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Kenexa 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2007

OR

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

For the transition period from         to        

Commission File number 000-51358

Kenexa Corporation

 (Exact Name of Registrant as Specified in Its Charter)

Pennsylvania

 

23-3024013

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

650 East Swedesford Road, Wayne, PA

 

19087

(Address of Principal Executive Offices)

 

(Zip Code)

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o                                   Accelerated filer  x                            Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o    No  x

On May 7, 2007, 25,267,614 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

 




Kenexa Corporation and Subsidiaries

FORM 10-Q

Quarter Ended March 31, 2007

Table of Contents

 

PART I: FINANCIAL INFORMATION

 

 

Item 1: Financial Statements (unaudited)

 

 

Consolidated Balance sheets as of March 31, 2007 and December 31, 2006

 

 

Consolidated Statements of Operations for the three months ended March 31, 2007 and March 31, 2006

 

 

Consolidated Statements of Shareholders’ Equity as of March 31, 2007 and December 31, 2006

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and March 31, 2006

 

 

Notes to Consolidated Financial Statements

 

 

Item 2: Management’s Discussion and Analysis of Financial Concern and Risks of Operations

 

 

Item 3: Quantitative and Qualitative Disclosures about Market Research

 

 

Item 4: Controls and Procedures

 

 

PART 2: OTHER INFORMATION

 

 

Item 1: Legal Proceedings

 

 

Item 1A: Risk Factors

 

 

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

 

 

Item 3: Defaults upon senior Securities

 

 

Item 4: Submission of matters to a vote of security holders

 

 

Item 5: Other Information

 

 

Item 6: Exhibits

 

 

Signatures

 

 

Exhibit Index

 

 

 

2




PART I FINANCIAL INFORMATION

Item 1: Financial Statements

Kenexa Corporation and Subsidiaries

Consolidated Balance Sheets

(In thousands, except share data)

(Unaudited)

 

 

March 31,
2007

 

December 31,
2006

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

33,111

 

$

42,502

 

Short term investments

 

78,573

 

 

Accounts receivable, net of allowance for doubtful accounts of $1,017 and $975

 

29,139

 

31,493

 

Unbilled receivables

 

1,925

 

1,005

 

Deferred income taxes

 

9,765

 

8,093

 

Prepaid expenses and other current assets

 

2,592

 

3,578

 

Total current assets

 

155,105

 

86,671

 

 

 

 

 

 

 

Property and equipment, net of accumulated depreciation

 

10,223

 

8,469

 

Software, net of accumulated depreciation

 

1,811

 

2,122

 

Goodwill

 

162,405

 

161,329

 

Intangible assets, net of accumulated amortization

 

4,393

 

4,570

 

Deferred income taxes non current

 

1,932

 

1,430

 

Deferred financing costs, net of accumulated amortization

 

866

 

1,295

 

Other assets

 

1,652

 

1,573

 

Total assets

 

$

338,387

 

$

267,459

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

7,423

 

$

5,672

 

Line of credit

 

 

20,000

 

Notes payable, current

 

123

 

138

 

Commissions payable

 

1,194

 

1,674

 

Accrued compensation and benefits

 

5,573

 

9,878

 

Other accrued liabilities

 

7,386

 

6,086

 

Deferred revenue

 

31,655

 

31,251

 

Capital lease obligations

 

199

 

229

 

Total current liabilities

 

53,553

 

74,928

 

 

 

 

 

 

 

Term loan

 

 

45,000

 

Capital lease obligations, less current portion

 

112

 

145

 

Notes payable, less current portion

 

95

 

111

 

Other liabilities

 

 

114

 

Total liabilities

 

53,760

 

120,298

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Preferred stock, par value $0.01; 100,000 shares authorized; no shares issued or outstanding

 

 

 

Common stock, $0.01 par value; 100,000,000 shares authorized; 25,266,814 and 20,897,777 shares issued and outstanding, respectively

 

253

 

209

 

Additional paid-in capital

 

309,018

 

176,345

 

Accumulated other comprehensive income

 

150

 

96

 

Accumulated deficit

 

(24,794

)

(29,489

)

Total shareholders’ equity

 

284,627

 

147,161

 

Total liabilities and shareholders’ equity

 

$

338,387

 

$

267,459

 

 

See notes to consolidated financial statements.

3




Kenexa Corporation and Subsidiaries

Consolidated Statements of Operations

(In thousands, except share and per share data)

(Unaudited)

 

 

Three months ended
March 31,

 

 

 

2007

 

2006

 

Revenue

 

 

 

 

 

Subscription revenue

 

$

34,687

 

$

17,593

 

Other revenue

 

7,530

 

5,422

 

Total revenue

 

42,217

 

23,015

 

Cost of revenue

 

11,432

 

6,354

 

Gross profit

 

30,785

 

16,661

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

8,230

 

5,728

 

General and administrative

 

9,672

 

5,287

 

Research and development

 

4,323

 

1,536

 

Depreciation and amortization

 

1,430

 

722

 

Total operating expenses

 

23,655

 

13,273

 

 

 

 

 

 

 

Income from operations before income taxes and interest income

 

7,130

 

3,388

 

Interest income

 

123

 

120

 

Income from operations before income tax

 

7,253

 

3,508

 

Income tax expense on operations

 

2,558

 

229

 

Net income available to common shareholders

 

$

4,695

 

$

3,279

 

Basic and diluted income per share:

 

 

 

 

 

 

 

 

 

 

 

Basic net income per weighted average common share outstanding:

 

$

0.20

 

$

0.18

 

Weighted average shares used to compute net income available to common shareholders per common share – basic

 

24,047,807

 

18,217,945

 

 

 

 

 

 

 

Diluted net income per weighted average common share outstanding:

 

$

0.19

 

$

0.17

 

Weighted average shares used to compute net income available to common shareholders per common share - diluted

 

24,479,548

 

18,952,231

 

 

See notes to consolidated financial statements.

4




Kenexa Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity (Deficiency)

(in thousands)

 

 

Common
stock

 

Additional
paid-in
capital

 

Accumulated
(deficit)

 

Accumulated
other
comprehensive
(loss) income

 

Deferred
compensation

 

Note
receivable
on common
stock

 

Total
stockholders’
equity

 

Comprehensive
income

 

Balance, December 31, 2005

 

$

174

 

$

97,140

 

$

(45,382

)

$

(30

)

$

(1,040

)

$

(120

)

$

50,742

 

$

5,967

 

Payments received on notes receivable for class A common stock

 

 

 

 

 

 

120

 

120

 

 

Gain on currency exchange

 

 

 

 

126

 

 

 

126

 

126

 

Reclassification of deferred compensation balance to additional paid-in capital

 

 

(1,040

)

 

 

1,040

 

 

 

 

Share-based compensation

 

 

3,076

 

 

 

 

 

3,076

 

 

Income tax benefits realized from activity in employee stock plans

 

 

2,762

 

 

 

 

 

2,762

 

 

Option exercises

 

4

 

4,360

 

 

 

 

 

4,364

 

 

Conversion of class B, D & E warrants

 

3

 

(3

)

 

 

 

 

 

 

Public stock offering, net

 

26

 

66,255

 

 

 

 

 

66,281

 

 

Common Stock Issuance for Gantz Wiley Research Acquisition

 

2

 

3,168

 

 

 

 

 

3,170

 

 

Common Stock Issuance for Psychometrics Services Ltd. Acquisition

 

 

627

 

 

 

 

 

627

 

 

Net Income

 

 

 

 

 

15,893

 

 

 

 

 

 

 

15,893

 

15,893

 

Balance, December 31, 2006

 

$

209

 

$

176,345

 

$

(29,489

)

$

96

 

$

 

$

 

$

147,161

 

$

16,019

 

Gain on currency exchange

 

 

 

 

54

 

 

 

54

 

54

 

Share-based compensation

 

 

715

 

 

 

 

 

715

 

 

Income tax benefits realized from activity in employee stock plans

 

 

341

 

 

 

 

 

341

 

 

Option exercises

 

1

 

396

 

 

 

 

 

397

 

 

Employee stock purchase plan

 

 

35

 

 

 

 

 

35

 

 

Public stock offering, net

 

43

 

130,536

 

 

 

 

 

130,579

 

 

Common Stock Issuance for Gantz-Wiley earn out

 

 

650

 

 

 

 

 

650

 

 

Net income

 

 

 

4,695

 

 

 

 

4,695

 

4,695

 

Balance, March 31, 2007

 

$

253

 

$

309,018

 

$

(24,794

)

$

150

 

$

 

$

 

$

284,627

 

$

4,749

 

 

See notes to consolidated financial statements.

