##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the transition period from  to
 Commission File Number 000-30277
 Knova Software, Inc.
  Delaware
    
    25-1647861(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)10201 Torre Avenue, Suite 350Cupertino, CA
    
    95014(Address of Principal Executive Offices)
    
    (Zip Code)
 (408) 863-5800
  þ o
  o o þ
 o þ




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##### 



Knova Software, Inc.
Form 10-Q
September 30, 2006
INDEX
 Page No.PART I. FINANCIAL INFORMATIONITEM 1. Unaudited Consolidated Financial StatementsConsolidated Balance Sheets as of September 30, 2006 (unaudited) and December 31, 2005
    
    
    3Consolidated Statements of Operations for the three and nine months
ended September 30, 2006 and 2005 (unaudited)
    
    
    4Consolidated Statements of Stockholders Equity for the nine months ended
September 30, 2006 and 2005 (unaudited)
    
    
    5Consolidated Statements of Cash Flows for the nine months ended
September 30, 2006 and 2005 (unaudited)
    
    
    6Notes to Unaudited Consolidated Financial Statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    16ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24ITEM 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONITEM 1 Legal Proceedings
    
    
    25ITEM 1A Risk Factors
    
    
    25ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25ITEM 6. Exhibits
    
    
    25EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Consolidated Financial Statements
 KNOVA Software, Inc.
 
 CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share amounts)
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)AssetsCurrent assetsCash and cash equivalents
    
    $
    9,277
    
    
    $
    6,731Marketable securities
    
    
    1,075
    
    
    
    5,461Accounts receivable, less allowance for doubtful accounts of
$125 at September 30, 2006 and $126 at December 31, 2005
    
    
    6,379
    
    
    
    6,442Prepaid expenses and other current assets
    
    
    460
    
    
    
    781Total current assets
    
    
    17,191
    
    
    
    19,415Non current assetsProperty and equipmentOffice furniture, equipment, and leasehold improvements
    
    
    1,518
    
    
    
    1,518Computer equipment
    
    
    5,924
    
    
    
    5,166Total property and equipment
    
    
    7,442
    
    
    
    6,684Less accumulated depreciation
    
    
    (6,614
    )
    
    
    (6,319
    )Property and equipment, net
    
    
    828
    
    
    
    365Intangible assets, net of amortization of $1,415 at September 30, 2006
and $778 at December 31, 2005
    
    
    4,267
    
    
    
    4,604Goodwill
    
    
    14,814
    
    
    
    14,485Other noncurrent assets
    
    
    61
    
    
    
    123Total noncurrent assets
    
    
    19,970
    
    
    
    19,577Total assets
    
    $
    37,161
    
    
    $
    38,992Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    
    2,433
    
    
    
    1,636Accrued compensation and benefits
    
    
    793
    
    
    
    1,003Deferred revenue  licenses
    
    
    118
    
    
    
    1,571Deferred revenue  services
    
    
    5,521
    
    
    
    5,114Accrued restructuring charges
    
    
    20
    
    
    
    261Line of credit  short term
    
    
    2,175
    
    
    
    3,600Current portion of capital lease obligations
    
    
    21
    
    
    
    40Current portion of equipment loan
    
    
    372
    
    
    
    Other current liabilities
    
    
    969
    
    
    
    795Commitments and Contingencies
    
    
    100
    
    
    
    Total current liabilities
    
    
    12,522
    
    
    
    14,020Noncurrent deferred revenue
    
    
    598
    
    
    
    182Other non-current liabilities
    
    
    63
    
    
    
    89Long term portion of equipment loan
    
    
    431
    
    
    
    Capital lease obligations
    
    
    22
    
    
    
    35Total liabilities
    
    
    13,636
    
    
    
    14,326Commitments and ContingenciesStockholders equityCommon stock, $0.01 par; 50,000 shares authorized, 8,901 and 8,744
shares outstanding at September 30, 2006 and December 31, 2005,
respectively
    
    
    89
    
    
    
    87Additional paid in capital
    
    
    103,387
    
    
    
    101,472Treasury stock, 26 shares at September 30, 2006 and December 31, 2005
    
    
    (151
    )
    
