##### 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, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the transition period fromto
 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 350
 Cupertino, CA
    
    95014(Address of Principal Executive Offices)
    
    (Zip Code)
 (408) 863-5800
 
 þ o
 o þ
 o þ




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Knova Software, Inc.
Form 10-Q
September 30, 2005
INDEX
 Page No.PART I. FINANCIAL INFORMATIONITEM 1. Unaudited Consolidated Financial StatementsConsolidated Balance Sheets as of September 30, 2005 (unaudited) and December 31,
2004
    
    
    3Consolidated Statements of Operations for the three and nine months
ended September 30, 2005 and 2004 (unaudited)
    
    
    4Consolidated Statements of Stockholders Equity for the nine months ended
September 30, 2005 and 2004 (unaudited)
    
    
    5Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004 (unaudited)
    
    
    6Notes to Unaudited Consolidated Financial Statements
    
    
    7ITEM 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    14ITEM 3. Quantitative and Qualitative Disclosures About Market
Risk
    
    
    27ITEM 4. Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONITEM 6. Exhibits
    
    
    28Exhibit 31.1Exhibit 31.2Exhibit 32
  
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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 31,2005
    
    
    2004(Unaudited)AssetsCurrent assetsCash and cash equivalents
    
    $
    3,950
    
    
    $
    1,672Marketable securities
    
    
    5,399
    
    
    
    9,266Accounts receivable, less allowance for doubtful accounts of $120 as
of September 30, 2005 and $95 as of December 31, 2004
    
    
    4,306
    
    
    
    2,529Prepaid expenses and other current assets
    
    
    960
    
    
    
    513Total current assets
    
    
    14,615
    
    
    
    13,980Non current assetsProperty and equipmentOffice furniture, equipment, and leasehold improvements
    
    
    1,516
    
    
    
    1,511Computer equipment
    
    
    4,983
    
    
    
    4,830Total property and equipment
    
    
    6,499
    
    
    
    6,341Less accumulated depreciation
    
    
    (6,169
    )
    
    
    (5,890
    )Property and equipment, net
    
    
    330
    
    
    
    451Intangible assets, net of amortization of $987 as of September 30, 2005
    
    
    4,816
    
    
    
    Goodwill
    
    
    14,485
    
    
    
    2,324Other non current assets
    
    
    156
    
    
    
    198Total non current assets
    
    
    19,787
    
    
    
    2,973Total assets
    
    $
    34,402
    
    
    $
    16,953Liabilities and Stockholders EquityCurrent liabilitiesAccounts payable
    
    
    1,657
    
    
    
    1,693Accrued compensation and benefits
    
    
    839
    
    
    
    407Deferred revenue  licenses
    
    
    271
    
    
    
    379Deferred revenue  services
    
    
    4,591
    
    
    
    2,720Accrued restructuring charges
    
    
    330
    
    
    
    Current portion of capital lease obligations
    
    
    44
    
    
    
    34Other current liabilities
    
    
    995
    
    
    
    572Total current liabilities
    
    
    8,727
    
    
    
    5,805Non current deferred revenue
    
    
    178
    
    
    
    323Other non current liabilities
    
    
    102
    
    
    
    Capital lease obligations
    
    
    44
    
    
    
    61Total liabilities
    
    
    9,051
    
    
    
    6,189Commitments and ContingenciesStockholders equityCommon stock, $0.01 par; 50,000 shares authorized, 8,770 and 5,269 shares
issued and 8,743 and 5,252 shares outstanding as of September 30, 2005
and December 31, 2004, respectively
    
    
    88
    
    
    
    53Additional paid in capital
    
    
    101,471
    
    
    
    83,835Treasury stock, 27 and 17 shares as of September 30, 2005 and
December 31, 2004, respectively
    
    
    (150
    )
    
    
    (62
    )Deferred compensation
    
    
    (29
    )
    
    
    (162
    )Warrants
    
    
    6,549
    
    
    
    4,765Accumulated other comprehensive income (loss)
    
    
    (14
    )
    
    
    514Accumulated deficit
    
    
    (82,564
    )
    
    
    (78,179
    )Total stockholders equity
    
    
    25,351
    
    
    