5




Kenexa Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Three months ended
March 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net income from operations

 

$

4,695

 

$

3,279

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Depreciation and amortization

 

1,430

 

722

 

Share-based compensation

 

715

 

572

 

Excess tax benefits from share-based payment arrangements

 

(341

)

(361

)

Amortization of deferred financing fees

 

510

 

32

 

Bad debt expense

 

(2

)

4

 

Deferred taxes

 

(1,979

)

(937

)

Changes in assets and liabilities

 

 

 

 

 

Accounts and unbilled receivables

 

1,399

 

(241

)

Prepaid expenses and other current assets

 

971

 

(588

)

Other assets

 

(83

)

87

 

Accounts payable

 

1,231

 

(42

)

Accrued compensation and other accrued liabilities

 

(2,163

)

29

 

Commissions payable

 

(480

)

94

 

Deferred revenue

 

378

 

(1,737

)

Other liabilities

 

(114

)

(11

)

Net cash provided by operating activities

 

6,167

 

902

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchases of property and equipment

 

(2,693

)

(879

)

Purchases of available-for-sale securities

 

(78,573

)

 

Acquisitions, net of cash acquired

 

(1,046

)

(32,069

)

Net cash used in investing activities

 

(82,312

)

(32,948

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Net repayments under line of credit

 

(65,000

)

 

Repayments of notes payable

 

(32

)

(49

)

Collections of notes receivable

 

 

30

 

Share issuance from Employee stock purchase plan

 

35

 

 

Excess tax benefits from share-based payment arrangements

 

341

 

361

 

Net proceeds from public offering

 

131,100

 

67,333

 

Deferred financing costs

 

(81

)

(119

)

Net proceeds from option exercises

 

397

 

694

 

Repayments of capital lease obligations

 

(59

)

(174

)

Net cash provided by financing activities

 

66,701

 

68,076

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

53

 

(48

)

Net (decrease) increase in cash and cash equivalents

 

(9,391

)

35,982

 

Cash and cash equivalents at beginning of year

 

42,502

 

43,499

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

33,111

 

$

79,481

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information

 

 

 

 

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest expense

 

$

622

 

$

344

 

Income taxes

 

$

1,009

 

$

965

 

 

 

 

 

 

 

Non-cash investing and financing activities

 

 

 

 

 

Capital lease obligations

 

$

 

$

56

 

Common Stock Issuance for Gantz-Wiley earn out

 

$

650

 

 

 

See notes to consolidated financial statements.

6




Kenexa Corporation and Subsidiaries

Notes to Consolidated Financial Statements - Unaudited

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

1. Organization

Kenexa Corporation and its subsidiaries (collectively, the “Company”) commenced operations in 1987 as a provider of recruiting services to a wide variety of industries. In 1993, the Company offered its first automated talent management system. Between 1994 and 2006, the Company acquired 25 businesses that enabled it to offer comprehensive human capital management, or HCM, services integrated with web-based technology.

The Company began its operations in 1987 under its predecessor companies, Insurance Services, Inc., or ISI, and International Holding Company, Inc., or IHC, in 1987. In December 1999, the Company reorganized its corporate structure by merging ISI and IHC with and into Raymond Karsan Associates, Inc., or RKA, a Pennsylvania corporation and a wholly owned subsidiary of Raymond Karsan Holdings, Inc., or RKH, a Pennsylvania corporation. Each of RKA and RKH were newly created to consolidate the businesses of ISI and IHC. In April 2000, the Company changed its name to TalentPoint, Inc. and changed the name of RKA to TalentPoint Technologies, Inc. In November 2000, the Company changed its name to Kenexa Corporation and changed the name of TalentPoint Technologies, Inc. to Kenexa Technology, Inc., or Kenexa Technology. Currently, Kenexa transacts business primarily through Kenexa Technology. The Company operates in one segment.

2. Summary of Significant Accounting Policies

The accompanying financial statements for the three months ended March 31, 2007 and 2006 have been prepared by the Company without audit.  In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position and the results of operations and cash flows for the three months ended March 31, 2007 and 2006 have been made.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or eliminated.  The results for the three months ended March 31, 2007 are not necessarily indicative of the results to be expected for the year ended December 31, 2007 or for any other interim period.

Principles of Consolidation

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

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid investments with remaining maturities of three months or less at the time of purchase.  Cash which is restricted for lease deposits is included in other assets.

Financial Instruments

Short term investments consist of investments with original maturities of greater than three months and remaining maturities of less than one year.  Investments with maturities beyond one year are classified as short-term based on their highly liquid nature and because such marketable securities represent the investment in cash that is available for current operations.  All cash and short term investments are classified as available for sale and are recorded at market value; unrealized gains and losses (excluding other-than-temporary impairments) are reflected in other comprehensive income.   Short term investments consist of tax free municipal bonds with credit ratings of AA or higher.

Prepaid Expenses and Other Assets

Prepaid expenses and other current assets consist primarily of prepaid software maintenance agreements, deferred implementation costs, insurance and other current assets.  Deferred implementation costs represent internal payroll and other costs incurred in connection with the customization of the sites associated with internet hosting arrangements.  These costs are deferred over the implementation period, typically three to four months, and are expensed ratably over the subscription period, typically one to three years.  These amounts aggregated $858 and $985 at March 31, 2007 and December 31, 2006, respectively.  The current portion of these deferred costs of $412 and $636 at March 31, 2007 and December 31, 2006, respectively, is included in other current assets and the non-current portion of $446 and $349 at March 31, 2007 and December 31, 2006, respectively, is included in other assets in the accompanying consolidated balance sheets.

7




Software Developed for Internal Use

 

In accordance with EITF 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware”, the Company applies AICPA Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, will be capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Maintenance and training cost are expensed as incurred. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal software in any of the periods covered in this audit report.

The Company capitalized internal-use software costs for the three months ended March 31, 2007 and the year ended December 31, 2006 of $241 and $1,954, respectively.  Amortization of capitalized internal-use software costs for the three months ended March 31, 2007 and the year ended December 31, 2006 were $319 and $1,291, respectively.

Revenue Recognition

The Company derives its revenue from two sources: (1) subscription revenue for solutions, which is comprised of subscription fees from clients accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from clients purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for discrete professional services. Because the Company provides its solution as a service, the Company follows the provisions of Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revenue Recognition. On August 1, 2003, the Company adopted Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. The Company recognizes revenue when all of the following conditions are met:

·  There is persuasive evidence of an arrangement;

·  The service has been provided to the client;

·  The collection of the fees is probable; and

·  The amount of fees to be paid by the client is fixed or determinable.

 

Subscription fees and support revenues are recognized on a monthly basis over the lives of the contracts. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

Discrete professional services and other revenues, when sold with subscription and support offerings, are accounted for separately since these services have value to the customer on a stand-alone basis and there is objective and reliable evidence of fair value of the delivered elements. The Company’s arrangements do not contain general rights of return. Additionally, when professional services are sold with other elements, the consideration from the revenue arrangement is allocated among the separate elements based upon the relative fair value. Professional services and other revenues are recorded as follows: Consulting revenues are recognized upon completion of the contracts that are of short duration (generally less than 60 days) and as the services are rendered for contracts of longer duration.

In determining whether revenues from professional services can be accounted for separately from subscription revenue, the Company considers the following factors for each agreement: availability from other vendors, whether objective and reliable evidence of fair value exists of the undelivered elements, the nature and the timing of when the agreement was signed in comparison to the subscription agreement start date and the contractual dependence of the subscription service on the client’s satisfaction with the other services. If the professional service does not qualify for separate accounting, the Company recognizes the revenue ratably over the remaining term of the subscription contract. In these situations the Company defers the direct and incremental costs of the professional service over the same period as the revenue is recognized.

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

8




The Company records “Out-of-Pocket Expenses Incurred (“EITF 01-14”), which requires that reimbursements received for out-of-pocket expenses be classified as revenues and not as cost reductions. Before the effective date of EITF 01-14, out-of-pocket reimbursements from clients were netted with the applicable costs. These items primarily include travel, meals and certain telecommunication costs.  For the three months ended March 31, 2007 and 2006, reimbursed expenses totaled $422 and $264, respectively.

Self-Insurance

The Company is self-insured for the majority of its health insurance costs, including claims filed and claims incurred but not reported subject to certain stop-loss provisions. The Company estimated the liability based upon management’s judgment and historical experience. At March 31, 2007 and December 31, 2006, self-insurance accruals totaled $485 and $340, respectively.  Management continuously reviews the adequacy of the Company’s stop-loss insurance coverage. Material differences may result in the amount and timing of insurance expense if actual experience differs significantly from management’s estimates.

Concentration of Credit Risk

Financial instruments which potentially expose the Company to concentration of credit risk consist primarily of accounts receivable. Credit risk arising from receivables is mitigated due to the large number of clients comprising the Company’s client base and their dispersion across various industries.  The clients are concentrated primarily in the Company’s U.S. market area.  At March 31, 2007, there were no clients that represented more than 10% of the net accounts receivable balance. There were no clients that individually exceeded 10% of the Company’s revenues.

Cash balances are maintained at several banks. Accounts located in the United States are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $100. Certain operating cash accounts may exceed the FDIC limits.

