##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



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

For the three months ended September 30, 2006



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

For the transition period from              to
            .

Commission File Number: 000-25331



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Critical Path, Inc.



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|                         |  |                               
|------------------------ |  | ------------------------------
|A California Corporation |  | I.R.S. Employer No. 91-1788300

2 Harrison Street, 2nd Floor

San Francisco, California 94105

415-541-2500



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

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

Large Accelerated Filer ̈Accelerated
Filer ̈Non-accelerated Filer  x

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

As of November 1, 2006, the Company had outstanding 37,575,248 shares of common stock, $0.001 par value per share.



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##### Table of Contents

TABLE OF CONTENTS



|                               |  |                                                                                      |  |   
|------------------------------ |  | ------------------------------------------------------------------------------------ |  | --
|PART 1 -
FINANCIAL INFORMATION |  | 3                                                                                   
|                               |  |                                                                                     
|ITEM 1                         |  | UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                |  | 3 
|                               |  |                                                                                     
|ITEM 2                         |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 22
|                               |  |                                                                                     
|ITEM 3                         |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           |  | 37
|                               |  |                                                                                     
|ITEM 4                         |  | CONTROLS AND PROCEDURES                                                              |  | 37
|                               | 
|PART II -
OTHER INFORMATION    |  | 39                                                                                  
|                               |  |                                                                                     
|ITEM 1                         |  | LEGAL PROCEEDINGS                                                                    |  | 39
|                               |  |                                                                                     
|ITEM 1A                        |  | RISK FACTORS                                                                         |  | 39
|                               |  |                                                                                     
|ITEM 2                         |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                          |  | 51
|                               |  |                                                                                     
|ITEM 3                         |  | DEFAULTS UPON SENIOR SECURITIES                                                      |  | 51
|                               |  |                                                                                     
|ITEM 4                         |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  |  | 51
|                               |  |                                                                                     
|ITEM 5                         |  | OTHER INFORMATION                                                                    |  | 51
|                               |  |                                                                                     
|ITEM 6                         |  | EXHIBITS                                                                             |  | 52
|                               | 
|SIGNATURE                      |  | 53                                                                                  
|                               | 
|Exhibit Index                  |  | 54                                                                                  



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##### Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CRITICAL PATH, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ---------- | - | ----------------- | - | ---------- | -
|                                                                                                                                                         |  | December 31,2005(a)       |            |   | September 30,2006 |  
|                                                                                                                                                         |  | (in thousands; unaudited) |           
|ASSETS                                                                                                                                                   |  |                           |            |   |                   |   |            |  
|Current assets:                                                                                                                                          |  |                           |            |   |                   |   |            |  
|Cash and cash equivalents                                                                                                                                |  | $                         | 18,707     |   |                   | $ | 19,414     |  
|Accounts receivable, net                                                                                                                                 |  |                           | 10,096     |   |                   |   | 8,945      |  
|Assets held for sale                                                                                                                                     |  |                           | 2,782      |   |                   |   |           |  
|Prepaid and other current assets                                                                                                                         |  |                           | 2,411      |   |                   |   | 2,715      |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total current assets                                                                                                                                     |  |                           | 33,996     |   |                   |   | 31,074     |  
|Property and equipment, net                                                                                                                              |  |                           | 2,625      |   |                   |   | 2,515      |  
|Goodwill                                                                                                                                                 |  |                           | 7,047      |   |                   |   | 7,310      |  
|Restricted cash                                                                                                                                          |  |                           | 277        |   |                   |   | 212        |  
|Other assets                                                                                                                                             |  |                           | 1,479      |   |                   |   | 624        |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total assets                                                                                                                                             |  | $                         | 45,424     |   |                   | $ | 41,735     |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS DEFICIT                                                                            |  |                           |            |   |                   |   |            |  
|Current liabilities:                                                                                                                                     |  |                           |            |   |                   |   |            |  
|Accounts payable                                                                                                                                         |  | $                         | 2,726      |   |                   | $ | 2,763      |  
|Accrued liabilities                                                                                                                                      |  |                           | 19,727     |   |                   |   | 18,892     |  
|Deferred revenue                                                                                                                                         |  |                           | 6,574      |   |                   |   | 9,694      |  
|Capital lease and other obligations, current                                                                                                             |  |                           | 106        |   |                   |   | 38         |  
|Liabilities held for sale                                                                                                                                |  |                           | 219        |   |                   |   |           |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total current liabilities                                                                                                                                |  |                           | 29,352     |   |                   |   | 31,387     |  
|Deferred revenue, net of current portion                                                                                                                 |  |                           | 710        |   |                   |   | 522        |  
|Notes payable, long-term                                                                                                                                 |  |                           | 18,493     |   |                   |   | 21,370     |  
|Capital lease and other obligations, net of current portion                                                                                              |  |                           | 50         |   |                   |   |           |  
|Embedded derivative liability                                                                                                                            |  |                           | 1,534      |   |                   |   | 690        |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total liabilities                                                                                                                                        |  |                           | 50,139     |   |                   |   | 53,969     |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Mandatorily redeemable preferred stock                                                                                                                   |  |                           | 120,293    |   |                   |   | 130,811    |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|                                                                                                                                                         |  |                          
|Commitments and contingencies (see Note 9)                                                                                                               |  |                           |            |   |                   |   |            |  
|                                                                                                                                                         |  |                          
|Shareholders deficit:                                                                                                                                   |  |                           |            |   |                   |   |            |  
|Common stock and additional paid-in-capital, par value $0.001; shares authorized: 200,000; shares issued and outstanding 37,499 and 37,587,
respectively |  |                           | 2,177,177  |   |                   |   | 2,167,365  |  
|Common stock warrants                                                                                                                                    |  |                           | 5,947      |   |                   |   | 5,250      |  
|Unearned compensation                                                                                                                                    |  |                           | (537       | ) |                   |   |           |  
|Accumulated deficit                                                                                                                                      |  |                           | (2,304,377 | ) |                   |   | (2,313,005 | )
|Accumulated other comprehensive loss                                                                                                                     |  |                           | (3,218     | ) |                   |   | (2,655     | )
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total shareholders deficit                                                                                                                              |  |                           | (125,008   | ) |                   |   | (143,045   | )
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  
|Total liabilities, mandatorily redeemable preferred stock and shareholders deficit                                                                      |  | $                         | 45,424     |   |                   | $ | 41,735     |  
|                                                                                                                                                         |  |                           |            |   |                   |   |            |  



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|(a) | The condensed consolidated balance sheet at December 31, 2005 has been derived from the audited financial statements at that date.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.



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##### Table of Contents

CRITICAL PATH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | --------------------------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                         |  | Three months endedSeptember 30,                     |        |   | Nine months endedSeptember 30, |  
|                                                                         |  | 2005                                                |        |   | 2006                           |   |        | 2005 |  |   | 2006    |  
|                                                                         |  | (in thousands, except per share amounts; unaudited) |       
|Net revenues                                                             |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Software licensing                                                       |  | $                                                   | 5,593  |   |                                | $ | 2,688  |      |  | $ | 14,810  |   |  | $ | 9,097   |  
|Hosted messaging                                                         |  |                                                     | 3,309  |   |                                |   | 1,220  |      |  |   | 12,048  |   |  |   | 3,609   |  
|Professional services                                                    |  |                                                     | 3,119  |   |                                |   | 2,257  |      |  |   | 9,929   |   |  |   | 7,660   |  
|Maintenance and support                                                  |  |                                                     | 5,059  |   |                                |   | 4,687  |      |  |   | 14,842  |   |  |   | 13,524  |  
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total net revenues                                                       |  |                                                     | 17,080 |   |                                |   | 10,852 |      |  |   | 51,629  |   |  |   | 33,890  |  
|                                                                         |  |                                                     |        |  
|Cost of net revenues                                                     |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Software licensing                                                       |  |                                                     | 1,364  |   |                                |   | 1,105  |      |  |   | 3,606   |   |  |   | 3,470   |  
|Hosted messaging                                                         |  |                                                     | 3,047  |   |                                |   | 740    |      |  |   | 11,972  |   |  |   | 2,275   |  
|Professional services                                                    |  |                                                     | 2,307  |   |                                |   | 1,943  |      |  |   | 7,100   |   |  |   | 6,139   |  
|Maintenance and support                                                  |  |                                                     | 1,457  |   |                                |   | 1,303  |      |  |   | 4,558   |   |  |   | 3,820   |  
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total cost of net revenues                                               |  |                                                     | 8,175  |   |                                |   | 5,091  |      |  |   | 27,236  |   |  |   | 15,704  |  
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                                                             |  |                                                     | 8,905  |   |                                |   | 5,761  |      |  |   | 24,393  |   |  |   | 18,186  |  
|                                                                         |  |                                                     |        |  
|Operating expenses                                                       |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Selling and marketing                                                    |  |                                                     | 4,239  |   |                                |   | 2,728  |      |  |   | 12,852  |   |  |   | 9,544   |  
|Research and development                                                 |  |                                                     | 3,013  |   |                                |   | 2,375  |      |  |   | 11,579  |   |  |   | 7,219   |  
|General and administrative                                               |  |                                                     | 2,714  |   |                                |   | 2,850  |      |  |   | 10,373  |   |  |   | 9,140   |  
|Restructuring expense                                                    |  |                                                     | 40     |   |                                |   | 137    |      |  |   | 1,847   |   |  |   | 1,178   |  
|Gain on sale of assets                                                   |  |                                                     |       |   |                                |   | (1,007 | )    |  |   |        |   |  |   | (2,978  | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                 |  |                                                     | 10,006 |   |                                |   | 7,083  |      |  |   | 36,651  |   |  |   | 24,103  |  
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating loss                                                           |  |                                                     | (1,101 | ) |                                |   | (1,322 | )    |  |   | (12,258 | ) |  |   | (5,917  | )
|                                                                         |  |                                                     |        |  
|Other income, net                                                        |  |                                                     | 1,357  |   |                                |   | 469    |      |  |   | 5,598   |   |  |   | 547     |  
|Interest expense, net                                                    |  |                                                     | (918   | ) |                                |   | (911   | )    |  |   | (2,483  | ) |  |   | (2,664  | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss before provision for income taxes                                   |  |                                                     | (662   | ) |                                |   | (1,764 | )    |  |   | (9,143  | ) |  |   | (8,034  | )
|                                                                         |  |                                                     |        |  
|Provision for income taxes                                               |  |                                                     | (364   | ) |                                |   | (280   | )    |  |   | (789    | ) |  |   | (594    | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                 |  |                                                     | (1,026 | ) |                                |   | (2,044 | )    |  |   | (9,932  | ) |  |   | (8,628  | )
|                                                                         |  |                                                     |        |  
|Accretion on mandatorily redeemable preferred stock                      |  |                                                     | (3,519 | ) |                                |   | (3,551 | )    |  |   | (15,311 | ) |  |   | (10,518 | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss attributable to common shareholders                             |  | $                                                   | (4,545 | ) |                                | $ | (5,595 | )    |  | $ | (25,243 | ) |  | $ | (19,146 | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share attributable to common shareholders |  | $                                                   | (0.13  | ) |                                | $ | (0.15  | )    |  | $ | (0.83   | ) |  | $ | (0.53   | )
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in the basic and diluted per share calculations              |  |                                                     | 34,557 |   |                                |   | 36,533 |      |  |   | 30,452  |   |  |   | 36,248  |  
|                                                                         |  |                                                     |        |   |                                |   |        |      |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.



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CRITICAL PATH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                        |  |                                |        |   |      |   |        |  
|------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                        |  | Nine months endedSeptember 30, |       
|                                                        |  | 2005                           |        |   | 2006 |  
|                                                        |  | (in thousands; unaudited)      |       
|Cash flows from operating activities:                   |  |                                |        |   |      |   |        |  
|Net loss                                                |  | $                              | (9,932 | ) |      | $ | (8,628 | )
|Provision for allowance for doubtful accounts           |  |                                |       |   |      |   | 80     |  
|Depreciation                                            |  |                                | 5,715  |   |      |   | 1,276  |  
|Stock-based compensation expense                        |  |                                | 917    |   |      |   | 550    |  
|Change in fair value of embedded derivative liabilities |  |                                | (2,799 | ) |      |   | (844   | )
|Amortization of debt discount                           |  |                                | 925    |   |      |   | 684    |  
|Loss on fixed asset disposals                           |  |                                | 199    |   |      |   | 17     |  
|Gain on sale of certain Hosted Assets                   |  |                                |       |   |      |   | (2,978 | )
|Restructuring charges, non-cash                         |  |                                | 1,453  |   |      |   |       |  
|Changes in assets and liabilities:                      |  |                                |        |   |      |   |        |  
|Accounts receivable                                     |  |                                | 1,417  |   |      |   | 2,429  |  
|Other assets                                            |  |                                | (75    | ) |      |   | 448    |  
|Accounts payable                                        |  |                                | (1,188 | ) |      |   | (60    | )
|Accrued and other liabilities                           |  |                                | (1,616 | ) |      |   | 658    |  
|Deferred revenue                                        |  |                                | 1,481  |   |      |   | 2,047  |  
|                                                        |  |                                |        |   |      |   |        |  
|Net cash used in operating activities                   |  |                                | (3,503 | ) |      |   | (4,321 | )
|                                                        |  |                                |        |   |      |   |        |  
|Cash flows from investing activities                    |  |                                |        |   |      |   |        |  
|Proceeds from sale of certain Hosted Assets             |  |                                |       |   |      |   | 5,470  |  
|Restricted cash                                         |  |                                | 2,500  |   |      |   | 66     |  
|Purchase of property and equipment                      |  |                                | (1,304 | ) |      |   | (1,137 | )
|                                                        |  |                                |        |   |      |   |        |  
|Net cash provided by investing activities               |  |                                | 1,196  |   |      |   | 4,399  |  
|                                                        |  |                                |        |   |      |   |        |  
|Cash flows from financing activities                    |  |                                |        |   |      |   |        |  
|Proceeds from the issuance of convertible notes, net    |  |                                | 7,000  |   |      |   |       |  
|Repayment of convertible notes                          |  |                                | (5,565 | ) |      |   |       |  
|Principal payments on note and lease obligations        |  |                                | (858   | ) |      |   | (49    | )
|                                                        |  |                                |        |   |      |   |        |  
|Net cash provided by (used in) financing activities     |  |                                | 577    |   |      |   | (49    | )
|                                                        |  |                                |        |   |      |   |        |  
|Net change in cash and cash equivalents                 |  |                                | (1,730 | ) |      |   | 29     |  
|Effect of exchange rates on cash and cash equivalents   |  |                                | (1,023 | ) |      |   | 678    |  
|Cash and cash equivalents, beginning of period          |  |                                | 23,239 |   |      |   | 18,707 |  
|                                                        |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                |  | $                              | 20,486 |   |      | $ | 19,414 |  
|                                                        |  |                                |        |   |      |   |        |  

The accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.



5



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##### Table of Contents

CRITICAL PATH, INC.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS DEFICIT



|                                                                                                         |  |                                       |        |                       |   |                                           |  |   |                       |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   |          |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | --------------------- | - | ----------------------------------------- |  | - | --------------------- | - |  | --------------------- | ----- | - | ---------------------------------------------- | - | ---- | ----- |  | - | ---------- | - |  | - | -------- | -
|                                                                                                         |  | Mandatorilyredeemable preferred stock |        | Shareholders deficit |  
|                                                                                                         |  | Amended Series D                      |        | Series E              |   | Commonstock andadditional paid in capital |  |   | Common stock warrants |   |  | Unearned compensation |       |   | Accumulateddeficitand other comprehensive loss |   |      | Total | 
|                                                                                                         |  | (in thousands; unaudited)             |       
|Balance at December 31, 2005                                                                             |  | $                                     | 56,907 |                       | $ | 63,386                                    |  | $ | 2,177,177             |   |  | $                     | 5,947 |   |                                                | $ | (537 | )     |  | $ | (2,307,595 | ) |  | $ | (125,008 | )
|Accretion of dividend on mandatorily redeemable preferred stock                                          |  |                                       | 2,541  |                       |   | 3,159                                     |  |   | (5,700                | ) |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | (5,700   | )
|Accretion to redemption value for mandatorily redeemable preferred stock                                 |  |                                       | 1,875  |                       |   | 2,943                                     |  |   | (4,818                | ) |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | (4,818   | )
|Employee Stock Purchase Plan                                                                             |  |                                       |        |                       |   |                                           |  |   | (4                    | ) |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | (4       | )
|Stock-based compensation associated with stock option grants                                             |  |                                       |        |                       |   |                                           |  |   | 19                    |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | 19       |  
|Stock-based compensation associated with June 2006 stock option exchange                                 |  |                                       |        |                       |   |                                           |  |   | 193                   |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | 193      |  
|Stock-based compensation associated with restricted stock grants                                         |  |                                       |        |                       |   |                                           |  |   | 338                   |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   | 338      |  
|Expiration of common stock purchase warrants                                                             |  |                                       |        |                       |   |                                           |  |   | 697                   |   |  |                       | (697  | ) |                                                |   |      |       |  |   |            |   |  |   | 0        |  
|Reclassification of unamortized unearned restricted stock compensation pursuant to adoption of SFAS 123R |  |                                       |        |                       |   |                                           |  |   | (537                  | ) |  |                       |       |   |                                                |   | 537  |       |  |   |            |   |  |   | 0        |  
|Foreign currency translation adjustments                                                                 |  |                                       |        |                       |   |                                           |  |   |                       |   |  |                       |       |   |                                                |   |      |       |  |   | 563        |   |  |   | 563      |  
|Net loss                                                                                                 |  |                                       |        |                       |   |                                           |  |   |                       |   |  |                       |       |   |                                                |   |      |       |  |   | (8,628     | ) |  |   | (8,628   | )
|                                                                                                         |  |                                       |        |                       |   |                                           |  |   |                       |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   |          |  
|Balance at September 30, 2006                                                                            |  | $                                     | 61,323 |                       | $ | 69,488                                    |  | $ | 2,167,365             |   |  | $                     | 5,250 |   |                                                | $ |     |       |  | $ | (2,315,660 | ) |  | $ | (143,045 | )
|                                                                                                         |  |                                       |        |                       |   |                                           |  |   |                       |   |  |                       |       |   |                                                |   |      |       |  |   |            |   |  |   |          |  

The accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.



6



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##### Table of Contents

CRITICAL PATH, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1  Basis of Presentation and Summary
of Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include the accounts of the Company, and its wholly owned and majority-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

These interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for
interim financial information, and the rules and regulations of the United States Securities and Exchange Commission (SEC) for interim financial statements and accounting policies, consistent, in all material respects, with those applied in
preparing the Companys audited consolidated financial statements included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2005. The unaudited financial information furnished herein reflects all adjustments,
consisting only of normal recurring adjustments, that in the Companys opinion are necessary for a fair statement of its consolidated financial position, the results of operations, cash flows and shareholders deficit for the periods
presented. This Quarterly Report on Form 10-Q should be read in conjunction with the Companys audited financial statements for the year ended December 31, 2005 included in the 2005 Form 10-K. The condensed consolidated statement of
operations for the three and nine months ended September 30, 2006 are not necessarily indicative of results to be expected for any subsequent periods or for the entire fiscal year ending December 31, 2006.

Liquidity and Capital Resources

The Company has focused on capital
financing initiatives in order to maintain current and planned operations. The Company has operated at a loss since inception and its history of losses from operations and cash flow deficits, in combination with its cash balances, raise concerns
about the Companys ability to fund operations. The Companys primary sources of capital have come from both debt and equity financings that it has completed over the past several years and the sale of the Hosted Assets in January 2006. In
2003 and 2004, the Company secured additional funds through several rounds of financing that involved the sale of senior secured convertible notes all of which converted into Series E preferred stock in 2004. In the third quarter of 2004, the
Company completed a rights offering and, in the fourth quarter of 2004, secured and drew $11.0 million from an $18.0 million round of debt financing. In March 2005, the Company drew down the remaining $7.0 million from the $18.0 million round of
debt financing. The Company is not required to make any payments of principal or interest under this $18.0 million debt financing until maturity in December 2007. In January 2006, the Company sold its Hosted Assets for $6.3 million and in September
2006, received another $1.0 million in connection with certain post-closing conditions related to the sale (see Note 2Sale of Hosted Assets below). If the Company is unable to increase its revenues or if the Company is unable to reduce the
amount of cash used by its operating activities during 2006 and 2007, the Company may be required to undertake additional restructuring alternatives, or seek additional debt financing. However, the Companys ability to incur additional
indebtedness is subject to certain limitations as discussed in the section below captioned Ability to incur additional indebtedness and the Company does not believe equity financing on terms reasonably acceptable is currently available.

Additionally, the Companys common stock now trades in the over-the-counter market on the OTC Bulletin Board owned by the Nasdaq Stock Market, Inc.,
which was established for securities that do not meet the listing requirements of the Nasdaq Global Market or the Nasdaq Capital Market. The OTC Bulletin Board is generally considered less efficient than the Nasdaq Global Market. Consequently,
selling the Companys common stock is likely more difficult because of diminished liquidity in smaller quantities of shares likely being bought and sold, transactions could be delayed, and securities analysts and news media coverage of
the Company may be limited. The Company believes its listing on the OTC Bulletin Board, or further declines in its stock price, may greatly impair the Companys ability to raise additional capital, should it be necessary, through equity or debt
financing.

The Companys principal sources of liquidity include its cash and cash equivalents. As of September 30, 2006, the Company had cash
and cash equivalents available for operations totaling $19.4 million, of which $10.9 million was located in accounts outside the United States and which is not readily available for domestic operations. The Company is considering making changes to
its foreign subsidiaries to provide easier access to its foreign cash. Accordingly, the Companys readily available cash resources in the United States as of September 30, 2006 was $8.5 million. As of September 30, 2006, the Company
had cash collateralized letters of credit totaling approximately $0.2 million, which is recorded as restricted cash on the Companys balance sheet and is not readily available for operations.

Based on the Companys recent financing activities, recent restructuring activities and managements projections as to the Companys operating results, the
Company believes that it has sufficient cash to meet its cash operating requirements for the next 12 months as well as the on-going investments in capital equipment to support its research and development efforts and news group operations.



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Management believes these projections are reasonable; however, these projections are subject to risks and uncertainties, some of which are beyond the
Companys control, such as the amount of revenues that will be generated. As a result, actual results could differ materially from such projections. In addition, as the Company approaches the December 31, 2007 maturity of the $18.0 million
principal amount of the 13.9% Notes, the Company anticipates that it will need to restructure its debt or seek additional financing in order to pay the 13.9% Notes upon maturity. The Company has no present understandings, commitments or agreements
for any material acquisitions of, or investments in, other complementary businesses, products or technologies. The Company continually evaluates potential acquisitions of, or investments in, other businesses, products and technologies, and may in
the future utilize its cash resources or may require additional equity or debt financing to accomplish any acquisitions or investments. These alternatives could increase liquidity through the infusion of investment capital by third-party investors
or decrease the Companys liquidity as a result of the Company seeking to fund expansion into these markets. Such expansions might also cause an increase in capital expenditures and operating expenses. For the long-term, the Company believes
future improvements in the Companys operating activities will be necessary to provide the liquidity and capital resources sufficient to support its business.

Ability to incur additional indebtedness

Subject to limited exceptions, the Company must seek the consent of its preferred shareholders and
debt holders in order to incur any additional indebtedness.

Segment and Geographic Information

The Company does not currently manage its business in a manner that requires it to report financial results on a segment basis. The Company currently operates in one
segment, digital communications software and services, and management uses one measure of profitability. Revenue information on a product and service basis has been disclosed in the Companys statement of operations.