    10,764Total liabilities and stockholders equity
    
    $
    34,402
    
    
    $
    16,953
 See accompanying notes to the financial statements.
 3




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Knova Software, Inc.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Amounts in thousands, except per share amounts
 (Unaudited)
 Three months ended September 30,
    
    
    Nine months ended September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenuesLicenses
    
    $
    2,208
    
    
    $
    1,605
    
    
    $
    6,409
    
    
    $
    4,144Services
    
    
    3,511
    
    
    
    2,368
    
    
    
    10,351
    
    
    
    5,553Total revenues
    
    
    5,719
    
    
    
    3,973
    
    
    
    16,760
    
    
    
    9,697Cost of revenuesCost of licenses
    
    
    227
    
    
    
    116
    
    
    
    647
    
    
    
    260Cost of services
    
    
    2,186
    
    
    
    1,493
    
    
    
    6,034
    
    
    
    3,192Total cost of revenues
    
    
    2,413
    
    
    
    1,609
    
    
    
    6,681
    
    
    
    3,452Gross margin
    
    
    3,306
    
    
    
    2,364
    
    
    
    10,079
    
    
    
    6,245Operating expensesSales and marketing
    
    
    2,080
    
    
    
    1,137
    
    
    
    5,784
    
    
    
    3,678Research and development
    
    
    1,364
    
    
    
    387
    
    
    
    4,205
    
    
    
    1,615General and administrative
    
    
    777
    
    
    
    660
    
    
    
    3,175
    
    
    
    2,070Intangible assets amortization
    
    
    70
    
    
    
    
    
    
    
    187
    
    
    
    Restructuring charges
    
    
    
    
    
    
    
    
    
    
    1,355
    
    
    
    Total operating expenses
    
    
    4,291
    
    
    
    2,184
    
    
    
    14,706
    
    
    
    7,363Income (loss) from operations
    
    
    (985
    )
    
    
    180
    
    
    
    (4,627
    )
    
    
    (1,118
    )Other income (expense)Interest expense
    
    
    (2
    )
    
    
    (2
    )
    
    
    (5
    )
    
    
    (1,276
    )Other (net)
    
    
    45
    
    
    
    23
    
    
    
    247
    
    
    
    48Other income (expense), net
    
    
    43
    
    
    
    21
    
    
    
    242
    
    
    
    (1,228
    )Net income (loss)
    
    ($
    942
    )
    
    $
    201
    
    
    ($
    4,385
    )
    
    ($
    2,346
    )Net income (loss) per common share, basic:
    
    ($
    0.11
    )
    
    $
    0.04
    
    
    ($
    0.53
    )
    
    ($
    0.46
    )Net income (loss) per common share, diluted:
    
    ($
    0.11
    )
    
    $
    0.04
    
    
    ($
    0.53
    )
    
    ($
    0.46
    )Shares used in computing per share amounts, basic
    
    
    8,725
    
    
    
    5,219
    
    
    
    8,212
    
    
    
    5,114Shares used in computing per share amounts, diluted
    
    
    8,725
    
    
    
    5,317
    
    
    
    8,212
    
    
    
    5,114
 See accompanying notes to the 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, 2004
    
    
    5,252
    
    
    $
    53
    
    
    $
    83,835
    
    
    
    17
    
    
    $
    (62
    )
    
    $
    (162
    )
    
    $
    4,765
    
    
    $
    514
    
    
    $
    (78,179
    )
    
    $
    10,764Exercise of stock options
    
    
    2
    
    
    
    
    
    
    
    (3
    )
    
    
    (2
    )
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Issuance of common stock for
merger
    
    
    3,501
    
    
    
    35
    
    
    
    17,262
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,297Issuance of warrants for merger
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,784
    
    
    
    
    
    
    
    
    
    
    
    1,784Stock based compensation expense
    
    
    
    
    
    
    
    
    
    
    382
    
    
    
    
    
    
    
    
    
    
    
    98
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    480Issuance of stock under
Employee Stock Purchase Plan
    
    
    2
    
    
    
    
    
    
    
    (5
    )
    
    
    (2
    )
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6Forfeiture of restricted stock
    
    
    (14
    )
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    (110
    )
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (75
    )Comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized loss on short term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (14
    )Reclassification adjustment for
gains realized in net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (514
    )
    
    
    
    
    
    
    (514
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,385
    )
    