    
    (151
    )Deferred compensation
    
    
    
    
    
    
    (5
    )Warrants
    
    
    6,549
    
    
    
    6,549Accumulated other comprehensive loss
    
    
    
    
    
    
    (12
    )Accumulated deficit
    
    
    (86,349
    )
    
    
    (83,274
    )Total stockholders equity
    
    
    23,525
    
    
    
    24,666Total liabilities and stockholders equity
    
    $
    37,161
    
    
    $
    38,992
 See accompanying condensed notes to unaudited interim consolidated financial statements
 3




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##### Table of Contents



KNOVA Software, Inc.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
(Unaudited)
 Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RevenuesLicenses
    
    $
    2,086
    
    
    $
    2,208
    
    
    $
    8,054
    
    
    $
    6,409Services
    
    
    3,710
    
    
    
    3,511
    
    
    
    12,229
    
    
    
    10,351Total revenues
    
    
    5,796
    
    
    
    5,719
    
    
    
    20,283
    
    
    
    16,760Cost of revenuesCost of licenses
    
    
    225
    
    
    
    227
    
    
    
    639
    
    
    
    647Cost of services
    
    
    2,047
    
    
    
    2,186
    
    
    
    6,778
    
    
    
    6,034Total cost of revenues
    
    
    2,272
    
    
    
    2,413
    
    
    
    7,417
    
    
    
    6,681Gross margin
    
    
    3,524
    
    
    
    3,306
    
    
    
    12,866
    
    
    
    10,079Operating expensesSales and marketing
    
    
    2,837
    
    
    
    2,080
    
    
    
    7,775
    
    
    
    5,784Research and development
    
    
    1,754
    
    
    
    1,364
    
    
    
    5,236
    
    
    
    4,205General and administrative
    
    
    826
    
    
    
    777
    
    
    
    2,566
    
    
    
    3,175Intangible assets amortization
    
    
    70
    
    
    
    70
    
    
    
    210
    
    
    
    187Restructuring charges
    
    
    139
    
    
    
    
    
    
    
    139
    
    
    
    1,355Total operating expenses
    
    
    5,626
    
    
    
    4,291
    
    
    
    15,926
    
    
    
    14,706(Loss) income from operations
    
    
    (2,102
    )
    
    
    (985
    )
    
    
    (3,060
    )
    
    
    (4,627
    )Other income (expense)Interest expense
    
    
    (29
    )
    
    
    (2
    )
    
    
    (66
    )
    
    
    (5
    )Other, net
    
    
    (6
    )
    
    
    45
    
    
    
    51
    
    
    
    247Other income (expense), net
    
    
    (35
    )
    
    
    43
    
    
    
    (15
    )
    
    
    242Net (loss) income
    
    ($
    2,137
    )
    
    ($
    942
    )
    
    ($
    3,075
    )
    
    ($
    4,385
    )Net (loss) income per common share, basic
    
    ($
    0.24
    )
    
    ($
    0.11
    )
    
    ($
    0.35
    )
    
    ($
    0.53
    )Net (loss) income per common share, diluted
    
    ($
    0.24
    )
    
    ($
    0.11
    )
    
    ($
    0.35
    )
    
    ($
    0.53
    )Shares used in computing per share amounts,
basic
    
    
    8,828
    
    
    
    8,725
    
    
    
    8,782
    
    
    
    8,212Shares used in computing per share amounts,
diluted
    
    
    8,831
    
    
    
    8,725
    
    
    
    8,783
    
    
    
    8,212
 See accompanying condensed notes to unaudited interim consolidated financial statements
 4




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KNOVA Software, Inc.
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(Amounts in thousands, except per share amounts)
(Unaudited)
 Accumulatedother
    
    
    
    
    
    TotalCommon stock
    
    Additional
    
    Treasury stock
    
    Deferred
    
    
    
    
    
    comprehensive
    
    Accumulated
    
    StockholdersShares
    
    Amount
    
    paid in capital
    
    Shares
    
    Amount
    
    Compensation
    
    Warrants
    
    (loss) gain
    
    Deficit
    
    EquityBalance at December 31, 2005
    
    
    8,744
    
    
    $
    87
    
    
    $
    101,472
    
    
    
