form10-q.htm

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PART 1: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets as of June 30, 2012 (unaudited) and December 31, 2011	3
Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011 (unaudited)	4
Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2012 and 2011 (unaudited)	5
Consolidated Statements of Shareholders’ Equity for the six months ended June 30, 2012 (unaudited) and the year ended December 31, 2011	6
Consolidated Statements of Cash Flows for the six months ended June 30, 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	26
Item 3: Quantitative and Qualitative Disclosures about Market Risk	39
Item 4: Controls and Procedures	39
PART II: OTHER INFORMATION
Item 1: Legal Proceedings	40
Item 1A: Risk Factors	40
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3: Defaults Upon Senior Securities	40
Item 4: Mine Safety Disclosures	40
Item 5: Other Information	40
Item 6: Exhibits	41
Signatures	42
Exhibit Index	43


	June 30,			December 31,
	2012			2011
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	82,758		$	67,459
Short-term investments		6,930			51,807
Accounts receivable, net of allowance for doubtful accounts of $2,646 and $3,045		58,609			52,664
Unbilled receivables		4,506			3,385
Income tax receivable		76			196
Deferred income taxes		6,442			5,477
Prepaid expenses and other current assets		13,439			9,555
Total current assets		172,760			190,543

Long-term investments		-			9,710
Property and equipment, net		20,799			18,632
Software, net		30,643			27,179
Goodwill		67,343			43,265
Intangible assets, net		83,732			73,074
Deferred income taxes, non-current		29,867			35,092
Deferred financing costs, net		248			354
Other long-term assets		7,704			7,795
Total assets	$	413,096		$	405,644

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	11,519		$	7,909
Notes payable, current		11			11
Term loan, current		5,000			5,000
Commissions payable		4,302			3,673
Accrued compensation and benefits		15,518			18,061
Other accrued liabilities		15,655			13,970
Deferred revenue		90,528			81,795
Capital lease obligations		416			282
Total current liabilities		142,949			130,701

Revolving credit line and term loan		22,500			25,000
Capital lease obligations, less current portion		360			218
Deferred revenue, less current portion		5,908			7,042
Deferred income taxes		1,310			1,823
Other long-term liabilities		4,490			5,330
Total liabilities		177,517			170,114

Commitments and Contingencies

Temporary equity
Noncontrolling interest		4,804			4,990

Shareholders' equity
Preferred stock, $0.01 par value; authorized 10,000,000 shares; issued and outstanding: none		-			-
Common stock, par value $0.01; authorized 100,000,000 shares; shares issued and outstanding: 27,387,715 and 27,124,276, respectively		274			271
Additional paid-in-capital		390,916			385,511
Accumulated deficit		(153,554	)		(149,376	)
Accumulated other comprehensive loss		(6,861	)		(5,866	)
Total shareholders' equity		230,775			230,540

Total liabilities and shareholders' equity	$	413,096		$	405,644


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Revenues:
Subscription	$	62,213		$	49,867		$	117,549		$	96,070
Other		24,071			19,148			46,537			32,923
Total revenues		86,284			69,015			164,086			128,993
Cost of revenues		33,121			26,867			65,390			50,212
Gross profit		53,163			42,148			98,696			78,781

Operating expenses:
Sales and marketing		20,207			15,688			37,740			29,963
General and administrative		14,533			13,219			28,600			25,967
Research and development		7,546			4,819			13,978			9,264
Depreciation and amortization		10,993			8,006			21,516			15,924
Total operating expenses		53,279			41,732			101,834			81,118
(Loss) income from operations		(116	)		416			(3,138	)		(2,337	)
Interest expense, net		(321	)		(344	)		(605	)		(784	)
Gain (loss) on change in fair market value of investments, net		41			(264	)		41			(264	)
Loss before income taxes		(396	)		(192	)		(3,702	)		(3,385	)
Income tax expense		(1,328	)		(596	)		(660	)		(570	)
Net loss	$	(1,724	)	$	(788	)	$	(4,362	)	$	(3,955	)
(Income) loss allocated to noncontrolling interest		-			(149	)		184			(149	)
Accretion associated with variable interest entity		-			(652	)		-			(652	)
Net loss allocable to common shareholders'	$	(1,724	)	$	(1,589	)	$	(4,178	)	$	(4,756	)
Basic and diluted net loss per share	$	(0.06	)	$	(0.06	)	$	(0.15	)	$	(0.20	)

