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

1. Overview

We provide business solutions for human resources. Our solutions include a comprehensive suite of On-Demand software applications and complementary services, including outsourcing services and consulting, to help global organizations recruit high performing individuals and to foster optimal work environments to increase employee productivity and retention. We employ a large force of organizational and industrial psychologists and statisticians who study the science of human behavior and its impact on business outcomes. This research is the foundation of our suite of software applications and supporting services that enable our customers to improve business results through human resources.

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 nine months ended September 30, 2009 and 2008, revenue from these subscriptions comprised approximately 84.8% and 79.3%, 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. Since 2005, subscription revenue has represented approximately 80% of our total 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, 2008, we had a customer base of approximately 4,400 companies, including approximately 180 companies on the Fortune 500 list published in April 2008. Our customer base includes companies that we billed for services during the year ended December 31, 2008 and does not necessarily indicate an ongoing relationship with each such customer. Our top 80 customers contributed approximately $65.7 million, or 55.4%, of our total revenue for the nine months ended September 30, 2009.

As of September 2009, unemployment in the United States continued to increase and was at a 20 year high of 9.8% while gross domestic product rose at a seasonally annual adjusted rate of 3.4% during the third quarter of 2009. The extent or degree to which we may be affected by these events is extremely difficult to predict. The uncertain economic prospects being experienced by our customers will likely translate into slower growth, or contraction, for us, since a substantial portion of our business is dependent upon our customers' hiring and human capital needs. However, we believe that, by optimizing our internal resources for the current business conditions, we can minimize these adverse effects and emerge from this economic crisis with a return to our historic operating margins.

Although our compound annual growth of revenue for the three year period ending December 31, 2008 was 45.9% and our historic subscription renewal rate has been approximately 90% each year, some of our customers, facing uncertainty and cost pressures in their own businesses during the current economic downturn, have indicated that they are delaying the purchase of our products and increasingly seeking purchasing terms and conditions that are less favorable to us. As a result of this trend, we experienced lower renewal rates during the second half of fiscal 2008, resulting in a renewal rate by aggregate value of multi-year subscriptions for the year ended December 31, 2008 of approximately 70% - 80% and as a result we have experienced lower business levels for 2009.

Due to the decline in our stock price and market capitalization, expected reductions in projected future net income, reduced future cash flow estimates and predicted slower growth rates in our industry, we recorded an impairment charge totaling $167.0 million for the year ended December 31, 2008, representing a portion of our acquired goodwill. During the quarter ended March 31, 2009, we recorded an additional impairment charge totaling $33.3 million, representing the remaining acquired goodwill.

On May 21, 2009, we elected not to renew our secured credit agreement with PNC Bank. We believe that our cash, short-term investments, UBS Settlement Agreement for our auction rate securities and projected cash from operations will be sufficient to meet our liquidity needs for at least the next twelve months.

2. Recent Events

During the three months ended March 31, 2009, due to a 32.5% decline in our stock price and market capitalization from the previous quarter, lower projected net income, cash flow estimates and slower projected growth rates in our industry, we reevaluated our goodwill impairment analysis. Our analysis was performed to determine the implied fair value of our goodwill with neither the write up or write down of any assets or liabilities, nor recording of any additional unrecognized identifiable intangible assets. Based upon our analysis we recorded a goodwill impairment charge of $33.3 million during the quarter ended March 31, 2009. This goodwill impairment charge had no effect on our cash balances.

In response to the challenging macroeconomic environment, the strengthening U.S. dollar relative to other currencies of countries in which we do business, and the slowing or delaying of a number of projects by our customers, we announced during the fourth quarter 2008, a restructuring program involving staff reductions of approximately 12% of our workforce which included one-time severance, outplacement benefits and certain legal fees totaling approximately $2.0 million. As a result of the continued deterioration in the economic environment during the first quarter of 2009, we executed an additional reduction in force resulting in the elimination of 159 employees, as a result we incurred one-time severance and outplacement benefit costs totaling $1.2 million.

On April 2, 2008, we acquired Quorum International Holdings Limited ("Quorum"), a provider of recruitment process outsourcing services based in London, England, for a purchase price of approximately $27.9 million, in cash. The total cost of the acquisition, including legal, accounting, and other fees of $1.1 million, was approximately $29.0 million. In addition, the acquisition agreement contains an earn out provision which provides for the payment of additional consideration by us based upon the gross profit of Quorum for the twelve month period ending June 30, 2009 and June 30, 2010. Formulaically, the earnout is 3.86 times Quorum's gross profit less the amount of base consideration, as defined in the agreement. Based upon our results for the twelve month period ending June 30, 2009, no earnout was due to the former shareholders of Quorum. We believe that our acquisition of Quorum broadened our presence in the global recruitment market.

On February 20, 2008, our board of directors authorized a stock repurchase plan providing for the repurchase of up to 3.0 million shares of our common stock, of which 1.1 million shares were repurchased at an aggregate cost of $20.4 million as of December 31, 2008. These shares were restored to original status and accordingly are presented as authorized but not issued. The timing, price and volume of repurchases were based on market conditions, relevant securities laws and other factors. As of September 30, 2009, the amount of shares available for repurchase under the stock repurchase plan was 1.9 million. For the nine months ended September 30, 3009, there were no repurchases under the stock repurchase plan. In addition, in January 2008, we repurchased 0.5 million shares under a previously authorized stock repurchase plan for an aggregate cost of $9.8 million.