    26
    
    
    $
    (151
    )
    
    $
    (5
    )
    
    $
    6,549
    
    
    $
    (12
    )
    
    $
    (83,274
    )
    
    $
    24,666Exercise of stock options
    
    
    75
    
    
    
    1
    
    
    
    194
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    195Stock based compensation expense
    
    
    
    
    
    
    
    
    
    
    1,418
    
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,423Issuance of common stock for company
purchase
    
    
    82
    
    
    
    1
    
    
    
    303
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    304Comprehensive loss:Unrealized gain on short term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (24
    )
    
    
    
    
    
    
    (24
    )Reclassification adjustment for net
losses realized in net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    
    
    
    
    36Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,075
    )
    
    
    (3,075
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (3,063
    )Balance at September 30, 2006
    
    
    8,901
    
    
    $
    89
    
    
    $
    103,387
    
    
    
    26
    
    
    $
    (151
    )
    
    $
    
    
    
    $
    6,549
    
    
    $
    
    
    
    $
    (86,349
    )
    
    $
    23,525
 See accompanying condensed notes to unaudited interim consolidated financial statements
 5




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KNOVA Software, Inc.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, except per share amounts)
(Unaudited)
 Nine months ended September 30,2006
    
    
    2005Cash flows from operating activities
    
    
    ($3,075
    )
    
    
    ($4,385
    )Net lossAdjustments to reconcile net loss to net cash used in operations:Non cash items:Depreciation
    
    
    299
    
    
    
    330Amortization of intangible assets
    
    
    637
    
    
    
    566Stock based compensation
    
    
    1,423
    
    
    
    505Non-cash charge for shares of common stock
    
    
    304
    
    
    
    Forfeiture of restricted stock
    
    
    
    
    
    
    (75
    )Acquired in-process research and development
    
    
    
    
    
    
    421Loss on disposal of equipment
    
    
    
    
    
    
    4Net loss (gain) on sale of investments
    
    
    33
    
    
    
    (282
    )Changes in operating assets and liabilities, net of assets and liabilities acquired:Decrease in accounts receivable
    
    
    64
    
    
    
    255Decrease (increase) in other assets
    
    
    382
    
    
    
    (41
    )(Decrease) increase in accounts payable
    
    
    798
    
    
    
    (1,180
    )(Decrease) increase in accrued compensation
    
    
    (210
    )
    
    
    (182
    )(Decrease) increase in accrued restructuring charges
    
    
    (241
    )
    
    
    330Decrease in deferred revenue
    
    
    (629
    )
    
    
    (258
    )(Decrease) increase in other liabilities
    
    
    247
    
    
    
    (425
    )Net cash
provided by (used in) operating activities
    
    
    32
    
    
    
    (4,417
    )Cash flows from investing activitiesPurchases of marketable securities
    
    
    
    
    
    
    (5,698
    )Proceeds from sale of marketable securities
    
    
    4,365
    
    
    
    9,319Proceeds from sale of assets
    
    
    
    
    
    
    1Proceeds from acquisition of Active Decisions
    
    
    75Acquisition costs for business combination
    
    
    (704
    )
    
    
    Acquisition costs for Kanisa merger
    
    
    
    
    
    
    (561
    )Cash acquired from Kanisa merger
    
    
    
    
    
    
    3,779Property and equipment acquisitions
    
    
    (762
    )
    
    
    (127
    )Net cash provided by investing activities
    
    
    2,974
    
    
    
    6,713Cash flows from financing activitiesRepayments of principal of capital lease obligations
    
    
    (32
    )
    
    
    (32
    )Repayments of revolving line of credit, net
    
    
    (1,425
    )
    
    
    Proceeds from borrowings
    
    
    803
    
    
    
    Proceeds from stock option exercises
    
    
    194
    
    
    
    14Net cash used in financing activities
    
    
    (460
    )
    
    
    (18
    )Increase in cash and cash equivalents
    
    
    2,546
    
    
    
    2,278Cash and cash equivalents at beginning of period
    
    
    6,731
    
    
    
