10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2006

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: 000-50463

Callidus Software Inc.

(Exact name of registrant as specified in its charter)

Delaware
(State or Other Jurisdiction of
Incorporation or Organization) 77-0438629
(I.R.S. Employer
Identification Number)

Callidus Software Inc.
160 West Santa Clara Street, Suite 1500
San Jose, CA 95113
(Address of principal executive offices, including zip code)
(408) 808-6400
(Registrant’s Telephone Number, including area code)

     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 reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ 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-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

     There were 27,481,106 shares of the registrant’s common stock, par value $0.001, outstanding on May 8, 2006, the latest practicable date prior to the filing of this report.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	27
Item 4. Controls and Procedures	28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	28
Item 1A. Risk Factors	29
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	39
Item 6. Exhibits	39
Signatures	39
Exhibit Index	40
EXHIBIT 10.18
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

     Callidus Software^®, the Callidus logo^®, TRUEANALYTICS™, TRUECOMP^®, TRUEINFORMATION™, and TRUEPERFORMANCE^® are our trademarks, among others not referenced in this quarterly report of Form 10-Q. All other trademarks, service marks, or trade names referred to in this report are the property of their respective owners.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amount)

	March 31,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	19,202		$	23,705
Short-term investments		41,442			40,000
Accounts receivable, net		11,103			11,063
Prepaids and other current assets		1,368			1,581
Total current assets		73,115			76,349
Property and equipment, net		2,919			2,801
Deposits and other assets		1,452			1,494
Total assets	$	77,486		$	80,644
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,315		$	756
Accrued payroll and related expenses		3,791			6,383
Accrued expenses		2,107			2,043
Deferred revenue		11,818			12,205
Total current liabilities		19,031			21,387
Deferred rent		608			377
Long-term deferred revenue		554			729
Total liabilities		20,193			22,493
Stockholders’ equity:
Common stock, $0.001 par value; 100,000 shares authorized; 27,355 and 26,854 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively		27			27
Additional paid-in capital		187,974			186,232
Deferred stock-based compensation		—			(445	)
Accumulated other comprehensive income		236			171
Accumulated deficit		(130,944	)		(127,834	)
Total stockholders’ equity		57,293			58,151
Total liabilities and stockholders’ equity	$	77,486		$	80,644

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

	Three Months Ended
	March 31,
	2006			2005
	(Unaudited)
Revenues:
License revenues	$	6,958		$	3,500
Maintenance and service revenues		9,999			11,001
Total revenues		16,957			14,501
Cost of revenues:
License revenues		136			97
Maintenance and service revenues(1)		7,780			7,230
Total cost of revenues		7,916			7,327
Gross profit		9,041			7,174
Operating expenses:
Sales and marketing(1)		6,190			4,538
Research and development(1)		3,570			3,075
General and administrative(1)		3,087			2,342
Total operating expenses		12,847			9,955
Operating loss		(3,806	)		(2,781	)
Interest expense		—			(11	)
Interest and other income, net		568			323
Loss before provision for income taxes		(3,238	)		(2,469	)
Provision for income taxes		—			25
Loss before cumulative effect of a change in accounting principle		(3,238	)		(2,494	)
Cumulative effect of a change in accounting principle		128			—
Net loss	$	(3,110	)	$	(2,494	)
Net loss per share — basic
Loss before cumulative effect of a change in accounting principle	$	(0.12	)	$	(0.10	)
Cumulative effect of a change in accounting principle		0.01			—
Net loss	$	(0.11	)	$	(0.10	)
Net loss per share — diluted
Loss before cumulative effect of a change in accounting principle	$	(0.12	)	$	(0.10	)
Cumulative effect of a change in accounting principle		0.01			—
Net loss	$	(0.11	)	$	(0.10	)
Shares used in basic per share computation		27,116			25,742
Shares used in diluted per share computation		27,116			25,742

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CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS — (Continued)
(In thousands, except per share data)

⁽¹⁾ Effective January 1, 2006, the Company adopted SFAS 123R, “Share-Based Payments” under the modified prospective method. Accordingly, for the three months ended March 31, 2006, stock-based compensation was accounted for under SFAS 123R, while for the three months ended March 31, 2005, stock-based compensation was accounted for under APB No. 25, “Accounting for Stock Issued to Employees”. See Note 7 — Stock-based Compensation. The amounts above include stock-based compensation as follows:

Cost of maintenance and service revenues	$	264	$	50
Sales and marketing		266		126
Research and development		247		124
General and administrative		432		140

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

	Three Months Ended March 31,
	2006			2005
	(Unaudited)
Cash flows from operating activities:
Net loss	$	(3,110	)	$	(2,494	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and other amortization		418			399
Provision for doubtful accounts and sales returns		500			234
Stock-based compensation		1,209			440
Non-cash expenses associated with non-employee options and warrants		—			4
Loss on disposal of property		3			—
Cumulative effect of a change in accounting principle		(128	)		—
Changes in operating assets and liabilities:
Accounts receivable		(529	)		1,999
Prepaids and other current assets		264			11
Other assets		—			(333	)
Accounts payable		560			(281	)
Accrued payroll and related expenses		(2,594	)		(311	)
Accrued expenses		79			45
Deferred revenue		(562	)		918
Net cash (used in) provided by operating activities		(3,890	)		631
Cash flows from investing activities:
Purchases of investments		(19,787	)		(4,994	)
Proceeds from maturities and sale of investments		18,400			6,500
Purchases of property and equipment		(322	)		(361	)
Change in deposits		(9	)		—
Net cash (used in) provided by investing activities		(1,718	)		1,145
Cash flows from financing activities:
Repayments of bank line of credit		—			(149	)
Net proceeds from issuance of common stock and warrants		1,106			1,845
Net cash provided by financing activities		1,106			1,696
Effect of exchange rates on cash and cash equivalents		(1	)		(23	)
Net (decrease) increase in cash and cash equivalents		(4,503	)		3,449
Cash and cash equivalents at beginning of period		23,705			7,651
Cash and cash equivalents at end of period	$	19,202		$	11,100
Supplemental disclosures of cash flow information:
Cash paid for interest	$	—		$	11

See accompanying notes to unaudited condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies

     Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements included in the Callidus Software Inc. Annual Report on Form 10-K for the year ended December 31, 2005. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations regarding interim financial statements. All amounts included herein related to the condensed consolidated financial statements as of March 31, 2006 and the three months ended March 31, 2006 and 2005 are unaudited and should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

     In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all necessary adjustments for the fair presentation of the Company’s financial position, results of operations and cash flows. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the full fiscal year ending December 31, 2006.

     Reclassifications

     Certain amounts from prior periods have been reclassified to conform to the current period presentation. See Note 7 – Stock-based Compensation for further discussion of these reclassifications.

     Cumulative Effect of a Change in Accounting Principle

     Cumulative effect of a change in accounting principle was $128,000 for the three months ended March 31, 2006 and resulted from the change in accounting principle from APB No. 25 to SFAS 123R. The cumulative effect of a change in accounting principle is generally one time in nature and not expected to occur as part of our normal business on a regular basis. See Note 7 – Stock-based Compensation for further discussion.

     Principles of Consolidation

     The consolidated financial statements include the accounts of Callidus Software Inc. and its wholly owned subsidiaries (collectively, the Company), which include wholly-owned subsidiaries in the United Kingdom, Germany and Australia. All intercompany transactions and balances have been eliminated in consolidation.

     Use of Estimates

     Preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission (SEC) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.

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     Valuation Accounts

     Trade accounts receivable are recorded at the invoiced amount where revenue has been recognized and do not bear interest. The Company offsets gross trade accounts receivable with its allowance for doubtful accounts and sales return reserve. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days are reviewed individually for collectibility. Account balances are charged off against the allowance after reasonable means of collection have been exhausted and the potential for recovery is considered remote. The sales return reserve is the Company’s best estimate of the probable amount of remediation services it will have to provide for ongoing professional service arrangements. To determine the adequacy of the sales return reserve, the Company analyzes historical experience of actual remediation service claims as well as current information on remediation service requests. Provisions for allowance for doubtful accounts are recorded in general and administrative expenses, while provisions for sales returns are offset against maintenance and service revenues.

     Below is a summary of the changes in the Company’s valuation accounts for the three months ended March 31, 2006 and 2005, respectively (in thousands):

	Balance at		Provision,					Balance at
	Beginning		Net of					End of
	of Period		Recoveries		Write-Offs			Period
Allowance for doubtful accounts
Three months ended March 31, 2006	$	480	$	80	$	(5	)	$	555
Three months ended March 31, 2005		320		72		(65	)		327

	Balance at		Provision,		Remediation			Balance at
	Beginning		Net of		Service			End of
	of Period		Recoveries		Claims			Period
Sales return reserve
Three months ended March 31, 2006	$	310	$	420	$	(473	)	$	257
Three months ended March 31, 2005		537		162		(305	)		394

     Restricted Cash

     Included in deposits and other assets in the consolidated balance sheets at March 31, 2006 and December 31, 2005 is restricted cash of $676,000, related to security deposits on leased facilities for our New York, New York and San Jose, California offices. The restricted cash represents investments in certificates of deposit and secures letters of credit required by landlords to meet security deposit requirements for the leased facilities. Restricted cash is included in other assets based on the expected term for the release of the restriction.

     Net Loss Per Share

     Basic net loss per share is calculated by dividing net loss attributable to common stockholders for the period by the weighted average common shares outstanding during the period, less shares subject to repurchase. Diluted net loss per share is calculated by dividing the net loss for the period by the weighted average common shares outstanding, adjusted for all dilutive potential common shares, which includes shares issuable upon the exercise of outstanding common stock options and warrants to the extent these shares are dilutive. For the three months ended March 31, 2006 and 2005, the diluted net loss per share calculation was the same as the basic net loss per share calculation as all potential common shares were anti-dilutive.

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     Diluted net loss per share did not include the effect of the following potential weighted average common shares because to do so would be anti-dilutive for the periods presented (in thousands):

	Three Months Ended March 31,
	2006		2005
Stock options		6,666		4,623
Stock subject to repurchase		28		—
Warrants		111		14
Totals		6,805		4,637

     The weighted-average exercise price of stock options excluded during the three months ended March 31, 2006 and 2005 was $4.05 and $3.91, respectively. The weighted average exercise price of warrants excluded during the three months ended March 31, 2006 and 2005 was $5.09 and $20.15, respectively.

2. Investments

     The Company classifies debt and marketable equity securities based on the liquidity of the investment and management’s intention on the date of purchase and re-evaluates such designation as of each balance sheet date. Debt and marketable equity securities are classified as available-for-sale and carried at fair value, which is determined based on quoted market prices, with net unrealized gains and losses, net of tax effects, included in accumulated other comprehensive income (loss) in the accompanying condensed consolidated financial statements. Interest is included in interest and other income, net, in the accompanying condensed consolidated financial statements. Realized gains and losses are calculated using the specific identification method. The components of the Company’s debt and marketable equity securities were as follows for March 31, 2006 and December 31, 2005 (in thousands):

			Unrealized		Unrealized
March 31, 2006	Cost		Gains		Losses			Fair Value
Auction rate securities and preferred stock	$	30,975	$	—	$	—		$	30,975
Corporate notes and obligations		12,083		—		(24	)		12,059
US government and agency obligations		4,500		—		(12	)		4,488
Investments in debt and equity securities	$	47,558	$	—	$	(36	)	$	47,522

			Unrealized		Unrealized
December 31, 2005	Cost		Gains		Losses			Fair Value
Auction rate securities and preferred stock	$	20,575	$	—	$	—		$	20,575
Corporate notes and obligations		11,997		—		(35	)		11,962
US government and agency obligations		12,500		—		(56	)		12,444
Investments in debt and equity securities	$	45,072	$	—	$	(91	)	$	44,981

9

	March 31,		December 31,
	2006		2005
Recorded as:
Cash equivalents	$	6,080	$	4,981
Short-term investments		41,442		40,000
	$	47,522	$	44,981

     There were no realized gains or losses on the sales of these securities for the quarters ended March 31, 2006 and 2005, respectively.

3. Debt

     Bank Line of Credit

     The Company had a master loan and security agreement that included a revolving line of credit of $10.0 million that expired in March 2005 and was not renewed.

4. Commitments and Contingencies

     In July 2004, a purported securities class action complaint was filed in the United States District Court for the Northern District of California against the Company and certain of its present and former executives and directors. Lead plaintiff and lead counsel were appointed by the Court and on November 29, 2004, plaintiff filed a consolidated amended class action complaint (“Complaint”). The Complaint alleged that the Company and certain individual defendants made materially false or misleading statements or omissions in violation of the federal securities laws during the period of January 22, 2004 through June 23, 2004 (the “Class Period”). The Complaint sought to recover damages on behalf of anyone who purchased or otherwise acquired our stock during the Class Period. Following the Company’s motion to dismiss, the complaint was initially dismissed with leave to amend in 2005 and, following plaintiffs’ acknowledgement that they could not amend, the action was dismissed with prejudice.

