**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**Washington, D.C.20549

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**FORTHE FISCAL YEAR ENDED DECEMBER 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**FORTHE TRANSITION PERIOD FROM***            * TO *            *

**COMMISSIONFILE NUMBER 000-31321**

**RIGHTNOWTECHNOLOGIES, INC.**(Exactname of registrant as specified in its charter)

| **DELAWARE**                    | ** ** | **81-0503640**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**40 ENTERPRISE BLVD, BOZEMAN,MONTANA 59718**(Addressof principal executive offices) (Zip code)

**(406) 522-4200**(Registrant’stelephone number, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

| Title of each class:               |   | Name of each exchange on which registered: |
|------------------------------------|--------|--------------------------------------------|
| **COMMON STOCK, PAR VALUE $0.001** |   | **THE NASDAQ STOCK MARKET LLC**            |

 

Securities registered pursuant to Section 12(g) ofthe Act:**NONE**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o    No x

Indicate by check mark whether if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act.  Yes o    No x

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

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

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

The aggregate market value of common stock held bynon-affiliates of the registrant as of June 30, 2006, the last businessday of the registrant’s most recently completed second fiscal quarter, wasapproximately $284,276,656, based on the closing sales price of the registrant’scommon stock on that date as reported by the Nasdaq Global Market. For thepurposes of the foregoing calculation only, all of the registrant’s directors,executive officers and persons known to the registrant to hold ten percent orgreater of the registrant’s outstanding common stock have been excluded in thatsuch persons may be deemed to be affiliates. This determination of affiliatestatus is not a determination for other purposes.

The number of shares outstanding of the registrant’scommon stock as of February 21, 2007 was 32,884,260.

**DOCUMENTSINCORPORATED BY REFERENCE:**

Information required by Items 10 through 14 of Part IIIof this Form 10-K, to the extent not set forth herein, isincorporated herein by reference to portions of the registrant’s definitiveproxy statement for the registrant’s 2007 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission not later than 120days after the end of the fiscal year ended December 31, 2006. Except withrespect to the information specifically incorporated by reference in this Form 10-K,the registrant’s definitive proxy statement is not deemed to be filed as a partof this Form 10-K.

 

----

**RightNowTechnologies, Inc.**

**Annual Report on Form 10-K**

**For The Fiscal YearEnded December 31, 2006**

**Tableof Contents**

| PART I   |   |                                                                                                                    |   |   |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.       |   | Business                                                                                                                |   | 2      |
| Item 1A.      |   | Risk Factors                                                                                                            |   | 10     |
| Item 1B.      |   | Unresolved Staff Comments                                                                                               |   | 24     |
| Item 2.       |   | Properties                                                                                                              |   | 24     |
| Item 3.       |   | Legal Proceedings                                                                                                       |   | 24     |
| Item 4.       |   | Submission of Matters to a Vote of Security Holders                                                                     |   | 24     |
| PART II  |   |                                                                                                                    |   |   |
| Item 5.       |   | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |   | 25     |
| Item 6.       |   | Selected Financial Data                                                                                                 |   | 27     |
| Item 7.       |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                             |   | 28     |
| Item 7A.      |   | Quantitative and Qualitative Disclosures about Market  Risk                                                             |   | 46     |
| Item 8.       |   | Financial Statements and Supplementary Data                                                                             |   | 46     |
| Item 9.       |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                   |   | 46     |
| Item 9A.      |   | Controls and Procedures                                                                                                 |   | 47     |
| Item  9B.     |   | Other  Information                                                                                                      |   | 48     |
| PART III |   |                                                                                                                    |   |   |
| Item 10.      |   | Directors, Executive Officers and Corporate Governance                                                                  |   | 49     |
| Item 11.      |   | Executive Compensation                                                                                                  |   | 49     |
| Item 12.      |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                         |   | 49     |
| Item 13.      |   | Certain Relationships and Related Transactions, and  Director Independence                                              |   | 50     |
| Item 14.      |   | Principal Accountant Fees and Services                                                                                  |   | 50     |
| PART IV  |   |                                                                                                                    |   |   |
| Item 15.      |   | Exhibits and Financial Statement Schedules                                                                              |   | 51     |
|          |   | Signatures                                                                                                              |   | 53     |

 

----

**CAUTIONARYSTATEMENT**

*In this report, theterms “RightNow Technologies,” “RightNow,” “Company,” “we,” “us” and “our”refer to RightNow Technologies, Inc. and its subsidiaries.*

*All statementsincluded or incorporated by reference in this report, other than statements orcharacterizations of historical fact, are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Theseforward-looking statements are based on our current expectations, estimates andprojections about our industry, management’s beliefs, and certain assumptionsmade by us, all of which are subject to change. Forward-looking statements canoften be identified by words such as “anticipates,” “expects,” “intends,” “plans,”“predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,”“could,” “potential,” “continue,” “ongoing,” similar expressions, andvariations or negatives of these words, and include, but are not limited to,statements regarding projected results of operations, market acceptance andperformance of our products, our ability to retain and hire key executives,sales and technical personnel and other employees in the numbers, with thecapabilities, and at the compensation levels needed to implement our businessand product plans, the competitive nature of and anticipated growth in ourmarkets, our accounting estimates, assumptions and judgments, and management’sfuture strategic plans. These forward-looking statements are not guarantees offuture results and are subject to risks, uncertainties and assumptions that aredifficult to predict and that could cause our actual results to differmaterially and adversely from those expressed in any forward-looking statement.The risks and uncertainties referred to above include, but are not limited to,risks associated with changing our business model; our ability to develop oracquire, introduce, market and gain market acceptance for new products andenhancements to existing products in a cost-effective and timely manner; the gainor loss of key customers; competitive pressures and other similar factors suchas the availability and pricing of competing products and technologies and theresulting effects on sales and pricing of our products; the rate at which ourpresent and future customers adopt our existing and future products andservices; our ability to expand operations; possible fluctuations in ouroperating results including our revenue mix and our rate of growth;fluctuations in our operating results from the impact of stock-basedcompensation expense; interruptions or delays in our hosting operations;breaches of our security measures; our ability to expand, retain and motivateour employees and manage our growth; the impact of potential acquisitions, ifany; and various other factors, some of which are described under the sectionbelow entitled “Risk Factors”, in Item 1A of this report. These forward-lookingstatements speak only as of the date of this Report. We undertake no obligationto revise or update publicly any forward-looking statement for any reason,except as otherwise required by law.*

1

----

**Part I**

**Item 1.**                        Business

**OVERVIEW**

RightNow Technologies (“we”, “us”, “our”, the “Company”or “RighNow”) provides industry-leading software solutions that help companiesimprove customer experiences while reducing operating costs. In today’shyper-competitive business environment, providing superior customer experiencesis the single most powerful way for companies to drive sustainabledifferentiation. RightNow’s customer-focused technology enables organizationsto deliver consistent customer experiences by connecting the right informationto every interaction channel. Additionally, our on demand delivery approach, orsoftware-as-a-service (“SaaS”), results in lower costs of ownership, reducedcomplexity, and quick results. Our value-added services, including businessprocess optimization and lifetime product tune-ups, improve our customers’efficiency, increase user adoption and enable a maximum return on investment. RightNow’s1,800 clients worldwide include British Airways, British Telecom, CiscoSystems, Continental Tire North America, John Deere, Nikon and the SocialSecurity Administration.

RightNow was incorporatedin Montana in September 1995 and reincorporated in Delaware in August 2000.Our principal executive offices are located at 40 Enterprise Boulevard,Bozeman, Montana 59718-9300, and our telephone number is (406) 522-4200.We have regional field offices in Boston, Massachusetts; Chicago, Illinois;Dallas, Texas; San Mateo, California; Princeton, New Jersey; New York, NewYork; Rochester, New York; and Washington, D.C. We also have subsidiary officesin London, England; Munich, Germany; Sydney, Australia; and Tokyo, Japan. Ourinternet address is **http://www.rightnow.com**.Our annual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, amendments to those reports and otherSecurities and Exchange Commission, or SEC, filings are available free ofcharge through our website as soon as reasonably practicable after such reportsare electronically filed with, or furnished to, the SEC. Our common stocktrades on the Nasdaq Global Market under the symbol RNOW. The inclusion of ourinternet address in the report does not include or incorporate by referenceinto this report any information contained on, or accessible through, our website.

**PRODUCTS ANDSERVICES**

Our solutions are basedupon a single application platform designed to be easy to implement, use andmaintain, and to support improving the customer experience across multiplecustomer interaction points. Our solutions integrate with traditionalenterprise and/or back office applications, and are available in 20 languages. RightNowService, RightNow Marketing, RightNow Sales, RightNow Feedback and RightNowVoice each have custom analytics and reporting capabilities.

**RightNow Service**TM

First released in 1997,RightNow Service is the flagship offering in our portfolio of customerrelationship management (“CRM”) solutions and generates approximately 80% to90% of our revenue. Built upon a self-learning knowledge foundation, RightNowService provides an integrated multi-channel customer service that capturescustomer interactions across traditional and online channels. Our knowledgefoundation automatically learns from each customer interaction to deliverrelevant content, thereby improving the customer experience.

2

----

**Features ofRightNow Service**

*Seamless multi-channel contact center***—**blendstraditional and online channels so customer service agents have a single viewof the customer across all channels and can provide consistent information throughphone, email, web, and chat.