Weighted average common shares - basic & diluted		27,330,887			24,876,801			27,255,857			23,964,869


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Net loss	$	(1,724	)	$	(788	)	$	(4,362	)	$	(3,955	)
(Income) loss allocated to noncontrolling interest		-			(149	)		184			(149	)
Accretion associated with variable interest entity		-			(652	)		-			(652	)
Net loss allocable to common shareholders'	$	(1,724	)	$	(1,589	)	$	(4,178	)	$	(4,756	)
Other
(Loss) gain on currency translation adjustments		(1,743	)		(263	)		(995	)		719
Unrealized loss on investments		-			(57	)		-			(57	)
Comprehensive loss	$	(3,467	)	$	(1,909	)	$	(5,173	)	$	(4,094	)

	.												Accumulated
													other			Total
		Common Stock					Additional			Accumulated			comprehensive			shareholders'
		Shares			Amount		paid-in-capital			deficit			loss			equity
Balance December 31, 2010			22,900,253		$	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 adjustments			-			-		(344	)		-			-			(344	)
Stock options exercised			719,052			7		8,920			-			-			8,927
Issuance of restricted shares			7,104			-		-			-			-			-
Vested restricted stock units converted to shares			24,450			-		-			-			-			-
Employee stock purchase plan			23,417			-		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			3,450,000			35		91,389			-			-			91,424
Net loss			-			-		-			(3,871	)		-			(3,871	)
Balance December 31, 2011			27,124,276		$	271	$	385,511		$	(149,376	)	$	(5,866	)	$	230,540
Loss on currency translation adjustments			-			-		-			-			(995	)		(995	)
Share-based compensation expense			-			-		4,350			-			-			4,350
APIC Pool adjustments			-			-		(2,197	)		-			-			(2,197	)
Stock options exercised			197,320			2		2,990			-			-			2,992
Issuance of restricted shares			6,036			-		-			-			-			-
Vested restricted stock units converted to shares			50,206			1		(1	)		-			-			-
Restricted shares withheld for payroll tax payments			(2,627	)		-		(76	)		-			-			(76	)
Employee stock purchase plan			12,504			-		339			-			-			339
Loss allocated to noncontrolling interest			-			-		-			184			-			184
Net loss			-			-		-			(4,362	)		-			(4,362	)
Balance June 30, 2012 (unaudited)			27,387,715		$	274	$	390,916		$	(153,554	)	$	(6,861	)	$	230,775


	Six months ended June 30,
	2012			2011
Cash flows from operating activities
Net loss from operations	$	(4,362	)	$	(3,955	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		21,516			15,924
Loss on disposal of property and equipment		22			81
Amortization of bond premium		479			-
Realized loss on available-for-sale securities		32			-
Share-based compensation expense		4,350			2,786
Amortization of deferred financing costs		106			106
Bad debt (recoveries) expense, net		(629	)		802
Deferred income tax benefit		(1,804	)		(961	)
Changes in assets and liabilities, net of business combinations
Accounts and unbilled receivables		(2,918	)		(3,246	)
Prepaid expenses and other current assets		(3,663	)		(1,541	)
Income taxes receivable		146			16
Other long-term assets		(169	)		1,240
Accounts payable		2,828			1,519
Accrued compensation and other accrued liabilities		155			(185	)
Commissions payable		504			(269	)
Deferred revenue		3,217			8,389
Other liabilities		(880	)		(121	)
Net cash provided by operating activities		18,930			20,585