Information regarding net revenues attributable to the Companys primary geographic regions is as follows:



|                       |  |                                  |        |  |                                 |   |  |      |        |  |      |   |  |   |        |  |     |   |  |   |        |  |     |  
|---------------------- |  | -------------------------------- | ------ |  | ------------------------------- | - |  | ---- | ------ |  | ---- | - |  | - | ------ |  | --- | - |  | - | ------ |  | --- | -
|                       |  | Three months ended September 30, |        |  | Nine months ended September 30, |  
|                       |  | 2005                             |        |  | 2006                            |   |  | 2005 |        |  | 2006 |  
|                       |  | (in thousands)                   |       
|North America          |  | $                                | 4,587  |  | 27                              | % |  | $    | 2,679  |  | 25   | % |  | $ | 13,214 |  | 26  | % |  | $ | 8,078  |  | 24  | %
|                       |  |                                  |        |  |                                 |   |  |     
|Europe                 |  |                                  | 11,917 |  | 70                              | % |  |      | 7,849  |  | 72   | % |  |   | 36,507 |  | 71  | % |  |   | 25,098 |  | 74  | %
|Latin America          |  |                                  | 365    |  | 2                               | % |  |      | 67     |  | 1    | % |  |   | 891    |  | 2   | % |  |   | 215    |  | 1   | %
|Asia Pacific           |  |                                  | 211    |  | 1                               | % |  |      | 257    |  | 2    | % |  |   | 1,017  |  | 2   | % |  |   | 499    |  | 1   | %
|                       |  |                                  |        |  |                                 |   |  |      |        |  |      |   |  |   |        |  |     |   |  |   |        |  |     |  
|Subtotal international |  |                                  | 12,493 |  | 73                              | % |  |      | 8,173  |  | 75   | % |  |   | 38,415 |  | 74  | % |  |   | 25,812 |  | 76  | %
|                       |  |                                  |        |  |                                 |   |  |      |        |  |      |   |  |   |        |  |     |   |  |   |        |  |     |  
|                       |  | $                                | 17,080 |  | 100                             | % |  | $    | 10,852 |  | 100  | % |  | $ | 51,629 |  | 100 | % |  | $ | 33,890 |  | 100 | %
|                       |  |                                  |        |  |                                 |   |  |      |        |  |      |   |  |   |        |  |     |   |  |   |        |  |     |  

Information regarding long-lived assets is as follows:



|              |  |                |       |      |   |      
|------------- |  | -------------- | ----- | ---- | - | -----
|              |  | September 30, 
|              |  | 2005           |       | 2006
|              |  | (in thousands)
|United States |  | $              | 4,413 |      | $ | 1,347
|Other         |  |                | 1,889 |      |   | 1,168
|              |  |                |       |      |   |      
|              |  | $              | 6,302 |      | $ | 2,515
|              |  |                |       |      |   |      

Customer Concentration

During the three months ended September 30, 2005, the Company had one customer that accounted for 9.9% of net revenues. During the nine months ended September 30, 2005 and during the three and nine months ended September 30,
2006, the Company had no customers that accounted for more than 10% of net revenues.

At September 30, 2005, one customer accounted for 14.8% and
another customer accounted for 14.0% of the Companys accounts receivable and at September 30, 2006, one customer accounted for 13.3% of the Companys accounts receivable.



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Stock-Based Compensation Accounting Policy

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised in 2004) (SFAS 123R), Share-Based Payment, which revised SFAS 123, Accounting for
Stock-Based Compensation. SFAS 123R requires all share-based payment transactions with employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair
values. SFAS 123R is a new and very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option
lives, as well as expected option forfeiture rates, to value equity-based compensation. Prior to the adoption of SFAS 123R, stock-based compensation expense related to employee stock options was not recognized in the statement of operations. There
was no cumulative effect of adoption. See Note 10  Stock Based Compensation.

Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 155, Accounting for Certain Hybrid
Financial Instruments. SFAS No. 155 replaces SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. SFAS No. 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. This statement will be effective for all
financial instruments acquired or issued after the beginning of an entitys fiscal year that begins after September 15, 2006. The Company is currently evaluating the impact of this new standard on its financial position and results of
operations.

In March 2006, the FASB issued SFAS No. 156, which amends SFAS No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement (i) requires an entity to recognize a servicing asset or servicing liability each
time it undertakes an obligation to service a financial asset by entering into certain servicing contracts; (ii) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if
practicable; (iii) permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, provided that the available-for-sale securities are identified in some manner as offsetting the entitys exposure to changes in fair value of servicing
assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and (iv) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of
financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. This statement will be effective as of the beginning of an entitys first fiscal year that begins after September 15,
2006. The Company is currently evaluating the impact of this new standard on its financial position and results of operations.

In July 2006, the FASB
issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109,(FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires
that the Company recognizes in its financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of
the beginning of the Companys 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48
on its financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.
Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company
has not yet determined the impact, if any, that the implementation of SFAS No. 157 will have on its financial position and results of operations.

In
September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides guidance
on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current years financial statements are materially misstated. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have an impact on the Companys financial position and results of operations.



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Note 2  Sale of Hosted Assets

On December 14, 2005, the Company entered into an Asset Purchase Agreement with Tucows.com (Tucows) for the sale of a portion of the Companys hosted messaging assets, including a portion of its hosted
messaging customer base, assembled hosted messaging workforce, and hosted messaging hardware (the Hosted Assets). On January 3, 2006, the Company completed the sale of its Hosted Assets. Under the Agreement, Tucows also acquired a software
license for the Companys Memova® product and assumed certain contractual liabilities related to the Hosted Assets. Tucows has paid the Company $7.3
million in cash, of which $0.8 million has been allocated to deferred revenue for the future maintenance and support services to be provided by the Company in connection with the Memova license provided to Tucows under the Asset Purchase Agreement.
Tucows will also pay up to an additional $0.2 million to the Company during the three months ended December 31, 2006 if certain remaining post-closing conditions are satisfied by such date.

In connection with the sale of these assets, the Company recognized a gain of approximately $3.0 million during the nine month period ended September 30, 2006.
Additionally, in connection with the Asset Purchase Agreement, the Company also agreed to perform certain transition services during a six month period following the close of the transaction. The Company agreed to provide such services to insure a
smooth transition of the hosted email service to Tucows in an effort to minimize customer disruption. The Company estimated the cost of these services to be approximately $0.2 million which were recorded as a reduction to the gain on sale during the
three months ended March 31, 2006.

In connection with the Asset Purchase Agreement, the Company also provided Tucows with a license to the
Companys Memova product. This license was for a fixed number of users and provided two years of free maintenance and support services. In connection with this free support, the Company recorded approximately $0.8 million of the proceeds
received from the sale to deferred revenue based upon the maintenance renewal rate provided in the license agreement. This deferred revenue will be amortized over a period of two years beginning from the closing date of the sale. During the three
and nine months ended September 30, 2006, the Company recognized in its maintenance and support revenues approximately $0.1 and $0.3 million, respectively, of this deferred revenue.

During the three months ended June 30, 2006, Tucows purchased an additional license to the Companys Memova product. This license was for a fixed number of users and provided free maintenance and support
until December 2007 in accordance with the Asset Purchase Agreement. In connection with this free support, the Company recorded approximately $0.1 million of the license fee to deferred revenue, which will be amortized ratably through December 2007,
and the balance of approximately $0.4 million was recorded to license fee revenue during the three months ended June 30, 2006.

Note 3 
Restructuring Activities

During the three and nine months ended September 30, 2006, the Company recorded restructuring expenses totaling $0.1
million and $1.2 million primarily related to severance benefits paid to employees terminated in connection with the sale of the Hosted Assets as well as employees terminated in connection with the reorganization of the Companys sales force
and employees to be terminated in connection with the transition of the Companys U.S. accounting operations to Dublin, Ireland. At September 30, 2006, the Company carried a restructuring liability of $0.3 million, the majority of which is
expected to be utilized by December 31, 2006. The following table summarizes the remaining balance related to restructure liability as of September 30, 2006.



|                                |  |                     |       |   |                                                         |   |      |       |  |   |        |  
|------------------------------- |  | ------------------- | ----- | - | ------------------------------------------------------- | - | ---- | ----- |  | - | ------ | -
|                                |  | Workforce reduction |       |   | Facility and operations consolidation and other charges |   |      | Total | 
|                                |  |                     |       |   | (in thousands)                                          |   |      |       | 
|Liability at December 31, 2005  |  | $                   | 84    |   |                                                         | $ | 303  |       |  | $ | 387    |  
|Restructure charge              |  |                     | 1,010 |   |                                                         |   | 168  |       |  |   | 1,178  |  
|Cash payments                   |  |                     | (938  | ) |                                                         |   | (349 | )     |  |   | (1,287 | )
|Adjustments                     |  |                     | (4    | ) |                                                         |   | (8   | )     |  |   | (12    | )
|                                |  |                     |       |   |                                                         |   |      |       |  |   |        |  
|Liability at September 30, 2006 |  | $                   | 152   |   |                                                         | $ | 114  |       |  | $ | 266    |  
|                                |  |                     |       |   |                                                         |   |      |       |  |   |        |  

Note 4  Goodwill

At September 30, 2006, the Company was carrying $7.3 million of goodwill assets, which, in accordance with SFAS No. 142, are not amortized. The change in the balance subsequent to December 31, 2005 was due to the revaluation
of foreign currency denominated goodwill balances.

The Company tests its goodwill assets for impairment on an annual basis and on a more frequent basis if
events occur or circumstances change that would more likely than not reduce the fair value of any of the Companys reporting units below their carrying value.



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Note 5  Promissory Notes

13.9% Notes

In December 2004, the Company issued $11.0 million in principal amount of 13.9% Notes to General
Atlantic Partners 74, L.P., Gapstar, LLC, GAP Coinvestment Partners II, L.P., GAPCO GmbH & Co. KG., Cenwell Limited, Campina Enterprises Limited, Great Affluent Limited, Dragonfield Limited, Lion Cosmos Limited and Richmond III, LLC
(referred to collectively as the 13.9% Note Investors). As part of the financing transaction, the Company issued warrants to the 13.9% Note Investors to purchase 235,712 shares of Series F preferred stock at a per share purchase price of $14
per share, which is equivalent to $1.40 per share on a common stock equivalent basis.

In March 2005, the Company issued an additional $7.0 million of the
13.9% Notes to the 13.9% Note Investors. As part of this financing transaction, the Company issued warrants to purchase 149,998 shares of Series F preferred stock.

The 13.9% Notes accrue interest at a rate of 13.9% per annum; however, the Company is not obligated to make interest payments on the notes prior to their maturity date of December 30, 2007. The 13.9% Notes
are due and payable on the earlier to occur of the maturity of the 13.9% Notes on December 30, 2007, when declared due and payable upon the occurrence of an event of default, or a change of control of the Company.

The $18.0 million in proceeds from the financing transaction were allocated to the 13.9% Notes and warrants based upon their relative estimated fair values. The
estimated fair value of the warrants has been classified as a derivative instrument and recorded as a liability on the Companys balance sheet in accordance with current authoritative guidance. In accordance with the provisions of SFAS
No. 133, Accounting for Derivative Instruments, the Company is required to adjust the carrying value of the instrument to its fair value at each balance sheet date and recognize any change since the prior balance sheet date as a
component of Other Income. The warrant derivative liability is being carried on the Companys books at its fair value of $0.2 million at September 30, 2006.

These 13.9% Notes are carried on the balance sheet as long-term Notes payable as follows:



|                                                                                                         |  |                      |        |  
|-------------------------------------------------------------------------------------------------------- |  | -------------------- | ------ | -
|                                                                                                         |  | At September 30,2006 |       
|                                                                                                         |  | (in thousands)       |       
|Proceeds from the issuance of the 13.9% Notes                                                            |  | $                    | 18,000 |  
|Less: proceeds allocated to the fair value of the Series F preferred stock warrant derivative instrument |  |                      | (2,711 | )
|Add: accretion to redemption value                                                                       |  |                      | 1,500  |  
|Add: accrued interest                                                                                    |  |                      | 4,581  |  
|                                                                                                         |  |                      |        |  
|Carrying value of the 13.9% Notes                                                                        |  | $                    | 21,370 |  
|                                                                                                         |  |                      |        |  

Note 6  Comprehensive Loss



|                                             |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                             |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|                                             |  | 2005                            |        |   | 2006                           |   |        | 2005 |  |   | 2006    |  
|                                             |  | (in thousands)                  |       
|Net loss attributable to common shareholders |  | $                               | (4,545 | ) |                                | $ | (5,595 | )    |  | $ | (25,243 | ) |  | $ | (19,146 | )
|Foreign currency translation adjustments     |  |                                 | (1,729 | ) |                                |   | (258   | )    |  |   | (3,386  | ) |  |   | 563     |  
|                                             |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total comprehensive loss                     |  | $                               | (6,274 | ) |                                | $ | (5,853 | )    |  | $ | (28,629 | ) |  | $ | (18,583 | )
|                                             |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



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Note 7  Net Loss per Share Attributed to Common Shareholders

Net loss per common share is calculated as follows:



|                                                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                  |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|                                                                                                                  |  | 2005                            |        |   | 2006                           |   |        | 2005 |  |   | 2006    |  
|                                                                                                                  |  | (in thousands)                  |       
|Net loss attributable to common shareholders                                                                      |  | $                               | (4,545 | ) |                                | $ | (5,595 | )    |  | $ | (25,243 | ) |  | $ | (19,146 | )
|Weighted average shares outstanding                                                                               |  |                                 | 36,075 |   |                                |   | 37,696 |      |  |   | 32,130  |   |  |   | 37,521  |  
|Weighted average shares subject to repurchase agreements                                                          |  |                                 | (1,477 | ) |                                |   | (1,122 | )    |  |   | (1,637  | ) |  |   | (1,232  | )
|Weighted average shares held in escrow related to acquisitions                                                    |  |                                 | (41    | ) |                                |   | (41    | )    |  |   | (41     | ) |  |   | (41     | )
|                                                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in the computation of basic and diluted net loss attributable to common shareholders per common share |  |                                 | 34,557 |   |                                |   | 36,533 |      |  |   | 30,452  |   |  |   | 36,248  |  
|                                                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                                                                  |  | $                               | (0.13  | ) |                                | $ | (0.15  | )    |  | $ | (0.83   | ) |  | $ | (0.53   | )
|                                                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  

As of September 30, 2005 and 2006, there were 112.5 million and 114.7 million, respectively,
potential common shares that were excluded from the determination of diluted net loss per share, as the effect of such shares on a weighted average basis is anti-dilutive. The weighted average exercise prices of the potential common shares excluded
from the determination of diluted net loss per share at September 30, 2005 and 2006 were $4.02 and $2.93, respectively.

Note 8  Mandatorily
Redeemable Preferred Stock

Series F Redeemable Convertible Preferred Stock

In December 2004, the Companys Board of Directors authorized the issuance of up to 0.5 million shares of Series F Redeemable Convertible Preferred Stock (the Series F preferred stock). The
Series F preferred stock will rank equally with the Series E preferred stock, and will rank senior to all other capital stock with respect to rights on liquidation, dissolution and winding up. The Series F preferred stock will accrue
dividends at a simple annual rate of 5 3/4% of the purchase price of $14.00 (equivalent to $1.40 per share on a common
stock equivalent basis), whether or not declared by the board of directors. Dividends in respect of the Series F preferred stock will not be paid in cash but will be added to the value of the Series F preferred stock and will be taken into
account for purposes of determining the liquidation and change in control preference, conversion rate and voting rights.

The Company must declare
or pay dividends on the Series F preferred stock when the Company declares or pay dividends to the holders of common stock. Holders of Series F preferred stock are entitled to notice of all shareholders meetings and are entitled to vote on all
matters submitted to the shareholders for a vote, voting together with the holders of the common stock and all other classes of capital stock entitled to vote, voting as a single class (except where a separate vote is required by the Companys
amended and restated articles of incorporation, its bylaws or California law). The holders of Series F preferred stock will be entitled to vote as a separate class on any amendment to the terms or authorized number of shares of Series F
preferred stock, the issuance of any equity security ranking senior to the Series F preferred stock and the redemption of or the payment of a dividend in respect of any junior security. At any time, holders of Series F preferred stock may
elect to convert their Series F preferred stock into shares of common stock. Each share of Series F preferred stock is currently convertible into ten shares of common stock. After three years from the date the Series E preferred stock
is first issued, the Company may call for redemption of the Series F preferred stock under certain circumstances. On the fourth anniversary of the date the Series E preferred stock is first issued, the Company must call for redemption of
the Series F preferred stock.

At September 30, 2006, no shares of Series F preferred stock have been issued or were outstanding. Warrants
to purchase 0.4 million shares of Series F preferred stock were issued and outstanding as of September 30, 2006 in connection with the issuance of the 13.9% Notes.

Series E Redeemable Convertible Preferred Stock

During the three months ended September 30, 2004, the
Company issued a total of approximately 55.9 million shares of Series E Redeemable Convertible Preferred Stock (the Series E preferred stock) as follows: in July 2004, the Company issued approximately 30.6 million shares of
Series E preferred stock to convert $45.5 million of the 10% Convertible Secured Subordinated Notes due March 2008 (the Senior Notes) plus accrued interest, 21.9 million shares of Series E preferred stock to convert $32.8 million of
the 53/4% Convertible Subordinated Notes due April 1, 2005 (the 53/4% Notes) and approximately 0.8 million shares of Series E preferred stock to convert certain holders of Series D preferred stock into Series E
preferred stock; and in August 2004, the Company issued approximately 2.6 million shares of Series E preferred stock in connection with its rights offering from which the Company received gross proceeds of approximately $4.0 million.



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##### Table of Contents

The Series E preferred stock ranks pari passu to the Series F preferred stock (none of which was issued or
outstanding as of September 30, 2006) and senior to all other preferred and common stock of the Company in priority of dividends, rights of redemption and payment upon liquidation. The principal terms of the Series E preferred stock
include an automatic redemption on July 9, 2008, cumulative dividends at a rate of 5 3/4% per year (dividends are
not paid in cash but are added to the value of the Series E preferred stock on June 30 and December 31 each year), and conversion into shares of common stock calculated based on the quotient of the Series E accreted value divided
by the Series E conversion price of $1.50.

At issuance, the total amount of costs associated with converting the Companys debt into
Series E preferred stock and costs associated with the rights offering, totaling approximately $4.6 million, will accrete over the term of the Series E preferred stock. Additionally, the conversion of the $45.5 million Senior Notes into
the Series E preferred stock was deemed to have a beneficial conversion feature totaling approximately $16.3 million. The value of the beneficial conversion feature, at issuance, was initially recorded as a reduction of the carrying amount of
the Series E preferred stock and will accrete over the term of the Series E preferred stock.

As of September 30, 2006, there were
approximately 48.8 million shares of Series E preferred stock outstanding. The carrying value of the Series E preferred stock is as follows (in thousands):



|                                                                        |  |   |       
|----------------------------------------------------------------------- |  | - | ------
|Beginning balance - Series E preferred stock at December 31, 2005       |  | $ | 63,386
|Add: accrued dividends and accretion                                    |  |   | 6,102 
|                                                                        |  |   |       
|Carrying value of the Series E preferred stock at September 30, 2006    |  | $ | 69,488
|                                                                        |  |   |       
|Liquidation value of the Series E preferred stock at September 30, 2006 |  | $ | 82,575
|                                                                        |  |   |       

Series D Cumulative Redeemable Convertible Preferred Stock

In December 2001, the Company completed a financing transaction with a group of investors and their affiliated entities. In connection with this financing transaction,
the Company issued 4.0 million shares of its Series D Cumulative Redeemable Convertible Preferred Stock (the Series D preferred stock), in a private offering, resulting in gross cash proceeds of approximately $30.0 million, and the
simultaneous retirement of approximately $65.0 million in face value of the Companys outstanding convertible subordinated notes. The investors were led by General Atlantic Partners LLC and affiliates and included Hutchison Whampoa Limited and
affiliates and Vectis Group LLC and affiliates. In addition, General Atlantic LLC was granted warrants to purchase 0.6 million shares of the Companys common stock in connection with this offering.

At issuance, costs of $3.1 million were recorded as a reduction of the carrying amount of the Series D preferred stock and will accrete over the term of the
Series D preferred stock. Additionally, at issuance, the Series D preferred stock was deemed to have an embedded beneficial conversion feature which was limited to the net proceeds allocable to the Series D preferred stock of approximately
$42.0 million. The value of the beneficial conversion feature, at issuance, was initially recorded as a reduction of the carrying amount of the Series D preferred stock and will accrete over the term of the Series D preferred stock.

The Series D preferred stock issued in the financing transaction ranks senior to all of the Companys common stock in priority of dividends,
rights of redemption and payment upon liquidation. The fair value ascribed to the Series D preferred stock was based on actual cash paid by independent investors and the approximate fair value of the 5 3/4% Notes retired in connection with the offering. The original principal terms of the Series D preferred stock included an automatic
redemption on November 8, 2006, cumulative dividends at a rate of 8% per year, compounded on a semi-annual basis and payable in cash or additional shares of Series D preferred stock, conversion into shares of common stock calculated
based on the Accreted Value, which is the purchase price plus accrued dividends divided by $4.20, and preference in the return of equity in any liquidation or change of control (subject to the rights of holders of Series E preferred stock and Series
F preferred stock, if any).

The purchase agreement provides for a preferential return of equity to the Series D preferred shareholders, before
any return of equity to the common shareholders, and also provides for the Series D preferred shareholders to participate on a pro rata basis with the common shareholders, in any remaining equity, once the preferential return has been
satisfied. Under the terms of this provision, the preferential return of equity is equal to the purchase price of the Series D preferred stock plus all dividends that would have accrued during the term of the preferred stock, even if a change
in control occurs prior to the redemption date. The right to receive a preferential return lapses if either: (i) the Company is sold for a price per share of Series D preferred stock, had each such share been converted into common stock
prior to the change in control, of at least four times the Accreted Value, or (ii) the Companys stock trades on NASDAQ for 60 days prior to the change in control at an average price of not less than four times the Accreted Value.



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##### Table of Contents

The warrants issued to General Atlantic LLC are exercisable at any time after November 8, 2002 until
November 8, 2006 at an exercise price of $4.20, and convert into one share of the Companys common stock. A portion of the proceeds received for the Series D preferred stock was allocated to the warrants and the preferred stock, based
upon their relative fair market values. As a result of this allocation, approximately $5.3 million of the proceeds were allocated to the warrants, which was recorded as a reduction of the carrying value of the Series D preferred stock. Using
the Black-Scholes option pricing model, assuming a four-year term, 200% volatility, a risk-free rate of 6.0% and no dividend yield, the fair market value of the warrants was $6.2 million. As part of the Companys November 2003 private placement
of 10% Senior Secured Convertible Notes, the Company obtained shareholder approval to amend the warrants to reduce the exercise price per share from $4.20 to $1.50. As of September 30, 2006 these warrants remain unexercised.

As part of the Companys November 2003 private placement of 10% Senior Secured Convertible Notes, the Company agreed to seek shareholder approval to amend the terms
of the Series D preferred stock to, among other things, amend the Series D preferred stock liquidation preference upon a liquidation and change of control, to eliminate the participation feature, to reduce the conversion price from $4.20
to $1.50 and to reduce the amount of dividends to which the holders of Series D preferred stock are entitled. In July 2004, at a special meeting of shareholders, the Companys shareholders approved proposals to amend and restate the
certificate of determination of preferences of Series D preferred stock (the Amended Series D). As part of this amendment, the automatic redemption date was changed to July 2008, the dividend accrual rate was reduced to 53/4% and the conversion price was reduced to $1.50. The dividends which had accrued on the Series D preferred stock
totaling approximately $12.2 million were recorded as a reduction to the carrying value of the Amended Series D. This amount will accrete over the term of the Amended Series D. As of September 30, 2006, the conversion value of all
Amended Series D preferred stock, as accreted is $66.5 million. Additionally, the Amended Series D preferred stock currently contains a liquidation preference of $22 per share (unless the Company does not have sufficient funds to redeem
the Series D preferred stock in July 2008, in which event dividends will continue to accrue and may exceed $22 per share in the future).