*Web and voice self-service***—**enables customers****toaccess the information they need 24/7 on the web and over the****phone,and also reduces contact center workloads.

Patented self-learning knowledge base**—**dynamically captures and presents complete, relevant andup-to-date information to customers, contact center staff, outsourcers andother business partners

*Email response management***—**leverages****knowledge base content to speedresponse times and provides customers with accurate answers; also detectspotential customer issues for immediate attention and resolution.

*Custom analytics and reporting*—pre-builtreports and a custom reporting engine enable real-time performance tracking. Reportscan be automatically scheduled to run on specific timetables, to head offservice and product issues with exception-based notification.

*Integration with enterpriseresource planning, return merchandise authorization,**andother back-office systems*—provides access to operational systems soagents can resolve customer issues without leaving the RightNow desktop.

**RightNow MarketingTM**

RightNow Marketing isdesigned to deliver the functionality needed to manage multi-channel,multi-stage campaigns. RightNow Marketing automates standard campaignactivities, optimizes resources and leverages the information captured in salesand service interactions. In addition, with RightNow Marketing, customerservice organizations can preempt service inquiries by proactively targetingcustomers with relevant, personalized communications.

**Features ofRightNow Marketing**

*Multi-stage, multi-channelcampaign management*—userscan design,execute and manage campaigns from one central location

*Lead-generating email marketing*—enablesthe creation of personalized email marketing campaigns to boost leadgeneration, increase conversion rates and improve the relevancy of marketing communications.

*Event-triggered messages*—automates the delivery of personalizedmessages triggered from any type of customer action—from a website request toan in-store retail purchase.

*Comprehensive response and lead routing*—tracksall aspects of campaign performance and provides automated lead routingbased on geography, product or other attributes.

*Effective list management and deliverability—*providesappropriate opt-in/opt-out controls, manages deletion of obsolete addresses, andmaintains compliance with relevant industry standards.

*Customanalytics and reporting*—real-time, pre-built and customizablereports provided out-of-the-box track and measure the success of marketingcampaigns.

**RightNow SalesTM**

RightNow Sales is designed to simplify the salesprocess so that sales organizations can more easily manage accounts, trackleads, organize contacts and create selling opportunities. Traditional salesprocesses such as contact management, forecasting, quote generation andopportunity status are fully 

3

----

integrated, saving salesrepresentatives’ time and shortening sales cycles. RightNow Sales improves theaccuracy of sales forecasting and reporting with real-time visibility intosales pipeline data.

In 2006, RightNow acquiredSalesnet, Inc., a leading sales automation vendor. The technology anddomain expertise gained through this acquisition are expected to accelerate andexpand capabilities within the RightNow offering.

**Features ofRightNow Sales**

*Opportunity and pipeline management*—allowsthe user to see the entire sales pipeline and individual opportunity details onone screen.

*Contact, account and task management*—userscan enter, update and track all relevant contact and deal information in oneplace.

*Lead management*—optimizes leadflow across marketing and sales organizations.

*Forecasting*—opportunity levelforecasting provides visibility into performance of sales representativesacross pipelines and committed revenue.

*Custom analyticsand reporting*—providesanalysis of the total forecast overview with details by region, salesrepresentative and opportunity, and provides for the creation of custom reportsto support unique business processes.

*Microsoft Outlookintegration—*is fullyintegrated within the RightNow product suite for increased productivity. Usersmay view and use Outlook within RightNow and synchronize data betweenapplications.

*Automatic contract,quote and proposal generation*—providesaccurate, customer-ready contracts, quotes and proposals.

*Territory and quotamanagement—*fully customizablequota-setting and real-time performance monitoring tools track staff andmanagement performance.

*Sales methodology implementation—*replicates and enforces conformance to provenmethodologies.

**RightNow FeedbackTM**

RightNowFeedback is designed to enable organizations to capture and measurecustomer feedback across all touch-points in real time and take immediateaction on that feedback.Companies can also use packaged templates to gather, monitor and act oncustomer satisfaction and service issues or collect insights from their ownemployees.

**Features ofRightNow Feedback**

*Multiple feedbackcapture techniques*—capturesinput from customers via email, phone or the web.

*Collaborative survey design—*allowsteams to create and test surveys with various response types and questionbranching.

*Audience management—*enables**surveyaudience segmentation and analysis of outbound communications to ensurerelevant surveying of customers.

*Customer record integration—*feedbackresponses are captured in customer records so that all employees interactingwith customers are informed of preferences and potential issues.

*Robust reporting and analysis—*graphical reporting anddashboard functionality allow the tracking and measurement of customersatisfaction and loyalty.

4

----

**RightNow VoiceTM**

RightNow Voice providesvoice automation options for interacting with customers and prospects. Customerscan use self-service options to access information, and, if needed, calls areautomatically routed to appropriate staff for quick resolution.

**Features ofRightNow Voice**

*Dynamic voice routing***—**provides relevant content to callers and****directs calls—along with customer-specific information—tothe appropriate department.

*Voice self-service—*enables customers to find*answers*overthe phone 24 hours a day without contacting the call center staff.

*Web click-to-callback—*allowscustomers visiting a company’s web site to request a call when they needadditional assistance completing a transaction or making a purchase decision.

*Inboundand outbound survey tools***—**enables****polling of customers to monitor satisfaction levels, gaugeinterest in new products or services and gain other market intelligence.

**RightNow AnalyticsTM**

RightNow Analyticsprovides visibility into customer behavior across service, sales, marketing andfeedback touch points, enabling organizations to capture, synthesize,distribute and manage customer intelligence.

**Features ofRightNow Analytics**

*Service analytics—*measures**thepost-sales service experience, enabling organizations to track customerbehaviors, identify and act on potential issues and determine how to optimizeresource allocation.

*Sales analytics—*provides visibility into the salespipeline for accurate forecasts and historical trending tools to pinpointeffective sales tactics for replication.

*Marketing analytics—*enables evaluation of historical marketingdata for visibility into effective campaigns and offers.

*Feedback analytics—*consolidate, evaluate anddistribute customer feedback to track and measure the effect of customerinteractions.

**ProfessionalServices**

Our Professional Services organization combinesproject management with technical and business-focused consulting services toour clients. Using proven methods and customer-centric best practices, ourProfessional Services group is experienced in implementing RightNow productsacross many industries, drawing on in-depth knowledge and practical expertisegained from thousands of deployments. Professional services helps customersdetermine strategic business objectives, align business processes and definesuccess metrics as well as helping with rapid system configuration anddeployment while adjusting business solutions to ensure full user adoption. Wealso provide tune-up services to our clients, auditing their solution againstour library of best practices.

5

----

**Sales and Marketing**

RightNow products andservices are sold predominantly through our direct sales organization and to alesser extent, through indirect channels. The sales team is organized aroundprospect company size and vertical industry, calling on potential new clientsas well as focusing on managing existing client relationships and furtherpenetrating those relationships.

*Pilot Program*

A prospective client may deploy our full solutionsuite to a test group or its entire customer base to ensure that RightNowsolutions meet its needs, prior to committing to any license fees. A pilotprogram typically lasts 30 to 60 days. The prospective client’s objectivesare quantified and results measured during the period. As a result of thisprogram, we believe we have experienced shorter sales cycles, higher closurerates and larger deal sizes.

In 2006 we continued to grow our indirect channelrevenue and broaden our global partner program. On December 31, 2006, wehad 76 partners in our Global Partner Program, including 13 Sales SolutionPartners (gained through the Salesnet acquisition) who resell RightNow salessolutions to small and mid market accounts. We have continued to develop andgrow our Service Provider Partner channel through strategic relationships withlarge customer care outsourcers such as Convergys, West Corporation,TelePerformance, Precision Response Corporation, ICT Group, Harte-Hanks, andLockheed Martin. These partners deliver increased value to clients throughRightNow-enabled outsourced services. In addition, we continue to developbusiness alliance and referral partner relationships with independent softwarecompanies, systems integrators, and contact center infrastructure providers,including Comergent, and UCN, to create additional opportunities for our directsales team and enhanced capabilities for our customers. We have entered intotechnology alliance partnerships with Informatica and Cast Iron to enhance ourenterprise systems integration capabilities.

In those international markets where we do not have adirect selling presence, we rely on system integrators and resellers to sellour solutions. This strategy is primarily employed in Europe, New Zealand andAsia. We intend to continue to broaden our distribution to these markets throughresellers.

Our marketing departmentcoordinates future product and service direction, manages generation of clientleads, and directs public and industry analyst relations. To expand our clientbase, we have also developed and will continue to increase innovative marketinginitiatives.

**Clients**

As of December 31,2006, we had approximately 1,800 active clients in various industries,including technology, financial and insurance, consumer products,telecommunications and travel and hospitality, as well as government agenciesand educational institutions. For the year ended December 31, 2006,approximately 39% of our revenue was generated from entities with over $1billion in annual revenue, 44% of our revenue was generated from entities withless than $1 billion in annual revenue and 16% of our revenue was generatedfrom government/educational institutions. No single client accounted for morethan 10% of our revenue in the year ended December 31, 2006.