Earnings Per Share

The Company follows SFAS 128, “Earnings Per Share.” Under SFAS 128, companies that are publicly held or have complex capital structures are required to present basic and diluted earnings per share on the face of the statement of operations.  Earnings per share are based on the weighted average number of shares and common stock equivalents outstanding during the period.  In the calculation of diluted earnings per share, shares outstanding are adjusted to assume conversion of the Company’s non-interest bearing convertible stock and the exercise of options and warrants if they are dilutive.  In the calculation of basic earnings per share, weighted average numbers of shares outstanding are used as the denominator.  The Company had a net income available to common shareholders for the periods ended March 31, 2007 and 2006.  Income per share is computed as follows:

 

Three months ended
March 31,

 

 

 

2007

 

2006

 

Numerator:

 

 

 

 

 

Net income available to common shareholders

 

$

4,695

 

$

3,279

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average shares used to compute net income available to common shareholders per common share - basic

 

24,047,807

 

18,217,945

 

Effect of dilutive stock options and warrants

 

431,741

 

734,286

 

 

 

 

 

 

 

Weighted average shares used to compute net income available to common shareholders per common share – dilutive

 

24,479,548

 

18,952,231

 

 

 

 

 

 

 

Basic net income per share to common shareholder

 

$

0.20

 

$

0.18

 

 

 

 

 

 

 

Diluted net income per share to common shareholder

 

$

0.19

 

$

0.17

 

 

9




Share-based compensation

On January 1, 2006, we adopted SFAS No. 123R using the Modified Prospective Approach (“MPA”). The MPA requires that compensation expense be recorded for restricted stock and all unvested stock options as of January 1, 2006. Since the adoption we continue to recognize the cost of previously granted share-based awards under the straight-line basis and recognize the cost for new share-based awards on a straight-line basis over the requisite service period.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair-value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair-value measurements would be separately disclosed by level within the fair-value hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  We do not believe the adoption of SFAS No. 157 will have a material impact on our consolidated financial position, results of operations or cash flows.

We adopted the Financial Accounting Standard Board’s Interpretation No. 48, Accounting for Income Tax Uncertainties (“FIN 48”), on January 1, 2007.  FIN 48 clarifies the accounting for uncertain income tax positions recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority.  As of December 31, 2006 and March 31, 2007, we had an insignificant amount of unrecognized tax benefits, none of which would materially affect our effective tax rate if recognized.  We do not expect that the amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months.  Our policy is to recognize interest and penalties on unrecognized tax benefits in interest expense and general and administrative expense in the consolidated statements of operations.  The amount of interest and penalties for the three months ended March 31, 2007 was insignificant.  Tax years beginning in 2004 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.

In November 2005, the FASB issued FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, to provide an alternative approach of accounting for the tax effects of employee share-based awards. We have elected to adopt the alternative transition method provided in FSP FAS 123(R)-3 for calculating the tax effects of share-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon the adoption of SFAS 123(R).

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS 123R also establishes fair value as the measurement method in accounting for share-based payments. The FASB required the provisions of SFAS 123R be adopted for interim or annual periods beginning after June 15, 2005. In April 2005, the SEC adopted a new rule amending the compliance dates for SFAS 123R for public companies. In accordance with this rule, we adopted SFAS 123R effective January 1, 2006 using the modified prospective transition method. We did not modify the terms of any previously granted options in anticipation of the adoption of SFAS 123R.

The application of the provisions of SFAS 123R resulted in a pretax expense of approximately $715 for the three months ended March 31, 2007. Based on the same assumptions used to value our 2006 compensation expense, we estimate our pretax expense associated with our share-based compensation plans will approximate $3,562 in 2007 and $3,232 in 2008.

Use of Estimates

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

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial assets and liabilities, including cash, accounts receivable and accounts payable at March 31, 2007 and 2006 approximate fair value of these instruments.

10




3. Acquisitions

Psychometric Services

On November 20, 2006, the Company acquired all of the outstanding stock of Psychometric Services, Ltd., a provider of user friendly psychometric tests, based in Harrow, United Kingdom, for a purchase price of approximately $7,459 in cash and $627 in stock consideration.  The total cost of the acquisition, including legal, accounting, and other professional fees of $295, was approximately $8,382.  In connection with the acquisition $758 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 Psychometrics Services under the acquisition agreement.   The escrow agreement will remain in place for one year from the acquisition date, and any funds remaining in the escrow account at the end of the one year period will be distributed to the stockholders of Psychometric Services Ltd.  The purchase price has been allocated on a preliminary basis to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill.    In accordance with Statement of Financial Accounting Standard No. 141 the purchase price and related purchase price allocation may be updated to reflect changes such as any additional transaction fees or the valuation of certain assets acquired or liabilities assumed.

BrassRing

On November 13, 2006, the Company acquired BrassRing, LLC, a provider of talent management solutions, combining innovative technology, consulting, and outsourcing with recruitment expertise to build successful workforces to meet the specific needs of clients, for approximately $114,708 in cash.  The total cost of the acquisition, including legal, accounting, and other professional fees of $3,007, was approximately $117,714.  On the date of close, approximately $11,500 or 10% of the aggregate purchase price was deposited into an escrow account to cover any claims for indemnification made by the Company against BrassRing under the acquisition agreement.  Assuming there are no indemnification claims, this amount will be released to BrassRing on or about May 13, 2008.

BrassRing’s results of operations were included in the Company’s consolidated financial statements beginning on November 13, 2006.

The purchase price was allocated as follows:

Description

 

Amount

 

Amortization
period

 

Assets acquired

 

 

 

 

 

Cash and short-term investments

 

$

10,567

 

 

 

Accounts receivable

 

6,326

 

 

 

Prepaid expenses and other current assets

 

1,499

 

 

 

Property & equipment

 

1,776

 

 

 

Other long-term assets

 

520

 

 

 

Technology-related assets

 

368

 

1.5 years

 

Contract-related assets

 

416

 

5 years

 

Goodwill

 

105,607

 

Indeterminable

 

Other intangibles, net

 

24

 

 

 

Deferred income taxes

 

3,331

 

5 years

 

 

 

 

 

 

 

Less: Liabilities assumed

 

 

 

 

 

Accounts payable

 

3,875

 

 

 

Accrued salary

 

880

 

 

 

Deferred federal income taxes

 

21

 

 

 

Deferred revenue

 

7,445

 

 

 

Deferred rent

 

499

 

 

 

Total cash purchase price

 

$

117,714

 

 

 

 

11




The purchase price was initially allocated on a preliminary basis to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill.    In accordance with Statement of Financial Accounting Standard No. 141, the purchase price and related purchase price allocation was updated to reflect additional transaction fees totaling $96 incurred during the quarter ended March 31, 2007 and the valuation of additional liabilities assumed for severance totaling $880 and other insignificant changes to working capital.  The estimated fair values of the intangibles assets are further described below.  Contract-related assets, technology-related assets, and net operating loss tax attributes are being amortized over their estimated useful lives.   Goodwill is not amortized but is periodically evaluated for impairment.

The valuation of contract-related assets in the amount of $416, which relates to BrassRing’s current customer portfolio, was determined based upon estimated discounted incremental future cash flow to be received as a result of these relationships.

Goodwill from the acquisition resulted from our belief that the recruiter products developed by BrassRing will be complementary to our Kenexa Recruiter product offerings and will help us remain competitive in the talent acquisition market.  The goodwill from the BrassRing acquisition will not be deductible for tax purposes.

If the BrassRing acquisition had occurred on January 1, 2006, the unaudited pro forma results of operations for the quarter ended March 31, 2006 would have been:

 

Period ended
March 31, 2006

 

Revenue

 

$

32,668

 

Net income available to common shareholders

 

3,444

 

Net income per share available to common shareholders – basic

 

$

0.19

 

Net income per share available to common shareholders – diluted

 

$

0.18

 

 

Gantz Wiley Research

On August 14, 2006, the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc., acquired all of the outstanding stock of Gantz Wiley Research, an employee and customer research firm based in Minneapolis, Minnesota, for a purchase price including contingent consideration, of approximately $3,302 in cash and $3,820 in stock consideration.  The total cost of the acquisition, including estimated legal, accounting, and other professional fees of $46,  was approximately $7,168.  The acquisition agreement with Gantz Wiley Research also contained an earnout provision which provided for the payment of additional consideration by the Company based upon the annual revenues of Gantz Wiley Research through December 31, 2006.  Based upon the results, contingent consideration of  $1,300 was paid in cash and equity during the first quarter of 2007 to the former shareholder of Gantz Wiley Research.  The related liability has been reflected in the financial statements at December 31, 2006 and is included in the total cost of the acquisition.  In connection with the acquisition, $600 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 Gantz Wiley Research under the acquisition agreement.   The escrow agreement will remain in place for one year from the acquisition date, and any funds remaining in the escrow account at the end of the one year period will be distributed to the stockholder of Gantz Wiley Research.   The purchase price has been allocated on a preliminary basis to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill.    In accordance with Statement of Financial Accounting Standard No. 141 the purchase price and related purchase price allocation may be updated to reflect changes such as any additional transaction fees or the valuation of certain assets acquired or liabilities assumed.

12




Knowledge Workers

On April 10, 2006, the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc., and Kenexa Acquisition Corp., a wholly-owned subsidiary of Kenexa Technology, acquired all of the outstanding stock of Knowledge Workers, Inc., a human capital consulting and technology firm based in Denver, Colorado, for a purchase price of approximately $2,476 in cash.  The total cost of the acquisition, including estimated legal, accounting, and other professional fees, was approximately $2,580.  In connection with the acquisition the Company deposited $100 into an escrow account to cover any claims for indemnification made by the Company against Knowledge Workers, Inc. under the acquisition agreement.   The escrow agreement will remain in place for two years from the acquisition date.  The purchase price has been allocated on a preliminary basis to the assets acquired and liabilities assumed based upon management’s best estimate of fair value with any excess over the net tangible and intangible assets acquired allocated to goodwill.    In accordance with Statement of Financial Accounting Standard No. 141 the purchase price and related purchase price allocation may be updated to reflect changes such as any additional transaction fees or the valuation of certain assets acquired or liabilities assumed.

