Kenexa (KNXA) 10-Q 2012 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

OR

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

For the transition period from to

Commission File number 000-51358

Kenexa Corporation

(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania	23-3024013
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
650 East Swedesford Road, Wayne, PA	19087
(Address of Principal Executive Offices)	(Zip Code)

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x  No   ¨

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

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

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

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

On May 7, 2012, 27,335,456 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

Kenexa Corporation and Subsidiaries

FORM 10-Q

Quarter Ended March 31, 2012

Table of Contents

	Page
PART 1:  FINANCIAL INFORMATION
Item 1:  Financial Statements
Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011	3
Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (unaudited)	4
Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2012 and 2011  (unaudited)	5
Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2012 (unaudited) and the year ended December 31, 2011	6
Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (unaudited)	7
Notes to Consolidated Financial Statements (unaudited)	8
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
Item 3: Quantitative and Qualitative Disclosures about Market Risk	46
Item 4: Controls and Procedures	46
PART II: OTHER INFORMATION
Item 1: Legal Proceedings	47
Item 1A: Risk Factors	47
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3: Defaults Upon Senior Securities	47
Item 4: Mine Safety Disclosures	47
Item 5: Other Information	47
Item 6: Exhibits	48
Signatures	49
Exhibit Index	50

2

PART 1 FINANCIAL INFORMATION

Item 1:  Financial Statements

Kenexa Corporation and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

	March 31, 2012		December 31, 2011
Assets		(unaudited)
Current Assets
Cash and cash equivalents	$	66,690	$	67,459
Short-term investments		16,332		51,807
Accounts receivable, net of allowance for doubtful accounts of $2,832 and $3,045		60,584		52,664
Unbilled receivables		4,026		3,385
Income tax receivable		29		196
Deferred income taxes		5,763		5,477
Prepaid expenses and other current assets		10,864		9,555
Total current assets		164,288		190,543
Long-term investments		—		9,710
Property and equipment, net		19,686		18,632
Software, net		28,596		27,179
Goodwill		75,001		43,265
Intangible assets, net		89,738		73,074
Deferred income taxes, non-current		25,383		35,092
Deferred financing costs, net		301		354
Other long-term assets		7,941		7,795
Total assets	$	410,934	$	405,644
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable	$	10,492	$	7,909
Notes payable, current		11		11
Term loan, current portion		5,000		5,000
Commissions payable		3,972		3,673
Accrued compensation and benefits		12,360		18,061
Other accrued liabilities		15,318		13,970
Deferred revenue		90,445		81,795
Capital lease obligations		237		282
Total current liabilities		137,835		130,701
Revolving credit line and term loan		23,750		25,000
Capital lease obligations, less current portion		25		218
Deferred revenue, less current portion		6,106		7,042
Deferred income taxes		1,526		1,823
Other long-term liabilities		5,538		5,330
Total liabilities	$	174,780	$	170,114
Commitments and Contingencies
Temporary equity
Noncontrolling interest		4,828		4,990
Shareholders’ Equity
Preferred stock, par value $0.01; 10,000,000 shares authorized; no shares issued or outstanding		—		—
Common stock, par value $0.01; 100,000,000 shares authorized; 27,295,336 and 27,124,276 shares issued and outstanding, respectively		273		271
Additional paid-in-capital		388,001		385,511
Accumulated deficit		(151,830)		(149,376)
Accumulated other comprehensive loss		(5,118)		(5,866)
Total shareholders’ equity		231,326		230,540
Total liabilities and shareholders’ equity	$	410,934	$	405,644

See notes to consolidated financial statements.

3

Kenexa Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited; in thousands, except share and per share data)

	Three Months Ended March 31,
	2012		2011
Revenues:
Subscription	$	55,336	$	46,203
Other		22,466		13,775
Total revenues		77,802		59,978
Cost of revenues		32,269		23,345
Gross profit		45,533		36,633
Operating expenses:
Sales and marketing		17,533		14,275
General and administrative		14,067		12,748
Research and development		6,432		4,445
Depreciation and amortization		10,523		7,918
Total operating expenses		48,555		39,386
Loss from operations		(3,022)		(2,753)
Interest expense, net		(284)		(440)
Loss before income taxes		(3,306)		(3,193)
Income tax benefit		668		26
Net loss	$	(2,638)	$	(3,167)
Loss allocated to noncontrolling interests		184		—
Net loss allocable to common shareholders	$	(2,454)	$	(3,167)
Basic and diluted net loss per share	$	(0.09)	$	(0.14)
Weighted average shares used to compute net loss allocable to common shareholders’ per share – basic and diluted		27,180,819		23,042,809

See notes to consolidated financial statements.

4

Kenexa Corporation and Subsidiaries

Consolidated Statements of Comprehensive Loss

(Unaudited; in thousands, except share data)

	March 31, 2012			March 31, 2011
Net loss	$	(2,638	)	$	(3,167	)
Loss allocated to noncontrolling interest		184			—
Net loss allocable to common shareholders		(2,454	)		(3,167	)
Other
Gain on currency translation adjustments		748			982
Comprehensive loss	$	(1,706	)	$	(2,185	)

See notes to consolidated financial statements.

5

Kenexa Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity

(In thousands)

	Common stock		Additional paid-in capital		Accumulated deficit		Accumulated other comprehensive loss		Total shareholders’ equity
Balance, December 31, 2010	$	229	$	281,791	$	(145,271)	$	(3,882)	$	132,867
Loss on currency translation adjustments		—		—		—		(1,984)		(1,984)
Share-based compensation expense		—		6,369		—		—		6,369
APIC Pool adjustment		—		(344)		—		—		(344)
Option exercises		7		8,920		—		—		8,927
Employee stock purchase plan		—		545		—		—		545
Income allocated to noncontrolling interest		—		—		(234)		—		(234)
Accretion associated with noncontrolling interest (variable interest entity)		—		(3,159)		—		—		(3,159)
Public stock offering, net		35		91,389		—		—		91,424
Net loss		—		—		(3,871)		—		(3,871)
Balance December 31, 2011	$	271	$	385,511	$	(149,376)	$	(5,866)	$	230,540
Gain on currency translation adjustments		—		—		—		748		748
Share-based compensation expense		—		1,917		—		—		1,917
APIC Pool adjustment		—		(1,528)		—		—		(1,528)
Option exercises		2		2,012		—		—		2,014
Shares withheld for payroll taxes payments		—		(72)		—		—		(72)
Employee stock purchase plan		—		161		—		—		161
Loss allocated to noncontrolling interest		—		—		184		—		184
Net loss		—		—		(2,638)		—		(2,638)
Balance March 31, 2012 (unaudited)	$	273	$	388,001	$	(151,830)	$	(5,118)	$	231,326

See notes to consolidated financial statements.

6

Kenexa Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited; in thousands)

	Three months ended March 31,
	2012		2011
Cash flows from operating activities
Net loss	$	(2,638)	$	(3,167)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and amortization		10,523		7,918
Amortization of bond premium		366		—
Realized loss on available-for-sale securities		19		—
Share-based compensation expense		1,917		1,127
Amortization of deferred financing costs		53		53
Bad debt (recoveries) expense, net		(486)		248
Deferred income tax benefit		(713)		(270)
Changes in assets and liabilities, net of acquisitions
Accounts and unbilled receivables		(4,019)		(6,339)
Prepaid expenses and other current assets		(1,028)		202
Income tax receivable		193		17
Other long-term assets		269		1,265
Accounts payable		1,730		(70)
Accrued compensation and other accrued liabilities		(7,410)		(5,595)
Commissions payable		159		(389)
Deferred revenue		3,222		5,690
Other liabilities		(441)		(89)
Net cash provided by operating activities		1,716		601
Cash flows from investing activities
Capitalized software and purchases of property and equipment		(7,135)		(6,593)
Purchase of available-for-sale securities		(1,469)		—
Sales of available-for-sale securities		46,270		—
Acquisitions, net of cash acquired		(41,101)		(9,682)
Net cash used in investing activities		(3,435)		(16,275)
Cash flows from financing activities
Borrowings under revolving credit line		—		3,000
Repayments under revolving credit line		(1,250)		(25,750)
Repayments of notes payable		(74)		(87)
Repayments of capital lease obligations		(237)		(282)
Proceeds from common stock issued through Employee Stock Purchase Plan		161		108
Shares authorized, but not issued, to settle employees’ withholding liability		(72)		—
Net proceeds from option exercises		2,014		5,479
Net cash provided by (used in) financing activities		542		(17,532)
Effect of exchange rate changes on cash and cash equivalents		408		408
Net decrease in cash and cash equivalents		(769)		(32,798)
Cash and cash equivalents at beginning of year		67,459		52,455
Cash and cash equivalents at end of period	$	66,690	$	19,657
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest expense	$	290	$	397
Income taxes paid	$	1,028	$	1,009
Income taxes refunded	$	204		—
Non-cash investing and financing activities
Capital lease obligations incurred	$	—	$	568

See notes to consolidated financial statements.

7

 Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

1. Organization

Kenexa Corporation and its subsidiaries (collectively the “Company” or “Kenexa”) is a leading provider of software-as-a-service, or SaaS, solutions that enable organizations to more effectively recruit and retain employees. Kenexa’s solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. Kenexa’s software applications are complemented with tailored combinations of proprietary content, outsourcing services and consulting services based on its 24 years of experience assisting customers in addressing their Human Resource (HR) requirements. Together, the software applications, content and services form complete solutions that customers find more effective than the point technology or service solutions available from alternative vendors. The Company believes that these solutions enable its customers 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.

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. Although the Company has several product lines, our chief decision makers determine resource allocation decisions and assess and evaluate periodic performance under one operating segment.

2. Summary of Significant Accounting Policies

The accompanying consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the three months ended March 31, 2012 and 2011 have been made. The results for the three months ended March 31, 2012 are not necessarily indicative of the results to be expected for the year ended December 31, 2012 or for any other interim period. Certain information and footnote disclosures normally included in the Company’s annual consolidated financial statements have been condensed or omitted and, accordingly, the accompanying financial information should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K, filed with the United States Securities and Exchange Commission for the year ended December 31, 2011.

Use of Estimates

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

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of Kenexa Corporation and its subsidiaries and variable interest entity as described in Footnote 5 – Variable Interest Entity in the Notes to Consolidated Financial Statements.  All significant intercompany accounts and transactions have been eliminated in consolidation.

8

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Interest Rate Swap Agreements

The Company’s variable-rate debt obligations expose it to variability in interest payments due to changes in interest rates. To limit the variability of a portion of its interest payments, the Company has entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. This swap changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest rate swap, the Company receives variable interest rate payments and makes fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. See Footnote 11 – Line of Credit in the Notes to Consolidated Financial Statements for further details.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial assets and liabilities, including cash and cash equivalents, restricted cash, accounts receivable, short and long-term investments, if presented, accounts payable and accrued expenses at March 31, 2012 and December 31, 2011 approximate fair value of these instruments due to their short-term nature.

In accordance with ASC 820, “Fair Value Measurements and Disclosure”, the Company uses three levels of inputs to measure fair value:

• Level 1 - Quoted prices in active markets for identical assets or liabilities.

• Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or valuations in which all significant inputs are observable or can be obtained from observable market data.

• Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of March 31, 2012, the Company’s financial assets valued based on Level 1 inputs consisted of cash and cash equivalents in a U.S. Treasury money market fund and its financial assets valued based on Level 2 inputs consisted of municipal bonds. The Company's interest rate swap derivative value was based upon Level 2 inputs, as described below.