**Product Developmentand Technology**

Our product development efforts are focused onimproving and enhancing our existing solutions and service offerings as well asdeveloping new proprietary technology. Our product development philosophyincorporates our long-term strategic view of our market and incorporates customerfeedback to improve and enhance our products. We currently are developingproducts and solutions to broaden and deepen our offerings within the CRMmarket. We have an applied research group, RightNow Labs, which focuses on 

6

----

knowledgebase, artificialintelligence, information retrieval and novel applications of current researchfor use within our solutions. Although we allow our clients to run differentversions of our software, our support and development efforts are focused onthe current and future releases of our products. Our research and developmentexpenses totaled approximately $7.8 million in 2004, $10.4 million in2005, and $14.5 million in 2006.

We believe we have significant technology expertise indeveloping and deploying highly scalable and reliable on demand CRMapplications. All of our products have been designed using industry standardsfor the Internet and are designed to meet the following goals: cost efficientdeployment, highly configurable, scaleable, easily integrated, multi-tenant andcapable of being internationalized. The architectural components describedbelow form the foundation for the delivery of a variety of features within oursolution.

*Self-learning**KnowledgeFoundation.**  *Knowledgebasetechnologies are used within our customer service solution to provideself-service and automatic email response to users and as an automatedassistant for our clients’ customer service representatives. Core technologiesin the area of the knowledge foundation include automatic learning and decay ofthe relevancy and relatedness of information, natural language processing,word-stemming algorithms, information clustering and classification algorithms,and information retrieval technologies.

*Integration**with OtherEnterprise Applications.**  *Ourhosted and non-hosted clients are able to integrate our solution with theirother mission-critical enterprise applications through several techniques,including: web services, application level triggers; user interfaceextensibility that allows the integration of other applications into oursolution; and “pass through” authentication that allows our solution to inherituser credentials from other applications to identify and enforce access to ourclients’ web sites. In addition, pre-packaged connectors are available forintegration with other third-party applications. We are also developing a webportal focused on integration topics which will provide our customers andpartners with up-to-date documentation and sample integrations as well ason-line discussion forums that are moderated by RightNow experts.

*User**Interface.**  *The end-user portion of ourproduct, which allows our clients to serve their customers through the web, isbrowser based and provides support for all current browsers and versions, and complieswith web accessibility standards. Recently, we have re-architected our back-endinterface to make use of Microsoft Corporation’s Smart Client technology. Theback-end interface is used by administrators, agents, sales representatives andmarketing users. The Smart Client user interface (or “UI”) communicates withour server via web services. This UI combines the speed and power oftraditional client/server applications with the flexibility and reduced totalcost of ownership associated with browser based applications. With the SmartClient UI, a richer user experience is possible than could be provided througha browser. Since the Smart Client is automatically network installed andupdated, the desktop maintenance headache associated with client/serverapplications is eliminated.

*Software**Architecture.**  *Oursolution has been developed using a logical three-tier Internet architectureconsisting of presentation, application logic and data management layers.Because of the tiered separation, our solution is designed to be highlyscalable, allowing expansion at the presentation and application logic tiersand at the data management tier. We have experience deploying our solution inhighly available, highly scalable, load-balanced web server and clustereddatabase server configurations. We support most commonly available operatingsystems (Linux, Microsoft Windows Server) and databases (Oracle, Microsoft SQLServer, MySQL).

**IntellectualProperty**

Our success depends to a significant degree upon thedevelopment and protection of our software and other proprietary technologyrights. We believe we have a strong base of intellectual property. As of 

7

----

February 28, 2007,our base of intellectual property included six issued U.S. patents, one issuedUnited Kingdom patent, and fourteen pending U.S. patents, five U.S. trademarkregistrations, and multiple foreign trademark registrations. The majority ofour patent applications concern our knowledgebase technology, includingprocesses relating to the relative usefulness ranking and the order of displayof retrieved information in the knowledgebase; the ability of the knowledgebaseto suggest related information to a user accessing the knowledgebase; and theability of the knowledgebase to produce a relational map of help informationitems based on the historical usage patterns of customers accessing theknowledgebase. Our patent portfolio includes one issued U.S. patent and twoU.S. patent applications that relate to our voice technology.

The following is a summary of our issued U.S. patents:

*ImplicitRating of Retrieved Information in an Information Search System.**  *This process relates to aninformation search and retrieval system through a network, such as theInternet, in which the relative usefulness ranking and the order of display ofthe retrieved information in the knowledgebase is adjusted based on actionstaken by a user. This patent continues until April 2020.

*TemporalUpdates of Relevancy Rating of Retrieved Information in an Information SearchSystem.**  *Thisprocess relates to an information search and retrieval system through anetwork, such as the Internet, in which the relative usefulness ranking and theorder of display of the retrieved information in the knowledgebase is adjustedbased on the amount of time elapsed since the particular information was lastaccessed. This patent continues until April 2020.

*UsageBased Strength between Related Information in an Information Retrieval System.**  *This patent describes aninformation retrieval system in which information is displayed based onnavigation behavior of previous users. This patent continues until April 2020.

*Systemand Method for Generating a Dynamic Interface via a Communications Network.**  *This patent describes a system fordynamically adapting selections in an automatic phone support system. Thisinvention enables the provision of information from a dynamic knowledgebase viaa telephone channel. This patent continues until June 2020.

*UsageBased Strength between Related Help Topics and Context Based Mapping Thereof ina Help Information retrieval System.*   Thisprocess allows the knowledgebase to suggest related information to a personbased on the keyword search and navigation patterns of that person. This patentcontinues until April 2020.

*DisplayScreen for a Computer.**  *Thisis a design patent relating to the user interface to our software. This patentcontinues until March 2016.

We have been issued the following U.K. patent: *Method for routing Electronic Correspondence Based on the Level andType of Emotion Contained Therein*. This process relates todetermining the emotional content of an electronic correspondence to rout orprioritize the information, to set the expectations of a customer supportworker, to flag those workers who are using inappropriate language with thecustomer, or determine another best course to send the correspondence. In apreferred embodiment, a customer sends an electronic correspondence to acompany by email. Emotionally charged words or symbols in each sentence aredetected. The message is then given an emotional ranking, which is used todetermine what future action is most appropriate for the correspondence. Thispatent continues until October 2022.

We also hold licenses to five United States patentsthat we acquired from a third party.

Our five registered trademarks in the United Statesare RIGHTNOW, RIGHT NOW, RIGHTNOW TECHNOLOGIES (stylized), SMARTASSISTANT ANDLOCATOR. We use our “RightNow” mark as a descriptor of all of our products.These marks continue indefinitely subject to continuous use and payment ofregistration fees at the statutorily required intervals. We also use thefollowing common law 

8

----

marks “RightNow Metrics,” “RightNowOutbound,” “RightNow Marketing”, RightNow Sales”, “RightNow Service”, “SmartSense”,“SmartConversion”, “ProServices”, “RightNow Live”, “RightPractices”, “RightStart”,“Talk RightNow”, “RightFit”, “Multi-View Technology”, “SmartAttributeTechnology”, “iKnow”, and “Salesnet”. Other trademarks, trade names or servicemarks appearing in this report are the property of their respective holders.

We also incorporate anumber of third party software products into our software pursuant to relevantlicenses. Some of the software is proprietary and some is open source. We usethird party software for, among other things, spell checking certain foreignlanguages, improving graphics in our analytics module, language parsing, andlocating and indexing documents on websites, secure data transfer, and formiscellaneous data utilities. These functions are peripheral in nature, we arenot substantially dependent upon these third party software licenses and webelieve the licensed software is generally replaceable, by either licensing orpurchasing similar software from another vendor or building the softwarefunction ourselves.

**Competition**

The CRM software market consists of three major marketsegments: customer service, sales force automation and marketing automation.Within this segmentation, vendors are offering solutions through either ondemand or traditional on premise delivery methods. We compete in all segmentsof the CRM software market and believe that we are the leader in on demandcustomer service.

The market for CRM solutions is highly competitive andfragmented and is subject to rapidly changing technology, shifting clientrequirements, frequent introductions of new products and services, andincreased marketing activities of other industry participants.

We face competition from other companies currentlyproviding customer service solutions, some of which offer hosted services,including BMC Software Corporation, eGain Communications Corporation,FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc.,Microsoft Corporation, Netsuite, Oracle Corporation/Siebel Systems, SAP AG, andsalesforce.com. In interactive voice response technology, competing vendorsinclude Apptera, Edify, IBM, Intervoice, Microsoft, TuVox, Unveil Technologies,and Voxify.

We expect to compete with these and additionalcompanies as we further expand into the CRM market, and as more companiesexpand into the customer service segment. In addition, our solutions competewith CRM systems that are developed and maintained internally by businesses, aswell as CRM products or services that are developed, or bundled with otherproducts or services, and installed on a client’s premises by software vendors.We also face competition from outsourced contact center providers who bundlesolutions and agent labor in their service offerings. To the extent ourcompetitors have an existing relationship with a potential client, that clientmay be unwilling to switch vendors due to the time and financial commitmentsalready made with our competitors.

Many of our current and potential competitors havelonger operating histories and larger presence in the general CRM market,greater name recognition, access to larger customer bases and substantiallygreater financial, technical, sales and marketing, management, service, supportand other resources than we have. As a result, such competitors may be able torespond more quickly than we can to new or changing opportunities,technologies, standards or client requirements or devote greater resources tothe promotion and sale of their products than we can. In addition, many of ourcurrent and potential competitors have established or may establish business,financial or strategic relationships among themselves or with existing orpotential clients, alliance partners or other third parties, or may combine andconsolidate to become more formidable competitors with better resources.