Webhire

On January 13, 2006, the Company, through its wholly-owned subsidiary, Kenexa Technology, Inc., and Kenexa Acquisition Corp., a wholly-owned subsidiary of Kenexa Technology, completed its acquisition of Webhire, Inc. (“Webhire”) for approximately $34,395 in cash. The total cost of the acquisition, including legal, accounting, and other professional fees of $666, was approximately $35,061.

Approximately $5,000, or 14.3% of the aggregate purchase price, remains deposited in an escrow account to cover any claims for indemnification made by the Company against Webhire under the acquisition agreement.  Assuming there are no indemnification claims, this amount will be released to the former stockholders of Webhire on or about June 13, 2007.

Webhire’s results of operations were included in the Company’s consolidated financial statements beginning on January 1, 2006.

4. Property, Equipment and Software

A summary of property, equipment and software and related accumulated depreciation as of March 31, 2007 and December 31, 2006 is as follows:

 

March 31, 2007

 

December 31, 2006

 

 

 

 

 

 

 

Equipment

 

$

10,699

 

$

8,914

 

Software

 

10,047

 

9,934

 

Office furniture and fixtures

 

1,223

 

1,225

 

Leasehold improvements

 

1,306

 

1,282

 

Land

 

708

 

708

 

Building construction in progress

 

619

 

430

 

Software in development

 

491

 

237

 

 

 

25,093

 

22,730

 

Less accumulated depreciation

 

13,059

 

12,139

 

 

 

$

12,034

 

$

10,591

 

 

Equipment, office furniture and fixtures included capital leases totaled $2,499 at March 31, 2007 and December 31, 2006. Depreciation and amortization expense, including amortization of assets under capital leases, was $1,249 and $3,312 for the period ended March 31, 2007 and December 31, 2006, respectively.

13




5. Other Accrued Liabilities

Other accrued liabilities consist of the following:

 

March 31, 2007

 

December 31, 2006

 

Accrued professional fees

 

$

123

 

$

361

 

Straight line rent accrual

 

1,444

 

1,405

 

Other taxes payable (non-income tax)

 

358

 

666

 

Income taxes payable

 

3,909

 

740

 

Other liabilities

 

1,552

 

1.614

 

Contingent purchase price

 

 

1,300

 

Total other accrued liabilities

 

$

7,386

 

$

6,086

 

 

6. Line of Credit

On November 13, 2006, the Company entered into a new secured credit agreement with PNC Bank, N.A., as administrative agent, in connection with its acquisition of BrassRing (the “Credit Agreement”).   The new Credit Agreement increased the maximum amount available under the facility from $25,000 to $75,000, consisting of (i) a $25,000 revolving credit facility, including a sublimit of up to $2,000 for letters of credit, and (ii) a $50,000 term loan.  Borrowings under the Credit Agreement are secured by substantially all of the Company’s assets and the assets of its subsidiaries.   This credit facility replaced the prior $25,000 revolving credit facility with PNC Bank.  As of December 31, 2006 the Company had borrowings of $65,000 from the credit facility with a weighted average interest rate of 7.9% per annum

On March 26, 2007, the Company entered into a First Amendment to Credit Agreement  (the “Amendment”) with PNC Bank.   The Amendment increased the maximum amount available under the revolving credit facility portion of the Credit Agreement from $25 million to $50 million, including a sublimit of up to $2 million for letters of credit.  In January 2007, the Company repaid the balance of its obligations relating to the term loan portion of the Credit Agreement with the net proceeds from the Company’s public offering of its common stock in January 2007.  The Amendment provides that the Credit Agreement will terminate, and all borrowings will become due and payable, on March 26, 2010.  The Company and each of the U.S. subsidiaries of Technology are guarantors of the obligations of Technology under the Credit Agreement, as amended by the Amendment.

On December 29, 2005, the Company entered into a Third Amendment and Modification to the Revolving Credit and Security Agreement with PNC Bank, N.A., originally dated July 15, 2003, and as amended on October 10, 2003 and March 22, 2005. The Third Amendment increased the maximum amount available under the credit facility from $10,000 to $25,000, including a sublimit of up to $2,000 for letters of credit. No amounts were outstanding on the line on December 31, 2005. On January 13, 2006, the Company borrowed $25,000 from the credit facility for working capital purposes.

The Company’s borrowings under the credit facility bear interest at tiered rates based upon the ratio of Net Funded Debt to Modified EBITDA Ratio as defined in the Credit Agreement. The Company may also elect interest rates on its borrowings calculated by reference to  (i) the higher of PNC’s prime rate or the current Federal Funds rate plus ½% (the “Base Rate”), or (ii) the Eurodollar rate (the “Eurodollar Rate”), in either case plus a margin based upon the ratio of the Company and its consolidated subsidiaries’ Net Funded Debt to EBITDA ratio.   Interest is payable quarterly for Base Rate loans and at the end of the applicable interest period for Eurodollar Rate loans.   Eurodollar Rate advances will be available for periods of 1, 2, 3, 6 or, if available to all lenders under the Credit Agreement, 9 or 12 months.   Eurodollar Rate pricing will be adjusted for any statutory reserves.

Repayment of amounts outstanding under certain notes payable and all issued or issuable shares of common and preferred stock are subordinated to the rights of the lender under terms of the Credit Agreement. The Credit Agreement contains various terms and covenants that provide for restrictions on capital expenditures, payment of dividends, dispositions of assets, investments and acquisitions and require the Company, among other things, to maintain minimum levels of tangible net worth, net income and fixed charge coverage.  The Company was compliant with covenants at March 31, 2007.

14




7. Commitments and Contingencies

 

Litigation

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

We are involved in claims, including those identified above, which arise in the ordinary course of business. In the opinion of management, we have made adequate provision for potential liabilities, if any, arising from any such matters.  However, litigation is inherently unpredictable, and the costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in any such matters, and developments or assertions by or against us relating to intellectual property rights and intellectual property licenses, could have a material adverse effect on our business, financial condition and operating results.

8. Equity

On January 18, 2007, the Company completed a public offering of 3,750,000 shares of its common stock at a price to the public of $31.86 per share. Net proceeds to the Company aggregated approximately $114,000 after payment of all offering fees and underwriters’ commission and offering expenses of $5,475.  On January 24, 2007, the underwriters exercised their over-allotment option under the terms of the underwriting agreement to purchase 562,500 additional shares of common stock. Net proceeds to the Company following the sale of the overallotment shares were $17,100.

9. Stock Plans

The Company’s 2005 Equity Incentive Plan (the “2005 Option Plan”), which was adopted by the Company’s Board of Directors (the “Board”) in March 2005 and was approved by the Company’s shareholders in June 2005, provides for the granting of stock options to employees and directors at the discretion of the Board or a committee of the Board.  The 2005 Option Plan replaced the Company’s 2000 Stock Option Plan (the “2000 Option Plan”).  The purpose of stock options is to recognize past services rendered and to provide additional incentive in furthering the continued success of the Company.  Stock options granted under both the 2005 Option Plan and the 2000 Stock Option Plan expire between the fifth and tenth anniversary of the date of grant and generally vest on the third anniversary of the date of grant.  Unexercised stock options may expire up to 90 days after an employee’s termination.

As of March 31, 2007, there were options to purchase 1,571,771 shares of common stock outstanding under the 2005 Option Plan.  The Company is authorized to issue up to an aggregate of 4,842,910 shares of its common stock pursuant to stock options granted under the 2005 Option Plan.  As of March 31, 2007, there were a total of 2,832,846 shares of common stock not subject to outstanding options and available for issuance under the 2005 Option Plan.

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.  In 2007 and 2006, the fair value of each grant was estimated using the Black-Scholes valuation model.  Expected volatility was based upon a weighted average of peer companies, comparable indices, and the Company’s stock volatility.  The expected life was determined based upon an average of the contractual life and vesting period of the options.  The estimated forfeiture rate was based upon an analysis of historical data.   The risk-free rate was based on U.S. Treasury zero coupon bond yields at the time of grant.  The following table provides the assumptions used in determining the fair value of the share-based awards for the three months ended March 31, 2007 and year ended December 31, 2006, respectively.

 

Three months ended
March 31, 2007

 

Year ended
December 31, 2006

 

 

 

 

 

 

 

Expected volatility

 

47.70

%

39.5 – 41.98

%

Expected dividends

 

0

 

0

 

Expected term (in years)

 

4

 

4-5

 

Risk-free rate

 

4.46

 

4.6 – 5.1

%

 

15




A summary of the status of the Company’s stock options as of March 31, 2007 and December 31, 2006 and changes during the period then ended is as follows:

 

Options Outstanding

 

Options Exercisable

 

 

 

Shares
available for
grant

 

Shares

 

Wtd. avg.
exercise
price

 

Shares

 

Wtd. avg.
exercise
price

 

Balance at December 31, 2005

 

3,265,859

 

1,562,181

 

$

11.74

 

638,781

 

$

12.08

 

Granted

 

(316,333

)

316,333

 

$

25.24

 

 

 

Exercised

 

 

(387,986

)

$

11.25

 

 

 

Forfeited or expired

 

188,520

 

(188,520

)

$

15.47

 

 

 

Balance at December 31, 2006

 

3,138,046

 

1,302,008

 

$

14.63

 

321,208

 

$

14.26

 

Granted

 

(314,000

)

314,000

 

$

34.97

 

 

 

 

 

Exercised

 

 

(35,437

)

$

11.20

 

 

 

 

 

Forfeited or expired

 

8,800

 

(8,800

)

$

28.60

 

 

 

 

 

Balance at March 31, 2007

 

2,832,846

 

1,571,771

 

$

18.69

 

330,571

 

$

13.28

 

 

The total intrinsic value of options outstanding, exercisable and exercised for the period ended March 31, 2007 was $20,861, $5,914 and $882, respectively.   The weighted average fair value for options granted during the period ended March 31, 2007 and December 31, 2006 was $14.82 and $11.05, respectively.