Cash flows from investing activities
Capitalized software and purchases of property and equipment		(15,604	)		(12,097	)
Purchases of available-for-sale securities		(1,469	)		(57,161	)
Sales of available-for-sale securities		55,545			-
Acquisitions, net of cash acquired		(42,236	)		(9,682	)
Net cash used in investing activities		(3,764	)		(78,940	)

Cash flows from financing activities
Borrowings under revolving credit line and term loan		-			3,000
Repayments under revolving credit line and term loan		(2,500	)		(27,000	)
Repayments of notes payable		(74	)		(87	)
Repayments of capital lease obligations		(279	)		(351	)
Proceeds from common stock issued through Employee Stock Purchase Plan		339			236
Shares authorized, but not issued, to settle employees withholding liability		(76	)		-
Net proceeds from option exercises		2,992			8,209
Net proceeds from public offering		-			91,669
Net cash provided by financing activities		402			75,676

Effect of exchange rate changes on cash and cash equivalents		(269	)		638

Net increase in cash and cash equivalents		15,299			17,959
Cash and cash equivalents at beginning of period		67,459			52,455
Cash and cash equivalents at end of period	$	82,758		$	70,414

Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest expense	$	582		$	810
Income taxes	$	1,838		$	3,448
Income taxes refunded	$	245		$	-

Noncash investing and financing activities
Capital lease obligations incurred	$	555		$	568

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.

The accompanying consolidated financial statements as of June 30, 2012 and for the three and six months ended June 30, 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 six months ended June 30, 2012 and 2011 have been made. The results for the three and six months ended June 30, 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.

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.

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.

	•	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.

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.

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 reduction in shareholders’ equity of $995 and $1,984 for the period ended June 30, 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 $128 and $285 for the three and six months ended June 30, 2012, respectively, and net losses of $42 and $33 for the three and six months ended June 30, 2011, respectively.

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 June 30, 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 10.3% and 9.0% at June 30, 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, 9.3% and 10.4% of the Company’s total revenues for the three and six months ended June 30, 2012, respectively, and 12.0% and 11.1% for the three and six months ended June 30, 2011, respectively.

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 June 30, 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.

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 June 30, 2012 and December 31, 2011, self-insurance accruals totaled $1,312 and $1,083. There were no stop loss recoveries at June 30, 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.

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 period ended June 30, 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.

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.

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:

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. Reimbursed expenses totaled $1,635 and $3,254 for the three and six months ended June 30, 2012, respectively, and $1,597 and $2,588 for the three and six months ended June 30, 2011, 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”).

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 one 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.

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.

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 and six months ended June 30, 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 June 30,				Six months ended June 30,
		2012		2011		2012		2011
Numerator:
Net loss allocable to common shareholders	$	(1,724)	$	(1,589)	$	(4,178)	$	(4,756)

Denominator:
Weighted average shares used to compute net loss allocable to common shareholders per common share - basic		27,330,887		24,876,801		27,255,857		23,964,869
Effect of dilutive stock options		—		—		—		—
Weighted average shares used to compute net loss allocable to common shareholders per common share – dilutive		27,330,887		24,876,801		27,255,857		23,964,869

Basic and diluted net loss per share	$	(0.06)	$	(0.06)	$	(0.15)	$	(0.20)

Total antidilutive stock options and unvested restricted stock issued and outstanding or granted		950,301		945,126		934,044		953,730

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 six months ended June 30, 2012, which would give rise to an impairment analysis.

In July 2012, the FASB issued ASU 2012-02, “Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment,” (ASU 2012-02). ASU 2012-02 amends the guidance in ASC 350-302 on testing indefinite-lived intangible assets, other than goodwill, for impairment by allowing an entity to perform a qualitative impairment assessment before proceeding to the two-step impairment test. If the entity determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is not more likely than not (i.e., a likelihood of more than 50 percent) impaired, the entity would not need to calculate the fair value of the asset. In addition, the ASU does not amend the requirement to test these assets for impairment between annual tests if there is a change in events or circumstances; however, it does revise the examples of events and circumstances that an entity should consider in interim periods. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption being permitted. The adoption of this standard will not have a material effect on our Consolidated Results of Operations and Financial Condition.