9

----

New companies are entering the CRM software market,the on demand applications market and the on demand CRM market, or expandingfrom any one of these markets to the others. We expect that new competitors,such as enterprise software vendors and online service providers that havetraditionally focused on enterprise resource planning or back officeapplications, will continue to enter the on demand CRM market with competingproducts as the on demand CRM market develops and matures. It is possible thatthese new competitors could rapidly acquire significant market share.

We believe theprincipal factors that generally determine a company’s competitive advantage inthe on demand customer service and broader CRM markets include the following:

·       Lowtotal cost of ownership and easily demonstrable cost-effective benefits forclients;

·       Effectivenessin improving the quality of clients’ interactions with their customers acrosscustomer service, sales and marketing departments;

·       Broadproduct functionality to meet complex client process requirements;

·       Abilityto leverage information from customer interactions to more accurately targetmarketing efforts and enhance revenue opportunities;

·       Speedand ease of implementation;

·       Easeof use and associated high rates of utilization;

·       Systemperformance, security, scalability, flexibility and reliability;

·       Easeof integration with existing applications and data;

·       Availabilityand quality of implementation, consulting and education services;

·       Qualityof client care;

·       Competitivesales and marketing capabilities; and

·       Financialstability and reputation of the vendor.

We cannot assure you thatwe will be successful in all or any of these areas that we believe contributeto competitive advantage, or that we will be able to compete successfullyagainst current or potential competitors, or that competition will not have amaterial adverse effect on our business, financial condition and results ofoperations.

**Employees**

As of December 31,2006, we had 658 full-time employees. Of the total employees, we had 247 insales and marketing, 134 in software development, 138 in professional services,74 in technical support and hosting, and 65 in finance and administration. Noneof our employees are represented by a labor union. We believe that ourrelationship with our employees is good.

**Item 1A.**                RiskFactors

*Before deciding to purchase, hold or sell our commonstock, you should carefully consider the risks described below, in addition tothe other cautionary statements and risks described elsewhere and the otherinformation contained in this Report and in our other filings with the SEC,including our reports on Forms 10-Q and 8-K. The risks anduncertainties described below are not the only ones we face. Additional risksand uncertainties not presently known to us or that we currently deemimmaterial may also affect our business. If any of these known or unknown risksor uncertainties actually occurs with material adverse effects on RightNow, ourbusiness, financial condition and results of operations could be seriouslyharmed. In that event, the market price for our common stock could decline andyou may lose all or part of your investment.*

10

----

***We may not be able to achieve, sustain or increaseprofitability in the future.***

Prior to 2004, we incurredsignificant net losses of approximately $4.1 million in 2003,$2.7 million in 2002 and $15.3 million in 2001. We incurred a netloss of $5.0 million in 2006. As of December 31, 2006, we had anaccumulated deficit of $38.3 million. We expect to continue to incursignificant sales and marketing, research and development and general andadministrative expenses as we expand our operations and, as a result, we willneed to generate significant revenue to achieve profitability. Additionally,beginning in 2007 we expect to sell substantially less perpetual licenses thanin prior years, which will unfavorably impact revenue. Even if we achieveprofitability, we may not be able to increase profitability on a quarterly orannual basis in the future, which may cause the price of our stock to decline.

***Our recently announced business model changes carry anumber of risks which may be harmful to our business.***

In January 2007,we announced that we are changing the nature of our product offerings fromsubstantially all software license agreements to substantially all subscriptionservices agreements. We also intend to largely eliminate sales of perpetuallicenses in 2007 which will negatively and materially affect our operatingresults when compared to 2006. Increased operating losses in 2007 could resultin a significant decline in the price of our common stock. Additionally,customers may choose to pay for their subscription agreements over time insteadof upfront which could reduce our cash flow from operations as compared toprior years. A decline in cash flow from operations could cause investors andmarket analysts to react negatively towards investing in our stock which couldmaterially and adversely affect the price of our stock.  In addition, our subscription strategy cariesa number of additional risks, including:

·       wemay not be able to deliver our products in accordance with the original termsof sale with existing customers;

·       ouraverage price per transaction could decline substantially;

·       wemay see declining demand for our implementation services;

·       wemay not achieve the expected level of market penetration under our subscriptionstrategy; and

·       we may have a short-termand/or long-term decrease in total revenue as a result of this transition.

***Our quarterly results of operations may fluctuate inthe future.***

Our quarterlyrevenue and results of operations may fluctuate as a result of a variety offactors, many of which are outside of our control. If our quarterly revenue orresults of operations fall below the expectations of investors or securitiesanalysts, the price of our common stock could decline substantially.Fluctuations in our results of operations may be due to a number of factors,including, but not limited to, those listed below and identified throughoutthis “Risk Factors” section:

·       ourability to retain and increase sales to existing clients, attract new clientsand satisfy our clients’ requirements;

·       changesin the volume and mix of subscriptions and perpetual licenses sold in aparticular quarter, because perpetual license revenue is recorded into revenueupon delivery whereas subscriptions are recorded into revenue ratably over thecontractual period;

·       oursuccess in shifting our business model away from software license arrangementsand toward subscription services arrangements;

·       ourpolicy of expensing sales commissions when earned under license arrangements,which is typically at the time of invoice, while the majority of our revenue isrecognized ratably over future periods;

11

----

·       changesin the mix of revenue between professional services and software, hosting andsupport, because the gross margin on professional services is typically lowerthan the gross margin on software, hosting and support;

·       changesin the mix of voice self service applications sold and/or usage volume, becausethe gross margin on voice self service applications is typically lower than thegross margin on our sales, marketing, feedback and service applications;

·       thetiming and success of new product introductions or upgrades by us or ourcompetitors;

·       changesin our pricing policies or those of our competitors;

·       theamount and timing of expenditures related to expanding our operations;

·       changesin our assumptions of stock price volatility or employee exercise behaviors, orchanges in the number of stock options granted and vesting requirements in anyparticular period, which effects the amount of stock-based compensationexpense;

·       changesin the payment terms for our products and services, including changes in the mixof payment options chosen by our customers;

·       thepurchasing and budgeting cycles of our clients; and

·       generaleconomic, industry and market conditions.

Because the sales cycle for the evaluation andimplementation of our solutions typically ranges from 60 to 180 days, wemay also experience a delay between increasing operating expenses and thegeneration of corresponding revenue, if any. Moreover, because most of therevenue from new sales agreements is recognized over time, downturns or upturnsin sales may not be immediately reflected in our operating results. Most of ourexpenses, such as salaries and third-party hosting co-location costs, arerelatively fixed in the short-term, and our expense levels are based in part onour expectations regarding future revenue levels. As a result, if revenue for aparticular quarter is below our expectations, we may not be able toproportionally reduce operating expenses for that quarter, causing adisproportionate effect on our expected results of operations for that quarter.

Due to the foregoingfactors, and the other risks discussed in this report, you should not rely onquarter-to-quarter comparisons of our results of operations as an indication ofour future performance.

***If our efforts to enhance existing solutions,introduce new solutions or expand the applications for our products andsolutions to broader CRM markets do not succeed, our ability to grow ourbusiness will be adversely affected.***

Approximately 80% to 90%of our revenue is derived from RightNow Service, a suite of solutions used tooptimize customer service operations. If we are unable to successfully developand sell new and enhanced versions of RightNow Service, or introduce newproducts and solutions for the customer service market, our financialperformance will suffer. Although to date the majority of business has beenfocused on providing solutions for customer service operations, we haveintroduced sales, marketing, feedback and voice-enabled applications to expandour solution offerings. Our efforts to expand beyond the customer servicemarket may not be successful because certain of our competitors have fargreater experience and brand recognition in the broader segments of the CRMmarket. In addition, our efforts to expand our on demand software solutionsbeyond the customer service market may divert management resources from ourexisting operations and require us to commit significant financial resources toa market where we are less proven, which may harm our business, financialcondition and results of operations.

12

----

***We face intense competition, and our failure tocompete successfully could make it difficult for us to add and retain clientsand could reduce or impede the growth of our business.***

The market for CRM solutions is highly competitive andfragmented, and is subject to rapidly changing technology, shifting clientrequirements, frequent introductions of new products and services, andincreased marketing activities of other industry participants. Competition hasintensified with our most recent product releases. Increased competition couldresult in pricing pressure, reduced sales, lower margins or the failure of oursolutions to achieve or maintain broad market acceptance. If we are unable tocompete effectively, it will be difficult for us to add and retain clients, andour business, financial condition and results of operations will be seriouslyharmed.

We face competitionfrom:

·       companiescurrently providing customer service solutions, some of whom offer hostedservices, including BMC Software Corporation, Inc., eGain CommunicationsCorporation, FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc.,Microsoft Corporation, Netsuite, Oracle Corporation/Siebel Systems, SAP AG, andsalesforce.com;

·       CRMsystems that are developed and maintained internally by businesses;

·       CRMproducts or services that are developed, or bundled with other products orservices, and installed on a client’s premises by software vendors;

·       outsourcedcontact center providers who bundle solutions and agent labor in their serviceofferings;

·       newcompanies entering the CRM software market, the on demand applications marketand the on demand CRM market, or expanding from any one of these markets to theothers; and

·       voicesystem integrators and voice-enabled IVR technology providers, such as Apptera,IBM, Intervoice, Microsoft, TuVox, Voxify, and Unveil Technologies.