As of
September 30, 2006, there were approximately 3.5 million shares of Series D preferred stock outstanding. The following table sets forth the carrying value and liquidation values of the Amended Series D preferred stock (in
thousands):



|                                                                                                   |  |   |       
|-------------------------------------------------------------------------------------------------- |  | - | ------
|Beginning balance - Amended Series D preferred stock at December 31, 2005                          |  | $ | 56,907
|Add: accrued dividends and accretion                                                               |  |   | 4,416 
|                                                                                                   |  |   |       
|Carrying value of the Amended Series D preferred stock at September 30, 2006                       |  | $ | 61,323
|                                                                                                   |  |   |       
|Liquidation value of the Amended Series D preferred stock at September 30, 2006 (at $22 per share) |  | $ | 77,452
|                                                                                                   |  |   |       

Accretion on Mandatorily Redeemable Preferred Stock

Accretion on mandatorily redeemable preferred stock represents the accrued dividends and accretion of the beneficial conversion features of the outstanding Series D and
Series E preferred stock as well as the accretion to the redemption value of the outstanding Series D preferred stock. The following table sets forth the accretion on mandatorily redeemable preferred stock for the periods indicated:



|                                                                |  |                                 |       |                                |   |       |  |      |        |  |   |       
|--------------------------------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ------ |  | - | ------
|                                                                |  | Three months endedSeptember 30, |       | Nine months endedSeptember 30,
|                                                                |  | 2005                            |       | 2006                           |   | 2005  |  | 2006
|                                                                |  | (in thousands)                 
|Accrued dividends                                               |  | $                               | 1,923 |                                | $ | 1,900 |  | $    | 5,989  |  | $ | 5,700 
|Accretion to redemption value and beneficial conversion feature |  |                                 | 1,596 |                                |   | 1,651 |  |      | 9,322  |  |   | 4,818 
|                                                                |  |                                 |       |                                |   |       |  |      |        |  |   |       
|                                                                |  | $                               | 3,519 |                                | $ | 3,551 |  | $    | 15,311 |  | $ | 10,518
|                                                                |  |                                 |       |                                |   |       |  |      |        |  |   |       

Note 9  Commitments and Contingencies

Leases

The Company leases office space and equipment under non-cancelable operating and capital leases with various
expiration dates through 2014. Rent expense for the nine months ended September 30, 2006 totaled $2.0 million. Future minimum lease payments under non-cancelable operating and capital leases are as follows:



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##### Table of Contents

|                                                       |  |                |    |   |                 |   |      
|------------------------------------------------------ |  | -------------- | -- | - | --------------- | - | -----
|                                                       |  | CapitalLeases  |    |   | OperatingLeases
|                                                       |  | (In thousands)
|Year Ending December 31                                |  |                |    |   |                 |   |      
|2006 (remaining three months ending December 31, 2006) |  | $              | 16 |   |                 | $ | 591  
|2007                                                   |  |                | 12 |   |                 |   | 1,726
|2008                                                   |  |                |   |   |                 |   | 1,278
|2009                                                   |  |                |   |   |                 |   | 1,030
|2010                                                   |  |                |   |   |                 |   | 1,011
|Thereafter                                             |  |                |   |   |                 |   | 4,044
|                                                       |  |                |    |   |                 |   |      
|Total minimum lease payments                           |  |                | 28 |   |                 | $ | 9,680
|                                                       |  |                |    |   |                 |   |      
|Less: amount representing interest                     |  |                | (5 | ) |                 |   |      
|                                                       |  |                |    |   |                 |   |      
|Present value of capital lease obligations             |  | $              | 23 |   |                 |   |      
|                                                       |  |                |    |   |                 |   |      

Relocation of San Francisco Offices

During the first quarter of 2005, the Company recorded a restructuring charge totaling $1.6 million, of which, $1.3 million was related to the relocation of the Companys headquarters facility as discussed below
and the balance related to consolidation of data centers and the elimination of certain employee positions.

On May 5, 2005, the Company entered into
the Second Amendment to Lease (the Second Amendment) with PPF Off 345 Spear Street, L.P. (PPF Off 345 Spear), to amend the Lease dated as of November 16, 2001, as amended (the Lease), under which the Company leased its headquarter facilities in
San Francisco, California, located at 350 The Embarcadero. Under the terms of the Second Amendment, on June 29, 2005 the Company vacated its facility at 350 The Embarcadero and moved into new office space located at 2 Harrison Street,
2ndFloor, San Francisco, California. In addition, in connection with the Second Amendment, the Company made a lease
termination payment related to the facility at 350 The Embarcadero totaling approximately $1.3 million during the three months ended June 30, 2005. The new office space at 2 Harrison Street was comprised of two suites consisting of
approximately 22,881 square feet with a lease for a term of five years. Approximately 15,000 square feet of such space was utilized by the Company as its headquarters facilities, and the remaining approximately 8,000 square feet was utilized as
storage space.

On June 28, 2006, the Company terminated the Lease with PPF 345 Off Spear, and Babcock & Brown LP (Babcock & Brown)
signed a lease with PPF 345 Off Spear to become the new tenant of the office space occupied by the Company at 2 Harrison Street. On June 28, 2006, the Company entered into a Sublease Agreement (the Sublease) with Babcock & Brown to
lease 15,000 square feet of its existing headquarters facilities at 2 Harrison Street. The Sublease with Babcock & Brown has a two-year term and monthly rent of $39,000. In November 2006, the square footage occupied by the Company of the
subleased premises will be reduced by approximately 9,000 square feet at which point the monthly rent will also be reduced in accordance with the terms of the Sublease.

Other Contractual Obligations

The Company entered into other contractual obligations which totaled $2.7 million
at September 30, 2006. These obligations are primarily associated with royalty obligations incurred in connection with sales of third-party software products, the future purchase of maintenance related to hardware and software products being
utilized within engineering and hosted operations, the management of data center operations and network infrastructure storage for the Companys hosted operations and the use of third-party developers. These obligations are expected to be
completed over the next 1.25 years, including $0.9 million in 2006.

Service Level Agreements

Certain net revenues are derived from contractual relationships that typically have one to three year terms. Certain agreements require minimum performance standards
regarding the availability and response time of email services. If these standards are not met, such contracts are subject to termination and the Company could be subject to monetary penalties.



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##### Table of Contents

Litigation and Investigations

The Company is a party to lawsuits in the normal course of its business. Litigation in general, and securities and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the
results of complex legal proceedings are difficult to predict. Other than as described below, the Company is not a party to any other material legal proceedings.

Action in the Superior Court of San Diego. In April 2006, the Company was added as a named defendant in a lawsuit previously filed by a former shareholder of Extricity, Inc. against current and former officers and directors of
Peregrine Systems, Inc., Peregrines former accountants, some of Peregrines customers, including the Company, and various other unnamed defendants. Although the Company was added as a defendant, the complaint does not specify what causes
of action are being asserted against the Company nor does it contain any specific factual allegations against the Company. The complaint alleges against certain of the other named defendants that they, as Peregrines customers, engaged in
fraudulent transactions with Peregrine that were not accounted for by Peregrine in conformity with GAAP and that this substantially inflated the value of Peregrine securities issued as consideration in Extricitys merger with Peregrine. When,
if ever, the complaint is amended to make specific factual allegations against the Company and assert specific causes of action, the Company will then be in a position to make a determination as to the merits of the lawsuit. The Company believes the
allegations to be without merit and intends to defend itself vigorously. The Company had not recorded a liability against this claim as of September 30, 2006.

Securities Class Action in Southern District of New York. Beginning in July 2001, a number of securities class action complaints were filed against the Company, and certain of the Companys former officers and directors and
underwriters connected with the Companys initial public offering (IPO) of common stock in the U.S. District Court for the Southern District of New York (In re Initial Public Offering Sec. Litig.). The purported class action complaints were
filed by individuals who allege that they purchased the Companys common stock at the initial and secondary public offerings between March 29, 1999 and December 6, 2000. The complaints allege generally that the prospectus under which
such securities were sold contained false and misleading statements with respect to discounts and excess commissions received by the underwriters as well as allegations of laddering whereby underwriters required their customers to
purchase additional shares in the aftermarket in exchange for an allocation of IPO shares. The complaints seek an unspecified amount in damages on behalf of persons who purchased the Companys common stock during the specified period. Similar
complaints have been filed against 55 underwriters and more than 300 other companies and other individuals. The over 1,000 complaints have been consolidated into a single action. The Company has reached an agreement in principle with the plaintiffs
to resolve the cases. The proposed settlement involves no monetary payment by the Company and no admission of liability. The settlement has been preliminarily approved by the Court. However, the settlement is subject to final approval by the Court
which has not yet occurred. The Company had not recorded a liability against this claim as of September 30, 2006.

Cable & Wireless
Liquidating Trust. In December 2005, the Company was named in a complaint for avoidance and recovery of preferential transfers filed by Cable & Wireless Liquidating Trust, or the Trust, in respect of the Trusts claim that
Cable & Wireless, USA, Inc. made a preferential payment to the Company of approximately $1.1 million within the 90-day preference period before Cable & Wireless filed for bankruptcy protection. The Company settled this claim in
September 2006 and recorded a $0.3 million liability against this claim as of September 30, 2006. In October 2006, the Company paid the $0.3 million to the Trust.

Indemnifications. The Company provides general indemnification provisions in its license agreements. In these agreements, the Company generally states that it will defend or settle, at its own expense, any
claim against the customer by a third party asserting a patent, copyright, trademark, trade secret or proprietary right violation related to any products that the Company has licensed to the customer. The Company agrees to indemnify its customers
against any loss, expense or liability, including reasonable attorneys fees, from any damages alleged against the customer by a third party in its course of using products sold by the Company. The Company has not received any claims under this
indemnification and does not know of any instances in which such a claim may be brought against the Company in the future.

Under California law, in
connection with the Companys charter documents and indemnification agreements the Company entered into with its executive officers and directors, the Company must indemnify its current and former officers and directors to the fullest extent
permitted by law. The indemnification covers any expenses and liabilities reasonably incurred in connection with the investigation, defense, settlement or appeal of legal proceedings. The Company has made payments in connection with the
indemnification of officers and directors in connection with past lawsuits and governmental investigations. As of September 30, 2006, there were no outstanding claims or payments related to the Companys indemnification agreements.



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##### Table of Contents

Note 10  Stock-Based Compensation

Stock plan activity

Stock options

The Company grants stock options through its 1998 Stock Option Plan (the 1998 Plan) and the 1999 Nonstatutory Stock Option Plan (the 1999 Plan, together with the 1998
Plan, the Option Plans and each a Plan). The 1998 Plan provides for the granting of options to purchase shares of common stock to employees, officers, directors and consultants. The number of shares available for grant under the 1998 Plan increases
annually on January 1 of each year by an amount equal to 2% of the total number of shares of the Companys common stock authorized for issuance at the end of the most recently concluded fiscal year. The 1999 Plan provides for the granting
of options to purchase shares of common stock to non-executive officer employees or the initial employment grant for executive officers. Options granted under the 1999 Plan may only be nonqualified stock options (NSOs). The 1998 Plan is a
shareholder approved plan and allows for options to be granted as either incentive stock options (ISOs) or NSOs. ISOs may be granted only to Company employees, including officers, and employee directors. NSOs may be granted to Company employees,
non-employee directors and consultants.

Except for options issued in connection with our option exchange offer discussed below, stock options granted
generally expire ten years from the date of grant and vest over four years. The Company has no stock option awards with market or performance conditions.

Due to the significant decline in the Companys share price, the exercise price of outstanding options held by its employees, consultants and directors was higher, in many cases significantly, than the current fair market value of the
Companys common stock. On May 31, 2006, the Company commenced a tender offer (the Option Exchange Offer) to Company employees, consultants and directors who, as of May 31, 2006, were actively employed by or providing services to the
Company and had outstanding options granted under the Option Plans to exchange some or all of their outstanding options granted under the Option Plans for new options (the New Options) to purchase shares of common stock to be granted under the 1998
Plan. Each New Option issued has substantially the same terms and conditions as the eligible option cancelled in exchange for the New Option, except as follows:



| |  |  | all New Options expire June 28, 2013, seven years after the New Option grant date;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | the exercise price per share for each New Option is $0.20;
| | - |  | ----------------------------------------------------------



| |  |  | the New Options issued to eligible employees and consultants have a four-year vesting period adjusted as follows: (1) 50% of the New Options issued to eligible employees and
consultants that provided services to the Company as of May 31, 2006 for two or more years immediately vested with the remaining portion vesting in equal monthly installments for each full month of continuous service over the subsequent
24-month period; and (2) 25% of the New Options issued to eligible employees and consultants that provided services to the Company as of May 31, 2006 for less than two years immediately vested with the remaining portion vesting in equal
monthly installments for each full month of continuous service over the subsequent 36-month period;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the New Options issued to eligible directors retained the vesting schedule and vesting commencement date that would have been in effect for their tendered eligible options in the
absence of the acceleration of vesting that occurred on December 27, 2005;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | for certain eligible participants in the exchange offer, the number of shares of common stock underlying their New Options was less than the number of shares of common stock
underlying their eligible options (as described below); and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | eligible participants who held eligible options issued under the 1999 Stock Option Plan received New Options issued from the 1998 Plan.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------

The number of shares subject to the New Option received in exchange for a tendered eligible option depended on the per share exercise price in effect under the tendered
option. If the exercise price per share of an eligible option was at least $0.19 but not more than $4.00, the number of shares subject to the New Option was the same as the number of shares subject to the tendered eligible option. If the exercise
price per share of an eligible option was at least $4.01 but not more than $5.00, the number of shares subject to the New Option was determined by dividing the number of shares subject to the tendered eligible option by two, rounded down to the
nearest whole number. If the exercise price per share of an eligible option was more than $5.01, the number of shares subject to the New Option was determined by dividing the number of shares subject to the tendered eligible option by five, rounded
down to the nearest whole number.

The exchange offer expired on June 28, 2006. Eligible participants tendered, and the Company accepted for
cancellation, eligible options to purchase an aggregate of 7,554,590 shares of common stock, representing 85.5% of the total shares of common stock underlying options eligible for exchange in the exchange offer. As a result of the exchange ratios
described above, the Company issued replacement options to purchase an aggregate of 7,096,570 shares of common stock in exchange for the cancellation of the tendered eligible options.



17



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##### Table of Contents

The following table summarizes activity under all stock option plans for the nine month period ended September 30,
2006 (in thousands, except for per share amounts):



|                                                                           |  |                            |   |  |                    |   |  |                                           |      
|-------------------------------------------------------------------------- |  | -------------------------- | - |  | ------------------ | - |  | ----------------------------------------- | -----
|                                                                           |  | Shares Available for Grant |   |  | Number Outstanding |   |  | Weighted Average Exercise Price per Share
|Balance at December 31, 2005                                               |  | 11,506                     |   |  | 11,437             |   |  | $                                         | 11.49
|Additional shares authorized                                               |  | 4,000                      |   |  |                   |   |  |                                           |      
|Options granted not in connection with the June 2006 Option Exchange Offer |  | (608                       | ) |  | 608                |   |  |                                           | 0.22 
|Options granted in the June 2006 Option Exchange Offer                     |  | (7,097                     | ) |  | 7,097              |   |  |                                           | 0.20 
|Options exercised                                                          |  |                            |   |  | (1                 | ) |  |                                           | 0.08 
|Options cancelled in the June 2006 Option Exchange Offer                   |  | 7,555                      |   |  | (7,555             | ) |  |                                           | 11.01
|Options forfeited                                                          |  | 1,790                      |   |  | (1,790             | ) |  |                                           | 14.16
|                                                                           |  |                            |   |  |                    |   |  |                                           |      
|Balance at September 30, 2006                                              |  | 17,146                     |   |  | 9,796              |   |  | $                                         | 2.50 
|                                                                           |  |                            |   |  |                    |   |  |                                           |      
|Exercisable, September 30, 2006                                            |  |                            |   |  | 6,204              |   |  | $                                         | 3.83 
|                                                                           |  |                            |   |  |                    |   |  |                                           |      

The Company issues new shares of common stock upon exercise of stock options. During the nine months ended
September 30, 2005 and 2006, zero and 921 stock options were exercised, respectively. The stock options exercised during the nine months ended September 30, 2006, had an insignificant aggregate intrinsic value. The aggregate intrinsic
value represents the difference between the option exercise price and the closing stock price on the date of exercise for each option exercised during the period.

The aggregate intrinsic value of stock options outstanding at September 30, 2005 and 2006 was $5,948 and zero, respectively. The aggregate intrinsic value of vested stock options at September 30, 2005 and 2006 was $315 and zero,
respectively. The aggregate intrinsic value, for purposes of this calculation, represents, on a pretax basis, the difference between the Companys closing stock price as of the end of the third quarter of 2005 and 2006, respectively, and the
option exercise price, multiplied by the number of options outstanding or exercisable. Stock options with exercise prices which are greater than or equal to the closing quarter end stock price are excluded from this calculation.



18



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##### Table of Contents

The following table summarizes information about stock options outstanding at September 30, 2006 (options in
thousands):



|                         |  |                     |  |                                             |  |                                 |        |                    |       |                                 |   |       
|------------------------ |  | ------------------- |  | ------------------------------------------- |  | ------------------------------- | ------ | ------------------ | ----- | ------------------------------- | - | ------
|                         |  | Options Outstanding |  | Options Exercisable                        
|Range of Exercise Prices |  | Number Outstanding  |  | Weighted Average Remaining Contractual Life |  | Weighted Average Exercise Price |        | Number Exercisable |       | Weighted Average Exercise Price
|$ 0.16 - $ 0.20          |  | 7,395               |  | 6.75                                        |  | $                               | 0.20   |                    | 3,848 |                                 | $ | 0.20  
|$ 0.21 - $ 0.50          |  | 132                 |  | 8.86                                        |  |                                 | 0.33   |                    | 87    |                                 |   | 0.36  
|$ 0.51 - $ 1.00          |  | 221                 |  | 8.43                                        |  |                                 | 0.65   |                    | 221   |                                 |   | 0.65  
|$ 1.01 - $ 2.00          |  | 649                 |  | 5.69                                        |  |                                 | 1.58   |                    | 649   |                                 |   | 1.58  
|$ 2.01 - $ 3.00          |  | 17                  |  | 7.07                                        |  |                                 | 2.46   |                    | 17    |                                 |   | 2.46  
|$ 3.01 - $ 4.00          |  | 505                 |  | 6.30                                        |  |                                 | 3.24   |                    | 505   |                                 |   | 3.24  
|$ 4.01 - $ 6.00          |  | 163                 |  | 4.88                                        |  |                                 | 4.77   |                    | 163   |                                 |   | 4.77  
|$ 6.01 -$ 10.00          |  | 203                 |  | 5.11                                        |  |                                 | 6.32   |                    | 203   |                                 |   | 6.32  
|$ 10.01 -$ 50.00         |  | 437                 |  | 5.24                                        |  |                                 | 10.28  |                    | 437   |                                 |   | 10.28 
|$ 50.01 - $ 300.00       |  | 74                  |  | 3.58                                        |  |                                 | 183.97 |                    | 74    |                                 |   | 183.97
|                         |  |                     |  |                                             |  |                                 |        |                    |       |                                 |   |       
|                         |  | 9,796               |  | 6.57                                        |  | $                               | 2.50   |                    | 6,204 |                                 | $ | 3.83  
|                         |  |                     |  |                                             |  |                                 |        |                    |       |                                 |   |       

As of September 30, 2005, there were 12,061,495 options outstanding and 6,800,297 options exercisable.

Restricted stock and other stock-based plans

The Company has granted shares of restricted stock and restricted stock units to certain key employees and executive officers through its 1998 Plan. In March and August 2004, the Company issued 707,368 and 680,823 shares of restricted
stock, respectively, to Mark Ferrer, the Companys Chief Executive Officer, in connection with Mr. Ferrers employment agreement. In November 2004, the Company issued 515,000 shares of restricted stock and 277,708 restricted stock
units to Executive Officers and certain key employees of the Company. During the nine months ended September 30, 2005, the Company issued 130,000 shares of restricted stock and 20,000 restricted stock units to certain key employees. The Company
did not issue any shares of restricted stock or restricted stock units during the nine month period ended September 30, 2006.

The restricted stock
gives employees certain ownership rights, including the right to vote on shareholder matters; whereas, restricted stock units do not convey any voting rights, but present the holder with the right to receive shares of the Companys common stock
as the underlying units vest. The restricted stock and restricted stock units vest 25 percent every 6 months over a term of 2 years, with any unvested shares/units forfeited if a recipient terminates his or her employment with the Company.

The following table reflects the activity associated with shares of unvested restricted stock and restricted stock units during the nine months ended
September 30, 2006 (in thousands):



|                                                 |  |        |   |  |                                        |     
|------------------------------------------------ |  | ------ | - |  | -------------------------------------- | ----
|                                                 |  | Shares |   |  | Weighted Average Grant Date Fair
Value
|Unvested restricted shares at December 31, 2005  |  | 1,297  |   |  | $                                      | 1.07
|Granted                                          |  |       |   |  |                                        |     
|Vested                                           |  | (451   | ) |  |                                        | 1.06
|Forfeited                                        |  | (64    | ) |  |                                        | 0.62
|                                                 |  |        |   |  |                                        |     
|Unvested restricted shares at September 30, 2006 |  | 782    |   |  | $                                      | 1.12
|                                                 |  |        |   |  |                                        |     

The fair value of restricted stock and restricted stock units which vested during the nine month period ended
September 30, 2006 totaled approximately $110,000.

As of September 30, 2006, there was approximately $0.2 million in total unrecognized
compensation cost associated with the unvested shares of restricted stock and restricted stock units. The cost is expected to be recognized over the future weighted average vesting period of 0.8 years.

In January 2006, the Company terminated its Employee Stock Purchase Plan (ESPP). No shares of stock were purchased nor compensation expense recognized under the ESPP
during 2006.



19



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Accounting for stock-based compensation

The Company adopted SFAS No. 123R (revised in 2004), Share-based payment, on January 1, 2006. SFAS 123R requires the measurement and recognition of compensation expense, using a fair-value based
method, for all share-based awards made to the Companys employees and directors, including grants of stock options, restricted stock and other stock-based plans. The Company recognizes the stock compensation expense over the requisite service
period of the individual grants, which generally equals the vesting period.

The Company has elected to follow the modified prospective transition method
in adopting SFAS 123R. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption and the Companys prior period consolidated financial statements have not been restated to reflect the
impact of SFAS 123R.

In March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment, which provided guidance on
the adoption of SFAS 123R as it relates to certain SEC rules and regulations. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.

Prior to January 1, 2006, the Company followed the intrinsic value method for stock-based awards to employees and directors in accordance with Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to
Employees, as allowed under SFAS No. 123, Accounting for Stock-based Compensation. Under the intrinsic value method, stock-based compensation expense was recognized in the Companys Condensed Consolidated Statement of Operations
for the fair value of restricted stock granted prior to January 1, 2006. However, no stock-based compensation expense had been recognized in the Companys Condensed Consolidated Statement of Operations for any period prior to the
Companys adoption of SFAS 123R on January 1, 2006, for stock options granted to employees and directors, when the exercise price of the stock options granted equaled the fair market value of the underlying stock at the date of grant.

Valuation of stock options granted

The Company
utilized the Black-Scholes valuation model to estimate the fair value of stock options granted and stock-based compensation expense recognized in the third quarter and first nine months of 2006, and as presented in the pro-forma disclosure below for
the third quarter and first nine months of 2005, as required under SFAS 123. The Company used the following weighted-average assumptions:



|                          |  |                                  |   |  |                                 |   |  |             |   |  |             |  
|------------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | ----------- | - |  | ----------- | -
|                          |  | Three months ended September 30, |   |  | Nine months ended September 30, |  
|                          |  | 2005                             |   |  | 2006                            |   |  | 2005        |   |  | 2006        |  
|Risk free interest rate   |  | 4.2                              | % |  | 4.6                             | % |  | 3.7-4.2     | % |  | 4.6-5.1     | %
|Expected lives (in years) |  | 4.0                              |   |  | 4.75                            |   |  | 4.0         |   |  | 4.0-4.75    |  
|Dividend yield            |  | 0.0                              | % |  | 0.0                             | % |  | 0.0         | % |  | 0.0         | %
|Expected volatility       |  | 130.0                            | % |  | 132.0                           | % |  | 130.0-142.0 | % |  | 132.0-137.0 | %

The risk-free interest rate was derived from the U.S. treasury zero-coupon rate in effect at the end of the
quarter in which the stock option was granted, utilizing the yield offered by an instrument with a maturity approximating the expected life of the option. The expected life assumption for 2006 option grants utilizes the simplified method
provided under SAB 107, which allows companies with traditional service-based option grants to use an expected life assumption equal to the midpoint between the vesting period and contractual term of the options. The 2005 expected life assumption
was based upon the weighted average period the stock options were expected to remain outstanding for stock options granted during the period. The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no
present intention to pay cash dividends. The expected volatility assumption is based upon the historical volatility of our common stock.

