59a85b8bb0014f8

Kenexa Corporation and Subsidiaries

FORM 10-Q

Quarter Ended September 30, 2012

Table of Contents


PART 1: FINANCIAL INFORMATION	Page
Item 1: Financial Statements
Consolidated Balance Sheets as of September 30, 2012 (unaudited) and December 31, 2011	3
Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and 2011 (unaudited)	4
Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2012 and 2011 (unaudited)	5
Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2012 (unaudited) and the year ended December 31, 2011	6
Consolidated Statements of Cash Flows for the nine months ended September 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	30
Item 3: Quantitative and Qualitative Disclosures about Market Risk	42
Item 4: Controls and Procedures	43
PART II: OTHER INFORMATION
Item 1: Legal Proceedings	43
Item 1A: Risk Factors	44
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3: Defaults Upon Senior Securities	44
Item 4: Mine Safety Disclosures	44
Item 5: Other Information	44
Item 6: Exhibits	45
Signatures	46
Exhibit Index	47

PART 1 FINANCIAL INFORMATION

Item 1: Financial Statements

Kenexa Corporation and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share and per share data)


	September 30,		December 31,
	2012		2011
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	57,041	$	67,459
Short-term investments		6,847		51,807
Accounts receivable, net of allowance for doubtful accounts of $2,848 and $3,045		64,507		52,664
Unbilled receivables		6,577		3,385
Income tax receivable		80		196
Deferred income taxes		5,552		5,477
Prepaid expenses and other current assets		16,523		9,555
Total current assets		157,127		190,543

Long-term investments		-		9,710
Property and equipment, net		23,768		18,632
Software, net		32,507		27,179
Goodwill		67,588		43,265
Intangible assets, net		78,096		73,074
Deferred income taxes, non-current		30,485		35,092
Deferred financing costs, net		130		354
Other long-term assets		9,557		7,795
Total assets	$	399,258	$	405,644

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	9,223	$	7,909
Notes payable, current		11		11
Term loan, current		-		5,000
Commissions payable		6,746		3,673
Accrued compensation and benefits		20,004		18,061
Other accrued liabilities		18,885		13,970
Deferred revenue		91,847		81,795
Capital lease obligations		1,195		282
Total current liabilities		147,911		130,701

Revolving credit line and term loan		-		25,000
Capital lease obligations, less current portion		2,852		218
Deferred revenue, less current portion		5,009		7,042
Deferred income taxes		1,236		1,823
Other long-term liabilities		4,066		5,330
Total liabilities		161,074		170,114

Commitments and Contingencies

Temporary equity
Noncontrolling interest		4,855		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: 27,603,010 and 27,124,276, respectively		276		271
Additional paid-in-capital		397,007		385,511
Accumulated deficit		(157,734)		(149,376)
Accumulated other comprehensive loss		(6,220)		(5,866)
Total shareholders' equity		233,329		230,540

Total liabilities and shareholders' equity	$	399,258	$	405,644

See notes to consolidated financial statements.

Kenexa Corporation and Subsidiaries

Consolidated Statements of Operations

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


	Three Months Ended					Nine Months Ended
		September 30,				September 30,
		2012		2011		2012		2011
Revenues:
Subscription	$	64,190	$	53,462	$	181,739	$	149,532
Other		26,558		22,241		73,095		55,164
Total revenues		90,748		75,703		254,834		204,696
Cost of revenues		32,580		29,693		97,970		79,905
Gross profit		58,168		46,010		156,864		124,791

Operating expenses:
Sales and marketing		20,474		16,390		58,214		46,353
General and administrative		20,361		15,114		48,961		41,081
Research and development		8,148		4,912		22,126		14,176
Depreciation and amortization		11,247		8,244		32,763		24,168
Total operating expenses		60,230		44,660		162,064		125,778
(Loss) income from operations		(2,062)		1,350		(5,200)		(987)
Interest (income) expense, net		(265)		59		(870)		(725)
(Loss) gain on change in fair market value of investments, net		(19)		(127)		22		(391)
(Loss) gain before income taxes		(2,346)		1,282		(6,048)		(2,103)
Income tax (expense) benefit		(1,869)		(1,602)		(2,529)		(2,172)
Net loss	$	(4,215)	$	(320)	$	(8,577)	$	(4,275)
Loss (income) allocated to noncontrolling interest		35		(288)		219		(437)
Accretion associated with variable interest entity		-		(2,507)		-		(3,159)
Net loss allocable to common shareholders'	$	(4,180)	$	(3,115)	$	(8,358)	$	(7,871)
Basic and diluted net loss per share	$	(0.15)	$	(0.12)	$	(0.31)	$	(0.31)

Weighted average common shares - basic & diluted		27,503,535		27,043,135		27,339,019		25,002,236

See notes to consolidated financial statements.