    
    (4,385
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,899
    )Balance at September 30, 2005
    
    
    8,743
    
    
    $
    88
    
    
    $
    101,471
    
    
    
    27
    
    
    $
    (150
    )
    
    $
    (29
    )
    
    $
    6,549
    
    
    $
    (14
    )
    
    $
    (82,564
    )
    
    $
    25,351Balance at December 31, 2003
    
    
    2,433
    
    
    $
    247
    
    
    $
    76,433
    
    
    
    36
    
    
    $
    (134
    )
    
    
    
    
    
    $
    46
    
    
    
    
    
    
    $
    (76,485
    )
    
    $
    107Exercise of warrants and stock
options
    
    
    18
    
    
    
    
    
    
    
    32
    
    
    
    (16
    )
    
    
    60
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93Beneficial conversion feature
of convertible notes
    
    
    
    
    
    
    
    
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    233Issuance of common stock and
warrants, net of $574 of
issuance costs
    
    
    1,231
    
    
    
    123
    
    
    
    2,681
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,614
    
    
    
    
    
    
    
    
    
    
    
    7,418Issuance of warrants for
settlement of lawsuit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    105
    
    
    
    
    
    
    
    
    
    
    
    105Issuance of common stock
related to note conversion
    
    
    1,535
    
    
    
    154
    
    
    
    3,685
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,839Stock based compensation expense
    
    
    32
    
    
    
    2
    
    
    
    295
    
    
    
    
    
    
    
    
    
    
    
    (199
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98Issuance of stock under
Employee Stock Purchase Plan
    
    
    1
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Comprehensive (loss) gain:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized loss on short term
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8
    )
    
    
    
    
    
    
    (8
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,346
    )
    
    
    (2,346
    )Total comprehensive (loss) gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,354
    )Balance at September 30, 2004
    
    
    5,250
    
    
    $
    526
    
    
    $
    83,361
    
    
    
    20
    
    
    $
    (68
    )
    
    $
    (199
    )
    
    $
    4,765
    
    
    $
    (8
    )
    
    $
    (78,831
    )
    
    $
    9,547
 See accompanying notes to the 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 30,2005
    
    
    2004Cash flows from operating activities
    
    ($
    4,385
    )
    
    ($
    2,346
    )Net lossAdjustments to reconcile net loss to net cash (used in) provided by operations:Non cash items:Depreciation
    
    
    330
    
    
    
    240Amortization of intangible assets
    
    
    566
    
    
    
    33Cost of warrants in connection with lease settlement
    
    
    
    
    
    
    105Amortization of beneficial conversion feature related to convertible notes
    
    
    
    
    
    
    1,162Amortization of discount on convertible notes
    
    
    
    
    
    
    50Interest expense paid by issuing common stock
    
    
    
    
    
    
    107Stock based compensation
    
    
    505
    
    
    
    98Forfeiture of restricted stock
    
    
    (75
    )Acquired in-process research and development
    
    
    421
    
    
    
    Loss (gain) on disposal of equipment
    
    
    4
    
    
    
    (7
    )Other non cash items
    
    
    
    
    
    
    (8
    )Gain on sale of investments
    
    
    (282
    )
    
    
    Changes in operating assets and liabilities, net of assets and liabilities acquired:Decrease (increase) in accounts receivable
    
    
    255
    
    
    
    (212
    )Decrease in other assets
    
    
    (41
    )
    
    
    121(Decrease) increase in accounts payable
    
    
    (1,180
    )
    
    
    224(Decrease) increase in accrued compensation
    
    
    (182
    )
    
    
    38Increase in accrued restructuring charges
    
    
    330
    
    
    
    (Decrease) increase in deferred revenue
    
    
    (258
    )
    
    
    308(Decrease) increase in other liabilities
    
    
    (425
    )
    
    
    416Net cash (used in) provided by operating activities
    
    
    (4,417
    )
    
    
    329Cash flows from investing activitiesPurchases of marketable securities
    
    
    (5,698
    )
    
    
    (11,604
    )Proceeds from sale of marketable securities
    
    
    9,319
    
    
    
    4,525Proceeds from sale of assets
    
    
    1
    
    
    
    1Acquisition costs for Kanisa merger
    
    
    (561
    )
    
    
    Cash acquired from Kanisa merger
    
    
    3,779
    
    
    