     In July and October 2004, two derivative complaints were filed in state and federal court, respectively, against certain of our present and former executives and directors (the “Derivative Complaints”). The Derivative Complaints allege state law breach of fiduciary duty claims arising out of the underlying matters alleged in the securities Complaint identified above. The state court derivative plaintiff has agreed to stay his case and has joined in a first amended complaint filed in the federal derivative case. The Company filed a motion to dismiss the complaint in October 2005, which was denied by the federal court on March 13, 2006.

     In addition, the Company is from time to time a party to various other litigation matters incidental to the conduct of its business, none of which, at the present time, is likely to have a material adverse effect on the Company’s future financial results.

     In accordance with SFAS No. 5, “Accounting for Contingencies” (SFAS 5), the Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews the need for any such liability on a quarterly basis and records any necessary adjustments to reflect the effect of ongoing negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case in the period they become known. At March 31, 2006, the Company has not recorded any such liabilities in accordance with SFAS 5. The Company believes that it has valid defenses with respect to the legal matters pending against the Company and that the probability of a loss under such matters is remote.

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     Other Contingencies

     The Company generally warrants that its products shall perform to its standard documentation. Under the terms of the warranty, should a product not perform as specified in the documentation, the Company will repair or replace the product. Such warranties are accounted for in accordance with SFAS 5. To date, the Company has not incurred material costs related to warranty obligations.

     The Company’s product license agreements include a limited indemnification provision for claims from third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. To date, the Company has not incurred any costs related to such indemnification provisions.

5. Segment, Geographic and Customer Information

     SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method of determining what information is reported is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision maker is considered to be the Company’s chief executive officer (CEO). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. By this definition, the Company operates in one business segment, which is the development, marketing and sale of enterprise software. The Company’s TrueComp Suite is its only product line which includes all of its software application products.

     The following table summarizes revenues for each of the three months ended March 31, 2006 and 2005 by geographic areas (in thousands):

	Three Months Ended March 31,
	2006		2005
United States	$	13,798	$	12,588
Europe		387		1,295
Asia Pacific		2,772		618
	$	16,957	$	14,501

     Substantially all of the Company’s long-lived assets are located in the United States. Long-lived assets located outside the United States are not significant.

     The following table summarizes revenues to significant customers (including resellers when product is sold through them to an end user) as a percentage of total revenues:

	Three Months Ended March 31,
	2006			2005
Customer 1		16	%		7	%
Customer 2		15	%		6	%
Customer 3		10	%		—	%
Customer 4		4	%		10	%

6. Comprehensive Loss

     Comprehensive loss includes net loss, unrealized gains (losses) on investments, net and foreign currency translation adjustments. Comprehensive loss is comprised of the following (in thousands):

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	Three Months Ended March 31,
	2006			2005
Net loss	$	(3,110	)	$	(2,494	)
Other comprehensive income (loss):
Change in accumulated unrealized loss on investments, net		55			(38	)
Change in cumulative translation adjustments		10			(17	)
Comprehensive loss	$	(3,045	)	$	(2,549	)

7. Stock-based Compensation

     Adoption of New Accounting Standard

     Effective January 1, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with FASB Statement No. 123R (revised 2004), “Share-Based Payment” (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB 107). SFAS 123R requires the recognition of the fair value of stock compensation in net income. Prior to January 1, 2006, the Company had adopted SFAS 123, “Accounting for Stock-Based Compensation” (SFAS 123), but in accordance with SFAS 123, had elected to account for stock options according to the provisions of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. Therefore, the Company recorded no related compensation expense for awards granted with no intrinsic value. In accordance with SFAS 123, the Company previously provided pro forma disclosure of the effect of using the fair value-based method of measuring stock-based compensation expense under SFAS 123 in its financial statement notes.

     The Company elected the modified prospective transition method in adopting SFAS 123R. Under this method, the provisions of SFAS 123R apply only to awards granted or modified after the date of adoption. For awards granted prior to, but not yet vested at, the date of adoption of SFAS 123R, stock-based compensation is recognized in net income in the periods after the date of adoption based on the unrecognized expense calculated for pro-forma fair value disclosure under SFAS 123 using the same valuation method (i.e. Black-Scholes) and assumptions, as disclosed in the Company’s previous filings. In addition, the deferred stock-based compensation of $445,000 as of December 31, 2005, which was accounted for under APB No. 25, was reclassified into additional paid-in capital upon the adoption of SFAS 123R.

     Upon adoption of SFAS 123R, compensation cost associated with stock options consists of the amortization related to the remaining unvested portion of all stock option awards granted prior to January 1, 2006 determined in accordance with SFAS 123 and the amortization related to all stock option awards granted subsequent to January 1, 2006 determined in accordance with SFAS 123R. In addition, the Company records expense over the offering period and the vesting term in connection with shares issued under its Employee Stock Purchase Plan (ESPP) and restricted stock. The compensation expense for stock-based compensation awards includes an estimate for forfeitures and is recognized over the expected term of the options using the straight-line method.

     Prior to the adoption of SFAS 123R, benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows. SFAS 123R requires that they be recorded as a financing cash inflow rather than as a reduction of taxes paid. For the quarter ended March 31, 2006, the Company had no excess tax benefits generated from option exercises. The Company is in the process of computing the excess tax benefits in additional paid-in capital as of the date of adoption of SFAS 123R. This analysis is not expected to result in a material change to the Company’s financial statements.

     Also, upon the adoption of SFAS 123R, the Company recorded a cumulative effect of a change in accounting principle, reducing the net loss for the three months ended March 31, 2006 by $128,000. The cumulative effect of a change in accounting principle resulted from the requirement of SFAS 123R to

12

reduce the amount of stock-based compensation expense by an estimated forfeiture rate or, in other words, the estimated number of shares that are not expected to vest as a result of an employee terminating prior to becoming fully vested in an award. Prior to the adoption of SFAS 123R, the Company did not reduce stock-based compensation expense based on an estimated forfeiture rate but rather recorded an adjustment to stock-based compensation as actual forfeitures occurred. The cumulative effect of a change in accounting principle of $128,000 represent the total reduction in stock-based compensation expense that would have been recorded on previously reported stock-based compensation expense for unvested options outstanding on the date of adoption of SFAS 123R.

     Expense Summary

     Under the provisions of SFAS 123R, $1.2 million of stock compensation expense was recorded for the three months ended March 31, 2006 on the unaudited condensed consolidated statement of operations. Of the total stock compensation expense, approximately $1.0 million was related to stock options and $0.2 million was related to ESPP. As of March 31, 2006, there were $6.1 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 1.71 years for stock options.

     In addition, SFAS 123R requires the Company to present pro forma information for the comparative period prior to the adoption of SFAS 123R as if all stock-based employee compensation was accounted for under the fair value method of SFAS 123. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation for the three months ended March 31, 2005 (in thousands, except per share amounts):

	Three
	Months
	Ended
	March 31,
	2005
Net loss as reported	$	(2,494	)
Add: Stock-based employee compensation expense under APB No. 25 included in reported net loss, net of tax		440
Less: Stock-based employee compensation expense determined under the fair value method for all awards, net of tax		(973	)
Pro forma net loss	$	(3,027	)
Basic net loss per share, as reported	$	(0.10	)
Pro forma basic net loss per share	$	(0.12	)
Diluted net loss per share, as reported	$	(0.10	)
Pro forma diluted net loss per share	$	(0.12	)

     Determination of Fair Value

     The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the following table. Because the Company has limited available data, the expected life of options is based on the simplified method as allowed by SAB 107. The expected volatility of stock options is based upon on the combination of the historical volatility of the price of the Company’s common stock as well as the historical stock price volatility and implied volatility of traded options of similar entities’ common stock. The Company believes that this blended approach provides a better estimate of the expected future volatility of the Company’s common stock over the expected life of its stock options. Prior to the first quarter of 2006, the Company had used its historical stock price volatility in accordance with SFAS 123 for purposes of its pro forma information disclosures of stock-based

13

compensation expense. The expected volatility of ESPP shares is based on the historical volatility of the price of the Company’s common stock. Expected volatilities of both options and ESPP shares equal the expected terms of the options and ESPP shares respectively. The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option. The dividend yield reflects that the Company has not paid any cash dividends since inception and does not intend to pay any cash dividends in the foreseeable future.

	Three Months Ended March 31,
	2006			2005
Stock Option Plans
Expected life (in years)		6.00			3.09
Risk-free interest rate	4.36% to 4.70%				3.61	%
Volatility		60	%		60	%
Employee Stock Purchase Plan
Expected life (in years)		0.49 to 1.00			1.05
Risk-free interest rate		4.68 to 4.69	%		1.88	%
Volatility	36% to 43%				56	%

     Stockholder-Approved Stock Option Plans

     The Company has two stock option plans approved by stockholders, the 1997 Stock Option Plan and the 2003 Stock Incentive Plan.

     Under the 1997 Stock Option Plan, incentive and nonstatutory options to purchase the Company’s common stock were granted to employees with vesting generally over 4 years and a contractual term of 10 years, as determined by the board. The vesting period generally equals the requisite service period of the individual grantees. Under the 1997 Stock Option Plan, as of March 31, 2006, the Company was authorized to issue approximately 3,547,000 shares of common stock. Following the Company’s initial public offering, shares are no longer granted from the 1997 Stock Option Plan and all shares that remained available for future grant under this plan at the time of the Company’s initial public offering became available for issuance under the 2003 Stock Incentive Plan, as described below.

     The 2003 Stock Incentive Plan became effective upon the completion of the Company’s initial public offering in November 2003. As of March 31, 2006, the Company was authorized to issue approximately 4,514,000 shares of common stock. Under the plan, the board of directors may grant stock options or other types of stock-based awards, such as restricted stock, restricted stock units, stock bonus awards or stock appreciation rights. Incentive stock options may be granted only to the Company’s employees. Nonstatutory stock options and other stock-based awards may be granted to employees, consultants or non-employee directors. These options vest as determined by the board, generally over 4 years and expire 10 years from the date of grant. The vesting period generally equals the requisite service period of the individual grantees. On July 1 of each year, the aggregate number of shares reserved for issuance under this plan increases automatically by a number of shares equal to the lesser of (i) 5% of the Company’s outstanding shares, (ii) 2,800,000 shares or (iii) a lesser number of shares approved by the board.

     A summary of the status of the Company’s options under the 1997 Stock Option plan and the 2003 Stock Incentive Plan for the three months ended March 31, 2006 is as follows:

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							Weighted		Weighted
	Shares						Average		Average
	Available						Average		Remaining		Aggregate
	for			Number of			Exercise		Contractual		Intrinsic
	Grant			Shares			Price		Term (Years)		Value
											(in thousands)
Outstanding as of December 31, 2005		2,886,508			5,325,143		$	4.11
Authorized		—			—
Granted		(873,494	)		873,494			4.36
Exercised		—			(150,512	)		1.12
Forfeited		62,949			(62,949	)		4.60
Expired		69,991			(69,991	)		7.71
Outstanding as of March 31, 2006		2,145,954			5,915,185		$	4.17		8.29	$	6,266
Vested and Expected to Vest as of March 31, 2006					5,356,264		$	4.16		8.18	$	6,032
Exercisable as of March 31, 2006					2,446,478		$	3.87		7.07	$	4,377

     The weighted-average fair value of stock options granted during the three months ended March 31, 2006 and 2005 were $2.60 and $1.92 per share, respectively. The total intrinsic value of stock options exercised during the quarters ended March 31, 2006 and 2005 was $0.5 million and $1.7 million, respectively. The total cash received from employees as a result of stock option exercises was $0.2 million and $0.8 million for the quarters ended March 31, 2006 and 2005, respectively. The Company settles employee stock option exercises with newly issued common shares.

     2003 Employee Stock Purchase Plan

     In August 2003, the board of directors adopted the 2003 Employee Stock Purchase Plan (ESPP) which became effective upon the completion of the Company’s initial public offering and is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. The ESPP is designed to enable eligible employees to purchase shares of the Company’s common stock at a discount on a periodic basis through payroll deductions. Except for the first offering period, each offering period will be for 12 months and will consist of two consecutive six-month purchase periods. The purchase price for shares of common stock purchased under the purchase plan will be 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable offering period and the fair market value of the Company’s common stock on the last day of each purchase period. The Company issued approximately 350,000 shares during the first quarter of 2006. The weighted-average fair value of stock purchase rights granted under ESPP during the three months ended March 31, 2006 and 2005 was $1.29 and $1.88 per share respectively.