The Company values its interest rate swap using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each interest rate swap. This analysis reflects the contractual terms of the interest rate swap, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair value of the interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. 

Foreign Currency Translation

The financial position and operating results of the Company’s foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date, and the local currency revenues and expenses are translated at average rates of exchange to the U.S. dollar during the reporting period. The related translation adjustments are reported in the shareholders’ equity section of the balance sheet and resulted in a net gain in shareholders’ equity of $748 and net reduction of $1,984 for the period ended March 31, 2012 and for the year ended December 31, 2011, respectively. The foreign currency translation adjustment is not adjusted for income taxes as it relates to an indefinite investment in a non-U.S. subsidiary. Transaction net gains and losses resulting from the Company’s foreign operations resulted in net gains of $157 and $9 for the three months ended March 31, 2012 and 2011, respectively.

9

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

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 by the large number of customers comprising the Company's customer base and their dispersion across various industries. The Company does not require collateral. The customers are concentrated primarily in the Company’s U.S. market area. At March 31, 2012 and December 31, 2011, there were no customers that represented more than 10% of the net accounts receivable balance. The Company’s top 3 customers represented, collectively, approximately 11.3% and 9.0% at March 31, 2012 and December 31, 2011, respectively, of the Company’s net accounts receivable balance. In addition, no one customer individually exceeded 10% of the Company’s revenues. The Company’s top 3 customers represented, collectively, approximately, 12.4% and 10.4% of the Company’s total revenues for the three months ended March 31, 2012 and 2011, respectively.

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid investments with remaining maturities of three months or less at the time of purchase. Cash balances are maintained at several banks. Cash held in fixed term deposits with original maturities of three months or less at the time of purchase totaled $500 at December 31, 2011. There were no fixed term deposits held at March 31, 2012. Accounts located in the United States are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100 (which has been temporarily increased to $250 through December 31, 2013). Certain operating cash accounts may periodically exceed the FDIC limits.

Cash and cash equivalents in foreign denominated currencies which are held in foreign banks totaled $14,799 and $13,536 and represented 22.2% and 20.1% of our total cash and cash equivalents balance at March 31, 2012 and December 31, 2011, 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 estimates the liability based upon management’s judgment and historical experience and records the amount on a gross basis. At March 31, 2012 and December 31, 2011, self-insurance accruals totaled $1,312 and $1,083. There were no stop loss recoveries at March 31, 2012 and December 31, 2011. Management continuously reviews the adequacy of the Company’s stop loss insurance coverage. Material differences may result in the amount and timing of health insurance claims if actual experience differs significantly from management’s estimates.

Long-Lived Assets

The Company evaluates its long-lived assets, including certain identifiable assets, for impairment whenever events or circumstances indicate that the carrying value of such assets may not be recoverable. The Company noted no triggering event during the three months ended March 31, 2012, which would give rise to an impairment analysis.  Given the uncertainty around the global economic recovery, it is possible that the estimated future cash flows of the asset groupings will be reduced, which may result in an impairment in future periods.  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.

Guarantees

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

10

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Revenue Recognition

The Company derives its revenue from two sources: (1) subscription revenue for solutions, which is comprised of subscription fees from customers accessing the Company’s on-demand software (application services), proprietary content, outsourcing services and consulting services and from customers purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for discrete consulting services. Because the Company provides its solutions as a service, the Company follows the provisions of ASC 605-10, “Revenue Recognition” and ASC 605-25 “Multiple Elements Arrangements.”We recognize revenue when all of the following conditions are met:

• There is persuasive evidence of an arrangement;

• The service has been provided to the customer;

• The collection of the fees is probable; and

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

Subscription fees and support revenues 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.

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

The Company records expenses billed to customers in accordance with ASC 605-45, “Revenue Recognition-Principal Agent Considerations,” which requires that reimbursements received for out-of-pocket expenses be classified as revenues and not as cost reductions.  These items primarily include travel, meals and agency fees.  For the three months ended March 31, 2012 and 2011, reimbursed expenses totaled $1,619 and $991, respectively.

The Company’s arrangements with customers may include provision of consulting services, grant of software licenses and delivery of data. For arrangements that contain multiple deliverables, the selling price hierarchy established in ASU 2009-13 is used to determine the selling price of each deliverable. The selling price hierarchy allows for the use of an estimated selling price (“ESP”) to determine the allocation of arrangement consideration to each deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”).

To qualify as a separate unit of accounting, deliverable items must have value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transaction is deferred until all elements are delivered.

11

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

The Company determines the selling price in multiple-element arrangements using VSOE or TPE if available. VSOE is determined based on the price charged for the same deliverable when sold separately and TPE is established based on the price charged by our competitors or third parties for the same deliverable. If the Company is unable to determine the selling price because VSOE or TPE does not exist, the ESP is used. The Company determines its ESP for its application services and license fees based on the following:

• The Company utilizes a pricing model for its products which considers market factors such as customer demand for our products and the geographic regions where the products are sold. In addition, the model considers entity-specific factors such as volume based pricing, discounts for bundled products and total contract commitment. Management approval of the model ensures that all of the Company’s selling prices are consistent and within an acceptable range for use with the relative selling price method.

• While the pricing model currently in use captures all critical variables, unforeseen changes due to external market forces may result in the Company revising some of its inputs. These modifications may result in the consideration allocation in future periods differing from the one presently in use. Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect the Company’s allocation of arrangement consideration.

• The Company determined the ESP for consulting services based on sales of those services sold separately or on consulting rates estimated based on the value of the services being provided.

The revenue guidance contained in ASU 2009-13 modifies the way the Company accounts for certain arrangements, by allowing the Company to separate consulting services and corresponding license fees into two separate units of accounting. These two deliverables represent the primary elements in those arrangements and are recognized upon performance or delivery of each service or product, respectively to the end customer. Revenue related to consulting services is recognized as obligations are fulfilled on a proportional performance basis and typically earned over a three to six month period, while the license fees may be recognized over a two to five year period. After the adoption of ASU 2009-13, costs associated with the delivery of our consulting services are expensed as incurred.

Multiple element arrangements consisting of multiple products are impacted by the new revenue guidance. Under ASU 2009-13, total consideration for an arrangement is allocated to each product or service using the hierarchy of VSOE, third party evidence or the relative selling price method and is recognized as each product or service is delivered to the customer. Consistent with current practice, revenue may be deferred if the arrangement includes any unusual terms including extended payment terms, specified acceptance terms, or hold backs payable upon final acceptance of the product or service.

Income Taxes

The Company files a consolidated income tax return with its subsidiaries for federal tax purposes and on various bases depending on applicable taxing statutes for state and local as well as foreign tax purposes. Deferred income taxes are provided using the asset and liability method for temporary differences between the financial statement and tax basis 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 net deferred tax assets to the amounts which are more likely than not expected to be realized.

Other Taxes

Non-income taxes such as sales and value-added taxes are presented on a net basis within general and administrative expense, on the statement of operations.

12

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Loss Per Share

The Company follows ASC 260, “Earnings Per Share,” which requires companies that are publicly held or have complex capital structures to present basic and diluted earnings per share on the face of the statement of operations. Earnings (loss) per share is based on the weighted average number of shares and common stock equivalents outstanding during the period. In the calculation of diluted earnings per share, shares outstanding are adjusted to assume conversion of the exercise of options if they are dilutive. In the calculation of basic earnings per share, weighted average numbers of shares outstanding are used as the denominator.

As a result of the variable interest entity commencing in 2009 and its corresponding put option, the Company uses the two-class method of calculating earnings per share as the put feature was issued by the Company and requires adjustments to the carrying value of the noncontrolling interest and the income allocable to common shareholders. There were no common stock equivalents of stock options and restricted stock issued and outstanding included in the computation of diluted earnings per share for the three months ended March 31, 2012 and 2011 since their effect was antidilutive. A summary of the computation for basic and diluted net loss per share is presented in the table below.  

	Three months ended March 31,
		2012		2011
Numerator:
Net loss allocable to common shareholders	$	(2,454)	$	(3,167)
Denominator:
Weighted average shares used to compute net loss allocable to common shareholders per common share - basic		27,180,819		23,042,809
Effect of dilutive stock options		—		—
Weighted average shares used to compute net loss allocable to common shareholders per common share – dilutive		27,180,819		23,042,809
Basic and diluted net loss per share	$	(0.09)	$	(0.14)
Total antidilutive stock options and unvested restricted stock issued and outstanding or granted		928,974		951,200

13

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Recently Adopted Accounting Pronouncements

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income”, which requires disclosure of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. In December 2011, the FASB has issued ASU 2011-12, Comprehensive Income (Topic 220), that deferred the requirement to separately present within net income reclassification adjustments of items out of accumulated other comprehensive income.  The adoption of this standard is presented in the current financial statements and only impacted the presentation format of the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (revised topic)”. The revised standard is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary. The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this standard did not materially impact the Company’s consolidated financial statements.The Company noted no triggering event during the three months ended March 31, 2012, which would give rise to an impairment analysis.

3.  Investments

           Short-term and long-term investments at March 31, 2012 and December 31, 2011 are comprised of municipal bonds with varying maturities and credit risk ratings of A3 and VMIG 1 or greater by various rating agencies. Investments are recorded at fair value based on current market rates and are classified as available-for-sale securities. The current yield on the Company’s municipal bonds at March 31, 2012 was 4.8%. Available-for-sale securities are reported at fair value with changes in the related unrealized gains and losses included in comprehensive (loss) income in the accompanying consolidated financial statements. The cost of securities is determined based on the specific identification method. At March 31, 2012 the cost of the available-for-sale securities approximated their fair value.

14

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

4. Acquisitions

The Ashbourne Group

On August 2, 2011, the Company entered into a share purchase agreement with The Ashbourne Group (“Ashbourne”), a supplier of HR and occupational psychology services based in London, England, for a purchase price of approximately $1,846 in cash. The total cost of the acquisition, including legal, accounting, and other professional fees of $10, was approximately $1,856. The acquisition of Ashbourne provides the Company with valuable assessment, learning and development products based on government competencies and performance standards. The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill. The value of the tax receivable remains open pending the resolution of the value. Due to the nature of the acquisition the goodwill and related intangible assets from the Ashbourne acquisition will be amortized and deducted for tax purposes.

Batrus & Hollweg, L.C.

On November 14, 2011, the Company entered into a share purchase agreement with Batrus & Hollweg, L.C. (“BHI”), a provider of talent management solutions, particularly in the hospitality sector based in Texas, for a purchase price of approximately $17,235 including cash and contingent consideration. The total cost of the acquisition, including legal, accounting, and other professional fees of $46, was approximately $17,281. At the date of the acquisition, the Company accrued $5,113 related to the contingent consideration. The Company expects to pay $2,394 by March 31, 2013 and the remaining $2,719 by March 31, 2014. The contingent consideration is calculated based on the Company’s estimated revenue growth within the hospitality industry. In connection with the acquisition, $1,000 of the cash portion of the purchase price was deposited into an escrow account to cover any claims for indemnification made by the Company against BHI under the acquisition agreement. The escrow agreement will remain in place for approximately eighteen months from the acquisition date, and any funds remaining in the escrow account at the end of the eighteenth month will be distributed to the former stockholders of BHI. The acquisition of BHI will add to the Company's existing research and content portfolio. In addition, it will increase the Company’s presence in the hospitality sector. The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible assets acquired allocated to goodwill and intangible assets. The Company is in the process of finalizing its estimate of contingent consideration as it relates to the revenue and profitability forecasts and the overall integration of the BHI product portfolio and its impact on the calculation. During the measurement period and as the forecasts and calculation are finalized, the Company will record adjustments, if necessary. Due to the nature of the acquisition, the goodwill and related intangible assets from the BHI acquisition will be amortized and deducted for tax purposes.