Short-term and long-term investments at June 30, 2012 and December 31, 2011 are comprised of municipal bonds with varying maturities and credit risk ratings of A1 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 June 30, 2012 was 5.1%. 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 June 30, 2012 the cost of the available-for-sale securities approximated their fair value.

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 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. 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.

On November 14, 2011, the Company entered into a share purchase agreement with Batrus & Hollweg, L.C. (“BHI”), a provider of talent management solutions, primarily in the hospitality sector based in Texas, for a purchase price of approximately $14,656 including cash and contingent consideration. The total cost of the acquisition, including legal, accounting, and other professional fees of $46, was approximately $14,702. At the date of the acquisition, the Company accrued contingent consideration of $5,113, which was subsequently adjusted to $2,534 during the quarter ended June 30, 2012. The adjustment was due in part to a revision of the preliminary earnout calculation totaling $2,355 and a change in the forecasted projections which reduced the earnout by $224. The adjustments were recorded to goodwill and operations, respectively, during the quarter ended June 30, 2012. The Company expects to pay $835 by March 31, 2013 and the remaining $1,699 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.

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.

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.


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 relationships		8,300	15 years
Acquired development		11,300	10 years
Goodwill		25,308	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, net		3,295
Deferred revenue, net		4,319

Total cash purchase price	$	46,229

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 June 30, 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% ownership interest and the calculated value of the put right in the variable interest entity amounting to $4,804 and $4,990 at June 30, 2012 and December 31, 2011, respectively, in noncontrolling interest and classified the amount as temporary equity on the consolidated balance sheet.

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 evaluates its goodwill by comparing 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 six months ended June 30, 2012, which would give rise to an impairment analysis.

(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 paid the additional consideration of $1,135 during the quarter ended June 30, 2012.

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 $5,838 and $11,216 for the three and six months ended June 30, 2012, respectively, and $3,583 and $7,114 for the three and six months ended June 30, 2011, respectively.


	June 30, 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	$	81,940	$	(23,649)	$	58,291	9.4	$	71,783	$	(17,809)	$	53,974	9.6
Intellectual property		37,569		(14,076)		23,493	4.0		26,134		(9,316)		16,818	2.2
Non-compete		1,000		(686)		314	0.5		2,007		(1,546)		461	0.7
Trademarks		2,234		(600)		1,634	5.1		2,232		(411)		1,821	5.6
Fully amortized intangibles		5,406		(5,406)		—	—		4,199		(4,199)		—	—
Total	$	128,149	$	(44,417)	$	83,732	7.6	$	106,355	$	(33,281)	$	73,074	7.4

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.

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.

Depreciation and amortization expense is excluded from cost of revenues. Equipment and office furniture and fixtures included gross assets under capital leases totaled $3,376 and $2,820 at June 30, 2012 and December 31, 2011, respectively. Depreciation and amortization expense, including amortization of assets under capital leases, was $5,155 and $10,300 for the three and six months ended June 30, 2012, respectively, and $4,422 and $8,810 for the three and six months ended June 30, 2011, respectively.

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 June 30, 2012, the Company had outstanding borrowings of $27,500 with an average interest rate of 3.0% 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 June 30, 2012.

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. During the six months ended June 30, 2012 the Company recorded a gain of $41 for the change in the fair value of its interest rate swap. 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.

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 2007 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.

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.

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.

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.

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.

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.

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.

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 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 has been based solely 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 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 June 30, 2012 is as follows:

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 June 30, 2012, there were 351,311 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 12,504 and 23,417 for the periods ended June 30, 2012 and December 31, 2011, respectively.

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 six months ended June 30, 2012 and 2011, the Company paid Pepper Hamilton LLP $210 and $220, respectively. The payments in 2012 were primarily for work relating to the Company’s acquisition of OutStart and general legal matters. The payments in 2011 were primarily for work relating to the Company’s class action shareholder litigation, acquisitions, credit facility and general legal matters. The amount payable to Pepper Hamilton, LLP as of June 30, 2012 and 2011 was $8 and $285, respectively.


