Form 10-Q

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x YES ¨ NO

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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ YES x NO

On October 31, 2007, approximately 36,832,485 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

See accompanying notes to unaudited condensed consolidated financial statements.

Kana Software, Inc. and its subsidiaries (the “Company” or “KANA”) were incorporated in July 1996 in California and reincorporated in Delaware in September 1999. KANA develops, markets and supports customer communications software products. The Company sells its products primarily in the United States and Europe, and to a lesser extent, in Asia, through its direct sales force and third party integrators. References to “we,” “our” and “us” and “Company” collectively refer to KANA, our predecessor and our subsidiaries and their predecessors.

The unaudited condensed consolidated financial statements include the accounts of KANA and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.

The unaudited condensed consolidated financial statements have been prepared by KANA and reflect all normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2007. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with KANA’s audited consolidated financial statements and notes included in KANA’s Annual Report on Form 10-K for the year ended December 31, 2006, filed with the SEC on April 2, 2007. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Restatement Relating to Stock-Based Compensation and Other Revenue and Expense Items

The financial information as of and for the three and nine months ended September 30, 2006 is restated since it has been revised from the amounts previously stated in our Quarterly Report on Form 10-Q filed with the SEC on November 13, 2006. Subsequent to the issuance of the Company’s interim condensed consolidated financial statements for the quarter ended September 30, 2006, the Company determined that non-cash compensation expenses relating to certain options granted in 1999 were incorrectly recorded in the first, second and third quarters of 2006. Additionally, certain other revenue and expense items were recorded in the improper quarter within 2006. The restatement is further discussed in Note 14 of the consolidated financial statements in the Company’s Form 10-K for the year ended December 31, 2006 filed with the SEC on April 2, 2007.

The preparation of the interim unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ materially from those estimates.

The Company recognizes revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” (“SOP 97-2”), as amended.

Revenue from software license agreements is recognized when the basic criteria of software revenue recognition have been met (i.e. persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collection is probable). The Company uses the residual method described in AICPA SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” (“SOP 98-9”), to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and vendor-specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as license revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

For all sales the Company uses either a signed license agreement, a signed amendment to an existing license agreement, a signed order form, a binding purchase order where we either have a signed master license agreement or an order form signed by the customer, or a signed statement of work as evidence of an arrangement.

Software delivery is primarily by electronic means. If the software or other deliverable is subject to acceptance for a specified period after the delivery, revenue is deferred until the acceptance period has expired or the acceptance provision has been met.

When licenses are sold together with consulting services, license fees are recognized upon delivery, provided that (1) the basic criteria of software revenue recognition have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the consulting services do not provide significant customization of the software products and are not essential to the functionality of the software that was delivered. The Company does not provide significant customization of its software products.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable, and the Company generally does not recognize revenue on these arrangements until the customer payments become due and all other revenue recognition criteria have been met.

Probability of collection is based upon assessment of the customer’s financial condition through review of their current financial statements or publicly-available credit reports. For sales to existing customers, prior payment history is also considered in assessing probability of collection. The Company is required to exercise significant judgment in deciding whether collectibility is reasonably assured, and such judgments may materially affect the timing of our revenue recognition and our results of operations.

Services revenues include revenues for consulting services, customer support and training, OnDemand and hosting. Consulting services revenues are generally recognized on a time and materials basis. For consulting services contracts that have a fixed fee, the Company recognizes the license and professional consulting services revenues using either the percentage-of-completion method or the completed contract method as prescribed by AICPA SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts” (“SOP 81-1”). KANA’s consulting arrangements do not include significant customization of the software. Customer support agreements provide technical support and the right to unspecified future upgrades on an if-and-when available basis. Customer support revenues are recognized ratably over the term of the support period (generally one year). Training services revenues are recognized as the related training services are delivered. The unrecognized portion of amounts billed in advance of delivery for services is recorded as deferred revenue. OnDemand includes our KANA OnDemand ‘software as a service’ and outsourcing offerings as well as Advanced Customer Services. OnDemand revenue is recognized in accordance with the SEC Staff Accounting Bulletin No. 104, “Revenue Recognition, corrected copy” (“SAB 104”). Revenues from OnDemand services are recognized ratably over the term of the arrangement, while application fees are recognized ratably over the sum of the term of the arrangement and the term of expected renewals. Hosting service arrangements are a means of deployment whereby the customer’s software and data is physically located in third party facilities. Customers pay a fee to remotely access the hosted software and data via a secure internet connection. Hosting fees are recognized as the hosting service is delivered in accordance with SAB 104.

Vendor-specific objective evidence for consulting and training services are based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. Vendor-specific objective evidence for support services is generally based on the price charged when an element is sold separately or the stated contractual renewal rates.

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options and employee stock purchases under an employee stock purchase plan, based on estimated fair values.

Stock-based compensation expense recognized during the three and nine months ended September 30, 2007 and 2006 is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We use the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock.

Employee stock-based compensation expense recognized under SFAS 123(R) was $729,000 and $1.5 million for the three months ended September 30, 2007 and 2006, respectively, and $2.1 million for each of the nine month periods ended September 30, 2007 and 2006. The effect on net income (loss) per share for the three months ended September 30, 2007 and 2006 was $0.02 and $0.04 per share, respectively, and $0.06 per share for the nine month periods ended September 30, 2007 and 2006, respectively.

For stock options granted to non-employees, the Company recognizes compensation expense in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, which require such equity instruments to be recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. The Company amortizes compensation expense related to non-employee stock options in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” (“FIN 28”). In 2005 and 2006, the Company extended the vesting period of approximately 1,000,000 stock options held by four terminated employees who had agreements to provide consulting services. In fiscal year 2006, the Company granted a total of 57,500 stock options to four non-employees who had agreements to provide consulting services. During the three and nine months ended September 30, 2007 there were no stock option grants to non-employees.

As a result of these stock option modifications to former employees and the stock option grants to consultants, the Company recorded non-employee stock-based compensation expense of $2,000 and $266,000 for the three months ended September 30, 2007 and 2006, respectively, and expense of $105,000 and $520,000 for the nine months ended September 30, 2007 and 2006, respectively, allocated as follows:

Basic net loss per share is computed using the weighted average number of outstanding shares of common stock. Diluted net loss per share is computed using the weighted average number of outstanding shares of common stock and, when dilutive, shares of common stock issuable upon exercise of options and warrants deemed outstanding using the treasury stock method. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

For each of the three and nine month periods ended September 30, 2007, outstanding stock options and warrants to purchase common stock in an aggregate of approximately 13,053,000 shares have been excluded from the calculation of diluted net loss per share as all such securities were anti-dilutive. For the three and nine month periods ended September 30, 2006, outstanding stock options and warrants to purchase common stock in an aggregate of approximately 7,740,000 and 12,119,000 shares, respectively, have been excluded from the calculation of diluted net loss per share as all such securities were anti-dilutive.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of a company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which a company has chosen to use fair value on the face of the balance sheet. This statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157. The Company is currently evaluating whether the adoption of SFAS 159 will have a material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). The purpose of SFAS 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for the Company beginning in the first quarter of fiscal 2008. The Company is currently evaluating the effects of implementing SFAS 157.

In June 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109” (“FIN 48”). FIN 48 establishes a single model to address accounting for uncertain tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 on January 1, 2007. During the implementation, the Company identified, evaluated, and measured the amount of income tax benefits to be recognized for all material income tax positions. The net assets recognized under FIN 48 did not materially differ from the net assets recognized before adoption, and, therefore, the Company did not record an adjustment related to the adoption of FIN 48. At the adoption date of January 1, 2007, the Company had $145,000 of unrecognized tax benefits, all of which would affect the Company’s effective tax rate if recognized. At September 30, 2007, the Company had $145,000 of unrecognized tax benefits.

Our continuing practice is to recognize interest and/or penalties related to income tax matters as a component of income tax expense. Upon implementation of FIN 48 approximately $28,000 of accrued interest and penalties had already been recorded related to uncertain tax positions. There was no change in the amount of unrecognized tax benefits or accrued interest and penalties during the third quarter ended September 30, 2007.

The tax years 2003-2006 remain open to examination by the major taxing jurisdictions to which the Company is subject.

Additions to purchased intangible assets during the nine months ended September 30, 2007, include $2.5 million of customer relationships purchased in connection with the acquisition of eVergance Partners LLC (“eVergance”) in June 2007. See Note 11 for further details. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the assets, which is five years. The Company reported amortization expense on purchased intangible assets of $125,000 and $34,000 for the three months ended September 30, 2007 and 2006, respectively, and $164,000 and $100,000 for the nine months ended September 30, 2007 and 2006, respectively.

The estimated future amortization expense of purchased intangible assets as of September 30, 2007 is as follows (in thousands):

Additions to goodwill during the nine months ended September 30, 2007, include $3.9 million relating to the eVergance acquisition in June 2007. See Note 11 for further details.

In May 2006, the Company amended the registration agreement related to the June and September 2005 private placements (collectively referred to as “Private Placements”) to extend the registration deadline of the shares of common stock and underlying shares of common stock of the warrants issued to September 30, 2006 from January 27, 2006 and to change the penalty for failure to register the underlying shares of common stock from a cash penalty to a share-based payment, in exchange for the issuance of 593,854 shares of common stock. The shares were valued at approximately $1.0 million based on the fair market value of the Company’s common stock on the date of the amendment less a 10% discount to reflect that unregistered stock was issued. The September 30, 2006 registration deadline was not met and an additional 59,383 shares of common stock was issued. The shares were valued at approximately $166,000 based on the fair market value of the Company’s common stock on September 30, 2006 less a 10% discount to reflect that unregistered stock was issued. Registration rights penalties of $166,000 and $1.2 million were recorded as non-operating expenses during the three and nine months ended September 30, 2006, respectively

On November 9, 2006, the Company completed the registration of the shares of common stock and shares of common stock underlying the warrants issued to the investors in the Private Placements.

The Company’s 1999 Stock Incentive Plan (the “1999 Stock Incentive Plan”), as successor to the 1997 Stock Option Plan (the “1997 Stock Option Plan”), provides for shares of the Company’s common stock to be granted to employees, independent contractors, officers, and directors. Options are granted at an exercise price equivalent to the closing fair market value on the date of grant. All options are granted at the discretion of the Company’s Board of Directors and have a term not greater than 10 years from the date of grant. Options are immediately exercisable when vested and generally vest monthly over four years.

The following table summarizes activity under the equity incentive plans for the indicated periods:

At September 30, 2007, the Company had 6,464,912 options available for grant under its equity incentive plans.

Options vested and exercisable at September 30, 2007 include certain options which are vested but not yet exercisable. In certain situations, a stock option will be vested but not exercisable. The number of shares vested and not exercisable at September 30, 2007 was 325,662 and the weighted average exercise price of such shares as $5.06 per share.

At September 30, 2007, the Company had $4.6 million of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock options that will be recognized over the weighted average remaining period of 2.8 years. This amount excludes unrecognized stock-based compensation expense that relates to non-employee stock options, which cannot be estimated prior to the measurement date.

The following table summarizes significant ranges of outstanding and vested and exercisable options as of September 30, 2007:

The Company uses the Black-Scholes option pricing model for estimating the fair value of options granted under the Company’s equity incentive plans. The weighted average assumptions that were used to calculate the grant date fair value of the Company’s employee stock option grants for the three and nine months ended September 30, 2007 are as follows:

Risk-free interest rates for the options were taken from the Daily Federal Yield Curve Rates on the grant dates for the expected life of the options as published by the Federal Reserve.

The expected volatility of the stock options was based upon historical data and other relevant factors such as the Company’s changes in historical volatility and its capital structure in addition to mean reversion.

In the analysis of expected life the Company used an approach that determines the time from grant to exercise for options that have been exercised and adjusts this number for the expected time to exercise for options that have not yet been exercised. The expected time to exercise for options that have not yet been exercised is calculated from grant as the midpoint of contractual termination of the option and the later of measurement date or vesting date. All times are weighted by number of option shares in developing the expected life assumption.

The weighted-average fair value of options granted during the three and nine months ended September 30, 2007 was $1.25 and $1.52 per share, respectively.

The forfeiture rate of employee stock options for 2007 was calculated using the Company’s historical terminations data.

The warrants issued in June, September and October 2005 (collectively referred to as the “Warrants”) had cash penalties for the failure to register the underlying shares of common stock. Pursuant to Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”), the Company recorded the Warrants as liabilities at their fair value using the Black-Scholes option pricing model with changes in value reported to other income or expense each period. For the three and nine months ended September 30, 2006, $0 and $774,000 respectively, was recorded to other expense for the change in fair value of the Warrants.

The Warrants require physical settlement but allow for net-share settlement if the underlying shares of common stock are not registered. A maximum of 1,914,586 shares of common stock could be issued to settle the Warrants under a net-share settlement.

As noted above in Note 3, in May 2006, the Company amended the registration agreements related to the Private Placements to extend the registration deadline of the shares of common stock and underlying shares of common stock of the Warrants. The Company amended the penalty for failure to register the underlying shares of common stock from cash to share-based payments, with a maximum limit of 59,383 penalty shares to be issued. Pursuant to EITF 00-19, with the elimination of these cash penalties and a maximum limit on penalty shares, the fair value of the Warrants on the date of this amendment was reclassified to equity from liability, and gains or losses recorded to account for the contract at fair value during the period that the contract was classified as a liability were not reversed.

Comprehensive income (loss) is comprised of net income (loss) and foreign currency translation adjustments. The total changes in comprehensive income (loss) during the three and nine month periods ended September 30, 2007 and 2006 were as follows (in thousands):

The Company leases its facilities under non-cancelable operating leases with various expiration dates through January 2011. In connection with its existing leases, the Company entered into letters of credit totaling $771,000 expiring in 2007 and through 2010. The Company’s letters of credit can be supported by either restricted cash or the Company’s line of credit. At September 30, 2007, the Company had $13.1 million in non-cancelable operating lease obligations offset by $4.4 million of sublease income from subleases that are under contract.

At September 30, 2007, the Company had other future contractual obligations requiring payments of $2.9 million. The obligations represent payments on a legal settlement, minimum payments to vendors for future royalty fees, marketing services, training services, consulting services, engineering services, and sales events.

On January 24, 2007, RightNow Technologies, Inc. (“RightNow”) filed a suit against the Company and four former RightNow employees who had joined the Company in the Eighteenth Judicial District Court of Gallatin County, Montana. The suit alleges violation of certain provisions of employment agreements, misappropriation of trade secrets, as well as other claims, and seeks damages. The Company is undertaking to defend itself and the named individuals to the extent required by applicable laws. The Company believes it has meritorious defenses to these claims and intends to defend against this action vigorously.

On March 16, 2006, Polaris IP, LLC filed a suit against the Company, Sirius Satellite Radio, Inc., Priceline.com, Capital One, Continental Airlines, Inc., and E*Trade Financial in the U.S. District Court for the Eastern District of Texas alleging infringement of U.S. Patent Nos. 6,411,947 and 6,278,996 and seeking injunctive relief, damages and attorneys’ fees. On March 23, 2007, the parties entered into a settlement agreement and this matter was dismissed with prejudice on April 26, 2007.

The underwriters for the Company’s initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Soundview Capital Corp as well as the Company and certain current and former officers of the Company were named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The cases allege violations of various securities laws by more than 300 issuers of stock, including the Company, and the underwriters for such issuers, on behalf of a class of plaintiffs who, in the case of the Company, purchased the Company’s stock between September 21, 1999 and December 6, 2000 in connection with the Company’s initial public offering. Specifically, the complaints allege that the underwriter defendants engaged in a scheme concerning sales of the Company’s and other issuers’ securities in the initial public offering and in the aftermarket. In July 2003, the Company decided to join a settlement negotiated by representatives of a coalition of issuers named as defendants in this action and their insurers. In April 2005, the court requested a modification to the original settlement arrangement which was approved by the Company. Although the Company believed that the plaintiffs’ claims had no merit, the Company had decided to accept the settlement proposal to avoid the cost and distraction of continued litigation. The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the District Court. However, while the settlement was awaiting final approval by the District Court, in December 2006, the Court of Appeals

reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the District Court approved a stipulation withdrawing the proposed settlement. The parties had agreed upon a July 31, 2007 deadline for plaintiffs to file an amended complaint, and a September 27, 2007 deadline for filing a motion for class certification. On July 30, 2007, the plaintiffs requested and the District Court approved an extension and theplaintiffs filed an amended complaint on August 14, 2007. On November 9, 2007, the defendants filed a motion to dismiss the complaint for failure to state a claim. The Company believes it has meritorious defenses to these claims and intends to defend against this action vigorously. Because the settlement will be funded entirely by the Company’s insurers, the Company does not believe that the settlement will have any effect on its consolidated financial condition, results of operation or cash flows and accordingly, the Company has not accrued an amount for this loss contingency in its consolidated financial statements at September 30, 2007.

Other third parties have from time to time claimed, and others may claim in the future that the Company has infringed their past, current, or future intellectual property rights. The Company in the past has been forced to litigate such claims. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business, or could require the Company to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm the Company’s business.

The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on the Company’s results of operations, consolidated balance sheets and cash flows, due to defense costs, diversion of management resources and other factors.

Many of our software license agreements require us to indemnify our customers for any claim or finding of intellectual property infringement. We periodically receive notices from customers regarding patent license inquiries they have received which may or may not implicate our indemnity obligations. Any litigation, brought by others, or us could result in the expenditure of significant financial resources and the diversion of management’s time and efforts. In addition, litigation in which we are accused of infringement might cause product shipment delays, require us to develop alternative technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a successful claim of infringement was made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed. Such indemnification provisions are accounted for in accordance with SFAS No. 5 “Accounting for Contingencies” (“SFAS 5”). In prior periods, the Company has incurred minimal costs related to such claims under such indemnifications provisions; accordingly, the amount of such obligations cannot be reasonably estimated. The Company did however record a settlement charge resulting from a settlement of an infringement claim on the Company’s consolidated statement of operations for the year ended December 31, 2006, which was not considered material. There were no outstanding claims of infringement at September 30, 2007.

As permitted by Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer is, or was, serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and enables the Company to recover a portion of any such amounts. As a result of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is insignificant. Accordingly, the Company has no liabilities recorded for these agreements as of September 30, 2007.

The following table provides a summary of restructuring activity during the nine months ended September 30, 2007 and 2006 (in thousands):

In July 2007, we implemented various cost reduction and restructuring activities to reduce operating costs. The expense related to our reduction in work force was approximately $240,000 and expense related to ceasing use of one of our offices was approximately $8,000.

In September 2007, we agreed with the landlord of one of the facilities included in our restructuring accrual to surrender the remaining term of the lease in exchange for a lump sum cash payment. As a result of this agreement we recorded additional restructuring expense of approximately $319,000 and reclassified the long-term portion of the restructuring liability to accrued restructuring under current liabilities. Additionally, we reclassified the related lease deposit from other assets to other current assets.

The Company’s chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment: specifically the licensing and support of its software applications. Revenue classification is based upon customer location.

Geographic information on revenues for the three and nine months ended September 30, 2007 and 2006 is as follows (in thousands):

During the three months ended September 30, 2007, one customer represented approximately 16% of revenues. During the nine month period ended September 30, 2007, no customer represented more than 10% of total revenues. During the three months ended September 30, 2006, one customer represented 15% of total revenues and during the nine months ended September 30, 2006, one customer represented 12% of total revenues.

Geographic information on the Company’s long-lived assets (Property and Equipment, net, and Other Assets), based on physical location, is as follows (in thousands):

On November 30, 2005, the Company established a new banking relationship with Bridge Bank N.A. (“Bridge”) and entered into a Business Financing Agreement and Intellectual Property Security Agreement with Bridge under which the Company has access to a Loan Facility of $7.0 million (“November Loan”). This November Loan is made up of two parts: (i) a Formula Revolving Line of Credit of up to $5.0 million and (ii) a Non-Formula Revolving Line of Credit of up to $6.0 million, of which $2.0 million is available for stand-by letters of credits, settlement limits on foreign exchange contracts or cash management products. The combined total borrowing under the two parts cannot exceed $7.0 million. The Formula Revolving Line of Credit is collateralized by all of our assets and expired on November 29, 2006. Interest for the Formula Revolving Line of Credit accrues at Bridge’s Prime Lending Rate plus 2% while interest for the Non-Formula Revolving Line of Credit accrues at Bridge’s Prime Lending Rate plus 0.50%. On December 29, 2005, the Company entered into a Business Financing Agreement with Bridge, which provided for additional advances up to $1.5 million based on an advance rate of 80% of eligible receivables. The overall November Loan was increased to $7.5 million.

On March 30, 2006, the Company modified the Business Financing Agreement with Bridge to increase the additional advances for accounts receivable to $2.0 million and the overall November Loan to $8.0 million.

On November 28, 2006 the Business Financing Agreement was further modified to extend the expiration date to February 28, 2007.

On February 27, 2007, the Company entered into an Amended and Restated Loan and Security Agreement with Bridge under which the Company has access to a Loan facility of $10.0 million (“February Loan”). The February Loan is a formula based revolving line of credit based on 80% of eligible receivables subject to two sub limits; a sub-limit of $2.5 million that is available for stand-by letters of credit, settlement limits on foreign exchange contracts or cash management products and a maximum amount of $5.0 million available as a term loan. The total combined borrowing under the February Loan and sub-limits cannot exceed $10.0 million. The February Loan is collateralized by all of the Company’s assets and expires February 27, 2009 at which time the entire balance under the formula based line of credit will be due. The Company has a twelve month period to draw down against the term loan, which is repaid over a 36 month period. Interest for the formula based revolving line of credit accrues at the Wall Street Journal’s (“WSJ”) Prime Lending Rate plus 1.25% while interest for the term loan accrues at the WSJ’s Prime Lending Rate plus 1.75%. The February Loan contains certain restrictive covenants including but not limited to certain financial covenants such as maintaining profitability net of stock-based compensation and maintenance of certain key ratios. If the Company is not in compliance with the covenants of the February Loan, Bridge has the right to declare an event of default and all of the outstanding balances owed under the February Loan would become immediately due and payable.

On May 7, 2007, the Company entered into a Second Amendment to the February Loan with Bridge (the “Second Amendment”) in which Bridge waived the Company’s compliance with certain financial ratios for any period prior to the month and quarter ending June 30, 2007 and consented to the Company’s acquisition of eVergance. The terms of the Second Amendment limit the maximum borrowing under the February Loan to $5 million until the Company has met certain restrictive covenants for two consecutive quarters.

On June 14, 2007, the Company entered into a Third Amendment to the February Loan (the “Third Amendment”) which provided for additional loans to the Company in the amount of $1.5 million, all of which were advanced on June 14, 2007, to fund mergers and acquisitions activities and pay acquisition related expenses. The Third Amendment also provides for an additional $500,000 of such loans to be available to the Company under certain circumstances. These loans were required to be repaid on October 1, 2007, and bear interest at the lender’s prime rate plus 1.75%. In addition, the Third Amendment provides for Bridge to make equipment advances to the Company from time to time to finance capital expenditures, in an aggregate amount of up to $1 million (subject to increase to $2 million under certain circumstances). These equipment advances will bear interest at the lender’s prime rate plus 1.25%, subject to reduction under certain circumstances, and are required to be repaid in 33 monthly installments beginning on March 31, 2008. The Third Amendment also modified the financial covenants set forth in the February Loan, provided for the payment of certain fees to Bridge, and limited the total amount of loans under the February Loan to $10 million (excluding equipment advances).

On August 21, 2007, the Company entered into a Loan and Security Modification Agreement to the February Loan that provided a one-time waiver for of out-of-compliance conditions with certain financial covenants that existed for the period ended June 30, 2007.

On October 3, 2007, the Company entered into a Loan and Security Modification Agreement to the February Loan (the “October 3rd Modification”) that provided a one-time waiver for of out-of-compliance conditions with certain financial covenants that existed for the period ended July 31, 2007. In addition, the October 3 Modification extended the due date for the repayment of loans related to mergers and acquisitions until November 30, 2007. Maturity of the other loans remains the same as agreed in the February Loan as described above. The October 3rd Modification also provided that in lieu of compliance with certain financial covenants the Company may sell its equity securities in an underwritten offering pursuant to a registration statement filed under the Securities Act of 1933 and provided for the payment of certain fees to Bridge.

As of September 30, 2007, the Company had $6.5 million drawn against the February Loan all of which is shown as current liabilities on the condensed consolidated balance sheet as the Company was not in compliance with certain financial covenants.

As of September 30, 2007, there was $2.1 million classified as current portion of note payable and $115,000 classified as long-term. The long-term portion was included in other long-term liabilities on the condensed consolidated balance sheet. The note payable consists of three obligations. The first is a promissory note with De Lage Landen Financial Services, Inc. for the financing of software license and support purchased and has a fixed interest rate of 3.15%, payable in monthly installments of principal and interest. The second is with First Insurance Funding Corp of California for short-term financing of Errors and Omissions insurance and has a fixed interest rate of 9.87%, payable in monthly installments of principal and interest. The third is to former members of eVergance in connection with the acquisition of all the membership interests of eVergance and bears no interest. This note was recorded at its present value using a discount rate of 9.5%. The Company recognizes imputed interest expense as the note matures. At September 30, 2007, the Company had future payments of $562,000 for the three months ending December 2007, and $1.7 million and $73,000 for the years ending December 2008 and 2009, respectively, with no required payments thereafter. As of December 31, 2006, there was $327,000 classified as current portion of note payable and $242,000 classified as long-term.

On October 30, 2006, the Company entered into a consulting agreement (“the Consulting Agreement”) with William T. Clifford, a member of KANA’s Board of Directors. Mr. Clifford provided consulting services to KANA’s management as an independent contractor on matters pertaining to strategic planning and business (in addition to his role as a member of the Board of Directors) for a period of twelve months that commenced on January 24, 2006. During the nine months ended September 30, 2007, the Company paid Mr. Clifford a fee of $59,900 in consideration for his consulting services pursuant to the terms of the Consulting Agreement.

On May 4, 2007, the Company executed a definitive agreement with the members of eVergance to acquire all of their membership interests. On June 14, 2007 (the “Closing Date”), the Company agreed to issue an aggregate of 600,000 shares of its common stock (the “Stock”) to the former members of eVergance and Mr. Angel, and an aggregate of 400,000 non-equity plan options to purchase shares of its common stock (the “Options”) and $3.3 million in cash consideration to the former members of eVergance. Twenty-five percent of the Stock was issued as of the Closing Date and twenty-five percent was issued three months after the Closing Date and an additional twenty-five percent will be issued six and nine months after such date. The fair value of KANA’s stock was determined using a value of $3.16, which was the average closing price of KANA’s stock two days before and after the announcement date of May 7, 2007, less a 10% discount to reflect that unregistered stock was issued and is issuable. The unissued stock is accounted for as common stock subscription on the condensed consolidated balance sheet. Twenty-five percent of the Options were issued and are exercisable as of the Closing Date and twenty-five percent were issued three months after the Closing Date and an additional twenty-five percent of the Options will be issued and exercisable six and nine months after such date. The Options have an exercise price per share equal the closing sale price of the Company’s common stock on June 13, 2007 as quoted on the Over the Counter Bulletin Board. The fair value of the options was determined using the Black-Scholes option pricing model, using assumptions of a risk-free interest rate of 4.76%, expected volatility of 53%, the ten year contractual term, and no expected dividends. The fair value of the common stock underlying the options was discounted as discussed above. The options granted have been excluded from the summaries of options outstanding in Note 3 and had a fair value of $2.19 per share upon grant. The aggregate consideration for the transaction was as follows (in thousands):

The Company relied on an exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and Rule 506 promulgated thereunder. The former members of eVergance represented to KANA that they were “accredited investors” as defined in Rule 501(a) promulgated in the Securities Act and that they were purchasing the Registrable Securities for their own account and not with a present view towards the public sale or distribution thereof.

eVergance is a management consulting and systems integration firm offering end-to-end consulting services for CRM optimization, knowledge management, and web self-service deployments. Through this acquisition, the Company will significantly expand its professional services portfolio to meet growing demand for consulting and implementation services. Under the term of the definitive agreements related to the acquisition, the purchase consideration consisted of cash, Stock and Options issued and issuable.

This transaction was accounted for using the purchase method of accounting. Management allocated the purchase price to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date giving consideration to an independent appraisal. To the extent that the purchase price exceeded the fair value of the assets and liabilities assumed, goodwill was recorded. The intangible assets acquired in connection with the acquisition are being amortized over a five-year period.

The following is a summary of the preliminary allocation of the purchase price (in thousands):

The unaudited condensed consolidated financial statements include the operating results of eVergance from the date of acquisition. Pro forma results of operations for the eVergance acquisition have not been presented because the effect of the acquisition was not material to the Company’s financial results.

On October 3, 2007, the Company entered into a Loan and Security Modification Agreement to the February Loan (the “October 3rd Modification”) with Bridge Bank, which provided a one-time waiver of out-of-compliance conditions with certain financial covenants that existed for the period ended July 31, 2007. In addition, the October 3rd Modification extended the due date for the repayment of loans related to mergers and acquisitions until November 30, 2007. The October 3rd Modification also provided that, in lieu of compliance with certain financial covenants the Company may sell its equity securities in an underwritten offering pursuant to a registration statement filed under the Securities Act of 1933 and provided for the payment of certain fees to Bridge.

In November 2007, we executed an agreement with a landlord to surrender the remaining term of our facility lease on the facility in Marlow, UK. The terms of the agreement include a lump sum payment in exchange for release of all remaining liability related to our original lease. The Company has adjusted the accrued restructuring liability as of September 30, 2007.

In addition to historical information, this report 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. The forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions. Words such as “anticipate,” “believe,” “estimate,” “expects,” “intend,” “plan,” “will” and variations of these words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described in “Risk Factors” and elsewhere in this report. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or false.

The following discussion should be read in conjunction with our Annual Report on Form 10-K filed on April 2, 2007, and the consolidated financial statements and notes thereto. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Kana Software, Inc. and its subsidiaries (the “Company” or “KANA,” and references to “we,” “our”, “us”, and similar pronouns refer to KANA) offer an innovative approach to customer service with cost-effective solutions that enhance the quality of customer interaction. Built on open standards for a high degree of adaptability and integration, KANA solutions intelligently automate the processes needed to successfully serve our clients’ customers, so that our clients can deliver higher value service at lower cost. KANA provides an integrated solution which enables organizations to deliver consistent, managed service across all channels, including email, chat, call centers, and Web self-service, ensuring a consistent service experience across communication channels.

Our revenue is primarily derived from the sale of our software and related maintenance and support of the software. To a lesser extent, we derive revenues from consulting and training. Our larger customers often use a systems integrator, such as IBM, Accenture or BearingPoint, for the project to install KANA software as well as do the business process, workflow, and other associated required work. KANA’s professional services group assists the integrators as subject matter experts, and in other cases will act as the prime contractor for implementation of our software. While we continue this practice, we are increasingly providing consulting and implementation services directly to our customers. These services may be provided to our existing customers who would prefer us to review their KANA implementations or to new customers who are not large enough to gain the interest of a systems integrator to provide initial implementation services. However, in the case of most of the initial installations of our applications that are generally installed by our customers using a system integrator, these services generally increase the cost of a project substantially and subject their purchase to more approval levels and cost savings reviews resulting in longer sales cycles. This contributes to the difficulty that we face in predicting the quarter in which sales to expected customers will occur and to the uncertainty of our future operating results. To the extent that significant sales occur earlier or later than anticipated, revenues for subsequent quarters may be lower or higher, respectively, than expected. In addition, we recently began offering our software on a hosted basis for a subscription fee, through our OnDemand service. In June 2007, we purchased eVergance Partners LLC (“eVergance”), a management consulting and systems integration firm, and our service revenues and related expenses have increased due to this acquisition. Through this acquisition, we significantly expanded our professional services portfolio to meet growing demand for consulting and implementation services.

In late 2005, we made a decision to eliminate outsourced product development and bring core technology development back to our personnel in the United States in a process that we refer to as “back-shoring” and, by the end of the third quarter of 2006, we brought back all core technology development to the United States, except for development on one product group, which was brought back in the first quarter of 2007. We also back-shored our technical support during the fourth quarter of 2006. As we continue to rebuild the sales organization and increase our marketing, our sales and marketing expenses increased in 2007 due to increases in headcount, commissions as a result of higher revenues, and marketing programs. We will strive to match our spending with the anticipated revenue but, given the unpredictability of our license revenue, we are unable to predict with any certainty the period(s) when we will be profitable, if at all.

Since 1997 we have incurred substantial costs to develop our products and to recruit, train and compensate personnel for our engineering, sales, marketing, client services, and administration departments. As a result, we have incurred substantial losses since inception. On September 30, 2007, we had ending cash and cash equivalents of $1.4 million and $8.7 million of borrowings outstanding under a loan payable and notes payable. As of September 30, 2007, we had an accumulated deficit of $4.3 billion and a negative working capital of $21.3 million. Loss from operations was $729,000 and $7.8 million for the three and nine months ended September 30, 2007, respectively. Net cash used for operating activities was $8.6 million and $623,000 for the first nine months of 2007 and 2006, respectively.

We added 30 employees through the eVergance acquisition, and as of September 30, 2007, we had 231 full-time employees which represent an increase from 181 employees at December 31, 2006 and an increase from 153 employees at September 30, 2006.

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates.

We believe the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and require management’s most difficult, subjective and complex judgments.

We recognize revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” (“SOP 97-2”), as amended.

Revenue from software license agreements is recognized when the basic criteria of software revenue recognition have been met (i.e. persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collection is probable). We use the residual method described in AICPA SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” (“SOP 98-9”), to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and vendor-specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as license revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

For all sales, we use either a signed license agreement, a signed amendment to an existing license agreement, a signed order form, a binding purchase order where we either have a signed master license agreement or an order form signed by the Company, or a signed statement of work as evidence of an arrangement.

When licenses are sold together with consulting services, license fees are recognized upon delivery, provided that (1) the basic criteria of software revenue recognition have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the consulting services do not provide significant customization of the software products and are not essential to the functionality of the software that was delivered. We do not provide significant customization of its software products.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable, and we generally do not recognize revenue on these arrangements until the customer payments become due and all other revenue recognition criteria have been met.

Probability of collection is based upon assessment of the customer’s financial condition through review of their current financial statements or publicly-available credit reports. For sales to existing customers, prior payment history is also considered in assessing probability of collection. We are required to exercise significant judgment in deciding whether collectibility is reasonably assured, and such judgments may materially affect the timing of our revenue recognition and our results of operations.

Services revenues include revenues for consulting services, customer support and training, and OnDemand and hosting. OnDemand includes our KANA OnDemand ‘software as a service’ and outsourcing offerings as well as Advanced Customer Services. Consulting services revenues and the related cost of services are generally recognized on a time and materials basis. For consulting services contracts that have a fixed fee, we recognize the license and professional consulting services revenues using either the percentage-of-completion method or the completed contract method as prescribed by AICPA SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts” (“SOP 81-1”). KANA’s consulting arrangements do not include significant customization of the software. Customer support agreements provide technical support and the right to unspecified future upgrades on an if-and-when available basis. Customer support revenues are recognized ratably over the term of the support period (generally one year). Training services revenues are recognized as the related training services are delivered. The unrecognized portion of amounts billed in advance of delivery for services is recorded as deferred revenue. OnDemand revenue is recognized in accordance with the SEC Staff Accounting Bulletin No. 104, “Revenue Recognition, corrected copy” (“SAB 104”). Revenues from OnDemand services are recognized ratably over the term of the arrangement, while application fees are recognized ratably over the sum of the term of the arrangement and the term of expected renewals. Hosting service arrangements are a means of deployment whereby the customer’s software and data is physically located in third party facilities. Customers pay a fee to remotely access the hosted software and data via a secure internet connection. Hosting fees are recognized as the hosting service is delivered in accordance with SAB 104.

Internal-use software costs, including fees paid to third parties to implement the software, are capitalized beginning when we have determined various factors are present, including among others, that technology exists to achieve the performance requirements, we have made a decision as to whether we will purchase the software or develop it internally, and we have authorized funding for the project. Capitalization of software costs ceases when the software implementation is substantially complete and is ready for its intended use, and the capitalized costs are amortized over the software’s estimated useful life (generally five years) using the straight-line method.

When events or circumstances indicate the carrying value of internal use software might not be recoverable, we assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is recognized to the extent that the carrying value exceeds the projected discounted future operating cash flows and is recognized as a write down of the asset. In addition, if it is no longer probable that computer software being developed will be placed in service, the asset will be adjusted to the lower of its carrying value or fair value, if any, less direct selling costs. Any such adjustment would result in an expense in the period recorded, which could have a material adverse effect on our condensed consolidated statements of operations.

Our capitalized costs for internal use software of $561,000 have been fully amortized as of September 30, 2007.

During 2001, we recorded significant liabilities in connection with our restructuring program. These reserves included estimates pertaining to contractual obligations related to excess leased facilities in Menlo Park, California; Princeton, New Jersey; Framingham, Massachusetts; and Marlow in the United Kingdom. Remaining lease commitments terminate over various dates beginning in April 2007 and through January 2011. We are seeking to sublease or renegotiate the obligations associated with the excess space. We have subleased some of the excess space, but in all cases, the sublease income is less than the rent we pay the landlord. We had $5.0 million in accrued restructuring costs as of September 30, 2007, which was our estimate, as of that date, of the exit costs of these excess facilities. We have worked with real estate brokers in each of the markets where the properties are located to help us estimate the amount of the accrual. This process involves significant judgments regarding these markets. If we determine that any of these real estate markets has deteriorated further, additional adjustments to this accrual may be required, which would result in additional restructuring expenses in the period in which such determination is made. Likewise, if any of these real estate markets strengthen, and we are able to sublease the properties earlier or at more favorable rates than projected, or if we are otherwise able to negotiate early termination of obligations on favorable terms, adjustments to the accrual may be required that would increase income in the period in which such determination is made. As of September 30, 2007, our estimate of accrued restructuring cost included an assumption that we would receive $861,000 in sublease payments that are not subject to any contractual arrangement as of September 30, 2007. We have assumed that the majority of these assumed sublease payments will begin in 2008 and continue through the end of the related leases. In December 2006, we determined that we may not be able to sublease a leased facility in Princeton, New Jersey, and we changed our assumption of subleasing this excess space. We recorded a restructuring charge of $739,000 during the three months ended December 31, 2006 mainly related to this change in estimate of sublease assumption that is not subject to any contractual arrangement.

We regularly evaluate all potential indicators of impairment of goodwill and intangible assets, but at a minimum, test goodwill and intangible assets for impairment on an annual basis. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired.

The remaining balance of goodwill as of September 30, 2007 is $12.5 million. We continue to assess whether any potential indicators of impairment of goodwill have occurred and have determined that no such indicators have arisen since June 30, 2007, the date of our annual goodwill impairment test. Any future impairment loss could have a material adverse impact on our financial condition and results of operations.

We estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as net operating loss carryforwards, and stock-based compensation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we establish a valuation allowance. We concluded that a full valuation allowance was required for all periods presented. While we have considered future taxable income in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would be made, increasing our income in the period in which such determination was made.

Pursuant to the Internal Revenue Code, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize include, but are not limited to, a cumulative change of more than 50% ownership of the company, as defined, over a three-year period. The portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets.

On January 1, 2007, we adopted FASB Interpretation No. 48 “accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement 109” (“FIN 48”). FIN 48 establishes a single model to address accounting for uncertain tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. During the implementation, we identified, evaluated, and measured the amount of income tax benefits to be recognized for all material income tax positions. The net income tax assets recognized under FIN 48 did not materially differ from the net assets recognized before adoption, and, therefore, we did not record an adjustment related to the adoption of FIN 48. At the adoption date of January 1, 2007, we had $145,000 of unrecognized tax benefits, all of which would affect our effective tax rate if recognized. At September 30, 2007, we had $145,000 of unrecognized tax benefits.

We are subject to lawsuits and other claims and proceedings. We assess the likelihood of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of loss contingency required, if any, for these matters are made after careful analysis of each individual matter. The required loss contingencies may change in the future as the facts and circumstances of each matter changes.

On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including employee stock options and employee stock purchases under an employee stock purchase plan based on estimated fair values.

Employee stock-based compensation expense recognized under SFAS 123(R) for the three months ended September 30, 2007 and 2006 was $729,000 and $1.5 million, respectively and was $2.1 million for each of the nine month periods ended September 30, 2007 and 2006.

For stock options granted to non-employees, we recognize compensation expense in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which require such equity instruments to be recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. We amortize compensation expense related to non-employee stock options in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” (“FIN 28”). In 2005 and 2006, we extended the vesting period of approximately 1,000,000 stock options held by four terminated employees who had agreements to provide consulting services. In fiscal year 2006, we granted a total of 57,500 stock options to four non-employees who had agreements to provide consulting services. As a result of these stock option modifications to former employees and the stock option grants to consultants, we recorded non-employee stock-based compensation expense of $2,000 and $266,000 for the three months ended September 30, 2007 and 2006, respectively, and expense of $105,000 and $520,000 for the nine months ended September 30, 2007 and 2006, respectively.

Also see stock-based compensation in Note 1 to the condensed consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of acompany’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which a company has chosen to use fair value on the face of the balance sheet. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). We are currently evaluating whether the adoption of SFAS 159 will have a material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS 157. The purpose of SFAS 157 is to define fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for us beginning in the first quarter of fiscal 2008. We are currently evaluating the effects of implementing SFAS 157.

In June 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement 109” (“FIN 48”). FIN 48 establishes a single model to address accounting for uncertain tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted FIN 48 on January 1, 2007. During the implementation, we identified, evaluated, and measured the amount of income tax benefits to be recognized for all material income tax positions. The net income tax assets recognized under FIN 48 did not materially differ from the net assets recognized before adoption, and, therefore, we did not record an adjustment related to the adoption of FIN 48. At the adoption date of January 1, 2007, we had $145,000 of unrecognized tax benefits, all of which would affect the Company’s effective tax rate if recognized. At September 30, 2007, we had $145,000 of unrecognized tax benefits.

The tax years 2003-2006 remain open to examination by the major taxing jurisdiction to which we are subject.

The following table sets forth selected data for the indicated periods. Percentages are expressed as a percentage of total revenues.

Total revenues increased by 28% to $16.8 million for the three months ended September 30, 2007 from $13.2 million for the three months ended September 30, 2006, as a result of higher license revenues and services revenues in 2007 than in 2006. Total revenues increased by 10% to $43.3 million for the nine months ended September 30, 2007 from $39.2 million for the nine months ended September 30, 2006, as a result of higher services revenues partially offset by lower license revenues in 2007 than in 2006.

License revenues include licensing fees only, and exclude associated support, training and consulting revenue. The majority of our licenses to customers are perpetual and associated revenues are recognized upon delivery provided that all revenue recognition criteria are met as discussed in “Revenue Recognition” under “Critical Accounting Policies” above. License revenues increased by 33% to $5.8 million for the three months ended September 30, 2007 from $4.3 million for the same period in the prior year. License revenues decreased by 2% to $12.9 million for the nine months ended September 30, 2007 from $13.1 million for the same period in the prior year. The increase for the three months ended September 30, 2007 compared to the same quarter in the prior year was the result of an increased number of license transactions in the three months of 2007 compared to 2006 and the inclusion of a larger multi-million dollar transaction in 2007. License revenue for the nine month periods ended September 30, 2007 and 2006, were basically flat. While we are focused on increasing license revenue, we are unable to predict such revenue from period to period with any degree of accuracy because, among other things, the market for our products is unpredictable and intensely competitive, and our sales cycle is long and unpredictable.

Our services revenues consist of support revenues and professional services fees. Support revenues relate to providing customer support, product maintenance and updates to our customers. Professional services revenues relate to providing consulting, training and implementation services to our customers including hosting and OnDemand, software as a service option. Services revenues increased by 25% to $11.0 million for the three months ended September 30, 2007, compared to

$8.8 million for the same period in 2006. Services revenues increased by 17% to $30.3 million for the nine months ended September 30, 2007, compared to $26.0 million for the same period in 2006. Support revenues are the largest component of services revenues, and during the three and nine months ended September 30, 2007, support revenues remained flat compared to the same periods in 2006, because support revenues from new maintenance contracts associated with new license transactions offset support renewal cancellations. The other part of services revenues are professional services fees that increased for the three and nine months ended September 30, 2007 compared to the same periods in 2006 mainly due to an increase in consulting, training and OnDemand revenues. Consulting and training revenues increased as a result of increased license sales in prior quarters and the inclusion of a full quarter of eVergance revenue. Customers who purchase licenses frequently purchase implementation consulting and training, which usually occur subsequent to the license sales.

Revenues from domestic sales were $13.1 million and $7.4 million for the three months ended September 30, 2007 and 2006, respectively, and $31.6 million and $26.9 million for the nine months ended September 30, 2007 and 2006, respectively. Revenues from international sales were $3.8 million and $5.7 million for the three months ended September 30, 2007 and 2006, respectively, and $11.7 million and $12.2 million for the nine months ended September 30, 2007 and 2006, respectively. Our international revenues were derived from sales in Europe and Asia Pacific.

Total cost of revenues increased by 37% to $4.6 million for the three months ended September 30, 2007 compared to $3.4 million for the same period in 2006. Total cost of revenues increased by 27% to $11.9 million for the nine months ended September 30, 2007 compared to $9.4 million for the same period in 2006.

License Fees. Cost of license fees consists of third party software royalties, costs of product packaging, documentation, and production and delivery costs for shipments to customers. Cost of license fees as a percentage of license fees was 7% for the three months ended September 30, 2007, compared to 19% for the same period in the prior year. Cost of license fees as a percentage of license fees was 7% for the nine months ended September 30, 2007, compared to 16% for the same period in the prior year. The decrease was partially due to a reduction in royalty costs associated with a relatively lower proportion of non-revenue-related shipments, such as upgrades and updates, as we had a lower proportion of such shipments during the nine months of 2007. In addition, we reduced our royalty costs by replacing certain third-party technology with a lower cost alternative. We expect that our cost of license fees as a percentage of sales will vary based on changes in the mix of products we sell and the timing of upgrades. We are not able to predict when customers will choose to upgrade their software which will then cause us to incur this royalty cost. We are continuing to look at alternatives for some third-party products embedded in KANA products.

Services. Cost of services consists primarily of compensation and related expenses for our customer support, consulting and training and OnDemand services organizations, and allocation of facility costs and system costs incurred in providing customer support. Cost of services increased to 37% of services revenues, or $4.1 million, for the three months ended September 30, 2007 compared to 29% of services revenues, or $2.5 million, for the same period in 2006. Cost of services increased to 36% of services revenues, or $10.8 million, for the nine months ended September 30, 2007 compared to 28% of services revenues, or $7.2 million, for the same period in 2006. The decrease in service margins in the nine months of 2007 compared to the same period in 2006 was due to an increase in professional service staffing levels in 2007 as well as OnDemand related costs. As of September 30, 2007, we had 67 employees in the support, consulting, training and OnDemand organizations compared to 42 employees as of September 30, 2006, an increase of 60%. Twenty-three employees were added to the consulting and training organizations during the latter part of June 2007 as a result of the eVergance acquisition.

Cost of services may increase or decrease depending on the demand for customer support, consulting and training and OnDemand services. The expenses may also be affected by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

Amortization of Acquired Intangible Assets. The amortization of acquired intangible assets recorded in the three-month period ended September 30, 2007 related to $2.5 million of identifiable intangibles purchased in connection with the eVergance acquisition in June 2007. The amortization of acquired intangible assets recorded in the three-month period ended September 30, 2006 related to $400,000 of identifiable intangibles purchased in connection with the Hipbone acquisition in February 2004. The amortization of acquired intangible assets recorded in the nine-month periods ended September 30, 2007 and 2006 related to intangibles purchased in connection with the eVergance and Hipbone acquisitions. Acquired intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the asset (five and three years, respectively). The intangibles purchased in connection with the Hipbone acquisition were fully amortized in the first quarter of 2007. Amortization expense may increase if we acquire another company.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related costs for sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials. Sales and marketing expenses increased by 49% to $6.4 million for the three months ended September 30, 2007,

from $4.3 million for the same period in 2006. Sales and marketing expenses increased by 45% to $19.3 million for the nine months ended September 30, 2007, from $13.3 million for the same period in 2006. This was primarily due to an increase in compensation and related costs as a result of our strategy of increasing our sales and marketing personnel and an increase in our marketing programs. As of September 30, 2007, we had 73 employees in sales and marketing compared to 49 employees as of September 30, 2006, an increase of 49%. Four employees were added during the latter part of June 2007 as a result of the eVergance acquisition.

Sales and marketing expenses may increase or decrease, depending primarily on the amount of future revenues and our assessment of market opportunities and sales channels. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

Research and Development. Research and development expenses consist primarily of compensation and related costs for research and development employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses increased by 12% to $3.0 million for the three months ended September 30, 2007 from $2.7 million for the same period in 2006. Research and development expenses increased by 31% to $9.8 million for the nine months ended September 30, 2007 from $7.5 million for the same period in 2006. This was attributable primarily to higher compensation and related costs as a result of an increase in head count as well as retention bonuses paid to some employees. As of September 30, 2007, we had 54 employees in research and development compared to 32 employees as of September 30, 2006, an increase of 69%.

Research and development expenses including related head count may increase or decrease, depending primarily on the amount of future revenues, customer needs, and our assessment of market demand. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

General and Administrative. General and administrative expenses consist primarily of compensation and related costs for finance, legal, human resources, corporate governance, and bad debt expense. Information technology and facilities costs are allocated among all operating departments. General and administrative expenses increased by 12% to $2.9 million for the three months ended September 30, 2007 from $2.6 million for the same period in 2006. General and administrative expenses increased by 31% to $9.5 million for the nine months ended September 30, 2007 from $7.3 million for the same period in 2006. The increase in expenses during the three months ended September 30, 2007 was primarily due to higher compensation and related costs as a result of new hires, including a full quarter of eVergance general and administrative costs and the reversal of a state tax expense during 2006 as a result of a favorable tax ruling partially offset by a bad debt reversal and a foreign currency gain. The increase in expenses during the nine months ended September 30, 2007 was primarily due to higher compensation and related costs as a result of new hires and the reversal of a state tax expense during 2006. As of September 30, 2007 we had 42 employees in general and administrative, information technology and facilities combined compared to 30 employees as of September 30, 2006, a 40% increase. Three employees were added during the latter part of June 2007 as a result of the eVergance acquisition.

General and administrative expenses may increase or decrease, depending primarily on the amount of future revenues and corporate infrastructure requirements including insurance, professional services, taxes, bad debt expense, and other administrative costs. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

Restructuring Costs. During the three and nine months ended September 30, 2007 we recorded $567,000 of restructuring charges. The charge was comprised of $240,000 related to our reduction in work force and $8,000 related to the ceased use of a facility based on the July 2007 cost reductions. Additionally, we recorded a restructuring charge of $319,000 related to a lease surrender. There were no restructuring charges during the three months ended September 30, 2006. During the nine months ended September 30, 2006, there was a restructuring charge of $46,000 for leasehold improvements partially offset by a recovery of $36,000 due to the changes in the assumptions related to severance of employees in our New Hampshire facility.

Interest and other income (expense), net consists primarily of interest income, interest expense and changes in fair value of warrant liabilities. Interest income consists primarily of interest earned on cash and cash equivalents and was $31,000 and $69,000 for the three months ended September 30, 2007 and 2006, respectively, and $79,000 and $156,000 for the nine months ended September 30, 2007 and 2006, respectively. The decrease in interest income related to lower cash and cash equivalents balances in the three and nine months ended September 30, 2007 compared to the same periods in 2006. Interest expense relates primarily to our loan payable and was $575,000 and $18,000 for the three months ended September 30, 2007 and 2006, respectively, and $727,000 and $280,000 for the nine months ended September 30, 2007 and 2006, respectively. The increase in interest expense related to higher average borrowings against the loan payable in the three

and nine months ended September 30, 2007 compared to the same periods in 2006 and a loan fee included in 2007. Interest and other income (expense), net also consists of changes in the fair value of warrant liabilities of approximately $774,000 for the nine months ended September 30, 2006.

We have incurred net losses on a consolidated basis for all periods from inception through September 30, 2007, with the exception of the second and third quarters of 2006. Accordingly, we have recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future realization of the tax benefit is not currently more likely than not. During the three and nine months ended September 30, 2007 and 2006, certain of our foreign subsidiaries were profitable, based upon application of our intercompany transfer pricing agreements, which resulted in us reporting income tax expense totaling approximately $32,000 and $53,000 for the three months ended September 30, 2007 and 2006, respectively, and approximately $133,000 and $129,000 for the nine months ended September 30, 2007 and 2006, respectively, in those foreign jurisdictions.

As of September 30, 2007, we had $1.4 million in cash and cash equivalents, compared to $5.7 million in cash and cash equivalents at December 31, 2006. As of September 30, 2007, we had negative working capital of $21.3 million, compared to negative working capital of $11.0 million as of December 31, 2006. As of September 30, 2007, our current liabilities included $15.8 million of deferred revenue (primarily reflecting payments received for future maintenance services to be provided to our customers).

We have had negative cash flow from operating activities in each year since significant business operations began in 1997. To date, we have funded our operations primarily through issuances of common stock and, to a lesser extent, cash acquired in acquisitions. The rate of cash we have used in operations was $13.1 million in 2004, $16.3 million in 2005, $1.7 million in 2006 and $8.6 million in the first nine months of 2007. In 2003, 2004 and 2005, we implemented successive net workforce reductions of approximately 154, 30 and 56 employees, respectively. During 2006 and the first nine months in 2007, we had a net increase of 56 and 63 employees, respectively. Staffing is expected to change from time to time based upon a number of factors, including anticipated demand for our products and the balancing of roles between employees and contract staffing. We experienced negative cash flow from operations during 2006 and during the first nine months of 2007 due to continued net losses. During the nine month period ended September 30, 2007, our operating expenses have increased more rapidly than revenue largely as a result of our increased headcount hired to focus on increasing sales revenue. As a result, the cash used in our operations has increased. In addition, as of September 30, 2007, we had payment obligations under contractual commitments due over the next twelve months of $14.3 million which includes, among other items, loan payments on receivables based loans under our revolving credit line of $6.5 million to BridgeBank N.A. and payments of $2.0 million to the former members of eVergance. In the short term, we will need to raise funds to meet these short term commitments, and we will need to increase our revenues in order to meet our ongoing working capital and capital expenditure needs. Our cash collections during any quarter are driven primarily by the amount of invoices created for renewal maintenance, services delivered, and sales of new license and initial maintenance orders in the previous quarter. We cannot be certain that we will meet our revenue expectations in any given period.

Our ability to generate cash in the future depends upon our success in generating sufficient sales transactions, especially new license transactions. We expect our support renewals in 2007 to continue to be relatively flat from 2006. Since our new license transactions are relatively small in number and are difficult to predict, we may not be able to generate new license transactions as anticipated in any particular future period. From time to time, changes in assets and liabilities, such as changes in levels of accounts receivable and accounts payable, may also affect our cash flows.

For the nine month period ended September 30, 2007, we had negative cash flow from operating activities of $8.6 million. This negative cash flow included an $8.6 million net loss, a $1.7 million decrease in accounts payable and accrued liabilities, a $1.5 million decrease in accrued restructuring and a $688,000 decrease in deferred revenue, partially offset by non-cash charges of $2.2 million for stock-based compensation expense and $748,000 of depreciation. In comparison, for the nine month period ended September 30, 2006, our operating activities used $623,000 of cash and cash equivalents.

Our investing activities used $2.2 million the first nine months of 2007 which consisted primarily of the purchase of eVergance and property and equipment. Our investing activities used $627,000 of cash for the first nine months of 2006 which consisted primarily of the purchase of property and equipment.

Our financing activities provided $6.5 million of cash for the nine months ended September 30, 2007, which consisted primarily of $5.9 million of cash related to net borrowings under our bank loan payable, $1.3 million in proceeds from issuances of common stock resulting from exercises of stock options under our stock option plans, and borrowings of $71,000 on notes payable offset in part by the repayment of $840,000 on notes payable. For the first nine months of 2006, our financing activities used $395,000 of cash and cash equivalents.

On November 30, 2005, we established a new banking relationship with Bridge Bank N.A. (“Bridge”). In addition, on November 30, 2005, we entered into a Business Financing Agreement and Intellectual Property Security Agreement with Bridge under which we had access to a Loan Facility of $7.0 million (the “November Loan”). On March 30, 2006, we modified the Business Financing Agreement with Bridge to increase the additional advances for accounts receivable to $2.0 million and the overall November Loan to $8.0 million. On November 28, 2006, the Business Financing Agreement was modified to extend the expiration date to February 27, 2007.

We have since amended our agreement with Bridge most recently on February 27, 2007, whereby we entered into an Amended and Restated Loan and Security Agreement with Bridge under which we have access to a Loan Facility of $10.0 million (“February Loan”). The February Loan is a formula based revolving line of credit based on 80% of eligible receivables subject to two sub limits; a sub limit of $2.5 million that is available for stand-by letters of credit, settlement limits on foreign exchange contracts or cash management products and a maximum amount of $5.0 million available as a term loan. The total combined borrowing under the February Loan and sublimits cannot exceed $10.0 million. The February Loan is collateralized by all of our assets and expires February 27, 2009 at which time the entire balance under the formula based line of credit will be due. We have a twelve month period to draw down against the term loan, which is repaid over a 36 month period. Interest for the formula based revolving line of credit accrues at the Wall Street Journal’s (“WSJ”) Prime Lending Rate plus 1.25% while interest for the term loan accrues at the WSJ’s Prime Lending Rate plus 1.75%. The February Loan contains certain restrictive covenants including but not limited to certain financial covenants such as maintaining profitability net of stock-based compensation and maintenance of certain key ratios. If we are not in compliance with the covenants of the February Loan, Bridge Bank has the right to declare an event of default and all of the outstanding balances owed under the February Loan would become immediately due and payable.

On May 7, 2007, we entered into a Second Amendment to the February Loan with Bridge (the “Second Amendment”), in which Bridge waived our compliance with certain financial ratios for any period prior to the month and quarter ending June 30, 2007 and consented to our acquisition of eVergance. The terms of the Second Amendment limit our maximum borrowing under the February Loan to $5 million until we have met certain restrictive covenants for two consecutive quarters.

On June 14, 2007, we entered into a Third Amendment to the February Loan (the “Third Amendment”) that provided for additional loans to us in the amount of $1.5 million, all of which were advanced on June 14, 2007, to fund mergers and acquisitions activities and pay acquisition related expenses. The Third Amendment also provides for an additional $500,000 of such loans to be available to us under certain circumstances. These loans were required to be repaid on October 1, 2007, and bear interest at the lender’s prime rate plus 1.75%. In addition, the Third Amendment provides for Bridge to make equipment advances to us from time to time to finance capital expenditures, in an aggregate amount of up to $1 million (subject to increase to $2 million under certain circumstances). These equipment advances will bear interest at the lender’s prime rate plus 1.25%, subject to reduction under certain circumstances, and are required to be repaid in 33 monthly installments beginning on March 31, 2008. The Third Amendment also modified the financial covenants set forth in the February Loan, provided for the payment of certain fees to Bridge, and limited the total amount of loans under the February Loan to $10 million (excluding equipment advances).

On August 21, 2007, we entered into a Loan and Security Modification Agreement to the February Loan that provided a one-time waiver for out-of-compliance conditions with certain financial covenants that existed for the period ended June 30, 2007.

On October 3, 2007, we entered into a Loan and Security Modification Agreement to the February Loan (the “October 3rd Modification”) which provided a one-time waiver for of out-of-compliance conditions with certain financial covenants that existed for the period ended July 31, 2007. In addition, the October 3rd Modification extended the due date for the repayment of loans related to mergers and acquisitions until November 30, 2007. Maturity of the other loans remains the same as agreed in the February Loan as described above. The October 3rd Modification also provided that in lieu of compliance with certain financial covenants the Company may sell its equity securities in an underwritten offering pursuant to a registration statement filed under the Securities Act of 1933 and provided for the payment of certain fees to Bridge.

The combined borrowing under all facilities and sub limits may not exceed $10.0 million. As of September 30, 2007, we had $6.5 million outstanding borrowings from Bridge.

Our future payments due under debt and lease obligations and other contractual commitments as of September 30, 2007 are as follows (in thousands):

Based on our current 2007 and 2008 revenue expectations, and anticipated financing transaction, we expect our cash and cash equivalents will be sufficient to meet our working capital and capital expenditure needs through September 30, 2008. Our operating expenses have increased more rapidly than revenue in recent periods, largely as a result of our increased headcount hired to focus on our goal of increasing sales revenue. As a result, the cash used in our operations has increased. As of September 30, 2007, we have payment obligations for contractual commitments due over the next twelve months of $14.3 million which includes, among other items, loan payments on receivables based loans under our revolving credit line of $6.5 million to BridgeBank N.A. and payments of $2.0 million to the former members of eVergance. In the short term, we will need to raise funds to meet these short term commitments and we will need to increase our revenues in order to meet our ongoing working capital and capital expenditure needs. However, if we do not experience anticipated demand for our products, we will need to further reduce costs, or issue additional equity securities or borrow money to meet our cash requirements. If we raise additional funds through the issuance of equity or convertible securities, the percentage ownership of our stockholders would be reduced and the securities we issue might have rights, preferences and privileges senior to those of our current stockholders. In addition, rising interest rates may impede our ability to borrow additional funds as well as maintain our current debt arrangements. If adequate funds were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited. Our expectations as to our future cash flows and our future cash balances are subject to a number of assumptions, including assumptions regarding anticipated increases in our revenue, improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control.

We operate in a dynamic and rapidly changing business environment that involves substantial risks and uncertainty, including but not limited to the specific risks identified below. The risks described below are not the only ones facing our company. Additional risks not presently known to us, or that we currently deem immaterial, may become important factors that impair our business operations. Any of these risks could cause, or contribute to causing, our actual results to differ materially from expectations. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this report and our other public filings.

We have a history of losses and may not be able to generate sufficient revenue to achieve and maintain profitability and positive cash flow from operations.

Since we began operations in 1997, our revenues have not been sufficient to support our operations, and we have incurred substantial operating losses every year. As of September 30, 2007, our accumulated deficit was approximately $4.3 billion, which includes approximately $2.7 billion related to goodwill impairment charges. Our stockholders’ deficit at September 30, 2007 was $5.6 million. We continue to commit a substantial investment of resources to sales, product marketing, and developing new products and enhancements, and we will need to increase our revenue to achieve profitability and positive cash flows. For the nine months ended September 30, 2007, operating expenses have increased more rapidly than revenue largely as a result of our increased headcount hired to focus on generating increased sales revenue. As a result, the cash used in our operations has increased. As of September 30, 2007, we have payments for contractual commitments due over the next twelve months of $14.3 million which includes, among other items, loan payments on receivables based loans under our revolving credit line of $6.5 million to BridgeBank N.A. and payments of $2.0 million to the former members of eVergance. In the short term, we will need to raise funds to meet these short term commitments and we will need to increase our revenues in order to meet our ongoing working capital and capital expenditure needs. Our expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control. Our history of losses has previously caused some of our potential customers to question our viability, which has in turn hampered our ability to sell some of our products. Additionally, our revenue has been affected by the uncertain economic conditions in recent years, both generally and in our market. As a result of these conditions, we have experienced and expect to continue to experience difficulties in attracting new customers, which means that, even if sales of our products and services grow, we may continue to experience losses, which may cause the price of our stock to decline.

The relatively large size of many of our expected license transactions could contribute to our failure to meet expected sales in any given quarter and could materially harm our operating results if they are not closed in the expected time frame, are lost to a competitor or come in smaller than expected.

Our revenues and results of operations may fluctuate as a result of a variety of factors. Our revenues are especially subject to fluctuation because they depend on the completion of relatively large orders for our products and related services. The average size of our license transactions is generally large relative to our total revenue in any quarter, particularly as we have focused on larger enterprise customers, on licensing our more comprehensive integrated products, and have involved systems integrators or “SIs” in our sales process. If sales expected from a specific customer in a particular quarter are not realized in that quarter, we are unlikely to be able to generate revenue from alternate sources in time to compensate for the shortfall. Fluctuations in our results of operations may be due to a number of additional factors, including, but not limited to, our ability to retain and increase our customer base, changes in our pricing policies or those of our competitors, the timing and success of new product introductions by us or our competitors, the sales cycle for our products, our fixed expenses, the purchasing and budgeting cycles of our clients, and general economic, industry and marketing conditions.

This dependence on large orders makes our net revenue and operating results more likely to vary from quarter to quarter, and more difficult to predict, because the loss of any particular large order is significant. In recent periods, we have experienced increases in the length of a typical sales cycle. This trend may add to the uncertainty of our future operating results and reduce our ability to anticipate our future revenues. Moreover, to the extent that significant sales occur earlier than anticipated, revenues for subsequent quarters may be lower than expected. As a result, our operating results could suffer if any large orders are delayed or canceled in any future period. In part as a result of this aspect of our business, our quarterly revenues and operating results may fluctuate in future periods and we may fail to meet the expectations of investors and public market analysts, which could cause the price of our common stock to decline.

We may not be able to forecast our revenues accurately because our products have a long and variable sales cycle and we rely on systems integrator partners for sales.

The long sales cycle for our products may cause license revenue and operating results to vary significantly from period to period. To date, the sales cycle for most of our product sales has taken anywhere from 6 to 18 months. Our sales cycle typically requires pre-purchase evaluation by a significant number of individuals in our customers’ organizations. Along with third parties that often jointly market our software with us, we invest significant amounts of time and resources educating and providing information to prospective customers regarding the use and benefits of our products. Many of our customers evaluate our software slowly and deliberately, depending on the specific technical capabilities of the customer, the size of the deployment, the complexity of the customer’s network environment, and the quantity of hardware and the degree of hardware configuration necessary to deploy our products.

Furthermore, we rely to a significant extent on SIs to identify, influence, and manage large transactions with customers, and we expect this trend to continue as our industry consolidates. Selling our products in conjunction with our SIs who incorporate our products into their offerings can involve a particularly long and unpredictable sales cycle, as it typically takes more time for the prospective customer to evaluate proposals from multiple vendors. In addition, when SIs propose the use of our products to their customers, it is typically part of a larger project, which can require additional levels of customer approvals. We have little or no control over the sales cycle of an integrator-led transaction or our customers’ budgetary constraints and internal decision-making and acceptance processes.

As a result of increasingly long sales cycles, we have faced increased difficulty in predicting our operating results for any given period, and have experienced significant unanticipated fluctuations in our revenues from period to period. Any failure to achieve anticipated revenues for a period could cause our stock price to decline.

Our business relies heavily on customer service solutions, and these solutions may not gain market acceptance.

We have made customer service solutions our main focus and, in recent periods, have allocated a significant portion of our research and development and marketing resources to the development and promotion of such products. If these products are not accepted by potential customers, our business would be materially adversely affected. For our current business model to succeed, we believe that we will need to convince new and existing customers of the merits of purchasing our customer service solutions over traditional customer relationship management, or CRM, solutions and competitors’ customer service solutions. Many of these customers have previously invested substantial resources in adopting and implementing their existing CRM products, whether such products are ours or are those of our competitors. We may be unable to convince customers and potential customers that it is worth them purchasing substantial new software packages to provide them with our specific customer service capabilities. If our strategy of offering customer service solutions fails, we may not be able to sell sufficient quantities of our product offerings to generate significant license revenues, and our business could be harmed.

Our expenses are generally fixed and we will not be able to reduce these expenses quickly if we fail to meet our revenue expectations.

Most of our expenses, such as employee compensation and outsourcing of technical support and certain development functions, are relatively fixed in the short term. Other expenses like leases are fixed and are more long term. Moreover, our forecast is based, in part, upon our expectations regarding future revenue levels. As a result, in any particular quarter our total revenue can be below expectation and we could not proportionately reduce operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate negative effect on our expected operating results for that quarter.

If we fail to generate sufficient revenues to support our business and require additional financing, failure to obtain such financing would affect our ability to maintain our operations and to grow our business, and the terms of any financing we obtain may impair the rights of our existing stockholders.

In the future, we may be required to seek additional financing to fund our operations or growth, and such financing may not be available to us, or may impair the rights of our existing stockholders. Furthermore, any failure to raise sufficient capital in a timely fashion could prevent us from growing or pursuing our strategies or cause us to limit our operations and cause potential customers to question our financial viability. We had cash and cash equivalents of $1.4 million at September 30, 2007. It is possible that our cash position could decrease over the next few quarters and some customers could become increasingly concerned about our cash situation and our ongoing ability to update and maintain our products. This could significantly harm our sales efforts.

Factors such as the commercial success of our existing products and services, the timing and success of any new products and services, the progress of our research and development efforts, our results of operations, the status of competitive products and services, and the timing and success of potential strategic alliances or potential opportunities to acquire or sell technologies or assets may require us to seek additional funding sooner than we expect. In the event that we require additional cash, we may not be able to secure additional financing on terms that are acceptable to us, especially in the current uncertain market climate, and we may not be successful in implementing or negotiating other arrangements to improve our cash position. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and the securities we issue might have rights, preferences, and privileges senior to those of our current stockholders. If adequate funds were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.

If we fail to grow our customer base or generate repeat business, our operating results could be harmed.

Our business model generally depends on the sale of our products to new customers as well as on expanded use of our products within our customers’ organizations. If we fail to grow our customer base or generate repeat and expanded business from our current and future customers, our business and operating results will be seriously harmed. In some cases, our customers initially make a limited purchase of our products and services for pilot programs. These customers may not purchase additional licenses to expand their use of our products. If these customers do not successfully develop and deploy initial applications based on our products, they may choose not to purchase deployment licenses or additional development licenses. In addition, as we introduce new versions of our products, new product lines or new product features, our current customers might not require the additional functionality we offer and might not ultimately license these products. Furthermore, because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively affect our future services revenue. Also, if customers elect not to renew their support agreements, our services revenue could decline significantly. If customers are unable to pay for their current products or are unwilling to purchase additional products, our revenues would decline. Additionally, a substantial percentage of our sales come from repeat customers. If a significant existing customer or a group of existing customers decide not to repeat business with us, our revenues would decline and our business would be harmed.

We face substantial competition and may not be able to compete effectively.

The market for our products and services is intensely competitive, evolving, and subject to rapid technological change. From time to time, our competitors reduce the prices of their products and services (substantially in certain cases) in order to obtain new customers. Competitive pressures could make it difficult for us to acquire and retain customers and could require us to reduce the price of our products. Any such changes would likely reduce margins and could adversely affect operating results.

Our customers’ requirements and the technology available to satisfy those requirements are continually changing. Therefore, we must be able to respond to these changes in order to remain competitive. If our international development partners do not adequately perform the software programming, quality assurance, and technical documentation activities we

outsourced, we may not be able to respond to such changes as quickly or effectively. Changes in our products may also make it more difficult for our sales force to sell effectively. In addition, changes in customers’ demand for the specific products, product features, and services of other companies’ may result in our products becoming uncompetitive. We expect the intensity of competition to increase in the future. Furthermore, we could lose market share if our competitors introduce new competitive products, add new functionality, acquire competitive products, reduce prices or form strategic alliances with other companies. We may not be able to compete successfully against current and future competitors, and competitive pressures may seriously harm our business.

Our competitors vary in size and in the scope and breadth of products and services offered. We currently face competition with our products from systems designed in-house and by our competitors. We expect that these systems will continue to be a major source of competition for the foreseeable future. Our primary competitors for electronic CRM platforms are larger, more established companies such as Oracle, which recently acquired Siebel Systems. We also face competition from Chordiant Software, ATG, Amdocs, Knova (a subsidiary of Consona Corporation), Talisma, eGain, RightNow, Instranet, and Pegasystems with respect to specific applications we offer. We may face increased competition upon introduction of new products or upgrades from competitors, or if we expand our product line through acquisition of complementary businesses or otherwise. As we have combined and enhanced our product lines to offer a more comprehensive software solution, we are increasingly competing with large, established providers of customer management and communication solutions as well as other competitors. Our combined product line may not be sufficient to successfully compete with the product offerings available from these companies, which could slow our growth and harm our business.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing, and other resources, significantly greater name recognition and a larger installed base of customers than we have. As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or client requirements or devote greater resources to the promotion and sale of their products and services than we can. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. We may lose potential customers to competitors for various reasons, including the ability or willingness of competitors to offer lower prices and other incentives that we cannot match. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of recent industry consolidations, as well as anticipated future consolidations.

