UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-K

|ý                                            | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|-------------------------------------------- | ----------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2005 
|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            

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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         
|Securities registered pursuant to Section 12(b) of the Act:                

Title of each class

Name of each exchange on which registeredNone

N/A


Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01 per share
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  o    No  ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act.
Yes  o    No  ý

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  ý    No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. ý

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

Large
Accelerated Filer  o                Accelerated
Filer  o                Non-accelerated filer  ý

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Act).
Yes  o    No  ý

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2005 was $111,320,840. Such aggregate market
value was computed by reference to the closing price of the common stock as reported on the Nasdaq National Market on June 30, 2005. For purposes of determining this amount only, the registrant
has defined affiliates as including the executive officers and directors of registrant on June 30, 2005.

The
number of shares outstanding of the registrant's Common Stock as of February 17, 2006 was 17,517,984.

DOCUMENTS INCORPORATED BY REFERENCE

DOCUMENT

FORM 10-K REFERENCEPortions of Proxy Statement for
2006 Annual Meeting of Shareholders

Part III




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KENEXA CORPORATION
FORM 10-K
DECEMBER 31, 2005

TABLE OF CONTENTS

|         |          |  |                                                                                                              | Page
|-------- | -------- |  | ------------------------------------------------------------------------------------------------------------ | ----
|PART I   |          |  |                                                                                                              |     
|         | Item 1.  |  | Business                                                                                                     |     
|         | Item 1A. |  | Risk Factors                                                                                                 |     
|         | Item 1B. |  | Unresolved Staff Comments.                                                                                   |     
|         | Item 2.  |  | Properties                                                                                                   |     
|         | Item 3.  |  | Legal Proceedings                                                                                            |     
|         | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |     
|PART II  |          |  |                                                                                                              |     
|         | Item 5.  |  | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchased of Equity Securities |     
|         | Item 6.  |  | Selected Financial Data                                                                                      |     
|         | Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                        |     
|         | Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |     
|         | Item 8.  |  | Financial Statements and Supplementary Data                                                                  |     
|         | Item 9.  |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |     
|         | Item 9A. |  | Controls and Procedures                                                                                      |     
|         | Item 9B. |  | Other Information                                                                                            |     
|PART III |          |  |                                                                                                              |     
|         | Item 10. |  | Directors and Executive Officers of the Registrant                                                           |     
|         | Item 11. |  | Executive Compensation                                                                                       |     
|         | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |     
|         | Item 13. |  | Certain Relationships and Related Transactions                                                               |     
|         | Item 14. |  | Principal Accountant Fees and Services                                                                       |     
|PART IV  |          |  |                                                                                                              |     
|         | Item 15. |  | Exhibits, Financial Statement Schedules                                                                      |     

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PART I

This Annual Report on Form 10-K and the documents incorporated herein contain "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Those statements are therefore entitled to the protection of
the safe harbor provisions of these laws. These forward-looking statements, which are usually accompanied by words such as "may," "might," "will," "should," "could," "intends," "estimates,"
"predicts," "potential," "continue," "believes," "anticipates," "plans," "expects" and similar expressions, involve risks and uncertainties, and relate to, without limitation, statements about our
market opportunities, our strategy, our competition, our projected revenue and expense levels and the adequacy of our available cash resources. There are important factors that could cause our actual
results, level of activity, performance or achievements to differ materially from those expressed or forecasted in, or implied by, such forward-looking statements, particularly those factors discussed
in "Item 1ARisk Factors" in this Annual Report on Form 10-K.

Although
we believe that the expectations reflected in these forward-looking statements are based upon reasonable assumptions, no assurance can be given that such expectations will be
attained or that any deviations will not be material. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report on
Form 10-K may not occur and our actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We disclaim any obligation
or undertaking to disseminate any updates or revision to any forward-looking statement contained herein to reflect any change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.

ITEM 1. Business

Company 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 18 years of experience assisting clients in addressing their HR requirements. Together,
our software applications and services form what are commonly referred to as solutions. We believe that these solutions enable our clients to improve the effectiveness of their talent acquisition
programs, increase employee productivity and retention, measure key HR metrics and make their hiring and employee performance management programs more efficient.

We
sell our solutions to large- and medium-sized organizations through our direct sales force. As of December 31, 2005, we had a client base of approximately 2,200 companies,
including approximately 119 companies on the Fortune 500 list published in April 2005. As a result of our acquisition of Webhire, Inc. in January 2006, we increased our client
base to approximately 2,400 companies, including approximately 131 companies on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services
during the year ended December 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately 65.6% and 70.6% of our
total revenue for the years ended December 31, 2004 and 2005, respectively. Our clients typically purchase multi-year subscriptions which provide us with a recurring revenue stream.
During the year ended December 31, 2005, our clients renewed more than 90% of the aggregate contract value eligible to be renewed during the period.

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Our Initial Public Offering

On June 29, 2005, we completed our initial public offering in which we sold an aggregate of 5,750,000 shares of our common stock, including 750,000 shares
sold pursuant to the underwriters' exercise of their over-allotment option on July 3, 2005, at a price of $12.00 per share. The net proceeds from our initial public offering
aggregated approximately $61.7 million after deducting underwriting commissions and offering expenses. We used approximately $28.6 million and $11.4 million of the net proceeds of
our offering to pay for part of the consideration for the redemption of all outstanding shares of our series A and series B redeemable preferred stock, respectively. We used the balance
of the net proceeds from our initial public offering for general corporate purposes including our acquisition of Webhire, Inc. in January 2006.

Recent Transactions

On December 29, 2005, we entered into an amendment to our revolving credit facility with PNC Bank, N.A. Under the terms of this amendment, our maximum
borrowings under our revolving credit facility increased from $10.0 million to $25.0 million, including availability of up to $2.0 million for letters of credit.

On
January 13, 2006, we acquired Webhire, Inc., a provider of end-to-end talent acquisition solutions for recruitment and human resource
professionals in middle-market enterprises across all industries, for approximately $34.4 million in cash. We intend to sell Webhire's talent acquisition system along with our existing talent
acquisition system to Webhire's and our clients under the name Kenexa Recruiter.

Industry Overview

Talent acquisition is the sourcing, recruiting, screening and assessment of employees. Employee performance management is the systematic process by which an
organization tracks, monitors and optimizes employee behavior and productivity, and evaluates performance through employee reviews, appraisals and business metrics.



According to the Bureau of Economic Analysis, an agency of the U.S. Department of Commerce, the amount spent on U.S. labor in 2004 was approximately $6.8
trillion, or approximately 56% of the total U.S. gross domestic product. In January 2005, HR Magazine reported that as much as 80% of a company's worth is tied to its human capital. At the same
time, competition for qualified employees continues to intensify, driven by the retirement of the baby-boomers, the increasing service component of the U.S. economy and improved economic
conditions. According to the U.S. Bureau of Labor Statistics, the unemployment rate in January 2006 of 4.7% was at its lowest level since July 2001.

Over
the past two decades, many organizations have implemented software systems that systemize best practices and drive efficiency in most departments, including enterprise resource
planning systems, customer relationship management systems and supply chain management systems. These software applications provide a wide array of benefits that both increase revenue growth and
eliminate expenses. Based on our experience, however, we believe that the HR departments of many of these organizations have only implemented HR information systems, which track basic employee
information for payroll and benefits purposes, or rudimentary applicant tracking systems. Although these systems provide some level of automation, they do little to increase the effectiveness of
talent acquisition and employee performance management programs. Based on our experience, we believe that few organizations have systemized best practices for talent acquisition and employee
performance management or have implemented software applications to support these processes and provide HR professionals with critical analytics and metrics.

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Our
experience indicates that, presently, many organizations' talent acquisition functions consist of manual, paper-based processes, ad hoc outsourcing and third-party or custom software
applications with limited functionality. As a result, we believe that they suffer from the following shortcomings:



Similarly,
based on our experience, we believe that many organizations have neither automated nor applied best practices to employee performance management. We believe that most
organizations' employee performance management processes consist of annual performance reviews and informal mentoring programs. According to a December 2004 study by Aberdeen Group, 52% of
respondents reported that their organization is locked into paper-based evaluations that are conducted yearly and rarely reviewed again. In fact, Aberdeen Group reported that 90% of respondents cited
improved employee performance management as a key to competitive advantage. We believe that effective employee performance management requires a consistent, systemized process that identifies employee
strengths, weaknesses and issues in a timely manner, continually aligns employee goals with the evolving goals of the organization, monitors opportunities for internal advancement and enables
management to analyze employee data over time. The absence of effective employee performance management systems and processes has the following negative implications:



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We
believe that the failure to employ sophisticated systems in their talent acquisition and employee performance management processes inhibits organizations from leveraging valuable data
generated through these functions. This can negatively impact organizations in several ways, including the failure both to identify overall trends that could improve the efficiency and effectiveness
of its processes and to quickly identify problems that could lead to employee turnover.



Based on our experience, we believe that organizations have become increasingly dissatisfied with traditional enterprise software applications, resulting in the
growing adoption of the on-demand model for enterprise software. Traditionally, organizations have purchased perpetual software licenses and deployed enterprise software applications
on-site within their IT environment. This traditional method of purchasing and deploying enterprise software applications has left many organizations questioning whether the benefits of
these technologies outweigh the following burdens:



Recent
developments in technology have enabled software developers to offer enterprise software applications on an on-demand basis. Leveraging the Internet, multi-tiered
architectures, advances in security and open standards for application integration, software vendors can offer software applications to their clients as a service, hosting the software on servers
operated by the software vendor. Clients,

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using
an Internet browser, access the applications, which are designed to be easily configured and integrated with a client's existing applications.

The
on-demand model fundamentally changes both the purchasing and deployment of enterprise software from a client perspective. Rather than making large, up-front
investments in perpetual licenses, clients purchase limited term subscriptions for on-demand software applications. Further, because only an Internet browser is required to access
on-demand software applications, which can be easily configured to meet the buyer's specific needs, organizations eliminate the expense of ancillary technology and third-party services
required to implement, configure and maintain the enterprise application on-site. Finally, the finite duration of client subscriptions provides a strong incentive to software vendors to
ensure that the software provides the expected benefits to the client, resulting in consistent customer service. The on-demand model also reduces research and development support costs for
the software developer. Because only limited versions of the software exist at any one time, the on-demand model relieves the burden of maintaining and upgrading historical versions of the
software. These dynamics are driving growth in the market for software on-demand.

We
believe that talent acquisition and employee performance management applications are particularly well-suited to the on-demand model. Talent acquisition and
employee performance management applications are generally purchased by an organization's HR department. Because the HR departments of most organizations have little historical experience making
capital
expenditures for enterprise software applications, we believe that providing these departments the opportunity to license software applications on a subscription basis eliminates a major impediment to
the adoption of talent acquisition and employee performance management applications.

Our Solution

We are a leading provider of talent acquisition and employee performance management solutions. Our solutions enable organizations to implement systematic talent
acquisition practices that ensure the efficient, effective and consistent hiring of qualified individuals. Our solutions also provide employee performance management systems that help to ensure that
organizations retain and optimize the performance of qualified individuals and identify employees who fail to perform. Our solutions are built around a suite of easily configurable software
applications that automate talent acquisition and employee performance management best practices. We believe that by providing our software applications on an on-demand basis, we
materially reduce the costs and risks associated with traditional enterprise software application implementations. We also believe that implementing feature-rich and scalable, or easily
configurable on a real-time basis, talent acquisition and employee performance management solutions that meet organizations' specific needs requires a combination of software, services and
domain-specific content. Accordingly, we complement our software applications with consulting services, outsourcing services and proprietary content. Together, these components form solutions that
enable our clients to improve the quality of their hiring programs, increase employee productivity and retention and make their talent acquisition and employee performance management programs more
cost-effective.



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Our Strategy

Our objective is to be the leading global provider of talent acquisition and employee performance management solutions. Key elements of our strategy include:



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Our Products and Services



Kenexa Recruiter.The Kenexa Recruiter system is a web-based talent acquisition system that streamlines and
automates the entire recruiting process. Kenexa Recruiter includes the following features:



We
intend to sell Webhire's web-based talent acquisition system along with our existing talent acquisition system to Webhire's and our client base under the name Kenexa
Recruiter.

Kenexa PeopleQuest.Our PeopleQuest system enables clients to expand the pool of qualified candidates for an open position by
automating the phone interview. By combining voice recognition technology from a third party, software and consulting services, the PeopleQuest solution assists clients in creating friendly and
effective pre-recorded phone interviews tailored to their specific needs. Our software also automates the data gathering, screening and interview scheduling process so that
high-potential candidates are processed efficiently.

Kenexa Prove It!The Kenexa Prove It! tool is an automated, easily configurable skills assessment tool that enables our
clients to accurately identify qualified candidates. Integrating software with proprietary content, Kenexa Prove It! provides our clients with over 800 skills assessments for clerical, software, call
center, industrial, healthcare and technical jobs.

Kenexa Selector.The Kenexa Selector tool is an automated, easily configurable candidate assessment tool that provides
accurate performance predictions for hourly, sales and managerial positions. Kenexa Selector integrates our software with our proprietary content to elicit responses that reveal candidate personality,
experience and problem-solving ability and then immediately translates this information into profiles of candidate strengths and weaknesses.

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Kenexa Insight.The Kenexa Insight solution is a consulting-based solution that provides our clients with customized,
research-based interviews that accurately and consistently identify talented candidates for hire and promotion. Our consultants work directly with our clients to analyze the most talented performers
in different positions within their organization. We translate this analysis into complete structured interviews that identify candidates that have similar traits and behaviors to our clients' most
talented employees. We offer clients the option of conducting the interviews themselves or outsourcing this task to our professionals. Following the interview, we track the results to validate the
relationship between the interview and actual performance.

Kenexa Interview Builder.Our Interview Builder tool is a software tool integrated with a reference library of proprietary
content, including more than 1,200 interview questions and competency profiles. Our clients use Interview Builder to generate efficient, accurate and consistent interviews that encourage candidates to
speak freely about their knowledge, abilities, skills and other crucial job requirements for more than 40 different competencies. We complement this proprietary content with training for creating and
conducting competency-linked, structured interviews.



Kenexa CareerTracker.The Kenexa CareerTracker system is a complete employee performance management system that streamlines
and automates the entire employee performance management process in order to improve employee retention and productivity. The Kenexa CareerTracker system consists of a suite of software applications
complemented by proprietary content and consulting services that together support an ongoing performance appraisal process and continuous employee improvement.

Kenexa
CareerTracker enables managers to:



Kenexa
CareerTracker enables employees to:



Kenexa Survey Technology.We believe that our survey technology enables our clients to conduct employee surveys that are easy
to administer even though the underlying organizational requirements are extremely complex. Our survey technology is comprised of:



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Multi-rater surveys.These surveys combine software, proprietary content and consulting services to provide our clients with
a comprehensive outsourced competency assessment service, including design, administration and reporting. The solution integrates our competency library, which contains more than 40 competencies and a
broad array of assessment items designed to measure the discrete behaviors that comprise a competency, with consulting services provided by our staff psychologists who have significant experience
developing, implementing and validating competency assessments.

Employee engagement surveys.Our consultants assist our clients in designing, administering and analyzing employee engagement
surveys. We developed our Employee Engagement model through studies of organizational effectiveness and a comprehensive review of the academic literature related to employee commitment, psychological
ownership, organizational pride, loyalty and satisfaction. We conduct analyses which link survey results to business metrics. By linking the survey results to clients'
performance variables, we can recommend actions for improved performance. We have documented the relationship between employee attitudes and business outcomes such as customer satisfaction, employee
retention and management effectiveness. We have used this information to improve customer satisfaction, to increase efficiency and ultimately to increase our clients' financial performance.



In concert with providing talent acquisition and employment performance management solutions that enable organizations to implement best practices in these areas,
we provide our clients with the option of outsourcing to us certain aspects of their staffing operations and recruiting campaigns, including the sourcing, recruiting, screening, assessment and
on-boarding of employees. Acknowledging that organizations need to retain strategic control of their HR programs, we offer our clients the ability to outsource only the tactical components
and design solutions that meet each client's specific objectives. These solutions combine our services and technology in what we believe is an integrated delivery platform that allows organizations to
manage fluctuation in hiring needs and leverage shared infrastructure to reduce costs. We employ a team of experienced staffing professionals who have worked in the internal departments of some of the
world's largest companies and have completed our comprehensive proprietary training and certification program.

We
believe our employment process outsourcing, or EPO, services enable our clients to reduce operating costs, focus on their core business, create a variable cost structure around
certain non-strategic HR functions, improve the quality of certain HR functions, foster innovation and obtain access to leading technology without the corresponding investment to own the
technology themselves. Clients contract for our EPO services for a pre-determined period. Generally, we will enter into service level agreements with our clients to ensure the quality of
our services.

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Our
EPO services include the following:



Our
EPO services are provided in concert with our talent acquisition and employee performance management solutions and we have developed proprietary technology for large volume sourcing
performed by our sourcing center in Hyderabad, India, enabling us to provide these services in an efficient and scalable manner.

Customer Support

We believe that superior customer support is critical to our clients. Our customer support group assists our clients by answering questions and troubleshooting
our solutions. Customer support is available 24 hours a day, 7 days a week by telephone, email and over the Internet from a member of our customer support team. Each member of our
customer support team receives comprehensive training and orientation to ensure that our clients receive high-quality support and service. Each of our clients is assigned a single point of
contact. When an issue is reported to us, our customer support

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personnel
follow a clearly defined escalation process to ensure that mission-critical issues are resolved to the satisfaction of the client. We believe that our customer service model has materially
contributed to our client retention rate. During the year ended December 31, 2005, we renewed more than 90% of the aggregate contract value subject to renewal.

We
utilize our talent acquisition and employee performance management solutions to recruit and manage our customer support personnel. We believe that applying these solutions to our
customer service department has resulted in a customer support group with superior skills, competencies and aptitude for customer service. As of December 31, 2005, our customer support group
consisted of 26 employees, 17 of whom are located in Lincoln, Nebraska and 9 of whom are located in Hyderabad, India.

Technology, Development and Operations



Our integrated suite of talent acquisition and employee performance management solutions is built on a multi-tier, platform independent Java 2
Platform, Enterprise Edition, or J2EE, architecture using our Core Application Framework, which consists of open source components, commercially available products and our own proprietary tools. The
Core Application Framework consists of the following components:



Our
software is designed to support easy-to-use features such as dynamic workflows, job templates and user configuration that enable clients to adapt the
application for their specific requirements. Dynamic workflows are designs that facilitate business processes whereby one step in the process cannot be completed until all prior steps have been
completed.

We
provide our clients with two options to use our solutions. Most of our clients use our solutions on an on-demand basis, with only a limited number of our clients
implementing our solutions on-site.



Innovation is an important part of our business. We believe that three primary factors drive our innovation: our employees, our domain experts and our clients. We
have a formalized system to cultivate participation from all of our employees in research and development. We also leverage the experience of our research scholars and domain experts, who produce
white papers, case studies and

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thought
pieces which form the foundation for our innovation. Our research and development team maintains a repository of ideas, and selected ideas are presented to the market validation team. Market
validated ideas progress to the prototype stage. The executive team reviews prototypes and selects those with the highest potential, which then enter the product development phase. In addition to our
employees and domain experts, some of the key ideas are generated from client feedback.

We
follow a development methodology that we believe allows us to develop projects quickly and then proceed on a predictable, low risk path for high-quality results. We
conduct our product development through our global development center, which consists of four locations: Hyderabad, India, Lincoln, Nebraska, Wayne, Pennsylvania and Lexington, Massachusetts. Product
development is primarily conducted at our highly efficient facility in India, which we established in 2003. As of December 31, 2005, we employed approximately 110 developers in India, 30 in
Nebraska and 20 in Pennsylvania. In connection with our acquisition of Webhire in January 2006, we added approximately 20 additional developers in Massachusetts. Our development process is ISO
9001:2000 certified.



Our data center in Wayne, Pennsylvania serves as the primary hosting facility for our on-demand solutions. We also have a secondary data center in
Lincoln, Nebraska. We adhere to industry standards and best practices in our global operations. We have entered into service level agreements with many of our clients. We have a comprehensive load
balanced environment for optimal performance and server redundancy to avoid single points of application failure. The environment is shared across clients to reduce costs for each individual client.
Each client's data is stored in a separate logical partition in the database, allowing increased security and maintenance efficiency in backing up data or exporting data to the client when requested.

Our
data center personnel are Certified Information Systems Security Professionals, or CISSPs, with training in the latest security and availability threats. Our data centers are
continuously and proactively monitored by a comprehensive set of tools and personnel, 24 hours a day, 7 days a week. Our data centers have built-in power redundancy, with two
uninterrupted power supplies backed up by an industrial strength generator to provide uninterrupted service to our clients. We have documented our network, server and database management procedures
including backup and recovery.

Clients

As of December 31, 2005, we had a base of approximately 2,200 active clients over a number of industries, including financial services and banking,
manufacturing, life sciences, biotechnology and pharmaceuticals, retail, healthcare, hospitality, call centers, and education, including 119 companies on the Fortune 500 list published in
April 2005. As a result of our acquisition of Webhire, Inc. in January 2006, we increased our client base to approximately 2,400 companies, including approximately 131 companies
on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services during the year ended December 31, 2005 and does not necessarily indicate
an ongoing relationship with each such client. For the year ended December 31, 2005, we provided our talent acquisition and employee performance management solutions on a subscription basis to
approximately 1,950 clients, with an average subscription term of two years. Other than a small number of perpetual license sales, the remainder of our clients in 2005 engaged us to provide
discrete professional services and may not engage us for future services once a project is completed. No single client accounted for more than 10% of our revenue in the year ended December 31,
2005.

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Sales and Marketing

Our target clients are large- and medium-sized organizations with complex talent acquisition and employee performance management needs. We sell our solutions to
both new and existing clients primarily through our direct sales force, which is comprised of inside sales, telesales and field sales personnel. As of December 31, 2005, we had 78 sales and
marketing representatives. Our marketing strategy focuses on generating qualified sales leads and building our brand. We generate sales leads through a combination of the marketing efforts described
below and a third-party lead generation service. We have sales offices located in Wayne, Pennsylvania, Philadelphia, Pennsylvania, Lincoln, Nebraska, London, England, Toronto, Canada and Hyderabad,
India. In connection with our acquisition of Webhire in January 2006, we added a sales office in Lexington, Massachusetts.

We
believe that our client relationships provide us with a meaningful opportunity to cross-sell additional solutions to our existing clients and to achieve greater
penetration with the organization. We have established a program intended to increase cross-selling into our largest clients, and we expect to continue to create innovative programs designed to incent
our employees and maximize the value from each of our clients.

Our
marketing initiatives are generally targeted toward specific vertical industries or specific solutions. Our marketing programs primarily consist of:



We
have focused our public relations efforts on building our brand. In 2004, we were recognized by the League of American Communication Professionals as the Gold winner of the 2004
Magellan Awards in the Publicity Campaign Competition for our media campaign that created awareness of Kenexa Selector, our pre-employment assessment offering.

Intellectual Property

Our intellectual property rights are important to our business. We rely on a combination of copyright, trade secret, trademark and other common laws in the United
States and other jurisdictions, as well as
confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. We currently have one pending patent application.

Although
we rely primarily on copyright, trade secret and trademark law, written agreements and common law, we believe that the following factors are more essential to establishing and
maintaining a competitive advantage:



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Others
may develop products that are similar to our technology. We generally enter into confidentiality and other written agreements with our employees and partners, and through these
and other written agreements, we attempt to control access to and distribution of our software, documentation and other proprietary technology and other information. Despite our efforts to protect our
proprietary rights, third parties may, in an unauthorized manner, attempt to use, copy or otherwise obtain and market or distribute our intellectual property rights or technology or otherwise develop
a product with the same functionality as our software. Policing unauthorized use of our software and intellectual property rights is difficult, and nearly impossible on a worldwide basis. Therefore,
we cannot be certain that the steps we have taken or will take in the future will prevent misappropriation of our technology or intellectual property rights, particularly in foreign countries where we
do business or where our software is sold or used, where the laws may not protect proprietary rights as fully as do the laws of the United States or where enforcement of such laws is not common or
effective.