Based on the
assumptions utilized in the Black-Scholes valuation model as discussed above, the weighted-average fair value of options granted under the stock option plans for the three months ended September 30, 2005 and 2006 was approximately $0.40 and
$0.04, respectively.

Stock-based compensation expense

As a result of the consummation of the Companys stock option exchange offer on June 28, 2006, in accordance with SFAS 123R, compensation cost associated with the incremental fair value of these option awards was calculated at
approximately $358,000 using the Black-Scholes valuation model. Of this amount, $25,000 and $193,000 has been recognized as compensation expense within the Companys Consolidated Statement of Operations for the three and nine months ended
September 30, 2006, respectively, associated with the vesting of these option awards. The remaining fair value of these option awards of $165,000 will be recognized as expense on a straight-line basis over the remaining vesting periods, which
approximate 1.8 years on a weighted average basis.



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Also under the provisions of SFAS 123R, the Company recorded in its unaudited condensed consolidated statement of
operations for the three and nine month periods ended September 30, 2006, approximately $6,000 and $19,000, respectively, of stock-based compensation associated with non-exchange offer related 2006 stock option grants. Because the Company
accelerated the vesting of all outstanding options held by employees as of December 27, 2005, there was no remaining unamortized expense associated with any stock option awards as of the date of the Companys adoption of SFAS 123R. The
Company also recognized compensation expense associated with the vesting of restricted stock and restricted stock units in the amount of $356,000 and $85,000 in the three month periods ended September 30, 2005 and 2006, respectively, and
$892,000 and $338,000 in the nine month periods ended September 30, 2005 and 2006, respectively. The Company also recognized compensation expense during the first nine months of 2005 of approximately $25,000 associated with grants of restricted
stock and stock options to non-employee contractors.

The following table details stock-based compensation expense, related to all of the Companys
stock-based awards, including the June 2006 stock option exchange, on a functional basis as reported in the Companys Consolidated Statement of Operations for the three and nine months ended September 30, 2005 and 2006.



|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|----------------------------------------------------------------------- |  | -------------------------------- | --- | ------------------------------- | - | ---- |  | ---- | --- |  | - | ---
|                                                                        |  | Three months ended September 30, |     | Nine months ended September 30,
|                                                                        |  | 2005                             |     | 2006                            |   | 2005 |  | 2006
|                                                                        |  | (in thousands)                  
|Stock-based compensation expense reported in cost of net revenues:      |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Hosted messaging                                                        |  | $                                | 11  |                                 | $ | 1    |  | $    | 45  |  | $ | 10 
|Professional services                                                   |  |                                  | 37  |                                 |   | 6    |  |      | 106 |  |   | 50 
|Maintenance and support                                                 |  |                                  | 15  |                                 |   | 2    |  |      | 17  |  |   | 14 
|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Total stock-based compensation expense reported in cost of net revenues |  |                                  | 63  |                                 |   | 9    |  |      | 168 |  |   | 74 
|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Stock-based compensation expense reported in operating expenses:        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Selling and marketing                                                   |  |                                  | 34  |                                 |   | 8    |  |      | 73  |  |   | 41 
|Research and development                                                |  |                                  | 103 |                                 |   | 9    |  |      | 133 |  |   | 65 
|General and administrative                                              |  |                                  | 155 |                                 |   | 90   |  |      | 543 |  |   | 370
|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Total stock-based compensation expense reported in operating expenses   |  |                                  | 292 |                                 |   | 107  |  |      | 749 |  |   | 476
|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    
|Total stock-based compensation expenses                                 |  | $                                | 355 |                                 | $ | 116  |  | $    | 917 |  | $ | 550
|                                                                        |  |                                  |     |                                 |   |      |  |      |     |  |   |    

Stock-based compensation expense recognized in the Consolidated Statement of Operations for the three and nine
month periods ended September 30, 2006 was calculated based upon awards ultimately expected to vest and has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant, and revised, if necessary,
in subsequent periods if actual forfeitures differ from estimates.

The value of the portion of the stock award that is ultimately expected to vest is
recognized as expense on a straight-line basis over the requisite service periods. Including the unvested portion of the fair value of the June 28, 2006 option exchange, total stock-based compensation of stock options granted but not yet
vested, as of September 30, 2006, was approximately $228,000, which is expected to be recognized as expense over the future weighted average vesting period of 1.8 years.

The adoption of SFAS 123R did not have any impact upon the Companys income tax expense or cash flows.

SFAS 123R requires the Company to present pro forma information for the comparative prior year periods as if the Company had accounted for all employee stock options
under the fair value method of the original SFAS 123. The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation in the
prior-year period (dollars in thousands, except per-share data).



|                                                               |  |                                       |        |   |                                      |   |         |  
|-------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------------------------------ | - | ------- | -
|                                                               |  | Three months ended September 30, 2005 |        |   | Nine months ended September 30, 2005 |  
|Net loss as reported                                           |  | $                                     | (4,545 | ) |                                      | $ | (25,243 | )
|Add: employee stock compensation included in reported net loss |  |                                       | 355    |   |                                      |   | 917     |  
|Less: employee stock compensation under SFAS No. 123           |  |                                       | (1,278 | ) |                                      |   | (3,610  | )
|                                                               |  |                                       |        |   |                                      |   |         |  
|Pro forma net loss                                             |  |                                       | (5,468 | ) |                                      | $ | (27,936 | )
|                                                               |  |                                       |        |   |                                      |   |         |  
|Net loss per basic and diluted share as reported               |  | $                                     | (0.13  | ) |                                      | $ | (0.83   | )
|                                                               |  |                                       |        |   |                                      |   |         |  
|Pro forma net loss per basic and diluted share                 |  | $                                     | (0.16  | ) |                                      | $ | (0.92   | )
|                                                               |  |                                       |        |   |                                      |   |         |  



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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly
Report on Form 10-Q and the following disclosures contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended and in effect from time to time.
The words anticipates, expects, intends, plans, believes, seek, proposed, and estimate and similar expressions are intended to identify forward-looking
statements. These are statements that relate to future periods and include statements regarding our ability to operate in the future, our ability to obtain funding, the adequacy of funds to meet anticipated operating needs, our future strategic,
operational and financial plans, possible financing, strategic or business combination or divestiture transactions, anticipated or projected revenues, margins, expenses and operational growth, markets and potential customers for our products and
services, the amount of compensation expense to be incurred or avoided in the future, the continued seasonality of our business, development and timing of release of new and upgraded products and service offerings, plans related to sales strategies
and global sales efforts, the anticipated benefits of our relationships with strategic partners, growth of our competition, our ability to compete, investments in product development, our litigation strategy, use of future earnings, the features,
benefits and performance of our current and future products and services, plans to reduce operating costs through continued expense reduction, the effect of the repayment of debt, our plans and ability to improve our internal control over financial
reporting and our disclosure controls and procedures, our intent to restructure our foreign subsidiaries in order to repatriate cash located in accounts outside of the United States, the substance of the allegations and causes of action that may be
made against us in the action filed in April 2006 in the Superior Court of San Diego, anticipated improvement in our internal control over financial reporting as a result of our remediation efforts, and our belief as to our ability to successfully
emerge from the restructuring and refocusing of our operations. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Factors that might cause future
results to differ materially from those projected in the forward-looking statements include, but are not limited to, our management of expenses and restructuring activities, failure to obtain additional financing on favorable terms or at all, the
failure to revise our existing debt obligations, the effect of the conversion of our preferred stock, the liquidation preference of our preferred stock, the accrual of dividends for our preferred stock, risks associated with our internal controls
over financial reporting and our ability to address any material weaknesses in our internal controls over financial reporting, difficulties of forecasting future results due to our evolving business strategy, failure to meet sales and revenue
forecasts, the emerging nature of the market for our products and services, turnover within and integration of senior management, board of directors members and other key personnel, rate of growth of the messaging and directory infrastructure
market, difficulties in our strategic plans to exit certain products and services offerings, failure to expand our sales and marketing activities, potential difficulties associated with strategic relationships, investments and uncollected bills,
general economic conditions in markets in which we do business, risks associated with our international operations, inability to predict future trading prices of our common stock which have fluctuated significantly in the past, foreign currency
fluctuations, unplanned system interruptions and capacity constraints, software defects, and those discussed in Managements Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors and
elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements. The forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation to publicly release the results of
any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing.

All references to
Critical Path, we, our, or the Company mean Critical Path, Inc. and its subsidiaries, except where it is clear from the context that such terms mean only the parent company and excludes subsidiaries.

This Quarterly Report on Form 10-Q includes numerous trademarks and registered trademarks of Critical Path. Products or service names of other
companies mentioned in this Quarterly Report on Form 10-Q may be trademarks or registered trademarks of their respective owners.

Overview

We deliver software and services that enable the rapid deployment of highly scalable value-added solutions for messaging and identity management. Our
messaging and identity management solutions help organizations expand the range of digital communications services they provide while helping to reduce overall costs. Our messaging solutions, which were available in 2005 and prior years both as
licensed software and as hosted services, provided integrated access to a broad range of communication and collaboration applications from wireless devices, web browsers, desktop clients, and voice systems. In January 2006, we sold the assets
related to our hosted messaging business to Tucows and do not intend to directly offer hosted messaging services, other than our news group services, in the future. Our identity management solutions are designed to reduce burdens on helpdesks,
simplify the deployment of key security infrastructure, enable compliance with new regulatory mandates, and help reduce the cost and effort of deploying applications and services to distributed organizations, mobile users, suppliers, and customers.



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The target markets for our messaging and identity management solutions include wireless carriers and service providers as
well as enterprises and government agencies. We generate most of our revenues from telecommunications operators and from large enterprises. We believe wireless carriers, Internet service providers, or ISPs, and fixed-line service providers purchase
our products and services primarily to offer new services to their subscribers. While they may also purchase our products and services to lower their cost of operating existing services or infrastructure, their spending is often tied to the level of
investment they are willing to make on new revenue-generating services. Large enterprises typically buy our products and services to reduce their costs of operations particularly for handling distributed workforces or consolidations of multiple
organizations, improve the security of their infrastructure, facilitate compliance with new regulatory mandates, and to enable new applications to be deployed for their employees or users.

We generate revenues from four primary sources:

Software license sales. Our Memova®
Messaging applications are primarily sold as a perpetual license on a per-user basis, one for each person who might access the capabilities provided by the software. Revenue from our Memova® Anti-Abuse (anti-spam and anti-virus) application is generally recognized over a term
of twelve months. Our Memova® Mobile applications,
a newly released set of solutions, have recently been sold primarily as a perpetual license on a per-user basis, however, we also intend to license the Memova Mobile application on a subscription type basis. Our identity management software is
usually sold as a perpetual license according to the number of data elements and different business systems being managed. These layered applications are usually licensed per user. The Company believes that revenue from its Memova applications, for
example the Memova Mobile application that it launched in the first quarter of 2005, is an important source of future revenues and has made significant investments in their development, however, so far this year revenues from Memova Mobile have been
immaterial.

Hosted messaging services. For the hosted messaging services we offered prior to our sale of the Hosted Assets, customers paid initial
setup fees and regular monthly, quarterly or annual subscriptions for the services they wanted to be able to access. In connection with the sale of the Hosted Assets to Tucows in January 2006, we sold our hosted email, calendar and reserve solutions
and as a result hosted revenues going forward will only be comprised of our news group service.

Professional services. We offer a range of
different services designed to help our customers make more effective use of our products and services. Our licensed messaging and identity management software often require integration with customers existing infrastructure or customization
to provide special features or capabilities. In addition, our consultants offer expertise and experience in designing and delivering new services that our customers can use to supplement their own resources.

Maintenance and support services. We offer a variety of software support and maintenance plans that enable customers of our licensed software to receive expedited
technical support and access to new releases of our software. Most customers initially subscribe to these services when purchasing our software and then renew their subscriptions on a regular basis.

We believe that wireless carriers and service providers are increasingly seeking to offer more differentiated services and diversify into new markets. In addition,
enterprises and government agencies are faced with similar needs to deliver a broader range of information services while reducing the costs of operating such services and ensuring that privacy and security are maintained. We believe this provides a
growth opportunity for the messaging and directory infrastructure market. However, the growth of this market and our business is also faced with many challenges, including the emerging nature of the market, the demand for licensed solutions for
messaging and identity management products and outsourced messaging services, rapid technological change, competition and the recent decline in worldwide technology spending.

Restructuring Initiatives

We have operated at a loss since our inception and as of September 30, 2006, we had
an accumulated deficit of approximately $2.3 billion, which includes a $1.3 billion charge for impairment of goodwill and other long-lived assets that we recorded in fiscal year 2000. We have undertaken numerous restructuring initiatives in an
effort to align our operating structure not only to the business and economic environments through which we have operated but also in response to our changing business in an effort to generate net income. Our restructuring activities in 2005 and
2006 are as follows:



| |  |  | During 2005, we recorded restructuring charges totaling $1.9 million, of which, $1.3 million was related to the relocation of our headquarters facility and the balance related to
consolidation of data centers and the elimination of certain employee positions. On May 5, 2005, we entered into the Second Amendment to Lease (the Second Amendment) with PPF Off 345 Spear Street, L.P. (PPF Off 345 Spear), to amend the Lease
dated as of November 16, 2001, as amended (the Lease), under which we leased our headquarter facilities in San Francisco, California, located at 350 The Embarcadero. Under the terms of the Second Amendment, on June 29, 2005 we vacated our
facility at 350 The Embarcadero and moved into new office space located at 2 Harrison Street, 2ndFloor, San
Francisco, California. In addition, in connection with the Second Amendment, we made a lease termination payment related to the facility at 350 The Embarcadero totaling approximately $1.3 million during the
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | three months ended June 30, 2005. The new office space at 2 Harrison Street was comprised of two suites consisting of approximately 22,881 square feet with a lease for a term
of five years. Approximately 15,000 square feet of such space was utilized by us as our headquarters facilities, and the remaining approximately 8,000 square feet was utilized as storage space. On June 28, 2006, we terminated the Lease with PPF
345 Off Spear, and Babcock & Brown LP (Babcock & Brown) signed a lease with PPF 345 Off Spear to become the new tenant of the office space occupied by us at 2 Harrison Street. On June 28, 2006, we entered into a Sublease
Agreement (the Sublease) with Babcock & Brown to lease 15,000 square feet of our existing headquarters facilities at 2 Harrison Street. The sublease with Babcock & Brown has a two-year term and monthly rent of $39,000. In November
2006, the square footage we occupy of the sub leased premises will be reduced by approximately 9,000 square feet at which point the monthly rent will also be reduced in accordance with the terms of the Sublease. As a result of our facility
consolidations and restructurings we reduced our annual facility lease costs by approximately $1.2 million from 2004 to 2005 and expect our facility lease costs to decrease approximately $1.5 million from 2005 to 2006.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On December 14, 2005, we entered into an Asset Purchase Agreement with Tucows for the sale of our Hosted Assets. On January 3, 2006, we completed the sale of the Hosted
Assets. Under the Agreement, Tucows also acquired a software license for our Memova product and assumed certain contractual liabilities related to the Hosted Assets. Tucows paid us $6.3 million in cash upon completion of the sale and has paid an
additional $1.0 million in September 2006 in connection with certain post-closing conditions. We expect Tucows will also pay up to an additional $0.2 million during the three months ended December 31, 2006 if certain remaining post-closing
conditions are satisfied by such date. As part of this sale, the U.S. based hosted employees continued to work for Critical Path through the transition of sale, which concluded in June 2006. Beginning in July 2006, we no longer employed any U.S.
based hosted employees. In connection with the sale of hosted assets we recorded a $0.3 million of restructuring charges during the three months ended December 31, 2005 comprised of employee severance benefits and facility closure costs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During the nine months ended September 30, 2006, we recorded restructure charges in connection with the sale of the Hosted Assets of $0.3 million. During the three and
nine months ended September 30, 2006, we recorded restructuring charges related to the reorganization of our sales force totaling $28,000 and $0.6 million, respectively, and during the three months ended September 30, 2006, we recorded
restructure charges related to the transitioning of our U.S. based accounting operations to Dublin, Ireland totaling $0.1 million. These restructure charges are primarily related to facility consolidation costs and employee severance benefits.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In addition to these formal restructuring initiatives, we have sought to aggressively manage our cost structure, identifying incremental
savings where possible. We intend to continue to aggressively manage our expenses while maintaining strong service levels to our customers.

Critical
Accounting Policies

The following discussion and analysis of our financial condition and results of operations are based upon our consolidated
financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the
reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or
conditions. We believe our most critical accounting policies and estimates include:

Revenue recognition. Our revenues are derived from four primary
sources: software license sales, professional services, maintenance and support services and hosted messaging services. Revenues are recognized once the related products or services have been delivered and collection of the associated fees is
considered probable.



| |  |  | Software license revenues are generated from the sale of our messaging and identity management products as well as the resale of third-party software under perpetual and term
licenses. Software license revenues are recognized when persuasive evidence of an arrangement exists, delivery of the licensed software to the customer has occurred and the collection of a fixed or determinable license fee is considered probable. We
generally recognize license revenue from the sale of perpetual licenses upfront after the preceding criteria have been met while we recognize license revenue from the sale of term licenses ratably over the term of such licenses. Our revenue
recognition policies require that revenues recognized from software arrangements be allocated to each undelivered element of the arrangement based on the fair values of the elements, such as post contract customer support, installation, training or
other services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We also sell our license software products through resellers. Revenues from reseller agreements may include a nonrefundable, advance royalty which is payable upon the signing of the
contract and license fees based on the contracted value of our products purchased by the reseller. Additionally, revenues from reseller agreements may include nonrefundable fees related to software license products and related services for an
identified customer of
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | the reseller. Guaranteed license fees from resellers, where no right of return exists, are recognized when persuasive evidence of an arrangement exists, delivery of the licensed
software has occurred and the collection of a fixed or determinable license fee is considered probable. Non-guaranteed per-copy license fees from resellers are initially deferred and are recognized when they are reported as sold to end-users by the
reseller.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Hosted messaging revenues are generated from fees for hosting services we offer related to our news group service. These are primarily based upon monthly contractual per unit rates
for the services involved, which are recognized on a monthly basis over the term of the contract normally beginning with the month in which service delivery starts.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional service revenues are generated from fees primarily related to training, installation and configuration services associated with implementing and maintaining our license
software products for our customers. Professional service revenues are recognized in the period in which the services are performed.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support service revenues are generated from fees for post-contract customer support agreements associated primarily with our software license products. Maintenance
services typically include rights to future update and upgrade product releases and dial-up phone services and the associated fees are typically paid up-front by the customer, deferred and recognized ratably over the term of the support contract,
which is generally one year.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We also enter into arrangements that include multiple products and services where the services are deemed
essential to the functionality of a delivered element, under such circumstances we normally recognize the entire arrangement fee using the percentage of completion method. Under this method, individual contract revenues are recorded based on the
percentage relationship of the contract input hours incurred as compared to managements estimate of the total input hours to complete the contract.

Estimating allowance for doubtful accounts and contingencies. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingencies
at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. For this reason, actual results could differ from those estimates. Management must make estimates surrounding their ability to collect
revenues and related accounts receivable. Management specifically analyzes accounts receivable, historical and current economic trends, previous bad debts, customer concentrations, credit worthiness of customers, and payment terms of customer
accounts, when evaluating adequacy of the allowance for doubtful accounts.

Management estimates liabilities and contingencies at the end of each period.
The current financial statement presentation reflects managements best estimates of liabilities and pending litigation which are probable and where the amount and range of loss can be estimated. We record the minimum liability related to those
claims where there is a range of loss. Because of the uncertainties related to the probability of loss and the amount and range of loss on the pending litigation, management may not be able to make an accurate estimate of the liability that could
result from an unfavorable outcome. As additional information becomes available, we will continue to assess the potential exposure related to our pending litigation and update our estimates and related disclosures. Such future revisions in our
estimates could materially impact our financial results.

Valuation and impairment of long-lived assets and identifiable intangible assets.
Finite-lived intangible assets are presented at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over estimated useful lives of the assets, which has historically been between 3 and 5 years. We will
record an impairment charge on finite-lived intangibles or long-lived assets when we determine that the carrying value of intangibles and long-lived assets may not be recoverable. Factors considered important which could trigger impairment, include,
but are not limited to:



| |  |  | significant under performance relative to expected historical or projected future operating results;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | significant negative industry or economic trends;
| | - |  | -------------------------------------------------



| |  |  | significant decline in our stock price for a sustained period; and
| | - |  | ------------------------------------------------------------------



| |  |  | our market capitalization relative to net book value.
| | - |  | -----------------------------------------------------

Based upon the
existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current
business model.

Stock-based compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004) (SFAS 123R), Share-Based Payment, which revised SFAS 123, Accounting for Stock-Based Compensation. SFAS 123R requires all share-based payment transactions with employees, including grants of employee



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stock options, to be recognized as compensation expense over the requisite service period based on their relative fair
values. SFAS 123R is a new and very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option
lives, as well as expected option forfeiture rates, to value equity-based compensation. There is little experience or guidance available with respect to developing these assumptions and models. There is also uncertainty as to how the standard will
be interpreted and applied as more companies adopt the standard and companies and their advisors gain experience with the standard. SFAS 123R requires the recognition of the fair value of stock compensation in net income. Prior to the adoption of
SFAS 123R, stock-based compensation expense related to employee stock options was not recognized in the statement of operations. There was no cumulative effect of adoption.

Liquidity and Capital Resources

We have focused on capital financing initiatives in order to maintain current and
planned operations. We have operated at a loss since inception and our history of losses from operations and cash flow deficits, in combination with our cash balances, raise concerns about our ability to fund our operations. Our primary sources of
capital have come from both debt and equity financings that we have completed over the past several years and the sale of the Hosted Assets in January 2006. In 2003 and 2004, we secured additional funds through several rounds of financing that
involved the sale of senior secured convertible notes all of which converted into Series E preferred stock in 2004. In the third quarter of 2004, we completed a rights offering, and, in the fourth quarter of 2004, we secured and drew $11.0 million
from an $18.0 million round of debt financing. In March 2005, we drew down the remaining $7.0 million from the $18.0 million round of debt financing. We are not required to make any payments of principal or interest under this $18.0 million debt
financing until maturity in December 2007, at which time all principal and interest will become due. In January 2006, we sold our Hosted Assets for $6.3 million, and in September 2006 we received another $1.0 million in connection with certain
post-closing conditions related to the sale. We expect Tucows will also pay up to an additional $0.2 million during the three months ended December 31, 2006 if certain remaining post-closing conditions are satisfied by such date.

If we are unable to increase our revenues or if we are unable to reduce the amount of cash used by our operating activities during 2006 and into 2007, we may be required
to undertake additional restructuring alternatives, or seek additional debt financing. However, our ability to incur additional indebtedness is subject to certain limitations as discussed in the section below captioned Ability to incur
additional indebtedness and we do not believe equity financing on terms reasonably acceptable to us is currently available. Additionally, our common stock now trades in the over-the-counter market on the OTC Bulletin Board owned by the Nasdaq
Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq Global Market or the Nasdaq Capital Market. The OTC Bulletin Board is generally considered less efficient than the Nasdaq Global Market.
Consequently, selling our common stock is likely more difficult because of diminished liquidity in smaller quantities of shares likely being bought and sold, transactions could be delayed, and securities analysts and news media coverage of us
may be further reduced. We believe our listing on the OTC Bulletin Board, or further declines in our stock price, may greatly impair our ability to raise additional capital, should it be necessary, through equity or debt financing.