We rely on marketing, technology, and distribution relationships for the sale, installation, and support of our products that may generally be terminated at any time, and if our current and future relationships are not successful, our growth might be limited.

We rely on marketing and technology relationships with a variety of companies, including SIs and consulting firms that, among other things, generate leads for the sale of our products and provide our customers with implementation and ongoing support. If we cannot maintain successful marketing and technology relationships or if we fail to enter into additional such relationships, we could have difficulty expanding the sales of our products and our growth might be limited.

A significant percentage of our revenues depends on leads generated by SIs and their recommendations of our products. If SIs do not successfully market our products, our operating results will be materially harmed. In addition, many of our direct sales are to customers that will be relying on SIs to implement our products, and if SIs are not familiar with our technology or able to successfully implement our products, our operating results will be materially harmed. We expect to continue increasing our leverage of SIs as indirect sales channels and, if this strategy is successful, our dependence on the efforts of these third parties for revenue growth and customer service will remain high. Our reliance on third parties for these functions has reduced our control over such activities and reduced our ability to perform such functions internally. If we come to rely primarily on a single SI that subsequently terminates its relationship with us, becomes insolvent or is acquired by another company with which we have no relationship, or decides not to provide implementation services related to our products, we may not be able to internally generate sufficient revenue or increase the revenues generated by our other SI relationships to offset the resulting lost revenues. Furthermore, SIs typically suggest our solution in combination with other products and services, some of which may compete with our solution. SIs are not required to promote any fixed quantities of our products, are not bound to promote our products exclusively, and may act as indirect sales channels for our competitors. If SIs choose not to promote our products or if they develop, market, or recommend software applications that compete with our products, our business will be harmed.

In addition to relying on SIs to recommend our products, we also rely on SIs and other third-party resellers to install and support our products. If the companies providing these services fail to implement our products successfully for our customers, the customer may be unable to complete implementation on the schedule that it had anticipated and we may have increased customer dissatisfaction or difficulty making future sales as a result. We might not be able to maintain our relationships with SIs and other indirect sales channel partners and enter into additional relationships that will provide timely and cost-effective customer support and service. If we cannot maintain successful relationships with our indirect sales channel partners, we might have difficulty expanding the sales of our products and our growth could be limited. In addition, if such third parties do not provide the support our customers need, we may be required to hire subcontractors to provide these professional services. Increased use of subcontractors would harm our margins because it costs us more to hire subcontractors to perform these services than it would to provide the services ourselves.

Because certain customers account for a substantial portion of our revenues, the loss of a significant customer could cause a substantial decline in our revenues.

One customer, IBM who resells our software to its customers, accounted for 5% of revenue for the nine months ended September 30, 2007 and 9%, 11% and 11% of our revenue in 2006, 2005 and 2004 respectively. Given that we derive a significant portion of our license and services revenues from IBM, the loss of this customer could cause a decrease in revenues and operating results. Furthermore, if we lose major customers, or if a contract is delayed or cancelled or we do not contract with new major customers, our revenues and net loss would be adversely affected. In addition, customers that have accounted for significant revenues in the past may not generate revenues in any future period, and our failure to obtain new significant customers or additional orders from existing customers could materially affect our operating results.

We may not receive significant revenues from our current research and development efforts for several years, if at all.

Developing and localizing software is expensive and the investment in product development often involves a long payback cycle. We have and expect to continue making significant investments in software research and development and related product opportunities. Enhancing our products and pursuing new product developments require high levels of expenditures for research and development that could adversely affect our operating results if not offset by revenue increases. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we do not expect to receive significant revenues from these investments for several years, if at all.

Changes in our workforce may adversely affect our ability to release products and product updates in a timely manner.

We reduced our employee headcount in 2005 from a total of 181 as of December 31, 2004 to 125 as of December 31, 2005 and then increased to 181 as of December 31, 2006 and to 231 as of September 30, 2007. The majority of the 2005 reduction was the result of our decision to shift a significant portion of our software programming, quality assurance and technical documentation activities to international development partners in early 2003, a strategy we have since reversed through our “back-shoring” process. We reduced the size of our research and development department from 34 employees as of December 31, 2004, to 30 employees as of December 31, 2005 and then increased to 37 as of December 31, 2006 and to 54 as of September 30, 2007. In addition, we reduced the level of our expenditures on outsourced development in 2005, and, in December 2005, we consolidated a significant portion of our research and development operations into one location in Menlo Park, California to optimize our research and development processes and decrease overall operating expenses. As a result, we terminated the employment of 15 employees based in our New Hampshire office. The changes in our research and development headcount and the reductions in our outsourced development capacity may limit our ability to release products within expected timeframes. For example, many of the employees who were terminated in headcount reductions possessed specific knowledge or expertise that may prove to have been important to our operation, and which was not replaced in our more recent headcount increases. As a result, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities. Personnel reductions may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us to incur significant expense. Our termination of two outsourcing arrangements in early 2005 may further reduce our ability to respond to development challenges and to introduce new products in expected timeframes.

If our cost reduction and restructuring efforts are ineffective, our revenues and profitability may be hurt.

In July 2007, we undertook various cost reduction and restructuring activities. The restructuring charges were approximately $248,000; however, if we incur additional restructuring-related charges, our financial condition and results of operations may suffer. In addition, the cost reduction and restructuring activities may not produce the full efficiencies and benefits we expect or the efficiencies and benefits might be delayed. There can be no assurance that these efforts, as well as any potential future cost reduction and restructuring activities, will not adversely affect our business, operations or customer perceptions, or result in additional future charges.

We may be unable to hire and retain the skilled personnel necessary to develop and grow our business.

We rely on the continued service of our senior management and other key employees and the hiring of new qualified employees. In the software industry, there is substantial and continuous competition for highly skilled business, product development, technical and other personnel. Given the concern over our long-term financial strength, we may not be successful in recruiting new personnel and retaining and motivating existing personnel, which could lead to increased turnover and reduce our ability to meet the needs of our current and future customers. Because our stock price declined drastically in recent years, and has not experienced any sustained recovery from the decline, stock-based compensation, including options to purchase our common stock, may have diminished effectiveness as employee hiring and retention devices. If we are unable to retain qualified personnel, we could face disruptions to operations, loss of key information, expertise or know-how, and unanticipated additional recruitment and training costs. If employee turnover increases, our ability to provide customer service and execute our strategy would be negatively affected.

For example, our ability to increase revenues in the future depends considerably upon our success in training and retaining effective direct sales personnel and the success of our direct sales force. We might not be successful in these efforts. Our products and services require sophisticated sales efforts. We have experienced significant turnover in our sales force including domestic senior sales management, and may experience further turnover in future periods. It generally takes a new salesperson nine or more months to become productive, and they may not be able to generate new sales. Our business will be harmed if we fail to retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than anticipated. Additionally, we need to recruit experienced developers as a result of our back-shoring initiative.

If we fail to respond to changing customer preferences in our market, demand for our products and our ability to enhance our revenues will suffer.

If we do not continue to improve our products and develop new products that keep pace with competitive product introductions and technological developments, satisfy diverse and rapidly evolving customer requirements, and achieve market acceptance, we might be unable to attract new customers. Our industry is characterized by rapid and substantial developments in the technologies and products that enjoy widespread acceptance among prospective and existing customers. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. In addition, if our international development partners fail to provide the development support we need, our products and product documentation could fall behind those produced by our competitors, causing us to lose customers and sales. We might not be successful in marketing and supporting our products or developing and marketing other product enhancements and new products that respond to technological advances and market changes, on a timely or cost-effective basis. In addition, even if these products are developed and released, they might not achieve market acceptance. We have experienced delays in releasing new products and product enhancements in the past and could experience similar delays in the future. These delays or problems in the installation or implementation of our new releases could cause us to lose customers.

Our failure to manage multiple technologies and technological change could reduce demand for our products.

Rapidly changing technology and operating systems, changes in customer requirements, and evolving industry standards might impede market acceptance of our products. Our products are designed based upon currently prevailing technology to work on a variety of hardware and software platforms used by our customers. However, our software may not operate correctly on evolving versions of hardware and software platforms, programming languages, database environments, and other systems that our customers use. If new technologies emerge that are incompatible with our products, or if competing products emerge that are based on new technologies or new industry standards and that perform better or cost less than our products, our key products could become obsolete and our existing and potential customers could seek alternatives to our products. We must constantly modify and improve our products to keep pace with changes made to these platforms and to database systems and other back-office applications and Internet-related applications. Furthermore, software adapters are necessary to integrate our products with other systems and data sources used by our customers. We must develop and update these adapters to reflect changes to these systems and data sources in order to maintain the functionality provided by our products. As a result, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems, databases, customer relationship management software, web servers and other enterprise and Internet-based applications could delay our product development, increase our product development expense or cause customers to delay evaluation, purchase and deployment of our analytics products. If we fail to modify or improve our products in response to evolving industry standards, our products could rapidly become obsolete.

Our success depends upon our ability to develop new products and enhance our existing products on a timely basis.

The challenges of developing new products and enhancements require us to commit a substantial investment of resources to development, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could be exploited by our competitors and lead potential customers to choose alternative products. To be competitive, we must develop and introduce on a timely basis new products and product enhancements for companies with significant e-business customer interactions needs. Our ability to deliver competitive products may be negatively affected by the diversion of resources to development of our suite of products, and responding to changes in competitive products and in the demands of our customers. If we experience product delays in the future, we may face:

Furthermore, delays in bringing new products or enhancements to market can result, for example, from potential difficulties with managing outsourced research and development or from loss of institutional knowledge through reductions in force, or the existence of defects in new products or their enhancements.

Failure to license necessary third-party software incorporated in our products could cause delays or reductions in our sales.

We license third-party software that we incorporate into our products. These licenses may not continue to be available on commercially reasonable terms or at all. Some of this technology would be difficult to replace. The loss of any of these licenses could result in delays or reductions of our applications until we identify, license and integrate, or develop equivalent software. If we are required to enter into license agreements with third parties for replacement technology, we could face higher royalty payments and our products may lose certain attributes or features. In the future, we might need to license other software to enhance our products and meet evolving customer needs. If we are unable to do this, we could experience reduced demand for our products.

Defects in third-party products associated with our products could impair our products’ functionality and injure our reputation.

The effective implementation of our products depends upon the successful operation of third-party products in conjunction with our products. Any undetected defects in these third-party products could prevent the implementation or impair the functionality of our products, delay new product introductions or injure our reputation.

Our independent registered public accounting firm has identified material weaknesses in our internal controls that, if not remediated, could affect our ability to prepare timely and accurate financial reports, which could cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our stock.

During the 2006 year-end close, we identified and reported a material weakness in our internal controls over financial reporting related to our stock-based compensation. This material weakness related to our failure to complete a proper analysis of historical stock option vesting data within our system. This resulted in a net overstatement of our stock-based compensation during the interim reporting periods for fiscal year 2006. As a result of this material weakness, the quarterly results of operations have been restated, as provided in Note 14 of the consolidated financial statements in the Company’s 2006 Form 10-K for the year ended December 31, 2006 and the Company was unable to conclude that our disclosure controls and procedures were effective as of December 31, 2006.

Our management, with the oversight of the Audit Committee has begun to address this material weakness related to our stock-based compensation and is committed to effective remediation of this deficiency as expeditiously as possible. We have implemented a procedure to review the stock option reports on a quarterly basis to assure that only current employee options that are expected to vest are included in the employee stock-based compensation expense for the period. Our material weakness will not be considered remediated until new internal controls are developed and implemented throughout the Company, are operational for a period of time and are tested, and management concludes that these controls are operating effectively.

Our remediation measures may not be successful in correcting the material weakness related to our stock-based compensation reported by our current independent registered public accounting firm. In addition, we cannot assure you that additional material weaknesses or significant deficiencies in our internal controls will not be discovered in the future. In addition, internal controls may become inadequate because of changes in conditions and the degree of compliance with the policies or procedures may deteriorate. Any failure to remediate the material weaknesses described above or to implement and maintain effective internal controls could harm our operating results, delay our completion of our consolidated financial statements and our independent registered public accounting firm’s audit or review of our consolidated financial statements which could cause us to fail to timely meet our periodic reporting obligations with the Securities and Exchange Commission, or the SEC, or result in material misstatements in our consolidated financial statements which could also cause us to fail to timely meet our periodic reporting obligations with the SEC. Deficiencies in our internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

Our common stock was delisted from The NASDAQ Global Market and is currently quoted on the OTCBB.

Our common stock was delisted from The NASDAQ Global Market (formerly The NASDAQ National Market) effective at the opening of business on October 17, 2005. From October 17, 2005 to December 4, 2006, our common stock was quoted on the “Pink Sheets” and as of December 5, 2006, our common stock has been quoted on the Over the Counter Bulletin Board (“OTCBB”). Quotation of our common stock on the OTCBB will likely reduce the liquidity of our securities, could cause investors not to trade in our securities, result in a lower stock price and could have an adverse effect on the Company. Additionally, we may become subject to the SEC rules that affect “penny stocks,” which are stocks below $5.00

per share that are not quoted on The NASDAQ Stock Market. These SEC rules would make it more difficult for brokers to find buyers for our securities and could lower the net sales prices that our stockholders are able to obtain. If our price of common stock remains low, we may not be able to raise equity capital.

Our stock price has been highly volatile and has experienced a significant decline, and may continue to be volatile and decline.

The trading price of our common stock has fluctuated widely in the past and we expect that it will continue to do so in the future, as a result of a number of factors, many of which are outside our control, such as:

In addition, stock markets in general have, and particularly The NASDAQ Stock Market has, experienced extreme price and volume fluctuations that have affected the market prices of many technology and computer software companies, particularly Internet-related companies. Such fluctuations have often been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. Securities class action litigation could result in substantial costs and a diversion of our management’s attention and resources.

Since becoming a publicly traded security listed on The NASDAQ Global Market in September 1999, our common stock has reached a sales price high of $1,698.10 per share and a sales price low of $0.65 per share. On October 17, 2005, our common stock was delisted from The NASDAQ Global Market due to the failure to timely file our Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 with the SEC. Our common stock is currently quoted on the OTCBB. The last reported sale price of our shares on November 2, 2007 was $3.20 per share.

Our pending patents may never be issued and, even if issued, may provide little protection.