    Increase in restricted cash
    
    
    
    
    
    
    (61
    )Property and equipment acquisitions
    
    
    (127
    )
    
    
    (163
    )Net cash provided by (used in) investing activities
    
    
    6,713
    
    
    
    (7,302
    )Cash flows from financing activitiesRepayments of principal of capital lease obligations
    
    
    (32
    )
    
    
    (24
    )Repayments of principal of revolving line of credit
    
    
    
    
    
    
    (250
    )Proceeds from equity funding, net of debt issuance costs
    
    
    
    
    
    
    7,418Proceeds from stock option exercises and employee stock purchase plan issuances
    
    
    14
    
    
    
    78Net cash (used in) provided by financing activities
    
    
    (18
    )
    
    
    7,222Increase in cash and cash equivalents
    
    
    2,278
    
    
    
    249Cash and cash equivalents at beginning of period
    
    
    1,672
    
    
    
    1,438Cash and cash equivalents at end of period
    
    $
    3,950
    
    
    $
    1,687Supplemental disclosures of cash flow information:Cash paid for interest
    
    $
    5
    
    
    $
    8Supplemental disclosures of non-cash investing and financing activities:Conversion of convertible debt and accrued interest to common stock
    
    
    
    
    
    
    3,839Adjustment to beneficial conversion feature for convertible notes
    
    
    
    
    
    
    233Exercise of warrants by bank
    
    
    
    
    
    
    23Issuance of warrants
    
    
    1,784
    
    
    
    5,134Assets acquired under capital lease obligations
    
    
    
    
    
    
    32Unrealized loss on investments
    
    
    (14
    )
    
    
    Kanisa acquisition (note 10)
 See accompanying notes to the financial statements.
 6




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##### Table of Contents



Knova Software, Inc.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER 30, 2005
 (Unaudited)
 Note 1. Organization of the Company
    Note 2. Unaudited Interim Financial Information
 
  Note 3. Significant Accounting Policies
 Principles of Consolidation
  7




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Marketable Securities
   Stock Based Compensation
   For the three months ended
    
    
    For the nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands, except per share amounts)Net income (loss) from continuing operations, as reported
    
    ($
    942
    )
    
    $
    201
    
    
    ($
    4,385
    )
    
    ($
    2,346
    )Add: stock based compensation expense included in reported net
income (loss)
    
    
    5
    
    
    
    5
    
    
    
    398
    
    
    
    19Less: total stock based compensation expense under SFAS No. 123
    
    
    (341
    )
    
    
    (181
    )
    
    
    (2,226
    )
    
    
    (542
    )Pro forma net income (loss)
    
    ($
    1,278
    )
    
    $
    25
    
    
    ($
    6,213
    )
    
    ($
    2,869
    )Weighted average shares basic
    
    
    8,725
    
    
    
    5,219
    
    
    
    8,212
    
    
    
    5,114Weighted average shares diluted
    
    
    8,725
    
    
    
    5,317
    
    
    
    8,212
    
    
    
    5,114Pro forma net income (loss) per share, basic
    
    ($
    0.15
    )
    
    $
    0.00
    
    
    ($
    0.76
    )
    
    ($
    0.56
    )Pro forma net income (loss) per share, diluted
    
    ($
    0.15
    )
    
    $
    0.00
    
    
    ($
    0.76
    )
    
    ($
    0.56
    )
   Impact of Recently Issued Accounting Standards
  8




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Reclassification
  Revision in the Classification of Certain Securities
     Note 4. Debt
 Convertible Notes
     9




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##### Table of Contents



Note 5. Net Income (Loss) Per Share
  For the three months
    
    For the nine months endedended September 30,
    
    September 30,2005
    
    2004
    
    2005
    
    2004(in thousands, except per share amounts)Numerator:Net income (loss )
    
    ($
    942
    )
    
    $
    201
    
    
    ($
    4,385
    )
    
    ($
    2,346
    )Denominator:Denominator for basic earnings per share  weighted average shares
    
    
    8,725
    
    
    
    5,219
    
    
    
    8,212
    
    
    
    5,114Denominator for diluted earnings per share  weighted average shares
    
    
    8,725
    
    
    
    5,317
    
    
    
    8,212
    
    
    