OutStart

On February 6, 2012, the Company acquired substantially all of the outstanding capital stock of OutStart, Inc. (“OutStart”), a leading provider of SaaS e-learning solutions and services, based in Boston, Massachusetts, for a purchase price of approximately $46,229, including adjustments for certain working capital accounts as defined in the purchase agreement. The total cost of the acquisition, including legal, accounting, and other professional fees of $217, was approximately $46,446. In connection with the acquisition, $3,500 of the cash portion of the purchase price was deposited into an escrow account to cover any claims for indemnification made by the Company against OutStart under the acquisition agreement. The escrow agreement will remain in place for fifteen months from the acquisition date, and any funds remaining in the escrow account will be distributed to the former stockholders of OutStart.

The acquisition of OutStart will expand the Company’s reach into the e-learning market and enable Kenexa to provide a broader and deeper suite of talent management solutions. OutStart’s Learning Management Suite, which includes award-winning social and mobile learning solutions, will be integrated with Kenexa’s Global Talent Management solutions including its Performance Management suite.

15

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

OutStart’s results of operations will be included in the Company’s consolidated financial statements beginning on February 6, 2012. The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill. The value of the deferred tax asset remains open pending the resolution of the value. The fair value of deferred revenue was determined based upon the estimated direct cost of fulfilling the obligation to the customer plus a normal profit margin. Customer lists and intellectual property are being amortized over their estimated useful lives. The estimated fair values of the intangible assets are listed below. The valuation of the identified intangibles was determined based upon estimated discounted incremental future cash flow to be received as a result of these intangibles. Goodwill is not amortized but is periodically evaluated for impairment.

Goodwill from the acquisition resulted from our belief that the products developed by OutStart will be complementary to our Kenexa Global Talent Management solution and will help us remain competitive in the talent acquisition market. The Company is evaluating the acquired deferred tax asset and will record adjustments, if necessary.

The purchase price was allocated as follows:

Description	Amount		Amortization period
Assets acquired
Cash and cash equivalents	$	5,128
Accounts receivable		3,827
Prepaid expenses and other current assets		239
Property & equipment		129
Other long-term assets		202
Other intangibles		2,100	1 year
Customer lists		8,300	15 years
Intellectual Property		11,300	10 years
Goodwill		30,292	Indefinite
Less: Liabilities assumed
Accounts payable		778
Accrued compensation and benefits		1,009
Accrued other liabilities		473
Notes payable		74
Commissions payable		134
Long-term tax liability		222
Deferred tax liability		8,279
Deferred revenue		4,319
Total cash purchase price	$	46,229

Unaudited pro forma results of operations to reflect the acquisition as if it had occurred on the first date of all periods presented are shown below.

	Year ended December 31, 2011		Three months ending March 31, 2011		Three months ending March 31, 2012
Revenue	$	305,527	$	65,309	$	79,341
Net loss allocable to common shareholders	$	(6,550)	$	(3,278)	$	(2,492)
Net loss per share—basic and diluted	$	(0.26)	$	(0.14)	$	(0.09)

16

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

5. Variable Interest Entity

On January 20, 2009, the Company entered into an ownership interest transfer agreement (“the agreement”) with Shanghai Runjie Management Consulting Company, (“R and J”) in Shanghai, China. In conjunction with the agreement, the Company paid $1,337 as an initial equity contribution and to compensate the former owners of R and J, who transferred their existing business into a new entity, Shanghai Kenexa Human Resources Consulting Co., Ltd., (the “variable interest entity”). The initial payment provided the Company with a 46% ownership interest in the variable interest entity, and a presence in China’s human capital management market. In 2011 and 2010, based upon the preceding year’s operating results for R and J, the Company paid an additional $2,296 and $31, respectively, for an additional 1% ownership interest, for each year, in the variable interest entity. At March 31, 2012, the Company had a 49% ownership interest in the variable interest entity.

The variable interest entity is consolidated in the Company’s financial statements because of the Company’s implicit guarantee to provide financing as well as its significant influence over the day-to-day operations. The equity interests of R and J not owned by the Company are reported as a noncontrolling interest in the Company’s accompanying consolidated balance sheet. All inter-company transactions are eliminated. See Footnote 2 – Summary of Significant Accounting Policies Principles of Consolidation for additional details.

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

The variable interest entity was financed with $307 in initial equity contributions from the Company and R and J, and has no borrowings for which R and J’s assets would be used as collateral. Following the formation of the variable interest entity, the Company completed a valuation of the variable interest entity, which resulted in the recording of net tangible assets, intangible assets and goodwill of $314, $1,100 and $1,512, respectively in the consolidated balance sheet. On September 30, 2009, the Company provided $160 of financing for the variable interest entity in the form of an intercompany loan. The creditors of the variable interest entity do not have recourse to other assets of the Company.

Pursuant to ASC 480 “Distinguishing Liabilities from Equity” (formerly Emerging Issues Task Force Abstracts Topic No. D-98, “Classification and Measurement of Redeemable Securities”)due to the put rights included in the agreement, the Company has presented the estimated fair value of R and J’s 51% and 52% ownership interest and the calculated value of the put right in the variable interest entity amounting to $4,828 and $4,990 at March 31, 2012 and December 31, 2011, respectively, in noncontrolling interest and classified the amount as temporary equity on the consolidated balance sheet.

17

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

6.  Goodwill

The Company has recorded goodwill in accordance with the provisions of ASC 350, “Intangibles-Goodwill and Other,” which requires the Company to annually review the carrying value of goodwill for impairment. If goodwill becomes impaired, some or all of the goodwill would 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 carrying amount. The Company evaluates the carrying value of goodwill under two reporting units within a single segment. The Company performs an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired.

The Company evaluated its goodwill by comparing to the fair values of its reporting units, based upon management's estimate of the future discounted cash flows to be generated by the business using level three inputs and comparable company multiples, to their carrying values. 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 noted no triggering event during the three months ended March 31, 2012, which would give rise to an impairment analysis.

The changes in the carrying amount of goodwill, which include adjustments for earnouts, taxes, foreign currency, and acquisitions for the period ended March 31, 2012 as follows:

Balance as of December 31, 2011	$	43,265
Acquisitions or adjustments:
Quorum (1)		1,135
Ashbourne		72
BHI		(105)
OutStart		30,292
Foreign currency		342
Balance as of March 31, 2012	$	75,001

(1) Quorum International Holdings Limited (“Quorum”) was acquired by the Company on April 2, 2008. The acquisition agreement included an earnout based upon the gross profit of Quorum for each of the twelve month periods ending June 30, 2009 and June 30, 2010. Based upon the results through June 30, 2010 no earnout was initially thought to be due, however based upon subsequent review, Management and the former owners determined that an earnout was in fact due. The additional consideration of $1,135 was accrued and recorded to goodwill in accordance with permissible acquisition accounting guidelines in the financial statements at March 31, 2012. The Company expects to pay the additional consideration of $1,135 in 2012.

18

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

7. Intangible Assets

Intangible assets consist of intellectual property, non-compete agreements, customer lists and trademarks. Intellectual property, non-compete agreements and trademarks are amortized on a straight-line basis over their estimated useful lives or contract periods, generally ranging from 3 to 20 years. Customer lists are amortized based on the attrition rate of our customers. The amounts were based, in part, on an analysis of the incremental cash flows expected to be derived from the customer lists using historic retention rates and an appropriate discount rate. Amortization expense related to these intangible assets was $5,378 and $3,531 for the three months ended March 31, 2012 and 2011, respectively.

Intangible assets subject to amortization at March 31, 2012 and December 31, 2011 consist of the following:

	March 31, 2012							December 31, 2011
	Gross Carrying Amount		Accumulated Amortization		Net		Weighted Average Useful Life (in years)	Gross Carrying Amount		Accumulated Amortization		Net	Weighted Average Useful Life (in years)
Customer lists	$	82,424	$	(20,832)	$	61,592	9.7	$	71,783	$	(17,809)	53,974	9.6
Intellectual property		37,598		(11,661)		25,937	4.3		26,134		(9,316)	16,818	2.2
Non-compete		1,940		(1,467)		473	0.5		2,007		(1,546)	461	0.7
Trademarks		2,245		(509)		1,736	5.3		2,232		(411)	1,821	5.6
Fully amortized intangibles		4,471		(4,471)		—	—		4,199		(4,199)	—	—
Total	$	128,678	$	(38,940)	$	89,738		$	106,355	$	(33,281)	73,074

The estimated amortization expense for intangible assets for the next five years and thereafter is as follows:

Period	Amortization Expense
Remainder of 2012	$	17,417
2013		17,223
2014		10,735
2015		8,392
2016		7,265
Thereafter		28,706
Total	$	89,738

19

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

8. Software Developed for Internal Use

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

The total R&D spend, comprised of R&D expense and capitalized internal use software for the periods ended March 31, 2012 and 2011 is as follows:

	Three months ended March 31,
	2012		2011
Capitalized internal-use software costs	$	4,674	$	3,248
Research and development expenses		6,432		4,445
Total capitalized software costs and research and development expenses	$	11,106	$	7,693

Amortization of capitalized internal-use software costs was $3,117 and $2,288 for the three months ended March 31, 2012 and 2011, respectively.

9. Property, Equipment and Software

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 expense are recognized on a 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, and 3 to 5 years for computer equipment and software. Reviews are regularly performed if facts and circumstances exist that indicate that the carrying amount of assets may not be recoverable or that the useful life is shorter than originally estimated. 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 results of 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. Construction costs not yet placed into service are accumulated as building construction in progress. Upon placement into service, the costs of the assets are transferred to building.

20

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

A summary of property, equipment and capitalized software and related accumulated depreciation and amortization as of March 31, 2012 and December 31, 2011 is as follows:

		March 31, 2012	December 31, 2011
Equipment	$	23,441	$	22,543
Software		59,017		52,370
Office furniture and fixtures		3,200		2,754
Leasehold improvements		4,544		3,959
Land		653		628
Building		7,798		7,490
Software in development		6,656		7,992
Total property, equipment and software		105,309		97,736
Less accumulated depreciation and amortization		57,027		51,925
Total property, equipment and software, net of accumulated depreciation and amortization	$	48,282	$	45,811

Depreciation and amortization expense is excluded from cost of revenues. Equipment and office furniture and fixtures included gross assets under capital leases totaled $2,820 at March 31, 2012 and December 31, 2011, respectively. Depreciation and amortization expense, including amortization of assets under capital leases, was $5,145 and $4,388 for the three months ended March 31, 2012 and 2011, respectively.