Kenexa Corporation and Subsidiaries

Consolidated Statements of Comprehensive Loss

(Unaudited; in thousands)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
		2012		2011		2012		2011
Net loss	$	(4,215)	$	(320)	$	(8,577)	$	(4,275)
Loss (income) allocated to noncontrolling interest		35		(288)		219		(437)
Accretion associated with variable interest entity		-		(2,507)		-		(3,159)
Net loss allocable to common shareholders'	$	(4,180)	$	(3,115)	$	(8,358)	$	(7,871)
Other
Gain (loss) on currency translation adjustments		640		(1,802)		(354)		(1,083)
Unrealized loss on investments		-		(320)		-		(377)
Comprehensive loss	$	(3,540)	$	(5,237)	$	(8,712)	$	(9,331)

See notes to consolidated financial statements.

Kenexa Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity

(In thousands; except share data)



								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	-		-		-		-		(354)		(354)
Share-based compensation expense	-		-		6,710		-		-		6,710
APIC pool adjustments	-		-		(2,297)		-		-		(2,297)
Stock options exercised	408,125		4		6,626		-		-		6,630
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	16,994		-		534		-		-		534
Loss allocated to noncontrolling interest	-		-		-		219		-		219
Net loss	-		-		-		(8,577)		-		(8,577)
Balance September 30, 2012 (unaudited)	27,603,010	$	276	$	397,007	$	(157,734)	$	(6,220)	$	233,329

See notes to consolidated financial statements.

Kenexa Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited; in thousands)


		Nine months ended September 30,
		2012		2011
Cash flows from operating activities
Net loss from operations	$	(8,577)	$	(4,275)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		32,763		24,168
Loss on disposal of property and equipment		22		95
Amortization of bond premium		563		-
Realized loss on available-for-sale securities		32		62
Share-based compensation expense		6,710		4,593
Amortization of deferred financing costs		224		159
Bad debt (recoveries) expense, net		(413)		843
Deferred income tax benefit		(1,705)		(546)
Changes in assets and liabilities, net of business combinations
Accounts and unbilled receivables		(10,778)		(10,580)
Prepaid expenses and other current assets		(6,692)		(3,122)
Income taxes receivable		142		(893)
Other long-term assets		(2,004)		3,368
Accounts payable		439		585
Accrued compensation and other accrued liabilities		7,513		6,687
Commissions payable		2,938		339
Deferred revenue		3,475		11,037
Other liabilities		(1,516)		(1,078)
Net cash provided by operating activities		23,136		31,442

Cash flows from investing activities
Capitalized software and purchases of property and equipment		(22,174)		(17,999)
Purchases of available-for-sale securities		(1,469)		(86,076)
Sales of available-for-sale securities		55,545		18,330
Acquisitions, net of cash acquired		(42,236)		(11,520)
Net cash used in investing activities		(10,334)		(97,265)

Cash flows from financing activities
Borrowings under revolving credit line and term loan		-		3,000
Repayments under revolving credit line and term loan		(30,000)		(31,250)
Repayments of notes payable		(74)		(87)
Repayments of capital lease obligations		(335)		(426)
Purchase of additional interest in variable interest entity		-		(229)
Proceeds from common stock issued through Employee Stock Purchase Plan		534		391
Shares authorized, but not issued, to settle employees withholding liability		(76)		-
Net proceeds from option exercises		6,630		8,255
Net proceeds from public offering		-		91,432
Net cash (used in) provided by financing activities		(23,321)		71,086
Effect of exchange rate changes on cash and cash equivalents		101		(136)
Net (decrease) increase in cash and cash equivalents		(10,418)		5,127
Cash and cash equivalents at beginning of period		67,459		52,455
Cash and cash equivalents at end of period	$	57,041	$	57,582

Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest expense	$	769	$	1,168
Income taxes	$	2,464	$	3,992
Income taxes refunded	$	290	$	-
Noncash investing and financing activities
Capital lease obligations incurred	$	3,882	$	568

See notes to consolidated financial statements.

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 25 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 September 30, 2012 and for the three and nine months ended September 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 nine months ended September 30, 2012 and 2011 have been made. The results for the three and nine months ended September 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.

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.

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements - Unaudited (Continued)

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

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 September 30, 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 September 30, 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.

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 reduction in shareholders’ equity of $354 and $1,984 for the period ended September 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 losses of $316 and $31 for the three and nine months ended September 30, 2012, respectively, and net losses of $492 and $534 for the three and nine months ended September 30, 2011, respectively.

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 September 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 8.5% and 9.0% at September 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 10.0% of the Company’s total revenues for the three and nine months ended September 30, 2012, and 13.5% and 11.6% for the three and nine months ended September 30, 2011, respectively.

Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements - Unaudited (Continued)

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

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 $662 at September 30, 2012 and $500 at December 31, 2011. 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 $21,086 and $13,536 and represented 37.0% and 20.1% of our total cash and cash equivalents balance at September 30, 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 September 30, 2012 and December 31, 2011, self-insurance accruals totaled $1,298 and $1,083. There were no stop loss recoveries at September 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.

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 period ended September 30, 2012, which would give rise to an impairment analysis. 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.

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. Reimbursed expenses totaled $1,500 and $4,754 for the three and nine months ended September 30, 2012, respectively, and $1,974 and $4,562 for the three and nine months ended September 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”).

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.

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 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.

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.

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 and nine months ended September 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 September 30,				Nine months ended September 30,
		2012		2011		2012		2011
Numerator:
Net loss allocable to common shareholders	$	(4,180)	$	(3,115)	$	(8,358)	$	(7,871)

Denominator:
Weighted average shares used to compute net loss allocable to common shareholders per common share - basic		27,503,535		27,043,135		27,339,019		25,002,236
Effect of dilutive stock options		—		—		—		—
Weighted average shares used to compute net loss allocable to common shareholders per common share – dilutive		27,503,535		27,043,135		27,339,019		25,002,236

Basic and diluted net loss per share	$	(0.15)	$	(0.12)	$	(0.31)	$	(0.31)

Total antidilutive stock options and unvested restricted stock issued and outstanding or granted		442,132		981,276		877,471		943,276

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 nine months ended September 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 350-30 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.

3. Investments

Short-term and long-term investments at September 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 September 30, 2012 was 5.14%. Available-for-sale securities are reported at fair value with changes in the related unrealized gains and losses included in comprehensive loss in the accompanying consolidated financial statements. The cost of securities is determined based on the specific identification method. At September 30, 2012, the cost of the available-for-sale securities approximated their fair value.

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 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.

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, 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.

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 expanded the Company’s reach into the e-learning market and enabled 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, is being integrated with Kenexa’s Global Talent Management solutions including its Performance Management suite.

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 have been 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		3,835
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		25,300		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

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.


	Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011
Revenue	$	80,933	$	256,373	$	220,831
Net loss allocable to common shareholders	$	(3,022)	$	(7,464)	$	(7,601)
Net loss per share—basic and diluted	$	(0.11)	$	(0.27)	$	(0.30)

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 September 30, 2012, the Company had a 49% ownership interest in the variable interest entity.

On August 25, 2012, in connection with its pending acquisition by IBM, the Company entered into agreements with R and J and the variable interest entity pursuant to which it will divest its current ownership interest in the variable interest entity. Under the terms of the agreements, the Company will receive approximately $160 in exchange for its ownership interest in the variable interest entity and will pay R and J approximately $6,816 to release and settle all claims and liabilities, including the cancellation of loans from Kenexa to the variable interest entity totaling approximately $1,816. The Equity Interest Transfer Agreement is subject to customary governmental approvals by the Ministry of Commerce of the People’s Republic of China and the State Administration of Industry and Commerce.

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.

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 $4,855 and $4,990 at September 30, 2012 and December 31, 2011, respectively, in noncontrolling interest and classified the amount as temporary equity on the consolidated balance sheet.

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 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 nine months ended September 30, 2012, which would give rise to an impairment analysis.

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 changes in the carrying amount of goodwill, which include adjustments for earnouts, taxes, foreign currency, and acquisitions for the period ended September 30, 2012, are as follows:


Balance as of December 31, 2011	$	43,265
Acquisitions or adjustments:
Quorum (1)		1,135
BHI (2)		(2,460)
OutStart		25,300
Foreign currency and other		348
Balance as of September 30, 2012	$	67,588

(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.

(2) $2,355 of the adjustment, as described in Footnote 4 – Acquisitions in the Notes to Consolidated Financial Statements, relates to a revision of the preliminary earnout calculation.

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 $5,783 and $16,999 for the three and nine months ended September 30, 2012, respectively, and $3,571 and $10,685 for the three and nine months ended September 30, 2011, respectively.

Intangible assets subject to amortization at September 30, 2012 and December 31, 2011 consist of the following:


	September 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	$	82,212	$	(26,927)	$	55,285	9.1	$	71,783	$	(17,809)	$ 53,974	9.6
Intellectual property		37,612		(16,510)		21,102	3.8		26,134		(9,316)	16,818	2.2
Non-compete		1,000		(843)		157	0.3		2,007		(1,546)	461	0.7
Trademarks		2,251		(699)		1,552	4.8		2,232		(411)	1,821	5.6
Fully amortized intangibles		5,413		(5,413)		—	—		4,199		(4,199)	—	—
Total	$	128,488	$	(50,392)	$	78,096	7.4	$	106,355	$	(33,281)	$ 73,074	7.4



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)


Period		Amortization Expense
Remainder of 2012	$	5,766
2013		17,217
2014


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


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