     Other Plan Awards

     During 2005, the Company granted 28,000 shares of restricted stock to its chief executive officer. The shares are subject to repurchase until they become fully vested on May 31, 2006. The restricted stock was issued at fair value of $3.50 per share on the date of grant. Compensation expense is being amortized over the vesting period of one year and was $25,000 for the three months ended March 31, 2006. As of March 31, 2006, unrecognized costs related to the restricted stock award totaled approximately $16,000. The weighted average remaining contractual term as of March 31, 2006 was 9.19 and 9.19 for outstanding and vested and expected to vest shares, respectively. The aggregate intrinsic value as of March 31, 2006 was $26,000 and $26,000 for outstanding and vested and expected to vest shares, respectively.

     Additionally, on May 31, 2005, the Company granted its chief executive officer an option to purchase 1,000,000 shares of its common stock with an exercise price of $3.50 per share, which was the fair market value of our common stock on the date of grant. The shares have a contractual term of 10 years

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and vest over four years, with 25% vesting on the first anniversary of the grant date and 1/48^th vesting each month thereafter. The vesting period equals the requisite service period of the grant. The weighted average remaining contractual term as of March 31, 2006 was 9.17, 9.17 and zero for outstanding, vested and expected to vest and exercisable shares, respectively. The aggregate intrinsic value as of March 31, 2006 was $1.0 million, $0.9 million and $0 for outstanding, vested and expected to vest and exercisable shares, respectively.

     The agreements granting both the 28,000 shares of restricted stock and the option to purchase 1,000,000 shares were approved by the Company’s Compensation Committee, which is made up entirely of independent directors. As disclosed in a press release issued on April 28, 2005, these agreements were issued without shareholder approval as inducement grants to a new employee under applicable Nasdaq Marketplace Rules.

8. Related Party Transactions

     In 2005, the Company entered into a service agreement with Saama Technologies, Inc. for engineering consulting. William Binch, who was appointed to the Company’s Board of Directors in April 2005, is also currently a member of Saama’s Board of Directors. The Company had expenses of approximately $150,000 for services rendered by Saama during the quarter ended March 31, 2006.

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

     The following discussion of financial condition and results of operations should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005 and with the condensed consolidated financial statements and the related notes thereto contained elsewhere in this Quarterly Report on Form 10-Q . This section of the Quarterly Report on Form 10-Q, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: changes in and expectations with respect to maintenance and service and license revenues and gross margins, future operating expense levels, the impact of quarterly fluctuations of revenue and operating results, levels of capital expenditure, staffing and expense levels, expected future cash outlays, the adequacy of our capital resources to fund operations and growth, the impact of our adoption of one of the fair value methods for measuring stock-based compensation described in SFAS 123R, and the extent of stock-based compensation charges and expectations with respect to research and development spending. These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from any future results, level of activity, performance or achievements expressed or implied by these statements. Many of these trends and uncertainties are described in “Factors That Could Affect Future Results” set forth elsewhere in this Quarterly Report on Form 10-Q. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

Overview of the Results for the Three Months Ended March 31, 2006

     We are a leading provider of Enterprise Incentive Management (EIM) software systems to global companies across multiple industries. Large enterprises use EIM systems to model, administer, analyze and report on incentive compensation, or pay-for-performance plans, which compensate employees and business partners for the achievement of targeted quantitative and qualitative objectives, such as sales quotas, product development milestones and customer satisfaction. We sell our EIM products both directly through our sales force and indirectly through our strategic partners pursuant to perpetual or term software licenses, and offer professional services, including configuration, integration and training, generally on a time and materials basis. We also generate maintenance and support revenues associated with our product licenses, which are recognized ratably over the term of the maintenance agreement.

     During the first quarter of 2006, customers purchasing Callidus solutions included ADP, CDW Corporation, HSBC, Medtronic, Network Appliance, Nokia, North Carolina Farm Bureau, and Vodafone Australia. In addition, we launched our On-Demand Solutions group in the first quarter of 2006. This group had one customer that contracted for our on-premises managed services, which generated revenues over $1.5 million. Together, On-Demand and software maintenance revenues accounted for more than 30% of total revenues in the first quarter of 2006. Both On-Demand and software maintenance contracts provide for recurring revenue streams but remain subject to periodic adjustment or cancellation.

     In February, Charles M. Boesenberg was appointed to the Board of Directors. Mr. Boesenberg is CEO and Chairman of the Board of NetIQ and a 30-year veteran in the technology industry. We also announced the appointment of Bill Williamson to Regional Director for the Asia Pacific Region, continuing our focus on growing revenues internationally. We consider the hiring and appointment of these individuals as key additions to our leadership team whom will be integral to the development and achievement of our short and long-term business strategies.

     We adopted FASB Statement No. 123R (revised 2004), “Share-Based Payment” (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB 107), effective January 1, 2006. SFAS 123R requires the recognition of the fair value of stock compensation in net income. Our total stock based

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compensation expense for the first quarter of 2006 was $1.2 million, compared to $440,000 in the prior year period, when we accounted for stock-based compensation under APB No. 25.

     When comparing the first quarter of 2006 to the first quarter of 2005, our total revenues increased by 17% to $17.0 million from $14.5 million. This increase was the result of a 99% increase in license revenues, offset by a 9% decrease in maintenance and service revenues in the first quarter of 2006 compared to the first quarter of 2005. The positive change in license revenues was driven by an increase in the number of sales to both new and existing customers and a higher average recognition of revenue per customer. As a result of this substantial increase in higher-margin license revenues offset by $0.2 million from the inclusion of stock-based compensation in cost of maintenance and service revenues due to the adoption of SFAS 123R, our overall gross margin increased to 53% in the first quarter of 2006, compared to 49% in the first quarter of 2005.

     Operating expenses increased by 29%, to $12.9 million in the first quarter of 2006 compared to $10.0 million in the first quarter of 2005. This increase was primarily the result of increases of $1.7 million in sales and marketing expenses, $0.7 million in general and administrative expenses, and $0.5 million in research and development expenses. Included in the increases above is a $0.6 million increase in stock-based compensation due to the adoption of SFAS 123R.

     As a result of the increase in operating expenses, our net loss increased to $3.1 million for the first quarter of 2006, compared with a net loss of $2.5 million for the first quarter of 2005. Our cash, cash equivalents and short-term investments were $60.6 million as of March 31, 2006 compared to $63.7 million as of December 31, 2005, a decrease of $3.1 million.

     From a business perspective, we have a number of sales opportunities in process and many additional opportunities coming from our sales pipeline; however, we continue to experience wide variances in the timing and size of our license transactions and the timing of revenue recognition resulting from greater flexibility in licensing terms. We believe one of our major challenges is increasing prospective customers’ prioritization of purchasing our products over competing IT projects. To address these challenges, our goals for 2006 include expanding our marketing efforts, investing in the development of new modules for our TrueComp suite to broaden and increase its strategic value, and being more flexible and innovative in our licensing terms and in the methods we use to deliver our products. We believe these initiatives will, over time, help us better realize the market opportunity ahead of us.

     If we are unable to grow our revenues, we may be unable to return to profitability. In addition to these risks, our future operating performance is subject to the risks and uncertainties described in “Factors that could affect future results.”

Application of Critical Accounting Policies and Use of Estimates

     The discussion and analysis of our financial condition and results of operations which follows is based upon our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The application of GAAP requires our management to make estimates that affect our reported amounts of assets, liabilities, revenues and expenses, and the related disclosure regarding these items. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation of our financial condition or results of operations will be affected.

     In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that the accounting policies discussed below are critical to

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understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Our management has reviewed these critical accounting policies, our use of estimates and the related disclosures with our audit committee.

     Revenue Recognition

     We generate revenues primarily by licensing software and providing related software maintenance and professional services to our customers. Our software arrangements typically include: (i) an end-user license fee paid in exchange for the use of our products in perpetuity, generally based on a specified number of payees, and (ii) a maintenance arrangement that provides for technical support and product updates, generally over renewable twelve month periods. If we are selected to provide integration and configuration services, then the software arrangement will also include professional services, generally priced on a time-and-materials basis. Depending upon the elements in the arrangement and the terms of the related agreement, we recognize license revenues under either the residual or the contract accounting method.

     Residual Method. License fees are recognized upon delivery whether licenses are sold separately from or together with integration and configuration services, provided that (i) the criteria described below have been met, (ii) payment of the license fees is not dependent upon performance of the integration and configuration services, and (iii) the services are not otherwise essential to the functionality of the software. We recognize these license revenues using the residual method pursuant to the requirements of Statement of Position (SOP) 97-2, “Software Revenue Recognition”, as amended by SOP 98-9, “Software Revenue Recognition with Respect to Certain Transactions”. Under the residual method, revenues are recognized when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e., professional services and maintenance), but does not exist for one or more of the delivered elements in the arrangement (i.e., the software product). Each license arrangement requires careful analysis to ensure that all of the individual elements in the license transaction have been identified, along with the fair value of each undelivered element.

     We allocate revenue to each undelivered element based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. For a certain class of transactions, the fair value of the maintenance portion of our arrangements is based on stated renewal rates rather than stand- alone sales. The fair value of the professional services portion of the arrangement is based on the hourly rates that we charge for these services when sold independently from a software license. If evidence of fair value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue from the arrangement is deferred until evidence of fair value can be established, or until the items for which evidence of fair value cannot be established are delivered. If the only undelivered element is maintenance, then the entire amount of revenue is recognized over the maintenance delivery period.

     Contract Accounting Method. For arrangements where services are considered essential to the functionality of the software, such as where the payment of the license fees is dependent upon performance of the services, both the license and services revenues are recognized in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. We generally use the percentage-of-completion method because we are able to make reasonably dependable estimates relative to contract costs and the extent of progress toward completion. However, if we cannot make reasonably dependable estimates, we use the completed-contract method. If total cost estimates exceed revenues, we accrue for the estimated loss on the arrangement.

     For all of our software arrangements, we will not recognize revenue until persuasive evidence of an arrangement exists and delivery has occurred, the fee is fixed or determinable and collection is deemed probable. We evaluate each of these criteria as follows:

     Evidence of an Arrangement. We consider a non-cancelable agreement signed by us and the customer to be evidence of an arrangement.

     Delivery. We consider delivery to have occurred when media containing the licensed programs is provided to a common carrier, or in the case of electronic delivery, the customer is given access to the

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licensed programs. Our typical end-user license agreement does not include customer acceptance provisions.

     Fixed or Determinable Fee. We consider the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within our standard payment terms. We consider payment terms greater than 90 days to be beyond our customary payment terms. If the fee is not fixed or determinable, we recognize the revenue as amounts become due and payable.

     Collection is Deemed Probable. We conduct a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the customer. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the recognition of revenue until cash collection.

     A customer typically pre-pays maintenance for the first twelve months, and the related revenues are deferred and recognized ratably over the term of the initial maintenance contract. Maintenance is renewable by the customer on an annual basis thereafter. Rates for maintenance, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.

     Professional services revenues primarily consist of configuration and integration services related to the installation of our products as well as training revenues. Our implementation services do not involve customization to, or development of, the underlying software code. Substantially all of our professional services arrangements are on a time-and-materials basis. For professional service arrangements with a fixed fee we recognize revenue utilizing the proportional performance method of accounting. We estimate the proportional performance on fixed fee contracts on a monthly basis utilizing hours incurred to date as a percentage of total estimated hours to complete the project. If we do not have a sufficient basis to measure progress toward completion, revenue is recognized when we receive final acceptance from the customer. To the extent we enter into a fixed-fee services contract, a loss will be recognized any time the total estimated project cost exceeds project revenues.

     Certain arrangements result in the payment of customer referral fees to third parties that resell our software products. In these arrangements, license revenues are recorded, net of such referral fees, at the time the software license has been delivered to a third-party reseller and an end-user customer has been identified.

     On-Demand Revenue. On-Demand revenues include both on-premises and hosted managed service offerings and are recorded as maintenance and services revenues in our statements of operations. Our On-Demand offerings allow our customers to outsource the operation and management of our software products to us. Customers will typically prepay for these subscription services which the Company will defer and recognize ratably over the term of the customer contract based on the number of days the contract is outstanding during each period.

     In hosted arrangements where the Company provides its software application as a service, the Company follows the provisions of SEC Staff Accounting Bulletin No. 104, Revenue Recognition and Emerging Issues Task Force Issue No. 00-21 Revenue Arrangements with Multiple Deliverables. The Company evaluates whether each of the elements in these arrangements represents a separate unit of accounting, as defined by EITF 00-21, using all applicable facts and circumstances, including whether (i) the Company sells or could readily sell the element unaccompanied by the other elements, (ii) the element has stand-alone value to the customer, (iii) there is objective reliable evidence of the fair value of the undelivered item, and (iv) there is a general right of return.