    1,672Cash and cash equivalents at end of period
    
    $
    9,277
    
    
    $
    3,950Supplemental disclosures of cash flow information:Cash paid for interest
    
    $
    60
    
    
    $
    5Supplemental disclosures of non-cash investing and financing activities:Issuance of
common stock for company purchase
    
    $
    304
    
    
    
    
 See accompanying condensed notes to unaudited interim consolidated financial statements
 6




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##### Table of Contents



KNOVA Software, Inc.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
 Note 1. Organization of the Company
    Note 2. Unaudited Interim Financial Information
   Note 3. Significant Accounting Policies
 Principles of Consolidation
  Revenue Recognition
   7




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##### Table of Contents



Marketable Securities
   Stock Based Compensation
     For the three months
    
    
    For the nine monthsended
    
    
    endedSeptember 30, 2005
    
    
    September 30, 2005(in thousands, except per share amounts)Net income (loss) as reported
    
    $
    (942
    )
    
    $
    (4,385
    )Add: Stock based compensation expense included in reported net loss
    
    $
    5
    
    
    $
    398Less: Total stock based compensation expense under SFAS No. 123
    
    $
    (341
    )
    
    $
    (2,226
    )Pro forma net loss
    
    $
    (1,278
    )
    
    $
    (6,213
    )Weighted average shares used to calculate basic and diluted loss per
share
    
    
    8,725
    
    
    
    8,212Earnings per
share as originally reported
    
    $
    (0.11
    )
    
    $
    (0.53
    )Pro forma net loss per share, basic and diluted
    
    $
    (0.15
    )
    
    $
    (0.76
    )
 8




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##### Table of Contents



2006
    
    2005Risk-free interest rate
    
    
    4.71
    %
    
    
    4.02
    %Expected Dividend Yield
    
    
    0.00
    %
    
    
    0.00
    %Expected lives in years
    
    
    5.99
    %
    
    
    5.68Expected
volatility
    
    
    100.50
    %
    
    
    118.75
    %
 Impact of Recently Issued Accounting Standards
   .
       9




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##### Table of Contents



Accounting Changes and Error Corrections a b
     10




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##### Table of Contents



Reclassification
  Note 4. Debt
 Credit Facilities
   Note 5. Net Loss Per Share
  For the three months ended
    
    For the nine months endedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005(in thousands, except per
    
    (in thousands, except pershare amounts)
    
    share amounts)Numerator:Net (loss) income
    
    ($
    2,137
    )
    
    ($
    942
    )
    
    ($
    3,075
    )
    
    ($
    4,385
    )Denominator:Denominator
for basic and diluted earnings per share -
weighted average shares
    
    
    8,828
    
    
    
    8,725
    
    
    
    8,782
    
    
    
    8,212Net (loss) income per share, basic and diluted
    
    ($
    0.24
    )
    
    ($
    0.11
    )
    
    ($
    0.35
    )
    
    ($
    0.53
    )
 11




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##### Table of Contents



Note 6. Segment Information
  For the three months
    
    
    For the nine monthsended September 30,
    
    
    ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands, except per share
    
    
    (in thousands, except per shareamounts)
    
    
    amounts)Revenues (a)United States
    
    $
    5,439
    
    
    $
    5,540
    
    
    $
    19,048
    
    
    $
    16,060International
    
    
    357
    
    
    
    179
    
    
    
    1,235
    
    
    
    700Total
    
    $
    5,796
    
    
    $
    5,719
    
    
    $
    20,283
    
    
    $
    16,760
 
  Note 7. Capital Stock
   Note 8. Stock Option Plan
  12




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##### Table of Contents



Options
    
    Option Price
    Weighted AverageOutstanding
    
    Range per Share
    Exercise PriceOptions outstanding December 31, 2005
    
    
    2,090,514
    
    
    $
    2.50-$70.00
    
    
    $
    4.37Options granted
    
    
    642,250
    
    
    $
    2.43-$  3.95
    
    
    $
    3.19Options exercised
    
    
    (75,374
    )
    
    $
    2.50-$  3.20
    
    
    $
    2.58Options forfeited
    
    
    (112,263
    )
    