The following table sets forth our net losses attributable to common shareholders and the cash generated (used) by our operating activities for the periods indicated:



|                                             |  |                                 |        |   |        |   |        |                                |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |       |   |  |     |  
|-------------------------------------------- |  | ------------------------------- | ------ | - | ------ | - | ------ | ------------------------------ |  | - | ------ | - |  | ---- | - |  | ---- | ------- | - | - | - | ------- | - |  | - | ----- | - |  | --- | -
|                                             |  | Three months endedSeptember 30, |        |   | Change |   |        | Nine months endedSeptember 30, |  |   | Change |  
|                                             |  | 2005                            |        |   | 2006   |   |        | $                              |  |   | %      |   |  | 2005 |   |  | 2006 |         |   | $ |   |         | % | 
|                                             |  | (in thousands)                  |       
|Net loss attributable to common shareholders |  | $                               | (4,545 | ) |        | $ | (5,595 | )                              |  | $ | (1,050 | ) |  | 23   | % |  | $    | (25,243 | ) |   | $ | (19,146 | ) |  | $ | 6,097 |   |  | -24 | %
|Net cash used by operating activities        |  |                                 | (4,484 | ) |        |   | (998   | )                              |  |   | (5,482 | ) |  | -122 | % |  |      | (3,503  | ) |   |   | (4,321  | ) |  |   | (818  | ) |  | 23  | %

Our principal sources of liquidity include our cash and cash equivalents. As of September 30, 2006, we had
cash and cash equivalents available for operations totaling $19.4 million, of which $10.9 million was located in accounts outside the United States and which is not readily available for our domestic operations. We are considering making changes to
our foreign subsidiaries to provide easier access to our foreign cash. Accordingly, our readily available cash resources in the United States as of September 30, 2006 was $8.5 million. As of September 30, 2006, we had cash collateralized
letters of credit totaling approximately $0.2 million. This cash is recorded as restricted cash on our balance sheet and is not readily available for our operations.

Based on our recent financing activities, recent restructuring activities and managements projections as to our operating results, we believe that we have sufficient cash to meet our cash operating requirements for
the next 12 months as well as the on-going investments in capital equipment to support our research and development efforts and news group operations. We believe these projections are reasonable; however, these projections are subject to risks and
uncertainties, some of which are beyond our control, such as the amount of revenues that will be generated. As a result, actual results could differ materially from such projections. In addition, as we approach the December 31, 2007 maturity of the
$18.0 million principal amount of the 13.9% Notes, we anticipate



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that we will need to restructure our debt or seek additional financing in order to pay the 13.9% Notes upon maturity. We have no present understandings,
commitments or agreements for any material acquisitions of, or investments in, other complementary businesses, products or technologies. We continually evaluates potential acquisitions of, or investments in, other businesses, products and
technologies, and may in the future utilize its cash resources or may require additional equity or debt financing to accomplish any acquisitions or investments. These alternatives could increase liquidity through the infusion of investment capital
by third-party investors or decrease our liquidity as a result of our seeking to fund expansion into these markets. Such expansions might also cause an increase in capital expenditures and operating expenses. For the long-term, we believe future
improvements in our operating activities will be necessary to provide the liquidity and capital resources sufficient to support our business.

Cash and
cash equivalents

The following table sets forth our cash and cash equivalents balances as of the dates indicated:



|                          |  |                   |        |                    |   |        |  |   |     |  |   |  
|------------------------- |  | ----------------- | ------ | ------------------ | - | ------ |  | - | --- |  | - | -
|                          |  | December 31, 2005 |        | September 30, 2006 |   | Change | 
|                          |  |                   | $      |                    | % |       
|                          |  | (in thousands)    |        |                    |   |        | 
|Cash and cash equivalents |  | $                 | 18,707 |                    | $ | 19,414 |  | $ | 707 |  | 4 | %

Total cash and cash equivalents increased during the nine months ended September 30, 2006 primarily as a
result of the cash provided by our investing activities in connection with the sale of the Hosted Assets partially offset by cash used to support our operating activities as well as the beneficial effect of foreign exchange rates as set forth in the
table below (in thousands):



|                                                      |  |   |        |  
|----------------------------------------------------- |  | - | ------ | -
|Beginning balance at December 31, 2005                |  | $ | 18,707 |  
|                                                      | 
|Net cash used by operating activities                 |  |   | (4,321 | )
|Net cash provided by investing activities             |  |   | 4,399  |  
|Net cash used by financing activities                 |  |   | (49    | )
|                                                      |  |   |        |  
|Net increase in cash and cash equivalents             |  |   | 29     |  
|Effect of exchange rates on cash and cash equivalents |  |   | 678    |  
|                                                      |  |   |        |  
|Ending balance at September 30, 2006                  |  | $ | 19,414 |  
|                                                      |  |   |        |  

Net cash used by operating activities. Our operating activities used cash during the nine months
ended September 30, 2006. This cash was used to support our net loss of $8.6 million which, when adjusted for non-cash items such as: depreciation and amortization of $2.0 million, a $0.9 million gain due to the decrease in the fair value of
embedded derivative liabilities, amortization of stock-based expenses of $0.6 million as well as the gain on the sale of the Hosted Assets of $3.0 million; totaled $9.9 million. Additionally, cash was provided by our operating activities in
connection with a $2.4 million decrease in accounts receivable primarily as a result of improved collections performance, a $2.0 million increase in deferred revenue, primarily a result of maintenance and third-party software billings for which the
related revenue will be recognized ratably over the related service period, an increase in our accrued liabilities of $0.7 million and a decrease of $0.4 million in other assets.

Our primary source of operating cash flow is the collection of accounts receivable from our customers and the timing of payments to our vendors and service providers. We measure the effectiveness of our collections
efforts by an analysis of the average number of days our accounts receivable are outstanding, or DSOs. The following table sets forth our accounts receivable balances and DSOs as of the dates indicated:



|                         |  |                                      |        |                    |   |        |   |   |        |   |  |     |  
|------------------------ |  | ------------------------------------ | ------ | ------------------ | - | ------ | - | - | ------ | - |  | --- | -
|                         |  | December 31, 2005                    |        | September 30, 2006 |   | Change |  
|                         |  |                                      |        | $                  |   |        | % |  
|                         |  | (dollars in thousands; DSOs in days) |        |                    |   |       
|Accounts receivable, net |  | $                                    | 10,096 |                    | $ | 8,945  |   | $ | (1,151 | ) |  | -11 | %
|DSOs                     |  |                                      | 60     |                    |   | 74     |   |   | 14     |   |  | 24  | %

Accounts receivable balances and DSOs increased from December 31, 2005 primarily due to an increase in
deferred revenue due to higher maintenance and third-party software billings and the timing of such billings later in the quarter as well as a greater proportion of revenue being generated in Europe, which typically have longer payment terms than in
the United States, however, are still within the norms in such countries.

A number of non-cash items, such as: depreciation and amortization, stock-based
expenses, deferred interest on debt and certain restructuring charges have been charged to expense and impacted our net results during the three and nine months



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ended September 30, 2006. To the extent these non-cash items increase or decrease in amount and increase or decrease
our future operating results, there will be no corresponding impact on our cash flows. Our operating cash flows will be impacted in the future based on our operating results, our ability to collect our accounts receivable on a timely basis, and the
timing of payments to our vendors for accounts payable.

We face restrictions on our ability to use cash held outside of the United States for purposes
other than the operation of each of our respective foreign subsidiaries that hold that cash. For example, our ability to use cash held in a given European subsidiary for any reason other than the operation of this subsidiary may result in certain
tax liabilities and may be subject to local laws that could prevent the transfer of cash from Europe to any other foreign or domestic account. Additionally, we are exposed to foreign currency exchange rate risk inherent in our sales commitments,
anticipated sales, contracts with vendors, and working capital, as a significant portion or our worldwide operations have a functional currency other than the United States dollar. The impact of future exchange rate fluctuations cannot be predicted
adequately. To date, we have not sought to hedge the risks associated with fluctuations in exchange rates.

Revenue generated from the sale of our products
and services may not increase to a level that exceeds our expenses or could fluctuate significantly as a result of changes in customer demand or acceptance of future products. Although we expect to continue to review our operating expenses, if we
are not successful in achieving cost reductions or generating sufficient revenues, our cash flow from operations will continue to be negatively impacted.

Net cash provided by investing activities. Our investing activities provided $4.4 million of cash during the nine months ended September 30, 2006 primarily as a result of cash proceeds totaling $5.5 million from the
sale of the Hosted Assets. The cash provided from the proceeds of the sale was partially offset by purchases of equipment totaling $1.1 million primarily used to support our remaining hosted news group service infrastructure and research and
development efforts. We believe we will be required to continue to make investments in capital equipment during 2006 and in 2007 and we expect to fund these purchases through the use of our available cash resources. We do not believe leasing
arrangements on terms we find reasonably acceptable are currently available.

Ability to incur additional indebtedness

Subject to limited exceptions, we must seek the consent of our preferred shareholders and debt holders in order to incur any additional indebtedness.

Contractual Obligations and Commitments

The table below sets forth our significant cash obligations and commitments as of September 30, 2006.



|                                           |  |                |         |                                      |   |                                |  |      |        |      |   |            |  |   |       |  |   |       |  |   |      
|------------------------------------------ |  | -------------- | ------- | ------------------------------------ | - | ------------------------------ |  | ---- | ------ | ---- | - | ---------- |  | - | ----- |  | - | ----- |  | - | -----
|                                           |  | Total          |         | Three months ended December 31, 2006 |   | Fiscal year ended December 31,
|                                           |  |                |         | 2007                                 |   | 2008                           |  | 2009 |        | 2010 |   | Thereafter
|                                           |  | (in thousands)
|Mandatorily redeemable preferred stock (a) |  | $              | 162,514 |                                      | $ |                               |  | $    |       |      | $ | 162,514    |  | $ |      |  | $ |      |  | $ |     
|13.9% Notes (b)                            |  |                | 26,792  |                                      |   |                               |  |      | 26,792 |      |   |           |  |   |      |  |   |      |  |   |     
|Operating lease obligations                |  |                | 9,680   |                                      |   | 591                            |  |      | 1,726  |      |   | 1,278      |  |   | 1,030 |  |   | 1,011 |  |   | 4,044
|Capital lease obligations                  |  |                | 28      |                                      |   | 16                             |  |      | 12     |      |   |           |  |   |      |  |   |      |  |   |     
|Other purchase obligations (c)             |  |                | 2,691   |                                      |   | 925                            |  |      | 1,766  |      |   |           |  |   |      |  |   |      |  |   |     
|                                           |  |                |         |                                      |   |                                |  |      |        |      |   |            |  |   |       |  |   |       |  |   |      
|                                           |  | $              | 201,705 |                                      | $ | 1,532                          |  | $    | 30,296 |      | $ | 163,792    |  | $ | 1,030 |  | $ | 1,011 |  | $ | 4,044
|                                           |  |                |         |                                      |   |                                |  |      |        |      |   |            |  |   |       |  |   |       |  |   |      

---

|(a) | Includes dividends totaling $13.5 million (see also Note 8Mandatorily Redeemable Preferred Stock in the Notes to Consolidated Financial Statements) due in 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Includes interest totaling $8.8 million due in 2007.
|--- | ----------------------------------------------------

|(c) | Represents certain contractual obligations related to royalty obligations incurred in connection with sales of third-party software products, the future purchase of maintenance
related to hardware and software products being utilized within engineering and hosted operations, the management of data center operations and network infrastructure storage for the Companys hosted operations and the use of third-party
developers.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Results of Operations

In
view of the rapidly evolving nature of our business, prior acquisitions, organizational restructuring, and limited operating history, we believe that period over period comparisons of revenues and operating results, including gross profit margin and



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operating expenses as a percentage of total net revenues, are not meaningful and should not be relied upon as indications
of future performance. We do not believe that our historical fluctuations in revenues, expenses, or personnel are indicative of future results.

As a
result of the adoption of SFAS No. 123R (revised in 2004), Share-based payment, on January 1, 2006, the following financial results for the three and nine months ended September 30, 2006, include the recognition of compensation
expense, using a fair-value based method, for all share-based awards made to our employees and directors, including grants of stock options, restricted stock and other stock-based plans. Prior to the adoption on SFAS No. 123R, we only
recognized compensation expense related to share-based awards to non-employees and awards of restricted stock. Accordingly, the financial results presented for the periods prior to 2006 do not include the recognition of compensation expense for all
share-based awards made to our employees and directors. To better understand the comparability of our financial statements before and after the adoption of SFAS 123R, see Note 10  Stock-Based Compensation.



29



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##### Table of Contents

The following table sets forth our results of operations for the three and nine months ended September 30, 2005 and
2006:



|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|----------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ------ | - | ------ | ------------------------------- |  | - | ------ | - |  | ---- | - |  | ---- | ------- | - | - | - | ------- | - |  | - | ------- | - |  | --- | -
|                                                                        |  | Three months ended September 30,         |        |   | Change |   |        | Nine months ended September 30, |  |   | Change |  
|                                                                        |  | 2005                                     |        |   | 2006   |   |        | $                               |  |   | %      |   |  | 2005 |   |  | 2006 |         |   | $ |   |         | % | 
|                                                                        |  | (in thousands, except per share amounts) |       
|NET REVENUES                                                            |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Software licensing                                                      |  | $                                        | 5,593  |   |        | $ | 2,688  |                                 |  | $ | (2,905 | ) |  | -52  | % |  | $    | 14,810  |   |   | $ | 9,097   |   |  | $ | (5,713  | ) |  | -39 | %
|Hosted messaging                                                        |  |                                          | 3,309  |   |        |   | 1,220  |                                 |  |   | (2,089 | ) |  | -63  | % |  |      | 12,048  |   |   |   | 3,609   |   |  |   | (8,439  | ) |  | -70 | %
|Professional services                                                   |  |                                          | 3,119  |   |        |   | 2,257  |                                 |  |   | (862   | ) |  | -28  | % |  |      | 9,929   |   |   |   | 7,660   |   |  |   | (2,269  | ) |  | -23 | %
|Maintenance and support                                                 |  |                                          | 5,059  |   |        |   | 4,687  |                                 |  |   | (372   | ) |  | -7   | % |  |      | 14,842  |   |   |   | 13,524  |   |  |   | (1,318  | ) |  | -9  | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Total net revenues                                                      |  |                                          | 17,080 |   |        |   | 10,852 |                                 |  |   | (6,228 | ) |  | -36  | % |  |      | 51,629  |   |   |   | 33,890  |   |  |   | (17,739 | ) |  | -34 | %
|                                                                        |  |                                          |        |   |        |   |        |                                
|COST OF NET REVENUES                                                    |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Software licensing                                                      |  |                                          | 1,364  |   |        |   | 1,105  |                                 |  |   | (259   | ) |  | -19  | % |  |      | 3,606   |   |   |   | 3,470   |   |  |   | (136    | ) |  | -4  | %
|Hosted messaging                                                        |  |                                          | 3,047  |   |        |   | 740    |                                 |  |   | (2,307 | ) |  | -76  | % |  |      | 11,972  |   |   |   | 2,275   |   |  |   | (9,697  | ) |  | -81 | %
|Professional services                                                   |  |                                          | 2,307  |   |        |   | 1,943  |                                 |  |   | (364   | ) |  | -16  | % |  |      | 7,100   |   |   |   | 6,139   |   |  |   | (961    | ) |  | -14 | %
|Maintenance and support                                                 |  |                                          | 1,457  |   |        |   | 1,303  |                                 |  |   | (154   | ) |  | -11  | % |  |      | 4,558   |   |   |   | 3,820   |   |  |   | (738    | ) |  | -16 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Total cost of net revenues                                              |  |                                          | 8,175  |   |        |   | 5,091  |                                 |  |   | (3,084 | ) |  | -38  | % |  |      | 27,236  |   |   |   | 15,704  |   |  |   | (11,532 | ) |  | -42 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|GROSS PROFIT                                                            |  |                                          | 8,905  |   |        |   | 5,761  |                                 |  |   | (3,144 | ) |  | -35  | % |  |      | 24,393  |   |   |   | 18,186  |   |  |   | (6,207  | ) |  | -25 | %
|                                                                        |  |                                          |        |   |        |   |        |                                
|OPERATING EXPENSES                                                      |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Selling and marketing                                                   |  |                                          | 4,239  |   |        |   | 2,728  |                                 |  |   | (1,511 | ) |  | -36  | % |  |      | 12,852  |   |   |   | 9,544   |   |  |   | (3,308  | ) |  | -26 | %
|Research and development                                                |  |                                          | 3,013  |   |        |   | 2,375  |                                 |  |   | (638   | ) |  | -21  | % |  |      | 11,579  |   |   |   | 7,219   |   |  |   | (4,360  | ) |  | -38 | %
|General and administrative                                              |  |                                          | 2,714  |   |        |   | 2,850  |                                 |  |   | 136    |   |  | 5    | % |  |      | 10,373  |   |   |   | 9,140   |   |  |   | (1,233  | ) |  | -12 | %
|Restructuring expense                                                   |  |                                          | 40     |   |        |   | 137    |                                 |  |   | 97     |   |  | 243  | % |  |      | 1,847   |   |   |   | 1,178   |   |  |   | (669    | ) |  | -36 | %
|Gain on sale of assets                                                  |  |                                          |       |   |        |   | (1,007 | )                               |  |   | (1,007 | ) |  | 0    | % |  |      |        |   |   |   | (2,978  | ) |  |   | (2,978  | ) |  | 0   | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Total operating expenses                                                |  |                                          | 10,006 |   |        |   | 7,083  |                                 |  |   | (2,923 | ) |  | -29  | % |  |      | 36,651  |   |   |   | 24,103  |   |  |   | (12,548 | ) |  | -34 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|OPERATING LOSS                                                          |  |                                          | (1,101 | ) |        |   | (1,322 | )                               |  |   | (221   | ) |  | 20   | % |  |      | (12,258 | ) |   |   | (5,917  | ) |  |   | 6,341   |   |  | -52 | %
|Other income                                                            |  |                                          | 1,357  |   |        |   | 469    |                                 |  |   | (888   | ) |  | -65  | % |  |      | 5,598   |   |   |   | 547     |   |  |   | (5,051  | ) |  | -90 | %
|Interest expense                                                        |  |                                          | (918   | ) |        |   | (911   | )                               |  |   | 7      |   |  | -1   | % |  |      | (2,483  | ) |   |   | (2,664  | ) |  |   | (181    | ) |  | 7   | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Loss before provision for income taxes                                  |  |                                          | (662   | ) |        |   | (1,764 | )                               |  |   | (1,102 | ) |  | 166  | % |  |      | (9,143  | ) |   |   | (8,034  | ) |  |   | 1,109   |   |  | -12 | %
|Provision for income taxes                                              |  |                                          | (364   | ) |        |   | (280   | )                               |  |   | 84     |   |  | -23  | % |  |      | (789    | ) |   |   | (594    | ) |  |   | 195     |   |  | -25 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|NET LOSS                                                                |  |                                          | (1,026 | ) |        |   | (2,044 | )                               |  |   | (1,018 | ) |  | 99   | % |  |      | (9,932  | ) |   |   | (8,628  | ) |  |   | 1,304   |   |  | -13 | %
|Accretion on mandatorily redeemable preferred stock                     |  |                                          | (3,519 | ) |        |   | (3,551 | )                               |  |   | (32    | ) |  | 1    | % |  |      | (15,311 | ) |   |   | (10,518 | ) |  |   | 4,793   |   |  | -31 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|NET LOSS ATTRIBUTABLE TO COMMONSHAREHOLDERS                             |  | $                                        | (4,545 | ) |        | $ | (5,595 | )                               |  | $ | (1,050 | ) |  | 23   | % |  | $    | (25,243 | ) |   | $ | (19,146 | ) |  | $ | 6,097   |   |  | -24 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Basic and diluted net loss per share attributable tocommon shareholders |  | $                                        | (0.13  | ) |        | $ | (0.15  | )                               |  | $ | (0.02  | ) |  | 16   | % |  | $    | (0.83   | ) |   | $ | (0.53   | ) |  | $ | 0.30    |   |  | -36 | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  
|Shares used in the basic and diluted per share calculations             |  |                                          | 34,557 |   |        |   | 36,533 |                                 |  |   | 1,976  |   |  | 6    | % |  |      | 30,452  |   |   |   | 36,248  |   |  |   | 5,796   |   |  | 19  | %
|                                                                        |  |                                          |        |   |        |   |        |                                 |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |         |   |  |     |  



30



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##### Table of Contents

NET REVENUES

Total net revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year.



| |  |  | Software licensing. Software license revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year
primarily due to decreased licensing of our messaging and identity management software platforms (each marketed as components of Memova Messaging) as a result of a large transaction for our identity management software in each of the three months
ended March 31 and September 30, 2005 and a large transaction for our messaging software in the three months ended June 30, 2005 with no similarly large transactions in the three or nine months ended September 30, 2006 as well as
decreased license revenue from third-party products we sell. These decreases were partially offset by increased revenue recognized from Memova Anti-Abuse as a result of sales made during 2005 and the nine months ended September 30, 2006
(revenue from the sale of our Memova Anti-Abuse product is recognized ratably over a twelve month period and was introduced during the three months ended March 31, 2005). During the three and nine months ended September 30, 2005 and 2006,
revenue recognized from the sale of Memova Mobile has been immaterial.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Hosted messaging. Hosted messaging revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year
primarily due to the sale of our Hosted Assets in January 2006. The revenue reported as hosted messaging revenue during the three and nine months ended September 30, 2006 is related to our hosted newsgroup service, Supernews, which we retained.
We believe revenues from our Supernews service will remain approximately $1.2 million per quarter during the remainder of 2006 and into 2007.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services. Professional services revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior
year primarily as a result of decreased revenue from large engagements with customers in both Sweden and Switzerland.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support. Maintenance and support revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the
prior year primarily due to maintenance contracts that renewed at lower rates and the expiration of maintenance contracts in Europe that were not renewed.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We expect our total revenues to decrease in 2006 from the prior year primarily as a result of the sale of the Hosted Assets and the related revenue.

The following table sets forth our total revenues by region for the three and nine months ended September 30, 2005 and 2006:



|                       |  |                                  |        |  |        |   |  |                                 |        |  |        |   |  |      |        |   |      |     |   |   |   |        |   |     |   |  |   |        |  |     |   |  |   |         |   |  |     |  
|---------------------- |  | -------------------------------- | ------ |  | ------ | - |  | ------------------------------- | ------ |  | ------ | - |  | ---- | ------ | - | ---- | --- | - | - | - | ------ | - | --- | - |  | - | ------ |  | --- | - |  | - | ------- | - |  | --- | -
|                       |  | Three months ended September 30, |        |  | Change |   |  | Nine months ended September 30, |        |  | Change |  
|                       |  | 2005                             |        |  | 2006   |   |  | $                               |        |  | %      |   |  | 2005 |        |   | 2006 |     |   | $ |   |        | % |    
|                       |  | (in thousands)                   |       
|North America          |  | $                                | 4,587  |  | 27     | % |  | $                               | 2,679  |  | 25     | % |  | $    | (1,908 | ) |      | -42 | % |   | $ | 13,214 |   | 26  | % |  | $ | 8,078  |  | 24  | % |  | $ | (5,136  | ) |  | -39 | %
|                       |  |                                  |        |  |        |   |  |                                 |        |  |        |  
|Europe                 |  |                                  | 11,917 |  | 70     | % |  |                                 | 7,849  |  | 72     | % |  |      | (4,068 | ) |      | -34 | % |   |   | 36,507 |   | 71  | % |  |   | 25,098 |  | 74  | % |  |   | (11,409 | ) |  | -31 | %
|Latin America          |  |                                  | 365    |  | 2      | % |  |                                 | 67     |  | 1      | % |  |      | (298   | ) |      | -82 | % |   |   | 891    |   | 2   | % |  |   | 215    |  | 1   | % |  |   | (676    | ) |  | -76 | %
|Asia Pacific           |  |                                  | 211    |  | 1      | % |  |                                 | 257    |  | 2      | % |  |      | 46     |   |      | 22  | % |   |   | 1,017  |   | 2   | % |  |   | 499    |  | 1   | % |  |   | (518    | ) |  | -51 | %
|                       |  |                                  |        |  |        |   |  |                                 |        |  |        |   |  |      |        |   |      |     |   |   |   |        |   |     |   |  |   |        |  |     |   |  |   |         |   |  |     |  
|Subtotal international |  |                                  | 12,493 |  | 73     | % |  |                                 | 8,173  |  | 75     | % |  |      | (4,320 | ) |      | -35 | % |   |   | 38,415 |   | 74  | % |  |   | 25,812 |  | 76  | % |  |   | (12,603 | ) |  | -33 | %
|                       |  |                                  |        |  |        |   |  |                                 |        |  |        |   |  |      |        |   |      |     |   |   |   |        |   |     |   |  |   |        |  |     |   |  |   |         |   |  |     |  
|                       |  | $                                | 17,080 |  | 100    | % |  | $                               | 10,852 |  | 100    | % |  | $    | (6,228 | ) |      | -36 | % |   | $ | 51,629 |   | 100 | % |  | $ | 33,890 |  | 100 | % |  | $ | (17,739 | ) |  | -34 | %
|                       |  |                                  |        |  |        |   |  |                                 |        |  |        |   |  |      |        |   |      |     |   |   |   |        |   |     |   |  |   |        |  |     |   |  |   |         |   |  |     |  

North American revenues decreased in total and as a proportion of total revenue for the three and nine months
ended September 30, 2006 as compared to the same periods in the prior year primarily due to the sale of the Hosted Assets because the majority of our hosted messaging customers were located in North America. International revenues, although a
greater portion of total revenue, decreased in total for the three and nine months ended September 30, 2006 as compared to the same periods in the prior year primarily due to decreased licensing of our messaging and identity management
platforms, decreased professional services revenue as a result of decreased revenues from a customer in Sweden and decreased maintenance revenues primarily due to the expiration of maintenance contracts in Europe that were renewed at lower rates and
maintenance contracts that were not renewed.