    5,114Net income (loss) per share, basic
    
    ($
    0.11
    )
    
    $
    0.04
    
    
    ($
    0.53
    )
    
    ($
    0.46
    )Net income (loss) per share, diluted
    
    ($
    0.11
    )
    
    $
    0.04
    
    
    ($
    0.53
    )
    
    ($
    0.46
    )
  Note 6. Segment Information
  For the three months
    
    
    For the nine months endedended September 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands, except per share amounts)Revenues (a)United States
    
    $
    5,540
    
    
    $
    3,307
    
    
    $
    16,060
    
    
    $
    8,713International
    
    
    179
    
    
    
    666
    
    
    
    700
    
    
    
    984Total
    
    $
    5,719
    
    
    $
    3,973
    
    
    $
    16,760
    
    
    $
    9,697
 
  Note 7. Capital Stock
    10




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Note 8. Stock Option Plan
  Options
    
    
    Option Price
    
    
    Weighted AverageOutstanding
    
    
    Range per Share
    
    
    Exercise PriceOptions outstanding, December 31, 2004
    
    
    867,049
    
    
    $
    2.50-$70.00
    
    
    $
    5.0950Options granted
    
    
    1,374,940
    
    
    $
    3.70-$4.60
    
    
    $
    4.1734Options exercised
    
    
    (2,140
    )
    
    $
    2.60-$3.80
    
    
    $
    3.7215Options forfeited
    
    
    (307,418
    )
    
    $
    2.60-$25.00
    
    
    $
    4.8780Options outstanding, September 30, 2005
    
    
    1,932,431
    
    
    $
    2.50-$70.00
    
    
    $
    4.4754Options exercisable, September 30, 2005
    
    
    812,841
    
    
    $
    2.50-$70.00
    
    
    $
    4.8505
  Options
    
    
    Option Price
    
    
    Weighted AverageOutstanding
    
    
    Range per Share
    
    
    Exercise PriceOptions outstanding, December 31, 2003
    
    
    576,771
    
    
    $
    2.50-$70.00
    
    
    $
    4.7087Options granted
    
    
    379,195
    
    
    $
    4.09-$8.19
    
    
    $
    5.7949Options exercised
    
    
    (16,400
    )
    
    $
    2.60-$4.50
    
    
    $
    4.2726Options forfeited
    
    
    (68,057
    )
    
    $
    2.60-$51.25
    
    
    $
    5.9565Options outstanding, September 30, 2004
    
    
    871,509
    
    
    $
    2.50-$70.00
    
    
    $
    5.0921Options exercisable, September 30, 2004
    
    
    488,188
    
    
    $
    2.50-$70.00
    
    
    $
    4.7380
    Note 9. Contingencies
  Note 10. Acquisition
  11




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##### Table of Contents



Volatility
    
    
    142.67
    %Risk-free interest rate
    
    
    3.4
    %Dividend yield
    
    
    Expected life
    
    4 years
    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
    12




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##### Table of Contents



Pro forma results
  For the three months
    
    For the nine months endedended September 30,
    
    September 30,2005
    
    2004
    
    2005
    
    2004(in thousands, except per share amounts)Revenues
    
    $
    5,719
    
    
    $
    6,933
    
    
    $
    17,166
    
    
    $
    17,525Net loss
    
    ($
    1,363
    )
    
    ($
    1,631
    )
    
    ($
    4,806
    )
    
    ($
    10,573
    )Net loss per share
    
    ($
    0.16
    )
    
    ($
    0.19
    )
    
    ($
    0.59
    )
    
    ($
    1.23
    )Shares used in per share calculation
    
    
    8,725
    
    
    
    8,720
    
    
    
    8,212
    
    
    
    8,615
  Note 11. Restructuring Charges
  13




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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 communities and forums that
enables customers 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 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.
    