     The Company allocates the arrangement consideration to the separate units of accounting based on its relative fair values, as determined by the price of the undelivered items when sold separately.

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     If evidence of fair value cannot be established for the undelivered elements of an agreement, the entire amount of revenue from the arrangement is recognized ratably over the period that these elements are delivered.

     Allowance for Doubtful Accounts and Sales Return Reserve

     We must make estimates of the uncollectibility of accounts receivable. The allowance for doubtful accounts, which is netted against accounts receivable on our condensed consolidated balance sheets, totaled approximately $555,000 and $480,000 at March 31, 2006 and December 31, 2005, respectively. We record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Management specifically analyzes accounts receivable and historical bad debt experience, customer creditworthiness, current economic trends, international situations (such as currency devaluation) and changes in our customer payment history when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management will also change, which could affect the level of our future provision for doubtful accounts. Specifically, if the financial condition of our customers were to deteriorate, affecting their ability to make payments, an additional provision for doubtful accounts may be required and such provision may be material.

     We generally guarantee that our services will be performed in accordance with the criteria agreed upon in a statement of work, which we generally execute with each applicable customer prior to commencing work. Should these services not be performed in accordance with the agreed upon criteria, we typically would provide remediation services until such time as the criteria are met. In accordance with Statement of Financial Accounting Standards (SFAS) 48, “Revenue Recognition When Right of Return Exists”, management must use judgments and make estimates of sales return reserves related to potential future requirements to provide remediation services in connection with current period service revenues. When providing for sales return reserves, we analyze historical experience of actual remediation service claims as well as current information on remediation service requests as they are the primary indicators for estimating future service claims. Material differences may result in the amount and timing of our revenues, if for any period, actual returns differ from management’s judgments or estimates. The sales return reserve balance, which is netted against our accounts receivable on our condensed consolidated balance sheets, was approximately $257,000 and $310,000 at March 31, 2006 and December 31, 2005, respectively.

     Stock-Based Compensation

     Effective January 1, 2006, we began recording stock-based compensation expense associated with stock options and other forms of equity compensation in accordance with FASB Statement No. 123R (revised 2004), “Share-Based Payment” (SFAS 123R), as interpreted by SEC Staff Accounting Bulletin No. 107 (SAB 107). SFAS 123R is a new and very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as estimated option volatility, expected option lives and expected option forfeiture rates, to estimate the fair value of stock options and related stock-based compensation. There is little experience or guidance available with respect to developing these assumptions and models. There is also uncertainty as to how the standard will be interpreted and applied as more companies adopt the standard and companies and their advisors gain experience with the standard. SFAS 123R requires the recognition of the fair value of stock-based compensation in net income. Refer to Note 7 – Stock-based Compensation in our notes to our unaudited condensed consolidated financial statements included elsewhere in this quarterly report on form 10-Q for further discussion of our adoption of SFAS 123R.

     Income Taxes

     We are subject to income taxes in both the United States and foreign jurisdictions and we use estimates in determining our provision for income taxes. This process involves estimating actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on our balance sheet. Our deferred tax assets consist primarily of net operating loss carry forwards. We assess the likelihood that deferred tax assets will be recovered from future taxable income, and a valuation

21

allowance is recognized if it is more likely than not that some portion of the deferred tax assets will not be recognized. We maintained a full valuation allowance against our net deferred tax assets at March 31, 2006. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax assets would increase net income in the period such determination was made. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment and is subject to audit by tax authorities in the ordinary course of business.

Results of Operations

Comparison of the Three Months Ended March 31, 2006 and 2005

Revenues, cost of revenues and gross profit

     The table below sets forth the changes in revenues, cost of revenues and gross profit for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 (in thousands, except percentage data):

	Three					Three								Percentage
	Months					Months								of Dollar
	Ended		Percentage			Ended		Percentage			Year to Year			Change
	March 31,		of Total			March 31,		of Total			Increase			Year over
	2006		Revenues			2005		Revenues			(Decrease)			Year
Revenues:
License	$	6,958		41	%	$	3,500		24	%	$	3,458			99	%
Maintenance and service		9,999		59	%		11,001		76	%		(1,002	)		(9	)%
Total revenues	$	16,957		100	%	$	14,501		100	%	$	2,456			17	%

	Three					Three							Percentage
	Months					Months							of Dollar
	Ended		Percentage			Ended		Percentage			Year to Year		Change
	March 31,		of Related			March 31,		of Related			Increase		Year over
	2006		Revenues			2005		Revenues			(Decrease)		Year
Cost of revenues:
License	$	136		2	%	$	97		3	%	$	39		40	%
Maintenance and service		7,780		78	%		7,230		66	%		550		8	%
Total cost of revenues	$	7,916				$	7,327				$	589
Gross profit	$	9,041		53	%	$	7,174		49	%	$	1,867		26	%

Revenues

     License Revenues. License revenues increased $3.5 million or 99% in the three months ended March 31, 2006 compared to the three months ended March 31, 2005 primarily due to an increase in sales to new and existing customers and a higher average recognition of revenue per customer. The average license revenue per transaction in the first quarter of 2006 was $0.6 million compared to $0.4 million in the first quarter of 2005. We expect our license revenues to continue to fluctuate from quarter to quarter since we generally

22

complete a relatively small number of transactions in a quarter and the prices on those software license sales can vary widely.

     Maintenance and Service Revenues. Maintenance and service revenues decreased $1.0 million or 9% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The decrease is the result of a decline in configuration and implementation engagements by our consulting organization, partially offset by growth in our maintenance revenues and On-Demand revenues. The decline in configuration and implementation engagements resulted from our customers increasingly choosing third parties to perform these services, combined with the residual effects of our license revenue decline in the first half of 2005. We plan to continue to invest in our new On-Demand and other services offerings. We expect this investment to result in increased service revenues, but possibly at a lower related gross margin than we experienced in 2005. In addition, service revenues may continue to be negatively affected to the extent our customers select a third-party to implement our software rather than us. We expect continued growth in maintenance revenues in 2006 driven by product sales to new customers and renewals on existing contracts.

Cost of Revenues and Gross Margin

     Cost of License Revenues. Cost of license revenues increased $39,000 or 40% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily the result of royalties paid on our increased license revenues discussed above. We do not anticipate any changes in 2006 to our third-party technology agreements, under which we license rights to certain technology incorporated into our products. Accordingly, we expect license gross margins to remain at or above 95% for 2006.

     Cost of Maintenance and Service Revenues. Cost of maintenance and service revenues increased $550,000 or 8% for the three months ended March 31, 2006 compared to March 31, 2005. The increase is primarily due to the introduction of our On-Demand and other new service offerings coupled with an increase in stock-based compensation resulting from the adoption of SFAS 123R. This increase is partially offset by a decrease due to a reduction in service revenues as discussed above.

     Gross Margin. Our overall gross margin increased from 49% for the three months ended March 31, 2005 to 53% for the three months ended March 31, 2006. The increase in our gross margin is attributable primarily to the shift in revenue mix to higher margin license revenues, which represented 41% of our total revenues in the three months ended March 31, 2006 compared to 24% of total revenues in the three months ended March 31, 2005. The increase was partially offset by a decline in maintenance and service gross margin, driven primarily by lower utilization rates resulting from the decline in configuration and implementation engagements. In the future, we expect our gross margins to fluctuate depending on the mix of license versus maintenance and service revenues recorded as well as stock-based compensation resulting from the adoption of SFAS 123R.

Operating Expenses

     The table below sets forth the changes in operating expenses for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 (in thousands, except percentage data):

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	Three					Three							Percentage
	Months					Months							of Dollar
	Ended		Percentage			Ended		Percentage			Year to Year		Change
	March 31,		of Total			March 31,		of Total			Increase		Year over
	2006		Revenues			2005		Revenues			(Decrease)		Year
Operating expenses:
Sales and marketing	$	6,190		37	%	$	4,538		31	%	$	1,652		36	%
Research and development		3,570		21	%		3,075		21	%		495		16	%
General and administrative		3,087		18	%		2,342		16	%		745		32	%
Total operating expenses	$	12,847		76	%	$	9,955		69	%	$	2,892		29	%

     Sales and Marketing. Sales and marketing expenses increased $1.7 million or 36% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily attributable to increases in personnel compensation-related costs of $1.1 million, travel and expenses of $0.2 million, marketing and advertising costs of $0.2 million, recruitment costs of $0.1 million and $0.1 million due to the expensing of stock-based compensation resulting from the adoption of SFAS 123R. Excluding commissions, which vary as a function of sales, we expect sales and marketing expenses to increase slightly over the remainder of 2006 as we invest in sales and marketing efforts to drive further revenue growth.

     Research and Development. Research and development expenses increased $0.5 million or 16% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily due to increases in personnel compensation-related costs of $0.3 million, professional fees of $0.1 million and $0.1 million due to the expensing of stock-based compensation resulting from the adoption of SFAS 123R. We expect our research and development expense to increase slightly over the remainder of 2006 due to a planned increase in headcount associated with an acceleration of our product development efforts.

     General and Administrative. General and administrative expenses increased $0.7 million or 32% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily due to increases of $0.3 million in personnel costs, $0.3 million due to the expensing of stock-based compensation resulting from the adoption of SFAS 123R and $0.1 million due to travel and expenses. We expect general and administrative expenses to increase slightly over the remainder of 2006 primarily due to external audit and professional fees, including costs to test our compliance with Section 404 of the Sarbanes-Oxley Act.

Stock-Based Compensation

     The following table sets forth a summary of our stock compensation expenses in absolute dollars and expressed as a percentage of total revenues for the three months ended March 31, 2006 and 2005.

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	Three					Three
	Months					Months
	Ended		Percentage			Ended		Percentage
	March 31,		of Total			March 31,		of Total
	2006		Revenues			2005		Revenues
Stock-based compensation:
Cost of maintenance and service revenues	$	264		2	%	$	50		0	%
Sales and marketing		266		2	%		126		1	%
Research and development		247		1	%		124		1	%
General and administrative		432		3	%		140		1	%
Total stock-based compensation	$	1,209		7	%	$	440		3	%

     For the three months ended March 31, 2006, we accounted for stock-based compensation under SFAS 123R, while for the three months ended March 31, 2005, we accounted for stock-based compensation under APB No. 25. Under APB No. 25, we were generally required to record compensation expense only if there were positive differences between the market value of our common stock and the exercise price of the options granted to employees on the date of the grant. Under SFAS 123R, however, we record compensation expense for all share-based payments made to employees based on the fair value at the date of the grant. The amounts are not comparable because they were recorded under different accounting standards (see Note 7 – Stock-based Compensation).

     We expect our stock-based compensation expense for remaining quarters in 2006 to approximate the amount recorded in the first quarter of 2006, but is subject to the grant of new options, cancellation of existing options due to employee turnover and changes in the assumptions and estimates to calculate fair value.

Other Items

     The table below sets forth the changes in other items for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 (in thousands, except percentage data):

	Three					Three									Percentage
	Months					Months									of Dollar
	Ended		Percentage			Ended			Percentage			Year to Year			Change
	March 31,		of Total			March 31,			of Total			Increase			Year over
	2006		Revenues			2005			Revenues			(Decrease)			Year
Other income (expense), net:
Interest expense	$	—		0	%	$	(11	)		0	%	$	11			(100	)%
Interest and other income, net		568		3	%		323			2	%		245			76	%
Total other income, net	$	568		3	%	$	312			2	%	$	256			82	%
Provision for income taxes	$	—		0	%	$	25			0	%	$	(25	)		(100	)%
Cumulative effect of a change in accounting principle	$	128		1	%	$	—			0	%	$	128			100	%

Interest Expense and Interest and Other Income, Net

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     Interest expense decreased $11,000 or 100% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. We did not have any outstanding debt during the three months ended March 31, 2006.

     Interest and other income, net increased $0.2 million or 76% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily attributable to the increase in interest income generated from investments as a result of higher interest rates in the three months ended March 31, 2006 compared to the three months ended March 31, 2005.

     Provision for Income Taxes

     Provision for income taxes was zero for the three months ended March 31, 2006. Provision for income taxes was $25,000 for the three months ended March 31, 2005. The provision was related to income taxes currently payable on income generated from non-U.S. tax jurisdictions and state net worth taxes. We maintained a full valuation allowance against our deferred tax assets based on the determination that it was more likely than not that the deferred tax assets would not be realized.

     Cumulative Effect of a Change in Accounting Principle

     Cumulative effect of a change in accounting principle was $128,000 for the three months ended March 31, 2006 and resulted from the change in accounting principle from APB No. 25 to SFAS 123R. The cumulative effect of a change in accounting principle is generally one time in nature and not expected to occur as part of our normal business on a regular basis. See Note 7 – Stock-based Compensation for further discussion.