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##### Table of Contents

COST OF NET REVENUES AND GROSS MARGIN

Cost of net revenues decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year.



| |  |  | Software licensing. Software license cost of revenues consists primarily of third-party royalty costs. Software license cost of revenues decreased slightly during the three
and nine months ended September 30, 2006 as compared to the same periods in the prior year primarily due to decreased royalty costs related to the decrease in revenue from the third-party product we sell.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Hosted messaging. Hosted messaging cost of revenues consists primarily of costs incurred in the delivery and support of our news group service, including employee related
costs, depreciation expenses, Internet co-location and connection fees, hardware maintenance costs as well as other direct and allocated costs. Hosted messaging costs decreased during the three and nine months ended September 30, 2006 as
compared to the same periods in the prior year primarily due to the sale of the Hosted Assets in January 2006.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services. Professional services cost of revenues consists primarily of employee related and third party contractor costs providing installation, migration,
training services and custom engineering for our licensed solutions as well as other direct and allocated indirect costs. Professional services costs decreased during the three months ended September 30, 2006 as compared to the same period in
the prior year primarily due to a $0.3 million decrease in commission costs and a $0.2 million decrease in third-party contractor costs partially offset by a $0.1 million increase in each of employee related costs and facility and information
technology (IT) related costs.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Professional services costs decreased during the nine months ended September 30, 2006 as
compared to the same period in the prior year primarily due to a $0.6 million decrease in third-party contractor costs, a $0.3 million decrease in commission costs and a $0.2 million decrease in employee related costs partially offset by $0.2
million of increased facility and IT related costs.



| |  |  | Maintenance and support. Maintenance and support cost of revenues consists primarily of employee related and third party contractor costs related to the customer support
functions for our licensed solutions as well as other direct and allocated indirect costs. Maintenance and support costs decreased during the three months ended September 30, 2006 as compared to the same periods in the prior year primarily due
to a $0.1 million decrease in employee related costs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Maintenance and support costs decreased during the nine months ended
September 30, 2006 as compared to the same periods in the prior year primarily due to a $0.6 million decrease in employee related costs and a $0.1 million decrease in third-party contractor costs.

Our total gross margin, which is gross profit divided by total net revenue, increased to 53% and 54% during the three and nine months ended September 30, 2006,
respectively, as compared to 52% and 47% during the three and nine months ended September 30, 2005, respectively. These increases were primarily due to the increase in hosted messaging and maintenance and support gross margins as a result of
the cost decreases discussed above, partially offset by decreased margins from our software licenses and professional services primarily as a result of the decreased revenue as discussed above.



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##### Table of Contents

OPERATING EXPENSES

Total operating expenses decreased during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year primarily due to reduced selling and marketing costs, research and
development costs, general and administrative expense, restructuring costs and the gain on the sale of our Hosted Assets.



| |  |  | Selling and marketing. Selling and marketing expense consists primarily of employee costs, including commissions, as well as travel and entertainment, third party contractor
costs, advertising, public relations, other marketing related costs as well as other direct and allocated costs. Selling and marketing expenses decreased during the three months ended September 30, 2006 as compared to the same period in the
prior year primarily as a result of a $1.0 million decrease in employee related costs including commissions due to lower revenues and declines in our sales and marketing staff which decreased by 7 employees from an average of 48 employees in the
three months ended September 30, 2005 to an average of 41 employees in the three months ended September 30, 2006 as well as a $0.2 million decrease in facility and IT related costs and a $0.1 million decrease in each of marketing program
and travel and entertainment costs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the nine months ended September 30, 2006 selling and marketing expenses
decreased as compared to the same period in the prior year primarily as a result of a $1.9 million decrease in employee related costs including commissions due to lower revenues and declines in our sales and marketing staff which decreased by 6
employees from an average of 50 employees in the nine months ended September 30, 2005 to an average of 44 employees in the nine months ended September 30, 2006 as well as a $0.7 million decrease in facility and IT related costs and a $0.2
million decrease in each of travel and entertainment costs, third-party contractor costs and depreciation expense.



| |  |  | Research and development. Research and development expense consists primarily of employee related costs, depreciation and amortization of capital equipment associated with
research and development activities, facility related costs, third-party contractor costs as well as other direct and allocated costs. Research and development expenses decreased during the three months ended September 30, 2006 as compared to
the same period in the prior year primarily as a result of a $0.2 million decrease in each of employee related costs and third party contractor costs and a $0.1 million decrease in depreciation expense. These decreases are primarily attributable to
the sale of the Hosted Assets and the related costs being eliminated. Our research and development staff decreased by 10 employees, 9 of which were related to development of the Hosted Assets, from an average of 85 employees in the three months
ended September 30, 2005 to an average of 74 employees in the three months ended September 30, 2006.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Research and
development expenses decreased during the nine months ended September 30, 2006 as compared to the same period in the prior year primarily as a result of a $2.1 million decrease in depreciation expense, a $1.0 million decrease in employee
related costs and a $0.5 million decrease in each of third party contractor costs and facility and IT related costs. These decreases are primarily attributable to the sale of the Hosted Assets and the related costs being eliminated. Our research and
development staff decreased by 15 employees, 9 of which were related to development of the Hosted Assets, from an average of 88 employees in the nine months ended September 30, 2005 to an average of 73 employees in the nine months ended
September 30, 2006.



| |  |  | General and administrative. General and administrative expense consists primarily of employee-related costs, fees for outside professional services, insurance and other
direct and allocated indirect costs. General and administrative expenses increased during the three months ended September 30, 2006 as compared to the same period in the prior year primarily due to a $0.3 million settlement related to the
Cable & Wireless bankruptcy partially offset by a $0.1 million decrease in depreciation expense as assets reach the end of their depreciable lives.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

General and administrative expenses decreased during the nine months ended September 30, 2006 as compared to the same period in the prior year, primarily due to a $1.3 million decrease in accounting costs
primarily as a result of compliance costs incurred in connection with our initial efforts to comply with the attestation requirements of Section 404 of the Sarbanes-Oxley Act during the three months ended March 31, 2005, and a $0.3 million
decrease in insurance costs partially offset by the $0.3 million settlement related to the Cable & Wireless bankruptcy and a $0.2 million increase in bad debt expense.

In December 2005, we suspended our on-going testing efforts after the SEC adopted certain rules that no longer require us to comply with Section 404
for the fiscal years ended December 31, 2005 and 2006; however, we intend to continue our efforts to remediate the material weaknesses identified in connection with our initial 2004 implementation and compliance efforts with Section 404.
As a result of our on-going remediation of material weaknesses and significant deficiencies resulting from our initial compliance efforts, we expect that general and administrative expenses may increase in future periods.



33



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##### Table of Contents

| |  |  | Restructuring expense. Restructuring expenses consist primarily of employee severance costs as well as facility and operations consolidation and lease termination costs
incurred primarily as a result of our restructuring actions. The following table provides additional information with respect to the types of restructuring charges included in our operating expenses for the periods indicated:
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                       |  |                                  |    |        |   |     |                                 |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |      |  
|-------------------------------------- |  | -------------------------------- | -- | ------ | - | --- | ------------------------------- | - | ------ | - |  | ---- | - | ---- | - | ----- |  | - | ----- |  | - | ------ | - |  | ---- | -
|                                       |  | Three months ended September 30, |    | Change |   |     | Nine months ended September 30, |   | Change |  
|                                       |  | 2005                             |    | 2006   |   | $   |                                 |   | %      |   |  | 2005 |   | 2006 |   | $     |  |   | %     | 
|                                       |  | (in thousands)                   |   
|Employee severance benefits            |  | $                                | 31 |        | $ | 28  |                                 | $ | (3     | ) |  | -10  | % |      | $ | 342   |  | $ | 1,010 |  | $ | 668    |   |  | 195  | %
|Facility and operations consolidations |  |                                  | 9  |        |   | 109 |                                 |   | 100    |   |  | 1111 | % |      |   | 1,444 |  |   | 168   |  |   | (1,276 | ) |  | -88  | %
|Non-core product divestitures          |  |                                  |   |        |   |    |                                 |   |       |   |  | 0    | % |      |   | 61    |  |   |      |  |   | (61    | ) |  | -100 | %
|                                       |  |                                  |    |        |   |     |                                 |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |      |  
|                                       |  | $                                | 40 |        | $ | 137 |                                 | $ | 97     |   |  | 243  | % |      | $ | 1,847 |  | $ | 1,178 |  | $ | (669   | ) |  | -36  | %
|                                       |  |                                  |    |        |   |     |                                 |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |      |  

During the three and nine months ended September 30, 2006, we recorded restructuring expenses
totaling $0.1 million and $1.2 million, respectively, primarily related to severance benefits paid to employees terminated in connection with the sale of the Hosted Assets as well as employees terminated in connection with the reorganization of our
sales force and employees to be terminated in connection with the transition of our U.S. accounting operations to Dublin, Ireland. At September 30, 2006, we carried a remaining restructuring liability of $0.3 million, the majority of which is
expected to be utilized by December 31, 2006.



| |  |  | Gain on the Sale of Hosted Assets. On December 14, 2005, we entered into an Asset Purchase Agreement with Tucows for the sale of our Hosted Assets. On January 3,
2006, we completed the sale of our Hosted Assets. Under the Agreement, Tucows also acquired a software license for Memova Messaging and assumed certain contractual liabilities related to the Hosted Assets. Tucows has paid Critical Path $7.3 million
in cash, of which $0.8 million was allocated to deferred revenue for future maintenance and support services to be provided by us in connection with the Memova license provided to Tucows under the Asset Purchase Agreement. Tucows will also pay up to
an additional $0.2 million during the three months ended December 31, 2006 if certain remaining post-closing conditions are satisfied by such date.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the nine months ended September 30, 2006, we recorded a gain of approximately $3.0 million associated with the sale of the Hosted Assets. The gain was calculated as follows:



|                                            |  |   |        |  
|------------------------------------------- |  | - | ------ | -
|Net proceeds from sale of the Hosted Assets |  | $ | 6,537  |  
|Less: Net assets sold                       |  |   | (2,492 | )
|Transaction costs                           |  |   | (873   | )
|Transition services costs                   |  |   | (194   | )
|                                            |  |   |        |  
|Gain on sale of the Hosted Assets           |  | $ | 2,978  |  
|                                            |  |   |        |  



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##### Table of Contents

OTHER INCOME, NET

Other income consists primarily of gains and losses on foreign exchange transactions, changes in fair value of the embedded derivative in the Series D preferred stock that we issued in connection with a financing
transaction in December 2001 and the changes in fair value of the embedded derivative in the Series F preferred stock warrants that we issued in connection with our 13.9% Notes. In accordance with the provisions of SFAS No. 133, Accounting
for Derivative Instruments, we are required to adjust the carrying value of the derivatives to their fair value at each balance sheet date and recognize any change since the prior balance sheet date as a component of other income or expense. The
following table sets forth the components of other income for the periods indicated.



|                                                                     |               |                    |       |        |      |   |               |   |  |        |                   |   |  |      |   |      |   |       |   |   |      |   |  |   |        |   |  |      |  
|-------------------------------------------------------------------- | ------------- | ------------------ | ----- | ------ | ---- | - | ------------- | - |  | ------ | ----------------- | - |  | ---- | - | ---- | - | ----- | - | - | ---- | - |  | - | ------ | - |  | ---- | -
|                                                                     |               | Three months ended |       |        |      |   |               |   |  |        | Nine months ended |   |  |      |   |      |   |      
|                                                                     | September 30, |                    |       | Change |      |   | September 30, |   |  | Change |                  
|                                                                     |               | 2005               |       |        | 2006 |   |               | $ |  |        | %                 |   |  | 2005 |   | 2006 |   |       | $ |   |      | % | 
|                                                                     |               | (in thousands)     |       |        |      |   |               |   |  |        | (in thousands)    |   |  |      |   |      |   |      
|Foreign exchange gain (loss)                                         |               | $                  | 1,681 |        |      | $ | (143          | ) |  | $      | (1,824            | ) |  | -109 | % |      | $ | 2,855 |   | $ | 340  |   |  | $ | (2,515 | ) |  | -88  | %
|Gain (loss) from changes in the fair value of derivative instruments |               |                    | (125  | )      |      |   | 330           |   |  |        | 455               |   |  | -364 | % |      |   | 2,231 |   |   | 844  |   |  |   | (1,387 | ) |  | -62  | %
|Other                                                                |               |                    | (199  | )      |      |   | 282           |   |  |        | 481               |   |  | -242 | % |      |   | 512   |   |   | (637 | ) |  |   | (1,149 | ) |  | -224 | %
|                                                                     |               |                    |       |        |      |   |               |   |  |        |                   |   |  |      |   |      |   |       |   |   |      |   |  |   |        |   |  |      |  
|                                                                     |               | $                  | 1,357 |        |      | $ | 469           |   |  | $      | (888              | ) |  | -65  | % |      | $ | 5,598 |   | $ | 547  |   |  | $ | (5,051 | ) |  | -90  | %
|                                                                     |               |                    |       |        |      |   |               |   |  |        |                   |   |  |      |   |      |   |       |   |   |      |   |  |   |        |   |  |      |  

Foreign exchange gain (loss) will change primarily based upon fluctuations in the foreign currency rates between
the U.S. dollar and the Euro. During the three months ended September 30, 2006, the Euro weakened slightly in comparison to the dollar, generating a foreign exchange loss for the quarter. For the nine months ended September 30, 2006, the Euro
strengthened in relationship to the dollar, resulting in a foreign exchange gain for the nine month period. For the three and nine month periods ended September 30, 2005, the Euro and the Canadian dollar strengthened significantly in relationship to
the dollar, resulting in large foreign exchange gains during those periods.

For the three months ended September 30, 2005, the fair value of the
derivative instruments increased in value causing us to record a loss. For the three months ended September 30, 2006, the fair value of the derivative instruments decreased in value causing us to record a gain. For the nine months ended
September 30, 2006, the gain on the change in the fair value of the derivative instruments decreased primarily as a result of the smaller decline in the value of the derivative liability during the nine months ended September 30, 2006 as
compared to the prior periods.

INTEREST EXPENSE, NET

Interest income consists primarily of interest earnings on cash and cash equivalents. Interest expense consists primarily of the interest expense and amortization of issuance costs related to the 13.9% Notes issued in
December 2004 and March 2005 and interest on certain capital leases and other long-term obligations. The following table sets forth the components of interest expense, net for the periods indicated:



|                                               |  |                    |      |   |        |   |      |               |  |   |                   |   |  |      |   |  |      |        |   |   |   |        |   |  |   |      |   |  |      |  
|---------------------------------------------- |  | ------------------ | ---- | - | ------ | - | ---- | ------------- |  | - | ----------------- | - |  | ---- | - |  | ---- | ------ | - | - | - | ------ | - |  | - | ---- | - |  | ---- | -
|                                               |  | Three months ended |      |   |        |   |      |               |  |   | Nine months ended |   |  |      |   |  |      |       
|                                               |  | September 30,      |      |   | Change |   |      | September 30, |  |   | Change            |  
|                                               |  | 2005               |      |   | 2006   |   |      | $             |  |   | %                 |   |  | 2005 |   |  | 2006 |        |   | $ |   |        | % | 
|                                               |  | (in thousands)     |     
|Interest Income                                |  | $                  | 101  |   |        | $ | 135  |               |  | $ | 34                |   |  | 34   | % |  | $    | 371    |   |   | $ | 374    |   |  | $ | 3    |   |  | 1    | %
|13.9% Notes                                    |  |                    | (670 | ) |        |   | (764 | )             |  |   | (94               | ) |  | 14   | % |  |      | (1,693 | ) |   |   | (2,194 | ) |  |   | (501 | ) |  | 30   | %
|Amortization of debt issuance costs            |  |                    | (217 | ) |        |   | (264 | )             |  |   | (47               | ) |  | 22   | % |  |      | (659   | ) |   |   | (780   | ) |  |   | (121 | ) |  | 18   | %
|Line of credit facility                        |  |                    | (12  | ) |        |   |     |               |  |   | 12                |   |  | -100 | % |  |      | (189   | ) |   |   |       |   |  |   | 189  |   |  | -100 | %
|Capital leases and other long-term obligations |  |                    | (120 | ) |        |   | (18  | )             |  |   | 102               |   |  | -85  | % |  |      | (313   | ) |   |   | (64    | ) |  |   | 249  |   |  | -80  | %
|                                               |  |                    |      |   |        |   |      |               |  |   |                   |   |  |      |   |  |      |        |   |   |   |        |   |  |   |      |   |  |      |  
|                                               |  | $                  | (918 | ) |        | $ | (911 | )             |  | $ | 7                 |   |  | -1   | % |  | $    | (2,483 | ) |   | $ | (2,664 | ) |  | $ | (181 | ) |  | 7    | %
|                                               |  |                    |      |   |        |   |      |               |  |   |                   |   |  |      |   |  |      |        |   |   |   |        |   |  |   |      |   |  |      |  

PROVISION FOR INCOME TAXES

The provision for income taxes represents the tax on the income generated by certain of our European subsidiaries operations. The provision for income taxes decreased
during the three and nine months ended September 30, 2006 as compared to the



35



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##### Table of Contents

same periods in the prior year primarily due to lower profits being generated in certain of our foreign subsidiaries.
Since our inception, we have incurred net operating losses for income tax purposes in the U.S. and have incurred taxes only in those states which levy taxes on a state minimum or franchise tax basis. Additionally, no deferred provision or benefit
for federal or state income taxes has been recorded as we are in a net deferred tax asset position for which a full valuation allowance has been provided due to uncertainty of realization.

ACCRUED DIVIDENDS AND ACCRETION ON MANDATORILY REDEEMABLE PREFERRED STOCK

Accretion on mandatorily redeemable preferred stock represents the accrued dividends and accretion of the beneficial conversion features of our outstanding Series D and E preferred stock as well as the accretion to
the redemption value of the outstanding Series D preferred stock (see Note 8  Mandatorily Redeemable Preferred Stock). The following table sets forth the components of the accretion on mandatorily redeemable preferred stock for the periods
indicated.



|                                                                |  |                                 |       |        |   |       |                                |   |        |   |  |      |   |      |   |        |  |   |        |  |   |        |   |  |     |  
|--------------------------------------------------------------- |  | ------------------------------- | ----- | ------ | - | ----- | ------------------------------ | - | ------ | - |  | ---- | - | ---- | - | ------ |  | - | ------ |  | - | ------ | - |  | --- | -
|                                                                |  | Three months endedSeptember 30, |       | Change |   |       | Nine months endedSeptember 30, |   | Change |  
|                                                                |  | 2005                            |       | 2006   |   | $     |                                |   | %      |   |  | 2005 |   | 2006 |   | $      |  |   | %      | 
|                                                                |  | (in thousands)                  |      
|Accrued dividends                                               |  | $                               | 1,923 |        | $ | 1,900 |                                | $ | (23    | ) |  | -1   | % |      | $ | 5,989  |  | $ | 5,700  |  | $ | (289   | ) |  | -5  | %
|Accretion to redemption value and beneficial conversion feature |  |                                 | 1,596 |        |   | 1,651 |                                |   | 55     |   |  | 3    | % |      |   | 9,322  |  |   | 4,818  |  |   | (4,504 | ) |  | -48 | %
|                                                                |  |                                 |       |        |   |       |                                |   |        |   |  |      |   |      |   |        |  |   |        |  |   |        |   |  |     |  
|                                                                |  | $                               | 3,519 |        | $ | 3,551 |                                | $ | 32     |   |  | 1    | % |      | $ | 15,311 |  | $ | 10,518 |  | $ | (4,793 | ) |  | -31 | %
|                                                                |  |                                 |       |        |   |       |                                |   |        |   |  |      |   |      |   |        |  |   |        |  |   |        |   |  |     |  

Accretion on mandatorily redeemable preferred stock has decreased during the nine months ended September 30,
2006 as compared to the same period in the prior year primarily as a result of the conversions of Series E and Series D preferred stock into shares of common stock, at the owners election. Due to these conversions, the total number of
outstanding shares of preferred stock decreased which as a result lowers the amount of dividends that accrue and the outstanding accretion.

Recent
Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments. SFAS No. 155 replaces SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. SFAS No. 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. This statement will be effective for all
financial instruments acquired or issued after the beginning of an entitys fiscal year that begins after September 15, 2006. We are currently evaluating the impact of this new standard on our financial position and results of operations.

In March 2006, the FASB issued SFAS No. 156, which amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement (i) requires an entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into certain servicing contracts; (ii) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable;
(iii) permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities, provided that the available-for-sale securities are identified in some manner as offsetting the entitys exposure to changes in fair value of servicing
assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and (iv) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of
financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. This statement will be effective as of the beginning of an entitys first fiscal year that begins after September 15,
2006. We are currently evaluating the impact of this new standard on our financial position and results of operations.

In July 2006, the FASB issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109,(FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that we
recognize in our financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the



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beginning of our 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as
an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial position and results of operations.

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

In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the
current years financial statements are materially misstated. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have an impact on our financial position and
results of operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following table presents the hypothetical changes
in fair value in the 13.9% Notes at September 30, 2006. The value of the instrument is sensitive to changes in interest rates. The modeling technique used measures the change in fair values arising from hypothetical parallel shifts in the yield
curve of plus or minus 50 basis points (bps), 100 bps and 150 bps over a twelve-month time horizon. The base value represents the estimated traded fair market value of the notes.



|            |  |                                                                          |        |                           |   |                                                                          |  |   |        |  |         |        |         |   |        |  |   |        |  |   |       
|----------- |  | ------------------------------------------------------------------------ | ------ | ------------------------- | - | ------------------------------------------------------------------------ |  | - | ------ |  | ------- | ------ | ------- | - | ------ |  | - | ------ |  | - | ------
|            |  | Valuation of borrowing given an interest rate decrease of X basis points |        | No changein interest
rate |   | Valuation of borrowing given an interest rate increase of X basis points
|            |  | 150 bps                                                                  |        | 100 bps                   |   | 50 bps                                                                   |  |   | 50 bps |  | 100 bps |        | 150 bps
|            |  | (in thousands)                                                          
|13.9% Notes |  | $                                                                        | 12,278 |                           | $ | 12,252                                                                   |  | $ | 12,226 |  | $       | 12,200 |         | $ | 12,174 |  | $ | 12,148 |  | $ | 12,122

As of September 30, 2006, we had cash and cash equivalents of $19.4 million and no investments in marketable
securities and our long-term obligations consisted of our $18.0 million three year, 13.9% Notes due December 2007 and certain fixed rate capital leases. Accordingly, an immediate 10% change in interest rates would not affect our long-term
obligations or our results of operations.