A summary of the status of the Company’s nonvested share options as of December 31, 2006 and March 31, 2007 is presented below:

Nonvested Shares

 

Shares

 

Wtd. Avg.
Grant Date
Fair Value

 

Nonvested at December 31, 2005

 

923,400

 

$

8.10

 

Granted

 

316,333

 

$

11.05

 

Vested

 

(76,333

)

$

15.31

 

Forfeited or expired

 

(182,600

)

$

7.23

 

Nonvested at December 31, 2006

 

980,800

 

$

8.65

 

Granted

 

314,000

 

$

14.82

 

Vested

 

(44,800

)

$

12.78

 

Forfeited or expired

 

(8,800

)

$

12.65

 

Nonvested at March 31, 2007

 

1,241,200

 

$

10.03

 

 

Between January 1, 2007 and March 31, 2007, the Company granted options to certain employees to purchase an aggregate of 314,000 shares of the Company’s common stock at a weighted exercise price of $34.97 per share. The Company granted the options at prevailing market prices ranging from $34.10 to $36.33 per share.

Between January 1, 2006 and December 31, 2006, the Company granted options to certain employees to purchase an aggregate of 316,333 shares of the Company’s common stock at a weighted exercise price of $25.24 per share. The Company granted the options at prevailing market prices ranging from $21.10 to $32.69 per share.

As of March 31, 2007, there was $8,985 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2005 Option Plan and the 2000 Option Plan.  That cost is expected to be recognized over a weighted-average period of 3.25 years.

SFAS No. 123R also requires us to change the classification of any tax benefits realized upon exercise of stock options in excess of that which is associated with the expense recognized for financial reporting purposes. These amounts are presented as a financing cash inflow rather than as a reduction of income taxes paid in our consolidated statement of cash flows.

16




In accordance with Staff Accounting Bulletin No. 107, we classified share-based compensation within cost of goods sold, selling, general and administrative expenses and research and development corresponding to the same line as the cash compensation paid to respective employees, officers and non-employee directors.

The following table shows total share-based compensation expense included in the Consolidated Statement of Operations:

 

Three months ended March 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Cost of Revenue

 

$

177

 

$

116

 

Sales and marketing

 

179

 

201

 

General and administrative

 

321

 

220

 

Research and development

 

$

38

 

$

35

 

Pre-tax share-based compensation

 

715

 

572

 

Income tax benefit

 

278

 

216

 

Share-based compensation expense, net

 

$

437

 

$

356

 

 

Employee Stock Purchase Plan

The Employee Stock Purchase Plan, which was approved May 2006, enables substantially all of the Company’s U.S. and foreign employees to purchase shares of our common stock at a discounted offering price.  The offering price is 95% of the closing market price of our common stock on the NASDAQ National Market, LLC on the offering date.  500,000 common shares are available to our employees for purchase under the Plan. The Plan is not considered a compensatory plan in accordance with SFAS 123(R) and requires no compensation expense to be recognized.  1,100 shares of our common stock were purchased under the employee stock purchase plan during the ended March 31, 2007.

10. Related Party

One of the Company’s directors, Barry M. Abelson, is a partner in the law firm of Pepper Hamilton LLP. This firm has represented the Company since 1997. For the quarters ended March 31, 2007 and 2006, the Company paid Pepper Hamilton LLP, net of insurance coverage, $276 and $922, respectively, for general legal matters.  The amount payable to Pepper Hamilton as of March 31, 2007 was $485.

11.  Income Taxes

The Company’s tax provision for interim periods is determined using an estimate of its annual effective rate.  The 2007 effective tax rate is estimated to be lower than the 35% statutory rate primarily due to anticipated earnings in subsidiaries outside the U.S. in jurisdictions where the effective rate is lower than in the U.S.

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes,” (“FIN 48”).  As of January 1, 2007 unrecognized tax benefits totaled $234 which was recorded as an increase to goodwill.

As a result of the implementation of FIN 48, the Company recognized an increase of $6 in the liability for unrecognized tax benefits which was accounted for as an increase to goodwill.

We recognize interest and penalties related to our tax contingencies as other tax expense.  Our January 1, 2007 tax liabilities include $89 of interest related to the adoption of FIN 48.

17




It is not expected that the amount of unrecognized tax benefits will change in the next 12 months, however the Company does not expect any change to have a significant impact on the results of operations or financial position of the Company.

18




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

This Quarterly Report on Form 10-Q, including the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. Such statements are based on current expectations of future events that involve a number of risks and uncertainties that may cause the actual events to differ materially from those discussed herein. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward-looking terminology such as “believes,” “expects,” “may,” “could,” “will,” “should,” “seeks,” “potential,” “anticipates,” “predicts,” “plans,” “estimates,” or “intends,” or the negative of any thereof, or other variations thereon or comparable terminology, or by discussions of strategy or intentions. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Forward-looking statements should be considered in light of various important factors, including those set forth in this report under Part I, Item 1A “Risk Factors” in Kenexa Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission. All forward-looking statements, and reasons why results may differ, that are included in this report are made as of the date of this report, and except as required by law, we disclaim any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein or reasons why results might differ to reflect future events or developments. References herein to “Kenexa,” “we,” “our,” and “us” collectively refer to Kenexa Corporation, a Pennsylvania corporation, and all of its direct and indirect U.S., U.K., Canada, India, and other foreign subsidiaries.

1. Overview

We provide software, services and proprietary content that enable organizations to more effectively recruit and retain employees. Our solutions are built around a suite of easily configurable software applications that automate talent acquisition and employee performance management best practices. We offer the software applications that form the core of our solutions on an on-demand basis, which materially reduces the costs and risks associated with deploying traditional enterprise applications. We complement our software applications with tailored combinations of outsourcing services, consulting services and proprietary content based on our 19 years of experience assisting clients in addressing their human resource requirements. Together, our software applications and services form solutions that we believe enable our clients to improve the effectiveness of their talent acquisition programs, increase employee productivity and retention, measure key HR metrics and make their talent acquisition and employee performance management programs more efficient.

Since 1999, we have focused on providing talent acquisition and employee performance management solutions on a subscription basis and currently generate a significant portion of our revenue from these subscriptions. For the three months ended March 31, 2007 and 2006, revenue from these subscriptions comprised approximately 82.2% and 76.0%, respectively, of our total revenue. We generate the remainder of our revenue from discrete professional services that are not provided as part of an integrated solution on a subscription basis. These subscription-based solutions provide us with a recurring revenue stream and we believe represent a more compelling opportunity in terms of growth and profitability than discrete professional services.  As a result, since 1999 discrete professional services have represented a consistently decreasing percentage of our revenue.  We expect that trend to continue.

We sell our solutions to large and medium-sized organizations through our direct sales force.  As of December 31, 2006, we had a client base of approximately 3,000 companies, including approximately 166 companies on the Fortune 500 list published in April 2006. Our client base includes companies that we billed for services during the year ended December 31, 2006 and does not necessarily indicate an ongoing relationship with each such client. Our top 80 clients contributed approximately $22.8 million, or 54.0%, of our total revenue for the three months ended March 31, 2007.

2. Recent Events

On April 10, 2006, we acquired Knowledge Workers Inc., a human capital consulting and technology firm based in Denver Colorado, for approximately $2.5 million in cash.  The total cost of the acquisition, including estimated legal, accounting, and other professional fess, was approximately $2.6 million.

On August 14, 2006, we acquired Gantz-Wiley Research Consulting Group, Inc., an employee and customer survey data analysis firm based in Minneapolis, Minnesota, for a purchase price of approximately $3.3 million in cash and $3.8 million in stock consideration.  The total cost of the acquisition, including estimated legal, accounting, and other professional fees, was approximately $7.2 million.  In addition, our agreement with Gantz-Wiley contained an earnout provision which provided for the payment of additional consideration by the Company based upon the annual revenues of Gantz-Wiley Research through December 31, 2006.  Based upon these results, we paid an additional consideration of $1.3 million in cash and equity during the first quarter of 2007 to the former shareholder of Gantz-Wiley.

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On November 13, 2006, we acquired BrassRing Inc. and BrassRing LLC (“BrassRing”), a provider of talent management solutions, for approximately $114.7 million in cash.  The total cost of the acquisition, including legal, accounting, and other professional fees of $3.0 million, was approximately $117.7 million.  The strategic rationale for acquiring BrassRing included expansion of opportunities with large, global customers, expansion of global infrastructure and product capabilities, and creation of cross-marketing opportunities.

On November 13, 2006, we entered into a new secured credit facility with PNC Bank, N.A., as administrative agent, in connection with our acquisition of BrassRing. Our obligations under the new credit facility are secured by substantially all of our assets and the assets of our subsidiaries. This credit facility replaced our prior $25 million revolving credit facility with PNC Bank. Under the terms of the credit facility, we borrowed $75 million on November 13, 2006 to fund our acquisition of BrassRing.