    $
    2.60-$70.00
    
    
    $
    4.06Options outstanding September 30, 2006
    
    
    2,545,127
    
    
    $
    2.43-$70.00
    
    
    $
    4.14Options exercisable September 30, 2006
    
    
    1,248,004
    
    
    $
    2.43-$36.00
    
    
    $
    4.75
 Options
    
    Option Price
    Weighted AverageOutstanding
    
    Range per Share
    Exercise PriceOptions outstanding December 31, 2004
    
    
    867,049
    
    
    $
    2.50-$70.00
    
    
    $
    5.10Options granted
    
    
    1,374,940
    
    
    $
    3.70-$  4.60
    
    
    $
    4.17Options exercised
    
    
    (2,140
    )
    
    $
    2.60-$  3.80
    
    
    $
    3.72Options forfeited
    
    
    (307,418
    )
    
    $
    2.60-$25.00
    
    
    $
    4.88Options outstanding September 30, 2005
    
    
    1,932,431
    
    
    $
    2.50-$70.00
    
    
    $
    4.48Options exercisable September 30, 2005
    
    
    812,841
    
    
    $
    2.50-$70.00
    
    
    $
    4.85
  Note 9. Acquisitions
    Volatility
    
    142.67%Risk-free interest rate
    
    3.4%Dividend yield
    
    Expected life
    
    4 years
 13




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##### Table of Contents



Cash and cash equivalents
    
    $
    3,779Accounts receivable
    
    
    2,032Prepaid expenses and other current assets
    
    
    364Equipment
    
    
    87Intangible assets:Core and developed technologies
    
    
    3,981Acquired in-process research and development
    
    
    421Customer contracts/customer relations
    
    
    1,401Goodwill
    
    
    12,161Accounts payable
    
    
    (1,144
    )Accrued compensation and benefits
    
    
    (614
    )Other current liabilities
    
    
    (913
    )Deferred revenues
    
    
    (1,876
    )Capital lease obligations and other long term liabilities
    
    
    (62
    )Net assets acquired
    
    $
    19,617
        Cash and cash equivalents
    
    $
    75Intangible assets:Core and developed technologies
    
    
    113Customer contracts/customer relations
    
    
    188Goodwill
    
    
    246Deferred revenue
    
    
    (317
    )Net assets acquired
    
    $
    305
   Pro forma results of Active Decisions Acquisition
  For the three
    
    For the ninemonths ended
    
    months endedSeptember 30,
    
    September 30,2006
    
    2006Revenues
    
    $
    6,097
    
    
    $
    21,364Net loss
    
    
    ($1,976
    )
    
    
    ($2,619
    )Net loss per share
    
    
    ($0.22
    )
    
    
    ($0.30
    )Shares used in per share calculation
    
    
    8,828
    
    
    
    8,782
 14




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##### Table of Contents



Pro forma results of Kanisa Merger
  For the three months ended September 30,
    
    For the nine months ended September 30,2005
    
    2005Revenues
    
    $
    5,719
    
    
    $
    17,166Net loss
    
    ($
    1,363
    )
    
    ($
    4,806
    )Net loss per share
    
    ($
    0.16
    )
    
    ($
    0.59
    )Shares used in per share calculation
    
    
    8,725
    
    
    
    8,212
  Note 10. Restructuring Charges
   Note 11. Commitments and Contingencies
   Total
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter(in thousands)Amortization, core technologies  Kanisa
    
    $
    3,033
    
    
    $
    569
    
    
    $
    569
    
    
    $
    569
    
    
    $
    569
    
    
    $
    569
    
    
    $
    188Amortization, customer relations  Kanisa
    
    
    933
    
    
    
    280
    
    
    
    280
    
    
    
    280
    
    
    
    93
    
    
    
    
    
    
    
    Amortization, core technologies  Active
Decisions
    
    
    113
    
    
    
    16
    
    
    
    16
    
    
    
    16
    
    
    
    16
    
    
    
    16
    
    
    
    33Amortization, customer relations 
Active Decisions
    
    
    188
    
    
    
    37
    
    
    
    37
    
    
    
    37
    
    
    
    37
    
    
    
    37
    
    
    