10. Other Accrued Liabilities

Other accrued liabilities consist of the following:

		March 31, 2012	December 31, 2011
Accrued professional fees	$	233	$	322
Straight line rent accrual		3,634		2,928
Other taxes payable		1,346		1,505
Income taxes payable		3,205		3,436
Other liabilities		3,371		3,385
Contingent purchase price (1)		3,529		2,394
Total other accrued liabilities	$	15,318	$	13,970

(1)   Contingent purchase price relates to the earnout provisions for the BHI and Quorum acquisitions (refer to Footnote 4 – Acquisitions and Footnote 6 – Goodwill for additional information.)

21

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

11. Line of Credit

On October 20, 2010, the Company entered into a senior secured credit agreement (the “amended credit agreement”) with PNC Bank.  The maximum amount available under the amended credit agreement is $60,000, comprised of a $35,000 revolving facility, including a sublimit of up to $5,000 for letters of credit and a sublimit of up to $2,500 for swing loans (the “Revolving Facility”), and a $25,000 term facility (the “Term Facility”). The Company may request to increase the maximum amount available under the Revolving Facility to $50,000.  The amended credit agreement will terminate, and all borrowings will become due and payable, on October 19, 2013. The Company and each of its U.S. subsidiaries are guarantors of the obligations under the amended credit agreement. Borrowings under the amended credit agreement are secured by substantially all of the Company’s assets (including a pledge of the capital stock of our subsidiaries (but limited to only 65% of the voting stock of first-tier foreign subsidiaries)).  For the year ended December 31, 2010, the Company recorded $611 in deferred financing costs in connection with its credit agreements.  As of March 31, 2012, the Company had outstanding borrowings of $28,750 with an average interest rate of 3.02% in connection with its acquisitions and working capital requirements.

Borrowings under the amended credit agreement are cross-collateralized by a first priority perfected lien on the Company’s assets including, but not limited to, receivables, inventory, equipment, furniture, general intangibles, fixtures, real property and improvements.  The amended credit agreement contains various terms and covenants that provide for restrictions on 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. The Company was compliant with its financial covenants at March 31, 2012.

In March 2011 and October 2010 in connection with borrowings of $25,000 and $10,000 under the Term and Revolver Facilities, the Company entered into three interest rate swap agreements. As of March 31, 2012, the notional amount of these agreements totaled $28,750 with a quarterly weighted fixed interest rate of 1.07%. These swaps are set to expire in October 2013. The Company entered into these swaps to manage fluctuations in cash flows resulting from interest rate risk.

The Company has not designated any of its interest rate swaps as a hedge. The Company records each interest rate swap on its balance sheet at fair market value with the changes in fair value recorded as net gains or loss on change in fair market value of investments, net in its Consolidated Statement of Operations. See Footnote 2 - Summary of Significant Accounting Policies - Fair Value of Financial Instruments for information on the fair value of the Company’s interest rate swap.

22

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

12. Income Taxes

The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate which does not include the effect of discrete events that may occur during the year.  The effect of any discrete events is reflected in the quarter in which the event occurs.  The 2012 effective tax rate is lower than the 35% statutory U.S. Federal rate primarily due to favorable tax rates associated with certain foreign earnings generated in lower-tax jurisdictions.

On January 1, 2007, we adopted FASB ASC 740, “Income Taxes,” which clarifies the accounting for uncertain income tax positions recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority.  The Company does not expect that the amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months. Our policy is to recognize interest and penalties on unrecognized tax benefits in the provision for income taxes in the consolidated statements of operations.  Tax years beginning in 2005 are subject to examination by taxing authorities, although net operating loss and credit carryforwards from all years are subject to examinations and adjustments for at least three years following the year in which the attributes are used.

During the three months ended March 31, 2012, the valuation allowance increased to $18,367 from $18,211 at December 31, 2011 as management continues to believe, based on the weight of available evidence, that it is more likely than not that some of the deferred tax asset will not be realized.

23

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

13. Commitments and Contingencies

Litigation

Taleo litigation

On June 28, 2011, Kenexa Corporation and its subsidiaries (“Kenexa”) and Taleo Corporation and its subsidiaries (“Taleo”) (together, the “parties”) entered into a settlement agreement and other related documents resolving all outstanding litigations between the parties (“Settlement Agreement”). As a result of the Settlement Agreement, all litigations between the parties have been dismissed with prejudice. The Settlement Agreement also includes a license of certain Kenexa intellectual property to Taleo and a license of certain Taleo intellectual property to Kenexa. A $3,000 net cash settlement to Kenexa for all intellectual property licenses and settlement of litigations was recorded in the second quarter of 2011 as a reduction to legal expenses.

Genesys Shareholder Suit

On October 1, 2010, Kenexa completed its acquisition of Salary.com, Inc. which included responsibility for the suit filed on August 13, 2010 by former shareholders and option holders of Genesys Software Systems, Inc. (the “Genesys Parties” and “Genesys,” respectively) against Salary.com, Inc. and Silicon Valley Bank –Trustee Process Defendant in Massachusetts Superior Court. The Genesys Parties asserts claims for breach of contract, breach of implied covenant of good faith and fair dealing, violation of the Massachusetts Unfair Business Practices Act, and declaratory judgment seeking damages of $2,000 in contingent consideration related to the purchase of Genesys by Salary.com, plus other monetary damages and fees. On September 7, 2010, Salary.com filed an answer and counterclaim against the Genesys Parties, and certain former shareholders of Genesys, asserting breach of contract, breach of implied covenants of good faith and fair dealing, fraud, violation of the Massachusetts Unfair Business Practices Act, civil conspiracy, negligent misrepresentation, and declaratory judgment seeking to dismiss the original complaint and unspecified monetary damages. The $2,000 in contingent consideration was accrued for in the financial statements at December 31, 2010. The parties entered into a settlement agreement in September 2011 whereby Kenexa paid $1,780 in contingent consideration. On October 5, 2011, the Court dismissed the action with prejudice.

Salary.com Appraisal Suit

On February 2, 2011, Dorno Investment Partners, LLC filed a Petition for Appraisal of Stock in the Court of Chancery of the State of Delaware against Kenexa Compensation, Inc., the new name for the surviving entity subsequent to the all cash, short form merger of Salary.com, Inc. and Spirit Merger Sub, Inc. on October 1, 2010.  Dorno was the beneficial owner of 143,610 shares of Salary.com, Inc. common stock on the merger date. It demanded appraisal of the fair value of 140,000 shares pursuant to Delaware law, together with interest from October 1, 2010, costs, attorney’s fees, and other appropriate relief. The parties entered into a settlement agreement in June 2011, and on June 30, 2011, the Court dismissed the action with prejudice.

The Company is involved in claims, including those identified above, which arise in the ordinary course of business. In the opinion of management, the Company has made adequate provision for potential liabilities, if any, arising from any such matters. However, litigation is inherently unpredictable, and the costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in any such matters, could have a material adverse effect on the Company’s business, financial condition and operating results. Furthermore, the Company believes that the litigation matters described above, at their current state, are neither probable nor reasonably estimable at the time of filing.

24

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

14.  Equity

On May 25, 2011, the Company completed a public offering of 3,000,000 shares of its common stock at a price to the public of $27.75 per share. Net proceeds to the Company aggregated approximately $79,467 after payment of all offering fees and underwriters’ commission and offering expenses of $245. On May 25, 2011, the underwriters exercised their over-allotment option under the terms of the underwriting agreement to purchase 450,000 additional shares of common stock. Net proceeds to the Company following the sale of the over-allotment shares were $11,957.

Rollforward of Shares

The Company’s common shares issued and repurchased during the three months ended March 31, 2012 is as follows:

	Common Shares
December 31, 2011 ending balance		27,124,276
Stock option exercises		132,695
Restricted stock		32,242
Employee Stock Purchase Plan		6,123
March 31, 2012 ending balance		27,295,336

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 10,000,000 shares of $0.01 par value undesignated preferred stock authorized, with no shares issued or outstanding at March 31, 2012 or December 31, 2011. These shares have preferential rights in the event of liquidation and payment of dividends.

Common Stock

At March 31, 2012 and December 31, 2011, the Company had 100,000,000 authorized shares of common stock. Shares of common stock outstanding were 27,295,336 and 27,124,276 at March 31, 2012 and December 31, 2011, respectively. Each share of common stock has one-for-one voting rights.

15. Stock Plans

Equity Incentive Plan

The Company’s Equity Incentive Plan (the “plan”) provides for the granting of stock options and restricted stock to employees, officers and non-employee directors at the discretion of the Board or a committee of the Board. The purpose of the plan is to recognize past services rendered and to provide additional incentive in furthering the continued success of the Company.

The Company grants to certain employees and officers stock options and restricted stock unit awards. Stock options granted under the plan expire between the fifth and tenth anniversary of the date of grant and may vest on the third anniversary from the date of grant or may vest twenty-five percent per year over four years. Unexercised stock options may expire up to 90 days after an employee's termination for options granted under the plan. Restricted stock units granted under the plan vest twenty-five percent per year over four years. Under the plan all unvested restricted stock grants are forfeited to the issuer on the date of termination.

25

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

The Company grants to non-employee directors stock options and restricted stock awards. Stock options granted under the plan expire on the fifth anniversary from the date of grant and vest 100% on the day preceding the Company’s annual meeting of Shareholders.  Restricted stock awards granted under the plan vest 100% on the day preceding the Company’s annual meeting of Shareholders. In the event a non-employee director ceases to be a director for the Company before the shares are fully vested, the unvested restricted shares will be forfeited to the Company.

As of March 31, 2012, there were 2,860,320 options to purchase shares of common stock and 285,147 shares of restricted stock outstanding under the plan. The Company is authorized to issue up to an aggregate of 4,833,327 shares of its common stock under the plan. As of March 31, 2012, a total of 1,731,584 shares of common stock were available for future grants under the plan.

Share-based Compensation Expense

The Company accounts for its share-based arrangements in accordance with ASC 718, “Compensation-Stock Compensation.”The compensation expense for share-based awards with a service condition that cliff vest, is recognized on a straight-line basis over the award’s requisite service period based on its fair value on the date of grant. For those awards with a service condition that have graded vesting, compensation expense is calculated using the graded-vesting attribution method. This method entails recognizing compensation expense on a straight-line basis over the requisite service period for each separately vesting portion as if the grant consisted of multiple awards, each with the same service inception date but different requisite service periods. This method accelerates the recognition of compensation expense. In accordance with ASC 718, the pool of excess tax benefits available to absorb tax deficiencies was determined using the alternative transition method. Excess tax benefits, associated with the expense recognized for financial reporting purposes, are presented as a financing cash inflow rather than as a reduction of income taxes paid in our consolidated statement of cash flows and are recognized upon the exercise of stock options and determination of tax deductibility.

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

The Company records share-based compensation expense in the following categories included in the accompanying consolidated statement of operations:

	Three months ended March 31,
	2012		2011
Cost of revenues	$	85	$	46
Sales and marketing		291		153
General and administrative		1,408		837
Research and development		133		91
Pre-tax share-based compensation	$	1,917	$	1,127
Income tax benefit		—		—
Share-based compensation expense, net	$	1,917	$	1,127

As of March 31, 2012, there was $15,428 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the 2005 Option Plan. That cost is expected to be recognized over a weighted-average period of 1.6 years.

26

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Stock Options

The Company estimates the fair value of stock option awards using the Black-Scholes valuation model. Historically, expected volatility was based upon a weighted average of peer companies and the Company’s stock volatility, however as of the third quarter ended September 30, 2011 expected volatility was solely based upon the Company’s stock volatility.  The expected life was determined based upon an average of the contractual life and vesting period of the options. The estimated forfeiture rate was based upon an analysis of historical data.  The risk-free rate was based on U.S. Treasury zero coupon bond yields for periods commensurate with the expected term at the time of grant.