Substantial
litigation regarding intellectual property rights exists in the software industry. From time to time, in the ordinary course of our business, we are subject to claims
relating to our intellectual property rights or those of others, and we expect that third parties may commence legal proceedings or otherwise assert intellectual property claims against us in the
future, particularly as we expand the complexity and scope of our business, the number of similar products increases and the functionality of these products further overlap. We cannot be certain that
no third party intellectual property rights that exist could result in a claim against us in the future. These actual and potential claims and any resulting litigation could subject us to significant
liability for damages. In addition, even if we prevail, litigation could be time consuming and expensive to defend and could affect our business materially and adversely. Any claims or litigation from
third parties may also limit our ability to use various business processes, software and hardware, other systems, technologies or intellectual property subject to these claims or litigation, unless we
enter into license agreements with the third parties. However, these agreements may be unavailable on commercially reasonable terms, or not available at all.

Competition

We have experienced, and expect to continue to experience, intense competition from a number of companies. We compete with niche point solution vendors, such as
Authoria, Inc., BrassRing, LLC, Deploy Solutions, Inc., iCIMS, Inc., Integrated Performance Systems, Inc., InScope Corporation, PeopleClick, Inc., Performix
Technologies, Inc., Pilat HR Solutions, Inc., Previsor, Inc., Recruitmax Software, SHL Group plc, Success Factors, Inc., Taleo Corporation, Unicru, Inc., Virtual
Edge Corporation and Workstream Software, Inc., that offer products that compete with one or more applications in our suite of solutions. In some aspects of our business, we also compete with
established vendors of enterprise resource planning software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG and Lawson, Inc. To a lesser extent, we compete with
vendors of employment process outsourcing services and survey services such as Accolo, The Gallup Organization, Hyrian, LLC and Recruitment Enhancement Services.

The
principal competitive factors in our industry include:



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We
believe that we generally compete favorably with respect to these factors.

We
may face future competition in the talent acquisition and employee performance management market from large, established companies, such as Oracle and SAP, as well as from emerging
companies. Barriers to entry into our industry are relatively low, new software products are frequently introduced and existing products are continually enhanced. In addition, we expect that there is
likely to be consolidation in our industry, which would lead to increased price competition and other forms of competition. Established companies not only may develop their own competitive products,
but may also acquire or establish cooperative relationships with current or future competitors, including cooperative relationships between both larger, established and smaller public and private
companies.

In
addition, our ability to sell our solutions will depend, in part, on the compatibility of our software with software provided by our competitors. Our competitors could alter their
products so that they will no longer be compatible with our software or they could deny or delay access by us to advance software releases, which would limit our ability to adapt our software to these
new releases. If our competitors were to bundle their products in this manner or make their products
non-compatible with ours, our ability to sell our solutions might be harmed and could reduce our gross margins and operating income.

Employees

As of December 31, 2005, we had 693 employees, consisting of 78 employees in sales and marketing, 162 in development, 380 in delivery of our solutions and
73 in general and administrative positions. None of our employees are represented by a union. We consider our relationship with our employees to be good and have not experienced any interruptions of
our operations as a result of labor disagreements.

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ITEM 1A. Risk Factors

We operate in a market environment that involves significant risks, many of which are beyond our control. The following risk factors may
adversely impact our results of operations, cash flows and the market price of our common stock. Although we believe that we have identified and discussed below the key risk factors affecting our
business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our performance or financial
condition.

Our business may not continue to grow if the markets for our products do not continue to grow.

Our
growth is dependent upon the continued adoption of on-demand software as a key mechanism for delivering solutions in these markets. The rapidly evolving nature of this
market reduces our ability to accurately evaluate our future prospects and forecast quarterly or annual performance. The adoption of on-demand talent acquisition and employee performance
management solutions, particularly among organizations that have relied upon traditional software applications, requires the acceptance of a new way of conducting business and exchanging and compiling
information. Because these markets are new and evolving, it is difficult to predict with any assurance the future growth rate and size of these markets which, in comparison with the overall market for
enterprise software applications, is relatively small.

If our on-demand delivery model is not widely accepted, our operating results will be harmed.

The on-demand delivery of enterprise software is new and, to a large extent, unproven, and it is uncertain whether this model will achieve and sustain
high levels of demand and market acceptance. The majority of our clients access and use our software solutions on an on-demand basis. If the preferences of our clients change and our
clients elect to deploy our software on-site, either upon the initiation of a new agreement or upon the renewal of an existing agreement, we would potentially incur higher costs and
encounter greater complexity in providing maintenance and support for our software. Potential clients may be reluctant or unwilling to purchase enterprise software on-demand for a number
of reasons, including security and data privacy concerns. If such organizations do not adopt the on-demand delivery model, then the market for our solutions may develop more slowly than we
expect. The inability of our
on-demand delivery model to achieve widespread market acceptance would harm our business.

Our business will suffer if our existing clients terminate or do not renew their software subscriptions.

We expect to continue to derive a significant portion of our revenue from renewals of subscriptions for our talent acquisition and employee performance management
solutions. During the year ended December 31, 2005, our clients renewed more than 90% of the aggregate contract value eligible to be renewed during the period. If our clients terminate their
agreements, fail to renew their agreements, renew their agreements upon less favorable terms to us or fail to purchase new solutions from us, our revenue may decline or our future revenue growth may
be constrained.

Maintaining
the renewal rate of our existing subscriptions is critical to our future success. Factors that may affect the renewal rate for our solutions include:



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Most
of our existing clients have entered into subscription agreements with us that expire between one and three years from the initial contract date. Our clients have the right to
terminate their contracts and are not obligated to renew their subscriptions for our solutions after the expiration of the initial
terms of their subscription agreements. In addition, our clients may negotiate terms which are less favorable to us upon renewal, or may request that we license our software to them on a perpetual
basis, which may reduce recurring revenue from these clients. Our future success also depends in part on our ability to sell new solutions to our existing clients.

If we fail to develop or acquire new products or enhance our existing solutions to meet the needs of our existing and future clients, our revenue may
decline.

To remain competitive, we must continually improve and enhance the responsiveness, functionality and features of our existing solutions and develop new solutions
that address the talent acquisition and employee performance management requirements of organizations. If we are unable to successfully develop or acquire new solutions or enhance our existing
solutions, our revenue may decline and our business and operating results will be adversely affected. Since our initial public offering, we have introduced enhanced solutions. We intend to continue to
introduce enhanced solutions to generate additional revenue, attract new clients and respond to competition. We may not succeed in developing or introducing new or enhanced solutions or developing or
introducing them in a timely manner, and new or enhanced solutions that we develop or introduce may not achieve the market acceptance necessary to generate significant revenue.

In
addition, it is possible that evolving technology may enable new deployment mechanisms that make our on-demand business model obsolete. To the extent that we are not
successful in continuing to develop our solutions in correlation with evolving technology, we may not be successful in establishing or maintaining our client relationships.

We may engage in future acquisitions or investments which present many risks, and we may not realize the anticipated financial and strategic goals for
any of these transactions.

We have focused on developing solutions for the enterprise talent acquisition and employee performance management market. Our market is highly fragmented and in
the future we may acquire or make investments in complementary companies, products, services or technologies. Acquisitions and investments involve a number of difficulties that present risks to our
business, including the following:



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On
January 13, 2006, we acquired Webhire, Inc. for a purchase price of approximately $34.4 million. We are in the process of integrating Webhire's business. The
factors noted above could have a material adverse effect on our business, results of operations and financial condition or cash flows, particularly in the case of a larger acquisition or multiple
acquisitions in a short period of time. From time to time, we may enter into negotiations for acquisitions or investments that are not ultimately consummated. These negotiations could result in
significant diversion of management time, as well as out-of-pocket costs.

The
consideration paid for an investment or acquisition may also affect our financial results. If we were to proceed with one or more significant acquisitions in which the consideration
included cash, we could
be required to use a substantial portion of our available cash or obtain debt or equity financing. To the extent that we issue shares of our capital stock or other rights to purchase shares of our
capital stock as consideration for an acquisition or in connection with the financing of an acquisition, including options or other rights, our existing shareholders may be diluted, and our earnings
per share may decrease. In addition, acquisitions may result in the incurrence of debt, large one-time write-offs, including write-offs of acquired
in-process research and development costs, and restructuring charges. After acquiring Webhire for approximately $34.4 million in cash, we borrowed $25.0 million under our
revolving line of credit for working capital purposes. Acquisitions in the future may require us to incur additional indebtedness to finance our working capital and may also result in goodwill and
other intangible assets that are subject to impairment tests, which could result in future impairment charges.

If our efforts to attract new clients or to sell additional solutions to our existing clients are not successful, our revenue growth will be adversely
affected.

To
grow our revenue, we must continually add new clients and sell additional solutions to existing clients. If our existing and prospective clients do not perceive our solutions to be of
sufficiently high value and quality, we may not be able to attract new clients or to increase sales to existing clients. Our ability to attract new clients and to sell new solutions to existing
clients will depend in large part on the success of our sales and marketing efforts. However, our existing and prospective clients may not be familiar with some of our solutions, or may have
traditionally used other products and services for some of their talent acquisition and employee performance management requirements. Our existing and prospective clients may develop their own
solutions to address their talent acquisition and employee performance management requirements, purchase competitive product offerings or engage third-party providers of outsourced talent acquisition
and employee performance management services. Additionally, some clients may request that we license our software to them on a perpetual basis or that we allow them the contractual right to convert
from a term license to a perpetual license during the contract term, which may reduce recurring revenue from these clients.

If we are unable to compete effectively with companies offering enterprise talent acquisition and employee performance management solutions, our revenue
may decline.

We
may not have the resources or expertise to compete successfully in the future. If we are unable to successfully compete, we could lose existing clients, fail to attract new clients
and our revenue would decline. The talent acquisition and employee performance management solutions markets are rapidly evolving and highly competitive, and we expect competition in these markets to
persist and intensify. Barriers to entry into our industry are low, new software products are frequently introduced and existing products are continually enhanced. We compete with niche point solution
vendors such as Authoria, Inc., BrassRing LLC, Deploy Solutions, Inc., iCIMS, Inc., Integrated Performance Systems, Inc., InScope Corporation, PeopleClick, Inc.,
Performix Technologies, Inc., Pilat HR Solutions, Inc., Previsor, Inc., Recruitmax Software, Inc., SHL Group plc, Success Factors, Inc., Taleo Corporation,
Unicru, Inc., Virtual Edge Corporation and Workstream Inc. that offer products that compete with one or more applications contained in our solutions. In some aspects of our business, we

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also
compete with established vendors of enterprise resource planning, or ERP, software with much greater resources, such as Oracle Corporation (PeopleSoft), SAP AG and Lawson, Inc. To a lesser
extent, we compete with vendors of employment process outsourcing services and survey services such as Accolo, Inc., The Gallup Organization, Hyrian, LLC and Recruitment Enhancement Services.
In addition, many organizations have developed or may develop internal solutions to address enterprise talent acquisition and employee performance management requirements that may be competitive with
our solutions.

Many
of our competitors and potential competitors, especially vendors of ERP software, have significantly greater financial, support, technical, development, marketing, sales, service
and other resources, larger installed client bases, longer operating histories, greater name recognition and more established relationships than we have. In addition, ERP software competitors could
bundle their products with, or incorporate capabilities in addition to, talent acquisition and employee performance management functions, such as automated payroll and benefits, in products developed
by themselves or others. Products with such additional functions may be appealing to some clients because they would reduce the number of different types of software or applications used to run their
businesses. Our niche competitors' products may be more effective than our solutions at performing particular talent acquisition and employee performance management functions or may be more customized
for particular client needs in a given market. Further, our competitors may be able to respond more quickly than we can to changes in client requirements.

Mergers or other strategic transactions involving our competitors could weaken our competitive position or reduce our revenue.

We
believe that our industry is highly fragmented and that there is likely to be consolidation, which could lead to increased price competition and other forms of competition. Increased
competition may cause pricing pressure and loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. Our competitors
may establish or strengthen cooperative relationships with business process outsourcing vendors, systems integrators, third-party consulting firms or other parties. Established companies may not only
develop their own products but may also merge with or acquire our current competitors. In addition, we may face competition in the future from large established companies, as well as from emerging
companies that have not previously entered the markets for talent acquisition and employee performance management solutions or that currently do not have products that directly compete with our
solutions. It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share or sell their products at significantly discounted prices
causing pricing pressure. In addition, our competitors may announce new products, services or enhancements that better meet the price or performance needs of clients or changing industry standards. If
any of these events occur, our revenues and profitability could significantly decline.

If we encounter barriers to the integration of our software with software provided by our competitors or with the software used by our clients, our
revenue may decline and our research and development expenses may increase.

In
some cases our software may need to be integrated with software provided by our competitors. These competitors could alter their products in ways that inhibit integration with our
software, or they could deny or delay access by us to advance software releases, which would restrict our ability to adapt our software to facilitate integration with these new releases and could
result in lost sales opportunities. In addition, our software is designed to be compatible with the most common third-party ERP systems. If the design of these ERP systems changes, integration of our
software with new systems would require significant work and substantial allocation of our time and resources and increase our research and development expenses.

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Reductions in information technology spending could limit our ability to grow our business.

Our
operating results may vary based on changes in the information technology spending of our clients. The revenue growth and profitability of our business depend on the overall demand
for enterprise
application software and services. We sell our solutions primarily to large organizations whose businesses fluctuate with general economic and business conditions. As a result, decreased demand for
enterprise application software and services, and in particular talent acquisition and employee performance management solutions, caused by a weakening global economy may cause a decline in our
revenue. Historically, economic downturns have resulted in overall reductions in corporate information technology spending. In particular, software for talent acquisition and employee performance
management software may be viewed by some of our existing and potential clients as a lower priority and may be among the first expenditures reduced as a result of unfavorable economic conditions. In
the future, potential clients may decide to reduce their information technology budgets by deferring or reconsidering product purchases, which would negatively impact our operating results.

Because we recognize revenue from the sale of our solutions ratably over the term of the subscription period, a significant downturn in our business may
not be immediately reflected in our operating results.

A
decline in new or renewed subscriptions in any one quarter may not impact our financial performance in that quarter, but will negatively affect our revenue in future quarters. If a
number of contracts expire and are not renewed in the same quarter, our revenue could decline significantly in that quarter and in subsequent quarters.

We
derived approximately 77.7% of our total revenue for the year ended December 31, 2005 from the sale of subscriptions for our solutions and expect that a significant portion of
our revenue for the foreseeable future will be derived from those subscriptions. We recognize the associated revenue ratably over the term of the subscription agreement, which is typically between one
and three years. As a result, a significant portion of the revenue that we report in each quarter reflects the recognition of unearned revenue from subscription agreements entered into during previous
periods. Accordingly, the effect of significant declines in sales and market acceptance of our solutions may not be reflected in our short-term results of operations, making our results
less indicative of our future prospects.

If
our revenue does not meet our expectations, we may not be able to curtail our spending quickly enough and our cost of revenue, compensation and benefits and product development would
increase as a percentage of revenue. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any one period, as revenue from new clients is
recognized over the applicable subscription term.

Our financial performance may be difficult to forecast as a result of our focus on large clients and the long sales cycle associated with our solutions.

Our sales cycles are generally up to nine months and in some cases even longer. This long sales cycle impedes our ability to accurately forecast the timing of
sales in a given period which could adversely
affect our ability to meet our forecasts for that period. We focus our sales efforts principally on large organizations with complex talent acquisition and employee performance management
requirements. Accordingly, in any single quarter the majority of our revenue from sales to new clients may be composed of large sales made to a relatively small number of clients. Our failure to close
a sale in any particular quarter will impede revenue growth until the sale closes, if at all. As a result, substantial time and cost may be spent attempting to close a sale that may not be successful.
The period between an initial sales contact and a contract signing is relatively long due to several factors, including:



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Interruptions or delays in service from our Web hosting facilities could impair the delivery of our service and harm our
business.

We
provide our service through computer hardware that is currently located in Web hosting facilities that we operate. These facilities are vulnerable to damage or interruption from
earthquakes, floods, fires, power loss, telecommunications failures and similar events. These facilities are also subject to break-ins, sabotage, intentional acts of terrorism, vandalism
and similar misconduct. Despite precautions that we take at these facilities, the occurrence of a natural disaster, act of terrorism or other unanticipated problem at any of these facilities could
result in lengthy interruptions in our service. Interruptions in our service may reduce our revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions and
adversely affect our renewal rates. Our business will be harmed if our customers and potential customers believe our service is unreliable.

If our security measures are breached and unauthorized access is obtained to client data, clients may curtail or stop their use of our solutions, which
would harm our business, operating results and financial condition.

Our
solutions involve the storage and transmission of confidential information of clients and their existing and potential employees, and security breaches could expose us to a risk of
loss of, or unauthorized access to, this information, resulting in possible litigation and possible liability. Although we have never sustained such a breach, if our security measures were ever
breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, an unauthorized party obtained access to this confidential data, our reputation could be
damaged, our business may suffer and we could incur significant liability. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not discovered until
launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the
market perception of our security measures could be harmed and we could lose sales and clients.

Because our products collect and analyze applicants' and employees' stored personal information, concerns that our products do not adequately protect
the privacy of applicants and employees could inhibit sales of our products.

Some
of the features of our talent acquisition and employee performance management applications depend on the ability to develop and maintain profiles of applicants and employees for use
by our clients. These profiles contain personal information, including job experience, home address and home telephone number. Typically, our software applications capture this personal information
when an applicant creates a profile to apply for a job and an employee completes a performance review. Our software applications augment these profiles over time by capturing additional data and
collecting usage data. Although our applications are designed to protect user privacy, privacy concerns nevertheless may cause employees and applicants to resist providing the personal data necessary
to support our products.

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Any
inability to adequately address privacy concerns could inhibit sales of our products and seriously harm our business, financial condition and operating results.

We may increase our sales and marketing efforts to clients outside the United States, which would expose us to additional risks associated with
international operations, including the risks of managing a geographically diverse operation and foreign currency exchange rate fluctuations.

As
a part of our future business strategy, we intend to increase our international sales efforts in Canada, Europe and Asia. We currently maintain international sales offices in Toronto,
Canada and Hyderabad, India, and intend to open additional sales offices in Bangalore, India, Mumbai, India, Vizag, India and Kuala Lumpur, Malaysia. We may not be successful in these efforts.
International operations and sales subject us to risks and challenges that we would otherwise not face if we conducted our business only in the United States. For example, we will depend on third
parties to market our solutions through foreign sales channels, and we may be challenged by laws and business practices favoring local competitors. In addition, our ability to succeed in foreign
markets will depend on the ability of our software to properly filter foreign languages. We must also adopt our pricing structure to address different pricing environments and may face difficulty in
enforcing revenue collection internationally.

In
addition, a portion of our international sales are denominated in foreign currencies, and we incur operating expenses in Indian rupees, British pounds and Canadian dollars. We expect
our exposure to foreign exchange gains and losses to increase in the future.

We may be unsuccessful in establishing and maintaining our planned facilities in India and Malaysia.

We
are in the process of constructing a facility in Vizag, India that will serve as the center of our development activities in India, which are presently located in a facility that we
lease in Hyderabad, India. In addition, we intend to open an office in Kuala Lumpur, Malaysia to house employees who will specialize in the translation of our products into Japanese, Chinese and
Korean. We have no experience with managing the construction of new facilities in the United States or abroad. As a result, we may fail to obtain necessary permits or to comply with relevant
governmental regulations relating to the construction and operation of these facilities. We intend to move the majority of our developers from our existing offices in Hyderabad, India to our new
facility in Vizag, India. Some of our existing employees may not desire to make such a move and as a result may terminate their employment with us. If we fail to complete our construction project in
Vizag, India in a timely and cost-effective fashion, or if a substantial number of our existing employees do not continue their employment with us upon the opening of that facility, our
business may be harmed.

If the unemployment rate increases materially, our business may be harmed.

To the extent that the unemployment rate increases materially, our existing and potential clients may no longer consider improvement of their talent acquisition
and employee performance management systems a necessity, which could have a material adverse effect on our business, results of operations and financial condition. Demand for our solutions depends in
part on our clients' ability to hire their employees. According to the U.S. Bureau of Labor Statistics, the unemployment rate in January 2006 of 4.7% was at its lowest level since
July 2001.

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Material defects or errors in our software could affect our reputation, result in significant costs to us and impair our ability to sell our solutions,
which would harm our business.

The
software applications forming part of our solutions may contain material defects or errors, which could materially and adversely affect our reputation, result in significant costs to
us and impair our ability to sell our solutions in the future. The costs incurred in correcting any material product defects or errors may be substantial and would adversely affect our operating
results. After the release of our products, defects or errors may also be identified from time to time by our internal team and by our clients. Such defects or errors may occur in the future.

Any
defects that cause interruptions to the availability of our solutions could result in:



If we fail to adequately protect our proprietary rights, our competitive advantage could be impaired and we may lose valuable assets, experience reduced
revenue and incur costly litigation to protect our rights.

Our
intellectual property rights are important to our business, and our success is dependent, in part, on protecting our proprietary software and technology and our brand, marks and
domain names. We rely on a combination of copyright, trademark, trade secret and other common laws in the United States and other jurisdictions as well as confidentiality procedures and contractual
provisions to protect our proprietary technology, processes and other intellectual property. It may be possible for unauthorized third parties to copy our software and use information that we regard
as proprietary to create products and services that compete with ours, which could harm our competitive position and cause our revenue to decline.

We
have no issued patents, and currently have only one pending patent application. There is no guarantee that the U.S. Patent and Trademark Office will grant this patent, or do so in a
manner that gives us the protection that we seek. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our
intellectual property. Existing intellectual property laws only afford limited protection.

To
the extent that we expand our international activities, our exposure to unauthorized copying and use of our software and proprietary information may increase. Some license provisions
protecting against unauthorized use, copying, transfer and disclosure of our licensed products may be unenforceable under the laws of certain jurisdictions and foreign countries in which we operate.
Further, the laws of some countries, and in particular India, where we develop much of our intellectual property, do not protect proprietary rights to the same extent as the laws of the United States.
In the event that we are unable to protect our intellectual property rights, especially those rights that we develop in India, our business would be materially and adversely affected.

Litigation
may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in
substantial costs and diversion of management resources, either of which could seriously harm our business.

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Our results of operations may be adversely affected if we are subject to a protracted infringement claim or a claim that results in a significant damage
award.

We
expect that software product developers, such as ourselves, will increasingly be subjected to infringement claims as the number of products and competitors grows and the functionality
of products in different industry segments overlaps. Our competitors or other third parties may challenge the validity or scope of our intellectual property rights. A claim may also be made relating
to technology that we acquire or license from third parties. If we were subject to a claim of infringement, regardless of the merit of the claim or our defenses, the claim could:



Litigation
could be costly for us to defend, have a negative effect on our operating results and financial condition or require us to devote additional research and development resources
to change our software.

Changes in the regulatory environment and general economic condition in India and elsewhere could have a material adverse effect on our
business.

Adverse
changes in the business or regulatory climate in India could have a material adverse effect on our business. In addition, wages in India are increasing at a faster rate than in
the United States. In the event that wages continue to rise, the cost benefit of operating in India may diminish. India has also experienced significant inflation in the past and has been subject to
civil unrest and terrorism. There can be no assurance that these and other factors will not have a material adverse effect on our business, results of operations and financial condition.

We employ technology licensed from third parties for use in or with our solutions, and the loss or inability to maintain these licenses on similar terms
or errors in the software we license could result in increased costs, or reduced service levels, which would adversely affect our business.

We
include in the distribution of our solutions certain technology obtained under licenses from other companies. We anticipate that we will continue to license technology and development
tools from third parties in the future. There may not always be commercially reasonable software alternatives to the third-party software that we currently license, or any such alternatives may be
more difficult or costly to replace than the third-party software that we currently license. In addition, integration of our software with new third-party software may require significant work and
substantial allocation of our time and resources. Also, to the extent we depend upon the successful operation of third-party products in conjunction with our software, any undetected errors in these
third-party products could prevent the implementation or impair the functionality of our software, delay new solution introductions and injure our reputation. Our use of additional or alternative
third-party software would require us to enter into license agreements with third parties, which could result in higher costs.

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Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.