    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
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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
  15




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##### Table of Contents



Results of Operations
  Three months ended September 30,

    
    Nine months ended September 30,2005

    
    2004

    
    2005

    
    2004RevenuesLicenses
    
    
    38.6
    %
    
    
    40.4
    %
    
    
    38.2
    %
    
    
    42.7
    %Services
    
    
    61.4
    %
    
    
    59.6
    %
    
    
    61.8
    %
    
    
    57.3
    %Total revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenuesCost of licenses
    
    
    4.0
    %
    
    
    2.9
    %
    
    
    3.9
    %
    
    
    2.7
    %Cost of services
    
    
    38.2
    %
    
    
    37.6
    %
    
    
    36.0
    %
    
    
    32.9
    %Total cost of revenues
    
    
    42.2
    %
    
    
    40.5
    %
    
    
    39.9
    %
    
    
    35.6
    %Gross margin
    
    
    57.8
    %
    
    
    59.5
    %
    
    
    60.1
    %
    
    
    64.4
    %Operating expensesSales and marketing
    
    
    36.4
    %
    
    
    28.6
    %
    
    
    34.5
    %
    
    
    37.9
    %Research and development
    
    
    23.9
    %
    
    
    9.8
    %
    
    
    25.1
    %
    
    
    16.7
    %General and administrative
    
    
    13.6
    %
    
    
    16.6
    %
    
    
    18.9
    %
    
    
    21.3
    %Intangible assets amortization
    
    
    1.2
    %
    
    
    0.0
    %
    
    
    1.1
    %
    
    
    0.0
    %Restructuring charges
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    8.1
    %
    
    
    0.0
    %Total operating expenses
    
    
    75.1
    %
    
    
    55.0
    %
    
    
    87.7
    %
    
    
    75.9
    %Income (loss) from operations
    
    
    -17.3
    %
    
    
    4.5
    %
    
    
    -27.6
    %
    
    
    -11.5
    %Other income (expense), net
    
    
    0.8
    %
    
    
    0.5
    %
    
    
    1.4
    %
    
    
    -12.7
    %Net income (loss)
    
    
    -16.5
    %
    
    
    5.0
    %
    
    
    -26.2
    %
    
    
    -24.2
    %
 Three Months Ended September 30, 2005 and 2004
  Revenues
   Cost of Revenues
    Operating Expenses
 Sales and Marketing
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##### Table of Contents



Research and Development
 General and Administrative
 Intangible Assets Amortization
 Other income (expense), net
  Nine Months Ended September 30, 2005 and 2004
  Revenues
   Cost of Revenues
    Operating Expenses
 Sales and Marketing
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Research and Development
 General and Administrative
 Intangible Assets Amortization
 Restructuring
 Other income (expense), net
  Liquidity and Capital Resources
       18




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Contractual Obligations
  Payments due by period (in thousands)Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    4-5 yearsCapital lease obligations
    
    $
    88
    
    
    $
    44
    
    
    $
    41
    
    
    $
    3Operating lease obligations
    
    
    1,263
    
    
    
    532
    
    
    
    630
    
    
    
    101Restructuring charges
    
    
    330
    
    
    
    330
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    1,681
    
    
    $
    906
    
    
    $
    671
    
    
    $
    104
 Related Party Transactions
  Recent Accounting Pronouncements
    19




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##### Table of Contents



Additional Factors That May Affect Future Results
  We may not be able to reverse our history of losses.
  We may need additional capital to fund continued business operations and we cannot be sure that
additional financing will be available when and if needed.
  If we are not able to obtain capital when needed, we may need to dramatically change our business
strategy and direction, including pursuing options to sell or merge our business.
  Failure of our recent combination with Kanisa to achieve its potential benefits could harm our
business and operating results.
  
    
    marketing, sales and service and support organizations;
    
    information and communications systems;
    
    operating procedures;
    
    accounting systems and financial controls; and
    
    human resource policies, procedures and practices, including benefit programs.
  
    
    problems with compatibility of business cultures;
    
    customer perception of an adverse change in service standards, business focus or product and service offerings;
    
    costs and inefficiencies in delivering products and services to our customers;
    
    problems in successfully coordinating our research and development efforts;
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##### Table of Contents




    
    difficulty in integrating sales, support and product marketing;
    
    costs and delays in implementing common systems and procedures, including financial accounting systems; and
    
    the inability to retain and integrate key management, research and development,
technical sales and customer support personnel.
   Our change in management might not be successful.
  The market price of our common stock may decline as a result of the merger.
  