The following table provides the assumptions used in determining the fair value of service-based stock option awards:

	Quarter ended March 31, 2012			Year ended December 31, 2011
Expected volatility		63.96	%		62.85-64.42	%
Expected dividends		—			—
Expected term (in years)		6.25			3.00-6.25
Risk-free rate		1.49	%		0.71-2.88	%

A summary of the activity of stock options under all plans as March 31, 2012 is presented below:

	Outstanding Options
		Shares		Wtd. Avg. Exercise Price		Wtd. Avg. remaining contractual life in years			Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2011			2,865,390	$	15.73
Granted			411,700	$	28.48
Exercised			(132,695)	$	14.92			$	1,830
Forfeited or expired			(284,075)	$	34.23
Outstanding at March 31, 2012			2,860,320	$	15.77		6.35	$	44,828
Exercisable at March 31, 2012			1,204,877	$	15.78		4.13	$	19,212

A summary of the status of the Company’s unvested stock options for the period ended March 31, 2012 is presented below:

Unvested Shares	Shares		Wtd. Avg. Grant Date Fair Value
Unvested at December 31, 2011		1,657,618	$	6.68
Granted		411,700		16.96
Vested		(404,500)		7.75
Forfeited or expired		(9,375)		9.19
Unvested at March 31, 2012		1,655,443	$	8.96

27

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

Restricted Stock and Restricted Stock Units

The fair value of restricted stock and restricted stock units is measured based upon the closing price of the Company’s underlying stock as of the date of grant. Restricted stock and restricted stock units are amortized over the vesting period using the straight-line method. Upon vesting, restricted stock units convert into an equivalent number of shares of common stock.

A summary of the activity of restricted stock awards and restricted stock units under all plans as of March 31, 2012 is as follows:

	Restricted Stock Units		Restricted Stock Awards		Wtd. Avg. Grant Date Fair Value
Outstanding/unvested balance at December 31, 2011		189,650		7,104	$	22.11
Awarded		123,268		—	$	28.48
Released/vested		(34,725)		—	$	16.13
Forfeited/cancelled		(150)		—	$	31.25
Outstanding/unvested balance at March 31, 2012		278,043		7,104	$	25.59

Employee Stock Purchase Plan

The Employee Stock Purchase Plan, which was approved in May 2006, enables substantially all U.S. and foreign employees to purchase shares of our common stock at a 5% discounted offering price off the closing market price of our common stock on the offering date. The Company has granted rights to purchase up to 500,000 common shares to employees under the Plan. The Plan is not considered a compensatory plan in accordance with ASC 718 and requires no compensation expense to be recognized. As of March 31, 2012, there were 357,692 shares available for issuance pursuant to our 2006 Employee Stock Purchase Plan.  Shares of our common stock purchased under the employee stock purchase plan were 6,123 and 23,417 for the periods ended March 31, 2012 and December 31, 2011, respectively.

16. Related Party

One of the Company's directors, Barry M. Abelson, is a partner in the law firm of Pepper Hamilton LLP. This firm has represented the Company since 1997. For the three months ended March 31, 2012 and 2011, the Company paid Pepper Hamilton LLP $9 and $203, respectively, for general legal matters.  The payments in 2012 were primarily for work relating to the Company’s acquisition of OutStart. The payments in 2011 were primarily for work relating to the Company’s class action shareholder litigation, acquisitions and credit facility. The decrease in payments for the three months ended March 31, 2012 as compared to the previous year resulted from timing of invoices and corresponding payments. The amount payable to Pepper Hamilton, LLP as of March 31, 2012 and 2011 was $160 and $53, respectively.

28

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements- Unaudited (Continued)

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

17. Geographic Information

The following table summarizes the distribution of revenue by geographic region as determined by billing address for the three months ended March 31, 2012 and 2011.

	For the three months ended March 31, 2012					For the three months ended March 31, 2011
Country	Revenue		Revenue as a percentage of total revenue			Revenue		Revenue as a percentage of total revenue
United States	$	57,815		74.3	%	$	44,550		74.3	%
United Kingdom		6,987		9.0	%		5,161		8.6	%
Other European Countries		4,427		5.7	%		3,280		5.5	%
Germany		1,097		1.4	%		1,334		2.2	%
China		1,552		2.0	%		1,420		2.4	%
Canada		2,879		3.7	%		1,595		2.6	%
Other		3,045		3.9	%		2,638		4.4	%
Total	$	77,802		100.0	%	$	59,978		100.0	%

The following table summarizes the distribution of assets by geographic region.

	March 31, 2012					December 31, 2011
Country	Assets		Assets as a percentage of total assets			Assets		Assets as a percentage of total assets
United States	$	339,652		82.7	%	$	338,779		83.5	%
United Kingdom		29,368		7.1	%		25,207		6.2	%
India		9,179		2.2	%		8,449		2.1	%
New Zealand		7,468		1.8	%		7,508		1.9	%
China		5,710		1.4	%		6,676		1.6	%
Germany		4,451		1.1	%		5,663		1.4	%
Other		15,106		3.7	%		13,362		3.3	%
Total	$	410,934		100.0	%	$	405,644		100.0	%

29

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

1. Overview

We are a leading provider of software-as-a-service, or SaaS, solutions that enable organizations to more effectively recruit, retain and develop employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We complement our software applications with tailored combinations of proprietary content, outsourcing services and consulting services based on our 24 years of experience assisting customers in addressing their Human Resource (HR) requirements. Together, our software applications, content and services form complete solutions that our customers find more effective than the point technology or service solutions available from other vendors. We believe that these solutions enable our customers 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.

We derive revenue primarily from two sources, subscription fees for our solutions and fees for discrete professional services.  We offer our talent acquisition and employee performance management solutions on a subscription basis and currently generate a significant portion of our revenue from these subscriptions. We generate the remainder of our revenue from discrete professional services that are not provided as part of an integrated solution on a subscription basis.

For the three months ended March 31, 2012 and 2011, subscription revenue represented approximately 71.1% and 77.0% of our total revenue, respectively. Our customers typically purchase multi-year subscriptions and during the three months ended March 31, 2012 and 2011, our customers renewed approximately 87.3% and 82.8%, respectively, of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal. In addition, we recognize subscription revenue ratably over the term of the underlying contract. These aspects of our business model provide us with recurring revenue streams and revenue visibility.  We expect non-GAAP subscription revenue will be within a target range of 70% to 75% of our total revenues in 2012.

We market our solutions primarily to organizations with more than 2,000 employees. As of December 31, 2011, we had a global customer base of approximately 8,970 companies across a number of industries, including financial services and banking, manufacturing, government, life sciences, biotechnology and pharmaceuticals, retail, healthcare, hospitality, call centers, and education, including approximately 279 companies on the Fortune 500 list published in May 2011. Our customer base includes companies that we billed for services during the year ended December 31, 2011 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately $38.6 million and $29.5 million, or 49.6%, and 49.3%, of our total revenue for the three months ended March 31, 2012 and 2011, respectively.

30

2. Recent Events

On October 27, 2011, we announced the pending transfer of our common stock listing from the NASDAQ to the New York Stock Exchange ("NYSE"), and on November 9, 2011, our Common Stock was authorized for listing and began trading on the NYSE under its current ticker symbol "KNXA."

On November 14, 2011, we entered into a share purchase agreement with Batrus & Hollweg, L.C. (“BHI”), a provider of talent management solutions, particularly in the hospitality sector based in Frisco, Texas for a purchase price of approximately $17.3 million, including legal, accounting, other professional fees and contingent consideration. At the date of acquisition, we accrued $5.1 million of contingent consideration, based upon our estimated revenue growth within the hospitality industry. We believe the acquisition of BHI, along with their extensive research on talent management best practices, will add to the Company's existing research and content portfolio.

On February 6, 2012, we acquired substantially all of the outstanding capital stock of OutStart, Inc. (“OutStart”), a leading provider of SaaS e-learning solutions and services, based in Boston, Massachusetts, for a purchase price of approximately $46.4 million, including legal, accounting, other professional fees and adjustments for certain working capital accounts as defined in the purchase agreement. The acquisition of OutStart will expand the Company’s reach into the e-learning market and enable Kenexa to provide a broader and deeper suite of talent management solutions. We will integrate OutStart’s Learning Management Suite, which includes award-winning social and mobile learning solutions, with Kenexa’s Global Talent Management solutions including its Performance Management suite.

3. Sources of Revenue

We derive revenue primarily from two sources: subscription revenue and other revenue.

Subscription revenue

Subscription revenue for our solutions is comprised of subscription fees from customers accessing our on-demand software, proprietary content, outsourcing services and consulting services and from customers purchasing additional support that is not included in the basic subscription fee. Our customers primarily purchase renewable subscriptions for our solutions. The typical subscription term is one to three years, with some terms extending up to five years or beyond. We generally price our solutions based on the number of software applications and services included and the number of customer employees with access to such applications. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services. Consistent with our historical practices, revenue derived from subscription fees is recognized ratably over the term of the subscription agreement. We generally invoice our customers in advance in annual or quarterly installments and typical payment terms provide that our customers pay us within 30 days of invoice. The majority of our subscription agreements are not cancelable for convenience, but our customers have the right to terminate their contracts for cause if we fail to provide the agreed-upon services or otherwise breach the agreement. A customer does not generally have a right to a refund of any advance payments if the contract is cancelled. For the three months ended March 31, 2012 and 2011, our customers renewed approximately 87.3% and 82.8%, respectively, of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts up for renewal for each of those periods.

Amounts that have been invoiced are recorded in accounts receivable prior to the receipt of payment and in deferred revenue to the extent revenue recognition criteria have not been met. As of March 31, 2012, deferred revenue increased by $7.7 million, or 8.7%, to $96.5 million from $88.8 million at December 31, 2011. The increase in deferred revenue is a result of the increase in bookings and billings for our products, content and services, sales of multiple arrangements and from certain acquisitions.

Other revenue

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

31

Revenue by geographic region

For the three months ended March 31, 2012, approximately 74.3% of our total revenue was derived from sales in the United States. Foreign revenue that we generated from customers in the United Kingdom, Canada and China represented approximately 9.0%, 3.7% and 2.0% of our total revenue, respectively. Revenue from other countries amounted to an aggregate of 11.0% of our total revenue. Other than the countries listed, no other country represented more than 2.0% of our total revenue for the three months ended March 31, 2012. For the three months ended March 31, 2012, the percentage of revenue derived from sales in the United States was flat compared to the prior year.

Cost of Revenue and Operating Expenses

Cost of revenue

Our cost of revenue primarily consists of compensation, employee benefits and out-of-pocket travel-related expenses for our employees and independent contractors who provide consulting or other professional services to our customers. Additionally, our application hosting costs, amortization of third-party license royalty costs 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 customer base. Because cost as a percentage of revenue is higher for professional services than for software products, an increase in the services component of our solutions or an increase in discrete professional services as a percentage of our total revenue would reduce gross profit as a percentage of total revenue. As our revenues increase, we expect our cost of revenue to increase proportionately, subject to pricing pressure related to economic conditions and influenced by the mix of services and software. To the extent new customers are added, we expect that the cost of services as a percentage of revenue, will be greater than the cost of services associated with existing customers.