As
a result of fluctuations in our revenue and operating expenses, our quarterly operating results may vary significantly. We may not be able to curtail our spending quickly enough if
our revenue falls short of our expectations. We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our new product
development efforts and hire
additional personnel. Our operating results may fluctuate in the future as a result of the factors described below and elsewhere in this prospectus:



We
believe that period-to-period comparisons of our results of operations are not necessarily meaningful as our future revenue and results of operations may vary
substantially. It is also possible that in future quarters our results of operations will be below the expectations of securities market analysts and investors. In either case, the price of our common
stock could decline, possibly materially.

If we do not retain key personnel, our ability to manage our business and continue our growth could be negatively impacted.

We
have grown significantly in recent years, and our management remains concentrated in a small number of key employees, most of whom have been employed with us for at least five years.
Our future success will depend to a significant extent on the continued service of our key personnel, particularly Nooruddin S. Karsan, Elliot H. Clark, Troy A. Kanter, Donald F. Volk, Sarah M. Teten,
Ramarao V. Velpuri, Bill L. Erickson, Kevin T. Hudson, Roger C. Gaston, Archie L. Jones, Jr., P. Grant Parker and Raghuveer Sakuru as well as our other key employees, software engineers and
senior technical and sales personnel. We have not entered into employment agreements with any of our employees. The loss of the services of any of these individuals or group of individuals could have
a material adverse effect on our business, financial condition and results of operations. Competition for qualified personnel in the software industry is intense, and we compete for these personnel
with other software companies that have greater financial and other resources than we do. If we lose the services of one or more of our executive officers or other key personnel, or if one or more of
them decide to join a competitor or otherwise compete directly or indirectly with us, our business could be harmed. Searching for replacements for key personnel could also divert management's time and
attention and result in increased operating expenses.

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Our chief financial officer is a defendant in litigation that may require a significant amount of his attention.

Our
chief financial officer, who has been employed by us since 1996, is one of the named defendants in litigation based on services provided nearly 10 years ago by him, a former
partner of his and the accounting firm of which the two were partners. The plaintiffs' claims against the defendants are based on theories of professional negligence, breach of fiduciary duty, breach
of contract, and negligent and fraudulent misrepresentation in connection with services that were provided to the plaintiff by the defendants. Many of the allegations relate to activity that occurred
after our chief financial officer left his former firm. Although our chief financial officer believes that these claims are without merit and is vigorously defending against them, defending against
these claims may be time consuming and costly for our chief financial officer.

We will not be able to maintain our revenue growth if we do not attract, train or retain qualified sales personnel.

If
we fail to successfully maintain and expand our sales force, our future revenue and profitability will be adversely affected. We depend on our direct sales force for substantially all
of our revenue and intend to make significant expenditures in upcoming years to expand our sales force. Our future success will depend in part upon the continued expansion and increased productivity
of our sales force. To the extent that we experience attrition in our direct sales force, we will need to hire replacements. We face intense competition for sales personnel in the software industry,
and we may not be successful in hiring, training or retaining our sales personnel in accordance with our plans. Even if we hire and train a sufficient number of sales personnel, we may not generate
enough additional revenue to exceed the expense of hiring and training the new personnel.

Failure to implement the appropriate controls and procedures to manage our growth could harm our growth, business, operating results and financial
condition.

We
are currently experiencing a period of rapid growth in our operations, which has placed, and will continue to place, a significant strain on our management, administrative,
operational, technical and financial infrastructure. In particular, continued rapid growth will require us to invest significant resources in additional infrastructure and to hire additional
personnel. We decreased our employee base from 403 employees on December 31, 2002 to 393 on December 31, 2003, but then increased our employee base to 522 employees at
December 31, 2004 and 693 employees at December 31, 2005, and we expect to continue to significantly increase the number of personnel throughout 2006, which will increase our expenses.
As a result of our acquisition of Webhire in January 2006, we acquired 60 additional employees. In addition, we intend to increase our number of employees in India and to hire employees in
Malaysia. To manage our growth, we will need to continue to improve our operational, financial and management processes and controls and reporting systems and procedures. This effort may require us to
make significant capital expenditures or to incur significant expenses, and may divert the attention of our personnel from our core business operations, any of which may adversely affect our financial
performance. If we fail to successfully manage our growth, our business, operating results and financial condition will be adversely affected.

Evolving European Union regulations related to confidentiality of personal data may adversely affect our business.

In
order to provide our solutions to our clients, we rely in part on our ability to access our clients' employee data. The European Union has adopted various data protection regulations
related to the confidentiality of personal data. To date, these regulations have not restricted our business as we have qualified for a safe harbor available for U.S. companies that collect personal
data from areas under the jurisdiction of the European Union. To the extent that these regulations are modified in such a manner

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that
our safe harbor no longer applies, our ability to conduct business in the European Union may be adversely affected.

Our ability to use Webhire's net operating loss carryforwards in the United States will be significantly limited.

As
of September 30, 2005, Webhire had net operating loss carryforwards from U.S. operations of approximately $48 million for federal purposes. However, we believe that
there will be significant limitations on our ability to use Webhire's net operating loss carryforwards in the future. To the extent available, we intend to use Webhire's U.S. net operating loss
carryforwards to reduce the U.S. corporate income tax liability associated with our operations. Section 382 of the U.S. Internal Revenue Code of 1986 generally imposes an annual limitation on
the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership. Our ability to utilize Webhire's net
operating loss carryforwards will be limited by prior changes in its ownership and by our acquisition of Webhire in January 2006. To the extent our use of net operating loss carryforwards is
significantly limited, our income could be subject to U.S. corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.

Any impairment in the value of our goodwill will result in an accounting charge against our earnings, which could negatively impact our stock
price.

As
of December 31, 2005, we had $8.8 million of goodwill, representing approximately 11.9% of our total assets as of such date. We will likely record a significant portion
of the consideration that we paid in our acquisition of Webhire as goodwill. As a result of acquisitions that we may complete in the future, we may be required to record additional goodwill. In
accordance with U.S. generally accepted accounting principles, we conduct an impairment analysis of our goodwill annually and at such other times when an event or change in circumstances occurs which
would indicate potential impairment. As
a result of the sale our pharmaceutical training division in December 2003, we wrote off $0.6 million of goodwill associated with prior acquisitions against the net gain on the sale. If
we determine significant impairment of our goodwill as a result of any of those tests, we would be required to record a corresponding non-cash impairment charge against our earnings that
could negatively affect our stock price.

Evolving regulation of the Internet may increase our expenditures related to compliance efforts, which may adversely affect our financial
condition.

As
Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. We are particularly sensitive to these risks because the
Internet is a critical component of our business model. For example, we believe that increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation,
collection, processing or use of personal or consumer information could affect our clients' ability to use and share data, potentially reducing demand for solutions accessed via the Internet and
restricting our ability to store, process and share data with our clients via the Internet. In addition, taxation of services provided over the Internet or other charges imposed by government agencies
or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in
a decline in the use of the Internet and the viability of Internet-based services, which could harm our business.

The failure of our solutions to comply with employment laws may require us to indemnify our clients, which may harm our
business.

Some
of our client contracts contain indemnification provisions that require us to indemnify our clients against claims of non-compliance with employment laws related to
hiring. To the extent these

29

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claims
are successful and exceed our insurance coverages, these obligations would have a negative impact on our cash flow, results of operation and financial condition.

Our reported financial results may be adversely affected by changes in generally accepted accounting principles.

Generally
accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified
Public Accountants, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on
our historical or future financial results. For example, prior to January 1, 2006, we were not required to record stock-based compensation charges if the employee's stock option exercise price
is equal to or exceeds the deemed fair value of the underlying security at the date of grant. However, effective January 1, 2006 we are required to record the fair value of stock options as an
expense in accordance with new accounting pronouncements.

Anti-takeover provisions of Pennsylvania law and our articles of incorporation and bylaws could delay and discourage takeover attempts that
shareholders may consider to be favorable.

Certain
provisions of our articles of incorporation and bylaws and applicable provisions of the Pennsylvania Business Corporation Law may make it more difficult for a third party to, or
prevent a third party from, acquiring control of us or effecting a change in our board of directors and management. These provisions include:



The
Pennsylvania Business Corporation Law further provides that because our articles of incorporation provide for a classified board of directors, shareholders may remove directors only
for cause. These and other provisions of the Pennsylvania Business Corporation Law and our articles of incorporation and bylaws could delay, defer or prevent us from experiencing a change of control
or changes in our board of directors and management and may adversely affect our shareholders' voting and other rights. Any delay or prevention of a change of control transaction or changes in our
board of directors and management could deter potential acquirors or prevent the completion of a transaction in which our shareholders could receive a substantial premium over the then current market
price for their shares of our common stock.

30

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The market price of our common stock may be particularly volatile, and our shareholders may be unable to resell their shares at a
profit.

The
market price of our common stock has been subject to significant fluctuations and may continue to fluctuate or decline. Since our initial public offering in June 2005, the
closing prices of our common stock have ranged from a low of $11.80 to a high of $26.00. In the past several years, technology stocks have experienced high levels of volatility and significant
declines in value from their historic highs. Factors that could cause fluctuations in the trading price of our common stock include the following:



In
the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been brought against that company. If our stock
price is volatile, we may become the target of securities litigation. Securities litigation could result in substantial costs and divert our management's attention and resources from our business.

31

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ITEM 1B. Unresolved Staff Comments.

Not applicable.

ITEM 2. Properties

We lease our headquarters in Wayne, Pennsylvania, which consists of approximately 36,000 square feet. The table below provides additional information concerning
our principal facilities, including the approximate square footage of each facility and the lease expiration date. We also lease facilities in Philadelphia, Pennsylvania, Lincoln, Nebraska, Hyderabad,
India, London, England, Toronto, Canada and Lexington, Massachusetts. We believe that our facilities are in good operating condition and will adequately serve our needs for at least the next
12 months. We also anticipate that, if required, suitable additional or alternative space will be available on commercially reasonable terms, in office buildings we currently occupy or in space
nearby, to accommodate expansion of our operations.

|Location                   |  | Approximate
Square Footage |  | Monthly Rent |        | Lease Expiration
|-------------------------- |  | -------------------------- |  | ------------ | ------ | ----------------
|Wayne, Pennsylvania        |  | 36,635                     |  | $            | 82,148 |                 
|Lincoln, Nebraska          |  | 40,549                     |  | $            | 55,280 |                 
|Philadelphia, Pennsylvania |  | 4,400                      |  | $            | 3,872  |                 
|Hyderabad, India           |  | 4,900                      |  | $            | 2,245  |                 
|London, England            |  | 5,000                      |  | $            | 20,355 |                 
|Toronto, Canada            |  | 3,300                      |  | $            | 11,029 |                 
|Lexington, Massachusetts   |  | 29,241                     |  | $            | 52,390 |                 

---

32

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ITEM 3. Legal Proceedings

On October 31, 2000, Gallup, Inc., which conducts its business under the name The Gallup Organization, filed suit against us in U.S. District Court
for the Eastern District of Pennsylvania seeking unspecified damages and injunctive relief, alleging that we unlawfully raided Gallup's employees and tortuously interfered with Gallup's relationships
with former employees and customers, infringed on Gallup's copyrighted survey language and falsely advertised aspects of our employee survey services. In
November 2001, the District Court granted our motion to dismiss Gallup's claim that we conducted an unlawful raid of Gallup's employees. In December 2002, the District Court granted our
motion for summary judgment on the false advertising claim. In January 2003, the District Court granted our motion for summary judgment on the claims regarding our alleged tortuous interference
with Gallup's relationships with its former employees and its customers. Gallup did not appeal any of these rulings.

In
November 2004, the District Court granted our motion for summary judgment on the copyright claim. Gallup appealed that ruling to the U.S. Court of Appeals for the Third
Circuit, and the U.S. Court of Appeals reversed the judge's grant of summary judgment in our favor. On January 27, 2006, the parties settled the outstanding claim and entered into a
confidential settlement agreement. On January 30, 2006, the District Court entered a consent order relating to the settlement. The terms of the settlement will not have a material adverse
effect on our results of operation or financial position.

We
are involved in claims, including those identified above, 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 4. Submission of Matters to a Vote of Security Holders

None.

33

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PART II

ITEM 5.    Market For The Registrant's Common Equity, Related Stockholder Matters And Issuer Purchases of Equity Securities

Market Information and Dividends

Our common stock has been quoted on the Nasdaq National Market under the symbol "KNXA" since June 24, 2005. Prior to that date, there was no public market
for our common stock. The following table sets forth, for the periods indicated, the high and low sales prices of our common stock reported by the Nasdaq National Market.

Common Stock PriceHigh

LowYear Ended December 31, 2005:Second Quarter (from June 24, 2005)

$
13.38

$
11.99Third Quarter

$
16.20

$
11.71Fourth Quarter

$
21.61

$
13.00


On
February 17, 2006, the last reported sale price of our common stock on the Nasdaq National Market was $25.37 per share. As of February 17, 2006, there
were approximately 153 holders of record of our common stock.

We
have not declared or paid any cash dividends on our common stock since our inception. We intend to retain future earnings, if any, to finance the operation and expansion of our
business and do not anticipate paying any cash dividends in the foreseeable future. Consequently, shareholders will need to sell shares of our common stock to realize a return on their investment, if
any.

Sales of Unregistered Securities

During January 2006 and February 2006, warrants to purchase 41,235 shares of our common stock were exercised by "cashless exercise" resulting in the
issuance of an aggregate of 33,470 shares of our common stock. We did not receive any proceeds from the exercise of these warrants.

The
term "cashless exercise" refers to the surrender of a portion of a warrant as payment for the exercise price of the portion of the warrant exercised. No underwriters were involved in
the foregoing sales of securities. The sale of these securities was exempt from registration under the Securities Act in reliance on Section 4(2) thereof or Regulation D promulgated
thereunder relating to sales not involving a public offering.

Use of Proceeds from Initial Public Offering

On June 23, 2005 our registration statement on Form S-1 covering the offering of 5,000,000 shares of our common stock, commission file
number 333-124028 was declared effective. The offering closed on June 29, 2005 and did not terminate before any securities were sold. As of the date of filing this report the
offering has terminated and all of the securities registered pursuant to the offering have been sold.

The
offering was managed by SG Cowen & Co., Needham and Company, LLC, and JMP Securities as representatives of the several underwriters named in the Registration Statement ("the
Underwriters").

The
Underwriters exercised an over-allotment option to purchase an additional 750,000 shares of our common stock on July 1, 2005. The total price to the public for the
shares offered and sold by us, including the over-allotment, was $69,000,000.

34

---



We
incurred the following expenses in connection with the offering (in thousands):

Underwriting discounts and commissions

$
4,830Finders Fees


Expenses paid to or for our underwriters


Other expenses


2,048Total expenses

$
6,878


All
of the foregoing expenses were direct or indirect payments to persons other than (i) directors, officers or their associates; (ii) persons owning ten
(10%) or more of our common stock; or (iii) our affiliates except for $735,000 that was paid to Pepper Hamilton LLP. One of our directors, Barry M. Abelson, is a partner in the law firm of
Pepper Hamilton LLP. We believe that the services performed by Pepper Hamilton LLP in connection with the above offering were provided on terms no more or less favorable than those with unrelated
parties.

We
received net proceeds (in thousands) from the offering (after deducting the foregoing expenses), including the over-allotment option, of approximately $62,122,000. From
the effective
date of the registration statement to January 13, 2006, the net proceeds have been used for the following purposes:

Redemption of all outstanding shares of series A redeemable participating preferred stock

$
11,375Redemption of all outstanding shares of series B redeemable participating preferred stock


28,625Construction of plant, building and facilities


Purchase and installation of machinery and equipment


Purchase of land


577Acquisition of other business


Repayment of indebtedness


Working Capital


Acquisition of Webhire, Inc. on January 13, 2006


21,545Other purposes (for which at least $100,000 has been used), including: Investments, including debt instruments of the United States Government and its Agencies and in high quality corporate Issuers


Total

$
62,122


All
of the foregoing expenses were direct or indirect payments to persons other than (i) directors, officers or their associates; (ii) persons owning ten
(10%) or more of our common stock; or (iii) our affiliates.

As
of January 13, 2006, upon our acquisition of Webhire, Inc. for approximately $34.4 million in cash, including approximately $24.1 million of the net
proceeds remaining from our initial public offering, we have used all of the proceeds from our initial public offering.

35

---





ITEM 6. Selected Financial Data.

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below are derived from our consolidated financial statements and should be read in conjunction with our
consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on
Form 10-K. The consolidated statement of operations data for each of the years ended December 31, 2003, 2004 and 2005 and the consolidated balance sheet data as of
December 31, 2004 and 2005 are derived from, and qualified by reference to, our audited consolidated financial statements and related notes appearing elsewhere in this report. The consolidated
statement of operations data for each of the years ended December 31, 2001 and 2002 and the consolidated balance sheet data as of December 31, 2001, 2002 and 2003 are derived from our
audited consolidated financial statements which are not included in this report. All of the historical consolidated financial data set forth below gives retroactive effect to a
0.8-for-1 reverse stock split of our common stock. Our historical results are not necessarily indicative of results for any future period.

|                                                                                |                               | For the
Year Ended December 31, |        
|------------------------------------------------------------------------------- | ----------------------------- | ------------------------------- | -------
|
|
|Consolidated Statement of Operations Data:                                      |                               |                                 |        
|Revenue:                                                                        |                               |                                 |        
|                                                                                | Subscription revenue          |                                 | $      
|                                                                                | Other revenue                 |                                 |        
|                                                                                |                               |                                 |        
|                                                                                |                               | Total revenue                   |        
|Cost of revenue (exclusive of depreciation, shown separately below)             |                               |                                 | 8,664  
|                                                                                |                               |                                 |        
|Gross profit                                                                    |                               |                                 | 19,707 
|                                                                                |                               |                                 |        
|Operating expenses:                                                             |                               |                                 |        
|                                                                                | Sales and marketing           |                                 |        
|                                                                                | General and administrative    |                                 |        
|                                                                                | Research and development      |                                 |        
|                                                                                | Depreciation and amortization |                                 |        
|                                                                                |                               |                                 |        
|                                                                                |                               | Total operating expenses        |        
|                                                                                |                               |                                 |        
|(Loss) income from continuing operations before income tax and interest expense |                               |                                 | (13,877
|                                                                                |                               |                                 |        
|Interest expense (income)                                                       |                               |                                 | 848    
|Interest on mandatory redeemable preferred shares(1)                            |                               |                                 |       
|                                                                                |                               |                                 |        
|(Loss) income from continuing operations before income tax                      |                               |                                 | (14,725
|Income tax (benefit) expense on continuing operations                           |                               |                                 | (276   
|                                                                                |                               |                                 |        
|(Loss) income from continuing operations                                        |                               |                                 | (14,449
|Income from discontinued operations, net of taxes(2)                            |                               |                                 | 425    
|                                                                                |                               |                                 |        
|Net (loss) income before cumulative effect of change in accounting principle    |                               |                                 | (14,024
|Cumulative effect of change in accounting principle(1)                          |                               |                                 |       
|                                                                                |                               |                                 |        
|Net (loss) income                                                               |                               | $                               | (14,024
|                                                                                |                               |                                 |        

36

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|                                                                                  |                                         | For the
Year Ended December 31, |          
|--------------------------------------------------------------------------------- | --------------------------------------- | ------------------------------- | ---------
|
|
|Continuation of Consolidated Statement of Operations Data:                        |                                         |                                 |          
|Accretion of redeemable class B common shares and class C common shares           |                                         | $                               | 2,882    
|Accrued dividends on series A preferred shares and series B preferred shares      |                                         |                                 | 2,609    
|Accretion on series A preferred shares and series B preferred shares              |                                         |                                 |         
|                                                                                  |                                         |                                 |          
|Net loss available to common shareholders                                         |                                         | $                               | (19,515  
|Basic and diluted loss per share:                                                 |                                         |                                 |          
|                                                                                  | Net loss from continuing operations     |                                 | $        
|                                                                                  | Net income from discontinued operations |                                 |          
|Net loss from cumulative effect of change in accounting principle                 |                                         |                                 |         
|                                                                                  |                                         |                                 |          
|Net loss per share available to common shareholders                               |                                         | $                               | (3.17    
|Weighted average shares used to compute net loss available to common shareholders |                                         |                                 | 6,145,521

|                                        |  | As of December 31,
|--------------------------------------- |  | ------------------
|
|
|Consolidated Balance Sheet Data:        |  |                   
|Cash and cash equivalents               |  | $                 
|Total assets                            |  |                   
|Short term debt, net                    |  |                   
|Capital leases, net                     |  |                   
|Deferred revenue                        |  |                   
|Long term debt, net                     |  |                   
|Series A preferred stock                |  |                   
|Series B preferred stock                |  |                   
|Capital leases, long term               |  |                   
|Other long term debt, net               |  |                   
|Redeemable class B common stock         |  |                   
|Redeemable class C common stock         |  |                   
|Common stock                            |  |                   
|Treasury stock                          |  |                   
|Total shareholders' (deficiency) equity |  | $                 

---

For the Year Ended
December 31,2001

2002

2003Revenue:Subscription revenue

$


$


$
Other revenue


18,825


14,239


6,046Total revenue


18,825


14,239


6,046Cost of revenue


10,522


7,565


2,714Gross profit


8,303


6,674


3,332Total operating expenses


7,542


6,179


4,153Interest expense


52


24


23Income (loss) from discontinued operations before income taxes


709


471


(844
)Gain on sale of discontinued operations








869Income taxes expense


284


188


10Net income from discontinued operations

$
425

$
283

$
15


37

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ITEM 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the
"Selected Consolidated Financial Data" section and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical
information, this discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives,
expectations and intentions. Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including
those set forth in the "Item 1ARisk Factors" section and elsewhere in this Annual Report on Form 10-K.

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 18 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. During the years ended December 31, 2004 and 2005, revenue from these subscriptions comprised approximately 78.5% and 77.7%, respectively, of our total
revenue. We generated the remainder of our revenue from other sources, primarily from the sale of discrete professional services that were not provided as part of an integrated solution on a
subscription basis. Our 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. As a result, since 1999, discrete professional services have represented a consistently decreasing percentage of our revenue, although other components of our other
revenue have increased as a percentage of our
revenue. We expect that our revenue from discrete professional services will continue to decrease as a percentage of our total revenue.

We
sell our solutions to large- and medium-sized organizations through our direct sales force. As of December 31, 2005, we had a client base of approximately 2,200 companies,
including approximately 119 companies on the Fortune 500 list published in April 2005. As a result of our acquisition of Webhire, Inc. in January 2006, we increased our client
base to approximately 2,400 companies, including approximately 131 companies on the Fortune 500 list published in April 2005. Our client base includes companies that we billed for services
during the year ended December 31, 2005 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately 65.6% and 70.6% of our
total revenue for the years ended December 31, 2004 and 2005, respectively.

Our
revenue has increased at a compound annual growth rate of approximately 39% since 2003, from $34.0 million for the year ended December 31, 2003 to $46.3 million
for the year ended December 31, 2004 to $65.6 million for the year ended December 31, 2005.

Historically,
a substantial portion of our clients have renewed their subscriptions each year. During the years ended December 31, 2003, 2004 and 2005, our clients renewed
approximately 97%, 89% and

38

---



more
than 90%, respectively, of the aggregate contract value up for renewal during each of those periods.



We commenced operations in 1987 as a provider of recruiting services to a wide variety of industries. In 1993, we offered our first automated talent acquisition
system and by 1997 we had expanded our business to provide employee research, employee performance management technology and consulting services. In late 1997, responding to a growing demand from our
customers, we embarked on a strategy to provide comprehensive human capital management services integrated with on-demand software. Between 1994 and 1998, we acquired 15 businesses that
collectively enabled us to offer comprehensive HCM services integrated with on-demand technology.

In
1999, we commenced a strategy designed to focus our business on talent acquisition and employee performance management solutions and reduce our strategic focus on discrete
professional services that generated less predictable revenue streams and lower margins. To that end:



As
a result of our shift in strategic focus, since the beginning of 2000, an increasing proportion of our revenue has been derived from talent acquisition and employee performance
management solutions and a decreasing portion of our revenue has been derived from discrete professional services. In 2000, our revenue derived from subscriptions for these solutions comprised
approximately 54.4% of our total revenue. This percentage increased to approximately 65.6%, 70.1%, 75.1%, 78.5% and 77.7% of total revenue, respectively, for the years ended December 31, 2001,
2002, 2003, 2004 and 2005. This transition in revenue mix resulted in decreasing revenue from 2000 to 2001, 14.3% revenue growth from 2001 to 2002 and relatively flat revenue growth between 2002 and
2003 as incremental revenue from our talent acquisition and employee performance management solutions was offset by a decline in revenue from discrete professional services. More recently, customer
adoption of the on-demand model for software delivery and need for solutions that improve employee recruiting and retention have driven consistent quarterly revenue growth since
December 31, 2002.

From
our inception through 1999, our operations were funded primarily through internally generated cash flows and our line of credit. In December 1999, we issued common stock and
warrants to purchase common stock to several investors, including Parthenon Investors, L.P. and PCIP Investors, for approximately $22.0 million. In connection with this investment, we
repurchased common stock held by a co-founder and former president of our predecessor for consideration of approximately $6.9 million and restructured our outstanding debt. On
June 16, 2000, we entered into a bridge financing in which we issued promissory notes in an aggregate principal amount of $10.0 million to Parthenon and PCIP for aggregate cash proceeds
of $8.1 million, representing an original initial issue discount of $1.9 million. In connection with the bridge financing, Parthenon and PCIP also exercised warrants to purchase shares
of common stock that were acquired in the 1999 financing for an aggregate exercise price of $1.9 million.

39

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In
February 2001, we issued common and preferred stock to Wafra Acquisition Fund 14, L.P. for approximately $15.5 million and to Parthenon and PCIP in exchange for the
cancellation and discharge of the bridge notes issued in 2000. In March 2001, we issued common and preferred stock to Westbury Equity Partners SBIC, L.P. for approximately $6.0 million
in cash. In the same transaction, we redeemed a portion of the shares of common and preferred stock held by Parthenon and PCIP for an aggregate price of approximately $2.4 million.

In
December 2004, we conducted a share repurchase which closed on January 5, 2005. In the aggregate, we repurchased 873,114 shares of our common stock from eight former
employees at $1.25 per share, of which 369,075 were repurchased in December 2004. We decided to initiate the process for our initial public offering after this share repurchase had been
completed.



On June 29, 2005, we completed our initial public offering in which we sold an aggregate of 5,750,000 shares of our common stock, including 750,000 shares
sold pursuant to the underwriters' exercise of their over-allotment option on July 3, 2005, at a price of $12.00 per share. Our net proceeds from our initial public offering
aggregated approximately $61.7 million after deducting underwriting commissions and offering expenses.

Pursuant
to the terms of an agreement that we entered into prior to our initial public offering with the holders of all of our class B common stock, class C common stock,
series A preferred stock and series B preferred stock and as provided for in our articles of incorporation in effect prior to our initial public offering, all of our outstanding shares
of class B common stock and class C common stock automatically converted into 2,179,152 and 2,100,060 shares of our common stock, respectively, at the closing of our
initial public offering. Under the terms of this agreement, we also redeemed all of the outstanding shares of our series A preferred stock and series B preferred stock for a combination
of an aggregate of approximately $28.6 million and $11.4 million, respectively, in cash, and the issuance of 1,134,126 and 724,250 shares of our common stock, respectively. In addition,
pursuant to this agreement, we issued 396,195 shares of our common stock upon the exercise of warrants held by certain of our principal shareholders in connection with our initial public offering.

In
connection with the redemption and conversion transactions described above, we incurred charges of $32.6 million due to the accretion on our class B common stock,
class C common stock, series A preferred stock and series B preferred stock and $0.9 million due to accrued dividends on our series A preferred stock and
series B preferred stock.



On December 29, 2005, we entered into an amendment to our revolving credit facility with PNC Bank, N.A. Under the terms of this amendment, our maximum
borrowings under our revolving credit facility increased from $10.0 million to $25.0 million, including availability of up to $2.0 million for letters of credit. The amendment
provides that borrowings under our revolving credit facility bear interest at tiered rates based upon the ratio of Net Funded Debt to EBITDA, each as defined in the amendment. In the alternative, we
may also elect interest rates calculated by reference to LIBOR plus a margin based upon the ratio of our Net Funded Debt to EBITDA. Interest on LIBOR borrowings is calculated on an
actual/360 day basis and is payable on the last day of each interest period. LIBOR advances will be available for periods of 1, 2, 3 or 6 months. LIBOR pricing will be adjusted for any
statutory reserves. Our revolving credit facility, as amended, will terminate on December 31, 2008, at which time all outstanding borrowings must be repaid, and all outstanding letters of
credit, if any, must be cash collateralized.

On
January 13, 2006, we acquired Webhire, Inc., a provider of end-to-end talent acquisition solutions for recruitment and human resource
professionals in middle-market enterprises across all

40

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industries,
for approximately $34.4 million in cash. Our historical financial results may not be indicative of our future results due to the impact of the Webhire acquisition. Included in our
Current Report on Form 8-K/A filed on February 22, 2006 is unaudited pro forma financial information for the year ended and as of December 31, 2005 which gives effect to our
acquisition of Webhire. The strategic rationale for acquiring Webhire included the following:





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 included in the basic subscription fee;
and (2) fees from other services including sales of 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. We expect that we will continue to maintain our renewal rate of more
than 90% of the aggregate contract value up for renewal for 2006, 2007 and 2008. The 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 the subscription component of our revenue has grown and clients' willingness to pay us in advance for their subscriptions has increased, the amount of deferred revenue on our balance
sheet has grown at a higher rate than our revenue. As of December 31, 2003, 2004 and 2005, our deferred revenue was $3.3 million, $6.6 million and $12.6 million,
respectively. We expect this trend to continue. 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

41

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recognized
differently depending on the type of service provided as described in greater detail below under "Critical Accounting Policies."

We
generate substantially all of our revenue from within the United States. During the years ended December 31, 2003, 2004 and 2005, approximately 95.0%, 91.2% and 90.1% of our
total revenue, respectively, were derived from sales in the United States. Although, we derive a small amount of our revenues from areas outside the United States, we believe that global markets
represent a significant opportunity and we intend to expand the international distribution and sale of our solutions. At this time, we do not have any specific plans or commitments with respect to
this expansion. During the years ended December 31, 2003, 2004 and 2005, approximately 5.0%, 8.8% and 9.9%, respectively, of our total revenue were derived from areas outside the United States.
Other than the revenues that we generated from clients in the Netherlands and the United Kingdom, which in the aggregate amounted to 3.3%, 7.0% and 4.4% of our total revenue for the years ended
December 31, 2003, 2004 and 2005, respectively, and revenues that were generated from clients in Canada which amounted to 3.2% for the year ended December 31, 2005, we did not have
revenue from any other country in excess of 0.5% of our total revenue in 2003, 2004 or 2005.



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 business expands, we expect that third-party license royalty costs and personnel costs associated with the delivery of our solutions will continue to increase.



We classify our operating expenses as follows:

Sales and Marketing.Sales and marketing expenses primarily consist 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. Investment
in sales and marketing commencing in 2003 resulted in significant revenue growth during 2003, 2004 and 2005. We intend to continue to invest in sales and marketing to pursue new clients and expand
relationships with existing clients. Our sales and marketing expense has increased in absolute terms although it has decreased as a percentage of total revenue. We expect this trend to continue.

Research and Development.Research and development expenses primarily consist 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. Our research and
development efforts have been devoted primarily to enhancements and upgrades to our existing products. Historically, we have capitalized a small percentage of our research and development expenses.
Capitalized research and development expenses totaled $0.7 million,

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$0.4 million,
and $1.0 million for the years ended December 31, 2003, 2004 and 2005, respectively. The remaining research and development expenses have been expensed as incurred.
We expect research and development expenses to increase in the future as we employ more personnel to support enhancements of our solutions and new solutions offerings. However, we expect research and
development expenses to increase as a percentage of total revenue primarily due to the expansion of our research and development efforts.

General and Administrative.General and administrative expenses primarily consist of personnel and related costs for our
executive, finance, human resources and administrative personnel, professional
fees and other corporate expenses and allocated overhead. As we expand our business and incur additional expenses associated with being a public company, we believe that general and administrative
expenses will increase in dollar amount and may decrease as a percentage of total revenue in 2006 and future periods.



By 2002, we began to make significant progress in the sales of our talent acquisition and employee performance management solutions and began to redirect
resources to those solutions. As part of this change of focus, we began to exit lower-margin businesses with less predictable revenue streams. Accordingly, in November 2003, we decided to
discontinue our pharmaceutical training division and Oracle implementation business. In December 2003, we sold our pharmaceutical training division for $3.0 million in cash for a net
gain of approximately $0.9 million. See note 3 in our audited consolidated financial statements for additional discussion.

Key Performance Indicators

The following tables summarize the key performance indicators that we consider to be material in managing our business:

|                                                                         |  | For the
Year Ended December 31, |       
|------------------------------------------------------------------------ |  | ------------------------------- | ------
|
|
|Total revenue                                                            |  | $                               | 33,991
|Subscription revenue as a percentage of total revenue                    |  |                                 | 75.1  
|Income from continuing operations before income tax and interest expense |  | $                               | 1,089 
|Net cash provided by operating activities                                |  | $                               | 3,322 
|                                                                         |  |                                 |       

|                 |  | For the
Year Ended December 31,
|---------------- |  | -------------------------------
|
|
|Deferred revenue |  | $                              

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

Subscription revenue as a percentage of total revenue.Subscription revenue as a percentage of total revenue can be derived
from our consolidated statement 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. We expect the percentage of subscription revenue to continue to increase in

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future
periods due to our continuing focus on subscription-based solutions and our continued investment in marketing efforts.

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. Historically, our net cash provided by operating activities has
exceeded our net income primarily due to the positive impact of deferred revenue. We expect this trend to continue because of the advance payment structure of our subscription agreements and because
as our sales increase, we expect incremental costs to decline.

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 term of the contract, which are 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 at a
higher rate than our revenue growth rate. We expect this trend to continue.

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

|                                              |  | For the
Year Ended December 31, |        
|--------------------------------------------- |  | ------------------------------- | -------
|
|
|Deferred revenue at beginning of period       |  | $                               | 2,577  
|Total invoiced subscriptions during period    |  |                                 | 26,193 
|Subscription revenue recognized during period |  |                                 | (25,510
|                                              |  |                                 |        
|Deferred revenue at end of period             |  | $                               | 3,260  

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 uncollectable 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.

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



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 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, 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:



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. We
recorded subscription fees and support revenues of approximately $25.5 million, $36.3 million and $51.0 million for the years ended December 31, 2003, 2004 and 2005,
respectively.

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.

We
record reimbursable out-of-pocket expenses incurred in accordance with EITF issue 01-14, Income Statement Characterization of Reimbursements
Received for "Out-of-Pocket" Expenses Incurred, which requires that reimbursements received for out-of-pocket expenses be classified as revenue and not
as cost reductions. Before the December 15, 2001 effective date of EITF Issue 01-14, out-of-pocket reimbursements from clients were netted with the
applicable costs. These items primarily

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include
travel, meals and certain telecommunication costs. For the years ended December 31, 2003, 2004, and 2005, reimbursed expenses totaled $0.8 million, $1.3 million, and
$1.4 million, respectively.



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.



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 audit
report.



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. We have reviewed the carrying values of goodwill of each business unit by comparing the carrying values to the estimated fair values
of the business components. The fair value is based on management's estimate of the future discounted cash flows to be generated by the respective business components and comparable company multiples.
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 the recoverability of goodwill. We determined that
the carrying values of our goodwill did not exceed the fair values and as a result we do not believe that impairment of goodwill existed at December 31, 2005.

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Stock-based compensation is measured in accordance with Accounting Principles Board Opinion, APB, No. 25. We measure compensation expenses for our employee
and director stock-based compensation plans using the intrinsic value method. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair value of our common stock
at the date of grant over the amount an employee must pay to exercise the option.

Because
there was no public market for our stock before our initial public offering in June 2005, prior to our initial public offering we considered internal and external factors
to assist in our determination of the fair value of our common stock. Internal factors include the success of our sales efforts, client retention and overall profitability. External factors consist of
market conditions and comparable public companies. We made assumptions and estimates in the preparation of our valuation, including assumptions and estimates related to projected cash flows, discount
rates, comparable market value multiples, the value of preferences associated with our preferred stock, the effect that those preferences have on the value of our common stock, and the likelihood at
various points in time of certain transactions taking place such as a public offering, sale of our company, raising additional private financing or liquidation. If we had made different estimates and
assumptions, our conclusions and the
related stock-based compensation recorded for stock-based compensation granted prior to our initial public offering may have been different.

See
"Recent Accounting Pronouncements" and "New Accounting Pronouncements" in note 2 of our audited consolidated financial statements for a discussion of Financial Accounting
Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment, which will require a change in our method of accounting for stock based
compensation in the first quarter of 2006. SFAS No. 123(R) will require us to record compensation expense based on the fair value of the awards as the grant date and will result in increased
expenses. Based upon the number of options outstanding as of December 31, 2005, we expect our expense for stock-based compensation for the year ended December 31, 2006 to be
approximately $1.9 million. The impact on our financial condition or results of operations will depend on the number and terms of stock options outstanding on the date of change, as well as
future options that may be granted.



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 of 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.

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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 December 31, 2003, 2004 and 2005, self-insurance accruals totaled approximately $0.1 million, $0.2 million and
$0.2 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.

Consolidated Results of Operations and Geographic Information



The following table sets forth certain consolidated historical results of operations data expressed as a percentage of total revenue for the periods indicated.
Period-to-period comparisons of our financial results are not necessarily meaningful and you should not rely on them as an indication of future performance.

|                                                                         |                      | For the
Year Ended December 31, |                         
|------------------------------------------------------------------------ | -------------------- | ------------------------------- | ------------------------
|
|Revenue:                                                                 |                      |                                 |                         
|                                                                         | Subscription revenue |                                 | 75.1                    
|                                                                         | Other revenue        |                                 | 24.9                    
|                                                                         |                      |                                 |                         
|                                                                         |                      | Total revenue                   |                         
|Cost of revenue                                                          |                      | 25.8                            | %                       
|                                                                         |                      |                                 |                         
|Gross profit                                                             |                      | 74.2                            | %                       
|                                                                         |                      |                                 |                         
|Operating expenses:                                                      |                      |                                 |                         
|                                                                         |                      | Sales and marketing             |                         
|                                                                         |                      | General and administrative      |                         
|                                                                         |                      | Research and development        |                         
|                                                                         |                      | Depreciation and amortization   |                         
|                                                                         |                      |                                 |                         
|                                                                         |                      |                                 | Total operating expenses
|                                                                         |                      |                                 |                         
|Income from continuing operations before income tax and interest expense |                      | 3.2                             | %                       
|Interest expense (income)                                                |                      | 1.0                             | %                       
|Interest on mandatory redeemable preferred shares                        |                      | 4.9                             | %                       
|                                                                         |                      |                                 |                         
|(Loss) income from continuing operations before income tax               |                      | (2.7                            | )%                      
|Income tax expense (benefit) from continuing operations                  |                      | 0.1                             | %                       
|                                                                         |                      |                                 |                         
|(Loss) income from continuing operations                                 |                      | (2.8                            | )%                      
|Income from discontinued operations, net of tax                          |                      | 0.0                             | %                       
|                                                                         |                      |                                 |                         
|Cumulative effect of change in accounting principle                      |                      | 33.0                            | %                       
|Net (loss) income                                                        |                      | (35.8                           | )%                      
|                                                                         |                      |                                 |                         

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The following table summarizes the distribution of revenue by geographic region as determined by billing addresses for each of the periods shown:

|                               |               | For the Year
Ended December 31, |      
|------------------------------ | ------------- | ------------------------------- | -----
|
|United States                  |               | 95.0                            | %    
|Europe, Middle East and Africa |               | 4.0                             | %    
|Canada                         |               | 0.3                             | %    
|Asia-Pacific and other         |               | 0.7                             | %    
|                               |               |                                 |      
|                               | Total revenue |                                 | 100.0
|                               |               |                                 |      

Comparison of Years Ended December 31, 2004 and 2005



Total revenue increased by 41.7% to $65.6 million for the year ended December 31, 2005 from $46.3 million for the year ended
December 31, 2004. Our subscription revenue increased by 40.2% to $51.0 million for the year ended December 31, 2005 from $36.3 million for the year ended
December 31, 2004. Subscription revenue represented approximately 77.7% of our total revenue for the year ended December 31, 2005. This increase is attributable to increasing sales of
our talent acquisition and
employee performance management solutions primarily due to the increasing adoption of our on-demand model for software generally and talent acquisition and employee performance management
solutions in particular. Additionally, our average revenue per customer from our top 80 customers increased from approximately $0.4 million per customer for the year ended December 31,
2004 to approximately $0.6 million per customer for the year ended December 31, 2005. Our other revenue increased by 47.4% to $14.7 million for the year ended December 31,
2005 from $10.0 million for the year ended December 31, 2004. This increase was due to an increase in demand for our consulting services which resulted from an increase in our
subscription based revenues. We expect subscription-based and other revenues to increase in 2006 over the prior year due to primarily customer acquisitions and additional sales to existing customers.



Cost of revenue increased by 54.1% to $18.8 million for the year ended December 31, 2005 from $12.2 million for the year ended
December 31, 2004. As a percentage of revenue, cost of revenue increased by 2.2% to 28.6% for the year ended December 31, 2005 compared to 26.4% for the year ended December 31,
2004. The increase in the cost of revenue was primarily due to our increased revenue. The increase in the cost of revenue as a percentage of revenue was caused by a change in the mix of our sales,
specifically an increase in consulting revenues, which have more costs as a percentage of revenues than our subscription-based revenues.



Sales and marketing expense increased by 20.1% to $16.1 million for the year ended December 31, 2005 compared to $13.4 million for the year
ended December 31, 2004. Increased salary, performance bonus and commissions of $0.9 million, $0.7 million and $0.4 million, respectively, contributed to the increase in
sales and marketing expense for the year ended December 31, 2005 from the prior year. Additionally, increased travel, bad debt expense and marketing expense of $0.3 million,
$0.2 million and $0.2 million, respectively, contributed to the increase in sales and marketing expense for the year ended December 31, 2005 from the prior year. As a percentage
of total revenue, sales and marketing expense

49

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decreased
to 24.6% for the year ended December 31, 2005 from 29.0% the year ended December 31, 2004 due to increased revenues.



General and administrative expense increased by 47.6% to $15.1 million for the year ended December 31, 2005 compared to $10.2 million for the
year ended December 31, 2004. The $4.9 million increase was primarily due to an increase in staff related expense of $1.0 million, the addition of 17 employees, an increase in
performance bonuses for our executives and management of $1.6 million, an increase in professional fees of $0.5 million, an increase in rent expense of $0.2 million, and other
general and administrative infrastructure expenses totaling $1.6 million. As a percentage of total revenue, general and administrative expense increased to 23.0% for the year ended
December 31, 2005 compared to 22.1% for the prior year due to increased expense.



Research and development expense decreased by 6.7% to $4.0 million for the year ended December 31, 2005 compared to $4.3 million for the year
ended December 31, 2004. The $0.3 million decrease in research and development expense was due to the transition of our development effort to India. As a percentage of total revenue,
research and development expense decreased from 9.2% to 6.1% for the year ended December 31, 2005 compared to the year ended December 31, 2004 due to increased revenues. As a result of
the continuing transition of our research and development efforts to India, we expect to expand the features and functionality of our solutions without increasing research and development expenses as
a percentage of revenue.



Depreciation and amortization expense decreased 14.7% to $2.1 million for the year ended December 31, 2005 compared to $2.5 million for the
year ended December 31, 2004 due to an early version of our applicant tracking system becoming fully depreciated. In the future, we expect depreciation and amortization expense to increase due
to recent capital purchases.



Interest expense (income) decreased to income of $0.6 million for the year ended December 31, 2005 from an expense of $0.2 million for the
year ended December 31, 2004. The $0.8 million increase is due primarily to interest earned on the net proceeds of our initial public offering which was completed in June 2005.



Interest on mandatory redeemable preferred shares decreased by 59.5% to $3.4 million for the year ended December 31, 2005 from $8.4 million
for the year ended December 31, 2004. As a result of our adoption of SFAS No. 150 in 2003, dividends on and changes in fair value in the mandatory redeemable preferred shares were
recorded as a cumulative change in accounting principle through July 1, 2003 and as an interest expense in subsequent periods. As a result of the redemption of all of the outstanding shares of
our series A preferred stock and series B preferred stock in connection with our initial public offering in June 2005, we no longer have this expense.



Income tax expense on continuing operations increased to a $0.6 million expense for the year ended December 31, 2005 from a $0.7 million
benefit for the year ended December 31, 2004. The $1.3 million increase in income tax expense was primarily attributable to the increase in income offset by the utilization of its net
operating loss carryforward and reduction of valuation allowance of

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approximately
$5.0 million. The benefit realized in 2004 resulted from a decrease in our valuation allowance of $0.4 million and an increase in our deferred tax asset of
$0.6 million. These changes were due to management's evaluation of our positive and negative evidence bearing upon the realizability of its deferred tax assets and has determined that it is
more likely than not that we will realize a portion of the benefits of federal and state tax assets. Webhire, which we acquired in January 2006, had a net operating loss carryforward balance of
approximately $48 million for federal purposes as of September 30, 2005. However, we expect that there will be significant limitations on our ability to use Webhire's U.S. net operating
loss carryforwards. See "Risk FactorsOur ability to use Webhire's net operating loss carryforwards in the United States will be significantly limited."

Comparison of Years Ended December 31, 2003 and 2004



Total revenue increased by 36.2% to $46.3 million for the year ended December 31, 2004 from $34.0 million for 2003. The $12.3 million
increase in total revenue was primarily a result of new purchases of solutions by existing and new clients and contract renewals. Our subscription revenue increased by 42.5% to $36.3 million or
78.5% of total revenue for the year ended December 31, 2004 from $25.5 million or 75.1% of total revenue for 2003. Our other revenue, which is composed primarily of discrete professional
fees, increased by 17.4% to $10.0 million or 21.5% of total revenue for the year ended December 31, 2004 from $8.5 million or 24.9% of total revenue for 2003. The increase in
total revenue was attributable to increased sales of our solutions driven primarily by improving economic conditions, increasing adoption of the on-demand model for software delivery
generally and for talent acquisition and performance management solutions in particular, and increased effectiveness of our marketing program.



Cost of revenue increased by 39.5% to $12.2 million for the year ended December 31, 2004 from $8.8 million for 2003. As a percentage of total
revenue, cost of revenue increased to 26.4% for the year ended December 31, 2004 from 25.8% for 2003. The increase in cost of revenue was primarily the result of our increased revenue and
related third-party license royalty costs, which comprised $0.7 million of the increase, and personnel costs associated with the delivery of our talent acquisition and employee performance
management solutions, which comprised $2.1 million of the increase. The latter increase was primarily due to an increase in personnel responsible for delivery of our solutions from 186
employees as of December 31, 2003 to 264 employees as of December 31, 2004. The increase as a percentage of total revenue was primarily attributable to an increase in reimbursed
expenses.



Sales and marketing expenses increased by 27.5% to $13.4 million for the year ended December 31, 2004 from $10.5 million for 2003. The
$2.9 million increase in sales and marketing expense was due to an increase in selling personnel cost of $2.6 million due to the addition of 17 employees in 2004, an increase in
marketing and advertising of $0.6 million and an increase in sales support related cost of $0.6 million, offset by a decrease in bad debt expense $0.9 million.



General and administrative expense increased by 36.9% to $10.2 million for the year ended December 31, 2004 from $7.5 million for 2003. The
$2.7 million increase in general and administrative expense was due to an increase in performance bonuses of $1.2 million, an increase in employee benefits of $0.5 million, an
increase in rent of $0.2 million, a non-cash charge of $0.2 million related to the issuance of options with an exercise price of less than the fair value of the stock
underlying the option on the date of grant and an increase in general infrastructure cost to support our growth. The

51

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charge
related to the issuance of options represents the estimated difference between the fair market value of the share price and the exercise price of the options at the date of the grant.



Research and development expenses increased by 23.3% to $4.3 million for the year ended December 31, 2004 from $3.5 million for 2003. The
$0.8 million increase in product development expenses was due to an increase in expenses related to the expansion of our global development center, the transition of our research and
development efforts to Hyderabad, India, and enhancements to the features of our on-demand software applications and other software. As a percentage of total revenue, product development
expenses decreased due to efficiencies generated by our global development center. We also increased the number of employees in product development from 81 as of December 31, 2003 to 136 as of
December 31, 2004.