Liquidity and Capital Resources

     As of March 31, 2006, we had $60.6 million of cash and cash equivalents and short-term investments.

     Net Cash Used in/Provided by Operating Activities. Net cash used in operating activities was $3.9 million for the three months ended March 31, 2006 while net cash provided by operating activities was $0.6 million for the three months ended March 31, 2005. The significant cash receipts and outlays for the two periods are as follows (in thousands):

	Three Months Ended March 31,
	2006			2005
Cash collections	$	16,449		$	17,729
Payroll related costs		(15,320	)		(11,666	)
Professional services costs		(1,599	)		(1,990	)
Employee expense reports		(1,561	)		(1,037	)
Facilities related costs		(876	)		(871	)
Third-party royalty payments		(163	)		(334	)
Other		(820	)		(1,200	)
Net cash (used in) provided by operating activities	$	(3,890	)	$	631

     Net cash used in operating activities increased $4.5 million for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. The increase was primarily attributable to increases in payroll related costs of $3.7 million as well as a reduction in collections of $1.3 million, partially offset by a decrease of $0.4 million in professional services costs.

     Net Cash Used in/Provided by Investing Activities. Net cash used in investing activities was $1.7 million for the three months ended March 31, 2006 while net cash provided by investing activities was $1.1 million for the three months ended March 31, 2005. Net cash used in investing activities during the three months ended March 31, 2006 was primarily due to purchases of investments of $20.0 million, partially offset by

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proceeds from maturities and sale of investments of $18.4 million compared to purchases of investments of $5.0 million offset by proceeds from maturities and sale of investments of $6.5 million for the three months ended March 31, 2005. Purchases of equipment, software, furniture and leasehold improvements were $0.3 million and $0.4 million for the three months ended March 31, 2006 and March 31, 2005, respectively.

     Net Cash Provided by Financing Activities. Net cash provided by financing activities was approximately $1.1 million and $1.7 million for the three months ended March 31, 2006 and 2005, respectively. Net cash provided by financing activities for the three months ended March 31, 2006 was a result of proceeds from stock option exercises of approximately $1.1 million. Net cash provided by financing activities for the three months ended March 31, 2005 was due to the $1.8 million proceeds from stock option exercises, partially offset by repayments of long-term debt of approximately $149,000.

Contractual Obligations and Commitments

     The following table summarizes our contractual cash obligations and commercial commitments (in thousands) at March 31, 2006. Operating lease obligations that are cancelable upon notice and without significant penalties are not included in the following table.

	Payments due by Period
			Remaining										2011
Contractual Obligations	Total		2006		2007		2008		2009		2010		and beyond
Operating leases	$	9,968	$	1,596	$	2,306	$	2,380	$	2,193	$	1,493	$	—

     In 2004, we had access to a revolving line of credit which expired in March 2005 and was not renewed. We have no off-balance sheet arrangements, with the exception of the above operating lease commitments that have not been recorded in our condensed consolidated financial statements.

     For our New York, New York and San Jose, California offices, we have two certificates of deposit totaling approximately $676,000 as of March 31, 2006 and December 31, 2005, pledged as collateral to secure letters of credit required by our landlords for security deposits.

     We believe our existing cash and investment balances will be sufficient to meet our anticipated short-term and long-term cash requirements as well as the contractual obligations listed above. Our future capital requirements will depend on many factors, including revenues we generate, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, and the continuing market acceptance of our products.

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 exchange rates. We do not hold or issue financial instruments for trading purposes.

     Interest Rate Risk. We invest our cash in a variety of financial instruments, consisting primarily of investments in money market accounts, high quality corporate debt obligations or United States government obligations. Our investments are made in accordance with an investment policy approved by our Board of Directors. All of our investments are classified as available-for-sale and carried at fair value, which is determined based on quoted market prices, with net unrealized gains and losses included in “Accumulated other comprehensive income” in the accompanying consolidated balance sheets.

     Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities, that typically have a shorter duration, may produce less income than

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expected if interest rates fall. Due in part to these factors, our investment income may decrease in the future due to changes in interest rates. At March 31, 2006, the average maturity of our investments was approximately one month and all investment securities had maturities of less than twelve months. The following table presents certain information about our financial instruments at March 31, 2006 that are sensitive to changes in interest rates (in thousands, except for interest rates):

	Expected Maturity
							Total		Total
	1 Year			More Than			Principal		Fair
	or Less			1 Year			Amount		Value
Available-for-sales securities	$	47,558		$	—		$	47,558	$	47,522
Weighted average interest rate		4.39	%		—	%

     Our exposure to market risk also relates to the increase or decrease in the amount of interest expense we must pay on our outstanding debt instruments. As of March 31, 2006, we had no outstanding indebtedness for borrowed money. Therefore, we currently have no exposure to market risk related to our outstanding debt instruments. To the extent we enter into or issue debt instruments in the future, we will have interest expense market risk.

     Foreign Currency Exchange Risk. Our revenues and our expenses, except those related to our United Kingdom, Germany and Australia operations, are generally denominated in United States dollars. For the three months ended March 31, 2006, we earned approximately 19% of our revenue from our international operations. Of this revenue from our international operations, 83% was denominated in United States dollars. As a result, we have relatively little exposure to currency exchange risks and foreign exchange losses have been minimal to date. We expect to continue to do a majority of our business in United States dollars. We have not entered into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we believe our foreign currency exposure has increased, we may consider entering into hedging transactions to help mitigate that risk.

Item 4. Controls and Procedures

     Our chief executive officer and chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were adequate and designed to ensure that material information related to us and our consolidated subsidiaries would be made known to them by others within these entities.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     In July 2004, a purported securities class action complaint was filed in the United States District Court for the Northern District of California against the Company and certain of its present and former executives and directors. Lead plaintiff and lead counsel were appointed by the Court and on November 29, 2004, plaintiff filed a consolidated amended class action complaint (“Complaint”). The Complaint alleged that the Company and certain individual defendants made materially false or misleading statements or omissions in violation of the federal securities laws during the period of January 22, 2004 through June 23, 2004 (the “Class Period”). The Complaint sought to recover damages on behalf of anyone who purchased or otherwise acquired our stock during the Class Period. Following the Company’s motion to dismiss, the complaint was initially dismissed with leave to amend in 2005 and, following plaintiffs’ acknowledgement that they could not amend, the action was dismissed with prejudice.

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     In July and October 2004, two derivative complaints were filed in state and federal court, respectively, against certain of our present and former executives and directors (the “Derivative Complaints”). The Derivative Complaints allege state law breach of fiduciary duty claims arising out of the underlying matters alleged in the securities Complaint identified above. The state court derivative plaintiff has agreed to stay his case and has joined in a first amended complaint filed in the federal derivative case. The Company filed a motion to dismiss the complaint in October 2005. The federal court denied the defendants’ motion to dismiss the amended complaint on March 13, 2006.

     In addition, the Company is from time to time a party to various other litigation matters incidental to the conduct of its business, none of which, at the present time is likely to have a material adverse effect on the Company’s future financial results.

Item 1A. Risk Factors

Factors That Could Affect Future Results

     We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

RISKS RELATED TO OUR BUSINESS

     We have a history of losses, and we cannot assure you that we will achieve and sustain profitability.

     We incurred net losses of $8.6 million and $25.5 million in 2005 and 2004, respectively, and had net income of approximately $0.8 million in 2003. For the three months ended March 31, 2006, we had a net loss of $3.1 million. We expect that our reported expenses will increase in 2006 as we expand our operations domestically and internationally and as we begin expensing stock-based compensation in accordance with SFAS 123R. Consequently, we expect to incur a loss in 2006 and are not sure that we will achieve or sustain profitability on a quarterly or annual basis in the future. If we cannot increase our license revenues to compensate for our greater operating expenses, our future results of operations and financial condition will be negatively affected.

Our quarterly license revenues are dependent on a relatively small number of transactions involving sales of our products to new customers, and any delay or failure in closing one or more of these transactions could adversely affect our results of operations.

     Our quarterly license revenues are typically dependent upon the closing of a relatively small number of transactions involving sales of our products to new customers. As such, variations in the rate and timing of conversion of sales prospects into revenues could result in our failure to meet revenue objectives or achieve or maintain profitability in future periods. In addition, we generally recognize the bulk of our license revenues for a given sale either at the time we enter into the agreement and deliver the product, or over the period in which we perform any services that are essential to the functionality of the product. Unexpected changes in the size of transactions or other contractual terms late in the negotiation process or changes in the mix of contracts we enter into could therefore materially and adversely affect our license revenues in a quarter. Delays or reductions in the amount of customers’ purchases or when we recognize revenues would adversely affect our revenues, results of operations and financial condition.

Our success depends upon our ability to develop new products and enhance our existing products. Failure to successfully introduce new or enhanced products may adversely affect our operating results.

     The enterprise application software market is characterized by:

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• Rapid technological advances in hardware and software development;

• evolving standards in computer hardware, software technology and communications infrastructure;

• changing customer needs; and

• frequent new product introductions and enhancements.

     To keep pace with technological developments, satisfy increasingly sophisticated customer requirements, achieve market acceptance and effectively respond to competitive product introductions, we must quickly identify emerging trends and requirements, accurately define and design enhancements and improvements for existing products and timely introduce new products and services. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results. Further, any new products we develop may not be introduced in a timely manner and may not achieve the broad market acceptance necessary to generate significant revenues. For example, we introduced our new Callidus TrueAnalytics product in December 2005 and sales of this product to date have not been material. If we are unable to successfully and timely develop new products or enhance existing products or if we fail to position and price our products to meet market demand, our business and operating results will be adversely affected.

Our quarterly revenues and operating results are unpredictable and are likely to continue to fluctuate substantially, which may harm our results of operations.

     Our revenues are extremely difficult to forecast and are likely to fluctuate significantly from quarter to quarter due to a number of factors, many of which are wholly or partially beyond our control. For example, in the first six months of 2005 and throughout 2004, our license revenues were substantially lower than expected due to purchasing delays by our customers and failures to close transactions resulting in significant net losses. In addition, we have experienced lower than expected maintenance and service revenues over recent quarters as we have had fewer configuration and implementation engagements than we had forecast. Conversely, our license revenues for the last six months of 2005 and first three months of 2006 were greater than in prior periods primarily as a result of the closing several larger transactions, but there is no assurance that we will continue the recent revenue growth.

     Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of future performance.

     Factors that may cause our quarterly revenue and operating results to fluctuate include:

• The discretionary nature of our customers’ purchase and budget cycles and changes in their budgets for software and related purchases;

• the priority our customers place on the purchase of our products as compared to other information technology and capital acquisitions;

• competitive conditions in our industry, including new products, product announcements and discounted pricing or special payment terms offered by our competitors;

• our ability to hire, train and retain appropriate sales and professional services staff;

• varying size, timing and contractual terms of orders for our products, which may delay the recognition of revenues;

• indeterminate and often lengthy sales cycles;

• strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures,

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	strategic investments or changes in business strategy;
•	merger and acquisition activities among our customers which may alter their buying patterns;
•	our ability to timely complete our service obligations related to product sales;
•	the utilization rate of our professional services personnel and the degree to which we use third-party consulting services;
•	the extent to which our customers elect to engage us versus third parties for configuration and implementation engagements;
•	changes in the average selling prices of our products;
•	timing of product development and new product initiatives;
•	customers’ concerns regarding Sarbanes-Oxley Section 404 compliance and implementing large, enterprise-wide deployments of products, including our products; and
•	changes in the mix of revenues attributable to higher-margin product license revenues as opposed to substantially lower-margin service revenues.

Our products have long sales cycles, which makes it difficult to plan our expenses and forecast our results.

     The sales cycles for our products have historically averaged between six and twelve months, and longer in some cases, to complete. It is therefore difficult to predict the quarter in which a particular sale will close and to plan expenditures accordingly. The period between our initial contact with a potential customer and its purchase of our products and services is relatively long due to several factors, including:

• The complex nature of our products;

• the need to educate potential customers about the uses and benefits of our products;

• the requirement that a potential customer invest significant resources in connection with the purchase and implementation of our products;

• budget cycles of our potential customers that affect the timing of purchases;

• customer requirements for competitive evaluation and internal approval before purchasing our products;

• potential delays of purchases due to announcements or planned introductions of new products by us or our competitors; and

• the lengthy approval processes of our potential customers, many of which are large organizations.

     The failure to complete sales in a particular quarter would reduce our revenues in that quarter, as well as any subsequent quarters over which revenues for the sale would likely be recognized. Given that our license revenues are dependent on a relatively small number of transactions, any unexpected lengthening of the sales cycle in general or for one or more large orders would adversely affect the timing and amount of our revenues.