On November 20, 2006, we acquired Psychometric Services Limited., or PSL, a provider of online and paper-based assessment products, training and consultancy based in the United Kingdom, for approximately $7.5 million in cash and $0.6 million in stock consideration.  The strategic rationale for acquiring PSL was to add PSL’s library of content and team of psychologists to extend Kenexa’s value proposition and to further differentiate Kenexa from a domain expertise perspective.  In addition, we believe that the acquisition of PSL advances Kenexa’s efforts to build its international infrastructure, while adding an attractive customer list of commercial and government entities in the UK.

On January 18, 2007, we completed a public offering of 3,750,000 shares of our common stock at a price to the public of $31.86 per share.  We also sold an additional 562,500 shares of our common stock to cover over-allotments of shares.  Our net proceeds from the offering, after payment of all offering expenses and commissions, aggregated approximately $131.0 million. We repaid all of the outstanding borrowings under our credit facility with a portion of the net proceeds from the offering.

On March 26, 2007, we entered into a First Amendment to Credit Agreement with PNC Bank.   The amendment increased the maximum amount available under the revolving credit facility portion of the Credit Agreement from $25 million to $50 million, including a sublimit of up to $2 million for letters of credit.   The amendment provides that the credit agreement will terminate, and all borrowings will become due and payable, on March 26, 2010.

 3. Sources of Revenue

We derive revenue primarily from two sources: (1) subscription revenue for our solutions, which is comprised of subscription fees from clients accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from clients purchasing additional support that is not included in the basic subscription fee; and (2) fees for discrete professional services.

Our clients primarily purchase renewable subscriptions for our solutions. The typical term is one to three years, with some terms extending up to five years.  The majority of our subscription agreements are not cancelable for convenience although our clients have the right to terminate their contracts for cause if we fail to provide the agreed upon services or otherwise breach the agreement. A client does not generally have a right to a refund of any advance payments if the contract is cancelled. We expect that we will maintain our renewal rate of approximately 90.0% of the aggregate contract value up for renewal for  2007 and 2008. The revenue derived from subscription fees is recognized ratably over the term of the subscription agreement. We generally invoice our clients in advance in monthly or quarterly installments and typical payment terms provide that our clients pay us within 30 days of invoice. Amounts that have been invoiced are recorded in accounts receivable prior to the receipt of payment and in deferred revenue to the extent revenue recognition criteria have not been met. As the subscription component of our revenue has grown and clients’ willingness to pay us in advance for their subscriptions has increased, the amount of deferred revenue on our balance sheet has grown at a higher rate than our revenue. As of March 31, 2007, deferred revenue increased to $31.7 million from $31.3 million at December 31, 2006.  We generally price our solutions based on the number of software applications and services included and the number of client employees. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services.

A small portion of our clients purchase discrete professional services. These services primarily consist of consulting and training services. In addition, we recognize a small amount of revenue from sales of perpetual software licenses. The revenue from these services and licenses is recognized differently depending on the type of service or license provided as described in greater detail below under “Critical Accounting Policies and Estimates.”

We generate substantially all of our revenue from within the United States. For the three months ended March 31, 2007, approximately 87.2% of our total revenue was derived from sales in the United States.  Other than the revenue that we generated from clients in the Netherlands and the United Kingdom, which in the aggregate amounted to 8.4% of our total revenue for the three months ended March 31, 2007, and revenue that was generated from clients in Switzerland which amounted to 1.2% for the three months ended March 31, 2007, we did not have revenue from any other country in excess of 1.0% of our total revenue for the three months ended March 31, 2007.

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4. Key Performance Indicators

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

 

For the three months ended 
March 31,

 

 

 

2007

 

2006

 

 

 

(unaudited)

 

(unaudited)

 

Total Revenue

 

$

42,217

 

$

23,015

 

 

 

 

 

 

 

Subscription revenue as a percentage of total revenue

 

82.2

%

76.4

%

 

 

 

 

 

 

Income from operations before income tax and interest expense

 

$

7,130

 

$

3,388

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

6,167

 

$

902

 

 

 

 

 

 

 

 

 

As of March 31,

 

 

 

2007

 

2006

 

 

 

(unaudited)

 

(unaudited)

 

Deferred revenue

 

$

31,655

 

$

16,164

 

 

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

Subscription revenue as a percentage of total revenue. Subscription revenue as a percentage of total revenue can be derived from our consolidated statement of operations. This performance indicator illustrates the evolution of our business towards subscription-based solutions, which provide us with a recurring revenue stream and which we believe to be a more compelling revenue growth and profitability opportunity. We expect that the percentage of subscription revenue will be in the range of 76-80% of our total revenues through at least 2007.

Net cash provided by operating activities. Net cash provided by operating activities is taken from our consolidated statement of cash flows and represents the amount of cash generated by our operations that is available for investing and financing activities. Historically, our net cash provided by operating activities has exceeded our net income primarily due to the positive impact of deferred revenue. We expect this trend to continue because of the advance payment structure of our subscription agreements and because as our sales increase, we expect incremental costs to decline.

Deferred revenue. We generate revenue primarily from multi-year subscriptions for our on-demand talent acquisition and employee performance management solutions. We recognize revenue from these subscription agreements ratably over the term of the contract, which are typically one to three years. We generally invoice our clients in quarterly or monthly installments in advance. Deferred revenue, which is included in our consolidated balance sheets, is the amount of invoiced subscriptions in excess of the amount recognized as revenue. Deferred revenue represents, in part, the amount that we will record as revenue in our consolidated statements of operations in future periods. As the subscription component of our revenue has grown and customer willingness to pay us in advance for their subscriptions has increased, the amount of deferred revenue on our balance sheet has grown at a higher rate than our revenue growth rate. We expect this trend to continue.

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

 

For the
year ended
December 31,

 

For the
three months ended
March 31,

 

 

 

 

 

 

 

 

 

 

 

2006

 

2007

 

2006

 

 

 

 

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

 

 

Deferred revenue at the beginning of the period

 

$

12,588

 

$

31,251

 

$

12,558

 

Total invoiced subscriptions during period

 

95,087

 

$

35,091

 

15,886

 

Deferred revenue from acquisitions

 

14,046

 

 

5,313

 

Subscription revenue recognized during period

 

(90,470

)

(34,687

)

(17,593

)

Deferred revenue at end of period

 

$

31,251

 

$

31,655

 

$

16,164

 

 

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5. Results of Operations

Three months ended March 31, 2007 compared to three months ended March 31, 2006

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

Kenexa Corporation Unaudited Consolidated Statement of Operations

(In thousands)

 

 

For the
Three Months Ended
March 31,

 

 

 

2007

 

2006

 

 

 

Amount

 

Percent of
Revenues

 

Amount

 

Percent of
Revenues

 

Revenue:

 

 

 

 

 

 

 

 

 

Subscription revenue

 

$

34,687

 

82.2

%

$

17,593

 

76.4

%

Other revenue

 

7,530

 

17.8

%

5,422

 

23.6

%

 

 

 

 

 

 

 

 

 

 

Total revenue

 

42,217

 

100.0

%

23,015

 

100.0

%

Cost of revenue

 

11,432

 

27.1

%

6,354

 

27.6

%

 

 

 

 

 

 

 

 

 

 

Gross profit

 

30,785

 

72.9

%

16,661

 

72.4

%

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

8,230

 

19.5

%

5,728

 

24.9

%

General and administrative

 

9,672

 

22.9

%

5,287

 

23.0

%

Research and development

 

4,323

 

10.2

%

1,536

 

6.7

%

Depreciation and amortization

 

1,430

 

3.4

%

722

 

3.1

%

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

23,655

 

56.0

%

13,273

 

57.7

%

 

 

 

 

 

 

 

 

 

 

Income from operations before income tax and interest expense

 

7,130

 

16.9

%

3,388

 

14.7

%

 

 

 

 

 

 

 

 

 

 

Interest income

 

123

 

0.3

%

120

 

0.5

%

 

 

 

 

 

 

 

 

 

 

Income from operations before income tax

 

7,253

 

17.2

%

3,508

 

15.2

%

Income tax expense from continuing operations

 

2,558

 

6.1

%

229

 

1.0

%

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

4,695

 

11.1

%

$

3,279

 

14.2

%

 

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Revenues

Total revenue increased by $19.2 million or 83.4% to $42.2 million during the three months ended March 31, 2007 compared to the same period in 2006.   Our subscription revenue increased by $17.1 million or 97.2% to $34.7 million during the three months ended March 31, 2007 compared to the same period in 2006.  Subscription revenue represented approximately 82.2% of our revenue for the three months ended March 31, 2007.  This increase is primarily attributable to the BrassRing, Gantz-Wiley, Psychometrics and Knowledge Workers acquisitions and integration of our two sales forces and the continued acceptance of our on-demand model.  Revenue from our acquisitions contributed $11.2 million to our total revenue increase for the three months ended March 31, 2007.  Our other revenue increased by $2.1 million or 38.9% to $7.5 million for the three months ended March 31, 2007 compared to the same period in 2006. This increase was due to primarily to an increase in demand for our consulting services resulting from an increase in our subscription based revenues.  For the remainder of the year we expect subscription based and other revenue to increase from the prior year due to customer acquisitions and additional sales to existing customers.