    3Total
    
    $
    4,267
    
    
    $
    902
    
    
    $
    902
    
    
    $
    902
    
    
    $
    715
    
    
    $
    622
    
    
    $
    224
 Note 12. Subsequent Events
   15




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
   Overview
     
    
    KNOVA Contact Centeris an assisted-service application for customer service and
help desk agents that enables them to resolve customer issues and questions more
effectively. KNOVA Contact Center integrates a sophisticated knowledge management
system with additional features such as search, collaboration, interview scripting,
email response, and knowledge authoring. KNOVA Contact Center features business
process support integrated with customer relationship management systems that can
tailor the resolution experience based on the customers or employees issue or
question.
    
    KNOVA Self-Serviceis a self-service application that enables customers and
employees to resolve their own issues and questions on an enterprise website. KNOVA
Self-Service features business process support that can provide a personalized and
guided resolution experience based on the issue or question the customer or employee
has.
    
    KNOVA Forumsis an application for online customer and
employee communities and forums that
enables users to discuss and collaborate on topics of interest, including an
enterprises products and services. KNOVA Forums enables customers and employees to
assist each other, reducing service delivery costs and providing valuable insight to
the enterprise.
    
    KNOVA Guided Selling
 is a product comparison and recommendation application that enables customers via self-service, or employees assisting customers in person or via the contact
center, to make informed decisions regarding which products or services best meet
their needs.  Based on the Active Advisor product, one of
the assets purchased from Active Decisions Inc, KNOVA Guided Selling identifies each customers underlying needs, and
dynamically generates relevant and balanced suggestions, as well as potential cross-sell and up-sell options.
    
    KNOVA Field Serviceis a mobile support application that enables field technicians
and service professionals to search the knowledge base and resolve problems at the
customer site. KNOVA Field Service runs on a
disconnected laptop computer and synchronizes via a network connection with the Field
Service application server to update the knowledge base content.
 16




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##### Table of Contents




    
    KNOVA Knowledge Deskis a packaged knowledge management solution for service and
help desks to resolve questions, author knowledge, and manage repositories of
intellectual capital. KNOVA Knowledge Desk is integrated with traditional service and
help desk applications from companies such as Remedy and Hewlett Packard (HP). It
is based on a patented self-learning search technology that is designed to improve
with usage. KNOVA Knowledge Desk features application modules for different user
types and functions.
  Factors Affecting Future Operations
  Critical Accounting Policies and Estimates
  Description of Statement of Operations
 Revenues
  Cost of Revenues
  Operating Costs
  17




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Results of Operations
   Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RevenuesLicenses
    
    
    36.0
    %
    
    
    38.6
    %
    
    
    39.7
    %
    
    
    38.2
    %Services
    
    
    64.0
    %
    
    
    61.4
    %
    
    
    60.3
    %
    
    
    61.8
    %Total revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of
revenuesCost of licenses
    