Depreciation and amortization decreased by 9.0% to $2.5 million for the year ended December 31, 2004 from $2.7 million in 2003.



Discontinued operations resulted in net income, net of income tax, of $15,000 for the year ended December 31, 2003. This income was generated by the
pharmaceutical training division and the Oracle implementation business which were sold and exited, respectively, in 2003. The income includes gain on sale of $0.9 million offset by a loss from
discontinued operation of $0.8 million. Income (loss) from discontinued operations is not reflected in the financial results for the year ended December 31, 2004, as these businesses
were no longer part of our operations.

The
operating results for the pharmaceutical training division and the Oracle implementation business are classified as discontinued operations in the statements of operations for all
periods presented, net of tax. A summary of discontinued operations is as follows:

For the
Year Ended December 31,2003

2004(in thousands)Revenue:Subscription revenue

$


$
Other revenue


6,046


Total revenue


6,046


Cost of revenue


2,714


Gross profit


3,332


Total operating expenses


4,153


Interest expense excluding interest on mandatory redeemable preferred shares


23


Loss from discontinued operations before income taxes


(844
)

Gain on sale of discontinued operations


869


Income tax expense


10


Net income from discontinued operations

$
15

$



52

---





Interest expense decreased by 54.7% to $0.2 million for the year ended December 31, 2004 from $0.4 million for 2003. The $0.2 million
decrease in interest expense was primarily attributable to the repayment in 2004 of all borrowings on our revolving credit facility.



Interest on mandatory redeemable preferred shares increased 402.9% to $8.4 million for the year ended December 31, 2004 from $1.7 million for
2003.



Income tax expense decreased to a $0.7 million benefit for the year ended December 31, 2004 from $0.0 million for 2003. The
$0.7 million decrease in income tax expense was primarily attributable to the recognition of net operating loss carryforwards. Our federal net operating loss carryforward balance as of
December 31, 2004 was $15.7 million.



The following tables present our unaudited quarterly results of operations for each of the eight quarters in the period ended December 31, 2005 and our
unaudited quarterly results of operations expressed as a percentage of our subscription and other revenues for the same periods. You should read the following tables in conjunction with our audited
consolidated financial statements and related notes appearing at the end of this prospectus. We have prepared the unaudited information on a basis consistent with our audited consolidated financial
statements and have included all adjustments, which, in the opinion of management, are necessary to fairly present our operating results for the quarters presented. Our historical unaudited quarterly
results of operations are not necessarily indicative of results for any future quarter or for a full year.

53

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|                                                                     |                          | For the Three Months Ended |       
|-------------------------------------------------------------------- | ------------------------ | -------------------------- | ------
|
|
|Consolidated Statement of Operations Data:                           |                          |                            |       
|Revenue                                                              |                          |                            |       
|Subscription                                                         |                          | $                          | 8,183 
|Other                                                                |                          |                            | 1,837 
|                                                                     |                          |                            |       
|                                                                     |                          | Total revenue              |       
|Cost of revenues (exclusive of depreciation, shown separately below) |                          |                            | 2,304 
|                                                                     |                          |                            |       
|                                                                     |                          | Gross profit               |       
|                                                                     |                          |                            |       
|Operating expenses:                                                  |                          |                            |       
|Sales and marketing                                                  |                          |                            | 3,306 
|General and administrative                                           |                          |                            | 2,210 
|Research and development                                             |                          |                            | 926   
|Depreciation and amortization                                        |                          |                            | 607   
|                                                                     |                          |                            |       
|                                                                     | Total operating expenses |                            |       
|Income from operations before income tax and interest expense        |                          |                            | 667   
|                                                                     |                          |                            |       
|Interest expense (income)                                            |                          |                            | 48    
|                                                                     |                          |                            |       
|Interest on mandatory redeemable preferred shares                    |                          |                            | 2,068 
|                                                                     |                          |                            |       
|(Loss) income from operations before income tax                      |                          |                            | (1,449
|Income tax (benefit) expense on operations                           |                          |                            | 2     
|                                                                     |                          |                            |       
|Net (loss) income                                                    |                          | $                          | (1,451
|                                                                     |                          |                            |       
|Net (loss) income available to common shareholders                   |                          | $                          | (1,706
|                                                                     |                          |                            |       
|Net (loss) income per share available to common shareholders         |                          | $                          | (0.28 
|                                                                     |                          |                            |       

54

---





|                                                                     |                               | For the Three Months Ended |     
|-------------------------------------------------------------------- | ----------------------------- | -------------------------- | ----
|
|
|Consolidated Statement of Operations Data:                           |                               |                            |     
|Revenue                                                              |                               |                            |     
|Subscription                                                         |                               | 81.7                       | %   
|Other                                                                |                               | 18.3                       | %   
|                                                                     |                               |                            |     
|                                                                     |                               | Total revenue              |     
|Cost of revenues (exclusive of depreciation, shown separately below) |                               | 23.0                       | %   
|                                                                     |                               |                            |     
|                                                                     |                               | Gross profit               |     
|Operating expenses:                                                  |                               |                            |     
|                                                                     | Sales and marketing           |                            | 33.0
|                                                                     | General and administrative    |                            | 22.0
|                                                                     | Research and development      |                            | 9.2 
|                                                                     | Depreciation and amortization |                            | 6.1 
|                                                                     |                               |                            |     
|                                                                     |                               | Total operating expenses   |     
|Income from operations before income tax and interest expense        |                               | 6.7                        | %   
|Interest expense (income)                                            |                               | 0.5                        | %   
|Interest on mandatory redeemable preferred shares                    |                               | 20.6                       | %   
|                                                                     |                               |                            |     
|(Loss) income from operations before income tax                      |                               | (14.4                      | )%  
|Income tax (benefit) expense on operations                           |                               | 0.0                        | %   
|                                                                     |                               |                            |     
|Net (loss) income                                                    |                               | (14.4                      | )%  
|                                                                     |                               |                            |     

55

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Comparison of Unaudited Quarterly Results



Total revenue has increased each of our last eight quarters primarily due to purchases of our solutions by new clients, purchases of additional solutions by
existing clients and contract renewals. Our subscription revenue increased in every quarter presented from $8.2 million for the three months ended March 31, 2004 to $14.6 million
for the three months ended December 31, 2005. Our other revenue increased from $1.8 million for the three months ended March 31, 2004 to $3.5 million for the three months
ended December 31, 2005. We believe that subscription revenue increased more quickly than other revenue due to our continuing shift in focus toward subscription-based solutions and away from
discrete professional services.



Cost of revenue for the quarters presented has fluctuated based on the mix of sales between subscription revenue and other revenue. Cost of revenue was highest as
a percentage of total revenue for the three months ended September 30, 2004. This was caused by the mix of sales included in other revenue in that quarter. In particular, sales of perpetual
licenses can have a meaningful impact on cost of revenue.



Sales and marketing expenses have decreased as a percentage of total revenue for each of the three month periods ended March 31, 2004 through
December 31, 2005. Sales and marketing expenses have increased in terms of absolute dollars through the same period as a result of increased marketing programs and variable compensation
programs. The decrease as a percentage of sales is a result of the effectiveness of the marketing program and the effectiveness of an experienced sales force.



General and administrative expenses for the quarters presented have generally increased each quarter due to an increase in performance bonuses. Headcount and
professional fees have also increased to support our growth.



Research and development expenses for the quarters presented have generally increased each quarter due to an increase in product development expenses and
enhancements and upgrades to our existing products and have recently decreased due to our transition of development work to India.

Liquidity and Capital Resources

Since we were formed in 1987, we have financed our operations primarily through internally generated cash flows, our revolving credit facility and the issuance of
preferred and common stock. As of December 31, 2005, we had cash and cash equivalents of $43.5 million and accounts receivable of $10.3 million. In addition, we had
$0.2 million of debt and less than $0.4 million in capital equipment leases.

In
2004, we had cash provided from continuing operations of $10.1 million. We used cash in investing activities in the amount of $1.2 million and we used cash in financing
activities of $2.5 million. Our net increase in cash and cash equivalents in 2004 was $6.4 million. In addition, we repaid in 2004 the $1.6 million outstanding balance on our
revolving credit facility.

56

---



In
2005, we had cash provided by operations of $16.9 million. We used cash in investing activities of $3.9 million, and had cash provided by financing activities of
$21.1 million, primarily from the net proceeds of our initial public offering of $61.5 million and after redeeming our series A and B preferred stock. Our net increase in cash and
cash equivalents in 2005 was $34.0 million. We expect our positive cash flow from operations to continue in future periods.

On
December 29, 2005, we entered into an amendment to our revolving credit facility with PNC Bank, N.A. Under the terms of this amendment, our maximum borrowings under our
revolving credit facility increased from $10.0 million to $25.0 million, including availability of up to $2.0 million for letters of credit. The amendment provides that borrowings
under our revolving credit facility bear interest at tiered rates based upon the ratio of Net Funded Debt to EBITDA, each as defined in the amendment. In the alternative, we may also elect interest
rates calculated by reference to LIBOR plus a margin based upon the ratio of our Net Funded Debt to EBITDA. Interest on LIBOR borrowings is calculated on an actual/360 day basis and is payable
on the last day of each interest period. LIBOR advances will be available for periods of 1, 2, 3 or 6 months. LIBOR pricing will be adjusted for any statutory reserves. Our revolving credit
facility, as amended, will terminate on December 31, 2008, at which time all outstanding borrowings must be repaid, and all outstanding letters of credit, if any, must be cash collateralized.

On
January 13, 2006, we acquired Webhire, Inc. for approximately $34.4 million in cash. In addition, on that date we borrowed $25.0 million under our
revolving credit facility. We believe that our cash and cash equivalents 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.



Net cash provided by operating activities for continuing operations was $4.0 million for the year ended December 31, 2003, $10.1 million for
the year ended December 31, 2004 and $16.9 million for the year ended December 31, 2005. Net cash provided by operating activities for the year ended December 31, 2003
primarily resulted from net loss of $12.2 million and non-cash charges to net income of $18.9 million, an increase in deferred revenue of $0.7 million offset by
working capital changes of $3.4 million. Non-cash charges include an $11.2 million adjustment for the effect of a
change in accounting resulting from the adoption of SFAS No. 150 on July 1, 2003 whereby the dividends and changes in fair value of the mandatory redeemable preferred shares were
recorded as a cumulative change in accounting principle through July 1, 2003 and as interest expense in the subsequent periods. As a result of the redemption of all of the outstanding shares of
our preferred stock in connection with our initial public offering in June 2005, we will not have this expense in the future. Net cash provided by operating activities for the year ended
December 31, 2004 primarily resulted from our net loss of $4.1 million plus non-cash charges to net income of $10.4 million plus an increase in deferred revenue of
$3.4 million plus changes in working capital of $0.4 million. Non-cash charges to net income include $8.4 million of accrued interest on mandatory redeemable preferred
shares. Net cash provided by operating activities for the year ended December 31, 2005 primarily resulted from net income of $6.1 million plus non-cash charges to net income
of $6.4 million plus an increase in deferred revenue of $5.9 million less charges in working capital of $1.5 million. Non-cash charges to net income include
$3.4 million of accrued interest on mandatory redeemable preferred shares.



Net cash used in investing activities for continuing operations was $0.8 million for the year ended December 31, 2003, $1.2 million for the
year ended December 31, 2004 and $3.9 million for the year ended December 31, 2005, of which $3.7 million was related to capitalized software activities and purchases of
computer hardware and $0.2 million was related to an acquisition in July 2005. Net cash

57

---



provided
from investing activities for discontinued activities was $3.0 million for the year ended December 31, 2003. In November 2003, we decided to discontinue our
pharmaceutical training division and we discontinued our Oracle implementation business. The sale of the pharmaceutical training division in December 2003 for $3.0 million in cash
produced a net gain of approximately $0.9 million.



Net cash used in financing activities was $2.9 million for the year ended December 31, 2003 and $2.5 million for the year ended
December 31, 2004. Net cash provided by financing activities was $21.1 million for the year ended December 31, 2005. For the years ended December 31, 2003 and 2004, net
cash used in financing activities consisted of repayments of borrowings under our revolving credit facility, repayments of notes payable and repayments of capital lease obligations. Repayments on our
revolving credit facility were $1.5 million and $1.6 million in the years ended December 31, 2003 and 2004, respectively. Repayments of our capital lease obligations were
$0.4 million, $0.3 million, and $0.2 million for the years ended December 31, 2003, 2004 and 2005, respectively. Repayments of notes payable were $0.7 million for
the year ended December 31, 2003 and zero for each of the years ended
December 31, 2004 and 2005. We also used $0.6 million and $0.5 million to repurchase shares of our common stock owned by certain of our former employees during the years ended
December 31, 2004 and December 31, 2005, respectively. In June 2005, we raised $61.5 million, after discounts and expenses, from our initial public offering and used approximately
$40.0 million of such net proceeds to redeem our series A and Series B preferred stock.

Our
available borrowings under our revolving credit facility on December 31, 2003, 2004 and 2005 were $2.7 million, $3.7 million and $25.0 million,
respectively. Amounts outstanding on the revolving credit facility were $1.6 million, $0, and $0 on December 31, 2003, 2004 and 2005, respectively.

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, including those described in "Risk Factors," may cause us to seek additional debt or equity financing on an accelerated basis. 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. We do not, however, have any current plans to issue additional equity, including any preferred stock, in the near future.

Contractual Obligations and Commitments

The following table summarizes our contractual arrangements at December 31, 2005:

|                 |       | Payments due by period
|---------------- | ----- | ----------------------
|
|
|
|Capital leases   |       | $                     
|Operating leases |       |                       
|                 |       |                       
|                 | Total |                       

The
amounts listed above for capital leases represent payments that we are required to make for equipment. If we fail to remain current with our obligations for any of these capital
leases, we would be in default, and our continued failure to cure such a default would cause our remaining obligations under the defaulted capital lease to become immediately due. The amounts listed
above exclude the

58

---



commitment
to purchase Webhire, Inc. In addition, we have no off-balance sheet commitments for the periods presented.

The
amounts listed above for operating leases represent our leases for office space. If we fail to make rent payments on any of these leases when due, we will be required to pay all
remaining rent payments on the leases.

Recent Accounting Pronouncements

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS
No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 affects the issuer's accounting for three types of freestanding financial instruments:



SFAS
No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for
all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption
of SFAS No. 150 caused us to classify $50.5 million and $58.9 million of redeemable participating preferred stock as liabilities in years ended December 31, 2003 and 2004,
respectively. We recorded interest expense on mandatory redeemable preferred shares of $8.4 million and $1.7 million in the years ended December 31, 2004 and 2003, respectively.
Additionally, we also recorded a change of $11.2 million in 2003 resulting from a change in an accounting principle. There was no material effect on our cash flows from the adoption of SFAS
No. 150. See the notes to our consolidated financial statements.

In
December 2003, the SEC issued Staff Accounting Bulletin No. 104, "Revenue Recognition," which updates and summarizes the Commission's views on the application of
generally accepted accounting principles to revenue recognition in financial statements. We believe that our revenue recognition policies conform to the requirements of Staff Accounting Bulletin
No. 104.

In
December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, an amendment of SFAS No. 123 and SFAS No. 95. SFAS No. 123(R) replaces SFAS
No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to recognize the fair
value of stock options and other stock-based compensation to employees effective as of the beginning of its next fiscal year that begins after June 15, 2005. We will be required to implement
SFAS No. 123(R) no later than the quarter beginning January 1, 2006. We currently measure stock-based compensation in accordance with APB Opinion No. 25. We anticipate adopting
the modified prospective method of SFAS No. 123 (R) on January 1, 2006. Based on the stock options outstanding as of December 31, 2005, we will recognize compensation
expense in future consolidated statements of income of approximately $1.9 million and $1.7 million in the years ended December 31, 2006 and 2007, respectively. The impact on our
financial condition or results of operations will depend on the number and terms of stock options outstanding on the date of change, as well as future options that may be granted.

59

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In
March 2005, the Financial Accounting Standards Board (FASB) issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of
SFAS No. 143, Accounting for Asset Retirement Obligations. This Interpretation clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation when incurred if the liability's fair value can be reasonably estimated. The provisions of this pronouncement are effective for fiscal years ending after December 15, 2005. The
Company does not expect the adoption of Interpretation No. 47 to have any material financial statement impact.

In
May 2005, FASB issued SFAS 154, "Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20 and FASB Statement No. 3."
SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principle. It also applies to
changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires retrospective application to
prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.
SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not expect that adoption of this statement will have a material impact on our
results of operations or financial condition.

60

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ITEM 7A.    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

In 2005, approximately 90.1% of our total revenue was comprised of sales to clients in the United States. 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 not have resulted in a material change to our results.

The
financial position and operating results of our United Kingdom and India 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 were $0.02 million, $0.1 million and less than $0.1 million at December 31, 2003, 2004 and 2005, 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 do not believe that a 10% change in interest rates would have a significant effect on our interest income.

61

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ITEM 8.    Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

|Kenexa Corporation and Subsidiaries Consolidated Financial Statements |                                                         |                                                                                                                  
|--------------------------------------------------------------------- | ------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------
|                                                                      | Report of Independent Registered Public Accounting Firm |                                                                                                                  
|                                                                      | Consolidated Financial Statements:                      |                                                                                                                  
|                                                                      |                                                         | Consolidated Balance sheets as of December 31, 2004 and 2005                                                     
|                                                                      |                                                         | Consolidated Statements of operations for the years ended December 31, 2003, 2004 and 2005                       
|                                                                      |                                                         | Consolidated Statements of shareholders' equity (deficiency) for the years ended December 31, 2003, 2004 and 2005
|                                                                      |                                                         | Consolidated Statements of cash flows for the years ended December 31, 2003, 2004 and 2005                       
|                                                                      | Notes to Consolidated Financial Statements              |                                                                                                                  

62

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Report of Independent Registered Public Accounting Firm

Board
of Directors and Stockholders of Kenexa Corporation

Wayne,
Pennsylvania

We
have audited the accompanying consolidated balance sheets of Kenexa Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2005, and the related consolidated
statements of operations, shareholders' equity (deficiency), and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kenexa Corporation and subsidiaries as of
December 31, 2004 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America.

As
discussed in Note 2 of the financial statements, the Company adopted the provisions of Statements of Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", as of July 1, 2003.

BDO
Seidman, LLP

Philadelphia,
PA

February 21,
2006

63

---





Kenexa Corporation and Subsidiaries        Consolidated Balance Sheets

|                                                                                     |  | December 31,
|------------------------------------------------------------------------------------ |  | ------------
|
|Assets                                                                               |  |             
|Current assets                                                                       |  |             
|Cash and cash equivalents                                                            |  | $           
|Accounts receivable, net of allowance for doubtful accounts of $287,736 and $447,490 |  |             
|Unbilled receivables                                                                 |  |             
|Deferred income taxes                                                                |  |             
|Prepaid expenses and other current assets                                            |  |             
|                                                                                     |  |             
|Total current assets                                                                 |  |             
|Property and equipment, net of accumulated depreciation                              |  |             
|Software, net of accumulated depreciation                                            |  |             
|Goodwill                                                                             |  |             
|Intangible assets, net of accumulated amortization                                   |  |             
|Deferred financing costs, net of accumulated amortization                            |  |             
|Other assets                                                                         |  |             
|                                                                                     |  |             
|Total assets                                                                         |  | $           
|                                                                                     |  |             

64

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Kenexa Corporation and Subsidiaries        Consolidated Balance Sheets (Continued)

|                                                        |                                                                                                                                                                                                                                                             | December 31, |            
|------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | -----------
|
|Liabilities and Shareholders' (Deficiency) Equity       |                                                                                                                                                                                                                                                             |              |            
|Current liabilities                                     |                                                                                                                                                                                                                                                             |              |            
|                                                        | Accounts payable                                                                                                                                                                                                                                            |              | $          
|                                                        | Note payable                                                                                                                                                                                                                                                |              |            
|                                                        | Commissions payable                                                                                                                                                                                                                                         |              |            
|                                                        | Other accrued liabilities                                                                                                                                                                                                                                   |              |            
|                                                        | Accrued compensation and benefits                                                                                                                                                                                                                           |              |            
|                                                        | Deferred revenue                                                                                                                                                                                                                                            |              |            
|                                                        | Capital lease obligations                                                                                                                                                                                                                                   |              |            
|                                                        |                                                                                                                                                                                                                                                             |              |            
|Total current liabilities                               |                                                                                                                                                                                                                                                             |              | 13,720,424 
|Capital lease obligations, less current portion         |                                                                                                                                                                                                                                                             |              | 276,524    
|Note payable, less current portion                      |                                                                                                                                                                                                                                                             |              |           
|Other liabilities                                       |                                                                                                                                                                                                                                                             |              | 100,693    
|Shares subject to mandatory redemption                  |                                                                                                                                                                                                                                                             |              |            
|                                                        | Series A preferred stock, stated value $1,000; 30,000 shares authorized; 29,953 shares issued and outstanding at December 31, 2004; no shares authorized, issued, or outstanding at December 31,
2005; redemption value of $45,601,127 and $0, respectively |              |            
|                                                        | Series B preferred stock, stated value $1,000; 12,042 shares authorized, issued and outstanding at December 31, 2004; no shares authorized, issued, or outstanding at December 31, 2005; redemption value
of $19,471,761 and $0, respectively               |              |            
|                                                        |                                                                                                                                                                                                                                                             |              |            
|Total liabilities                                       |                                                                                                                                                                                                                                                             |              | 73,002,175 
|Commitments and contingencies                           |                                                                                                                                                                                                                                                             |              |            
|                                                        | Redeemable class B common stock, par value $0.01; 200,000 shares authorized and 54,479 shares issued and outstanding at December 31, 2004 and no shares authorized, issued, or outstanding at December 31, 2005                                             |              |            
|                                                        | Redeemable class C common stock, par value $0.01; 2,000,000 shares authorized and 1,526,813 shares issued and outstanding at December 31, 2004 and no shares authorized, issued, or outstanding at December 31,
2005                                        |              |            
|Shareholders' (deficiency) equity                       |                                                                                                                                                                                                                                                             |              |            
|                                                        | Preferred stock, par value $0.01; 100,000 shares authorized; no shares issued or outstanding                                                                                                                                                                |              |            
|                                                        | Class A common stock, $0.01 par value; 100,000,000 shares authorized; 7,982,628 and 17,459,044 shares issued, respectively                                                                                                                                  |              |            
|                                                        | Additional paid-in capital                                                                                                                                                                                                                                  |              |            
|                                                        | Deferred compensation                                                                                                                                                                                                                                       |              |            
|                                                        | Notes receivable for class A common stock                                                                                                                                                                                                                   |              |            
|                                                        | Treasury stock, shares class A common stock, 2,410,138 and none, respectively, at cost                                                                                                                                                                      |              |            
|                                                        | Accumulated other comprehensive income (loss)                                                                                                                                                                                                               |              |            
|                                                        | Accumulated deficit                                                                                                                                                                                                                                         |              |            
|                                                        |                                                                                                                                                                                                                                                             |              |            
|Total shareholders' (deficiency) equity                 |                                                                                                                                                                                                                                                             |              | (49,575,813
|Total liabilities and shareholders' (deficiency) equity |                                                                                                                                                                                                                                                             | $            | 33,288,493 
|                                                        |                                                                                                                                                                                                                                                             |              |            

See accompanying summary of accounting policies and notes to consolidated financial statements.