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 are also included. We expense our sales commissions at the time the related revenue is recognized, and we recognize revenue from our subscription agreements ratably over the terms of the agreements.

General and Administrative

General and administrative expenses primarily consist of personnel and related costs for our executive, finance and accounting, human resources and administrative personnel. Professional fees, rent and other corporate expenses are also included in general and administrative expense.

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, user experience/interface designers, architects, product managers, project managers, HR-related subject matter experts, technical sales engineers and management information systems personnel and third-party consultants. Our research and development efforts have been devoted to the development of new products and new features for our existing products. Investments also include further development and deeper integrations of Kenexa content in support of its integrated talent management strategy.

We continue to enhance our 2x product suite which includes Kenexa 2x Recruit®, Kenexa 2x BrassRing®, Kenexa 2x Perform®, Kenexa 2x Onboard® and Kenexa 2x Mobile® with increased functionality, module touch points, and performance. Future modules on the 2x platform include Kenexa 2x Assess™, Kenexa 2x Compensation™, and others as well as a leveraged use of Kenexa’s rich set of content.  We believe that Kenexa 2x enables customers to improve productivity, increase cost savings, ensure compliance with corporate and legal mandates, and raise employee engagement.

Depreciation and Amortization

Depreciation costs are related to our capitalized equipment, software, furniture and fixtures, leasehold improvements, and building. Amortization costs are related to our intangible assets.

32

4. Key Performance Indicators

The following is a discussion of the key performance indicators that we consider to be material in managing our business.  The information provided below is stated in thousands (other than percentages). 

Deferred revenue.  We generate revenue primarily from multi-year subscriptions for our on-demand talent acquisition and employee performance management solutions and our compensation module. We recognize revenue from these subscription agreements ratably over the hosting period, which is typically one to three years. We generally invoice our customers in annual, 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 our customers are more willing to pay us in advance for their subscriptions, the amount of deferred revenue on our balance sheet has grown.  This trend may vary as business conditions change.

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

		For the three months ended March 31,				For the year ended
		2012		2011		December 31, 2011
Deferred revenue at the beginning of the period	$	88,837	$	76,052	$	76,052
Total invoiced subscriptions during period		58,731		52,359		217,015
Deferred revenue from acquisition		4,319		—		—
Subscription revenue recognized during period		(55,336)		(46,203)		(204,230)
Deferred revenue at end of period	$	96,551	$	82,208	$	88,837

Non-GAAP financial measures.  We believe that non-GAAP measures of financial results provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations.  We use these non-GAAP measures to compare our performance to that of prior periods for trend analyses, for purposes of determining executive incentive compensation, and for budget and planning purposes. These measures are used in monthly financial reports prepared for management and in quarterly financial reports presented to our Board of Directors. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing financial measures with other companies in our industry, many of which present similar non-GAAP financial measures to investors.

We do not consider these non-GAAP measures in isolation or as an alternative to measures determined in accordance with GAAP. The principal limitation of such non-GAAP financial measures is that they exclude significant expenses that are required to be recorded under GAAP. In addition, they are subject to inherent limitations as they reflect the exercise of judgments by management about which charges are excluded from the non-GAAP financial measures.

In order to compensate for these limitations, we present our non-GAAP financial measures in connection with our GAAP results.  We urge investors to review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures included below, and not to rely on any single financial measure to evaluate our business.

The Company’s non-GAAP financial measures as set forth in the tables below may exclude the following:

Share-based compensation.  Share-based compensation expense consists of expenses for stock options and stock awards recorded in accordance with ASC 718. Share-based compensation expense is excluded in our non-GAAP financial measures because the magnitude of the changes associated with share-based compensation are difficult to forecast as a result of their dependence upon the volume and timing of stock option grants (which are unpredictable and can vary dramatically from period to period) and external factors (such as interest rates and the trading price and volatility of our common stock). We believe that this exclusion provides meaningful supplemental information regarding our operating results because these non-GAAP financial measures facilitate the comparison of results over multiple periods.

Amortization of intangibles associated with acquisitions.  In accordance with GAAP, operating expense includes amortization of acquired intangible assets which are amortized over the estimated useful lives of such assets. Amortization of acquired intangible assets is excluded from our non-GAAP financial measures because we believe that such exclusion facilitates comparisons to our historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.

33

Acquisition-related fees.  In accordance with ASC 805, Business Combinations, acquisition-related fees including advisory, legal, accounting and other professional fees are reported as expense in the periods in which the costs are incurred and the services are received. Acquisition-related fees include legal, travel, and other fees not expected to recur from our acquisitions. Acquisition-related fees are excluded in the non-GAAP financial measures because we believe that such exclusion facilitates comparisons to our historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.

Deferred revenue associated with acquisition.  Deferred revenue consists of the impact of the write down of the deferred revenue associated with purchase accounting for the Salary.com and OutStart acquisitions. This effect is added back since we believe its inclusion provides a more accurate depiction of total revenue arising from these acquisitions.

Non-GAAP revenue.  Non-GAAP revenue consists of GAAP revenue adjusted to reverse the write down of the deferred revenue associated with purchase accounting for the Salary.com and OutStart acquisitions. The written-down deferred revenue is added back to non-GAAP revenue because we believe its inclusion provides a more accurate depiction of total revenue arising from these acquisitions.

Non-GAAP subscription revenue as a percentage of total non-GAAP revenue.  Non-GAAP subscription revenue as a percentage of total revenue can be derived from our consolidated statements of operations after adjusting subscription revenue to add back the write-down of the deferred revenue associated with purchase accounting for the Salary.com and OutStart acquisitions as described above. We expect that the percentage of non-GAAP subscription revenue will be within a range of 70% to 75% of our total non-GAAP revenues in 2012.

	For the three months ended March 31,
	2012			2011
	(unaudited)			(unaudited)
Revenue
Subscription revenue	$	55,336		$	46,203
Add: deferred revenue associated with acquisitions		2,274			2,986
Non-GAAP subscription revenue		57,610			49,189
Other revenue		22,466			13,775
Non-GAAP revenue		80,076			62,964
Cost of revenues		32,269			23,345
Less: share-based compensation expense		85			46
Non-GAAP gross profit	$	47,892		$	39,665
Non-GAAP subscription revenue as a percentage of total non-GAAP revenue		71.9	%		78.1	%
Non-GAAP gross profit as percent of total non-GAAP revenue		59.8	%		63.0	%

Non-GAAP income from operations.  Non-GAAP income from operations is derived from GAAP income (loss) from operations adjusted for noncash or nonrecurring expenses. We believe that measuring our operations using non-GAAP income from operations provides more useful information to management and investors regarding certain financial and business trends relating to our financial condition and ongoing results. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial measures with other companies in our industry, many of which present similar non-GAAP financial measures to investors.

	For the three months ended March 31,
	2012			2011
	(unaudited)			(unaudited)
Loss from operations	$	(3,022	)	$	(2,753	)
Deferred revenue associated with acquisition		2,274			2,986
Share-based compensation expense		1,917			1,127
Amortization of acquired intangibles		5,378			3,531
Acquisition-related fees		290			83
Non-GAAP income from operations	$	6,837		$	4,974

34

5. Results of Operations

Three months ended March 31, 2012 compared to three months ended March 31, 2011.

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

Kenexa Corporation Consolidated Statements of Operations

(in thousands, except for percentages; unaudited)

	For the three months ended March 31,
	2012				2011
	Amount		Percent of revenues		Amount		Percent of revenues
Revenues:
Subscription revenue	$	55,336	71.1	%	$	46,203	77.0	%
Other revenue		22,466	28.9	%		13,775	23.0	%
Total revenues		77,802	100.0	%		59,978	100.0	%
Cost of revenues		32,269	41.5	%		23,345	38.9	%
Gross profit		45,533	58.5	%		36,633	61.1	%
Operating expenses:
Sales and marketing		17,533	22.5	%		14,275	23.8	%
General and administrative		14,067	18.1	%		12,748	21.3	%
Research and development		6,432	8.3	%		4,445	7.4	%
Depreciation and amortization		10,523	13.5	%		7,918	13.2	%
Total operating expenses		48,555	62.4	%		39,386	65.7	%
Loss from operations		(3,022)	(3.9)	%		(2,753)	(4.6)	%
Interest (expense) income, net		(284)	(0.4)	%		(440)	(0.7)	%
Loss before income taxes		(3,306)	(4.3)	%		(3,193)	(5.3)	%
Income tax benefit		668	0.9	%		26	—	%
Net loss	$	(2,638)	(3.4)	%	$	(3,167)	(5.3)	%
Loss allocated to noncontrolling interest		184	0.2	%		—	—	%
Net loss allocable to common shareholders	$	(2,454)	(3.2)	%	$	(3,167)	(5.3)	%

35

Comparison of the Three Months Ended March 31, 2012 and 2011

Revenues

	For the three months ended March 31,
	2012		2011		Change		Percent
Revenues:	(in thousands)
Subscription	$	55,336	$	46,203	$	9,133		19.8	%
Other		22,466		13,775		8,691		63.1	%
Total revenues	$	77,802	$	59,978	$	17,824		29.7	%

Summary of changes in Revenues

The increase in total revenues for the three months ended March 31, 2012 was primarily due to an increase in demand across our product and service offerings for both subscription and other revenue. Subscription revenue increased due to large customer wins across our various product lines and from recent acquisitions.  The increase in other revenue is primarily due to increased success fees received from our recruitment process outsourcing or “RPO” activity and discrete professional services, which consist of consulting and training services. We expect our subscription-based and other revenues to continue to increase in 2012 due to the improved business environment for our products, content and service, renewals by existing customers, sales to new customers and new sales of our 2x platform™ and the addition of our learning module obtained with the acquisition of OutStart.

Cost of Revenues

	For the three months ended March 31,
	2012		2011		Change		Percent
	(in thousands)
Cost of revenues	$	32,269	$	23,345	$	8,924		38.2	%

Summary of changes in Cost of Revenues

(in thousands)	Change from 2011 to 2012
Employee-related	$	7,907
Third-party fees		362
Reimbursed expenses		617
Share-based compensation		38
Total change	$	8,924

The increase in cost of revenues for the three months ended March 31, 2012 was primarily due to increased headcount from our acquisitions and hiring activity necessary to support our new and expanded customers’ demand for our solutions and services.  The increase in third-party fees was due to an increase in non-billable travel and other expenses, hosting fees, job postings and outside consultants to support our increased revenues. Overall, the combined increased headcount and changes in the mix of other revenue versus subscription revenue increased the cost to deliver our solutions. As a percentage of revenue, cost of revenue increased by 2.6% to 41.5% for the three months ended March 31, 2012, compared to the same period in 2011.

We expect cost of revenues to increase in terms of absolute dollars in 2012 over the prior year due to increased headcount from our acquisitions of BHI in late 2011 and OutStart in early 2012. We expect cost of revenues to decrease as a percentage of revenues over the course of 2012.