Cost of Revenue

Our cost of revenue primarily consists of compensation, employee benefits and travel-related expenses for our employees and independent contractors who provide consulting or other professional services to our clients. Additionally, our application hosting costs, amortization of third-party license royalty costs, technical support personnel costs, allocated overhead and reimbursed expenses are also recorded as cost of revenue. Many factors affect our cost of revenue, including changes in the mix of products and services, pricing trends, changes in the amount of reimbursed expenses and fluctuations in our client base. Because cost as a percentage of revenue is higher for professional services than for software products, an increase in the services component of our solutions or an increase in discrete professional services as a percentage of our total revenue would reduce gross profit as a percentage of total revenue. As our business expands, we expect that third-party license royalty costs and personnel costs associated with the delivery of our solutions will continue to fall within a range of approximately 26% to 30% of revenues.

Cost of revenue increased by $5.1 million or 80% to $11.4 million for the three months ended March 31, 2007 compared to the same period in 2006. The addition of 113 employees, brought on by our recent acquisitions contributed approximately $3.0 million to the cost of revenue increase for the three months ended March 31, 2007 versus the prior year.  Additionally, other consulting and external services needed to support our customer’s requirements added approximately $1.9 million to the increase during the quarter ended March 31, 2007.  As a percentage of revenue, cost of revenue decreased 0.5% for the three months ended March 31, 2007 compared to the same period in 2006.  The decrease in cost of revenue as a percentage of revenue was mostly due to an increase in revenue with minimal corresponding costs.

Sales and Marketing (“S&M”) expense

S&M expense primarily consists of personnel and related costs for employees engaged in sales and marketing, including salaries, commissions and other variable compensation, travel expenses and costs associated with trade shows, advertising and other marketing efforts and allocated overhead. We expense our sales commissions at the time the related revenue is recognized, and we recognize revenue from our subscription agreements ratably over the term of the agreements. Investment in sales and marketing commencing in 2003 resulted in significant revenue growth during 2004 through 2006. We intend to continue to invest in sales and marketing to pursue new clients and expand relationships with existing clients. As a result, although we expect S&M expense to increase in total dollars, we also expect S&M to continue to decrease as a percentage of revenue for the next twelve months.

S&M expense increased by $2.5 million or 44% to $8.2 million for the three months ended March 31, 2007 compared to the same period in 2006.  Increased compensation expense, related travel and other expenses contributed approximately $2.0 million and $0.5 million, respectively, to the increase in S&M expense during the quarter ended March 31, 2007 from the prior year. The increase in compensation and travel expense was attributable to the addition of 50 employees hired in connection with our acquisitions in the prior year as well as 18 employees needed to support our organic growth.   As a percentage of revenues, S&M expense decreased from 24.9% to 19.5% for the three months ended March 31, 2007 compared to the same period in 2006 due to increased revenues.

  General and Administrative (“G&A”) expense

G&A expense primarily consists of personnel and related costs for our executive, finance, human resources and administrative personnel, professional fees and other corporate expenses and allocated overhead. As we expand our business and incur additional expenses associated with being a public company, including the costs of compliance with the Sarbanes-Oxley Act of 2002 and other regulations governing public companies, we believe that G&A expense will increase in dollar amount and may increase as a percentage of revenue in 2007 and future periods.

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G&A expense increased by $4.4 million or 83% to $9.7 million for the three months ended March 31, 2007 compared to the same period in 2006. The $4.4 million increase for the quarter ended March 31, 2007 was due primarily to an increase in staff related expenses of $1.7 million related to the addition of 26 employees hired in connection with our acquisitions in the prior year as well as 18 employees needed to support our organic growth.  In addition, rent expense, professional fees and office supplies contributed of $0.6 million, $0.9 million and $0.4 million, respectively, to the increase in G&A expense for the three months ended March 31, 2007 versus the comparable period in the prior year.  The remainder of the increase of $0.8 million was attributable to increases in infrastructure expenses such as phone, supplies, utilities, insurance and other.  As a percentage of revenue, G&A expense was approximately the same at 22% for each of the three months ended March 31, 2007 and 2006.

Research and Development (“R&D”) expense

R&D expense primarily consists of personnel and related costs, including salaries and employee benefits for software engineers, quality assurance engineers, product managers, technical sales engineers and management information systems personnel.  Our R&D efforts have been devoted primarily to new product offerings and incidental enhancements and upgrades to our existing products.  Historically, we have capitalized a small percentage of our R&D expense.  Capitalized R&D expense totaled $0.2 million and $0.1 million for the three months ended March, 2007 and 2006, respectively. The remaining R&D expense has been expensed as incurred. We expect R&D expense to be in a range of 6–9% of our revenues due to the continued growth of our business.

R&D expense increased by $2.8 million or 181% to $4.3 million for the three months ended March 31, 2007 compared to the same period in 2006.  The $2.8 million increase in R&D expense for the three months ended March 31, 2007 was primarily due to the addition of 62 developers hired in connection with our acquisitions in the prior year as well as 50 developers needed to support our broadening and deepening solution suite.  As a percentage of revenue R&D expense increased from 6.7% to 10.2% for the three months ended March 31, 2007 compared to the same period in 2006.

Depreciation and Amortization

Depreciation and amortization expense increased by $0.7 million or approximately 98% for the three months ended March 31, 2007, compared to the same period in 2006.  In the future, we expect depreciation and amortization expense to increase due to recent capital purchases.

Income tax expense on operations

Income tax expense on operations increased by $2.3 million for the three months ended March 31, 2007 compared to the same periods in 2006.  The increase in expense was due to increased taxable income and the full utilization of our federal net operating loss carryforwards from the prior periods.

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6.  Liquidity and Capital Resources

Since we were formed in 1987, we have financed our operations primarily through internally generated cash flows, our line of credit and the issuance of preferred and common stock. As of March 31, 2007, we had cash and cash equivalents of $33.1 million and short term investments of $78.6 million. In addition, we had $0.3 million in capital equipment leases.

Our cash provided from operations was $6.2 million and $0.9 million for the three months ended March 31, 2007 and 2006, respectively.  Cash used in investing activities was $82.3 million and $32.9 million for the three months ended March 31, 2007 and 2006, respectively.  Cash provided by financing activities was $66.7 million and $68.1 million for the three months ended March 31, 2007 and 2006, respectively.  Our net decrease in cash and cash equivalents was $9.4 million for the three months ended March 31, 2007, resulting primarily from the purchase of available-for-sale securities.  Our net increase in cash and cash equivalents was $36.0 million for the three months ended March 31, 2006 resulting primarily from our net proceeds, after the repayment of outstanding indebtedness under our credit facility, of $67.3 million from our public offering completed in March 2006.   We expect positive cash flow to continue in future periods.

On January 18, 2007, we completed a public offering of 3,750,000 shares of our common stock at a price to the public of $31.86 per share.  We also sold an additional 562,500 shares of our common stock to cover over-allotments of shares.  Our net proceeds from the offering, after payment of all offering expenses and commissions, aggregated approximately $131.0 million.   We used a portion of the net proceeds from the offering to repay all of the outstanding indebtedness under the credit facility.

On March 26, 2007, we entered into a First Amendment to Credit Agreement with PNC Bank.   The Amendment increased the maximum amount available under the revolving credit facility portion of the Credit Agreement from $25 million to $50 million, including a sublimit of up to $2 million for letters of credit.   The amendment provides that the credit agreement will terminate, and all borrowings will become due and payable, on March 26, 2010.

Operating Activities

Net cash provided by operating activities was $6.2 million and $0.9 million for the three months ended March 31, 2007 and 2006, respectively.  Net cash provided by operating activities for the three months ended March 31, 2007 resulted primarily from net income of approximately $4.7 million, non-cash charges to net income of $2.7 million, and other changes in working capital of $1.2 million, which included a $0.3 million reduction in taxes payable from the excess tax benefits from share based payments.    Net cash provided by operating activities for the three months ended March 31, 2006 primarily resulted from net income of approximately $3.3 million and non-cash charges to net income of $1.3 million partially offset by a decrease in deferred revenue of $1.7 million and changes in working capital of $2.0 million which included a $0.4 million reduction in taxes payable resulting from our adoption of FAS 123R in 2006.

Investing Activities

Net cash used in investing activities was $82.3 million and $32.9 million for the three months ended March 31, 2007 and 2006, respectively.  Cash flows from investing activities for the three months ended March 31, 2007 and March 31, 2006 consisted of the following:

 

Three months March 31,

 

In millions

 

2007

 

2006

 

Webhire acquisition

 

 

$

32.0

 

Psychometrics acquisition

 

$

0.3

 

 

Gantz Wiley Research acquisition

 

$

0.6

 

 

BrassRing acquisition

 

$

0.1

 

 

Capitalized software and purchases of computer hardware

 

$

2.7

 

$

0.9

 

Purchases of available for sale investments

 

$

78.6

 

 

 

Total Cash flows from investing activities

 

$

82.3

 

$

32.9

 

 

In the future, we expect our capital expenditures to increase as revenues increase and business needs arise.