65

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Kenexa Corporation and Subsidiaries        Consolidated Statements of Operations

|                                                                                                                     |                                                                   | Year ended December 31, |            
|-------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ----------------------- | -----------
|
|Revenue                                                                                                              |                                                                   |                         |            
|                                                                                                                     | Subscription revenue                                              |                         | $          
|                                                                                                                     | Other revenue                                                     |                         |            
|                                                                                                                     |                                                                   |                         |            
|Total revenue                                                                                                        |                                                                   |                         | 33,990,511 
|Cost of revenue (exclusive of depreciation, shown separately below)                                                  |                                                                   |                         | 8,767,283  
|                                                                                                                     |                                                                   |                         |            
|Gross profit                                                                                                         |                                                                   |                         | 25,223,228 
|Operating expenses:                                                                                                  |                                                                   |                         |            
|                                                                                                                     | Sales and marketing                                               |                         |            
|                                                                                                                     | General and administrative                                        |                         |            
|                                                                                                                     | Research and development                                          |                         |            
|                                                                                                                     | Depreciation and amortization                                     |                         |            
|                                                                                                                     |                                                                   |                         |            
|Total operating expenses                                                                                             |                                                                   |                         | 24,134,503 
|                                                                                                                     |                                                                   |                         |            
|Income from continuing operations before income taxes and interest expense                                           |                                                                   |                         | 1,088,725  
|Interest expense (income)                                                                                            |                                                                   |                         | 352,450    
|Interest on mandatory redeemable shares                                                                              |                                                                   |                         | 1,667,351  
|                                                                                                                     |                                                                   |                         |            
|(Loss) income from continuing operations before income tax                                                           |                                                                   |                         | (931,076   
|Income tax (benefit) expense on continuing operations                                                                |                                                                   |                         | 33,188     
|                                                                                                                     |                                                                   |                         |            
|(Loss) income from continuing operations                                                                             |                                                                   |                         | (964,264   
|Income from discontinued operations net of tax expense of $10,005 and zero and zero                                  |                                                                   |                         | 15,007     
|                                                                                                                     |                                                                   |                         |            
|Net (loss) income before cumulative effect of change in accounting principle                                         |                                                                   | $                       | (949,257   
|Cumulative effect of change in accounting principle                                                                  |                                                                   |                         | 11,233,392 
|                                                                                                                     |                                                                   |                         |            
|Net (loss) income                                                                                                    |                                                                   | $                       | (12,182,649
|Accretion of redeemable class B common shares and class C common shares                                              |                                                                   |                         | (3,443,136 
|Accretion of series A preferred shares and series B preferred shares                                                 |                                                                   |                         | 871,852    
|Accrued dividends on series A preferred shares and series B preferred shares                                         |                                                                   |                         | 1,585,958  
|                                                                                                                     |                                                                   |                         |            
|Net loss available to common shareholders                                                                            |                                                                   | $                       | (11,197,323
|                                                                                                                     |                                                                   |                         |            
|Basic and diluted loss per share:                                                                                    |                                                                   |                         |            
|                                                                                                                     | Net loss from continuing operations                               |                         | $          
|                                                                                                                     | Net income from discontinued operations                           |                         |            
|                                                                                                                     | Net loss from cumulative effect of change in accounting principle |                         |            
|                                                                                                                     |                                                                   |                         |            
|Net loss per share available to common shareholders                                                                  |                                                                   | $                       | (1.86      
|                                                                                                                     |                                                                   |                         |            
|Weighted average shares used to compute net loss available to common shareholders per common sharebasic and diluted |                                                                   |                         | 6,033,834  

See accompanying summary of accounting policies and notes to consolidated financial statements.

66

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Kenexa Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity (Deficiency)

|                                                                                                 |  |   |             |   |   |             |   |   |             | Stockholders' (Deficiency) Equity |  
|------------------------------------------------------------------------------------------------ |  | - | ----------- | - | - | ----------- | - | - | ----------- | --------------------------------- | -
|
|
|
|
|Balance, December 31, 2002                                                                       |  | $ | 5,200,946   |   | $ | 7,084,687   |   | $ | 23,419,833  |                                   | $
|Payments received on notes receivable for class A common stock                                   |  |   |            |   |   |            |   |   |            |                                   |  
|Accretion of mandatory redeemable preferred and common stock to redemption values                |  |   | (1,454,424  | ) |   | (1,988,712  | ) |   | 695,579     |                                   |  
|Accrued dividends                                                                                |  |   |            |   |   |            |   |   | 1,016,508   |                                   |  
|Cumulative effect of change in accounting principles                                             |  |   |            |   |   |            |   |   | 9,274,187   |                                   |  
|Interest on preferred shares                                                                     |  |   |            |   |   |            |   |   | 1,064,840   |                                   |  
|Gain on currency exchange                                                                        |  |   |            |   |   |            |   |   |            |                                   |  
|Net loss                                                                                         |  |   |            |   |   |            |   |   |            |                                   |  
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  
|Balance, December 31, 2003                                                                       |  | $ | 3,746,522   |   | $ | 5,095,975   |   | $ | 35,470,947  |                                   | $
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  
|Stock repurchase                                                                                 |  |   |            |   |   |            |   |   |            |                                   |  
|Payments received on notes receivable for class A common stock                                   |  |   |            |   |   |            |   |   |            |                                   |  
|Accretion of common stock to redemption values                                                   |  |   | 1,544,534   |   |   | (524,900    | ) |   |            |                                   |  
|Interest on preferred shares                                                                     |  |   |            |   |   |            |   |   | 6,255,633   |                                   |  
|Gain on currency exchange                                                                        |  |   |            |   |   |            |   |   |            |                                   |  
|Deferred stock compensation related to stock options                                             |  |   |            |   |   |            |   |   |            |                                   |  
|Amortization of deferred stock compensation                                                      |  |   |            |   |   |            |   |   |            |                                   |  
|Net loss                                                                                         |  |   |            |   |   |            |   |   |            |                                   |  
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  
|Balance, December 31, 2004                                                                       |  | $ | 5,291,056   |   | $ | 4,571,075   |   | $ | 41,726,580  |                                   | $
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  
|Stock repurchase                                                                                 |  |   |            |   |   |            |   |   |            |                                   |  
|Retirement of Treasury Stock                                                                     |  |   |            |   |   |            |   |   |            |                                   |  
|Payments received on notes receivable for class A common stock                                   |  |   |            |   |   |            |   |   |            |                                   |  
|Accretion of common stock to redemption values                                                   |  |   | 20,858,768  |   |   | 20,629,645  |   |   | (664,123    | )                                 |  
|Accrued dividends                                                                                |  |   |            |   |   |            |   |   | 1,147,055   |                                   |  
|Interest on preferred shares                                                                     |  |   |            |   |   |            |   |   |            |                                   |  
|Loss on currency exchange                                                                        |  |   |            |   |   |            |   |   |            |                                   |  
|Deferred stock compensation related to stock options                                             |  |   |            |   |   |            |   |   |            |                                   |  
|Amortization of deferred stock compensation                                                      |  |   |            |   |   |            |   |   |            |                                   |  
|Option exercises                                                                                 |  |   |            |   |   |            |   |   |            |                                   |  
|Conversion of class C warrants                                                                   |  |   |             |   |   |             |   |   |             |                                   |  
|Initial public stock offering, net                                                               |  |   |            |   |   |            |   |   | (28,600,000 | )                                 |  
|Conversion of preferred stock to common stock upon public offering                               |  |   |            |   |   |            |   |   | (13,609,512 | )                                 |  
|Conversion of class B and class C redeemable common stock to class A common upon public offering |  |   | (26,149,824 | ) |   | (25,200,720 | ) |   |            |                                   |  
|Net income                                                                                       |  |   |            |   |   |            |   |   |            |                                   |  
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  
|Balance, December 31, 2005                                                                       |  | $ |            |   | $ |            |   | $ |            |                                   | $
|                                                                                                 |  |   |             |   |   |             |   |   |             |                                   |  

See accompanying summary of accounting policies and notes to consolidated financial
statements.

67

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Kenexa Corporation and Subsidiaries    Consolidated Statements of Cash Flows

|                                                                                        |  | Year ended December 31, |            
|--------------------------------------------------------------------------------------- |  | ----------------------- | -----------
|
|Cash flows from operating activities                                                    |  |                         |            
|Net (loss) income from continuing operations                                            |  | $                       | (12,197,656
|Adjustments to reconcile net (loss) income to net cash provided by operating activities |  |                         |            
|Non-cash compensation                                                                   |  |                         |           
|Depreciation and amortization                                                           |  |                         | 2,720,048  
|Amortization of deferred financing fees                                                 |  |                         | 131,686    
|Bad debt expense                                                                        |  |                         | 3,133,458  
|Accrued interest on mandatory redeemable preferred stock                                |  |                         | 1,667,351  
|Adjustment for effect of change in accounting                                           |  |                         | 11,233,392 
|Imputed and accrued interest                                                            |  |                         | 3,046      
|Deferred taxes                                                                          |  |                         |           
|Changes in assets and liabilities                                                       |  |                         |            
|Accounts and unbilled receivables                                                       |  |                         | (3,395,337 
|Prepaid expenses and other current assets                                               |  |                         | (78,832    
|Income taxes receivable                                                                 |  |                         | 28,925     
|Other assets                                                                            |  |                         | 33,969     
|Accounts payable                                                                        |  |                         | (558,836   
|Accrued compensation and other accrued liabilities                                      |  |                         | 632,453    
|Commissions payable                                                                     |  |                         | 11,240     
|Deferred revenue                                                                        |  |                         | 683,319    
|Other liabilities                                                                       |  |                         | (11,239    
|                                                                                        |  |                         |            
|Cash provided by continuing operations                                                  |  |                         | 4,036,987  
|Cash provided by (used in) discontinued operations                                      |  |                         | (714,908   
|                                                                                        |  |                         |            
|Net cash provided by operating activities                                               |  |                         | 3,322,079  
|                                                                                        |  |                         |            
|Cash flows from investing activities                                                    |  |                         |            
|Purchases of property and equipment                                                     |  |                         | (781,188   
|Cash paid for intangible assets                                                         |  |                         |           
|Acquisition, net of cash acquired                                                       |  |                         |           
|                                                                                        |  |                         |            
|Cash used in investing for continuing operations                                        |  |                         | (781,188   
|Cash provided by investing for discontinued operations                                  |  |                         | 3,000,000  
|                                                                                        |  |                         |            
|Net cash (used in) provided by investing activities                                     |  |                         | 2,218,812  
|                                                                                        |  |                         |            
|Cash flows from financing activities                                                    |  |                         |            
|Repayments under line of credit agreement                                               |  | $                       | (1,486,701 
|Repayments of notes payable                                                             |  |                         | (714,539   
|Repurchase of common shares                                                             |  |                         |           
|Collections of notes receivable                                                         |  |                         | 1,955      
|Net proceeds from initial public offering of common stock                               |  |                         |           
|Redemption of series A and B preferred stock                                            |  |                         |           
|Deferred financing costs                                                                |  |                         | (234,754   
|Net proceeds from option exercises                                                      |  |                         |           
|Repayments of capital lease obligations                                                 |  |                         | (438,738   
|                                                                                        |  |                         |            
|Net cash (used in) provided by financing activities                                     |  |                         | (2,872,777 
|                                                                                        |  |                         |            
|Effect of exchange rate changes on cash and cash equivalents                            |  |                         |           
|Net increase in cash and cash equivalents                                               |  |                         | 2,668,114  
|Cash and cash equivalents at beginning of year                                          |  |                         | 410,365    
|                                                                                        |  |                         |            
|Cash and cash equivalents at end of year                                                |  | $                       | 3,078,479  
|                                                                                        |  |                         |            

68

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Kenexa Corporation and Subsidiaries    Consolidated Statements of Cash Flows  Supplemental disclosures of cash flow information

|                                                                                      |  | Year ended December 31, |           
|------------------------------------------------------------------------------------- |  | ----------------------- | ----------
|
|Supplemental disclosures of cash flow information                                     |  |                         |           
|Cash paid during the year for:                                                        |  |                         |           
|Interest expense (income)                                                             |  | $                       | 250,707   
|Income taxes                                                                          |  | $                       | (9,162    
|Noncash investing and financing activities                                            |  |                         |           
|Capital lease obligations                                                             |  | $                       | 369,778   
|Accretion of class B common stock and class C common stock to redemption value        |  |                         | (2,571,284
|Redemption and conversion of class B and class C common stock to class A common stock |  |                         |          
|Note receivable for Common stock applied against accrued bonus                        |  |                         |          
|Accretion of preferred stock to redemption value                                      |  |                         | 871,852   
|Accrued dividends on preferred stock                                                  |  |                         | 1,585,958 
|Cumulative effect of change in accounting principle                                   |  |                         | 11,233,392

See accompanying summary of accounting policies and notes to consolidated financial statements.

69

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Kenexa Corporation and Subsidiaries        Notes to Consolidated Financial Statements

1.    Organization

Kenexa Corporation, and its subsidiaries (collectively the "Company"), 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. Between 1994 and 1998, the Company acquired 15 businesses that enabled it to offer comprehensive human capital
management, or HCM, services integrated with web-based technology.

The
Company began its operations in 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. The
Company operates in one segment.

2.    Summary of Significant Accounting Policies

Principles of Consolidation

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

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.

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 customization of sites associated with internet hosting arrangements. These costs are
deferred over the implementation period, typically three to four months, and are expensed ratably over the subscription period, typically one to three years. These amounts aggregated $612,452 and
$1,088,660 at December 31, 2004 and December 31, 2005, respectively. The current portion of these deferred costs of $447,538 and $978,779 at December 31, 2004 and
December 31, 2005, respectively, is included in other current assets and the noncurrent portion of $164,914 and $109,881 at December 31, 2004 and December 31, 2005, respectively,
is included in other assets in the accompanying consolidated balance sheets.

Property and Equipment

Property and equipment are stated at cost. Equipment under capital lease is stated at the lower of the fair market value at the date of acquisition or net present
value of the minimum lease payments at inception of the lease. Depreciation and amortization are provided on the straight-line basis over the assets' estimated useful lives or, if shorter,
the lease terms for leasehold improvements. Estimated useful lives are generally 7 years for office furniture, 3 to 5 years for computer equipment and 3 to

70

---



5 years
for software. Costs of maintenance and repairs are charged to expense as incurred. When property and equipment or leasehold improvements are sold or otherwise disposed of, the fixed
asset account and related accumulated depreciation account are relieved and any gain or loss is included in operations. Costs of software not yet placed into service are accumulated as software in
development. Upon placement into service, the costs of the assets are transferred to software.

Allowance for Doubtful Accounts

The Company records an allowance for doubtful accounts based on specifically identified amounts that management believes to be uncollectible. The Company also
records an additional allowance based on certain percentages of aged receivables, which are determined based on historical experience and management's assessment of the general financial conditions
affecting the Company's customer base. If actual collections experience changes, revisions to the allowance may be required. Activity in the allowance for doubtful accounts is as follows:

|Year |  | Balance at
January 1, |           | Charged Costs |   | Write Offs |   | Balance at
December 31,
|---- |  | --------------------- | --------- | ------------- | - | ---------- | - | -----------------------
|2005 |  | $                     | 287,736   |               | $ | 313,613    |   | 153,859                
|2004 |  |                       | 813,461   |               |   | (93,488    | ) | 432,237                
|2003 |  |                       | 2,175,337 |               |   | 1,771,582  |   | 3,133,458              

Software Developed for Service Transactions

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, will be 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 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 audit report.

The
Company capitalized internal-use software costs for the years ended December 31, 2003, 2004 and 2005 of $677,132, $386,277 and $994,413, respectively. Amortization
of capitalized internal-use software costs for the years ended December 31, 2003, 2004 and 2005 were $841,120, $1,053,632 and $674,863, respectively.

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 Board Opinion No. 17,Intangible Assets. Upon adoption of
SFAS 142, the Company ceased amortization of existing goodwill and is 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

71

---



the
fair value of the reporting unit below its carrying amount. The Company has reviewed the carrying values of goodwill of each business component by comparing the carrying values to the estimated
fair values of the business components. The fair value is based on management's estimate of the future discounted cash flows to be generated by the respective business components and comparable
company multiples. These 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 the Company's business based on its knowledge of the industry. Changes in the underlying business could affect these estimates, which in turn could affect the recoverability of
goodwill. Management determined that the carrying values of its goodwill did not exceed the fair values and as a result believes that no impairment of goodwill existed at December 31, 2005.

The
changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2005 are as follows:

Balance as of December 31, 2003

$
8,533,874Goodwill


Balance as of December 31, 2004

$
8,533,874Acquisition


281,339Balance December 31, 2005

$
8,815,213


On
July 29, 2005 the Company entered into an Asset Purchase Agreement with Scottworks Solutions, Inc., a business-intelligence and management consulting firm based in Toronto,
Canada. Pursuant to the agreement, the Company purchased all of Scottworks' assets and assumed selected liabilities for $425, payable as follows: $170 at closing and $9 per month, payable in 30 equal
installments beginning on August 1, 2005. The amounts allocated to goodwill and identified intangibles are approximately $281 and $102, respectively. The agreement also includes contingent
payments based upon the achievement of certain revenue targets which will be recorded as goodwill when earned.

Intangible Assets

Intellectual property and non-compete agreements ("intangible assets") are amortized on a straight-line basis over their estimated useful
lives or contract periods, generally ranging from 3 to 20 years. Accumulated amortization of intangible assets was $1,237,278 and $1,274,903 as of December 31, 2004 and 2005,
respectively. Amortization expense related to these intangible assets were $11,361 and $37,766 as of December 31, 2004 and 2005, respectively.

Intangible
Assets that are subject to amortization at December 31, 2004 and 2005, consist of the following:

Gross Carrying Value

Accumulated AmortizationDescription2004

2005

2004

2005Customer Lists



101,955



33,511Trademarks

58,882

66,667

6,462

10,576Fully Amortization Intangibles

1,230,816

1,230,816

1,230,816

1,230,816Total

1,289,698

1,399,438

1,237,278

1,274,903


72

---



Estimated
amortization expense for each of the next five years is as follows:

Year Ending December 31,

Amortization Expense2006

72,9492007

4,5042008

4,5042009

4,5042010

4,504


Impairment of Long Lived Assets

The Company evaluates its long-lived assets, including certain identifiable intangible assets, for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of any asset to
future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds
the fair value of the assets.

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:



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.

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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.

Unearned
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 "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 year
ended December 31, 2003, 2004 and 2005, reimbursed expenses totaled $775,447, $1,330,854 and $1,436,467, respectively.

Income Taxes

Kenexa files a consolidated tax return with its subsidiaries for federal tax purposes and on a separate company basis for state tax purposes. Deferred income
taxes are provided using the asset and liability method for temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Advertising

Advertising costs are expensed when incurred. Advertising for the years ended December 31, 2003, 2004 and 2005 were $14,916, $117,350 and $177,688,
respectively.

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 December 31, 2004 and 2005, self-insurance accruals
totaled $204,811 and $189,969, respectively. Management continuously reviews the adequacy of the Company's stop loss insurance coverage. Material differences may result in the amount and timing of
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 clients are concentrated primarily in the Company's
U.S. market area. At December 31, 2005,

74

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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. Certain operating
cash accounts may exceed the FDIC limits.

401(k) Plan

The Company sponsors a 401(k) defined contribution plan which is available for participation to all eligible employees. Company contributions to the plan are
subject to the board of director's election to make a contribution each year. Company contributions, if elected by the board of directors, are allocated to the participants' accounts based upon the
percentage of each participant's contributions to the plan during the given year to the total of all participant contributions. The Company's board of directors did not elect to make a matching
contribution for the year ended December 31, 2003. For the years ended December 31, 2004 and 2005 the Company's board of directors elected to make a matching contribution of 50% and
25%of employee contributions, respectively.

Earnings (Loss) Per Share

The Company follows SFAS 128, "Earnings Per Share." Under SFAS 128, companies that are publicly held or have complex capital structures are required
to present basic and diluted earnings per share on the face of the statement of operations. Earnings (loss) per share are 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 and warrants 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 available to common shareholders for all periods presented. As a result, the common stock equivalents of stock options, warrants and convertible securities issued and
outstanding at December 31, 2003, 2004 and 2005 were not included in the computation of diluted earnings per share for the years then ended as they were antidilutive. Additionally, at
December 31, 2005 and 2004, the Company had 2,517,797 and 396,195 respectively, anti-dilutive shares that were excluded from diluted earnings per share calculation due to their

75

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anti-dilutive
nature. There were no anti-dilutive shares at December 31, 2003. Loss per share is computed as follows:

|                                                                                                                      |  | Twelve Months
Ended December 31, |            
|--------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | -----------
|
|
|Net (loss) income                                                                                                     |  | $                                | (12,182,649
|Accretion of redeemable class B common stock and redeemable class C common stock                                      |  |                                  | (3,443,136 
|Accretion of redeemable series A preferred stock and series B preferred stock                                         |  |                                  | 871,852    
|Accrued dividends on series A preferred stock and series B preferred stock                                            |  |                                  | 1,585,958  
|                                                                                                                      |  |                                  |            
|Net (loss) available to common shareholders                                                                           |  | $                                | (11,197,323
|                                                                                                                      |  |                                  |            
|Weighted average shares used to compute net loss available to common shareholders per common sharebasic and dilutive |  |                                  | 6,033,834  
|                                                                                                                      |  |                                  |            
|Basic and diluted (loss) per share                                                                                    |  | $                                | (1.86      

The Company has restated all shares to reflect a 0.8-for-1 reverse stock split.

Stock-Based Compensation

The Company has adopted the disclosure only provisions of SFAS No. 123,Accounting for Stock-Based
Compensation("SFAS 123"). SFAS 123 encourages, but does not require, companies to record compensation cost for stock-based compensation plans at fair value. The
Company elected to continue to account for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to
Employeesand related interpretations, as permitted by SFAS 123. Compensation expense for stock options is measured as the excess, if any, of the fair value of the
Company's Class A common stock over the amount an employee or director must pay to acquire this stock. Compensation for equity instruments, such as stock options, granted to
non-employees is expensed when issued based on the fair value of the equity instruments issued or the consideration received, whichever is more reliably measured.

Because
the Company accounts for stock options under Accounting Principles Board ("APB") Opinion 25 and no options have been granted with an exercise price below fair market value of the
class A common stock at the grant date, prior to December 31, 2003, no compensation cost has been recognized in the financial statements for stock options granted prior to
December 31, 2003. Had compensation expense for stock options granted been determined based on the fair value at the grant dates under the provisions of SFAS 123, the Company's pro forma
net loss would not have been materially different. The fair value of each option grant is estimated on the date of grant using the

76

---



Black-Scholes
pricing model, with a risk-free interest rate of 4.6%, volatility of 51.3%, an expected life of 10 years, and no expected dividend yield option.

|                                                                                                                          |  | 2003 |             | 2004 |   | 2005       |  
|------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | ---------- | -
|Net (loss) income as reported                                                                                             |  | $    | (12,182,649 | )    | $ | (4,092,917 | )
|Add: stock based employee compensation expense included in reported net income, net of tax                                |  |      |            |      |   | 213,474    |  
|Deduct: total stock-based compensation expense determined under fair value based method for all awards, net of tax        |  |      | 383,397     |      |   | 176,052    |  
|                                                                                                                          |  |      |             |      |   |            |  
|Pro forma net (loss) income                                                                                               |  | $    | (12,566,046 | )    | $ | (4,055,495 | )
|                                                                                                                          |  |      |             |      |   |            |  
|Accretion of redeemable class B common stock, class C common stock, series A preferred stock and series B preferred stock |  |      | (2,571,284  | )    |   | 1,019,634  |  
|Accrued dividends on series A preferred stock and series B preferred stock                                                |  |      | 1,585,958   |      |   |           |  
|                                                                                                                          |  |      |             |      |   |            |  
|Net (loss) available to common shareholders                                                                               |  | $    | (11,580,720 | )    | $ | (5,075,129 | )
|Basic and diluted (loss) per share as reported:                                                                           |  | $    | (1.86       | )    | $ | (0.85      | )
|Pro forma                                                                                                                 |  | $    | (1.92       | )    | $ | (0.85      | )
|Weighted average fair value of outstanding options                                                                        |  | $    | 3.50        |      | $ | 3.67       |  

On January 20, 2004, the Company granted to certain employees options to purchase an aggregate of 44,800 shares of the Company's
Class A common stock at an exercise price of $4.63 and an option to purchase an aggregate of 20,000 shares of the Company's Class A common stock at an exercise price of $4.18 per share.
The Company valued the shares at $15 per share and the excess of the underlying Class A common stock fair value over the applicable exercise prices was $681,300. The Company recognized $227,100
of this excess value as compensation expense in the years ended December 31, 2004 and 2005, respectively.

On
January 14, 2005, the Company granted options to certain employees to purchase an aggregate of 117,600 shares of the Company's common stock at an exercise price of $4.63 per
share. The Company valued the shares at $15 per share and the excess of the underlying Class A common stock fair value over the exercise price was $1,220,100. The Company recognized $406,700 of
this excess value as compensation expense in the year ended December 31, 2005.