36

Operating Expenses

	For the three months ended March 31,
	2012		2011		Change		Percent
		(in thousands)
Sales and marketing	$	17,533	$	14,275	$	3,258		22.8	%
General and administrative		14,067		12,748		1,319		10.3	%
Research and development		6,432		4,445		1,987		44.7	%
Depreciation and amortization		10,523		7,918		2,605		32.9	%
Total operating expenses	$	48,555	$	39,386	$	9,169		23.3	%

Summary of changes in Sales and Marketing Expense

(in thousands)	Change from 2011 to 2012
Employee-related	$	3,339
Marketing		(198)
Share-based compensation		138
Other expenses		(21)
Total change	$	3,258

The increase in sales and marketing expense for the three months ended March 31, 2012 was due primarily to increases in employee-related expense in connection with the expansion of our sales and marketing teams both internally and from our recent acquisitions. As a percentage of revenue, sales and marketing expense decreased by 1.3% to 22.5%, for the three months ended March 31, 2012 compared to the prior year due to increased revenues.

Consistent with our past practice, we intend to continue to invest in sales and marketing to pursue new customers and expand relationships with existing customers at levels we deem appropriate given current economic conditions. We expect sales and marketing expense to increase in terms of absolute dollars in 2012 due to increased staff expenses and continued investment in our branding and marketing campaigns, while decreasing as a percentage of total revenue, compared to the prior year.

Summary of changes in General and Administrative Expense

(in thousands)	Change from 2011 to 2012
Employee-related	$	1,058
Rent and utility		(398	)
Share-based compensation		572
Repairs and maintenance		(149	)
Software and licenses		243
Professional services		(68	)
Other expenses		61
Total change	$	1,319

The increase in general and administrative expense for the three months ended March 31, 2012 was attributable to an increase in employee-related expenses, share-based compensation and software and license expenses. The increase in employee-related expenses were the result of increases in compensation due to additional headcount from acquisitions.  The increase in share-based compensation expense resulted from new long-term incentive awards made during the first quarter of 2012. Our software and licenses expense increase was driven by additional maintenance support and licenses needed to support the increased headcount of our general and administrative teams both internally and from our recent acquisitions. The decrease in rent and utility and repairs and maintenance expense resulted from the consolidation of offices in London and Waltham, Ma.  As a percentage of revenue, general and administrative expense decreased by 3.2% to 18.1% for the three months ended March 31, 2012, compared to the same period in 2011 due to increased revenues.

We expect general and administrative expense to increase in terms of absolute dollars in 2012 over the prior year due to our acquisitions of BHI and OutStart and continued investments in our infrastructure, while decreasing as a percentage of total revenue.

37

Summary of changes in Research and Development Expense

(in thousands)	Change from 2011 to 2012
Employee-related	$	1,656
Professional services		352
Various other expenses		(21	)
Total change	$	1,987

The increase in research and development expense for the three months ended March 31, 2012 was primarily driven by an increase in employee-related expenses. The increase in employee-related costs resulted from increased bonus accruals and compensation costs related to additional headcount added to maintain our existing products. In addition, costs to further develop and improve feature enhancements not eligible for capitalization contributed to the increase. As a percentage of revenue, research and development expense increased by 0.9% to 8.3% for the three months ended March 31, 2012, compared to the same period in 2011.

As we continue to execute on our strategies, including continuing to develop our 2x platform™, we believe that research and development expenses will increase in absolute dollars and as a percentage of total revenues in 2012 over the prior year.

Summary of changes in Depreciation and Amortization Expense

(in thousands)	Change from 2011 to 2012
Depreciation expense	$	757
Amortization expense		1,848
Total change	$	2,605

The increase in amortization expense for the three months ended March 31, 2012 was primarily due to the acquired intangibles from our acquisitions of Ashbourne, BHI and OutStart. The increase in depreciation expense is due to an increase in the software development projects qualifying for capitalization, pursuant to ASC 350-40, “Internal-Use Software,” being placed into service during the period. As a percentage of revenue, depreciation and amortization expense increased by 0.3% to 13.5% for the three months ended March 31, 2012, compared to the same period in 2011. As we continue to execute on our strategies including our 2x platform™ and continuing to develop feature enhancements, we believe that depreciation and amortization expenses will increase in absolute dollars and remain constant as a percentage of total revenues in 2012 over the prior year as we place our developed software into service as we make additional capital purchases.

38

Income Tax Expense

	For the three months ended March 31,
	2012		2011		Change		Percent
	(in thousands)
Income tax benefit	$	668	$	26	$	642		2,469.2	%

The increase in income tax benefit for the quarter ended March 31, 2012 was primarily due to an increase in losses before tax that are expected to be realized during the current year and; decreases in tax rates in certain foreign jurisdictions and offset by changes in uncertain tax positions and an increase in our valuation allowance. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate and the tax effect of discrete tax events, if any, that occur during each interim period.  The 2012 effective tax rate is lower than the 35% statutory U.S. Federal rate primarily due to favorable tax rates associated with certain foreign earnings generated in lower-tax jurisdictions.

Changes to deferred income taxes are generally based on management's evaluation of our positive and negative evidence bearing upon the realizability of its deferred tax assets and the determination that it is more likely than not that we will realize a portion of the benefits of federal and state tax assets.  In assessing the need for a valuation allowance, management considers all available information within each taxing jurisdiction, including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. Any changes in management’s assessment of the amount of deferred tax assets that may be realized will result in an adjustment to its valuation allowance with a corresponding increase or decrease to income tax expense in the period in which such determination is made.

6. Liquidity and Capital Resources

Historically, our primary source of liquidity has been from cash generated from operations, proceeds from equity offerings and revolving credit facilities. As of March 31, 2012, we had cash and cash equivalents of $66.7 million and investments of $16.3 million. In addition, we have $24.5 million available for borrowing under the revolving line of credit. We also had borrowings of $28.7 million under our credit and term loans in connection with our acquisitions and to meet our working capital requirements and $0.3 million in capital equipment leases. We believe that our current cash and cash equivalents, investments, revolving credit facility and projected cash from operations will be sufficient to meet our liquidity needs for at least the next twelve months.

Cash held in foreign denominated currencies was $14.8 million, or 22.2%, of our total cash balance as of March 31, 2012. A ten percent change in the exchange rate of the underlying currencies would have changed our cash balances by approximately $1.5 million.

We calculate our quarterly days sales outstanding (“DSO”) as ending net accounts receivable divided by quarterly net revenues multiplied by 90.  For the three months ended March 31, 2012 and 2011, our DSO was 70 and 76, respectively.

On October 20, 2010, we entered into an amended credit agreement with PNC Bank.  The maximum amount available under the amended credit agreement is $60.0 million, comprised of a $35.0 million revolving facility, including a sublimit of up to $5.0 million for letters of credit and a sublimit of up to $2.5 million for swing loans (the “Revolving Facility”), and a $25.0 million term facility (the “Term Facility”). We may request to increase the maximum amount available under the Revolving Facility to $50.0 million.  The amended credit agreement will terminate, and all borrowings will become due and payable, on October 19, 2013.  As of March 31, 2012, we had borrowings of $28.7 million under the amended credit agreement in connection with our acquisitions and working capital requirements.

On January 11, 2011, we acquired substantially all of the assets and assumed selected liabilities of Talentmine, a global performance-based talent assessment and development system with real-time analytics and reports to help employers improve service quality, employee retention and business results, based in Lincoln, Nebraska, for a purchase price of approximately $3.0 million in cash.

39

On February 14, 2011, we entered into a share purchase agreement with JRA, a leading provider of employee climate/culture and related surveys based in Auckland, New Zealand, for a purchase price of approximately 9.0 million NZD or $6.9 million in cash.

On May 25, 2011, we completed a public offering of 3,000,000 shares of our common stock at a price to the public of $27.75 per share, and sold an additional 450,000 shares of our common stock to cover over-allotments of shares. Our net proceeds from the offering, after payment of all offering expenses and commissions, aggregated approximately $91.4 million.

On August 2, 2011, we acquired substantially all of the assets and liabilities of Ashbourne, a supplier of HR and occupational psychology services based in London, England, for a purchase price of approximately $1.8 million in cash. We believe the acquisition of Ashbourne will provide us with valuable assessment, learning and development products based on government competencies and performance standards.

On November 14, 2011, we entered into a share purchase agreement with BHI, a provider of talent management solutions, particularly in the hospitality sector based in Frisco, Texas, for a purchase price of approximately $17.3 million, including legal, accounting, other professional fees and contingent consideration. We believe the acquisition of BHI, along with their extensive research on talent management best practices, will add to the company's existing research and content portfolio.

On February 6, 2012, we acquired substantially all of the outstanding capital stock of OutStart, Inc. (“OutStart”), a leading provider of SaaS e-learning solutions and services, based in Boston, Massachusetts, for a purchase price of approximately $46.4 million, net of approximately $5.1 million of cash and including legal, accounting, other professional fees and adjustments for certain working capital accounts as defined in the purchase agreement. The acquisition of OutStart will expand the Company’s reach into the e-learning market and enable Kenexa to provide a broader and deeper suite of talent management solutions. We will integrate OutStart’s Learning Management Suite, which includes award-winning social and mobile learning solutions, with Kenexa’s Global Talent Management solutions including its Performance Management suite.

Summary of changes in cash and cash equivalents by activity

	For the three months ended March 31,
	2012		2011		Change		Percent
Cash provided by operations	$	1,716	$	601	$	1,115		185.5	%
Cash used in investing activities		(3,435)		(16,275)		12,840		78.9	%
Cash provided by (used in) financing activities		542		(17,532)		18,074		103.1	%

40

Operating Activities

Historically, our largest source of operating cash flows has been cash collections from our customers following the purchase and renewal of their software subscriptions. Payments from customers for subscription agreements are generally received quarterly in advance of providing services. We also generate significant cash from our recruitment process outsourcing services, and to a lesser extent, our consulting services. Our primary uses of cash from operating activities are for personnel-related expenditures as well as payments related to taxes and leased facilities.

	For the three months ended March 31,
	2012		2011		Change from 2011 to 2012
Net loss	$	(2,638)	$	(3,167)	$	529
Non-cash charges to net income
Depreciation and amortization		10,523		7,918		2,605
Share-based compensation expense		1,917		1,127		790
Deferred income tax (benefit) expense		(713)		(270)		(443)
Other non-cash charges to net income		(48)		301		(349)
Goodwill impairment charge
Changes in working capital
Accounts receivable		(4,019)		(6,339)		2,320
Deferred revenue		3,222		5,690		(2,468)
Other changes in working capital		(6,528)		(4,659)		(1,869)
Net cash provided by operations	$	1,716	$	601	$	1,115

The increase in non-cash charges to net income during 2012 compared to the same period in 2011 is primarily due to the amortization of intangible assets associated with our acquisitions of Salary.com, Ashbourne, BHI and OutStart and depreciation expense due to software development projects placed in service. Additionally, share-based compensation expense resulting from new long-term incentive awards contributed to the increase over the prior period. The decrease in other changes is primarily due to changes in accrued compensation and accrued liabilities.

Investing Activities

Net cash used in investing activities was $3.4 million and $16.3 million for the three months ended March 31, 2012 and 2011, respectively. Cash used in investing activities consisted primarily of the acquisition of OutStart and capitalized software and hardware, which was partially offset by sales of securities.

	For the three months ended March 31,
	2012		2011
JRA acquisition	$	—	$	(6,732)
Talentmine acquisition		—		(2,950)
OutStart acquisition		(41,101)		—
Capitalized software and purchases of computer hardware		(7,135)		(6,593)
Purchases of available-for-sale securities		(1,469)		—
Sales of available-for-sale securities		46,270		—
Net cash used in investing activities	$	(3,435)	$	(16,275)

Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2012 totaled $0.5 million and was primarily attributable to net proceeds of $2.1 million from stock option exercises and sales of our common stock issued through our employee stock purchase plan. This was offset by net repayments of our term and revolver loans of $1.3 million, repayments of notes payable and capital leases totaling $0.3 million.