	For the three months ended June 30,										For the six months ended June 30,
	2012					2011					2012					2011
Country	Amount		Percent of Revenues			Amount		Percent of Revenues			Amount		Percent of Revenues			Amount		Percent of Revenues
United States	$	60,915		70.6	%	$	50,412		73.0	%	$	118,730		72.4	%	$	94,962		73.6	%
United Kingdom		8,965		10.4	%		6,336		9.2	%		15,952		9.7	%		11,497		9.0	%
Germany		1,684		2.0	%		1,501		2.2	%		2,781		1.7	%		2,835		2.2	%
Other European Countries		4,960		5.7	%		4,278		6.2	%		9,387		5.7	%		7,558		5.8	%
Canada		2,744		3.2	%		1,637		2.4	%		5,623		3.4	%		3,232		2.5	%
China		2,541		2.9	%		2,432		3.5	%		4,093		2.5	%		3,852		3.0	%
Other		4,475		5.2	%		2,419		3.5	%		7,520		4.6	%		5,057		3.9	%
Total	$	86,284		100.0	%	$	69,015		100.0	%	$	164,086		100.0	%	$	128,993		100.0	%

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.

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.

For the three and six months ended June 30, 2012, subscription revenue represented approximately 72% of our total revenue. Our customers typically purchase multi-year subscriptions and during the three and six months ended June 30, 2012 our customers renewed approximately 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal for each of those periods. 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 June 30, 2012, we had a global customer base of approximately 8,500 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 286 companies on the Fortune 500 list published in May 2012. Our customer base includes companies that we billed for services during the six months ended June 30, 2012 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately $41.2 million and $78.5 million, or approximately 48% of our total revenue for the three and six months ended June 30, 2012, respectively.

On November 14, 2011, we entered into a share purchase agreement with BHI, a provider of talent management solutions, primarily in the hospitality sector based in Frisco, Texas for a purchase price of approximately $14.7 million, including legal, accounting, other professional fees and contingent consideration. We have accrued $2.5 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, 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.

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 license 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. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe to 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 and six months ended June 30, 2012 our customers renewed approximately 88% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts subject to renewal.

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 June 30, 2012, deferred revenue increased by $7.6 million, or 8.6%, to $96.4 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.

For the six months ended June 30, 2012, approximately 72.4% 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 9.7%, 3.4% and 2.5% of our total revenue, respectively. Revenue from other countries amounted to an aggregate of 12.0% of our total revenue. Other than the countries listed, no other country represented more than 2.0% of our total revenue for the six months ended June 30, 2012. The percentage of revenue derived from sales in the United States for the six months ended June 30, 2012 decreased slightly compared to the prior year.

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.

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, 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, partner integrations, 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. Newly introduced modules on the 2x platform include Kenexa 2x Assess™ and Kenexa 2x Compensation™. Kenexa will continue to invest in new 2x modules. We believe that Kenexa 2x enables customers to improve productivity, increase cost savings, ensure compliance with corporate and legal mandates, and raise employee engagement.

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles. 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. There have been no material changes during the six months ended June 30, 2012 to the critical accounting policies discussed in our Annual Report on Form 10-K for the year ended December 31, 2011.

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.

	For the three months ended June 30,						For the six months end June 30,
	2012			2011			2012			2011
	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Deferred Revenue at the beginning of the period	$	96,551		$	82,208		$	88,837		$	76,052
Total invoiced subscriptions during the period		62,098			52,609			120,829			104,968
Deferred revenue from acquisition		-			-			4,319			-
Subscription revenue recognized during the period		(62,213	)		(49,867	)		(117,549	)		(96,070	)
Deferred revenue at the end of the period	$	96,436		$	84,950		$	96,436		$	84,950

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.

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.

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.

Contingent Consideration. In accordance with ASC 805, Business Combinations, contingent consideration adjustments may result from changes in the preliminary earnout calculation or changes in the forecasted projections. Contingent consideration adjustments 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.