Between
June 23, 2005 and December 31, 2005 the Company granted options to certain employees to purchase an aggregate of 796,400 shares of the Company's common stock
at a weighted exercise price of $13.17 per share. The Company granted the options at prevailing market prices ranging from $12.05 to $17.72 per share.

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.

Fair Value of Financial Instruments

The carrying amounts of the Company's financial assets and liabilities, including cash, accounts receivable and accounts payable at December 31, 2004 and
2005 approximate fair value of these instruments. Redeemable preferred stock is carried at fair value, based upon redemption requirements. See footnote 9 for further discussion.

77

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Foreign Currency

The financial position and operating results of the United Kingdom and India 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 were $95,191 and $(124,339) for the years ended December 31, 2004 and 2005, respectively, and are reported
in the equity section of the balance sheet. The foreign currency translation adjustment is not adjusted for income taxes as it relates to an indefinite investment in a non-U.S. subsidiary.

Comprehensive Income (Loss)

Comprehensive income (loss) consists of net loss or gain on foreign currency translations and net income or loss from operations and is presented in the
consolidated statement of shareholders deficiency.

Reclassifications

Certain reclassifications of prior years' amounts have been made to conform to the current year presentation.

New Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN
46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest
entities" or "VIEs"). Variable interest entities within the scope of FIN 46 are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning
after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of this statement did not have
an impact on the Company's financial position, results of operations, or cash flows since the Company currently has no VIEs. In December 2003, the FASB issued FIN 46R with respect to VIEs
created before January 31, 2003, which, among other things, revised the implementation date to the first fiscal year or interim period ending after March 15, 2004, with the exception of
special purpose entities. The consolidation requirements apply to all special purpose entities in the first fiscal year or interim period ending after December 15, 2003. The Company adopted the
provision of FIN 46R effective January 1, 2004, and such adoption did not have a material impact on the financial statements since the Company currently has no special purpose entities.

On
May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS 150). SFAS
No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a
financial instrument that is within its scope as a liability

78

---



(or
an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 affects the issuer's accounting for three types of freestanding financial
instruments:



SFAS
No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for
all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption
of SFAS No. 150 caused the Company to classify $50,518,936 and $58,904,534 of mandatory redeemable preferred stock as liabilities in the years ended December 31, 2003 and 2004
respectively. The Company recorded interest expense on mandatory redeemable preferred stock of $1.7 million, $8.4 million and $3.4 million for the years ended December 31,
2003, 2004, and 2005 respectively. Additionally, we also recorded a charge of $11.2 million in 2003 resulting from a cumulative change in an accounting principle. There was no material effect
on the Company's cash flows from the adoption of SFAS No. 150. See Note 9 for further discussion.

In
December 2004, the FASB issued FAS No. 123(R), "Share-Based Payment," an amendment of FASB Statements No. 123 and 95. FAS No. 123(R) replaces FAS
No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." This statement requires companies to recognize the fair
value of stock options and other stock-based compensation to employees effective as of the beginning of its next fiscal year that begins after June 15, 2005. This means that Kenexa will be
required to implement FAS No. 123(R) no later than the quarter beginning January 1, 2006. The Company currently measures stock-based compensation in accordance with APB Opinion
No. 25 as discussed above. The Company anticipates adopting the modified prospective method of FAS No. 123(R) on January 1, 2006. Based on the stock options outstanding as of
December 31, 2005, the Company will recognize compensation expense, net of taxes, in future Consolidated Statements of Income of approximately $1,885,393 and $1,662,627 in the years ending
December 31, 2006 and 2007, respectively. The impact on the Company's financial condition or results of operations will depend on the number and terms of stock options outstanding on the date
of change, as well as future options that may be granted. See "Stock-Based Compensation" earlier in this Note for the pro forma impact that the fair value method would have had on the Company's net
income for each of the years ended December 31, 2003, 2004, and 2005.

In
March 2005, the Financial Accounting Standards Board (the FASB) issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, an interpretation
of SFAS No. 143, Accounting for Asset Retirement Obligations. This Interpretation clarifies that an entity is required to recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liability's fair value can be reasonably estimated. The provisions of this pronouncement are effective for fiscal years ending after December 15,
2005. The Company does not expect the adoption of Interpretation No. 47 to have any material financial statement impact.

79

---





In
May 2005, FASB issued SFAS 154, "Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20 and FASB Statement No. 3".
SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principle. It also applies to
changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires retrospective application to
prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.
SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not expect that adoption of this statement will have a material impact on our
results of operations or financial condition.

3. Discontinued Operations

On December 23, 2003, the Company sold its pharmaceutical training division for $3,000,000 in cash for a net gain of $868,812. Included in the sale were
accounts receivable of $1,147,622, unbilled receivables of $223,194, unearned revenue of $580,839 and fixed assets with a net book value of $142,474. As a result of this sale, the Company wrote off
$597,206 of goodwill associated with prior acquisitions. This write off of goodwill is reflected in the net gain on the sale. The Company did not hold any assets or liabilities related to this
division at December 31, 2003 or 2004.

In
2003, management decided to discontinue the operations of its Technology Solutions Group ("TSG") due to a change in business strategy. The Company recorded a charge of $282,340 for
future lease obligations included in discontinued operations. These charges are accruals for future lease obligations related to the abandoned lease space of TSG. The charges are calculated using the
discounted present values of future lease payments, net of estimated future sublease amounts.

In
addition to the segregation of operating financial results, assets, and liabilities, Emerging Issues Task Force ("EITF") No. 87-24, "Allocation of Interest to
Discontinued Operations," mandates the allocation of interest to discontinued operations in accordance with specific guidelines. The Company is using the permitted allocation method for interest
expense on corporate debt, which is based on the ratio of net assets sold or discontinued to the sum of total assets of the consolidated Company plus consolidated debt. Under this method, interest
expense of $24,000, $23,000 and $0 for the years ended 2002, 2003 and 2004, respectively was allocated to discontinued operations.

80

---



Transactions
related to the pharmaceutical training division and TSG have been reflected in discontinued operations for all periods presented. Revenues and income from consolidated
discontinued operations were as follows:

2003

2004

2005Discontinued operationsRevenues

$
6,046,352

$


Operating expenses


6,578,423




Accrual for future lease obligations


282,340




Goodwill


29,389




Net gain on sale on business unit


868,812




Income from discontinued operations before tax expense


25,012




Income tax expense


10,005




Net income (loss) from discontinued operations

$
15,007







4. Property, Equipment and Software

A summary of property, equipment and software and related accumulated depreciation as of December 31, 2004 and 2005 is as follows:

December 31,2004

2005Equipment

$
7,451,162

$
7,338,423Software


6,691,923


6,582,875Office furniture and fixtures


1,034,287


1,175,131Leasehold improvements


639,099


644,868Land





577,501Software in development


170,575


846,48315,987,046


17,165,281Less accumulated depreciation


12,311,189


11,578,327$
3,675,857

$
5,586,954


Equipment,
office furniture and fixtures included capital leases totaling $3,634,257 and $2,241,315 at December 31, 2004 and 2005, respectively. Depreciation and amortization
expense, including amortization of assets under capital leases, was $2,534,002 and $2,073,814 for the years ended December 31, 2004 and 2005, respectively.

81

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5. Other Accrued Liabilities

Other accrued liabilities consist of the following:

December 31,2004

2005Accrual for discontinued operations*

$
178,553

70,654Accrued professional fees


305,900

259,811Straight line rent accrual


166,257

199,371Other taxes payable (non-income tax)


81,725

220,000Income taxes payable




1,084,419Other liabilities


644,928

342,119Total other accrued liabilities

$
1,377,363

2,176,374


---

6. Line of Credit

On December 29, 2005, the Company entered into a Third Amendment and Modification to the Revolving Credit and Security Agreement with PNC Bank, N.A.,
originally dated July 15, 2003, and as amended on October 10, 2003 and March 22, 2005. The Third Amendment increased the maximum amount available under the credit facility from
$10 million to $25 million, including a sublimit of up to $2 million for letters of credit. No amounts were outstanding on the line on December 31, 2005. On
January 13, 2006, the Company borrowed $25 million from the credit facility for working capital purposes.

The
Company's borrowings under the credit facility 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. The credit facility will terminate on December 31, 2008, at which time all outstanding borrowings must be repaid, and all outstanding letters of credit, if any, must be cash
collateralized.

On
July 15, 2003, the Company refinanced its line of credit agreement by entering into a revolving credit and security agreement ("the Revolver") with a new lender. Maximum
available borrowings under the Revolver represent the lesser of $10,000,000 or the Borrowing Base, which is defined as 85% of the amount of Eligible Receivables and 75% of the amount of Unbilled
Receivables. Based upon these criteria, maximum available borrowings on December 31, 2004 were $3,726,901. No amounts were outstanding on the line of credit on December 31, 2004.

Borrowings
under the Revolver are collateralized by generally all the Company's assets, including a pledge of the capital stock of its subsidiaries. Repayment of amounts outstanding
under certain notes payable and all issued or issuable shares of common and preferred stock are subordinated to the rights of the lender under terms of the Revolver. The Revolver contains various
terms and covenants that

82

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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.

7. Income Taxes

The income tax expense (benefit) for the years ended December 31, 2003, 2004, and 2005 consisted of the following:

December 31,2003

2004

2005CurrentFederal

$
23,429

$
74,725


1,400,867Foreign





84,825


14,817State and local


19,764


140,605


671,666Total Current


43,193


300,155


2,087,350DeferredFederal





(869,380
)

(1,119,206
)Foreign








(270,000
)State and local





(153,420
)

(107,582
)Total Deferred





(1,022,800
)

(1,496,788
)Income tax (benefit) expense related to continuing operations


33,188


(722,645
)

590,563Income tax related to discontinued operations


10,005





Total Income tax provision (benefit)

$
43,193

$
(722,645
)
$
590,563


A
reconciliation of the Company's effective income tax rate to the statutory federal income tax rate of 34% for the years ended December 31, 2003, 2004 and 2005 is as follows:

December 31,2003

2004

2005Statutory federal tax rate

(34.0
)%
(34.0
)%
34.0
%Foreign tax differential

1.2
%
2.0
%
5.2
%Section 162 Credit





(2.5
)%Change in accounting principle

31.5
%


0.0
%Marking to market charge



36.3
%
17.3
%State income taxes

0.2
%
3.1
%
10.1
%Officer's life insurance

0.4
%
1.0
%
0.4
%Other nondeductible expenses

0.3
%
1.4
%
0.6
%AMT tax

0.2
%
1.6
%
0.0
%Change in valuation allowance

1.8
%
3.0
%
(25.7
)%Use of NOL

(1.2
)%
(30.1
)%
(30.5
)%Income tax expense

0.4
%
(15.7
)%
8.8
%


83

---



Significant
components of the Company's net deferred tax assets (liabilities) as of December 31, 2003, 2004 and 2005 were as follows:

December 31,2003

2004

2005Deferred tax assetsForeign net operating loss carryforward

$
1,267,670

$
1,185,308

$
1,215,930Accrued expenses


1,389,520


2,669,512


769,439Federal and state net operating losses


5,667,624


4,394,210


1,671,879AMT tax carryforward





138,908


Unearned revenue adjustment


366,829


1,030,666


1,705,542Accounts receivable allowance


322,397


185,182


369,527Other


1,199


3,525


Total deferred tax assets


9,015,239


9,607,311


5,732,317Deferred tax liabilitiesDepreciation and amortization


(812,238
)

(801,115
)

(126,813
)Amortization of intangibles


(1,790,347
)

(1,792,706
)

(2,139,986
)Total deferred tax liabilities


(2,602,585
)

(2,593,821
)

(2,266,799
)Net deferred tax asset

$
6,412,654

$
7,013,490

$
3,465,518Valuation allowance


(6,412,654
)

(5,990,690
)

(945,930
)Net deferred tax asset

$


$
1,022,800

$
2,519,588


A
valuation allowance of $6,412,654, $5,990,690 and $945,930 has been recorded at December 31, 2003, 2004 and 2005, respectively. In 2003 a 100% valuation
allowance has been recorded on the basis of uncertainty with respect to the ultimate realization of certain deferred tax assets. In 2004 based upon historical taxable income in 2003 and projected
taxable income for 2004 and 2005 the Company reduced its valuation allowance on its net deferred tax assets. At December 31, 2005, the Company has available net operating loss carryforwards
from U.S. operations of approximately $4.4 million for federal purposes which expire in the year 2022 and approximately $2.9 million for state purposes which expire in 2005 through 2022
for state purposes. At December 31, 2005, the Company also has available net operating loss carryforwards from foreign operations of approximately $4.9 million with no expiration date.
In 2005, the Company reduced its valuation allowance by approximately $5.0 million due to the utilzation of net operating loss carryforwards to offset the increase in income resulting in income
tax expense on continuing operations of $0.6 million for the year ended December 31, 2005. In 2004, the Company reduced its valuation allowance by approximately $0.4 million and
increased deferred tax assets by approximately $0.6 million as a result of management's determination that it is more likely than not that the Company will realize a portion of the benefits of
the federal and state tax assets resulting in an income tax benefit of $0.7 million for the year ended December 31, 2004.

The
Company does not provide for federal income taxes or tax benefits on the undistributed earnings or losses of its international subsidiaries because earnings are reinvested and, in
the opinion of management, will continue to be reinvested indefinitely. At December 31, 2005, the Company had not provided for federal income tax benefits for cumulative losses of individual
international subsidiaries which was $2,326,000 at December 31, 2005. Should these earnings be distributed in the form of

84

---



dividends
or otherwise, the Company would be subject to both U.S. income taxes and withholding taxes in various international jurisdictions. Determination of the related amount of unrecognized
deferred U.S. income tax liability is not practicable because of the com plexities associated with its hypothetical calculation. As noted above, the Company has significant net operating loss
carryforwards for U.S. federal income taxes purposes, which are available to offset the potential tax liability if the earnings were to be distributed.

8. Commitments and Contingencies

Leasing Arrangements

The Company leases certain of its facilities and equipment under various operating and capital leases. Equipment under capital leases consists primarily of
computer equipment and furniture and fixtures. These leases generally have terms of three to five years, bear interest of 9.0% to 13.0% per annum and are collateralized by the underlying equipment.
Operating leases primarily consist of leases for office space and equipment. Future minimum lease payments for each of the following five years are:

Year ended December 31,Capital
Leases

Operating
Leases2006

$
238,512

$
2,398,0512007


155,846


2,099,3102008


32,455


2,038,3722009


1,842


1,895,1892010


767


1,315,998Total minimum lease payments


429,422

$
9,746,920Less amount representing interest


25,955Present value of minimum payments under capital leases


403,467Less current portion


219,233$
184,234


Rent
expense was $2,161,850, $1,844,014 and $2,111,246 for the years ended December 31, 2003, 2004 and 2005, respectively.

Deferred Compensation

The Company has an unfunded deferred compensation contract with a former employee shareholder of the Company. Under the terms of the agreement, the former
employee shareholder is receiving monthly retirement benefit payments through June 2008. Amounts paid under this plan are payable to the former employee's beneficiaries in the event of his
death.

At
December 31, 2004 and 2005 the liability under the deferred compensation plan was $139,467 and $98,679, respectively. The present value of the estimated liability, is included
in other liabilities, and is determined by calculating the net present value of the retirement benefits expected to be earned by the former employee shareholder from the effective date of the
agreement through retirement date

85

---



using
a discount rate of 8.0%. The interest expense associated with this plan was $12,543 and $9,473 for the years ended December 31, 2004 and 2005, respectively.

Litigation

On October 31, 2000, Gallup, Inc., which conducts its business under the name The Gallup Organization, filed suit against us in United States
District Court for the Eastern District of Pennsylvania seeking unspecified damages and injunctive relief, alleging that we unlawfully raided Gallup's employees and tortiously interfered with Gallup's
relationships with former employees and customers, infringed on Gallup's copyrighted survey language and falsely advertised aspects of our employee survey services. In November 2001, the
District Court granted our motion to dismiss Gallup's claim that we conducted an unlawful raid of Gallup's employees. In December 2002, the District Court granted our motion for summary
judgment on the false advertising claim. In January 2003, the District Court granted our motion for summary judgment on the claims regarding our alleged tortious interference with Gallup's
relationships with its former employees and its customers. Gallup did not appeal any of these rulings.

In
November 2004, the District Court granted our motion for summary judgment on the copyright claim. Gallup appealed that ruling to the United States Court of Appeals for the
Third Circuit. The United States Court of Appeals has reversed the Judge's summary judgment grant in Kenexa's favor. Trial is now scheduled to commence in this case on December 6, 2005.

See
note no. 14, Subsequent Events, for an update on the Gallup matter.

The
Company is a party to certain legal actions arising in the ordinary course of business. While it is not possible to determine with certainty the outcome of these matters, in the
opinion of management the eventual resolution of these claims and actions outstanding will not have a material adverse effect on the Company's consolidated financial position, results of operations or
liquidity.

86

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9. Shares Subject to Mandatory Redemption

Mandatory Redeemable Preferred Stock

Rollforward of Shares

The Company's mandatory redeemable preferred shares issued remained the same during the years ended December 31, 2003, 2004, and 2005 and were converted to
the Company's Class A common stock during the Company's initial public offering as follows:

Mandatory
RedeemablePreferred StockSeries A

Series BBalance, December 31, 2002

29,953

12,042Balance, December 31, 2003

29,953

12,042Balance, December 31, 2004

29,953

12,042Conversion to Class A common stock

(29,953
)
(12,042
)Balance, December 31, 2005






No
shares were repurchased during this period. Effective with the Company's initial public offering on June 29, 2005 these shares were converted into 1,858,376 shares of common
stock.

Upon
the adoption of SFAS No. 150, effective July 1, 2003 as discussed in Note 2, the Company transferred its preferred stock previously presented in the equity
section of the balance sheet to the long term liability section of the Consolidated Balance Sheet. Also, effective July 1, 2003, dividends accrued on mandatory redeemable preferred stock and
any accretion of mandatory redeemable preferred stock to redemption value have been classified as interest expense on the Consolidated Statement of Operations. In 2003, 2004 and 2005 the interest
expense related to accrued dividends on preferred stock was $1,667,351, $3,490,714, and $1,817,233 respectively. In 2003, 2004 and 2005 interest expense related to the accretion of preferred stock was
$11,233,392, $4,894,884 and $1,578,836, respectively. The $11,233,392 of accretion in 2003 is reflected as a Cumulative Effect of Change in Accounting Principle on the Consolidated Statement of
Operations.

At
December 31, 2003 and 2004, the Company had 30,000 and 12,042 authorized shares of Series A and B preferred stock, respectively. The Series A and B preferred
stock both have a stated value of $1,000 per share and accrue dividends at 6% and 8% per annum, respectively, compounded quarterly. The Series A and B preferred stock are on a pari pasu basis
with each other and senior to all classes of common stock with respect to payment of dividends. The Series A preferred stock has preferential rights in the event of liquidation over all other
classes of preferred or common stock. The Series A and B preferred stock are mandatory redeemable upon the earlier of August 12, 2006 or occurrence of a Realization Event. A Realization
Event is defined as (a) the consummation of a qualified public offering of the Company's common stock or; (b) the consummation of a sale transaction involving the Company. Each
Series A and B preferred shareholder is entitled, except for the election of directors, to a number of votes equal to the preferred share participation factor multiplied by the number of
preferred shares owned. The participation factors for the Series A and B preferred are 9.3336 and 20.1072, respectively, and are subject to adjustment for anti-dilution events.

The
redemption price of each share of Series A and B preferred is based upon the fair market value of a share of Class A common on the redemption notice date multiplied by
the participation factor, plus the stated value of $1,000 per share and all accrued and unpaid dividends. The aggregate

87

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redemption
price on August 12, 2006 for the Series A preferred stock was estimated at $41.6 million, $45.6 million and $51.9 million at December 31, 2003,
2004 and March 31, 2005 respectively, based upon the estimated fair market value of the Class A common on these respective dates. The aggregate redemption price on August 12, 2006
for the Series B preferred stock was estimated at $18.6 million, $19.5 million and $20.8 million at December 31, 2003, 2004 and March 31, 2005, respectively,
based upon the estimated fair market value of the Class A common on these respective dates. The Company is accreting to the estimated redemption value of the Series A and B preferred
stock through August 12, 2006 and will continue to re-measure these values at each balance sheet date and adjust the aggregate accretion accordingly. The aggregate redemption value
will fluctuate based upon a number of factors including, but not limited to, the number of Series A and B preferred shares outstanding at the balance sheet date and changes in the estimated
fair value of the Class A common. At December 31, 2003, 2004 and March 31, 2005, the aggregate carrying value of the Series A preferred stock reflected in the accompanying
consolidated balance sheet was $35,470,947, $41,726,580 and $48,594,492, respectively, which included accretion and cumulative accrued and unpaid dividends. The Company recorded $9,969,765, $4,040,056
and $6,301,904 of accretion for the Series A preferred stock at December 31, 2003, 2004 and March 31, 2005, respectively. Cumulative accrued and unpaid dividends for the
Series A preferred stock were $5,665,310, $7,880,887 and $8,446,894, respectively, at December 31, 2003, 2004 and March 31, 2005. At December 31, 2003, 2004 and
March 31, 2005, the aggregate carrying value of the Series B preferred stock reflected in the accompanying consolidated balance sheet was $15,047,989, $17,177,954 and $18,844,002,
respectively, which included accretion and cumulative accrued and unpaid dividends. The Company recorded $2,135,478, $1,275,137 and $1,336,436 of accretion for the Series B preferred stock at
December 31, 2003, 2004 and March 31, 2005, respectively. Cumulative accrued and unpaid dividends for the Series B preferred stock were $3,146,673, $4,421,810 and $4,751,620,
respectively, at December 31, 2003, 2004 and March 31, 2005.

10. Redeemable Common Stock

Rollforward of Shares

The Company's redeemable common shares issued and outstanding at December 31, 2003 and 2004 were converted to the Company's Class A common stock
during the Company's initial public offering as follows:

Common SharesRedeemableClass B

Class CBalance, December 31, 2002

54,479

1,526,813Balance, December 31, 2003

54,579

1,526,813Balance, December 31, 2004

54,579

1,526,813Conversion to Class A common stock

(54,579
)
(1,526,813
)Balance, December 31, 2005






No
shares were repurchased during this period. Effective with the Company's initial public offering on June 29, 2005 these shares were converted into 9,439,942 shares of common
stock.

88

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Class B Redeemable Common Stock

At December 31, 2003 and 2004, the Company had 200,000 authorized shares of Class B redeemable common with 54,479 shares issued and outstanding at
December 31, 2003 and 2004. Class B redeemable common shares are mandatorily convertible upon occurrence of a Realization Event prior to August 12, 2006. Each Class B
redeemable common shareholder is entitled to a number of votes equal to the number of shares of Class A common into which the Class B redeemable shares are convertible, except for the
election of directors. Two of the Class B redeemable common shareholders have the right to designate two of the Company's directors.

The
aggregate redemption price on August 12, 2006 for outstanding shares of Class B redeemable common was estimated at zero, and $7.6 million at December 31,
2003 and 2004, respectively, based upon the estimated fair market value of the Class A common on these respective dates. The actual redemption price, on the date of conversion to Class A
common, based upon the actual fair value of the Company's initial offering price was $26.2 million. The Company recorded ($1,454,424), $1,544,534 and 20,858,768 of accretion for the
Class B redeemable common at December 31, 2003, 2004 and 2005, respectively.

Class C Redeemable Common Stock

At December 31, 2003 and 2004, the Company had 2,000,000 authorized shares of Class C redeemable common with 1,526,813 shares issued and
outstanding. At December 31, 2003 and 2004, the Class C redeemable common shares were convertible into Class A common shares upon election by the holder by dividing $14.08 by the
Class C conversion factor of 14.08, subject to adjustment for anti-dilution events. The Class C redeemable common redemption price is equivalent to the fair market value of
one share of Class A common multiplied by the number of shares of Class A common into which the Class C shares are convertible. The Company's Board of Directors has discretion
over whether this redemption is in cash or through issuance of a two-year interest bearing promissory note. Each Class C redeemable common shareholder is entitled to a number of
votes equal to the number of shares of Class A common into which the Class C shares are convertible, except for the election of directors.

The
2001 Private Placement included a contingency requiring the Company to issue up to 218,683 additional shares of Class C redeemable common to certain investors if the Company
did not repurchase at least an aggregate of $5.9 million shares of Series A preferred and Class C redeemable common from the Bridge Note investors by June 16, 2001. The
Company did not meet this requirement since only $2.4 million of Series A preferred and Class C redeemable common shares were repurchased by this date. In October 2002, the
Company issued 129,006 shares of Class C redeemable common to the 2001 Private Placement investors to satisfy this obligation.

The
aggregate redemption price on August 12, 2006 for outstanding shares of Class C redeemable common was estimated at zero and $4.3 million at December 31,
2003 and 2004, respectively, based upon the estimated fair market value of the Class A common on these respective dates. The actual redemption price, on the date of conversion to Class A
common, based upon the actual fair value of the Company's initial offering price was $25.2 million. At December 31, 2003, 2004 and 2005, the aggregate carrying value of the
Class C redeemable common reflected in the accompanying consolidated balance sheets was $5,095,975, $4,571,075 and $0, respectively, which included negative accretion of $1,988,712, $524,900
and positive accretion of $20,629,645, respectively.

89

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11. Equity

Rollforward of Shares

The Company's common shares issued and repurchased during the years ended December 31, 2004 and 2005 are as follows:

Common SharesClass A

Class A
TreasuryBalance, December 31, 2003

7,982,628

(1,948,794
)Repurchase of shares



(461,344
)Balance, December 31, 2004

7,982,628

(2,410,138
)Repurchase of shares



(411,760
)Shares from initial public offering

5,750,000

Shares from Class B, C and preferred stock conversion

6,137,249

Class C warrant exercises

396,195

Stock option exercises

14,870

Retirement of treasury shares to authorized but unissued

(2,821,898
)
2,821,898Balance, December 31, 2005

17,459,044




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

Stock and Voting Rights

Undesignated Preferred Stock

The Company has 100,000 shares of $0.01 par value undesignated preferred stock authorized, with no shares issued or outstanding at December 31, 2004 or
2005. These shares have preferential rights in the event of liquidation and payment of dividends.

Class A Common Stock

At December 31, 2004 and 2005, the Company had 100,000,000 authorized shares of Class A common. At December 31, 2004 and 2005 Class A
common shares of 5,572,490 and 17,459,044, respectively were outstanding, net of treasury stock discussed below. Each share of Class A common has one-for-one voting
rights.

Treasury Stock

During the year ended December 31, 2004 the board of directors granted management the authority to repurchase up to 800,000 shares of Class A common
stock at $1.25 per share. As of December 31, 2004, the Company repurchased 461,344 shares of Class A common stock from former employees.

Pursuant
to ratification from our Board of Directors, 2,821,898 of our treasury shares with a cost of $9,286,664 were restored to authorized but unissued Common stock. During the year
ended December 31, 2005 the board of directors granted management the authority to repurchase up to 873,114 shares of Class A common stock at $1.25 per share. Through the date our
treasury shares were restored to authorized but unissued, the Company repurchased 873,104 shares of Class A common stock from former employees under this repurchase plan.

90

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Shareholder Agreements

All shareholders have entered into shareholder agreements that define and provide for, among other things, the purchase, sale and transfer of shares in accordance
with the agreements. Certain employees have purchased shares of common stock using notes. These employees elected to purchase shares in accordance with provisions under the stock purchase agreement
that permitted an initial 25% cash payment at the time of purchase with the remainder due in equal annual installments each anniversary date during the next three years. The subscriptions bear no
interest to the employee. The unpaid portion of subscriptions receivable has been classified as contra-equity, notes receivable for Class A common stock in the accompanying consolidated balance
sheets.

12. Options and Warrants

Stock Option Plan

During 2000, the Company adopted a stock option plan agreement that provides for granting of stock options to employees and directors at the discretion of the
Company's Board of Directors (the "Option Plan"). The Company has an aggregate of 2,149,640 shares of Class A common authorized for granting of stock options under the Option Plan. The total
options available for issuance as of December 31, 2004 were 1,444,387. The purpose of stock options is to recognize past services rendered and to provide additional incentive in furthering the
continued success of the Company. Vesting of stock options granted under the Option Plan generally occurs on the third anniversary date from the date of grant. Unexercised stock options expire
90 days after an employee's termination.

A
summary of the status of the Company's stock options as of December 31, 2003, 2004 and 2005 and changes during the years then ended is as follows:

|                             |  |           |   | Options Outstanding |   | Options Exercisable
|---------------------------- |  | --------- | - | ------------------- | - | -------------------
|
|Balance, December 31, 2002   |  | 1,241,048 |   | 908,592             |   | $                  
|Granted at market            |  |          |   |                    |   |                    
|Forfeited                    |  | 78,070    |   | (78,070             | ) |                    
|                             |  |           |   |                     |   |                    
|Balance, December 31, 2003   |  | 1,319,118 |   | 830,522             |   | $                  
|Granted at market            |  | (64,800   | ) | 64,800              |   |                    
|Forfeited                    |  | 190,069   |   | (190,069            | ) |                    
|                             |  |           |   |                     |   |                    
|Balance, December 31, 2004   |  | 1,444,387 |   | 705,253             |   | $                  
|                             |  |           |   |                     |   |                    
|Additional authorized shares |  | 2,693,270 |   |                    |   |                    
|Granted at market            |  | (796,400  | ) | 796,400             |   |                    
|Granted below market         |  | (117,600  | ) | 117,600             |   |                    
|Exercised                    |  |          |   | (14,870             | ) |                    
|Forfeited                    |  | 42,202    |   | (42,202             | ) |                    
|                             |  |           |   |                     |   |                    
|Balance, December 31, 2005   |  | 3,265,859 |   | 1,562,181           |   | $                  
|                             |  |           |   |                     |   |                    

91

---



The
following table summarizes information about stock options outstanding at December 31, 2005:

Options OutstandingWeighted Average Remaining Contract Life (Years)



Options ExercisableRange of Exercise Prices

Number Outstanding

Weighted Average Exercise Price

Number Exercisable

Weighted Average Exercise Price$  3.54 - $  5.32

322,330

6.66

$
4.59

139,930

$
4.62$10.63 - $12.40

615,000

9.45

$
12.05

40,000

$
12.05$12.41 - $14.18

192,521

5.63

$
14.07

192,521

$
14.07$14.18 - $15.95

290,330

5.42

$
14.55

266,330

$
14.57$15.96 - $17.72

142,000

4.96

$
17.72$  3.54 - $17.72

1,562,181

7.24

$
11.74

638,781

$
12.08


In
January 2004, the Company granted options to certain employees to purchase 20,000 and 44,800 shares of our Class A common stock at exercise prices of $4.18 and $4.63
respectively. In January 2004, the Company valued the Class A common stock at $15 per share and the excess of the underlying Class A common stock fair value over the options
exercise price was $681,300. The Company recognized $227,100 of this excess value as compensation expense in the year ended December 31, 2004 and 2005.

On
January 14, 2005, the Company granted options to certain employees to purchase an aggregate of 117,600 shares of the Company's Class A common stock at an exercise price
of $4.63 per share. On January 14, 2005 the Company valued the Class A common stock at $15 per share and the excess of the underlying Class A common stock fair value over the
options exercise price was $1,220,100. The Company recognized $406,700 of this excess value as compensation expense in the year ended December 31, 2005. Total compensation expense recognized
was $227,100 and $633,800 for the year ended December 31, 2004 and 2005 respectively in connection with options granted in January 2004 and January 2005.

Between
June 23, 2005 and December 31, 2005 the Company granted options to certain employees to purchase an aggregate of 796,400 shares of the Company's common stock at a
weighted exercise price of $13.18 per share. The Company granted the options at prevailing market prices ranging from $12.05 to $17.72 per share.

Warrants

Warrants outstanding at December 31, 2005 and a general description of their terms are as follows:

Warrant Class

Class of Shares
Entitled to
Purchase

Number of Shares
Entitled to
Purchase

Exercise
Price

Expiration
DateClass B

Class A

622,542

$
20.88

12/16/2006Class D

Class A

158,480

$
4.18

12/16/2006Class E

Class A

13,120

$
20.88

12/16/2006


Class B,
D and E warrants are currently exercisable and expire on December 16, 2006. The holders of the Class D warrants also have the ability to require the Company
to repurchase these warrants at the Put Price, as defined by the warrant agreements, on or after August 12, 2006 if a

92

---



Realization
Event has not occurred. In connection with the 2001 Private Placement, the Class D warrant agreements were amended to only permit redemption of these warrants if all outstanding
Series A preferred shares had been redeemed.

Pursuant
to the initial public offering all of the Class C warrants to purchase 396,195 shares of Class A common were converted into Class A common shares and
396,195 Class A warrants were terminated. Additionally, the Class D warrant put feature expired.    Following the conversion and termination of warrants, the Company had
794,142 warrants outstanding with an average exercise price of $17.54 as of December 31, 2005.

All
outstanding warrants are subject to anti-dilution provisions and correspondingly their exercise and conversion prices will be adjusted for occurrence of certain events,
as defined, including changes in shares, options and warrants issued and currently outstanding. In connection with the 2001 Private Placement, all outstanding warrant agreements were amended to permit
the issuance of shares in connection with this transaction without triggering the anti-dilution provisions of these agreements.

The
fair value of the warrants are immaterial for all years presented.

13. Related Party

The Company's CEO served on the Board of Directors of a software development consulting company that provided services to the Company during the years ended
December 31, 2003 and 2004 in connection with software being developed for sale. In 2004, the Company's CEO resigned from the Board of Directors for this company. Payment for these services
aggregated $1,153,906 and $83,800 for the years ended December 31, 2003 and 2004, respectively, and is included in software or construction in progress in property and equipment and in prepaid
expense in the accompanying consolidated balance sheets. In 2003, the Company terminated its agreement with the software development consulting company. The Company paid $215,000 for perpetual
licenses in accordance with the termination agreement. This amount is being amortized over three years. The Company's CEO did not receive any cash compensation during 2003, 2004, or 2005 for his
participation on the Board of Directors of the software development consulting company.

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 years ended
December 31, 2003, 2004 and 2005 the Company paid Pepper Hamilton LLP net of insurance coverage $99,962, $39,203 and $1,057,729, respectively, for general legal matters. The increase in
payments to Pepper Hamilton LLP resulted from services performed in conjunction with our initial public offering, our acquisition of Scottworks and Webhire, Inc. and other corporate matters.

14. Subsequent Events

On January 13, 2006, the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc., and Kenexa Acquisition Corp., a wholly-owned
subsidiary of Kenexa Technology (collectively "Kenexa"), completed its Agreement and Plan of Merger with Webhire, Inc.("Webhire"), for $34.4 million. The total cost of the acquisition
including estimated legal, accounting, and other professional fees of $.5 million will approximate $34.9 million.

The
company acquired all assets and liabilities of Webhire, subject to a working capital adjustment as defined in the Agreement, which will be finalized not later than ninety days after
the close. The purchase price of $34.4 million was paid through existing cash of which $1.7 million or 5% has been deposited into escrow to cover any claims for indemnification made by
the Kenexa against Webhire

93

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under
the Agreement and Plan of Merger. Assuming there are no indemnification claims, this amount will be released to Webhire on or about January 13, 2007. The strategic rationale for acquiring
Webhire included expanding Kenexa's market opportunity and product suite, broadening Kenexa's vertical market specialization and increasing Kenexa's customer base through cross-sales to Webhire's
customers.

The
following amounts represent adjustments related to the acquisition of the assets of Webhire under the purchase method of accounting. The total purchase price has been allocated on a
preliminary basis to assets acquired and liabilities assumed based upon management's best estimates of fair value with any excess over the net tangible and intangible assets acquired allocated to
goodwill. The preliminary estimated purchase price is allocated as follows and is for illustrative purposes only:

|Description               |                                                  | Amount                    |   | Amortization period
|------------------------- | ------------------------------------------------ | ------------------------- | - | -------------------
|Assets Acquired           |                                                  |                           |   |                    
|                          | Cash and Short-term Investments                  |                           | $ | 2,403,361          
|                          | Accounts Receviable                              |                           |   | 2,108,814          
|                          | Prepaid Expenses and other Current Assets        |                           |   | 461,554            
|                          | Property & Equipment                             |                           |   | 623,145            
|                          | Other Assets                                     |                           |   | 208,625            
|                          | Trademark/Tradename, Service Marks & Domain Name |                           |   | 20,000             
|                          | Customer Lists                                   |                           |   | 1,030,666          
|                          | Internally Developed Software                    |                           |   | 876,936            
|                          | Goodwill                                         |                           |   | 34,619,485         
|Less: Liabilities Assumed |                                                  |                           |   |                    
|                          | Notes Payable                                    |                           |   | 25,550             
|                          | Capital Lease Obligations                        |                           |   | 173,610            
|                          | Accounts Payable                                 |                           |   | 293,782            
|                          | Accrued Expenses                                 |                           |   | 1,415,792          
|                          | Other Liabilities                                |                           |   | 226,073            
|                          | Deferred Revenue                                 |                           |   | 5,313,091          
|                          |                                                  |                           |   |                    
|                          |                                                  | Total Cash Purchase Price |   | $                  
|                          |                                                  |                           |   |                    

On
January 27, 2006 the Company and Gallup settled the outstanding claim and entered into a confidential settlement agreement. On January 30, 2006, the Court entered a
consent order relating to the settlement. The terms of the settlement will not have a material adverse effect on the results of operations or financial position.

94

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ITEM 9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

ITEM 9A.    Controls and Procedures.

Under the supervision 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 and procedures 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 and procedures 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.

ITEM 9B.    Other Information.

None.

95

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PART III

ITEM 10.    Directors and Executive Officers of the Registrant

We incorporate herein by reference the information contained under the captions "Board of Directors", "Structure and Practices of the Board of Directors,
"Executive Officers and Executive Compensation" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our proxy statement pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, to be filed by us in connection with our 2006 annual meeting of shareholders with the Securities and Exchange Commission within 120 days after the end of the
year covered by this Report (the "Proxy Statement").

We
have adopted a written code of business conduct and ethics, known as our Corporate Code of Business Conduct and Ethics, which applies to all of our directors, officers and employees,
including our principal executive officer and our principal financial and accounting officer. Our Corporate Code of Business Conduct and Ethics is available on our internet website, www.kenexa.com.
Any amendments to our Corporate Code of Business Conduct and Ethics or waivers from the provisions of the Corporate Code of Business Conduct and Ethics for our principal executive officer and our
principal financial and accounting officer will be disclosed on our internet website within five business days following the date of such amendment or waiver.

ITEM 11.    Executive Compensation

We incorporate herein by reference the information contained under the captions "Executive Officers and Executive Compensation" in the Proxy Statement.

ITEM 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

We incorporate herein by reference the information contained under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statements.

Equity Compensation Plan Information (as of December 31, 2005)

|Plan Category                                          |  | Number of Securities
to be issued
upon exercise |  | Weighted-average
exercise price |       | Securities available
for future issuance
under equity
compensation plans
|------------------------------------------------------ |  | ----------------------------------------------- |  | ------------------------------- | ----- | ------------------------------------------------------------------------
|Equity Compensation Plans approved by shareholders     |  | 791,000                                         |  | $                               | 13.18 |                                                                         
|Equity Compensation Plans not approved by shareholders |  | 771,181                                         |  | $                               | 10.26 |                                                                         

All
of the equity compensation plans pursuant to which we are currently granting equity awards have been approved by our shareholders.

ITEM 13.    Certain Relationships and Related Transactions

We incorporate herein by reference the information contained under the caption "Certain Relationships and Related Party Transactions" in the Proxy Statement.

ITEM 14.    Principal Accountant Fees and Services

We incorporate herein by reference the information contained under the caption "Proposal No. 2Ratification of Selection of Independent
Registered Public Accounting Firm" in the Proxy Statement.

96

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PART IV

ITEM 15.    Index to Consolidated Financial Statements.



|Exhibit
Number |  | Description of Document                                                                                                                                                                                                                                                                                                                                     
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1            |  | Agreement and Plan of Merger, dated as of December 21, 2005, among Kenexa Corporation, Kenexa Technology, Inc., Kenexa Acquisition Corp., Webhire, Inc., and Gazaway L. Crittenden, solely as the representative of
the Equityholders (incorporated by reference to Exhibit 2.1 filed with the Company's Current Report on Form 8-K dated December 22, 2005)
|3.1            |  | Amended and Restated Articles of Incorporation of Kenexa Corporation (incorporated by reference to Exhibit 3.3 filed with Amendment No. 2 to the Company's Registration Statement on Form S-1 dated June 6, 2005, Registration
No. 333-124028)                                                                                                              
|3.2            |  | Amended and Restated Bylaws of Kenexa Corporation (incorporated by reference to Exhibit 3.2 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005, Registration No. 333-124028)                                                                                                                                                  
|4.1            |  | Form of Specimen Common Stock Certificate of Kenexa Corporation (incorporated by reference to Exhibit 4.1 filed with Amendment No. 4 to the Company's Registration Statement on Form S-1 dated June 20, 2005, Registration
No. 333-124028)                                                                                                                  
|4.2            |  | Form of Amended and Restated Class B Common Stock Purchase Warrant to purchase common stock of Kenexa Corporation (incorporated by reference to Exhibit 4.4 filed with Amendment No. 1 to the Company's Registration Statement on
Form S-1 dated May 17, 2005, Registration No. 333-124028)                                                                 
|4.3            |  | Form of Amended and Restated Class D Common Stock Purchase Warrant to purchase common stock of Kenexa Corporation (incorporated by reference to Exhibit 4.5 filed with Amendment No. 1 to the Company's Registration Statement on
Form S-1 dated May 17, 2005, Registration No. 333-124028)                                                                 
|4.4            |  | Form of Amended and Restated Class E Common Stock Purchase Warrant to purchase common stock of Kenexa Corporation (incorporated by reference to Exhibit 4.6 filed with Amendment No. 1 to the Company's Registration Statement on
Form S-1 dated May 17, 2005, Registration No. 333-124028)                                                                 
|10.1*          |  | Kenexa Corporation 2000 Stock Option Plan                                                                                                                                                                                                                                                                                                                   
|10.2*          |  | Form of Non-Qualified Stock Option Agreement under the 2000 Stock Option Plan                                                                                                                                                                                                                                                                               
|10.3*          |  | Kenexa Corporation 2005 Equity Incentive Plan (incorporated by reference to Exhibit 10.3 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005, Registration No. 333-124028)                                                                                                                                                     
|10.4*          |  | Form of Non-Qualified Stock Option Award Agreement under the 2005 Equity Incentive Plan (Director) (incorporated by reference to Exhibit 10.4 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005,
Registration No. 333-124028)                                                                                                
|10.5*          |  | Form of Non-Qualified Stock Option Award Agreement under the 2005 Equity Incentive Plan (Employee) (incorporated by reference to Exhibit 10.5 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005,
Registration No. 333-124028)                                                                                                
|10.6           |  | Investor Agreement dated April 8, 2005 among Kenexa Corporation and certain shareholders (incorporated by reference to Exhibit 10.7 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005, Registration
No. 333-124028) of Kenexa Corporation                                                                                    
|               |  |                                                                                                                                                                                                                                                                                                                                                             

97

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|10.7  |  | Agreement Among Certain Management Shareholders dated April 8, 2005 among Kenexa Corporation and the investors named therein (incorporated by reference to Exhibit 10.8 filed with the Company's Registration Statement on Form S-1 dated
April 12, 2005, Registration No. 333-124028)                                    
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.8  |  | Second Amended and Restated Registration Rights Agreement, dated March 29, 2001 (incorporated by reference to Exhibit 10.9 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005, Registration
No. 333-124028)                                                                                 
|10.9  |  | Agreement of Lease between Liberty Property Limited Partnership and Raymond Karsan Associates dated July 1, 1996 (incorporated by reference to Exhibit 10.10 filed with the Company's Registration Statement on Form S-1 dated April 12,
2005, Registration No. 333-124028)                                               
|10.10 |  | First Amendment to Agreement of Lease dated August 14, 2002 between Liberty Property Limited Partnership and Kenexa Corporation (incorporated by reference to Exhibit 10.11 filed with the Company's Registration Statement on Form S-1 dated
April 12, 2005, Registration No. 333-124028)                                
|10.11 |  | Second Amendment to Agreement of Lease dated November 8, 2002 between Liberty Property Limited Partnership and Kenexa Corporation (incorporated by reference to Exhibit 10.12 filed with the Company's Registration Statement on Form S-1
dated April 12, 2005, Registration No. 333-124028)                              
|10.12 |  | Revolving Credit and Security Agreement dated July 15, 2003 between PNC Bank, National Association and Kenexa Technology, Inc. (incorporated by reference to Exhibit 10.13 filed with the Company's Registration Statement on Form S-1
dated April 12, 2005, Registration No. 333-124028)                                 
|10.13 |  | First Amendment and Waiver to Revolving Credit and Security Agreement dated October 10, 2003 between PNC Bank, National Association and Kenexa Technology, Inc. (incorporated by reference to Exhibit 10.14 filed with the Company's
Registration Statement on Form S-1 dated April 12, 2005, Registration No. 333-124028)
|10.14 |  | Second Amendment and Modification to Loan and Security Agreement dated March 22, 2005 between PNC Bank, National Association and Kenexa Technology, Inc. (incorporated by reference to Exhibit 10.15 filed with the Company's Registration
Statement on Form S-1 dated April 12, 2005, Registration No. 333-124028)       
|10.15 |  | Third Amendment and Modification to the Revolving Credit and Security Agreement dated December 29, 2005 between Kenexa Technology, Inc. and PNC Bank, National Association (incorporated by reference to Exhibit 10.24 filed with the
Company's Current Report on Form 8-K dated December 30, 2005)                       
|10.16 |  | Guaranty dated July 15, 2003 by Kenexa Corporation in favor of PNC Bank, National Association 1996 (incorporated by reference to Exhibit 10.6 filed with the Company's Registration Statement on Form S-1 dated April 12, 2005,
Registration No. 333-124028)                                                              
|10.17 |  | Form of Indemnification Agreements between Kenexa Corporation and each of its directors and certain officers 1996 (incorporated by reference to Exhibit 10.23 filed with the Company's Registration Statement on Form S-1 dated April 12,
2005, Registration No. 333-124028)                                              
|21.1  |  | Subsidiaries of Kenexa Corporation (incorporated by reference to Exhibit 21.1 filed with the Company's Registration Statement on Form S-1 dated January 31, 2006, Registration No. 333-131409)                                                                                                                            
|23.1  |  | Consent of BDO Seidman, LLP                                                                                                                                                                                                                                                                                               
|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                                                                                                                                                                                           

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98

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

|                        |  | KENEXA CORPORATION
|----------------------- |  | ------------------
|                        |  | By:               
|                        |  |                   
|                        |  |                   
|Date: February 22, 2006 |  |                   

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities
indicated on February 22, 2006.

|Signature                                 |  | Title                                                                                       
|----------------------------------------- |  | --------------------------------------------------------------------------------------------
|                                          |  |                                                                                             
|/s/NOORUDDIN S. KARSANNooruddin S. Karsan |  | Chairman of the Board and Chief Executive Officer and Director (Principal Executive Officer)
|/s/DONALD F. VOLKDonald F. Volk           |  | Chief Financial Officer (Principal Financial and Accounting Officer)                        
|/s/BARRY M. ABELSONBarry M. Abelson       |  | Director                                                                                    
|/s/ELLIOT H. CLARKElliot H. Clark         |  | Director                                                                                    
|/s/BILL L. ERICKSONBill L. Erickson       |  | Director                                                                                    
|/s/JOSEPH A. KONENJoseph A. Konen         |  | Director                                                                                    
|                                          |  |                                                                                             

99

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|/s/JOHN A. NIESJohn A. Nies             |  | Director
|--------------------------------------- |  | --------
|/s/RICHARD J. PINOLARichard J. Pinola   |  | Director
|/s/JOHN C. RUTHERFORDJohn C. Rutherford |  | Director

100

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EXHIBIT INDEX

|Exhibit
Number |  | Description of Document                                                                                                        
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|23.1           |  | Consent of BDO Seidman, LLP                                                                                                    
|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

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