     In addition, our management makes assumptions and estimates as to the timing and amount of future revenues in budgeting future operating costs and capital expenditures based on estimated closing dates and potential dollar amounts of transactions. Management aggregates these estimates periodically to generate

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our sales forecasts and then evaluates the forecasts to identify trends. Although we have reduced expenses to better align our costs with the expected receipt and amount of revenues, our costs are relatively fixed in the short term. As a result, failure to complete one or more license transactions during a particular quarter would cause our quarterly results of operations to be worse than anticipated.

If we are unable to increase sales of new product licenses, our maintenance and service revenues will be materially and adversely affected.

     While our license revenues have declined from 2003 levels, our maintenance and service revenues have, until recent quarters, remained relatively constant. In recent quarters, however, maintenance and service revenues have been lower than expected due to fewer configuration and implementation engagements than we had forecast. A substantial portion of our maintenance and service revenues, however, is derived from providing professional integration and configuration services associated with product licenses sold in prior periods. As such, if we are unable to increase sales of our product licenses, our maintenance and service revenues will likely decline.

Professional services comprise a substantial portion of our revenues and to the extent our customers choose to use other services providers, our revenues and operating results may decline.

     A substantial portion of our revenues are derived from the performance of professional services, primarily implementation, configuration, training and other consulting services in connection with new product licenses and other ongoing projects. However, there are a number of third party service providers available who offer these professional services and we do not require that our customers use our professional services. To the extent our customers choose to use third party service providers over us, as has happened in recent quarters, our revenues and operating income have been and may continue to be adversely affected, possibly significantly.

Our latest product features and functionality may require existing customers to migrate from their existing versions to more recent versions of our software. If existing customers fail or delay to migrate, our revenues may be harmed.

     We plan to pursue sales of new product modules to existing customers of our TrueComp software. For most of these customers to take advantage of new features and functionality in our latest modules, they may need to migrate to a more current version of our products at additional cost, which they may decline to do or delay. If a sufficient number do not migrate, our ability to sell additional products to these customers, and as a result, our revenues and operating income, may be harmed, possibly significantly.

If we do not compete effectively with competitors, our revenues may not grow and could decline.

     We have experienced, and expect to continue to experience, intense competition from a number of software companies. We compete principally with vendors of EIM software, enterprise resource planning software, and customer relationship management software. Our competitors may announce new products, services or enhancements that better meet the needs of customers or changing industry standards. Increased competition may cause price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, results of operations and financial condition.

     Many of our enterprise resource planning competitors and other potential competitors have significantly greater financial, technical, marketing, service and other resources. Many also have a larger installed base of users, longer operating histories or greater name recognition. Some of our competitors’ products may also be more effective at performing particular EIM system functions or may be more customized for particular customer needs in a given market. Even if our competitors provide products with more limited EIM system functionality than our products, these products may incorporate other capabilities, such as recording and accounting for transactions, customer orders or inventory management data. A product that performs these functions, as well as some of the functions of our software solutions, may be appealing to some customers because it would reduce the number of software applications used to run their business.

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     Our products must be integrated with software provided by a number of our existing or potential competitors. These competitors could alter their products in ways that inhibit integration with our products, or they could deny or delay our access to advance software releases, which would restrict our ability to adapt our products for integration with their new releases and could result in lost sales opportunities.

Our maintenance and service revenues produce substantially lower gross margins than our license revenues, and decreases in license revenues relative to service revenues have harmed, and may again harm, our overall gross margins in the future.

     Our maintenance and service revenues, which include fees for consulting, implementation, maintenance and training, were 71%, 78% and 48% of our revenues for years 2005, 2004 and 2003, respectively. Our maintenance and service revenues have substantially lower gross margins than our license revenues. The decrease in the percentage of total revenues represented by license revenues in 2005 and 2004 as compared to 2003 adversely affected our overall gross margins. Failure to maintain and increase our higher margin license revenues in the future would continue to adversely affect our gross margin and operating results.

     Historically, maintenance and service revenues as a percentage of total revenues have varied significantly from period to period due to fluctuations in licensing revenues, changes in the average selling prices for our products and services, and competitive service providers. In addition, the volume and profitability of services can depend in large part upon:

• Competitive pricing pressure on the rates that we can charge for our professional services;

• the complexity of the customers’ information technology environment;

• the resources directed by customers to their implementation projects; and

• the extent to which outside consulting organizations provide services directly to customers.

     As an example of more recent competitive pressure on our services offerings, many of our potential customers have begun to outsource technology projects offshore to take advantage of lower labor costs. Consequently, we expect some customers to demand lower hourly rates for the professional services we provide, which may erode our margins for our maintenance and service revenues or result in lost business.

     We expect maintenance and services revenue to continue to comprise a substantial majority of our overall revenues for the foreseeable future and any erosion of our margins for our maintenance and service revenue would adversely affect our operating results.

Managing large-scale deployments of our products requires substantial technical implementation and support by us or third-party service providers. Failure to meet these requirements could cause a decline or delay in recognition of our revenues and an increase in our expenses.

     Our customers regularly require large, often enterprise-wide deployments of our products, which require a substantial degree of technical and logistical expertise to implement and support. It may be difficult for us to manage these deployments, including the timely allocation of personnel and resources by us and our customers. Failure to successfully manage the process could harm our reputation both generally and with specific customers and may cause us to lose existing customers, face potential customer disputes or limit the number of new customers that purchase our products, each of which could adversely affect our revenues and increase our technical support and litigation costs.

     Our software license customers have the option to receive implementation, maintenance, training and consulting services from our internal professional services organization or from outside consulting organizations. In the future, we may be required to increase our use of third-party service providers to help meet our implementation and service obligations. If we require a greater number of third-party service providers than are currently available, we will be required to negotiate additional arrangements, which may result in lower gross margins for maintenance or service revenues.

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     If a customer selects a third-party implementation service provider and such implementation services are not provided successfully and in a timely manner, our customers may experience increased costs and errors, which may result in customer dissatisfaction and costly remediation and litigation, any of which could adversely impact our reputation, operating results and financial condition.

A substantial majority of our revenues are derived from TrueComp and related products and services and a decline in sales of these products and services could adversely affect our operating results and financial condition.

     We derive, and expect to continue to derive, a substantial majority of our revenues from our TrueComp product and related products and services. Because we have historically sold our product licenses on a perpetual basis and delivered new versions and enhancements to customers who purchase maintenance contracts, our future license revenues are substantially dependent on new customer sales. We have recently introduced our products on a service-based subscription model, but these services still consist substantially of providing our TrueComp product. In addition, substantially all of our TrueInformation product sales have historically been made in connection with TrueComp sales. As a result of these factors, we are particularly vulnerable to fluctuations in demand for TrueComp. Accordingly, if demand for TrueComp and related products and services declines significantly, our business and operating results will be adversely affected.

If we reduce prices or alter our payment terms to compete successfully, our margins and operating results may be adversely affected.

     The intensely competitive market in which we do business may require us to reduce our prices and/or modify our traditional licensing revenue generation strategies in ways that may delay revenue recognition on all or a portion of our licensing transactions. For example, we recently introduced an On-Demand offering of our product to be sold on a subscription basis in an effort to gain customers that are not interested in purchasing a perpetual license. If our competitors offer deep discounts on competitive products or services, we may be required to lower prices or offer other terms more favorable to our customers in order to compete successfully. Some of our competitors may bundle their competitive software products with their other products and services for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that we can charge for our products. If we cannot offset price reductions and other terms more favorable to our customers with a corresponding increase in the number of sales or decreased spending, then the reduced revenues resulting from lower prices or revenue recognition delays would adversely affect our margins and operating results.

Our products depend on the technology of third parties licensed to us and the loss or inability to maintain these licenses or errors in such software could result in increased costs or delayed sales of our products.

     We license technology from several software providers for our rules engine, analytics and web viewer and we anticipate that we will continue to do so. This software may not continue to be available on commercially reasonable terms, if at all. Some of the products we license could be difficult to replace, and developing or integrating new software with our products could require months or years of design and engineering work. The loss of any of these technology licenses could result in delays in the license of our products until equivalent technology is developed or, if available, is identified, licensed and integrated. In addition, our products depend upon the successful operation of third-party products in conjunction with our products, and therefore any undetected errors in these products could prevent the implementation or impair the functionality of our products, delay new product introductions and/or injure our reputation. Our use of additional or alternative third-party software would require us to enter into license agreements with third parties, which could result in higher royalty payments and a loss of product differentiation.

Errors in our products could be costly to correct, adversely affect our reputation and impair our ability to sell our products.

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     Our products are complex and, accordingly, they may contain errors, or “bugs,” that could be detected at any point in their product life cycle. While we continually test our products for errors and work with customers to timely identify and correct bugs, errors in our products are likely to be found in the future. Any errors could be extremely costly to correct, materially and adversely affect our reputation, and impair our ability to sell our products. Moreover, customers relying on our products to calculate and pay incentive compensation may have a greater sensitivity to product errors and security vulnerabilities than customers for software products in general. If we incur substantial costs to correct any product errors, our operating margins would be adversely affected.

     Because our customers depend on our software for their critical business functions, any interruptions could result in:

• Lost or delayed market acceptance and sales of our products;

• product liability suits against us;

• diversion of development resources; and

• substantially greater service and warranty costs.

Our revenues might be harmed by resistance to adoption of our software by information technology departments.

     Some potential customers have already made a substantial investment in other third-party or internally developed software designed to model, administer, analyze and report on pay-for-performance programs. These companies may be reluctant to abandon these investments in favor of our software. In addition, information technology departments of potential customers may resist purchasing our software solutions for a variety of other reasons, particularly the potential displacement of their historical role in creating and running software and concerns that packaged software products are not sufficiently customizable for their enterprises.

We recently experienced changes in our senior management team. The loss of key personnel or the inability of replacements to quickly and successfully perform in their new roles could adversely affect our business.

     During 2005 we experienced numerous changes in our executive management team, most notably the hiring of Robert Youngjohns as our new president and chief executive officer, Shanker Trivedi as our vice president, chief marketing officer, and Leslie Stretch as our vice president of worldwide sales. Although we do not expect similar changes in 2006, all of our existing personnel, including our executive officers, are employed on an “at will” basis. If we lose or terminate the services of one or more of our current executives or key employees or if one or more of our current or former executives or key employees joins a competitor or otherwise competes with us, it could harm our business and our ability to successfully implement our business plan. Additionally, if we are unable to timely hire qualified replacements for our executive and other key positions, our ability to execute our business plan would be harmed. Even if we can timely hire qualified replacements, we would expect to experience operational disruptions and inefficiencies during any transition.

We may lose sales opportunities and our business may be harmed if we do not successfully develop and maintain strategic relationships to implement and sell our products.

     We have relationships with third-party consulting firms, systems integrators and software vendors. These third parties may provide us with customer referrals, cooperate with us in the design, sales and/or marketing of our products, provide valuable insights into market demands and provide our customers with systems implementation services or overall program management. However, we do not have formal agreements governing our ongoing relationship with certain of these third-party providers and the

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agreements we do have generally do not include obligations with respect to generating sales opportunities or cooperating on future business. Should any of these third parties go out of business or choose not to work with us, we may be forced to develop all or a portion of those capabilities internally, incurring significant expense and adversely affecting our operating margins. Any of our third-party providers may offer products of other companies, including products that compete with our products. If we do not successfully and efficiently establish, maintain, and expand our industry relationships with influential market participants, we could lose sales and service opportunities which would adversely affect our results of operations.

If we fail to adequately protect our proprietary rights and intellectual property, we may lose valuable assets, experience reduced revenues and incur costly litigation to protect our rights.

     Our success and ability to compete is significantly dependent on the proprietary technology embedded in our products. We rely on a combination of copyrights, patents, trademarks, service marks, trade secret laws and contractual restrictions to establish and protect our proprietary rights. We cannot protect our intellectual property if we are unable to enforce our rights or if we do not detect its unauthorized use. Despite our precautions, it may be possible for unauthorized third parties to copy and/or reverse engineer our products and use information that we regard as proprietary to create products and services that compete with ours. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we engage in international activities, our exposure to unauthorized copying and use of our products and proprietary information increases.

     We enter into confidentiality or license agreements with our employees and consultants and with the customers and corporations with whom we have strategic relationships. No assurance can be given that these agreements will be effective in controlling access to and distribution of our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products. Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources, either of which could seriously harm our business.

Our results of operations may be adversely affected if we are subject to a protracted infringement claim or one that results in a significant damage award.

     From time to time, we receive claims that our products or business infringe or misappropriate the intellectual property rights of third parties and our competitors or other third parties may challenge the validity or scope of our intellectual property rights. We believe that claims of infringement are likely to increase as the functionality of our products expands and as new products are introduced. A claim may also be made relating to technology that we acquire or license from third parties. If we were subject to a claim of infringement, regardless of the merit of the claim or our defenses, the claim could:

• Require costly litigation to resolve;

• absorb significant management time;

• cause us to enter into unfavorable royalty or license agreements;

• require us to discontinue the sale of all or a portion of our products;

• require us to indemnify our customers or third-party systems integrators; or

• require us to expend additional development resources to redesign our products.