Net cash used in financing activities for the three months ended March 31, 2011 totaled $17.5 million and was primarily attributable to net repayments of our term and revolver loans of $22.7 million and repayments of notes payable and capital leases totaling $0.4 million. This was offset by proceeds of $5.6 million from stock option exercises and sales of our common stock issued through our employee stock purchase plan.

41

7. Critical Accounting Policies and Estimates

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

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

Revenue Recognition

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

• there is persuasive evidence of an arrangement;

• the service has been provided to the customer;

• the collection of the fees is probable; and

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

 Subscription fees and support revenues are recognized ratably on a monthly basis over the terms 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.

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

We record expenses billed to customers in accordance with ASC 605-45, “Revenue Recognition-Principal Agent Considerations,” which requires that reimbursements received for out-of-pocket expenses be classified as revenues and not as cost reductions. These items primarily include travel, meals and agency fees.  Reimbursed expenses totaled $1.6 million and $1.0 million for the three months ended March 31, 2012 and 2011, respectively.

For contracts entered into prior to our adoption of Accounting Standards Update (“ASU”) 2009-13, in determining whether revenues from consulting services could be accounted for separately from subscription revenue, we considered the following factors for each agreement: availability from other vendors, whether objective and reliable evidence of fair value exists of the undelivered elements, the nature and the timing of when the agreement was signed in comparison to the subscription agreement start date and the contractual dependence of the subscription service on the customer's satisfaction with the other services.

We enter into arrangements with customers which may include consulting services, software licenses and delivery of data.  For arrangements that contain multiple deliverables, the selling price hierarchy established in ASU 2009-13 is used to determine the selling price of each deliverable. The selling price hierarchy allows for the use of estimated selling price (“ESP”) to determine the allocation of arrangement consideration to a deliverable in a multiple-element arrangement in the absence of vendor specific objective evidence (“VSOE”) or third-party evidence (“TPE”).

42

To qualify as a separate unit of accounting, deliverable items must have value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. If the arrangement does not meet all criteria above, the entire amount of the transaction is deferred until all elements are delivered.

We determined our ESP of fair value for our application services based on the following:

• We utilize a pricing model for our products which considers market factors such as customer demand for our products, and the geographic regions where the products are sold.  In addition, the model considers entity-specific factors such as volume based pricing, discounts for bundled products and total contract commitment.  Management approval of the model ensures that all of our selling prices are consistent and within an acceptable range for use with the relative selling price method.

• While the pricing model currently in use captures all critical variables, unforeseen changes due to external market forces may result in revising some of the inputs.  These modifications may result in the consideration allocation differing from the one presently in use.  Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration.

• The Company determined the ESP for consulting services based on sales of those services sold separately or on consulting rates estimated based on the value of the services being provided.

The revenue guidance contained in ASU 2009-13 modifies the way we account for certain of its arrangements, by allowing us to separate consulting services and corresponding license fees into two separate units of accounting. These two deliverables represent the primary elements in those arrangements and are recognized upon performance or delivery of each service or product, respectively to the end customer.  Revenue related to consulting services is recognized as obligations are fulfilled on a proportional performance basis and typically earned over a three to six month period, while the license fees may be recognized over a two to five year period.  After the adoption of ASU 2009-13, costs associated with the delivery of our consulting services are expensed as incurred.

Multiple element arrangements consisting of multiple products are impacted by the new revenue guidance.  Under ASU 2009-13, total consideration for an arrangement is allocated to each product or service using the hierarchy of VSOE, third party evidence or the relative selling price method and is recognized as each product or service is delivered to the customer.  Consistent with current practice, revenue may be deferred if the arrangement includes any unusual terms, including extended payment terms, specified acceptance terms, or hold backs payable upon final acceptance of the product or service.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from customers’ inability to pay us. The provision is based on our historical experience and for specific customers that, in our opinion, are likely to default on our receivables from them. In order to identify these customers, we perform ongoing reviews of all customers that have breached their payment terms, as well as those that have filed for bankruptcy or for whom information has become available indicating a significant risk of non-recoverability. We rely on historical trends of bad debt as a percentage of total revenue over 90 days past due and apply these percentages to the accounts receivable associated with new customers and evaluate these customers over time. To the extent that our future collections differ from our assumptions based on historical experience, the amount of our bad debt and allowance recorded may be different.

Self-Insurance

We are self-insured for the majority of our health insurance costs, including claims filed and claims incurred but not reported subject to certain stop loss provisions. We estimate our liability based upon management’s judgment and historical experience and record the amount on a gross basis. We also rely on the advice of consulting administrators in determining an adequate liability for self-insurance claims. At March 31, 2012 and December 31, 2011, self-insurance accruals totaled $1.3 million and $1.1 million. There were no stop loss recoveries for the period ended March 31, 2012 and the year ended December 31, 2011. Management continuously reviews the adequacy of the Company’s stop loss insurance coverage. Material differences may result in the amount and timing of health insurance claims if actual experience differs significantly from management’s estimates.

43

Capitalized Software Development Costs

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

Goodwill and Other Identified Intangible Asset Impairment

We record goodwill in accordance with the provisions of ASC 350, “Intangibles-Goodwill and Other,” which requires us to annually review the carrying value of goodwill for impairment.  If goodwill becomes impaired, some or all of the goodwill would 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 carrying amount. We evaluate the carrying value of goodwill under two reporting units within a single segment. We perform an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired.

We evaluated the goodwill by comparing to the fair values of the reporting units, based upon management's estimate of the future discounted cash flows to be generated by the business using level three inputs and comparable company multiples, to their carrying values. 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 our 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 noted no triggering event during the three months ended March 31, 2012, which would give rise to an impairment analysis..

Accounting for Income Taxes

We are subject to income taxes in the U.S. and various foreign countries.  We record an income tax provision for the anticipated tax consequences of operating results reportable to each taxing jurisdiction in compliance with enacted tax legislation.  We account for income taxes in accordance with ASC 740, “Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities.  ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.

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

Our determination of the level of valuation allowance at March 31, 2012 is based on an estimated forecast of future taxable income which includes many judgments and assumptions primarily related to revenue, margins, operating expenses, tax planning strategies and tax attributes in multiple taxing jurisdictions.  Accordingly, it is at least reasonably possible that future changes in one or more of these assumptions may lead to a change in judgment regarding the level of valuation allowance required in future periods.

44

Accounting for Share-Based Compensation

Share-based compensation expense recognized during the period is based on the value of the number of awards that are expected to vest multiplied by the fair value. We use a Black-Scholes option-pricing model to calculate the fair value of our share-based awards. The calculation of the fair value of the awards using the Black-Scholes option-pricing model is affected by our stock price on the date of grant as well as assumptions regarding the following:

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

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

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

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

In certain instances where market based, performance share awards are granted, we use the Monte Carlo valuation model to calculate the fair value.  This approach utilizes a two-stage process, which first simulates potential outcomes for our shares using the Monte Carlo simulation. The first stage of the Monte Carlo simulation requires a variety of assumptions about both the statistical properties of our shares as well as potential reactions to such share price movements by our management.  Such assumptions include the natural logarithm of our stock price, a random log-difference using the Russell 2000 stock index and a random variable using the specific deviations of our returns relative to the returns dictated by the Capital Asset Pricing Model.  The second stage employs the Black-Scholes model to value the various outcomes predicted by the Monte Carlo simulation.  The resulting fair value, on the date of the grant (measurement date), is being recognized over the vesting period using the straight-line method.

45

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

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

Foreign Currency Exchange Risk

For the three months ended March 31, 2012, approximately 74.3% of our total revenue was comprised of sales to customers 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% increase in the value of the U.S. dollar during 2012, relative to each currency in which our non-U.S. generated sales are denominated, would have resulted in reduced annual revenues of approximately 2.9% for the three months ended March 31, 2012.

The financial position and operating results of our foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date, and the local currency revenue and expenses are translated at average rates of exchange to the U.S. dollar during the period. The related translation adjustments to shareholders’ equity were an increase of $0.7 million during the three months ended March 31, 2012 and a decrease of $2.0 million during the year ended December 31, 2011, and are included in accumulated other comprehensive loss. The foreign currency translation adjustment is not adjusted for income taxes because it relates to an indefinite investment in a non-U.S. subsidiary.

Interest Rate Risk

The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and certificates of deposit. Our cash equivalents, which consist solely of money market funds, are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. We believe that a 10% change in interest rates would not have had a significant effect on our interest income for the three months ended March 31, 2012.

We also have a $28.8 million loan with PNC Bank N.A., of which $28.8 million is subject to an interest rate swap, which we used to partially fund our acquisition of Salary.com in the third quarter of 2010. This swap effectively changed the variable rate cash flow exposure on the debt obligations to fixed cash flows, thereby eliminating our interest rate risk.

ITEM 4. 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.

No changes in our internal control over financing reporting occurred during the most recent fiscal quarter that materially affected, or are reasonably likely to materially, affect, our internal control over financial reporting.

46

PART II:  OTHER INFORMATION

Item 1.  Legal Proceedings

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, could have a material adverse effect on our business, financial condition and operating results. Furthermore, the Company believes that the litigation matters described above, due to their current state are neither probable nor reasonably estimable at the time of filing.

Item 1A: Risk Factors

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011 which could materially affect our business, financial condition or future results of operations. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2011 are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and future results of operations. There have been no material changes from the risk factors previously disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011.

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

Not applicable.

Item 3: Defaults Upon Senior Securities

Not applicable.

Item 4: Mine Safety Disclosures

Not applicable.

Item 5: Other Information

Not applicable.

47

Item 6:  Exhibits

The following exhibits are filed herewith:

2.1	Agreement and Plan of Merger, dated January 31, 2012, by and among Kenexa Corporation, Striper Merger Sub, Inc., OutStart, Inc. and the Securityholder Representative (as defined therein), incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 6, 2012.
10.1*	Kenexa Corporation Change in Control Severance Plan, adopted March 29, 2012, incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on Aril 4, 2012.
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.
101.INS**	XBRL Instance Documents
101.SCH**	XBRL Taxonomy Extension Schema Document.
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF**	XBRL Taxonomy Extension Definition Document
101.LAB**	XBRL Taxonomy Extension Label Linkbase Document
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document.
*	Management contracts and compensatory plans and arrangements.
**	Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised that, pursuant to Rule 406T, these interactive data files are deemed not filed and otherwise are not subject to liability.

48

SIGNATURES

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

May 10, 2012

Kenexa Corporation

 /s/ Nooruddin S. Karsan

 ----------------------------

    Nooruddin S. Karsan

    Chairman of the Board and Chief Executive Officer (Principal Executive Officer)

/s/ Donald F. Volk

    -----------------

    Donald F. Volk

    Chief Financial Officer (Principal Financial and Accounting Officer)

49

EXHIBIT INDEX

Exhibit Number	Description of Document
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.
101.INS**	XBRL Instance Documents
101.SCH**	XBRL Taxonomy Extension Schema Document.
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF**	XBRL Taxonomy Extension Definition Document
101.LAB**	XBRL Taxonomy Extension Label Linkbase Document
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document.

50

 

,