Many of our current and potential competitors havelonger operating histories and larger presence in the general CRM market,greater name recognition, access to larger customer bases and substantiallygreater financial, technical, sales and marketing, management, service, supportand other resources than we have. As a result, such competitors may be able torespond more quickly than we can to new or changing opportunities,technologies, standards or client requirements or devote greater resources tothe promotion and sale of their products and services than we can. To theextent our competitors have an existing relationship with a potential client,that client may be unwilling to switch vendors due to the time and financialcommitments already made with our competitors.

In addition, many of ourcurrent and potential competitors have established or may establish business,financial or strategic relationships among themselves or with existing orpotential clients, alliance partners or other third parties, or may combine andconsolidate to become more formidable competitors with better resources. Forexample, in January 2006, Oracle Corporation completed its acquisition ofSiebel Systems, Inc. We also expect that new competitors, such asenterprise software vendors and online service providers that havetraditionally focused on enterprise resource planning or back officeapplications, will continue to enter the on demand CRM market with competingproducts as the on demand CRM market develops and matures. For example,Microsoft recently announced its intention to offer on demand CRM applicationsto the small business market. It is possible that these new competitors couldrapidly acquire significant market share.

13

----

***The market for our on demand application services isat an early stage of development, and if it does not develop or develops moreslowly than we expect, our business will be harmed.***

The market for ondemand application services is at an early stage of development, and it isuncertain whether these application services will achieve and sustain highlevels of demand and market acceptance. Our success will depend to asubstantial extent on the willingness of companies to increase their use of ondemand application services in general and for on demand customer relationshipmanagement applications in particular. The willingness of companies to increasetheir use of any on demand application services is in part dependent on theactual and perceived reliability of hosted solutions. In addition, manycompanies have invested substantial personnel and financial resources tointegrate traditional enterprise software into their businesses, and thereforemay be reluctant or unwilling to migrate to on demand application services.While we have supported traditional on site deployment of our softwareapplications, widespread market acceptance of our on demand software solutionsis critical to the success of our business. Other factors that may affect themarket acceptance of our solutions include:

·       ondemand security capabilities and reliability;

·       concernswith entrusting a third party to store and manage critical customer data;

·       ourability to meet the needs of broader segments of the CRM market or other ondemand markets;

·       thelevel of customization we offer;

·       ourability to continue to achieve and maintain high levels of client satisfaction;

·       concernswith purchasing critical CRM solutions from a company with a history ofoperating losses;

·       customeracceptance of our subscription sales arrangements beginning in 2007; and

·       theprice, performance and availability of competing products and services.

If businesses do notperceive the benefits of on demand solutions in general, or our on demandsolutions in particular, then the market for these solutions may not developfurther, or it may develop more slowly than we expect, either of which wouldadversely affect our business, financial condition and results of operations.

***Failure to effectively develop and expand our salesand marketing capabilities could harm our ability to increase our client baseand achieve broader market acceptance of our solutions.***

Increasing our client baseand achieving broader market acceptance of our solutions will depend to asignificant extent on our ability to expand our sales and marketing operations.We plan to continue to expand our sales and marketing resources and engageadditional third-party channel partners, both domestically and internationally.This expansion will require us to invest significant financial and otherresources. Our business will be seriously harmed if our efforts do not generatea corresponding significant increase in revenue. We may not achieve anticipatedrevenue growth from expanding our sales and marketing resources if we areunable to hire and develop talented sales and marketing personnel, if our newsales personnel are unable to achieve desired productivity levels in areasonable period of time, or if we are unable to retain our existing sales andmarketing personnel. We also may not achieve anticipated revenue growth fromour third-party channel partners if we are unable to attract and retainadditional motivated channel partners, if any existing or future channelpartners fail to successfully market, resell, implement or support oursolutions for their customers, or if they represent multiple providers anddevote greater resources to market, resell, implement and support competingproducts and services.

14

----

***The majority of our solutions are sold pursuant totime-based agreements, and if our existing clients elect not to renew or torenew on terms less favorable to us, our business, financial condition andresults of operations will be adversely affected.***

Our solutions aregenerally sold pursuant to time-based agreements that are typically subject torenewal every two years or less and our clients have no obligation to renew.Because our clients may elect not to renew, we may not be able to consistentlyand accurately predict future renewal rates. Our clients’ renewal rates maydecline or fluctuate as a result of a number of factors, including their levelof satisfaction with our solutions, their ability to continue their operationsor invest in customer service, their acceptance of our intended change from aterm license agreement to a subscription service agreement beginning in 2007,or the availability and pricing of competing products. If large numbers ofexisting clients do not renew, or renew on terms less favorable to us, and if wecannot replace or supplement those non-renewals with new agreements generatingthe same or greater level of revenue, our business, financial condition andresults of operations will be adversely affected.

***We have experienced rapid growth in recent periods. Ifwe fail to manage our growth effectively, we may be unable to execute ourbusiness plan, maintain high levels of service or adequately addresscompetitive challenges.***

We have substantially expanded our overall business,headcount and operations in recent periods. We have increased our total numberof full-time employees to 658 at December 31, 2006 from 530 at December 31,2005. To achieve our business objectives, we will need to continue to expandour business at a rapid pace. This expansion has placed, and is expected tocontinue to place, a significant strain on our managerial, administrative,operational, financial and other resources. We anticipate that this expansionwill require substantial management effort and significant additional investmentin our infrastructure. If we are unable to successfully manage our growth, ourbusiness, financial condition and results of operations will be adverselyaffected.

Part of the challengethat we expect to face in the course of our expansion is to maintain the highlevel of customer service to which our clients have become accustomed. To date,we have focused on providing personalized account management and customerservice on a frequent basis to ensure our clients are effectively leveragingthe capabilities of our solution. We believe that much of our success to datehas been the result of high client satisfaction, attributable in part to thisfocus on client service. To the extent our client base grows, we will need toexpand our account management, client service and other personnel, andthird-party channel partners, in order to enable us to continue to maintainhigh levels of client service and satisfaction. If we are not able to continueto provide high levels of client service, our reputation, as well as ourbusiness, financial condition and results of operations, could be harmed.

***If there are interruptions or delays in our hostingservices through third-party error, our own error or the occurrence ofunforeseeable events, delivery of our solutions could become impaired, whichcould harm our relationships with clients and subject us to liability.***

As of December 31, 2006, approximately 86% of ourclients were using our hosting services for deployment of our softwareapplications. We generally provide our hosting services for our non-voiceapplications through computer hardware that we own and that is currentlylocated in third-party web hosting co-location facilities maintained andoperated in California, Massachusetts, New Jersey and London, England. In the UnitedKingdom, our voice applications are hosted by a third party who also owns andoperates the hardware on which our applications reside. We do not maintainlong-term supply contracts with any of our hosting providers, and providers donot guarantee that our clients’ access to hosted solutions will beuninterrupted, error-free or secure. Our operations depend on our providers’ability to protect their and our systems in their facilities against damage orinterruption from natural disasters, power or telecommunications failures,criminal acts and similar events. Our back-up computer 

15

----

hardware and systems havenot been tested under actual disaster conditions and may not have sufficientcapacity to recover all data and services in the event of an outage occurringsimultaneously at all hosting facilities. In the event that our hostingfacility arrangements were terminated, or there was a lapse of service oraccidental or willful damage to such facilities, we could experience lengthyinterruptions in our hosting service as well as delays and/or additionalexpense in arranging new facilities and services. Any or all of these eventscould cause our clients to lose access to their important data. In addition,the failure by our third-party hosting facilities to meet our capacityrequirements could result in interruptions in our service or impede our abilityto scale our operations.

Design and mechanicalerrors, spikes in usage volume and failure to follow system protocols andprocedures could cause our systems to fail, resulting in interruptions in ourclients’ service to their customers. Any interruptions or delays in our hostingservices, whether as a result of third-party error, our own error, naturaldisasters or security breaches, whether accidental or willful, could harm ourrelationships with clients and our reputation. This in turn could reduce ourrevenue, subject us to liability, cause us to issue credits or pay penalties orcause clients to fail to renew their licenses, any of which could adverselyaffect our business, financial condition and results of operations. In theevent of damage or interruption, our insurance policies may not adequatelycompensate us for any losses that we may incur.

***If the security of our clients’ confidentialinformation contained in our systems or stored by use of our software isbreached or otherwise subjected to unauthorized access, our hosting service orour software may be perceived as not being secure and clients may curtail orstop using our hosting service and our solutions.***

Our hosting systems andour software store and transmit proprietary information and critical databelonging to our clients and their customers. Any accidental or willfulsecurity breaches or other unauthorized access could expose us to a risk ofinformation loss, litigation and other possible liabilities. If securitymeasures are breached because of third-party action, employee error,malfeasance or otherwise, or if design flaws in our software are exposed andexploited, and, as a result, a third party obtains unauthorized access to anyof our clients’ data, our relationships with clients and our reputation will bedamaged, our business may suffer and we could incur significant liability.Because techniques used to obtain unauthorized access or to sabotage systemschange frequently and generally are not recognized until launched against atarget, we and our third-party hosting co-location facilities may be unable toanticipate these techniques or to implement adequate preventative measures.