Our success and ability to compete depend upon the protection of our software and other proprietary technology rights. We currently have five issued U.S. patents, three of which expire in 2018 and two of which expire in 2020, and multiple U.S. patent applications pending relating to our software. None of our technology is patented outside of the United States. It is possible that:

We rely upon trademarks, copyrights, and trade secrets to protect our proprietary rights, which may not be sufficient to protect our intellectual property.

In addition to patents, we rely on a combination of laws, such as copyright, trademark, and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. However, despite the precautions that we have taken:

Also, the laws of some other countries in which we market our products may offer little or no effective protection of our proprietary technology. Consequently, we may be unable to prevent our proprietary technology from being exploited abroad, which could diminish international sales or require costly efforts to protect our technology. Reverse engineering, unauthorized copying, or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business.

We may become involved in litigation over proprietary rights, which could be costly and time consuming.

The software industry is characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights, and our technologies may not be able to withstand any third-party claims or rights against their use. Some of our competitors in the market for customer communications software may have filed or may intend to file patent applications covering aspects of their technology that they may claim our technology infringes. Such competitors could make a claim of infringement against us with respect to our products and technology. Additionally, third parties may currently have, or may eventually be issued, patents upon which our current or future products or technology infringe and any of these third parties might make a claim of infringement against us. For example, we have recently been involved in litigation brought by Polaris IP, LLC against us and certain of our customers that claimed that certain of our products violates patents held by them.

As we grow, the possibility of intellectual property rights claims against us increases. We may not be able to withstand any third-party claims and regardless of the merits of the claim, any intellectual property claims could be inherently uncertain, time-consuming and expensive to litigate or settle. Many of our software license agreements require us to indemnify our customers from any claim or finding of intellectual property infringement. We periodically receive notices from customers regarding patent license inquiries they have received which may or may not implicate our indemnity obligations. Any litigation, brought by others, or us could result in the expenditure of significant financial resources and the diversion of management’s time and efforts. In addition, litigation in which we are accused of infringement might cause product shipment delays, require us to develop alternative technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a claim of infringement was made against us and we may not be able to develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.

We may face liability claims that could result in unexpected costs and damages to our reputation.

Our licenses with customers generally contain provisions designed to limit our exposure to potential product liability claims, such as disclaimers of warranties and limitations on liability for special, consequential, and incidental damages. In addition, our license agreements generally limit the amounts recoverable for damages to the amounts paid by the licensee to us for the product or service giving rise to the damages. However, some domestic and international jurisdictions may not enforce these contractual limitations on liability. We may be subject to claims based on errors in our software or mistakes in performing our services including claims relating to damages to our customers’ internal systems. A product liability claim could divert the attention of management and key personnel, could be expensive to defend, and could result in adverse settlements and judgments.

We face the possibility of higher costs as a result of the complexity of our products and the potential for undetected errors. Due to the critical nature of many of our products and services, errors could be particularly problematic. In the past, we have discovered software errors in some of our products after their introduction. We have only a few “beta” customers that test new features and functionality of our software before we make these features and functionalities generally available to our customers. If we are not able to detect and correct errors in our products or releases before commencing commercial shipments, we could face:

Any of the foregoing potential results of errors in our software could adversely affect our business, financial condition and results of operations.

Our security could be breached, which could damage our reputation and deter customers from using our services.

We must protect our computer systems and network from physical break-ins, security breaches, and other disruptive problems caused by the Internet or other users. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network, which could adversely affect our ability to retain or attract customers, damage our reputation, and subject us to litigation. We have been in the past, and could be in the future, subject to denial of service, vandalism, and other attacks on our systems by Internet hackers. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage in certain circumstances may be insufficient to cover losses that may result from such events.

We have significant international sales and are subject to risks associated with operating in international markets.

A substantial proportion of our revenues are generated from sales outside North America, exposing us to additional financial and operational risks. Sales outside North America represented 22% and 27% of our total revenues for the three and nine months ended September 30, 2007, respectively, compared to 43% and 31% of our total revenues for the three and nine months ended September 30, 2006 respectively. We have established offices in the United States, Europe, Japan, and Hong Kong. Sales outside North America could increase as a percentage of total revenues as we attempt to expand our international operations. In addition to the additional costs and uncertainties of being subject to international laws and regulations, international operations require significant management attention and financial resources, as well as additional support personnel. To the extent our international operations grow, we will also need to, among other things, expand our international sales channel management and support organizations and develop relationships with international service providers and additional distributors and SIs. International operations are subject to many inherent risks, including:

We believe that international sales will continue to represent a significant portion of our revenue for the foreseeable future. Any of these factors may adversely affect our future international sales and, consequently, affect our business, financial condition and results of operations.

Our international revenues and expenses are denominated in local currency. Therefore, a weakening of other currencies compared to the U.S. dollar could make our products less competitive in foreign markets and could negatively affect our operating results and cash flows. We have not yet experienced, but may in the future experience, significant foreign currency transaction losses, especially because we generally do not engage in currency hedging. To the extent the international component of our revenues grows, our results of operations will become more sensitive to foreign exchange rate fluctuations.

If we acquire companies, products, or technologies, we may face risks associated with those acquisitions.

We acquired Hipbone, Inc. in early 2004, and if we are presented with appropriate opportunities, we may make other investments in complementary companies, products, or technologies. In June 2007, we acquired all of the membership interests of eVergance Partners LLC (“eVergance”). We may not realize the anticipated benefits of the Hipbone or eVergance acquisition or any other acquisition or investment. For example, since inception, the Company has recorded $2.7 billion of impairment charges for the cost of goodwill obtained from acquisitions. Upon the acquisition of eVergance, or if we acquire another company, we will likely face risks, uncertainties, and disruptions associated with the integration process, including,

among other things, difficulties in the integration of the operations, technologies, and services of the acquired company, the diversion of our management’s attention from other business concerns, the potential loss of key employees of the acquired businesses, and the failure of the acquired businesses, products or technologies to generate sufficient revenue to offset acquisition costs. If we fail to successfully integrate other companies that we may acquire, our business could be harmed. Also, acquisitions, including the acquisition of eVergance, can expose us to liabilities and risks facing the company we acquire, such as lawsuits or claims against the company that are unknown at the time of the acquisition. Furthermore, we may have to incur debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our existing stockholders. In addition, our operating results may suffer because of acquisition-related costs or amortization expenses or charges relating to acquired goodwill and other intangible assets. These factors could have an adverse effect on our business, results of operations, financial condition or cash flows.

Compliance with regulations governing public company corporate governance and reporting will result in additional costs.

Our continuing preparation for and implementation of various corporate governance reforms and enhanced disclosure laws and regulations adopted in recent years requires us to incur significant additional accounting and legal costs. We are preparing for new accounting disclosures required by laws and regulations adopted in connection with the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). In particular, we are preparing to provide, beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2007, an Annual Report on our internal control over financial reporting and auditors’ attestation with respect to our report required by Section 404 of the Sarbanes-Oxley Act. Any unanticipated difficulties in preparing for and implementing these and other corporate governance and reporting reforms could result in material delays in compliance or significantly increase our costs. Also, there can be no assurance that we will be able to fully comply with these new laws and regulations. Any failure to timely prepare for and implement the reforms required by these new laws and regulations could significantly harm our business, operating results, and financial condition.

We have adopted anti-takeover defenses that could delay or prevent an acquisition of the Company.

Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock. Without any further vote or action on the part of the stockholders, the Board of Directors has the authority to determine the price, rights, preferences, privileges, and restrictions of the preferred stock. This preferred stock, if issued, might have preference over and harm the rights of the holders of common stock. Although the ability to issue this preferred stock provides us with flexibility in connection with possible acquisitions and other corporate purposes, it can also be used to make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

Our certificate of incorporation, bylaws, and equity compensation plans include provisions that may deter an unsolicited offer to purchase us. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer, or proxy contest. Furthermore, our Board of Directors is divided into three classes, only one of which is elected each year. In addition, directors are only removable by the affirmative vote of at least two-thirds of all classes of voting stock. These factors may further delay or prevent a change of control of us.

Future regulation of the Internet may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.

State, federal, and foreign regulators could adopt laws and regulations that impose additional burdens on companies that conduct business online. These laws and regulations could discourage communication by e-mail or other web-based communications, particularly targeted e-mail of the type facilitated by our products, which could reduce demand for our products and services.

The growth and development of the market for online services may prompt calls for more stringent consumer protection laws or laws that may inhibit the use of Internet-based communications or the information contained in these communications. The adoption of any additional laws or regulations may decrease the expansion of the Internet. A decline in the growth of the Internet, particularly as it relates to online communication, could decrease demand for our products and services and increase our costs of doing business, or otherwise harm our business. Any new legislation or regulations, application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or application of existing laws and regulations to the Internet and other online services could increase our costs and harm our growth.

The imposition of sales and other taxes on products sold by our customers over the Internet could have a negative effect on online commerce and the demand for our products and services.

The imposition of new sales or other taxes could limit the growth of Internet commerce generally and, as a result, the demand for our products and services. Federal legislation that limits the imposition of state and local taxes on Internet-related sales will expire on November 1, 2014. Congress may choose to modify this legislation or to allow it to expire, in which case

state and local governments would be free to impose taxes on electronically purchased goods. We believe that most companies that sell products over the Internet do not currently collect sales or other taxes on shipments of their products into states or foreign countries where they are not physically present. However, one or more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction companies that engage in e-commerce within their jurisdiction. A successful assertion by one or more states or foreign countries that companies that engage in e-commerce within their jurisdiction should collect sales or other taxes on the sale of their products over the Internet, even though not physically in the state or country, could indirectly reduce demand for our products.

Privacy concerns relating to the Internet are increasing, which could result in legislation that negatively affects our business in reduced sales of our products.

Businesses using our products capture information regarding their customers when those customers contact them on-line with customer service inquiries. Privacy concerns could cause visitors to resist providing the personal data necessary to allow our customers to use our software products most effectively. More importantly, even the perception of privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our products. In addition, legislative or regulatory requirements may heighten these concerns if businesses must notify website users that the data captured after visiting certain websites may be used by marketing entities to unilaterally direct product promotion and advertising to that user. If consumer privacy concerns are not adequately resolved, our business could be harmed. Government regulation that limits our customers’ use of this information could reduce the demand for our products. A number of jurisdictions have adopted, or are considering adopting, laws that restrict the use of customer information from Internet applications. The European Union has required that its member states adopt legislation that imposes restrictions on the collection and use of personal data, and that limits the transfer of personally identifiable data to countries that do not impose equivalent restrictions. In the United States, the Children’s Online Privacy Protection Act was enacted in October 1998. This legislation directs the Federal Trade Commission to regulate the collection of data from children on commercial websites. In addition, the Federal Trade Commission has investigated the privacy practices of businesses that collect information on the Internet. These and other privacy-related initiatives could reduce demand for some of the Internet applications with which our products operate, and could restrict the use of these products in some e-commerce applications. This could, in turn, reduce demand for these products.

The success of our products depends on the continued growth and acceptance of the Internet as a business and communications tool, and the related expansion of the Internet infrastructure.

The future success of our products depends upon the continued and widespread adoption of the Internet as a primary medium for commerce, communication and business applications. Our business growth would be impeded if the performance or perception of the Internet was harmed by security problems such as “viruses,” “worms” and other malicious programs, reliability issues arising from outages and damage to Internet infrastructure, delays in development or adoption of new standards and protocols to handle increased demands of Internet activity, increased costs, decreased accessibility and quality of service, or increased government regulation and taxation of Internet activity.

The Internet has experienced, and is expected to continue to experience, significant user and traffic growth, which has, at times, caused user frustration with slow access and download times. If Internet activity grows faster than Internet infrastructure or if the Internet infrastructure is otherwise unable to support the demands placed on it, our business growth may be adversely affected.

General economic conditions could adversely affect our customers’ ability or willingness to purchase our products, which could materially and adversely affect our results of operations.

Our customers consist of large and small companies in nearly all industry sectors and geographies. Potential new clients or existing clients could defer purchases of our products because of unfavorable macroeconomic conditions, such as rising interest rates, fluctuations in currency exchange rates, industry or national economic downturns, industry purchasing patterns, and other factors. Our ability to grow revenues may be adversely affected by unfavorable economic conditions.

We develop products in the United States and sell these products in North America, Europe, Asia, and Australia. In the nine months ended September 30, 2007 and the year ended December 31, 2006, revenues from customers outside of the United States approximated 27% and 32%, respectively, of total revenues. Generally, our sales are made in the local currency of our customers. As a result, our financial results and cash flows could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We rarely use derivative instruments to hedge against foreign exchange risk. As such, we are exposed to market risk from fluctuations in foreign currency exchange rates, principally from the exchange rate between the U.S. dollar and the Euro and the British pound. We manage exposure to variability in foreign currency exchange rates primarily due to the fact that liabilities and assets, as well as revenues and expenses, are denominated in the local currency. However, different durations in our funding obligations and assets may expose us to the risk of foreign exchange rate fluctuations. We have not entered into any derivative instrument transactions to manage this risk. Based on our overall foreign currency rate exposure at September 30, 2007, we do not believe that a hypothetical 10% change in foreign currency rates would have a material adverse affect on our financial position or results of operations. We do not consider our cash equivalents to be subject to interest rate risk due to their short maturities.

Regulations under the Exchange Act require public companies, including our company, to maintain “disclosure controls and procedures,” which are defined as controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer performed an evaluation of our disclosure controls and procedures as of the end of the period covered by this report and found that they were not effective as a result of the material weakness described below.

Regulations under the Exchange Act require public companies, including our Company, to evaluate any change in our “internal control over financial reporting” as such term is defined in Rule 13a-15(f) and Rule 15d-15(f) of the Exchange Act. In connection with their evaluation of our disclosure controls and procedures as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer did not identify any change in our internal control over financial reporting during the fiscal quarter covered by this report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

During the 2006 year-end close, we identified and reported a material weakness in our internal control over financial reporting related to stock-based compensation. This material weakness related to our failure to complete a proper analysis of historical stock option vesting data within our system, which resulted in a net overstatement of our stock-based compensation during the interim reporting periods for fiscal year 2006. Due to this material weakness, quarterly results of operations have been restated, as provided in Note 14 of the consolidated financial statements in the Company’s Form 10-K for the year ended December 31, 2006. We are unable to conclude that our disclosure controls and procedures were effective as of September 30, 2007.

Our management, with the oversight of the Audit Committee, has begun to address this material weakness related to stock-based compensation and is committed to effective remediation as expeditiously as possible. Our management has implemented a procedure to review the stock option reports on a quarterly basis to assure that only current employee options that are expected to vest are included in the employee stock-based compensation expense for such period. This material weakness will not be considered remediated until new internal controls are developed and implemented throughout the Company, are operational for a period of time and are tested, and our management concludes that these internal controls are operating effectively.