    
    our integration with Kanisa is not as successful as anticipated
    
    we do not achieve or are perceived not to have achieved the expected benefits of
the merger as rapidly or to the extent anticipated by financial or industry analysts or
investors
    
    the effect of the merger on our financial results is not consistent with the
expectations of financial or industry analysts or investors.
  The substantial costs of our combination with Kanisa could harm our financial results.
  We may not succeed in attracting and retaining the personnel we need for our business.
  A third party performs a significant percentage of our product development internationally, the
loss of which could substantially impair our product development efforts.
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##### Table of Contents



It is difficult to draw conclusions about our future performance based on our past performance due
to significant fluctuations in our quarterly operating results and the merger with Kanisa.
      The markets for knowledge management and service resolution management are evolving and, if they
do not grow rapidly, our business will be adversely affected.
  We currently have one core product family. If the demand for this line of products declines, our
business will be adversely affected.
  Due to the lengthy sales cycles of our products and services, the timing of our sales is difficult
to predict and may cause us to miss our revenue expectations.
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##### Table of Contents



We may not be able to expand our business internationally, and, if we do, we face risks relating
to international operations.
  If we are not able to keep pace with rapid technological change, sales of our products may
decrease.
  We depend on technology licensed to us by third parties, and the loss of this technology could
delay implementation of our products, injure our reputation or force us to pay higher royalties.
  Problems arising from the use of our products with other vendors products could cause us to incur
significant costs, divert attention from our product development efforts and cause customer
relations problems.
  If third parties cease to provide open program interfaces for their customer relationship
management software, it will be difficult to integrate our software with theirs. This may
decrease the attractiveness of our products.
  We face intense competition from both established and recently formed entities, and this
competition may adversely affect our revenues and profitability because we compete in the emerging
markets for knowledge management and service resolution management solutions.
  If our software products contain errors or failures, sales of these products could decrease.
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##### Table of Contents



We could incur substantial costs as a result of product liability claims because our products are
critical to the operations of our customers businesses.
  If our customers system security is breached and confidential information is stolen, our business
and reputation could suffer.
  We may acquire or make investments in companies or technologies that could hurt our business.
  
    
    failure to integrate the acquired assets and/or companies with our current business;
    
    the price we pay may exceed the value we eventually realize;
    
    potential loss of share value to our existing stockholders as a result of issuing equity
securities as part or all of the purchase price;
    
    potential loss of key employees from either our current business or the acquired business;
    
    entering into markets in which we have little or no prior experience;
    
    diversion of managements attention from other business concerns;
    
    assumption of unanticipated liabilities related to the acquired assets; and
    
    the business or technologies we acquire or in which we invest may have limited operating
histories and may be subject to many of the same risks we are.
  We may not be able to protect our intellectual property rights, which may cause us to incur
significant costs in litigation and erosion in the value of our brands and products.
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##### Table of Contents



We may initiate lawsuits to protect or enforce our patents. Lawsuits may be expensive and,
depending on the verdict, we may lose some, if not all, of our intellectual property rights, and
this may impair our ability to compete in the market.
  The success of our software products depends on its adoption by our customers employees. If
these employees do not accept the implementation of our products, our customers may fail to renew
their service contracts and we may have difficulty attracting new customers.
   We depend on increased business from our new customers and, if we fail to grow our customer base
or generate repeat business, our operating results could be adversely affected.
   A decline in information technology spending could reduce the sale of our products.
  Increasing government regulation of the Internet could harm our business.
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##### Table of Contents



We may become involved in securities class action litigation, which could divert managements
attention and harm our business.
  Our stock price may be adversely affected since our stock is not listed on an exchange or The
Nasdaq Stock Market.
   Shares available for future sale could adversely affect our stock price.
  Our management owns a significant percentage of our company and will be able to exercise
significant influence over our actions.
  Voting agreements in place assure election of our current directors for 2006.
  Terrorist attacks and other attacks or acts of war may adversely affect the markets on which our
common stock trades, our financial condition and our results of operations.
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##### Table of Contents



The regulatory environment surrounding accounting and corporate governance subjects us to certain
legal uncertainties in the operation of our business and may increase the cost of doing business.
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
 Evaluation of disclosure controls and procedures .
 Changes in internal controls .
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##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 6. Exhibits
           
     28




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##### Table of Contents



SIGNATURES
  KNOVA SOFTWARE, INC.Date: November 14, 2005
    
    
    
    By:
    
    /s/ THOMAS MUISEThomas MuisePrincipal Financial Officer
 29