***We have significant international sales and aresubject to risks associated with operating in international markets.***

International salescomprised 26% of our revenue for both of the years ended December 31, 2006and 2005. We intend to continue to pursue and expand our international businessactivities. Adverse political and economic conditions could make it difficultfor us to increase our international sales or to operate abroad. Internationaloperations are subject to many inherent risks, including:

·       political,social and economic instability, including conflicts in the Middle East andelsewhere abroad, terrorist attacks and security concerns in general;

·       adversechanges in tariffs and other protectionist laws and business practices thatfavor local competitors;

·       fluctuationsin currency exchange rates;

·       longercollection periods and difficulties in collecting receivables from foreignentities;

·       exposureto different legal standards and burdens of complying with a variety of foreignlaws, including employment, tax, privacy and data protection laws andregulations;

16

----

·       reducedprotection for our intellectual property in some countries;

·       expensesassociated with localizing products for foreign countries, includingtranslation into foreign languages; and

·       importand export license requirements and restrictions of the United States and eachother country in which we operate.

We believe thatinternational sales will continue to represent a significant portion of ourrevenue for the foreseeable future, and that continued growth will requirefurther expansion of our international operations. A substantial percentage ofour international sales are denominated in the local currency. As a result, anincrease in the relative value of the dollar could make our products moreexpensive and potentially less price competitive in international markets. Wehave not entered into any transactions designed to hedge against risks of lossdue to foreign currency fluctuations. Any of these factors may adversely affectour future international sales and, consequently, affect our business, financialcondition and results of operations.

***If we fail to respond effectively to rapidly changingtechnology and evolving industry standards, particularly in the on demand CRMindustry, our solutions may become less competitive or obsolete.***

The CRM industry is characterized by rapidtechnological advances, changes in client requirements, frequent new productand service introductions and enhancements, changes in protocols and evolvingindustry standards. Our hosted business model and the on demand CRM market arerelatively new and may evolve even more rapidly than the rest of the CRMmarket. Competing products and services based on new technologies or newindustry standards may perform better or cost less than our solutions and couldrender our solutions less competitive or obsolete. In addition, because oursolutions are designed to operate on a variety of network hardware and softwareplatforms using a standard Internet web browser, we will need to continuouslymodify and enhance our solutions to keep pace with changes in Internet-relatedhardware, software, communication, browser and database technologies and tointegrate with our clients’ systems as they change and evolve. Furthermore,uncertainties about the timing and nature of new network platforms or technologies,or modifications to existing platforms or technologies, could increase ourresearch and development expenses.

Our software incorporates use of Microsoft’s .NETFramework, and its Smart Client methodology. The .NET Framework is corefunctionality that Microsoft incorporates into operating systems, while theSmart Client methodology enables development and deployment of softwareapplications using the .NET Framework. We believe that the .NET Framework andSmart Client enable us to provide users with a richer experience and betterfunctionality that would be possible using a pure Web-based application. However,the .NET Framework has not been universally adopted. If software users do notadopt the .NET Framework or if the .NET Framework is superseded, the potentialmarket for our solutions will be reduced and we may need to develop analternative architecture.

If we are unable tosuccessfully develop and market new and enhanced solutions that respond in atimely manner to changing technology and evolving industry standards, and if weare unable to satisfy the diverse and evolving technology needs of our clients,our business, financial condition and results of operations will suffer.

***Our failure to attract and retain qualified or keypersonnel may prevent us from effectively developing, marketing, selling,integrating and supporting our products.***

Our success and futuregrowth depends to a significant degree upon the skills, experience, performanceand continued service of our senior management, engineering, sales, marketing,service, support and other key personnel. Specifically, we believe that ourfuture success is highly dependent on 

17

----

GregGianforte, our founder, Chairman and Chief Executive Officer. In addition, wedo not have employment agreements with any of our senior management or keypersonnel that require them to remain our employees and, therefore, they couldterminate their employment with us at any time without penalty. If we lose theservices of Mr. Gianforte or any of our other key personnel, our businesswill be severely disrupted and we may be unable to operate effectively. We donot maintain “key person” life insurance policies on any of our key employeesexcept Mr. Gianforte. This life insurance policy would not be sufficientto compensate us for the loss of his services. Our future success also dependsin large part upon our ability to attract, train, integrate, motivate andretain highly skilled employees, particularly sales, marketing and professionalservices personnel, software engineers, product trainers, and senior personnel.Competition for these personnel is intense, especially for engineers with highlevels of expertise in designing and developing software and for senior salesexecutives.

***If our solutions fail to perform properly or if theycontain technical defects, our reputation will be harmed, our market sharewould decline and we could be subject to product liability claims.***

Our software products may contain undetected errors ordefects that may result in product failures, slow response times, or otherwisecause our products to fail to perform in accordance with client expectations.Because our clients use our products for important aspects of their business,any errors or defects in, or other performance problems with, our productscould hurt our reputation and may damage our clients’ businesses. If thatoccurs, we could lose future sales, or our existing clients could elect to notrenew or to delay or withhold payment to us, which could result in an increasein our provision for doubtful accounts and an increase in collection cycles foraccounts receivable. Clients also may make warranty claims against us, whichcould result in the expense and risk of litigation. Product performanceproblems could result in loss of market share, failure to achieve marketacceptance and the diversion of development resources. If one or more of ourproducts fails to perform or contains a technical defect, a client may assert aclaim against us for substantial damages, whether or not we are responsible forthe product failure or defect. We do not currently maintain any warrantyreserves.

Product liability claimscould require us to spend significant time and money in litigation or to paysignificant settlements or damages. Although we maintain general liabilityinsurance, including coverage for errors and omissions, this coverage may notbe sufficient to cover liabilities resulting from such product liabilityclaims. Also, our insurer may disclaim coverage. Our liability insurance alsomay not continue to be available to us on reasonable terms, in sufficientamounts, or at all. Any product liability claims successfully brought againstus would cause our business to suffer.

***If we are unable to protect our intellectual propertyrights, our competitive position could be harmed or we could be required toincur significant expenses to enforce our rights.***

Our success depends to asignificant degree upon the protection of our software and other proprietarytechnology rights. We rely on trade secret, copyright and trademark laws,patents and confidentiality agreements with employees and third parties, all ofwhich offer only limited protection. The steps we have taken to protect ourintellectual property may not prevent misappropriation of our proprietary rightsor the reverse engineering of our solutions. We may not be able to obtain anyfurther patents or trademarks, and our pending applications may not result inthe issuance of patents or trademarks. Any of our issued patents may not bebroad enough to protect our proprietary rights or could be successfullychallenged by one or more third parties, which could result in our loss of theright to prevent others from exploiting the inventions claimed in thosepatents. Furthermore, legal standards relating to the validity, enforceabilityand scope of protection of intellectual property rights in other countries areuncertain and may afford little or no effective protection of our proprietarytechnology. Consequently, we may be unable to prevent our proprietary technologyfrom being exploited abroad, which could diminish international sales orrequire costly efforts to protect our technology. Policing the unauthorized useof our products, trademarks and 

18

----

otherproprietary rights is expensive, difficult and, in some cases, impossible.Litigation may be necessary in the future to enforce or defend our intellectualproperty rights, to protect our trade secrets or to determine the validity andscope of the proprietary rights of others. Such litigation could result in substantialcosts and diversion of management resources, either of which could harm ourbusiness. Accordingly, despite our efforts, we may not be able to prevent thirdparties from infringing upon or misappropriating our intellectual property.

***Our product development efforts may be constrained bythe intellectual property of others, and we may become subject to claims ofintellectual property infringement, which could be costly and time-consuming.***

The software and Internetindustries are characterized by the existence of a large number of patents,trademarks and copyrights, and by frequent litigation based upon allegations ofinfringement or other violations of intellectual property rights. As we seek toextend our CRM product and service offerings, we may be constrained by theintellectual property rights of others. We have in the past been named as adefendant in a lawsuit alleging intellectual property infringement, and we mayagain in the future have to defend against intellectual property lawsuits. Wemay not prevail in any future intellectual property infringement litigationgiven the complex technical issues and inherent uncertainties in litigation.Any claims, regardless of their merit, could be time-consuming and distractingto management, result in costly litigation or settlement, cause productdevelopment delays, or require us to enter into royalty or licensingagreements. If any of our products violate third-party proprietary rights, wemay be required to re-engineer our products or seek to obtain licenses fromthird parties, which may not be available on reasonable terms or at all.Because our sales agreements typically require us to indemnify our clients fromany claim or finding of intellectual property infringement, any such litigationor successful infringement claims could adversely affect our business,financial condition and results of operations. Any efforts to re-engineer ourproducts, obtain licenses from third parties on favorable terms or license asubstitute technology may not be successful and, in any case, may substantiallyincrease our costs and harm our business, financial condition and results ofoperations. Further, our software products contain open source softwarecomponents that are licensed to us under various public domain licenses. Whilewe believe we have complied with our obligations under the various applicablelicenses for open source software that we use, there is little or no legalprecedent governing the interpretation of many of the terms of certain of theselicenses and therefore the potential impact of such terms on our business issomewhat unknown. Use of open source standards also may make us more vulnerableto competition because the public availability of open source software couldmake it easier for new market entrants and existing competitors to introducesimilar competing products quickly and cheaply.