On January 24, 2007, RightNow Technologies, Inc. (“RightNow”) filed a suit in the Eighteenth Judicial District Court of Gallatin County, Montana against the Company and four former RightNow employees who had joined the Company. The suit alleges violation of certain provisions of employment agreements, misappropriation of trade secrets, as well as other claims, and seeks damages. We believe we have meritorious defenses to these claims and intend to defend against this action vigorously.

The underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros., Hambrecht & Quist LLC and Wit Soundview Capital Corp., the Company and certain current and former officers of the Company were named as defendants in federal securities class action lawsuits filed in the U. S. District Court for the Southern District of New York. The cases allege violations of various securities laws by more than 300 issuers of stock, including the Company, and the underwriters for such issuers, on behalf of a class of plaintiffs who, in the case of the Company, purchased the Company’s common stock between September 21, 1999 and December 6, 2000 in connection with our initial public offering. Specifically, the complaints allege that the underwriter defendants engaged in a scheme concerning sales of the Company’s and other issuers’ securities in the initial public offering and in the aftermarket. In July 2003, we decided to join a settlement negotiated by representatives of a coalition of issuers named as defendants in this action and their insurers to avoid the cost and distraction of continued litigation. The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the District Court. However, while the settlement was awaiting final approval by the District Court, in December 2006, the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the District Court approved a stipulation withdrawing the proposed settlement. The parties had agreed upon a July 31, 2007 deadline for plaintiffs to file an amended complaint, and a September 27, 2007 deadline for filing a motion for class certification. On July 30, 2007, the plaintiffs requested and the District Court approved an extension, and the plaintiffs filed an amended complaint on August 14, 2007. On November 9, 2007, the defendants filed a motion to dismiss the complaint for failure to state a claim. The Company believes it has meritorious defenses to these claims and intends to defend against this action vigorously.

Other third parties have from time to time claimed, and others may claim in the future that we have infringed their past, current or future intellectual property rights. We have in the past been forced to litigate such claims. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business or could require us to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm our business.

The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on our results of operations, consolidated balance sheets and cash flows due to defense costs, diversion of management resources and other factors.

Information regarding the Company’s risk factors appears in “Part I. Financial Information — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q and in “Part I.—Item 1A. Risk Factors” on our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 other than the material changes set forth below:

The 2007 Annual Meeting of Stockholders was held on July 26, 2007 at our headquarters, 181 Constitution Drive, Menlo Park, California. At the meeting, our stockholders voted on the three proposals described below. One Class I board nominee was elected under Proposal 1; three Class II board nominees were elected under Proposals 2; and Proposal 3 to ratify the selection of Burr, Pilger & Mayer LLP as our independent registered public accounting firm for fiscal year 2007 was approved.

Proposal 1: To elect one Class I director to the Board to hold office until the 2009 Annual Meeting of Stockholders and until her successor is elected and qualified or until her earlier resignation or removal was approved by our stockholders. The nominee received the following votes:

Proposal 2: To elect three Class II directors to the Board to hold office until the 2010 Annual Meeting of Stockholders and until their successors are elected and qualified or until their earlier resignation or removal was approved by our stockholders. The nominees received the following votes:

Proposal 3: To ratify the selection of Burr, Pilger & Mayer LLP as our independent registered public accounting firm for fiscal year 2007 was approved by our stockholders. This proposal received the following votes:

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.

Kana Software, Inc.

/s/ Michael S. Fields

Michael S. Fields

Chairman of the Board of Directors and Chief Executive Officer

(Principal Executive Officer)

/s/ John M. Thompson

John M. Thompson

Executive Vice President and Chief Financial Officer

(Principal Financial and Accounting Officer)


		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets—September 30, 2007 and December 31, 2006 (Unaudited)	3

	Condensed Consolidated Statements of Operations—Three and Nine Months Ended September 30, 2007 and 2006 (Unaudited)	4

	Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2007 and 2006 (Unaudited)	5

	Notes to the Unaudited Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42

Item 4T.	Controls and Procedures	42

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	43

Item 1A.	Risk Factors	43

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3.	Defaults Upon Senior Securities	44

Item 4.	Submission of Matters to a Vote of Security Holders	44

Item 5.	Other Information	44

Item 6.	Exhibits	45

	Signatures	46

	Exhibit Index	47

	Certifications


	September 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	1,441		$	5,719
Restricted cash		309			74
Accounts receivable, net of allowance of $196 and $155 at September 30, 2007 and December 31, 2006, respectively		9,780			8,756
Prepaid expenses and other current assets		4,105			1,967

Total current assets		15,635			16,516
Restricted cash, long-term		769			990
Property and equipment, net		2,007			1,221
Goodwill		12,513			8,623
Acquired intangible assets, net		2,351			15
Other assets		696			2,970

Total assets	$	33,971		$	30,335

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Loan payable	$	6,476		$	—
Notes payable		2,096			327
Accounts payable		2,966			2,684
Accrued liabilities		6,345			6,880
Accrued restructuring		3,268			1,844
Deferred revenue		15,750			15,825

Total current liabilities		36,901			27,560
Deferred revenue, long-term		208			410
Accrued restructuring, long-term		1,749			4,258
Other long-term liabilities		689			1,239

Total liabilities		39,547			33,467

Commitments and contingencies (Note 6)

Stockholders’ deficit:
Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $0.001 par value; 250,000,000 shares authorized; 36,803,911 and 35,972,283 shares issued and outstanding		37			36
Common stock subscription		949			—
Additional paid-in capital		4,307,851			4,302,495
Accumulated other comprehensive income (loss)		(19	)		171
Accumulated deficit		(4,314,394	)		(4,305,834	)

Total stockholders’ deficit		(5,576	)		(3,132	)

Total liabilities and stockholders’ deficit	$	33,971		$	30,335


	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006 Restated (2)			2007			2006 Restated (2)
Revenues:
License fees	$	5,793		$	4,345		$	12,920		$	13,148
Services		11,048			8,811			30,348			26,016

Total revenues		16,841			13,156			43,268			39,164

Costs and expenses (1):
Cost of license fees		415			832			942			2,044
Cost of services		4,084			2,515			10,820			7,228
Amortization of acquired intangible assets		125			34			164			100
Sales and marketing		6,443			4,325			19,296			13,295
Research and development		3,048			2,718			9,783			7,477
General and administrative		2,888			2,587			9,511			7,259
Restructuring		567			—			567			10

Total costs and expenses		17,570			13,011			51,083			37,413

Income (loss) from operations		(729	)		145			(7,815	)		1,751
Interest and other income (expense), net		(506	)		85			(612	)		(826	)
Registration rights penalty		—			(166	)		—			(1,198	)

Income (loss) before income taxes		(1,235	)		64			(8,427	)		(273	)
Income tax expense		(32	)		(53	)		(133	)		(129	)

Net income (loss)	$	(1,267	)	$	11		$	(8,560	)	$	(402	)

Basic net income (loss) per share	$	(0.03	)	$	0.00		$	(0.23	)	$	(0.01	)

Shares used in computing basic net income (loss) per share		37,061			34,570			36,487			34,263

Diluted net income (loss) per share	$	(0.03	)	$	0.00		$	(0.23	)	$	(0.01	)

Shares used in computing diluted net income (loss) per share		37,061			35,647			36,487			34,263


(1) Employee stock-based compensation included in the expense line items:

Cost of services	$	102		$	62		$	226		$	153
Sales and marketing		194			222			643			535
Research and development		120			102			261			252
General and administrative		313			1,099			1,009			1,184


	Nine Months Ended September 30,
	2007			2006 Restated (1)
Cash flows from operating activities:
Net loss	$	(8,560	)	$	(402	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		748			1,152
Loss on the disposal of property and equipment		—			46
Amortization of acquired intangible assets		164			100
Stock-based compensation		2,244			2,644
Provision for doubtful accounts		41			(1	)
Restructuring		327			10
Non-cash interest accretion		153			69
Registration rights penalty		—			1,198
Change in fair value of warrant liability		—			774
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable		(71	)		(1,051	)
Prepaid expenses and other assets		228			576
Accounts payable and accrued liabilities		(1,718	)		(4,555	)
Accrued restructuring		(1,503	)		(1,986	)
Deferred revenue		(688	)		803

Net cash used in operating activities		(8,635	)		(623	)

Cash flows from investing activities:
Purchases of property and equipment		(1,399	)		(627	)
Purchase of eVergance		(762	)		—
Increase in restricted cash		(14	)		—

Net cash used in investing activities		(2,175	)		(627	)

Cash flows from financing activities:
(Payments on) borrowings under line of credit		5,938			(7,400	)
Repayments under note payable		(840	)		(13	)
Borrowings under note payable		71			459
Decrease in restricted cash		—			5,900
Net proceeds from issuances of common stock and warrants		1,286			659

Net cash provided by (used in) financing activities		6,455			(395	)

Effect of exchange rate changes on cash and cash equivalents		77			63

Net decrease in cash and cash equivalents		(4,278	)		(1,582	)
Cash and cash equivalents at beginning of period		5,719			6,216

Cash and cash equivalents at end of period	$	1,441		$	4,634

Noncash activities:
Issuance of common stock and stock options in connection with the acquisition of eVergance	$	2,776			—
Reclassification of warrant liability		—		$	1,864


	Three Months Ended September 30,					Nine Months Ended September 30,
	2007			2006 Restated (1)		2007			2006 Restated (1)
Basic and diluted net income (loss) per share:
Numerator:
Net income (loss)	$	(1,267	)	$	11	$	(8,560	)	$	(402	)

Denominator:
Weighted average common shares outstanding		37,061			34,570		36,487			34,263

Basic net income (loss) per share	$	(0.03	)	$	0.00	$	(0.23	)	$	(0.01	)

Denominator:
Shares used in computing diluted net income (loss)		37,061			35,647		36,487			34,263

Diluted net income (loss) per share	$	(0.03	)	$	0.00	$	(0.23	)	$	(0.01	)


Remainder of year ending December 31, 2007	$	125
Year ending December 31, 2008		500
Year ending December 31, 2009		500
Year ending December 31, 2010		500
Year ending December 31, 2011		500
Year ending December 31, 2012		226

Total	$	2,351


	September 30, 2007			December 31, 2006
Goodwill	$	12,513		$	8,623

Intangibles:
Customer relationships	$	2,650		$	150
Purchased technology		14,650			14,650
Less: accumulated amortization		(14,949	)		(14,785	)

Intangibles, net	$	2,351		$	15


	Options Outstanding
	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Balances, December 31, 2006	9,201,921		$	6.12
Options cancelled and retired	(231,847	)		3.97
Options exercised	(232,661	)		2.59		$	218,319
Options granted	1,487,400			3.19

Balances, March 31, 2007	10,224,813			5.82	7.53		8,048,851
Options cancelled and retired	(223,294	)		3.94
Options exercised	(200,004	)		2.52			120,572
Options granted	1,120,100			3.18

Balances, June 30, 2007	10,921,615			5.65	7.21		3,067,576
Options cancelled and retired	(648,950	)		3.13
Options exercised	(98,963	)		1.70			92,817
Options granted	335,000			2.72

Balances, September 30, 2007	10,508,702			5.75	7.54		3,162,546

Options vested and exercisable and expected to be vested and exercisable at September 30, 2007	8,719,471			6.21	7.23		2,769,866
Options vested and exercisable at September 30, 2007	5,608,143		$	7.30	6.30	$	1,967,206


	Options Outstanding				Options Vested and Exercisable
Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life (in Years)	Weighted Average Exercise Price per Share		Number Exercisable	Weighted Average Exercise Price per Share
$ 0.10 – 2.88	1,933,679	6.64	$	1.85	1,301,310	$	1.86
2.95 – 2.95	3,416,127	8.74		2.95	1,670,184		2.95
3.00 – 3.13	2,263,291	8.68		3.10	592,978		3.10
3.22 – 14.41	2,752,676	5.99		7.36	1,935,427		9.03
16.55 – 998.50	142,929	2.78		136.21	108,244		131.79

Total	10,508,702	7.54	$	5.75	5,608,143	$	7.30


	Three Months Ended September 30, 2007		Nine Months Ended September 30, 2007
Risk-free interest rate	4.51	%	4.82	%
Expected volatility	48	%	52	%
Expected life (in years)	5		5
Dividend yield	0	%	0	%


	Facilities			Severance and Related			Total
Restructuring accruals:
Accrual as of December 31, 2005	$	7,270		$	282		$	7,552
Restructuring recoveries		46			(36	)		10
Payments made		(2,701	)		(246	)		(2,947	)
Sublease payments received		1,179			—			1,179

Accrual as of September 30, 2006	$	5,794		$	—		$	5,794

Accrual as of December 31, 2006	$	6,102		$	—		$	6,102
Restructuring charge		327			240			567
Payments made		(2,911	)		(240	)		(3,151	)
Sublease payments received		1,499			—			1,499

Accrual as of September 30, 2007	$	5,017		$	—		$	5,017


	September 30, 2007		December 31, 2006
United States	$	2,590	$	1,974
International (primarily Europe)		113		2,217

Total	$	2,703	$	4,191


Cash consideration	$	762
Present value of note payable to members of eVergance		2,358
Fair value of common stock issued and subscribed		1,899
Fair value of options issued and issuable		877
Direct acquisition costs		170

Total Consideration	$	6,066


Tangible assets:
Current assets	$	866
Property and equipment		134
Other assets		19

Total tangible assets acquired		1,019

Liabilities:
Current liabilities		(1,268	)
Long-term liabilities		(75	)

Total liabilities assumed		(1,343	)

Fair value of net tangible liabilities acquired		(324	)

Intangible assets consisting of:
Customer relationships		2,500

Total intangible assets acquired		2,500

Goodwill		3,890

Total consideration	$	6,066


	Payments Due By Period
	Total			Less than 1 year			1 - 3 years			3 - 5 years		More than 5 years
Contractual obligations:
Loan payable (1)	$	6,476		$	6,476		$	—		$	—	$	—
Notes payable		2,302			2,187			115			—		—
Non-cancelable operating lease obligation (2)		13,110			4,858			8,042			210		—
Less: Sublease income (3)		(4,381	)		(1,333	)		(3,048	)		—		—
Other contractual obligations (4)		2,916			2,150			516			250		—

Total	$	20,423		$	14,338		$	5,625		$	460	$	—


Nominee	For	Withheld
Stephanie Vinella	27,215,988	191,782


Nominees	For	Withheld
Jerry R. Batt	27,218,083	192,040
William T. Clifford	27,218,083	192,040
Michael J. Shannahan	27,218,083	192,040