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     In addition, we use a limited amount of open source software in our products and may use more in the future. From time to time there have been claims challenging the ownership of open source software against companies that incorporate open source software into their products. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software.

If we do not adequately manage and evolve our financial reporting and managerial systems and processes, our ability to manage and grow our business may be harmed.

     Our ability to successfully implement our business plan and comply with regulations, including the Sarbanes-Oxley Act of 2002, requires an effective planning and management process. We expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures and controls to manage our business effectively in the future. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to accurately forecast sales demand, manage our system integrators and other third party service vendors and record and report financial and management information on a timely and accurate basis. Additionally, as we prepare to comply with Section 404 of the Sarbanes-Oxley Act, we may identify one or more material weaknesses in our financial controls. The existence or disclosure of any such material weaknesses could adversely affect our stock price.

We may expand our international operations but we do not have substantial experience in international markets, and may not achieve the expected results.

     We expect to expand our international operations in 2006. For example, we have begun increasing the number of sales personnel in our subsidiaries overseas. International expansion may require substantial financial resources and a significant amount of attention from our management. International operations involve a variety of risks, particularly:

• Unexpected changes in regulatory requirements, taxes, trade laws and tariffs;

• differing ability to protect our intellectual property rights;

• differing labor regulations;

• greater difficulty in supporting and localizing our products;

• greater difficulty in establishing, staffing and managing foreign operations; and

• fluctuating exchange rates.

     We have limited experience in marketing, selling and supporting our products and services abroad. If we invest substantial time and resources to grow our international operations and fail to do so successfully and timely, our business and operating results could be seriously harmed.

Class action and derivative lawsuits have been filed against us and additional lawsuits may be filed.

     In July 2004, a purported class action lawsuit was filed against us and certain of our current directors and officers, by or on behalf of persons claiming to be our shareholders and persons claiming to have purchased or otherwise acquired our securities during the period from November 19, 2003 through June 23, 2004. In addition, in July and October 2004, derivative lawsuits were filed in state and federal courts, respectively, against certain of our present and former executives and directors. In February 2005, the parties stipulated to a stay of the state derivative cases in favor of the federal derivative case. In February 2005, we filed a motion to dismiss the amended complaint in the federal securities case. In May 2005 the court granted our motion and granted plaintiffs leave to amend. The plaintiffs declined to amend the complaint and the court thereafter entered a dismissal with prejudice on July 5, 2005.

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     The remaining derivative cases are still pending and on September 30, 2005, plaintiffs in the federal derivative case filed an amended complaint. The Company thereafter filed a motion to dismiss the amended complaint on October 14, 2005. The federal court denied the defendants’ motion to dismiss the amended complaint on March 13, 2006. Regardless of the outcome of any of these actions, it is likely that such actions will cause a diversion of our management’s time and attention.

RISKS RELATED TO OUR STOCK

Our stock price is likely to remain volatile.

     The trading price of our common stock has in the past and may in the future be subject to wide fluctuations in response to a number of factors, including those listed in this “Risks Related to Our Business” section above and in this section below. We receive only limited attention by securities analysts, and there frequently occurs an imbalance between supply and demand in the public trading market for our common stock due to limited trading volumes. Investors should consider an investment in our common stock as risky and should only purchase our common stock if they can withstand significant losses. Other factors that affect the volatility of our stock include:

• Our operating performance and the performance of other similar companies;

• announcements by us or our competitors of significant contracts, results of operations, projections, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;

• changes in our management team;

• publication of research reports about us or our industry by securities analysts; and

• developments with respect to intellectual property rights.

     Additionally, some companies with volatile market prices for their securities have been subject to securities class action lawsuits filed against them, any future suits such as these could have a material adverse effect on our business, results of operations, financial condition and the price of our common stock.

Future sales of substantial amounts of our common stock by us or our existing stockholders could cause our stock price to fall.

     Additional equity financings or other share issuances by us could adversely affect the market price of our common stock. Sales by existing stockholders of a large number of shares of our common stock in the public trading market (or in private transactions) including sales by our executive officers, directors or venture capital funds or other persons or entities affiliated with our officers and directors or the perception that such additional sales could occur, could cause the market price of our common stock to drop.

Provisions in our charter documents, our stockholder rights plan and Delaware law may delay or prevent an acquisition of our company.

     Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. For example, if a potential acquirer were to make a hostile bid for us, the acquirer would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms, which means that replacing a majority of our directors would require at least two annual meetings. The acquirer would also be required to provide advance notice of its proposal to replace directors at any annual meeting, and would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on the board of directors than if cumulative voting were permitted. In addition, we are a party to a stockholder rights agreement, which effectively prohibits a person from acquiring more than 15% (subject to certain exceptions) of our common stock without the approval of our board of directors. Furthermore, Section 203 of the Delaware General

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Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. All of these factors make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders. Our board of directors could choose not to negotiate with an acquirer that it does not believe is in our strategic interests. If an acquirer is discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by these or other measures, you could lose the opportunity to sell your shares at a favorable price.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     We continue to use the net proceeds of our initial public offering for working capital and general corporate purposes, including expanding our sales efforts, research and development and international operations. Pending use for these or other purposes, we have invested the net proceeds of the offering in interest-bearing, investment-grade securities.

Item 6. Exhibits

(a) Exhibits

Exhibit
Number	Description
10.18	Amended and Restated 2003 Stock Incentive Plan
31.1	302 Certification
31.2	302 Certification
32.1	906 Certification

Availability of this Report

     We intend to make this quarterly report on Form 10-Q publicly available on our website (www.callidussoftware.com) without charge immediately following our filing with the Securities and Exchange Commission. We assume no obligation to update or revise any forward-looking statements in this quarterly report on Form 10-Q, whether as a result of new information, future events or otherwise, unless we are required to do so by law.

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 on May 12, 2006.

CALLIDUS SOFTWARE INC.
By:	/s/ RONALD J. FIOR Ronald J. Fior
	Chief Financial Officer,
	Senior Vice President, Finance and Operations

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EXHIBIT INDEX
TO
CALLIDUS SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006

Exhibit
Number	Description
10.18	Amended and Restated 2003 Stock Incentive Plan
31.1	302 Certification
31.2	302 Certification
32.1	906 Certification

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EX-10.18

EXHIBIT 10.18

CALLIDUS SOFTWARE INC.
2003 STOCK INCENTIVE PLAN
(Amended and Restated as of April 24, 2006)

     1. Purposes of the Plan. The purposes of this Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Employees, Directors and Consultants and to promote the success of the Company’s business.

     2. Definitions. As used herein, the following definitions shall apply:

     (a) “Administrator” means the Board or any of its Committees as shall be administering the Plan in accordance with Section 4 hereof.

     (b) “Applicable Laws” means the requirements relating to the administration of stock plans under U.S. state corporate laws, U.S. federal and state securities laws, the Code, any stock exchange or quotation system on which the Common Stock is listed or quoted and the applicable laws of any other country or jurisdiction where Awards are granted under the Plan.

     (c) “Award” means any Option or other stock-based award granted under this Plan.

     (d) “Board” means the Board of Directors of the Company.

     (e) “Code” means the U.S. Internal Revenue Code of 1986, as amended.

     (f) “Committee” means a committee of Directors appointed by the Board in accordance with Section 4 hereof.

     (g) “Common Stock” means the common stock, par value $0.001 per share, of the Company.

     (h) “Company” means Callidus Software Inc., a Delaware corporation.

     (i) “Consultant” means any person who is engaged by the Company or any Parent or Subsidiary to render consulting or advisory services to such entity.

     (j) “Director” means a member of the Board of Directors of the Company.

     (k) “Employee” means any person employed by the Company or any Parent or Subsidiary of the Company. A Service Provider shall not cease to be an Employee in the case of (i) any leave of absence approved by the Company or protected as a matter of local law or (ii) transfers between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. Neither service as a Director nor payment of a

director’s fee by the Company shall be sufficient to constitute “employment” by the Company.

     (l) “Exchange Act” means the U.S. Securities Exchange Act of 1934, as amended.

     (m) “Fair Market Value” means, as of any date, the value of Common Stock determined as follows:

     (i) If the Common Stock is listed on any established stock exchange or traded on the Nasdaq National Market or the Nasdaq SmallCap Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system on the date of determination (or if such date is not a trading date, on the previous trading date), as reported in The Wall Street Journal or such other source as the Administrator deems reliable;

     (ii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator.

     (n) “Incentive Stock Option” means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code.

     (o) “Nonstatutory Stock Option” means an Option not intended to qualify as an Incentive Stock Option.

     (p) “Option” means a stock option granted pursuant to the Plan.

     (q) “Option Agreement” means an agreement evidencing the terms and conditions of an individual Option grant. Any Option Agreement is subject to the terms and conditions of the Plan.

     (r) “Optionee” means the holder of an outstanding Option granted under the Plan.

     (s) “Outside Director” means a Director who is not an Employee.

     (t) “Participant” means the holder of an outstanding Award granted under the Plan.

     (u) “Parent” means a “parent corporation,” whether now or hereafter existing, as defined in Section 424(e) of the Code.

     (v) “Plan” means this 2003 Stock Incentive Plan.

     (w) “Rule 16b-3” means Rule 16b-3 of the Exchange Act or any successor to Rule 16b-3.

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     (x) “Service Provider” means an Employee, Director or Consultant.

     (y) “Share” means a share of the Common Stock, as adjusted in accordance with Section 13 below.

     (z) “Subsidiary” means a “subsidiary corporation,” whether now or hereafter existing, as defined in Section 424(f) of the Code.

3. Stock Subject to the Plan.

     (a) Subject to the provisions of Section 13 of the Plan, the maximum aggregate number of Shares which may be issued under the Plan is 2,000,000 shares, plus (x) any Shares remaining available for grant of awards under the Company’s 1997 Stock Option Plan on the effective date of the Plan and (y) an annual increase on July 1 of each year during the term of the Plan beginning July 1, 2004, in each case in an amount equal to the lesser of (i) 2,800,000 shares, (ii) 5.0% of the outstanding shares on the immediately preceding date or (iii) an amount determined by the Board. The Shares may be authorized but unissued, or reacquired, shares or treasury shares.

     (b) No Participant may receive Options and stock appreciation rights under the Plan in any calendar year that relate to more than 1,500,000 Shares.

     (c) If any Shares covered by an Award, or to which such an Award relates, are forfeited, or if an Award otherwise terminates in whole or in part without the delivery of the full number of Shares related thereto, then the Shares covered by such Award, or to which such Award relates, to the extent of any such forfeiture or termination, shall again be, or shall become, available for issuance under the Plan. Shares that have been issued but are repurchased by, or surrendered or forfeited to, the Company shall become available for future grant under the Plan. For purposes of this paragraph, awards and options granted under the Company’s 1997 Stock Option Plan shall be treated as Awards.

4. Administration of the Plan.

     (a) The Plan shall be administered by the Board or a Committee appointed by the Board, which Committee shall be constituted to comply with Applicable Laws.

     (i) To the extent that the Administrator determines it to be desirable to qualify Awards granted hereunder as “performance-based compensation” within the meaning of Section 162(m) of the Code, the Plan shall be administered by a Committee of two or more “non-employee directors” within the meaning of Section 162(m) of the Code.

     (ii) To the extent desirable to qualify transactions hereunder as exempt under Rule 16b-3, the transactions contemplated hereunder shall be structured to satisfy the requirements for exemption under Rule 16b-3.

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     (b) Subject to the provisions of the Plan and, in the case of a Committee, the specific duties delegated by the Board to such Committee, and subject to the approval of any relevant authorities, the Administrator shall have the authority in its discretion:

     (i) to determine the Fair Market Value;

     (ii) to select the Service Providers to whom Awards may from time to time be granted hereunder;

     (iii) to determine the number of Shares to be covered by each such award granted hereunder;

     (iv) to approve forms of agreement for use under the Plan;

     (v) to determine the terms and conditions, of any Award granted hereunder. Such terms and conditions include, but are not limited to, the exercise price, the time or times when Awards may be exercised (which may be based on performance criteria), any vesting acceleration or waiver of forfeiture restrictions, and any restriction or limitation regarding any Award or the Common Stock relating thereto, based in each case on such factors as the Administrator, in its sole discretion, shall determine;

     (vi) to amend the terms of any Award; provided that (A) no such amendment shall directly or indirectly reduce the exercise price of any Award without the approval of the Company’s stockholders and (B) no such amendment shall impair the rights of any Participant without the consent of the Participant;

     (vii) to grant Awards with such terms as the Administrator deems necessary or appropriate in order to comply with or take advantage of the laws of any jurisdiction in which a Participant resides or is employed or to establish a sub-plan under this Plan for such purposes;

     (viii) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations relating to sub-plans established by the Administrator for the purpose of qualifying for preferred tax treatment under foreign tax laws or complying with foreign securities or other legal requirements;

     (ix) to allow Participants to satisfy withholding tax obligations by electing to have the Company withhold from the Shares to be issued upon exercise of an Award that number of Shares having a Fair Market Value equal to the amount required to be withheld; and

     (x) to construe and interpret the terms of the Plan and awards granted pursuant to the Plan.