3. Sources of Revenue

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

Our customers 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 customers have the right to terminate their contracts for cause if we fail to provide the agreed upon services or otherwise breach the agreement. A customer does not generally have a right to a refund of any advance payments if the contract is cancelled. Due to the current economic slowdown, a greater number of our customers are delaying or seeking to revise the terms and conditions of our service agreements. As a result, we experienced for the quarter ended September 30, 2009 renewal rates in the range of 70% - 80% of the aggregate value of multi-year subscriptions for our on-demand talent acquisition and performance management solution contracts rather than our historical renewal rate of more than 90%. We expect this trend to continue at least through the end of 2009.

Consistent with our historical practices, revenue derived from subscription fees is recognized ratably over the term of the subscription agreement. We generally invoice our customers in advance in monthly or quarterly installments and typical payment terms provide that our customers 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 of September 30, 2009, deferred revenue increased by $5.6 million or 14.4% to $44.2 million from $38.6 million at December 31, 2008. The increase in deferred revenue is a result of the increase in sales of our multiple elements or bundled arrangements. We generally price our solutions based on the number of software applications and services included and the number of customer employees. Accordingly, subscription fees are generally greater for larger organizations and for those that subscribe for a broader array of software applications and services.

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

For the quarter ended September 30, 2009, approximately 76.7% of our total revenue was derived from sales in the United States. Revenue that we generated from customers in the United Kingdom, Germany and Canada was approximately 7.2%, 3.4%, and 2.7%, respectively, for the quarter ended September 30, 2009. Revenue for all other countries amounted to an aggregate of 10.0%. Other than the countries listed, no other country represented more than 2.0% of our total revenue for the quarter ended September 30, 2009.

4. Key Performance Indicators

The following tables summarize the key performance indicators that we consider to be material in managing our business, in thousands (other than percentages):

                                              For the three months ended             For the nine months ended
                                                     September 30,                         September 30,
                                               2009                2008              2009                2008
                                            (unaudited)         (unaudited)       (unaudited)         (unaudited)
Total Revenue                              $      40,314       $      54,026     $     118,610       $     158,674
Subscription revenue as a percentage of
total revenue                                       82.4 %              79.6 %            84.8 %              79.3 %
Non-GAAP income from operations            $       4,310       $      10,307     $      12,611       $      30,276
Net cash provided by operating
activities                                 $       6,148       $       8,668     $      22,513       $      25,094

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

Non-GAAP income from operations. Non-GAAP income from operations is derived from income (loss) from operations adjusted for noncash or nonrecurring expenses. We believe that measuring our operations, using non-GAAP income from operations provides more useful information to management and investors regarding certain financial and business trends relating to our financial condition and ongoing results. We use these measures for purposes of determining executive compensation, and for budget and planning purposes.

                                              For the three months ended             For the nine months ended
                                                     September 30,                         September 30,
                                               2009                2008               2009                2008
                                           (unaudited)         (unaudited)        (unaudited)          (unaudited)
Income (loss) from operations              $      1,885       $        7,525     $      (29,823 )     $      21,902
Stock-based compensation expense                  1,384                1,256              4,079               4,429
Amortization of intangibles associated
with acquisitions                                 1,041                1,526              3,183               3,945
Restructuring charges                                 -                    -              1,156                   -
Goodwill impairment charge                            -                    -             33,329                   -
Professional fees associated with joint
ventures                                              -                    -                687                   -
Non-GAAP income from operations            $      4,310       $       10,307     $       12,611       $      30,276

Subscription revenue as a percentage of total revenue. Subscription revenue as a percentage of total revenue can be derived from our consolidated statements of operations. This performance indicator illustrates the evolution of our business towards subscription-based solutions, which provides us with a recurring revenue stream and which we believe to be a more compelling revenue growth and profitability opportunity. While subscription revenue as a percentage of total revenue increased to 82.4%, due to a decrease in other revenue, we expect that the percentage of subscription revenue will remain above our target range of 78% to 82% of our total revenues for the remainder of 2009.

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. Generally, our net cash provided by operating activities has exceeded our operating income primarily due to the positive impact of deferred revenue and more recently due to the collection of accounts receivables. It is possible that this trend may vary as business conditions change.

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 hosting period, which is typically one to three years. We generally invoice our customers 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. It is possible that this trend may vary as business conditions change.

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

                                        For the                     For the                             For the
                                       year ended             three months ended                   nine months ended
                                      December 31,               September 30,                       September 30,
                                          2008              2009              2008              2009              2008
                                                         (unaudited)       (unaudited)       (unaudited)       (unaudited)
Deferred revenue at the beginning
of the period                        $       35,076     $      42,223     $      38,741     $      38,638     $      35,076
Total invoiced subscriptions
during period                               166,982            35,190            41,286           106,081           127,775
Subscription revenue recognized
during period                              (163,420 )         (33,221 )         (43,031 )        (100,527 )        (125,855 )

Deferred revenue at end of period    $       38,638     $      44,192     $      36,996     $      44,192     $      36,996

5. Results of Operations

Three and nine months ended September 30, 2009 compared to three and nine months ended September 30, 2008

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: