in the fourth quarter 2008 and first
quarter 2009, we believe that the 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 1,316,009 shares of our common stock at an average price of
$18.66 per share and an aggregate cost of $24,607 for the three months ended
March 31, 2008.
  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 three 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 $8.9 million and $3.6 million for the three
months ended March 31, 2009 and 2008, respectively.  Net cash
provided by operating activities for the three months ended March 31, 2009
resulted primarily from a net loss of approximately $34.3 million, changes
in working capital of $2.8 offset by non-cash charges to net income of $4.8
million, a non-cash goodwill impairment charge of $33.3 million, an increase in
deferred revenue of $2.6 million, and a decrease in accounts receivables of
approximately $5.2 million. Net cash provided by operating activities for
the three months ended March 31, 2008 resulted primarily from net income of
approximately $4.8 million, non-cash charges to net income of $3.5 million, and
an increase in deferred revenue of $2.4 million, partially offset by changes in
working capital of $4.3 million, an increase in accounts receivable of $2.7
million and a reduction in taxes payable resulting from the excess tax
benefits from share based payments of $0.1 million.
 
 Investing
Activities
 
 Net cash
used in and provided by investing activities was $3.2 million and $21.9 million
for the three months ended March 31, 2009 and 2008, respectively, and consisted
of the following, in millions:
 
 
 For
      the three
                      months
      ended
                      March
      31, 2009
                    
                    
                    For
      the three
                      months
      ended
                      March
      31, 2008Scottworks
      acquisition
                    
                    $
                    —
                    
                    
                    $
                    (
      0.1
                    )StraightSource
      acquisition
                    
                    
                    —
                    
                    
                    
                    (1.1
                    )HRC
      acquisition
                    
                    
                    —
                    
                    
                    
                    (0.1
                    )Quorum
      acquisition
                    
                    
                    (0.4
                    )
                    
                    
                    —Capitalized
      software and purchases of computer hardware
                    
                    
                    (3.0
                    )
                    
                    
                    (5.6
                    )Purchases
      of available-for-sale securities
                    
                    
                    (0.8
                    )
                    
                    
                    (16.3
                    )Sales
      of available-for-sale securities
                    
                    
                    1.2
                    
                    
                    
                    45.1Sales
      of trading securities
                    
                    
                    1.2
                    
                    
                    
                    —Investment
      in joint venture
                    
                    
                    (1.4
                    )
                    
                    
                    —Total
      cash flows (used in) and provided by investing activities
                    
                    $
                    3.2
                    
                    
                    $
                    21.9
  In the
future, we expect our capital expenditures to increase as business needs
arise.
 
 Financing
Activities
  Net cash
provided by and used in financing activities was less than $0.1 million and
$24.2 million for the three months ended March 31, 2009 and 2008, respectively.
  For the three months ended March 31, 2008, net cash used in financing
activity consisted of repurchases of our common shares of $24.6 million,
partially offset by net proceeds from stock option exercises of $0.2 million,
excess tax benefits from share-based payment arrangements of $0.1 million and
proceeds from our employee stock purchase plan of $0.1 million.
  We
believe that our cash and cash equivalent balances and cash flows from
operations will be sufficient to satisfy our working capital and capital
expenditure requirements for at least the next 12 months.  We intend
to continue to invest our cash in excess of current operating requirements in
interest-bearing, investment-grade securities. Changes in our operating plans,
lower than anticipated revenue, increased expenses or other events, may cause us
to seek additional debt or equity financing. Financing may not be available on
acceptable terms, or at all, and our failure to raise capital when needed could
negatively impact our growth plans and our financial condition and consolidated
results of operations. Additional equity financing would be dilutive to the
holders of our common stock, and debt financing, if available, may involve
significant cash payment obligations and covenants or financial ratios that
restrict our ability to operate our business.
  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 clients accessing our on-demand
software, consulting services, outsourcing services and proprietary content, and
from clients purchasing additional support beyond the standard support that is
included in the basic subscription fee; and (2) other fees for professional
services, translation services and reimbursed out-of-pocket expenses. Because we
provide our solutions as a service, we follow the provisions of Staff Accounting
Bulletin No. 101, “Revenue Recognition in Financial
Statements”, as amended by Staff Accounting Bulletin No. 104, “Revenue Recognition”. On
August 1, 2003, we adopted Emerging Issues Task Force Issue No. 00-21,
“Revenue Arrangements with
Multiple Deliverables”. We recognize revenue when all of the following
conditions are met:
  •
              
              there
      is persuasive evidence of an
arrangement;
  •
              
              the
      service has been provided to the
client;
  •
              
              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 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.
 
 Other Revenue. Other revenue
consists of discrete professional services, translation services and
reimbursable out-of-pocket expenses. Discrete professional services, when sold
with subscription and support offerings, are accounted for separately since
these services have value to the customer on a stand-alone basis and there is
objective and reliable evidence of fair value of the delivered elements. Our
arrangements do not contain general rights of return. Additionally, when
professional services are sold with other elements, the consideration from the
revenue arrangement is allocated among the separate elements based upon the
relative fair value. Revenues from professional services are recognized as the
services are rendered.
 
 In
determining whether revenues from professional services can be accounted for
separately from subscription revenue, we consider the following factors for each
agreement: availability of professional services from other vendors, whether
objective and reliable evidence of the fair value exists of the undelivered
elements, the nature and the timing of when the agreement was signed in
comparison to the subscription agreement start date and the contractual
dependence of the subscription service on the customer's satisfaction with the
other services. If the professional service does not qualify for separate
accounting, we recognize the revenue ratably over the remaining term of the
subscription contract. In these situations we defer the direct and incremental
costs of the professional service over the same period as the revenue is
recognized.
  In
accordance with EITF 01-14, “Out-of-Pocket Expenses Incurred”we record reimbursements received for out-of-pocket expenses as revenue
and not netted with the applicable costs.  These items primarily
include travel, meals and certain telecommunication costs.  Reimbursed
expenses totaled $0.5 million and $0.6 million for the three months ended March
31, 2009 and 2008, respectively.
  37
 
 Allowance
for Doubtful Accounts
 
 We
maintain an allowance for doubtful accounts for estimated losses resulting from
clients’ inability to pay us. The provision is based on our historical
experience and for specific clients that, in our opinion, are likely to default
on our receivables from them. In order to identify these clients, we perform
ongoing reviews of all clients 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 clients, and we have less
payment history to rely upon with these clients. 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 clients and evaluate these clients over
time. To the extent that our future collections differ from our assumptions
based on historical experience, the amount of our bad debt and allowance
recorded may be different.
 
 Capitalized
Software Research and Development Costs
 
 In
accordance with EITF Issue 00-3, “Application of AICPA Statement of
Position 97-2 to Arrangements That Include the Right to Use Software Stored on
Another Entity's Hardware”, we apply AICPA Statement of Position
No. 98-1, “Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use”.
The costs incurred in the preliminary stages of development are expensed as
incurred. Once an application has reached the development stage, internal and
external costs, if direct and incremental, will be capitalized until the
software is substantially complete and ready for its intended use.
Capitalization ceases upon completion of all substantial testing. We also
capitalize costs related to specific upgrades and enhancements when it is
probable the expenditures will result in additional functionality. Maintenance
and training cost are expensed as incurred. Internal use software is amortized
on a straight-line basis over its estimated useful life, generally three years.
Management evaluates the useful lives of these assets on an annual basis and
tests for impairments whenever events or changes in circumstances occur that
could impact the recoverability of these assets. There were no impairments to
internal software in any of the periods covered in this report.
 
 Goodwill
and Other Identified Intangible Asset Impairment
 
 On
January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible
Assets”,which superseded Accounting Board Opinion No. 17, “Intangible Assets”. Upon
adoption of SFAS No. 142, we ceased amortization of existing goodwill and
are required to review the carrying value of goodwill for impairment. If
goodwill becomes impaired, some or all of the goodwill could be written off as a
charge to operations. This comparison is performed annually or more frequently
if circumstances change that would more likely than not reduce the fair value of
the reporting unit below its carry amount.
 
 During
the three months ended March 31, 2009 and December 31, 2008 we reviewed the
carrying values of goodwill by comparing the carrying values to the estimated
fair values of the enterprise. The fair value is based on management’s estimate
of the future discounted cash flows to be generated by the enterprise and our
market capitalization. Such cash flows consider factors such as future operating
income, historical trends, as well as demand and competition. Comparable company
multiples are based upon public companies in sectors relevant to our business
based on our knowledge of the industry. Changes in the underlying business could
affect these estimates, which in turn could affect our assessment of the
recoverability of goodwill.
 
 Based on
the analysis a goodwill impairment charge of $33.3 million and $167.0 million
for the three and twelve months ended March 31, 2009 and December 31, 2008,
respectively was recorded. The goodwill impairment charge had no effect on our
cash balances, but did cause us to be out of compliance with certain covenants
under our credit facility pursuant to which we did not as of March 31, 2009, and
do not as of the date of this report, have any borrowings or the ability to
borrow.
  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 subsequently traded as short-term
investments because of the interest rate reset feature. Consequently, we have
historically classified our auction rate securities as available for sale
short-term investments at par.
 
 During
2008, as a result of the deterioration in the credit markets, our auction rate
securities failed to trade at recent auctions due to insufficient bids from
buyers. These events have led to uncertainty surrounding the short-term
liquidity of our auction rate security investments.   Since it is
not possible to predict when auctions for the securities we hold will succeed in
the future, we have classified our auction rate securities to long-term
investments on our Consolidated Balance Sheet as of March 31, 2009.
 