Financing Activities

Net cash provided by financing activities was $66.7 million and $68.1 million for the three months ended March 31, 2007 and 2006, respectively.  For the three months ended March 31, 2007, net cash provided by financing activity consisted of net proceeds from our follow-on public offering of $131.1 million, net proceeds from stock option exercises of $0.4 million and excess tax benefits from share-based payment arrangements of $0.4 million, partially offset by the repayment of our credit facility of $65.0 million,

25




capital lease obligations and deferred financing costs of $0.1 million.   For the three months ended March 31, 2006, net cash provided by financing activity consisted of net proceeds from our follow-on public offering of $67.3 million, net proceeds from stock option exercises of $0.7 million and excess tax benefits from share-based payment arrangements of $0.4 million, partially offset by the repayments of capital lease obligations of $0.2 million and deferred financing costs of $0.1 million.

We believe that our cash and cash equivalent balances and cash flows from operations will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next 12 months.  We intend to continue to invest our cash in excess of current operating requirements in interest-bearing, investment-grade securities. Changes in our operating plans, lower than anticipated revenue, increased expenses or other events, may cause us to seek additional debt or equity financing. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and consolidated results of operations. Additional equity financing would be dilutive to the holders of our common stock, and debt financing, if available, may involve significant cash payment obligations and covenants or financial ratios that restrict our ability to operate our business.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

We derive our revenue from two sources: (1) subscription revenues for solutions, which are comprised of subscription fees from clients accessing our on-demand software, consulting services, outsourcing services and proprietary content, and from clients purchasing additional support beyond the standard support that is included in the basic subscription fee; and (2) other fees for discrete professional services. Because we provide our solutions as a service, we follow the provisions of Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104, Revenue Recognition. On August 1, 2003, we adopted Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. We recognize revenue when all of the following conditions are met:

·                  There is persuasive evidence of an arrangement;

·                  The service has been provided to the client;

·                  The collection of the fees is probable; and

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

Subscription fees and support revenues are recognized on a monthly basis over the terms of the contracts. Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

Discrete professional services, when sold with subscription and support offerings, are accounted for separately since these services have value to the customer on a stand-alone basis and there is objective and reliable evidence of fair value of the delivered elements. Our arrangements do not contain general rights of return. Additionally, when professional services are sold with other elements, the consideration from the revenue arrangement is allocated among the separate elements based upon the relative fair value. Revenues from professional services are recognized as the services are rendered.

In determining whether revenues from professional services can be accounted for separately from subscription revenue, we consider the following factors for each agreement: availability of professional services from other vendors, whether objective and reliable evidence of the fair value exists of the undelivered elements, the nature and the timing of the agreement execution in comparison to the subscription agreement start date and the contractual dependence of the subscription service on the customer’s satisfaction with the other services. If the professional service does not qualify for separate accounting, we recognize the revenue

26




ratably over the remaining term of the subscription contract. In these situations we defer the direct and incremental costs of the professional service over the same period as the revenue is recognized.

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

Allowance for Doubtful Accounts

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

Capitalized Software Research and Development Costs

In accordance with EITF Issue 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware,” we apply AICPA Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, will be capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Maintenance and training cost are expensed as incurred. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairments whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no impairments to internal software in any of the periods covered in this report.

Goodwill and Other Identified Intangible Asset Impairment

On January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets which superseded Accounting Board Opinion No. 17, Intangible Assets. Upon adoption of SFAS No. 142, we ceased amortization of existing goodwill and are required to review the carrying value of goodwill for impairment. If goodwill becomes impaired, some or all of the goodwill could be written off as a charge to operations. This comparison is performed annually or more frequently if circumstances indicate that the carrying value may not be recoverable. We have reviewed the carrying values of goodwill of each business unit by comparing the carrying values to the estimated fair values of the business components. The fair value is based on management’s estimate of the future discounted cash flows to be generated by the respective business components and comparable company multiples. Such cash flows consider factors such as future operating income, historical trends, as well as demand and competition. Comparable company multiples are based upon public companies in sectors relevant to our business based on our knowledge of the industry. Changes in the underlying business could affect these estimates, which in turn could affect the recoverability of goodwill.  Through March 31, 2007, we have not observed any changes to our business units which would lead us to believe that our goodwill or other identified intangibles’ carrying value exceeds their fair values.

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Accounting for Stock-Based Compensation

We use a Black-Scholes option-pricing model to calculate the fair value of our stock awards. The calculation of the fair value of the awards using the Black-Scholes option-pricing model is affected by our stock price on the date of grant as well as assumptions regarding the following:

·                  Volatility is a measure of the amount by which the stock price is expected to fluctuate each year during the expected life of the award and is based on a weighted average of peer companies, comparable indices and our stock volatility.   An increase in the volatility would result in an increase in our expense.

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

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

 

Stock-based compensation expense recognized during the period is based on the value of the number of awards that are expected to vest. In determining the stock-based compensation expense to be recognized, a forfeiture rate is applied to the fair value of the award. This rate represents the number of awards that are expected to be forfeited prior to vesting and is based on Kenexa’s employee historical behavior. Changes in the future behavior of employees could impact this rate. A decrease in this rate would result in an increase in our expense.

Accounting for Income Taxes

We account for income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” or SFAS 109, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of all of the deferred tax asset will not be realized.

The realization of the deferred tax assets is evaluated quarterly by assessing the valuation allowance and by adjusting the amount of the allowance, if necessary. The factors used to assess the likelihood of realization are the forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. We have used tax-planning strategies to realize or renew net deferred tax assets in order to avoid the potential loss of future tax benefits.

In addition, we operate within multiple taxing jurisdictions and are subject to audit in each jurisdiction. These audits can involve complex issues that may require an extended period of time to resolve. In our opinion, adequate provisions for income taxes have been made for all periods.

Self-Insurance

We are self-insured for the majority of our health insurance costs, including claims filed and claims incurred but not reported subject to certain stop loss provisions. We estimate our liability based upon management’s judgment and historical experience. We also rely on the advice of consulting administrators in determining an adequate liability for self-insurance claims. For the three months ended March 31, 2007 our self-insurance accrual totaled $0.5 million. We continuously review the adequacy of our insurance coverage. Material differences may result in the amount and timing of insurance expense if actual experience differs significantly from management’s estimates.

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Item 3: Quantitative and Qualitative Disclosures about Market Risk

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

Foreign Currency Exchange Risk

For the three months ended March 31, 2007, approximately 87.2% of our total revenue was comprised of sales to clients in the United States. A key component of our business strategy is to expand our international sales efforts, which will expose us to foreign currency exchange rate fluctuations. A 10% change in the value of the U.S. dollar relative to each of the currencies of our non-U.S-generated sales would not have resulted in a material change to our results. As of March 31, 2007, we were not engaged in any foreign currency hedging activities.

The financial position and operating results of our United Kingdom and India operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date, and the local currency revenue and expenses are translated at average rates of exchange to the U.S. dollar during the period. The related translation adjustments was approximately $0.1 million at March 31, 2007, and is included in accumulated other comprehensive income. The foreign currency translation adjustment is not adjusted for income taxes as it relates to an indefinite investment in a non-U.S. subsidiary.

Interest Rate Risk

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

Item 4: Controls and Procedures

Under the supervision of and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report, or the Evaluation Date. Based upon the evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the Evaluation Date. Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

In connection with this evaluation, our management identified no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II: OTHER INFORMATION

Item 1: Legal Proceedings

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

We are involved in claims, including those identified above, which arise in the ordinary course of business. In the opinion of management, we have made adequate provision for potential liabilities, if any, arising from any such matters.  However, litigation is inherently unpredictable, and the costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in any such matters, and developments or assertions by or against us relating to intellectual property rights and intellectual property licenses, could have a material adverse effect on our business, financial condition and operating results.

Item 1A: Risk Factors

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2006 which could materially affect our business, financial condition or future results of operations.  The risks described in our Annual Report on Form 10-K for the year ended December 31, 2006 are not the only risks that we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and future results of operations.  There have been no material changes from the risk factors previously disclosed in Item IA of our Annual Report on Form 10-K for the year ended December 31, 2006.

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

On March 8, 2007, as partial consideration for the Company’s acquisition of all of the outstanding stock of Gantz Wiley Research, the Company issued 20,000 shares of the Company’s common stock to the former sole shareholder of Gantz Wiley Research.  These shares were issued without registration under the Securities Act of 1933, as amended, or the securities laws of certain states, in reliance on the exemptions provided by Section 4(2) of the Securities Act and similar exemptions under applicable state laws.

Item 3: Defaults Upon Senior Securities

Not applicable.

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Item 4: Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5: Other Information

Not applicable.

Item 6: Exhibits

The following exhibits are filed herewith:

10.1    First Amendment to Credit Agreement dated March 26, 2007 by and among Kenexa Technology, Inc., the several     banks and other financial institutions from time to time parties thereto, and PNC Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K dated March 26, 2007.)

31.1    Certification by Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

31.2    Certification by Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

32.1    Certification Furnished Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

May 10, 2007

Kenexa Corporation

 

/s/

Nooruddin S. Karsan

 

 

 

Nooruddin S. Karsan

 

 

Chairman of the Board and Chief Executive Officer

 

 

 

 

 

 

 

 

 

/s/

Donald F. Volk

 

 

 

Donald F. Volk

 

 

Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit Number and Description

Exhibit 10.1    First Amendment to Credit Agreement dated March 26, 2007 by and among Kenexa Technology, Inc., the several     banks and other financial institutions from time to time parties thereto, and PNC Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K dated March 26, 2007.)

Exhibit 31.1    Certification by Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).

Exhibit 31.2    Certification by Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).

Exhibit 32.1    Certification Furnished Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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