A significant portion of our international operations has a functional currency other than the United States
dollar. Accordingly, we are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, and assets and liabilities of these operations. Fluctuations in exchange rates may harm our results of operations and
could also result in exchange losses. The impact of future exchange rate fluctuations cannot be predicted with any certainty; however, our exposure to foreign currency exchange rate risk is primarily associated with fluctuations in the Euro. We
realized a net loss on foreign exchange of $0.1 million during the three months ended September 30, 2006 and a $0.3 million gain during the nine months ended September 30, 2006. To date, we have not sought to hedge the risks associated
with fluctuations in exchange rates. An immediate 10% change in foreign currency exchange rates would not have a material effect on our results of operations.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the
Exchange Act) designed to ensure information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required
disclosure.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our
disclosure committee and management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and
15d-15(b). During this evaluation, management considered the impact any material weaknesses and other



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deficiencies in our internal control over financial reporting might have on our disclosure controls and procedures. In
accordance with Section 404 of the Sarbanes-Oxley Act and the rules and regulations promulgated under this section, we were required for our Annual Report on Form 10-K for the year ended December 31, 2004 to evaluate and report on our
internal control over financial reporting. In our report contained in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004, we reported the following material weaknesses related to our:

(1) Lack of expertise and resources to analyze and apply generally accepted accounting principles to significant non-routine transactions;

(2) Inadequate controls over period-end financial reporting processes;

(3) Inadequate segregation of duties; and

(4) Inadequate controls over access to financial applications and data.

Because the material weaknesses identified in
connection with the assessment of our internal control over financial reporting as of December 31, 2004, have not yet been remediated, our Chief Executive Officer and our Chief Financial Officer concluded our disclosure controls and procedures
were not effective as of September 30, 2006. Notwithstanding the material weaknesses described above, based on additional analysis and other post-closing procedures to ensure our consolidated financial statements are prepared in accordance with
generally accepted accounting principles, management believes the consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods
presented.

The certifications of our Chief Executive Officer and our Chief Financial Officer required in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002 are attached as exhibits to this Quarterly Report on Form 10-Q. The disclosures set forth in this Item 4 contain information concerning the evaluation of our disclosure controls and procedures, referred to in
paragraph 4 of the certifications. Those certifications should be read in conjunction with this Item 4 for a more complete understanding of the matters covered by the certifications.

Changes in Internal Control over Financial Reporting

As part of our
ongoing remediation efforts, during September and October 2006, we transitioned our U.S. accounting operations to Dublin, Ireland, which reduces our significant accounting locations from four at December 31, 2004 to two upon completion of the
transition. Additionally, in October 2006 we completed the evaluation and selection of new core business software related to accounting and professional services. We believe these actions will facilitate the application of uniform accounting
controls and processes among our locations if and when implemented in the first half of 2007, will be key to the remediation of items (2) and (4) above. Except for the foregoing, there was no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Cable & Wireless Liquidating Trust. In December 2005, the Company was named in a
complaint for avoidance and recovery of preferential transfers filed by Cable & Wireless Liquidating Trust, or the Trust. The Company settled with the Trust in September 2006 and recorded a $0.3 million liability as of September 30,
2006. In October 2006, the Company paid $0.3 million to the Trust.

ITEM 1A. RISK FACTORS

Investing in our securities involves a high degree of risk. In addition to the other information
contained in this report, you should consider the following risk factors before investing in our securities.

We expect that we will need to raise
additional capital, initiate other operational strategies and/or revise our existing debt obligations to continue our operations.

If we are unable
to significantly increase our revenues, reduce the amount of cash used by our operating activities and generate positive cash flow from our operating activities, we may be required to raise additional funds or undertake additional restructuring
initiatives to continue our operations. Additionally, as we approach the December 30, 2007 maturity of $18.0 million principal amount of our 13.9% Notes we anticipate that we will need to restructure our debt or seek additional financing in
order to satisfy or delay payment of the 13.9% Notes upon maturity. If we cannot restructure our debt or raise additional financing, our auditors opinion on our 2006 financial statements could include a going-concern qualification. This may impair
our ability to raise additional capital which financing may not be available in sufficient amounts or on terms acceptable to us. Furthermore, we would need to obtain consent from holders of two-thirds in principal amount of our outstanding 13.9%
Notes and our preferred stockholders in order to incur certain types of indebtedness. Additionally, we face a number of challenges in operating our business, including our ability to overcome viability concerns held by our prospective customers
given our recent capital needs and the amount of resources necessary to maintain worldwide operations. The delisting of our common stock from the Nasdaq Global Market also impairs our ability to raise additional capital.

We have a history of losses, expect continuing losses and may never achieve profitability.

We have not achieved profitability in any period and expect to continue to incur net losses in accordance with generally accepted accounting principles for the foreseeable future. In addition, we intend to continue to
spend resources on maintaining and strengthening our business, and this may, in the near term, cause our operating expenses to increase and our operating results to decline.

In past quarters, we have spent heavily on technology and infrastructure development. We may continue to spend substantial financial and other resources to further develop and introduce new messaging solutions, and to
improve our sales and marketing organizations, strategic relationships and operating infrastructure. We expect that our cost of revenues, sales and marketing expenses, general and administrative expenses, operations, research and customer support
expenses and depreciation and amortization expenses could continue to increase in absolute dollars and may increase as a percent of revenues. In addition, in future periods we may incur significant non-cash charges related to stock-based
compensation. If revenues do not correspondingly increase, our operating results could decline. If we continue to incur net losses in future periods, we may not be able to retain employees, or fund investments in capital equipment, sales and
marketing programs, and research and development to successfully compete. We also may never obtain sufficient revenues to exceed our cost structure and achieve profitability. In addition, in the event we are unable to improve our financial
condition, current and future customers may determine not to do business with us which would cause our revenues to further decline. If we do achieve profitability, we may not be able to sustain or increase profitability in the future.

Certain of our cash resources are not readily available for our operations.

We face restrictions on our ability to use cash that we currently hold outside of the United States for purposes other than the operation of each of our respective foreign subsidiaries that hold such cash. For
example, our ability to use cash held in a given European subsidiary for any reason other than the operation of that subsidiary may result in certain tax liabilities and are subject to local laws that could prevent the transfer of cash from that
subsidiary to any other foreign or domestic account. At September 30, 2006, approximately $10.9 million was held outside of the United States. Our inability to utilize this cash



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could slow our ability to operate and grow our business and reach our business objectives. We may also be forced to incur
certain costs, such as tax liabilities, to be able to use this cash for domestic operations, which could cause our expenses to increase and our operating results to decline. In addition, approximately $0.2 million of our cash is restricted,
primarily to support our letters of credit related to certain facility leases and is therefore unavailable for our operating activities.

Our failure
to continue to carefully manage expenses could require us to use substantial resources and cause our operating results to decline.

In the past, our
management of operational expenses, including the restructurings of our operations, have placed significant strain on managerial, operational and financial resources and contributed to our history of losses. In addition, we may need to improve or
replace our existing operational, customer service and financial systems, procedures and controls and/or incur incremental costs of compliance with legislation, such as the Sarbanes-Oxley Act of 2002. Any failure to properly manage these systems and
procedural transitions or these incremental compliance costs could impair our ability to attract and service customers, and could cause us to incur higher operating costs and delays in the execution of our business plan. If we cannot manage
restructuring activities and expenses effectively, our business and operating results could decline.

From time to time we engage in discussions with
or receive proposals from third parties relating to a potential change of control of Critical Path.

We may enter into a transaction that
constitutes a change of control of Critical Path. Any such transaction could happen at any time, could be material to our business and could take any number of forms, including, for example, a merger or a sale of all or substantially all of our
assets. We will in the future continue to evaluate potential business combinations or strategic transactions which, if consummated, may constitute a change of control and trigger the liquidation preference payments described below.

Our $18.0 million in principal amount of 13.9% Notes and a substantial liquidation preference to the holders of our preferred stock could significantly impact the
return to common equity holders.

In the event of liquidation, dissolution, winding up or change of control of Critical Path, we must repay the
principal and accrued interest of the 13.9% Notes, and the holders of Series E preferred stock would be entitled to receive $1.50 per share of Series E preferred stock plus all accrued dividends on such shares before any proceeds from the
liquidation, dissolution or winding up is paid with respect to any other Series or class of our capital stock. Accordingly, at September 30, 2006, the approximately 48.8 million shares of Series E preferred stock outstanding had
an aggregate liquidation preference of approximately $82.6 million. The aggregate amount of the preference will increase as the shares of Series E preferred stock accrue dividends based on simple interest at an annual rate of 5 3/4%. After all of the then outstanding shares of Series E preferred stock have received payment of their liquidation preference,
the holders of Series D preferred stock would be entitled to receive the greater of $13.75 per share of Series D preferred stock plus all accrued dividends on such shares (which, as of September 30, 2006, would result in an aggregate
liquidation preference of approximately $66.5 million) or $22 per share (which currently would equal a liquidation preference of $77.5 million) before any proceeds from the liquidation, dissolution, winding up or change in control is paid to holders
of our common stock. The combined liquidation preference of our Series D and Series E preferred stock is $160.1 million. Holders of our common stock will not receive any proceeds from a liquidation, winding up or dissolution, including from a change
of control, until after the holders of the $18.0 million in principal amount of our 13.9% Notes have been repaid and the liquidation preferences of our Series E preferred stock and our Series D preferred stock are paid in full.
Consequently, although we would likely be required under applicable law to obtain the separate class approval of the holders of our common stock for a change of control or the sale of all or substantially all of the shares of Critical Path, it is
possible that such a transaction could result in all or substantially all of the proceeds of such transaction being distributed to the holders of our 13.9% Notes, Series E preferred stock and Series D preferred stock.

The debt and significant equity ownership by the General Atlantic Investors and the Cheung Kong Investors may result in potential conflicts of interests, which
could adversely affect the holders of our common stock, delay a change in control and depress our stock price.

The debt and significant equity
ownership by each of the General Atlantic Investors and the Cheung Kong Investors could create conflicts of interest between these majority shareholders and our other shareholders and between the General Atlantic Investors and the Cheung Kong
Investors. For example, the General Atlantic Investors and the Cheung Kong Investors may only approve a change in control transaction that results in the payment of their liquidation preference even if our other shareholders oppose the transaction,
which could depress the price of our common stock. Alternatively, the General Atlantic Investors and the Cheung Kong Investors may prevent or delay a corporate transaction that is favored by our other shareholders. In addition, it is also possible
that the risk that the General Atlantic Investors and the Cheung Kong Investors may disagree on approving a significant corporate transaction, for example a change in control transaction, could limit the number of potential partners willing to
pursue such a transaction with us or limit the price that investors might be willing to pay for future shares of our common stock.



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The debt and significant equity ownership by the General Atlantic Investors and the Cheung Kong Investors may limit
the ability of our other shareholders to influence significant corporate decisions which could delay or prevent a change of control or depress our stock price.

As of September 30, 2006, the General Atlantic Investors beneficially own approximately 29.5% of our outstanding securities (which represents approximately 18.2% of the voting power) and the Cheung Kong Investors
beneficially own approximately 20.7% of our outstanding securities (which represents approximately 19.6% of the voting power). As a result, the General Atlantic Investors and the Cheung Kong Investors, although not affiliated, may have the ability,
as shareholders acting together, to control the outcome of shareholder votes, including votes concerning the election of a majority of our directors, approval of merger transactions involving us and the sale of all or substantially all of our assets
or other business combination transactions, charter and bylaw amendments and other significant corporate actions, which could delay or prevent a change in control or depress our stock price.

The General Atlantic Investors and the Cheung Kong Investors also hold a significant portion of our outstanding 13.9% Notes, which require us to obtain their consent
before taking certain corporate actions (for example, incurring indebtedness or selling assets) that would not otherwise require the consent of our shareholders. As a result, we may not be able to execute a transaction favored by management or
beneficial to our other shareholders if we are not able to obtain their consent.

Our common stock has been delisted from the Nasdaq Global Market
and thus the price and liquidity of our common stock has been affected and our ability to obtain future financing may be further impaired.

In
November 2005, we were delisted from the Nasdaq Global Market due to noncompliance with Marketplace Rule 4450(b)(4), which requires companies listed to have a minimum bid price of $1.00 per share, and Rule 4450(b)(3), which requires companies listed
to maintain a minimum market value of publicly held securities of at least $15 million.

Our common stock now trades in the over-the-counter market on the
OTC Bulletin Board owned by the Nasdaq Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq Global Market or the Nasdaq Capital Market. The OTC Bulletin Board is generally considered less
efficient than the Nasdaq Global Market. Consequently, selling our common stock is likely more difficult because of diminished liquidity in smaller quantities of shares likely being bought and sold, transactions could be delayed, and securities
analysts and news media coverage of us may be further reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of common stock.

Our listing on the OTC Bulletin Board, or further declines in our stock price, may greatly impair our ability to raise additional capital, should it be necessary, through equity or debt financing, and significantly
increase the dilution to our current stockholders caused by any issuance of equity in financing or other transactions. The price at which we would issue shares in such transactions is generally based on the market price of our common stock and a
decline in the stock price could result in our need to issue a greater number of shares to raise a given amount of funding.

In addition, as our common
stock is not listed on a principal national exchange, we are subject to Rule 15g-9 under the Securities and Exchange Act of 1934, as amended. That rule imposes additional sales practice requirements on broker-dealers that sell low-priced securities
to persons other than established customers and institutional accredited investors. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common stock
in the secondary market. Moreover, investors may be less interested in purchasing low-priced securities because the brokerage commissions, as a percentage of the total transaction value, tend to be higher for such securities, and some investment
funds will not invest in low-priced securities (other than those which focus on small-capitalization companies or low-priced securities).

The
conversion of our preferred stock would result in a substantial number of additional shares of common stock outstanding, which could decrease the price of our common stock.

Our preferred stock can be converted into common stock at anytime in the discretion of the holder of preferred stock. For example, during the three months ended September 30, 2005, at the request of certain
holders of our Series E preferred stock, we converted approximately 2.1 million shares of Series E preferred stock into approximately 2.2 million shares of common stock. As of September 30, 2006, there were approximately
3.5 million shares of Series D preferred stock outstanding, which were convertible into approximately 44.3 million shares of common stock. In addition, we have approximately 48.8 million shares of Series E preferred stock
outstanding, which are convertible as of September 30, 2006, at the option of the holders, into approximately 55.1 million shares of common stock. We also have outstanding warrants to purchase 0.4 million shares



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of Series F preferred stock which, if exercised, would initially be convertible into approximately 3.9 million
shares of common stock. Any conversion of our preferred stock into common stock would increase the number of additional shares of common stock that may be sold into the market, which could substantially decrease the price of our common stock.

As the preferred stock accrues dividends, the number of shares of common stock issuable upon conversion will increase, which may increase the
dilution to our holders of common stock and further decrease the price of our common stock.

Currently, shares of Series D preferred stock and
shares of Series E preferred stock accrue dividends at a rate of 53/4% per year. If the maximum amount
of dividends accrue on the outstanding shares of Series D preferred stock and Series E preferred stock prior to the automatic call for redemption date, the number of shares of common stock issuable upon conversion will increase by
approximately 8.9 million shares to approximately 108.3 million shares of common stock. Further, if we are legally unable to redeem the Series E preferred stock and our Series D preferred stock on the redemption date, the value
of these preferred shares will continue to accrue dividends and be convertible into an even greater number of shares until such time as they are converted or redeemed.

We may be unable to grow our business through effective sales and marketing, which could cause our operating results to decline.

Our ability to increase revenues will depend on our ability to successfully recruit, train and retain experienced and effective sales and marketing personnel and for our personnel to achieve results once they are
employed with us. Competition for experienced and effective personnel in certain markets is intense and we may not be able to hire and retain personnel with relevant experience. The complexity and implementation of our messaging and identity
management infrastructure products and services require highly trained sales and marketing personnel to educate prospective customers regarding the use and benefits of our services. Current and prospective customers, in turn, must be able to educate
their end-users. Any delays or difficulties encountered in our staffing and training efforts would impair our ability to attract new customers and enhance our relationships with existing customers, and ultimately, grow revenues. This would also
adversely impact the timing and extent of our revenues from quarter to quarter and overall or could jeopardize sales altogether. Because we have experienced turnover in our sales force and have fewer resources than many of our competitors, our sales
and marketing organizations may not be able to compete successfully against the sales and marketing organizations of our competitors. Moreover, our competitors frequently have larger and more established sales forces calling upon potential
enterprise customers with more frequency. In addition, certain of our competitors have longer and closer relationships with the senior management of customers who decide whose technologies and solutions to deploy. If we do not successfully operate
and grow our sales and marketing activities, our revenues and operating results could decline and the price of our common stock could continue to decline.

We have identified material weaknesses in our disclosure controls and procedures and our internal control over financial reporting, which, if not remedied effectively, could have an adverse effect on the trading price of our common
stock and otherwise seriously harm our business.

Management through, in part, the documentation, testing and assessment of our internal control
over financial reporting has concluded in the past that our disclosure controls and procedures and our internal control over financial reporting had material weaknesses as of December 31, 2004. Management has not performed similar
documentation, testing and assessments of our internal control over financial reporting as of December 31, 2005, because we are no longer currently required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. However, we take
disclosure controls and procedures seriously and have taken certain actions to begin to address those material weaknesses which were identified in connection with the assessment of our internal controls undertaken as of December 31, 2004. Our
inability to remedy our material weaknesses promptly and effectively could have a material adverse effect on our business, results of operations and financial condition, as well as impair our ability to meet our quarterly and annual reporting
requirements in a timely manner. These effects could in turn adversely affect the trading price of our common stock. Prior to the remediation of these material weaknesses, there remains risk that the transitional controls on which we currently rely
will fail to be sufficiently effective, which could result in a material misstatement of our financial position or results of operations and require a restatement. In addition, even if we are successful in strengthening our controls and procedures,
such controls and procedures may not be adequate to prevent or identify irregularities or facilitate the fair presentation of our financial statements or SEC reporting.

Failure or circumvention of our controls and procedures could seriously harm our business.

We are making
significant changes in our internal control over financial reporting and our disclosure controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, and
not absolute, assurances that the objectives of the system are met. In addition, the effectiveness of our remediation efforts and of our internal controls is subject to limitations, including the assumptions used in identifying the likelihood of
future events and the inability to eliminate misconduct completely. As a result, our remediation efforts to improve our internal control over financial reporting may not prevent all improper acts or ensure that all material information will be made
known to management in a timely fashion. In addition, because substantial additional costs may be necessary to implement these remedial measures, our limited resources may cause a further delay in the remediation of all of our material weaknesses.
The failure or circumvention of our controls, policies and procedures or of our remediation efforts could have a material adverse effect on our business, results of operations and financial condition.



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Due to our evolving business strategy and the nature of the markets in which we compete, our future revenues are
difficult to predict and our quarterly operating results may fluctuate.

We cannot accurately forecast our revenues as a result of our evolving
business strategy and the emerging nature of the messaging and directory infrastructure market. Forecasting is further complicated by recent strategic and operational restructurings, such as the sale of assets relating to our hosted messaging
services, and may continue to be complicated by future restructurings. In addition, our reliance on large dollar value transactions, as well as market fluctuations, can complicate our ability to forecast accurately. Our revenues in some past
quarters fell and could continue to fall short of expectations if we experience delays or cancellations of even a small number of orders. We often offer volume-based pricing, which may affect our operating margins. A number of factors are likely to
cause fluctuations in operating results, including, but not limited to:



| |  |  | the demand for licensed solutions for messaging and identity management products;
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| |  |  | our ability to attract and retain qualified personnel with industry expertise, particularly sales personnel;
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| |  |  | our ability to attract and retain customers and maintain customer satisfaction;
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| |  |  | the ability to upgrade, develop and maintain our systems and infrastructure and to effectively respond to the rapid technology change of the messaging and identity management
infrastructure market;
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| |  |  | the budgeting and payment cycles of our customers and potential customers;
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| |  |  | the amount and timing of operating costs and capital expenditures relating to expansion of business and infrastructure;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to quickly handle and alleviate technical difficulties or system outages;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | the announcement or introduction of new or enhanced services by competitors;
| | - |  | ----------------------------------------------------------------------------



| |  |  | general economic and market conditions and their effect on our operations and the operations of our customers; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of war, terrorism and any related conflicts or similar events worldwide.
| | - |  | -----------------------------------------------------------------------------------

In addition to the factors set forth above, our GAAP financial results have been and will continue to be impacted by the extent to which we incur non-cash charges associated with stock-based arrangements with
employees and non-employees. In particular, during the nine months ended September 30, 2006, we incurred stock-based compensation expense of approximately $0.6 million primarily relating to the issuance of common stock and the grant of options
and warrants to employees and non-employees. Grants of options and warrants also may be dilutive to existing shareholders.

Our revenues and operating
results have declined and could continue to decline as a result of the elimination of product or service offerings through termination, sale or other disposition. Future decisions to eliminate, revise or limit any other offerings of a product or
service would involve other factors that could cause our revenues to decline and our expenses to increase, including the expenditure of capital, the realization of losses, further reductions in our workforce, facility consolidation or the
elimination of revenues along with the associated costs.

As a result of the foregoing, we do not believe that period-to-period comparisons of operating
results are a good indication of future performance. It is likely that operating results in some quarters will be below market expectations. In this event, the price of our common stock is likely to prove volatile or subject to further declines.

We have in the past evaluated, and will continue to evaluate in the future, the performance of our business operations and, where appropriate,
invest further in certain business operations, and reduce investment in or divest other business operations.

In the past, due to the
underperformance of some of our business operations, we have elected to divest or discontinue certain of these business operations through termination, sale or other disposition. For example, in January 2006, we sold substantially all of the assets
relating to our hosted messaging business which contributed to a decline in our revenues for the three month period ending March 31, 2006 as compared to the previous three month period ending December 31, 2005. Furthermore, we may choose
to divest certain business operations based on our managements perception of their future growth, even if such operations have been profitable historically. Decisions to eliminate or limit certain business operations have involved in the past,
and could in the future involve, the expenditure of capital, consumption of management resources, realization of losses, transition and wind-up expenses, further reduction in workforce, facility consolidation and the elimination of revenues along
with associated costs, any of which could cause our operating results to decline and may fail to yield the expected benefits.



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A limited number of customers and markets account for a high and increasing percentage of our revenues and if we
lose a major customer, are unable to attract new customers, or the markets which we serve suffer financial difficulties, our revenues could decline.

We expect that sales of our products and services to a limited number of customers will continue to account for a high percentage of our revenue for the foreseeable future. For example, for the nine months ended September 30, 2006, our
top ten customers accounted for approximately 40% of our total revenues and for the years ended December 31, 2003, 2004 and 2005, our top 10 customers accounted for approximately 27%, 34% and 35%, respectively, of our total revenues. During the
three months ended September 30, 2006, we did not have any customers which accounted for 10% of our total revenue. Our future success depends on our ability to retain our current customers, and to attract new customers, in our target markets.
The loss of one or several major customers, whether through termination of agreements, acquisitions or bankruptcy, could significantly reduce our revenues. Our agreements with our customers typically have terms of one to three years often with
automatic one-year renewals and can be terminated without cause upon certain notice periods that vary among our agreements and range from a period of 30 to 120 days notice.

The telecommunications industry during the nine months ended September 30, 2006, accounted for approximately 84% of the revenues from our top ten customers whereas for the fiscal years ended December 31,
2003, 2004 and 2005 it accounted for approximately 52%, 57% and 32%, respectively, of the revenues from our top ten customers. If the relative financial performance of our customers deteriorates, it will impact our sales cycles and our ability to
attract new business. If our customers terminate their agreements for any reason before the end of the contract term, the loss of the customer would reduce our current and future revenues. Also, if we are unable to enter into agreements with new
customers and develop business with our existing customers, our business will not grow and we will not generate additional revenues.

Our sales cycle
is lengthy, and any delays or cancellations in orders in a particular quarter could cause our operating results to be below expectations, which may cause our stock price to decline.