     (c) All decisions, determinations and interpretations of the Administrator shall be final and binding on all Participants.

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     5. Eligibility.

     (a) Awards may be granted to Service Providers as determined by the Administrator in its sole discretion, except that Incentive Stock Options may be granted only to Employees.

     (b) Neither the Plan nor any Award shall confer upon any Participant any right with respect to continuing the Participant’s relationship as a Service Provider with the Company or its Subsidiary, nor shall it interfere in any way with his or her right or the right of the Company or its Subsidiary, as appropriate, to terminate such relationship at any time, with or without cause.

     6. Term of Plan. The Plan shall become effective as determined by the Board. It shall continue in effect for a term of ten years unless sooner terminated under Section 14 of the Plan.

     7. Terms of Options.

     (a) The term of each Option shall be stated in the Option Agreement; provided that the term shall be no more than ten (10) years from the date of grant thereof. In the case of an Incentive Stock Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant or such shorter term as may be provided in the Option Agreement.

     (b) Each Option shall be designated in the Option Agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designation, to the extent that the aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Optionee during any calendar year (under all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 7(b), Incentive Stock Options shall be taken into account in the order in which they were granted. The Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted.

     (c) The per share exercise price for the Shares to be issued upon exercise of an Option shall be such price as is determined by the Administrator, but in the case of any Incentive Stock Option shall be subject to the following:

     (A) the exercise price of any Incentive Stock Option granted to an Employee who, at the time of grant of such Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary shall be no less than 110% of the Fair Market Value per Share on the date of grant; and

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     (B) the exercise price of any Incentive Stock Option granted to any other Employee shall be no less than 100% of the Fair Market Value per Share on the date of grant.

     (d) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant). Such consideration may consist of (1) cash, (2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares acquired upon exercise of an Option, have been owned by the Optionee for more than six months on the date of surrender, and (y) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which such Option shall be exercised, (5) consideration received by the Company under a cashless exercise program implemented by the Company in connection with the Plan, or (6) any combination of the foregoing methods of payment. In making its determination as to the type of consideration to accept, the Administrator shall consider if acceptance of such consideration may be reasonably expected to benefit the Company.

8. Exercise of Option.

     (a) Any Option granted hereunder shall be exercisable according to the terms hereof at such times and under such conditions as determined by the Administrator and set forth in the Option Agreement. Unless the Administrator provides otherwise or unless required by local law, vesting of Options granted hereunder shall be tolled during any unpaid leave of absence. An Option may not be exercised for a fraction of a Share.

     (b) An Option shall be deemed exercised when the Company receives: (i) written or electronic notice of exercise (in accordance with the Option Agreement) from the person entitled to exercise the Option, and (ii) full payment for the Shares with respect to which the Option is exercised. Full payment may consist of any consideration and method of payment authorized by the Administrator and permitted by the Option Agreement and the Plan. Shares issued upon exercise of an Option shall be issued in the name of the Optionee or, if requested by the Optionee, in the name of the Optionee and his or her spouse. Until the Shares are issued (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company), no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Shares, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such Shares promptly after the Option is exercised. No adjustment will be made for a dividend or other right for which the record date is prior to the date the Shares are issued, except as provided in Section 13 of the Plan.

     (c) Exercise of an Option in any manner shall result in a decrease in the number of Shares thereafter available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised.

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     9. Termination of Relationship as a Service Provider.

     (a) Termination. If an Optionee ceases to be a Service Provider, such Optionee may exercise his or her Option within such period of time as is specified in the Option Agreement (of at least 30 days) to the extent that the Option is vested on the date of termination (but in no event later than the expiration of the term of the Option as set forth in the Option Agreement). In the absence of a specified time in the Option Agreement, the vested portion of the Option shall remain exercisable for 90 days following the Optionee’s termination. If, after termination, the Optionee does not exercise his or her Option within the time specified herein or in the Option Agreement, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

     (b) Disability of Optionee. If an Optionee ceases to be a Service Provider as a result of the Optionee’s disability, the Optionee may exercise an Option to the extent the Option is vested as of the date of termination, but only within 12 months from the date of such termination (and in no event later than the expiration date of the term of such Option as set forth in the Option Agreement). If such disability is not a “disability” as such term is defined in Section 22(e)(3) of the Code, in the case of an Incentive Stock Option such Incentive Stock Option shall automatically cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option on the day three months and one day following such termination. If, after termination, the Optionee does not exercise his or her Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

     (c) Death of Optionee. If an Optionee dies while a Service Provider, the Option may be exercised at any time within 12 months following the date of death (but in no event later than the expiration of the term of such Option as set forth in the Option Agreement) to the extent vested as of the date of death. The Option may be exercised by the executor or administrator of the Optionee’s estate or, if none, by the person(s) entitled to exercise the Option under the Optionee’s will or the laws of descent or distribution. If the Option is not so exercised within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan.

     (d) Buyout Provisions. The Administrator may at any time offer to buy out, for a payment in cash or Shares, an Award previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Participant at the time that such offer is made.

     10. Formula Grants to Outside Directors. Options may be granted to Outside Directors in accordance with the policies established from time to time by the Board specifying the number of shares (if any) to be subject to each such award and the time(s) at which such awards shall be granted. The current policy with respect to Options granted to Outside Directors under this Section effective as of the date set forth under the title of this Plan and continuing until modified or revoked by the Board from time to time, is as follows:

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     (a) Initial Grants. As of the date on which any Outside Director first becomes a member of the Board, whether by election by the stockholders or appointment by the Board, such individual shall be granted automatically a Nonstatutory Stock Option to purchase 45,000 Shares (an “Initial Option”).

     (b) Annual Grants. Immediately after the Company’s regularly scheduled annual meeting of stockholders each year, the following grants shall be made (each, an “Annual Option”):

     (i) Each Outside Director shall be granted automatically a Nonstatutory Stock Option to purchase 15,000 Shares; provided that if such Outside Director has served on the Board for less than one year, the number of Shares subject to such Annual Option shall be reduced pro rata based on the portion of the year that such Outside Director has served on the Board.

     (ii) The chair of the Audit Committee shall be granted automatically a Nonstatutory Stock Option to purchase 10,000 Shares; provided that if such Director has served in such capacity for less than one year, the number of Shares subject to such Annual Option shall be reduced pro rata based on the portion of the year that such Director has served in such capacity.

     (iii) The chair of the Compensation Committee and the Nominating and Corporate Governance Committee each shall be granted automatically a Nonstatutory Stock Option to purchase 5,000 Shares; provided that if such Director has served in such capacity for less than one year, the number of Shares subject to such Annual Option shall be reduced pro rata based on the portion of the year that such Director has served in such capacity.

     (c) Terms of Options. Options granted to Outside Directors pursuant to this Section 10 shall be on the following terms, unless otherwise determined by the Board:

     (i) The exercise price per Share shall be 100% of the Fair Market Value per Share on the date of grant of the Option.

     (ii) Each Initial Option shall vest and become exercisable over four years, with the first 25% vesting on the first anniversary of the grant date and the remainder vesting monthly thereafter.

     (iii) Each Annual Option shall be fully vested and exercisable immediately.

     (iv) The term of each such Option shall be five years unless otherwise specified in the Option Agreement, provided that the term may not exceed ten (10) years.

     11. Non-Transferability of Awards. Except as otherwise determined by the Administrator, Awards may not be sold, pledged, assigned, hypothecated, transferred, or

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disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Participant, only by the Participant.

     12. Other Stock Awards. The Administrator is hereby authorized to grant to Participants such other Awards (including, without limitation, grants of restricted stock, restricted stock units, stock bonus awards, and stock appreciation rights) that are denominated or payable in, valued in whole or in part by reference to, or otherwise based on or related to, Shares (including, without limitation, securities convertible into Shares) as are deemed by the Administrator to be consistent with the purposes of the Plan. Subject to the terms of the Plan, the Administrator shall determine the terms and conditions of such Awards, which shall be set forth in an Award Agreement.

     13. Adjustments Upon Changes in Capitalization, Merger or Asset Sale.

     (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each outstanding Award, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Awards have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Award, as well as the price per share of Common Stock covered by each such outstanding Award, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company. The conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Award.

     (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify each Participant as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for a Participant to have the right to exercise his or her Award prior to such transaction, including Shares as to which the Award would not otherwise be exercisable. In addition, the Administrator may provide that any Company repurchase option applicable to any Shares purchased upon exercise of an Award shall lapse as to all such Shares, provided the proposed dissolution or liquidation takes place at the time and in the manner contemplated. To the extent it has not been previously exercised, an Award will terminate immediately prior to the consummation of such proposed action.

     (c) Merger or Asset Sale. In the event of a merger of the Company with or into another corporation, or the sale of all or substantially all of the assets of the Company, each outstanding Award shall be continued or assumed or an equivalent award substituted by the Company or the successor corporation or a Parent or Subsidiary of the

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successor corporation. In the event that any Award is not so continued, assumed or substituted, such Award shall become fully vested and exercisable. If an Award becomes fully vested and exercisable in lieu of continuation, assumption or substitution, the Administrator shall notify the Participant in writing or electronically that the Award shall be fully exercisable for a period of no less than 15 days from the date of such notice, and the Award shall terminate upon the expiration of such period. For the purposes of this paragraph, the Award shall be considered assumed if, following the merger or sale of assets, the option or right confers the right to purchase or receive, for each Share subject to the Award immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided that if such consideration received is not solely common stock of the successor corporation or its Parent, the Administrator may provide for the consideration to be received upon the exercise of the Award, for each Share subject to the Award, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock.

     14. Amendment and Termination of the Plan.

     (a) Amendment and Termination. The Board may at any time amend, alter, suspend or terminate the Plan.

     (b) Stockholder Approval. The Board shall obtain stockholder approval of any Plan amendment to the extent necessary and desirable to comply with Applicable Laws.

     (c) Effect of Amendment or Termination. No amendment, alteration, suspension or termination of the Plan by the Board shall impair the rights of any Participant with the consent of the Participant. Termination of the Plan shall not affect the Administrator’s ability to exercise the powers granted to it hereunder with respect to Awards granted under the Plan prior to the date of such termination.

     15. Conditions Upon Issuance of Shares.

     (a) Legal Compliance. Shares shall not be issued pursuant to any Award granted hereunder unless the issuance and delivery of such Shares shall comply with Applicable Laws.

     (b) Tax Withholding. The Administrator shall require payment of any amount the Company may determine to be necessary to withhold for any income, employment or social insurance taxes or contributions, as applicable, as a result of the exercise of an award.

     16. Inability to Obtain Authority. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the

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Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained.

     17. Stockholder Approval. The Plan shall be subject to approval by the stockholders of the Company within twelve (12) months after the date the Plan is adopted. Such stockholder approval shall be obtained in the degree and manner required under Applicable Laws.

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EX-31.1

EXHIBIT 31.1

302 CERTIFICATION

I, Robert H. Youngjohns, certify that:

1.	I have reviewed this quarterly report of Callidus Software Inc. on Form 10-Q;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of this annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 12, 2006	/s/ ROBERT H. YOUNGJOHNS Robert H. Youngjohns
	President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

302 CERTIFICATION

I, Ronald J. Fior, certify that:

1.	I have reviewed this quarterly report of Callidus Software Inc. on Form 10-Q;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of this annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 12, 2006
	/s/ RONALD J. FIOR Ronald J. Fior
	Chief Financial Officer,
	Senior Vice President, Finance and Operations

EX-32.1

EXHIBIT 32.1

906 CERTIFICATION

     The certification set forth below is being submitted in connection with this quarterly report of Callidus Software Inc. on Form 10-Q (the “Report”) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code.

     Robert H. Youngjohns, the Chief Executive Officer and Ronald J. Fior, the Chief Financial Officer of Callidus Software Inc., each certifies that, to the best of his knowledge:

1.	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and
2.	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Callidus Software Inc.

Date: May 12, 2006
	/s/ ROBERT H. YOUNGJOHNS
	Robert H. Youngjohns
	President and Chief Executive Officer
	/s/ RONALD J. FIOR
	Ronald J. Fior
	Chief Financial Officer,
	Senior Vice President, Finance and Operations