***Future acquisitions could disrupt our business andharm our financial condition and results of operations.***

In order to expandour addressable market, we may decide to acquire additional businesses,products and technologies. In May 2005, we acquired the assets ofConvergent Voice and in May 2006, we acquired Salesnet, Inc.  Acquisitions could require significant capitalinfusions and could involve many risks, including, but not limited to, thefollowing:

·       anacquisition may negatively impact our results of operations because it mayrequire incurring large one-time charges, substantial debt or liabilities; itmay require the amortization or write down of amounts related to deferredcompensation, goodwill and other intangible assets; or it may cause adverse taxconsequences, substantial depreciation or deferred compensation charges;

·       wemay encounter difficulties in assimilating and integrating the business,technologies, products, personnel or operations of companies that we acquire,particularly if key personnel of the acquired company decide not to work forus;

19

----

·       ourexisting and potential clients and the customers of the acquired company maydelay purchases due to uncertainty related to an acquisition;

·       anacquisition may disrupt our ongoing business, divert resources, increase ourexpenses and distract our management;

·       theacquired businesses, products or technologies may not generate sufficientrevenue to offset acquisition costs;

·       wemay have to issue equity securities to complete an acquisition, which woulddilute our stockholders and could adversely affect the market price of ourcommon stock; and

·       acquisitionsmay involve the entry into a geographic or business market in which we havelittle or no prior experience.

We cannot assure you thatwe will be able to identify or consummate any future acquisitions on favorableterms, or at all. If we do pursue any future acquisitions, it is possible thatwe may not realize the anticipated benefits from the acquisitions or that thefinancial markets or investors will negatively view the acquisitions. Even ifwe successfully complete an acquisition, it could adversely affect ourbusiness, financial condition and results of operations.

***Changes to financial accounting standards may affectour results of operations and financial condition.***

Generally acceptedaccounting principles and accompanying accounting pronouncements,implementation guidelines and interpretations for many aspects of our business,such as software revenue recognition, accounting for stock-based compensation,and income tax uncertainties, are complex and involve subjective judgments bymanagement. Changes to generally accepted accounting principles, theirinterpretation, or changes in our products or business could significantlychange our reported earnings and financial condition and could add significantvolatility to those measures. For example, since our inception in 1997, we haveused stock options as a fundamental component of our employee compensationprograms. New accounting requirements that began January 1, 2006 make theuse of stock-based compensation much more expensive and introduce additionalvolatility in our results of operations. See Note 1(p) to the CondensedConsolidated Financial Statements and *Management’s Discussionand Analysis of Financial Condition and Results of Operations—CriticalAccounting Policies* in this report for additional information onrecently enacted changes to generally accepted accounting principles.

***The required adoption of SFAS 123R makes stock optionsa less attractive form of employee compensation, and our use of alternativeforms of employee compensation in response to SFAS 123R could adversely affectour ability to attract and retain personnel.***

We have historically usedstock options as a key component of our employee compensation because webelieve it aligns employees’ interests with our stockholders’ interest,encourages employee retention, and provides a competitive component of ouroverall compensation program. Due to the required adoption of SFAS 123R, andthe recording of stock option expense on our operating statements, we maydetermine that it is in our best interest to reduce the number or size of ourstock-based awards, or change the type of awards granted. In doing so, we maynot be able to attract, retain and motivate our employees.

***We may not be able to secure additional financing onfavorable terms, or at all, to meet our future capital needs.***

We may require additionalcapital to respond to business challenges, including the need to develop newsolutions or enhance our existing solutions, enhance our operatinginfrastructure, fund expansion, respond to competitive pressures and acquirecomplementary businesses, products and technologies. Absent sufficient cashflow from operations, we may need to engage in equity or debt financings tosecure 

20

----

additionalfunds to meet our operating and capital needs. In addition, even though we maynot need additional funds, we may still elect to sell additional equity or debtsecurities or obtain credit facilities for other reasons. We may not be able tosecure additional debt or equity financing on favorable terms, or at all, atthe time when we need such funding. If we raise additional funds throughfurther issuances of equity or convertible debt securities, our existingstockholders could suffer significant dilution in their percentage ownership ofour company, and any new equity securities we issue could have rights,preferences and privileges senior to those of holders of our common stock. Anydebt financing secured by us in the future could involve restrictive covenantsrelating to our capital raising activities and other financial and operationalmatters, which may make it more difficult for us to obtain additional capital,to pay dividends and to pursue business opportunities, including potentialacquisitions. In addition, if we decide to raise funds through debt orconvertible debt financings, we may be unable to meet our interest or principalpayments.

***The success of our products and our hosted businessdepends on the continued growth and acceptance of the Internet as a businessand communications tool, and the related expansion of the Internetinfrastructure.***

The future success of our products and our hostedbusiness depends upon the continued and widespread adoption of the Internet asa primary medium for commerce, communication and business applications. Ourbusiness growth would be impeded if the performance or perception of theInternet, or companies providing hosted solutions, was harmed by securityproblems such as “viruses,” “worms” and other malicious programs, reliabilityissues arising from outages and damage to Internet infrastructure, delays indevelopment or adoption of new standards and protocols to handle increaseddemands of Internet activity, increased costs, decreased accessibility andquality of service, or increased government regulation and taxation of Internetactivity.

Federal, state or foreign government bodies oragencies have in the past adopted, and may in the future adopt, laws orregulations affecting data privacy, the solicitation, collection, processing oruse of personal or consumer information, the use of the Internet as acommercial medium and the use of email for marketing or other consumercommunications. In addition, government agencies or private organizations maybegin to impose taxes, fees or other charges for accessing the Internet or forsending commercial email. These laws or charges could limit the growth ofInternet-related commerce or communications generally, result in a decline inthe use of the Internet and the viability of Internet-based services such asours and reduce the demand for our products, particularly our RightNowMarketing solution.

The Internet hasexperienced, and is expected to continue to experience, significant user andtraffic growth, which has, at times, caused user frustration with slow accessand download times. If Internet activity grows faster than Internetinfrastructure or if the Internet infrastructure is otherwise unable to supportthe demands placed on it, or if hosting capacity becomes scarce, our businessgrowth may be adversely affected.

***Privacy concerns and laws or other domestic or foreignregulations may adversely affect our business or reduce sales of our solutions.***

Businesses using our solutions collect personalinformation regarding their customers when those customers contact them withcustomer service inquiries. A valuable component of our solutions is theirability to allow our clients to use and analyze their customers’ information toincrease sales, marketing and up-sell or cross-sell opportunities. Federal,state and foreign government bodies and agencies, however, have adopted and areconsidering adopting laws and regulations regarding the collection, use anddisclosure of personal information obtained from consumers. The costs of compliancewith, and other burdens imposed by, such laws and regulations that areapplicable to the businesses of our clients may limit the use and adoption ofthis component of our solutions and reduce overall demand for our solutions. 

21

----

Furthermore, even where aclient desires to make full use of these features in our solutions, privacyconcerns may cause our clients’ customers to resist providing the personal datanecessary to allow our clients to use our solutions most effectively. Even theperception of privacy concerns, whether or not valid, may inhibit marketacceptance of our products.

European Union members have imposed restrictions onthe collection and use of personal data that are far more stringent, and imposemore significant burdens on subject businesses, than current privacy standardsin the United States. All of these domestic and international legislative andregulatory initiatives may adversely affect our clients’ ability to collectand/or use demographic and personal information from their customers, whichcould reduce demand for our solutions.

In addition to governmentactivity, privacy advocacy groups and the technology and direct marketingindustries are considering various new, additional or different self-regulatorystandards that may place additional burdens on us. If the gathering ofprofiling information were to be curtailed in this manner, customer service CRMsolutions would be less effective, which would reduce demand for our solutionsand harm our business.

***Non-solicitation concerns, laws or regulations mayadversely affect our clients’ ability to perform outbound marketing and otheremail communications, which could reduce sales of our solutions.***

In January 2004, the federal Controlling theAssault of Non-Solicited Pornography and Marketing Act of 2003, or CAN-SPAMAct, became effective. The CAN-SPAM Act regulates the transmission and contentof commercial emails and, among other things, obligates the sender of suchemails to provide recipients with the ability to opt-out of receiving futureemails from the sender, and establishes penalties for the transmission of emailmessages which are intended to deceive the recipient as to source or content.Many state legislatures also have adopted laws that impact the delivery ofcommercial email, and laws that regulate commercial email practices have beenenacted in many of the international jurisdictions in which we do business,including Europe, Australia, and Canada. In addition, Internet serviceproviders and licensors of software products have introduced a variety ofsystems and products to filter out certain types of commercial email, withoutany common protocol to determine whether the recipient desired to receive theemail being blocked. As a result, it is difficult for us to determine inadvance whether or not emails generated by our clients using our solutions willbe permitted by spam filters to reach the intended recipients.