Because we sell complex and sophisticated technology, our sales cycle, in particular with respect to our software solutions, can be long and unpredictable, often taking
between four to 18 months. Because of the nature of our product and service offerings it can take many months of customer education and product evaluation before a purchase decision is made. Further, and particularly with regard to newer
subscription based offerings, the deployment process following customer trials can add several months prior to the generation of revenue. In addition, many factors can influence the decision to purchase our product and service offerings including
budgetary constraints and decreases in capital expenditures, quarterly fluctuations in operating results of customers and potential customers, the emerging and evolving nature of the internet-based services and wireless services markets.
Furthermore, general global economic conditions, and weakness in global securities markets, continuing recessionary spending levels, and a protracted slowdown in technology spending in particular, have further lengthened and affected our sales
cycle. Such factors have led to and could continue to lead to delays and postponements in purchasing decisions and in many cases cancellations of anticipated orders. Any delay or cancellation in sales of our products or services could cause our
operating results to be lower than those projected and cause our stock price to decline.

If we are unable to successfully compete in our product
market, our ability to retain our customers and attract new customers could decline as would our revenues.

Competition for the products we provide
and services we offer is intense. The primary competitors of our messaging solutions include OpenWave Systems Inc., Sun Microsystems Sun ONE software division (formerly iPlanet), Microsoft Corporation, Comverse, Inc., Mirapoint Inc., Symantec,
Inc. and IronPort Systems, Inc., as well as a variety of smaller product suppliers. In the market for mobile email services, we are competing in an emerging market and face new competitors as the market develops. We frequently compete with small,
local technology providers and in some markets, Seven Networks, Inc., Visto, Inc., O3sis IT AG and Oz Communications, Inc. In the identity management market, we compete primarily with Sun Microsystems Sun ONE software division (formerly
iPlanet), IBM Corporation, Microsoft Corporation, Novell Corporation, Siemens Corporation and Computer Associates, as well as various small identity management application vendors. If our existing customers and other consumers prefer the products
and services offered by our competitors over ours, our revenues will decline.

While these competitors and others exist in each of our individual lines of
business, we believe our overall solution of products and services serves as a competitive advantage. Our products and services are designed to help customers easily integrate our broad range of products into their infrastructure, selecting multiple
products and services from us as their requirements demand.



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We believe that competitive factors affecting the market for our communications solutions include:



| |  |  | total cost of ownership and operation;
| | - |  | --------------------------------------



| |  |  | solution orientation of messaging of offerings that allow deployment with limited customization;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | breadth of platform features and functionality;
| | - |  | -----------------------------------------------



| |  |  | ease of integration and deployment into customers existing applications and systems;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | scalability, reliability, performance and ease of expansion and upgrade;
| | - |  | ------------------------------------------------------------------------



| |  |  | ability to extensively customize, personalize and tailor solutions to different classes of users across multiple markets;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | a full range of support services that includes market research, marking planning and technology planning; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | the perceived long-term stability of the vendor.
| | - |  | ------------------------------------------------

The relative importance
of each of these factors depends upon the specific customer environment. Although we believe that our products and services currently compete favorably with respect to such factors, we may not be able to maintain our competitive position against
current and potential competitors.

We believe competition will increase as current competitors increase the sophistication of their offerings, as new
participants enter the market and as the market continues to grow, becoming increasingly attractive. Many current and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater
financial, marketing and other resources than we do and may enter into strategic or commercial relationships with larger, more established and better-financed companies. Any delay in the development or introduction of products or services or
updates, would also allow additional time for our competitors to improve their service or product offerings, and for new competitors to develop messaging and identity management products and services for our target markets. Increased competition
could result in pricing pressures, reduced operating margins and loss of market share, any of which could cause our business to suffer.

We depend on
strategic relationships with our customers and others and the loss of such relationships could cause our revenues to decline.

We depend on
strategic relationships with our customers and others to expand distribution channels and opportunities and to undertake joint marketing efforts. Our ability to increase revenues depends upon aggressively marketing our services through new and
existing strategic relationships. We also depend on the ability of our customers to aggressively sell and market our services to their end-users. If we lose any strategic relationships, fail to fully exploit our relationships, or fail to develop new
strategic relationships, we could encounter increased difficulty in selling our products and services.

We may not be able to respond to the rapid
technological change of the messaging industry.

The messaging industry is characterized by rapid technological change, changes in user and customer
requirements and preferences, and the emergence of new industry standards and practices that could render our existing services, proprietary technology and systems obsolete. We must continually develop or introduce and improve the performance,
features and reliability of our services, particularly in response to competitive offerings. Our success depends, in part, on our ability to develop new functionality, technology and services that address the increasingly sophisticated and varied
needs of prospective customers. We believe that revenue from our Memova applications, for example the Memova Mobile application that we launched in the first quarter of 2005, is an important source of future revenues and we have made significant
investments in their development. However, so far this year revenues from some of our Memova applications have been negligible. If we do not properly identify the feature preferences of prospective customers, or if we fail to deliver email features
that meet the standards of these customers, our ability to market our service successfully and to increase revenues could be impaired. The development of proprietary technology and necessary service enhancements entails significant technical and
business risks and requires substantial expenditures and lead-time. We may not be able to keep pace with the latest technological developments. We may also be unable to use new technologies effectively or adapt services to customer requirements or
emerging industry standards.

We have experienced significant turnover of senior management and our current management team has been together for a
limited time, which could slow the growth of our business and cause our operating results to decline.

Throughout 2004 and 2005 we announced a
series of changes in our management that included the departure of senior executives, and there have also been changes in our board of directors. Two of our directors joined us in 2005 and many of the members of our current board of directors and
senior executives joined us in 2004. Further, we may continue to make additional changes to our senior management team. If our new management team is unable to accomplish our business



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objectives, our ability to grow our business and successfully meet operational challenges could be severely impaired. It
is possible that this high turnover at our senior management levels may also continue for a variety of reasons. The loss of the services of one or more of our key senior executive officers could also affect our ability to successfully implement our
business objectives, which could slow the growth of our business and cause our operating results to decline. For these reasons, our shareholders may lose confidence in our management team and decide to dispose of our common stock, which could cause
the price of our common stock to decline.

We may experience difficulty in attracting and retaining key personnel, which may negatively affect our
ability to develop new products or services or retain and attract customers.

The loss of the services of key personnel may create a negative
perception of our business and adversely affect our ability to achieve our business goals. Our success also depends on our ability to recruit, retain and motivate highly skilled sales and marketing, operational, technical and managerial personnel.
Competition for these people is intense and we may not be able to successfully recruit, train or retain qualified personnel. If we fail to do so, we may be unable to develop new products or services or continue to provide a high level of customer
service, which could result in the loss of customers and revenues. In addition, volatility and declines in our stock price may also affect our ability to retain key personnel, all of whom have been granted stock-based incentive compensation. Over
the past year we have reduced our work force and eliminated jobs to balance the size of our employee base with anticipated revenue levels. Reductions in our workforce could make it difficult to motivate and retain remaining employees or attract
needed new employees, and could also affect our ability to deliver products and solutions in a timely fashion and to provide a high level of customer service and support. We do not have long-term employment agreements with any of our key personnel.
In addition, we do not maintain key person life insurance on our employees and have no plans to do so. The loss of the services of one or more of our current key personnel could make it difficult to successfully implement our business objectives.

If we are not successful in implementing strategic plans for our operations, our expenses may not be offset by our corresponding sales and our
financial results could significantly decline.

In 2002, we incurred a number of restructuring charges related to the resizing of our business.
These efforts included additional facilities and equipment lease terminations, continuing expense management and headcount reductions. In 2003, we continued to restructure our operations, including consolidating some office locations and reducing
our global workforce by approximately 175 positions, or approximately 30% of the workforce. In 2004, we expanded our restructuring activities by the restructuring of contracts, consolidation of certain activities to offices in Toronto, Canada and
Dublin, Ireland from higher cost areas such as the San Francisco Bay area and the elimination of approximately 20% of employee positions and reduced use of third party contractors. In 2005, we restructured the lease for, and relocated, our
headquarter facilities, and in June 2006 we terminated the lease and entered into a sublease for 15,000 square feet of the same headquarter facilities. In January 2006, we completed the sale of the assets related to our hosted messaging services. We
expect to continue to make determinations about the strategic future of our business and operations, and our ability to execute on such plans effectively could affect our future operations. A failure to execute successfully on such plans and to plan
appropriately could cause our expenses to continue to outpace our revenues and our financial condition to significantly decline.

We may experience a
decrease in market demand due to concerns of international terrorism, war and social and political instability.

Turmoil and war in the Middle East
have increased the uncertainty in the global economy and may contribute to a decline in the international business environment. A substantial portion of our business is derived from international sales, and a decline in the global economy could have
a more severe impact on our financial results than on the results of some of our competitors. The effects of terrorist attacks, particularly in Europe where we derive a significant portion of our revenue, and other similar events and the war in Iraq
could affect demand for goods and services, including digital communications software and services.

We currently license many third-party
technologies and may need to license further technologies, which could delay and increase the cost of product and service developments.

We intend
to continue to license certain technologies from third parties and incorporate them into our products and services, including web server technology, virus and anti-spam solutions, storage and encryption technology and billing and customer tracking
solutions. The market is evolving and we may need to license additional technologies to remain competitive. We may not be able to license these technologies on commercially reasonable terms or at all. Many of these suppliers are small and may not
have the ability to continue to provide us with necessary technologies. To the extent we cannot license needed technologies or solutions, we may have to devote our resources to the development of such technologies, which could delay and increase the
cost of product and service developments.



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In addition, we may fail to integrate successfully any licensed or hosted technology into our services. These third-party
in-licenses may expose us to increased risks, including risks related to the integration of new technology, potential patent and copyright infringement issues, the diversion of resources from the development of proprietary technology, and an
inability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. In addition, an inability to obtain needed licenses could delay product and service development until equivalent technology can be
identified, licensed and integrated. Any delays in services or integration problems could hinder our ability to retain and attract customers and cause our business and operating results to suffer.

Unplanned system interruptions and capacity constraints could reduce our ability to provide services and could harm our business reputation.

Our customers have, in the past, experienced some interruptions in our hosted services. We believe that these interruptions will continue to occur from time to time. Our
ability to retain existing customers and attract new customers will suffer and our revenues will decline if we experience frequent or long system interruptions that result in the unavailability or reduced performance of systems or networks or reduce
our ability to provide usenet hosting services. We expect to experience occasional temporary capacity constraints due to unanticipated sharply increased traffic, which may cause unanticipated system disruptions, slower response times, impaired
quality and degradation in levels of customer service. If this were to continue to happen, our ability to retain existing customers and attract new customers could suffer dramatically and our revenues would decline.

Changes in the regulatory environment for the operation of our business or those of our customers could pose risks.

Few laws currently apply directly to activity on the Internet and the messaging business; however, new laws are proposed and other laws made applicable to Internet
communications every year. In particular, the operations of our business face risks associated with privacy, confidentiality of user data and communications, consumer protection, taxation, content, copyright, trade secrets, trademarks, antitrust,
defamation and other legal issues. In particular, legal concerns with respect to communication of confidential data have affected our financial services and health care customers due to newly enacted federal legislation. The growth of the industry
and the proliferation of Internet-based messaging devices and services may prompt further legislative attention to our industry and thus invite more regulatory control of our business. The imposition of more stringent protections or new regulations
and application of laws to our business could burden our company and those with which we do business. Any decreased generalized demand for our services or the loss of, or decrease, in business by a key partner due to regulation or the expense of
compliance with any regulation, could either increase the costs associated with our business or affect revenue, either of which could cause our financial condition or operating results to decline. Certain of our service offerings include operations
subject to the Digital Millennium Copyright Act of 1998 and the European Unions recent privacy directives. Our efforts to remain in compliance with DMCA and the EU privacy directives may not be sufficient. New legislation and case law may also
affect our products and services and the manner in which we offer them, which could cause our revenues to decline.

In addition, the applicability of laws
and regulations directly applicable to the businesses of our customers, particularly customers in the fields of banking and health care, will continue to affect us. The security of information about our customers end-users continues to be an
area where a variety of laws and regulations with respect to privacy and confidentiality are enacted. As our customers implement the protections and prohibitions with respect to the transmission of end user data, our customers will look to us to
assist them in remaining in compliance with this evolving area of regulation. In particular the Gramm-Leach-Bliley Act contains restrictions with respect to the use and protection of banking records for end-users whose information may pass through
our system and the Health Insurance Portability and Accountability Act contains provisions that require our customers to ensure the confidentiality of their customers health care information.

Finally, the Sarbanes-Oxley Act of 2002 and new rules subsequently implemented by the Securities and Exchange Commission have required changes in corporate governance
practices of public companies. We are currently reviewing all of our accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including those related to our relationships with our independent
registered public accounting firm, enhanced financial disclosures, internal controls, board and board committee practices, corporate responsibility and loan practices, and intend fully to comply with such laws. We expect these new rules and
regulations to increase our general and administrative expenses and to make it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our various committees
of the Board including, in particular, the audit committee.

We may have liability for Internet content and we may not have adequate liability
insurance.

As a provider of usenet hosting, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and
other claims based on the nature and content of the materials transmitted via our services. We do not screen the content generated by our users or their customers, and we could be exposed to liability with respect to this content.



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Furthermore, some foreign governments, such as Germany, have enforced laws and regulations related to content distributed
over the Internet that are more strict than those currently in place in the United States. In some instances, we may be subject to criminal liability in connection with Internet content transmission.

Our current insurance may not cover claims of these types or may not be adequate to indemnify us for all liability that may be imposed. There is a risk that a single
claim or multiple claims, if successfully asserted against us, could exceed the total of our coverage limits. There also is a risk that a single claim or multiple claims asserted against us may not qualify for coverage under our insurance policies
as a result of coverage exclusions that are contained within these policies. Should either of these risks occur, capital contributed by our shareholders might need to be used to settle claims. Any imposition of liability, particularly liability that
is not covered by insurance or is in excess of insurance coverage could result in substantial out-of-pocket costs to us, or could result in the imposition of criminal penalties.

Unknown software defects could disrupt our services and harm our business and reputation.

Our software
products are inherently complex. Additionally, our product and service offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects or errors in translation, particularly
when first introduced or when new versions are released or localized for international markets. We may not discover software defects in our products or that affect new or current services or enhancements until after they are deployed. Despite
testing, it is possible that defects may occur in the software. These defects could cause service interruptions, which could damage our reputation or increase service costs, cause us to lose revenue, delay market acceptance or divert development
resources.

If our system security is breached, our reputation could suffer and our revenues could decline.

A fundamental requirement for online communications is the secure transmission of confidential information over public networks. Third parties may attempt to breach our
security or that of our customers. If these attempts are successful, customers confidential information, including customers profiles, passwords, financial account information, credit card numbers or other personal information could be
breached. We may be liable to our customers for any breach in security and a breach could harm our reputation. We rely on encryption technology licensed from third parties. Our servers are vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to license encryption technology and additional technologies to protect against
security breaches or to alleviate problems caused by any breach. Failure to prevent security breaches may make it difficult to retain and attract customers and cause us to spend additional resources that could cause our operating results to decline.

We rely on trademark, copyright, trade secret laws, contractual restrictions and patents to protect our proprietary rights, and if these rights are
not sufficiently protected, our ability to compete and generate revenue could be harmed.

We rely on a combination of trademark, copyright and trade
secret laws, contractual restrictions, such as confidentiality agreements and licenses, and patents to establish and protect our proprietary rights, which we view as critical to our success. Our ability to compete and grow our business could suffer
if these rights are not adequately protected. Despite the precautionary measures we take, unauthorized third parties may infringe or copy portions of our services or reverse engineer or obtain and use information that we regard as proprietary, which
could harm our competitive position and market share. In addition, we have several patents pending in the United States and may seek additional patents in the future. However, the status of United States patent protection in the software industry is
not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. We do not know if our patent applications or any of our future patent applications will be issued with the scope of the claims sought, if at all, or
whether any patents we have received or will receive will be challenged or invalidated.

Our proprietary rights may not be adequately protected
because:



| |  |  | laws and contractual restrictions may not prevent misappropriation of our technologies or deter others from developing similar technologies;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | end user license provisions in our contracts that protect us against unauthorized use, copying, transfer and disclosure of the licensed program may be unenforceable.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

In addition, the laws of some foreign countries may not protect proprietary rights to the same extent as do the laws of the United States.
Our means of protecting proprietary rights in the United States or abroad may not be adequate and competitors



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may independently develop similar technology. Additionally, we cannot be certain that our products do not infringe issued
patents that may relate to our products. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products.

If we do not successfully address the risks inherent in the conduct of our international operations, our revenues and financial results could decline.

We derived 76% of our revenues from international sales during the nine months ended September 30, 2006 and 63%, 70% and 74% of our revenues
from international sales in the years ended December 31, 2003, 2004 and 2005, respectively. We intend to continue to operate in international markets and to spend significant financial and managerial resources to do so. If revenues from
international operations do not exceed the expense of establishing and maintaining these operations, our business and our ability to increase revenue and improve our operating results could suffer. We have limited experience in international
operations and may not be able to compete or operate effectively in international markets. We face certain risks inherent in conducting business internationally, including:



| |  |  | difficulties and costs of staffing and managing international operations;
| | - |  | -------------------------------------------------------------------------



| |  |  | fluctuations in currency exchange rates and imposition of currency exchange controls;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | differing technology standards and language and translation issues;
| | - |  | -------------------------------------------------------------------



| |  |  | difficulties in collecting accounts receivable and longer collection periods;
| | - |  | -----------------------------------------------------------------------------



| |  |  | changes in regulatory requirements, including U.S. export restrictions on encryption technologies;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | political and economic instability;
| | - |  | -----------------------------------



| |  |  | potential adverse tax consequences; and
| | - |  | ---------------------------------------



| |  |  | significantly reduced protection for intellectual property rights in some countries.
| | - |  | ------------------------------------------------------------------------------------

Any of these factors could harm our international operations and, consequently, our business and consolidated operating results. Specifically, failure to successfully manage international growth could result in higher
operating costs than anticipated or could delay or preclude altogether our ability to generate revenues in key international markets.

The use of our
net operating losses (NOLs) could be limited if an ownership change occurred during the preceding three-year period.

The use of our net operating
losses could be limited if an ownership change occurred during the preceding three-year period as a result of, for example, the issuance of Series E preferred stock upon conversion of the 10% Notes, the amendment to the terms of the
Series D preferred stock or the exercise of the subscription rights. In general, under applicable federal income tax rules, an ownership change is considered to have occurred if the percentage of the value of our stock owned by our
5% shareholders increased by more than 50 percentage points over the lowest percentage of the value of our stock owned by such shareholders over the preceding three-year period.

Due to the fact that a full valuation allowance has been provided for the net deferred tax asset relating to our net operating losses, we have never analyzed whether
events such as the issuance of Series E preferred stock upon conversion of the 10% notes, the amendment to the terms of the Series D preferred stock and/or the exercise of the subscription rights in the rights offering caused us to undergo
an ownership change for federal income tax purposes.

If such an ownership change were considered to have occurred, our use of our pre-change net operating
losses would generally be limited annually to the product of the long-term tax-exempt rate as of the time the ownership change occurred and the value of our Company immediately before the ownership change. (The current long-term tax-exempt rate is
4.52%.) This could increase our federal income tax liability if we generate taxable income in the future. There can be no assurance that the Internal Revenue Service would not be able to successfully assert that we have undergone one or more
ownership changes in the preceding three-year period.

Changes in accounting rules for employee stock options could significantly impact our
financial results.

Accounting policies affecting many aspects of our business, including rules relating to employee stock option grants, have
recently been revised or are under review. The FASB and other agencies have finalized changes to U.S. generally accepted accounting principles that require us to record a charge to earnings for employee stock option grants and other equity
incentives. We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could significantly harm our net results. In addition, since we historically have used equity-related
compensation as a component of our total employee compensation program, the accounting change could make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain employees.



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Our stock price has demonstrated volatility and overall declines during recent quarters and continued volatility in
the stock market may cause further fluctuations and/or decline in our stock price.

The trading price of our common stock has been and may continue
to experience volatility, wide fluctuations and declines. For example, during the third quarter of 2006, the closing sale prices of our common stock on the OTC Bulletin Board ranged from $0.21 on July 5, 2006 to $0.12 on August 25, 2006.
Our stock price may further decline or fluctuate in response to any number of factors and events, such as a reduction in the liquidity of our common stock as a result of moving from the Nasdaq Global Market to the OTC Bulletin Board, announcements
related to technological innovations, intense regulatory scrutiny and new corporate and securities and other legislation, strategic and sales relationships, new product and service offerings by us or our competitors, litigation outcomes, changes in
senior management, changes in financial estimates and recommendations of securities analysts, the operating and stock price performance of other companies that investors may deem comparable, news reports relating to trends in our markets and the
market for our stock, media interest in accounting scandals and corporate governance questions, overall market conditions and domestic and international economic factors unrelated to our performance. In addition, the stock market in general,
particularly with respect to technology stocks, has experienced extreme volatility and a significant cumulative decline in recent quarters. This volatility and decline has affected many companies, including our company, irrespective of the specific
operating performance of such companies. These broad market influences and fluctuations may adversely affect the price of our stock, regardless of our operating performance or other factors.

A decline in our stock price could result in securities class action litigation against us that could divert managements attention and harm our business.

We have been in the past and may in the future be subject to shareholder lawsuits, including securities class action lawsuits. In the past,
securities class action litigation has often been brought against a company after periods of volatility in the market price of securities. In the future, we may be a target of similar litigation. Securities litigation could result in substantial
costs and divert our managements attention and resources, which in turn could harm our ability to execute our business plan.

Our articles of
incorporation and bylaws contain provisions that could delay or prevent a change in control.

Our articles of incorporation and bylaws contain
provisions that could delay or prevent a change in control of our company. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some of these provisions:



| |  |  | authorize the issuance of preferred stock that can be created and issued by our board of directors without prior shareholder approval, commonly referred to as blank
check preferred stock, with rights senior to those of our common stock;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibit shareholder action by written consent; and
| | - |  | ---------------------------------------------------



| |  |  | establish advance notice requirements for submitting nominations for election to our board of directors and for proposing matters that can be acted upon by shareholders at a
meeting.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In March 2001, we adopted a shareholder rights plan or poison pill. This plan could cause the acquisition of our
company by a party not approved by our board of directors to be prohibitively expensive.

In addition, the General Atlantic Investors and the Cheung Kong
Investors own a sufficient amount of our securities to be able to control the outcome of matters submitted to a vote of our shareholders, which could have the effect of discouraging or impeding an acquisition proposal.

Limitations of our director and officer liability insurance may cause us to use our capital resources, which could cause our financial results to decline or slow
our growth.

Our current director and officer liability insurance may not be adequate for the liabilities and expenses potentially incurred in
connection with future claims. To the extent liabilities, expenses or settlements exceed the limitations or are outside of the scope of coverage, our business and financial condition could materially decline. Under California law, in connection with
our charter documents and indemnification agreements we entered into with our executive officers and directors, we must indemnify our current and former officers and directors to the fullest extent permitted by law. The indemnification covers any
expenses and liabilities reasonably incurred in connection with the investigation, defense, settlement or appeal of legal proceedings.



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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



|(a) | Sales of Unregistered Equity Securities
|--- | ---------------------------------------

None.



|(c) | Issuer Purchases of Equity Securities
|--- | -------------------------------------

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.



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ITEM 6. EXHIBITS



|     |   |  |                                                                                                                                                           
|---- | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |   |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|     |  
|31.2 |   |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|     |  
|32.1 | * |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|     |  
|32.2 | * |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         

---

|* | In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Managements Reports on Internal Control Over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed filed for purpose of Section 18
of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURE

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.



CRITICAL PATH, INC.By:

/s/ James A. ClarkJames A. Clark Executive Vice President
and Chief Financial Officer (Duly Authorized Officer
and Principal Financial and Accounting Officer)


Date: November 14, 2006



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Exhibit Index



|     |   |  |                                                                                                                                                           
|---- | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |   |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|     |  
|31.2 |   |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|     |  
|32.1 | * |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|     |  
|32.2 | * |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         

---

|* | In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Managements Reports on Internal Control Over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed filed for purpose of Section 18
of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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