Taleo settlement and litigation-related fees. Litigation-related activity which includes settlement proceeds and nonrecurring litigation fees, is excluded from our non-GAAP financial measures due to its infrequent and/or unusual nature and are not expected to recur. We believe that excluding these amounts provides meaningful supplemental information regarding our operating results because these non-GAAP financial measures facilitate the comparison of results for future periods with results from past periods.


Kenexa Corporation and Subsidiaries
Reconciliation of GAAP to Non-GAAP Financial Measures
(In thousands, except for per share amounts)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2012		2011		2012		2011
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Revenue and Gross Profit:
GAAP subscription revenue	$	62,213	$	49,867	$	117,549	$	96,070
Deferred revenue associated with acquisitions		1,883		2,298		4,157		5,284
Non-GAAP subscription revenue		64,096		52,165		121,706		101,354
Other revenue		24,071		19,148		46,537		32,923
Non-GAAP revenue	$	88,167	$	71,313	$	168,243	$	134,277

GAAP cost of revenues	$	33,121	$	26,867	$	65,390	$	50,212
Share-based compensation expense		102		72		187		118



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)


	Three Months Ended June 30, 2011		Six Months Ended June 30, 2012		Six Months Ended June 30, 2011
Revenue	$	74,589	$	165,625	$	139,898
Net loss allocable to common shareholders	$	(1,301)	$	(5,111)	$	(4,579)
Net loss per share—basic and diluted	$	(0.05)	$	(0.19)	$	(0.19)


Period	Amortization Expense
Remainder of 2012	$	11,293
2013		17,185
2014		10,708
2015		8,372
2016		7,255
Thereafter		28,919
Total	$	83,732


		June 30, 2012	December 31, 2011
Equipment	$	24,335	$	22,543
Software		67,126		52,370
Office furniture and fixtures		3,667		2,754
Leasehold improvements		4,671		3,959
Land		598		628
Building		7,175		7,490
Software in development		4,712		7,992
Total property, equipment and software		112,284		97,736
Less accumulated depreciation and amortization		60,842		51,925
Total property, equipment and software, net of accumulated depreciation and amortization	$	51,442	$	45,811



		June 30, 2012	December 31, 2011
Accrued professional fees	$	383	$	322
Straight line rent accrual		3,801		2,928
Other taxes payable		1,803		1,505
Income taxes payable		5,481		3,436
Other liabilities		3,352		3,385
Contingent purchase price (1)		835		2,394
Total other accrued liabilities	$	15,655	$	13,970


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


	•	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.


Balance as of December 31, 2011	$	43,265
Acquisitions or adjustments:
Quorum (1)		1,135
Ashbourne		72
BHI (2)		(2,460)
OutStart		25,308
Foreign currency		23
Balance as of June 30, 2012	$	67,343


	Six months ended June 30, 2012			Year ended December 31, 2011
Expected volatility		63.31-63.96	%		62.85-64.42	%
Expected dividends		—			—
Expected term (in years)		3.00 - 6.25			3.00 - 6.25
Risk-free rate		0.44-1.49	%		0.71-2.88	%


	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			443,996	$	28.80
Exercised			(197,320)	$	14.99			$	2,905
Forfeited or expired			(390,875)	$	34.75
Outstanding at June 30, 2012			2,721,191	$	15.19		6.37	$	37,957
Exercisable at June 30, 2012			1,092,820	$	14.26		4.32	$	16,297


Unvested Shares	Shares		Wtd. Avg. Grant Date Fair Value
Unvested at December 31, 2011		1,657,618	$	6.68
Granted		443,996	$	16.78
Vested		(454,368)	$	8.08
Forfeited or expired		(18,875)	$	12.34
Unvested at June 30, 2012		1,628,371	$	8.97


	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		127,750		6,036	$	28.84
Released/vested		(50,206)		(7,104)	$	21.67
Forfeited/cancelled		(150)		—	$	31.25
Outstanding/unvested balance at June 30, 2012		267,044		6,036	$	25.50