    
    3.9
    %
    
    
    4.0
    %
    
    
    3.2
    %
    
    
    3.9
    %Cost of services
    
    
    35.3
    %
    
    
    38.2
    %
    
    
    33.4
    %
    
    
    36.0
    %Total cost of revenues
    
    
    39.2
    %
    
    
    42.2
    %
    
    
    36.6
    %
    
    
    39.9
    %Gross margin
    
    
    60.8
    %
    
    
    57.8
    %
    
    
    63.4
    %
    
    
    60.1
    %Operating expenses
Sales and marketing
    
    
    48.9
    %
    
    
    36.4
    %
    
    
    38.3
    %
    
    
    34.5
    %Research and development
    
    
    30.3
    %
    
    
    23.9
    %
    
    
    25.8
    %
    
    
    25.1
    %General and administrative
    
    
    14.3
    %
    
    
    13.6
    %
    
    
    12.7
    %
    
    
    18.9
    %Intangible assets amortization
    
    
    1.2
    %
    
    
    1.2
    %
    
    
    1.0
    %
    
    
    1.1
    %Restructuring charges
    
    
    2.4
    %
    
    
    0.0
    %
    
    
    0.7
    %
    
    
    8.1
    %Total operating expenses
    
    
    97.1
    %
    
    
    75.0
    %
    
    
    78.5
    %
    
    
    87.7
    %Loss from operations
    
    
    (36.30
    )%
    
    
    (17.2
    )%
    
    
    (15.1
    )%
    
    
    (27.6
    )%Other income (expense), net
    
    
    (0.6
    )%
    
    
    0.8
    %
    
    
    (0.1
    )%
    
    
    1.4
    %Net loss
    
    
    (36.9
    )%
    
    
    (16.5
    )%
    
    
    (15.2
    )%
    
    
    (26.2
    )%
 Three Months Ended September 30, 2006 and 2005
 Revenues
   Cost of Revenues
    18




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Operating Expenses
 Sales and Marketing
 Research and Development
 General and Administrative
 Intangible Assets Amortization
 Restructuring Charges.
 Other income (expense), net
  Nine Months Ended September 30, 2006 and 2005
  Revenues
   Cost of Revenues
  19




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Operating Expenses
 Sales and Marketing
 Research and Development
 General and Administrative
 Intangible Assets Amortization
 Restructuring
 20




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Other income (expense), net
  Liquidity and Capital Resources
         Contractual Obligations
  Payments due by period (in thousands)Total
    
    Less than 1 year
    
    1-3 years
    
    4-5 yearsRevolving credit line
    
    $
    2,175
    
    
    $
    2,175
    
    
    $
    
    
    
    $
    Equipment line
    
    
    803
    
    
    
    372
    
    
    
    431
    
    
    
    Capital lease obligations
    
    
    43
    
    
    
    21
    
    
    
    22
    
    
    
    Operating lease obligations
    
    
    804
    
    
    
    400
    
    
    
    404
    
    
    
    Total contractual obligations
    
    $
    3,825
    
    
    $
    2,968
    
    
    $
    857
    
    
    $
    
 21




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Related Party Transactions
  Recent Accounting Pronouncements
   .
         22




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Accounting Changes and Error Corrections a b
      23




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures.
 Changes in internal controls .
 24




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 6. Exhibits
 3.1
    
    Third Amended and Restated Certificate of Incorporation (1)3.2
    
    Amended and Restated Bylaws of the Company(2)3.3
    
    Certificate of Amendment of Third Amended and Restated Certificate of Incorporation (reverse
split) (3)3.4
    
    Certificate of Amendment of Third Amended and Restated Certificate of Incorporation (name
change) (4)10.1
    
    Board compensation arrangement adopted on September 1, 2006.10.2
    
    Active Decisions Asset Purchase Agreement31.1
    
    Rule 13a  14(a) / 15d  14(a) Certification of Principal Executive Officer31.2
    
    Rule 13a  14(a) / 15d  14(a) Certification of Principal Financial Officer32
    
    Section 1350 Certifications
 
 (1)
    
    Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31,
2005.(2)
    
    Incorporated by reference to our Current Report on Form 8-K dated February 8, 2005.(3)
    
    Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31,
2004.(4)
    
    Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30,
2005. 25




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SIGNATURES
  KNOVA SOFTWARE, INC.Date: November 14, 2006
    By:
    /s/     THOMAS MUISEThomas MuisePrincipal Financial Officer 26




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Exhibit Index
 3.1
    
    Third Amended and Restated Certificate of Incorporation (1)3.2
    
    Amended and Restated Bylaws of the Company(2)3.3
    
    Certificate of Amendment of Third Amended and Restated Certificate of Incorporation (reverse
split) (3)3.4
    
    Certificate of Amendment of Third Amended and Restated Certificate of Incorporation (name
change) (4)10.1
    
    Board compensation arrangement adopted on September 1, 2006.10.2
    
    Active Decisions Asset Purchase Agreement31.1
    
    Rule 13a  14(a) / 15d  14(a) Certification of Principal Executive Officer31.2
    
    Rule 13a  14(a) / 15d  14(a) Certification of Principal Financial Officer32
    
    Section 1350 Certifications
 
 (1)
    
    Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31,
2005.(2)
    
    Incorporated by reference to our Current Report on Form 8-K dated February 8, 2005.(3)
    
    Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31,
2004.(4)
    
    Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30,
2005.