 Our
auction rate securities, which have a par value of $17.4 million at
 March 31, 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
“Agreement”) with UBS AG which provides to (1) us with a “no net cost” loan up
to the par value of Eligible ARS until June 30, 2010, (2) us 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) 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 this Agreement, we 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
Agreement, we transferred these investments from available–for-sale to trading
securities and began recording the change in fair value of the ARS in as gains
or losses in current period earnings.
  Also,
during the fourth quarter of 2008, we elected to measure the value of our option
to put the securities (“put option”) to UBS AG under the fair value option of
SFAS No. 159.   As a result, at December 31, 2008, we recorded
non-operating gain representing the estimated fair value of the put option and a
corresponding long-term asset of approximately $2,219.   At March 31,
2009, the put option’s estimated fair value decreased to $1,657, resulting in a
non-operating loss of $562 during the quarter.  The estimated fair value of
the put option as of March 31, 2009 was based in part on an expected life of
fifteen months and a discount rate of 4.36%.   As a result of the
transfer of the ARS from available-for-sale to trading investment securities
noted above, we also recorded a non-operating gain during the quarter
representing an increase in their estimated fair value of approximately
$267.   The recording of the gain relating to the increase in the fair
value of the ARS and the recognition of the loss on the put option resulted in
an overall loss of approximately $295 for the quarter ended March 31,
2009.
 
 We
anticipate that any future changes in the fair value of our put option under the
agreement with UBS AG will be offset by the changes in the fair value of the
related auction rate securities with no material net impact to our consolidated
statement of operations. Our option to put the securities to UBS AG under the
agreement will continue to be measured at fair value utilizing Level 3 inputs as
defined by SFAS 157 until the earlier of its maturity or exercise.
 
 The fair
values of our auction rate securities are estimated utilizing a discounted cash
flow analysis or other types of valuation models as of March 31, 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 the Company’s shares as well as potential
reactions to such share price movements by Company management.  Such
assumptions include the natural logarithm of the Company’s stock price, a random
log-difference using the Russell 2000 stock index and a random variable using
the specific deviations of the Company’s returns relative to the returns
dictated by the CAPM model.
 
 Accounting
for Income Taxes
 
 We
account for income taxes in accordance with FASB Statement No. 109, “Accounting for Income
Taxes,” or SFAS No. 109, which requires that deferred tax
assets and liabilities be recognized using enacted tax rates for the effect of
temporary differences between the book and tax basis of recorded assets and
liabilities. SFAS No. 109 also requires that deferred tax assets be
reduced by a valuation allowance if it is more likely than not that some portion
or all of the deferred tax asset will not be realized.
 
 The
realization of the deferred tax assets is evaluated quarterly by assessing the
valuation allowance and by adjusting the amount of the allowance, if necessary.
The factors used to assess the likelihood of realization are the forecast of
future taxable income and available tax planning strategies that could be
implemented to realize the net deferred tax assets. We have used tax-planning
strategies to realize or renew net deferred tax assets in order to avoid the
potential loss of future tax benefits.  In addition, we operate within
multiple taxing jurisdictions and are subject to audit in each jurisdiction.
These audits can involve complex issues that may require an extended period of
time to resolve. In our opinion, adequate provisions for income taxes have been
made for all periods.
 
 Self-Insurance
 
 We are
self-insured for the majority of our health insurance costs, including claims
filed and claims incurred but not reported subject to certain stop loss
provisions. We estimate our liability based upon management’s judgment and
historical experience. We also rely on the advice of consulting administrators
in determining an adequate liability for self-insurance claims. As of March 31,
2009 and December 31, 2008, self-insurance accruals totaled approximately
$0.6 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. We do not hold or issue financial instruments for
trading purposes.
 
 Foreign
Currency Exchange Risk
 
 A key
component of our business strategy is to expand our international sales efforts,
which will expose us to foreign currency exchange rate fluctuations. A 10%
change in the value of the U.S. dollar relative to each of the currencies of our
non-U.S. generated sales would have not resulted in a material change to our
results.  As of March 31, 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
$2.4 million and a gain of $0.1 million for the three months ended March
31, 2009 and 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, including commercial paper, 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 year ended December
31, 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
  We 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.  However, 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, and developments or assertions by or against us relating to
intellectual property rights and intellectual property licenses, 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 following risk factors, which contain material changes
to, and amend and restate in their entirety, the risk factors set forth 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 below
in this item 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.
 
 Item
2: Unregistered Sales of Equity Securities and Use of Proceeds
 
 Issuer
Purchases of Equity Securities.
  None
 
 Item
3: Defaults Upon Senior Securities
 
 Not
applicable.
 
 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.
  42
 
 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.
 
 May 11,
2009
 Kenexa
Corporation
 
 /s/ Nooruddin S. KarsanNooruddin
      S. KarsanChairman
      of the Board and Chief Executive Officer/s/ Donald F. VolkDonald
      F. VolkChief
      Financial Officer
  43
  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.
  44