Our RightNow Marketingsolution specifically serves the market for mass distribution marketing andother email communications. The increasing regulation of email delivery, bothdomestically and internationally, and the spam filtering practices of Internetservice providers and email users generally, will place significant additionalburdens on our clients who have outbound communication programs, and may causethose clients to substantially change their outbound communications programs orabandon them altogether. These factors may lead to a reduction in sales of ourRightNow Marketing solution, may make it necessary to redesign our RightNowMarketing solution to make it easier for our clients to conform to therequirements of such laws and standards, which would increase our expenses, ormay make it necessary for us to redefine the market for and use of our RightNowMarketing solution, which could reduce our revenue.

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

Our clients consist oflarge and small companies in nearly all industry sectors and geographies.Potential new clients or existing clients could defer purchases of our productsbecause of unfavorable macroeconomic conditions, such as rising interest rates,fluctuations in currency exchange rates, industry 

22

----

ornational economic downturns, industry purchasing patterns, and other factors.  Our ability to grow revenues may be adverselyaffected by unfavorable economic conditions.

***The significant control over stockholder voting mattersand our office leases that may be exercised by our founder and Chief ExecutiveOfficer will limit your ability to influence corporate actions and may requireus to find alternative office space to lease or buy in the future.***

At December 31, 2006, Greg Gianforte, our founderand Chief Executive Officer, and his spouse, Susan Gianforte, togetherbeneficially owned approximately 28% of our currently outstanding common stockand, together with our other officers and directors, beneficially ownedapproximately 44% of our currently outstanding common stock. In addition, noneof the shares of common stock held by Mr. Gianforte and Mrs. Gianforteare subject to vesting restrictions. As a result, Mr. Gianforte and Mrs. Gianforte,acting together with some of our other officers and directors, may be able tocontrol matters requiring stockholder approval, including the election ofdirectors, management changes and approval of significant corporatetransactions. This concentration of ownership may have the effect of delaying,preventing or deterring a change in control of RightNow, could deprive ourstockholders of an opportunity to receive a premium for their common stock aspart of a sale of RightNow and might reduce the market price of our commonstock.

In addition, Mr. Gianfortebeneficially owns, directly or indirectly, a 50% membership interest in GenesisPartners, LLC, our landlord from whom we lease our principal offices inBozeman, Montana. Consequently, Mr. Gianforte has significant control overany decisions by Genesis Partners regarding renewal, modification ortermination of our Bozeman, Montana leases. In the event that our currentleases with Genesis Partners were terminated or otherwise could not be renewed,or came up for renewal on commercially unreasonable terms, we would be requiredto find alternative office space to lease or buy.

***Anti-takeover provisions in our charter documents andDelaware law could discourage, delay or prevent a change in control of ourcompany and may affect the trading price of our common stock.***

Provisions of ourcertificate of incorporation and bylaws and Delaware law may discourage, delayor prevent a merger or acquisition that a stockholder may consider favorableand may limit the market price of our common stock. These provisions includethe following:

·       establishinga classified board in which only a portion of the total board members will beelected at each annual meeting;

·       authorizingthe board to issue preferred stock;

·       providingthe board with sole authority to set the number of authorized directors and tofill vacancies on the board;

·       limitingthe persons who may call special meetings of stockholders;

·       prohibitingcertain transactions under certain circumstances with interested stockholders;

·       requiringsupermajority approval to amend certain provisions of the certificate ofincorporation; and

·       prohibitingstockholder action by written consent.

It is possible that theprovisions contained in our certificate of incorporation and bylaws, theexistence of super voting rights held by insiders and the ability of our boardof directors to issue preferred stock without stockholder action may have theeffect of delaying, deferring or preventing a change in control of our companywithout further action by the stockholders, may discourage bids for our commonstock at a 

23

----

premiumover the market price of our common stock and may adversely affect the marketprice of our common stock and the voting and other rights of the holders of ourcommon stock.

**Item 1B.**               UnresolvedStaff Comments

None.

**Item 2.**                        Properties

Our corporateheadquarters, including our principal administrative, marketing, technicalsupport and research and development facilities, are located in Bozeman,Montana, where we lease approximately 30,000 square feet with a term thatexpires in March 2011, and approximately 22,000 square feet under twoleases with terms that expire in March and June 2010. In October 2005,we entered into an agreement to lease an additional 29,000 square feet inBozeman beginning early in 2007 when construction is complete. The lease termis expected to be seven years. We also currently occupy a number of domesticand international sales and service offices in California, Illinois, NewJersey, New York, Texas, Washington D.C., Australia, Germany, Holland, Japanand the United Kingdom, where we lease or license the use of an aggregate ofapproximately 66,000 square feet under multiple agreements, which have termsthat expire between March 2007 and February 2014. We believe that ourcurrent facilities are suitable and adequate to meet our current needs, andthat suitable additional or substitute space will be available as needed toaccommodate expansion of our operations. See Note 11(a) to theConsolidated Financial Statements and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Contractual Obligations andCommitments” for information regarding our lease obligations.

**Item 3.**                        LegalProceedings

From time to time, we areinvolved in legal proceedings arising in the ordinary course of business. Webelieve that the resolution of these matters will not have a material effect onour consolidated financial position, results of operations or liquidity.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

No matters were submitted to a vote of securityholders during the fourth quarter of 2006.

24

----

**Part II**

**Item 5.**                     Marketfor Registrant’s Common Equity, Related Stockholder Matters, and IssuerPurchases of Securities

The graph depicted below shows a comparison ofcumulative total stockholder returns for our common stock, the NASDAQ GlobalMarket Index and the Standard Industrial Code Index for Prepackaged Softwarefor the period from August 5, 2004, our initial public offering date, to December 29,2006, the last trading day of 2006.

ASSUMES $100INVESTED ON AUG. 5, 2004ASSUMES DIVIDEND REINVESTEDFISCAL YEAR ENDING DEC. 31, 2006

The graph above assumes that $100 was invested in thecommon stock of RightNow, and in each index, on August 5, 2004, and thatall dividends were reinvested. RightNow has not paid or declared any cashdividends on its common stock. The Standard Industrial Code (“SIC”) used is7372—Prepackaged Software.

Notwithstanding anythingto the contrary set forth in any of our previous filings made under theSecurities Act of 1933, as amended, or the Securities Exchange Act of 1934, asamended, that might incorporate future filings made by us under those statutes,neither the preceding Stock Performance Graph, nor the information relating toit, is “soliciting material” or is “filed” or is to be incorporated byreference into any such prior filings, nor shall such graph or information beincorporated by reference into any future filings made by us under thosestatutes.

25

----

**Market Informationfor Common Stock**

Ourcommon stock is traded on the Nasdaq Global Market under the symbol RNOW. Thetable below reflects the quarterly high and low per share sales prices of ourcommon stock for the period January 1, 2005 through December 31,2006, as reported by the Nasdaq Global Market. These prices represent pricesamong dealers, do not include retail markups, markdowns or commissions, and maynot represent actual transactions.

| **Quarter Ended**             | ** ** | ** ** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** |
|------------------------------------|------------|------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Year ended  December 31, 2005 |       |       |       |            |       |            |       |            |       |
| Common stock price per  share:     |       |       |       |            |       |            |       |            |       |
| High                               |       | $          | 17.70      |            | $          | 12.44           |       | $               | 15.00      |            | $          | 20.06 |   |
| Low                                |       | 10.99      |       | 7.45            |       | 10.78           |       | 12.62           |       |
| Year ended  December 31, 2006 |       |       |       |            |       |            |       |            |       |
| Common stock price per  share:     |       |       |       |            |       |            |       |            |       |
| High                               |       | $          | 20.00      |            | $          | 19.49           |       | $               | 17.10      |            | $          | 18.21 |   |
| Low                                |       | 14.93      |       | 13.90           |       | 11.84           |       | 15.00           |       |

 

**Holders**

On February 21, 2007,there were approximately 92 holders of record of our common stock.

**Dividends**

We have never declared orpaid cash dividends on our capital stock since converting from an S corporationto a C corporation at the end of 1999. We currently intend to retain futureearnings, if any, to finance the growth and development of our business, andtherefore do not anticipate paying any cash dividends in the foreseeablefuture.

**Unregistered Salesof Equity Securities**

None.

**Use of Proceedsfrom Sales of Registered Securities**

On August 5, 2004, the Securities and ExchangeCommission declared effective our Registration Statement on Form S-1(Reg. File No. 333-115331) under the Securities Act of 1933, asamended, in connections with the initial public offering of our common stock,par value $.001 per share. We sold 6.4 million shares, including sharessold upon exercise of the underwriters’ over-allotment option, for an aggregateoffering price of $44.9 million, and 321,945 shares, including shares sold uponexercise of the underwriters’ over-allotment option, were sold by a sellingstockholder for an aggregate offering price of $2.3 million. After deducting$3.3 million in underwriting discounts and commissions and $1.8 million inother offering costs, we received net proceeds from the offering ofapproximately $40 million. None of the expenses and none of our net proceedsfrom the offering were paid directly or indirectly to any director, officer,general partner of RightNow or their associates, persons owning 10% or more ofany class of equity securities of RightNow, or an affiliate of RightNow.

In May 2005, we spent$1 million of the offering proceeds to acquire the assets of Convergent Voice. InMay 2006, we spent $8.7 million of the offering proceeds to acquireSalesnet, Inc. We currently intend to use the remaining proceeds forgeneral corporate purposes as described in the prospectus for the offering. Pendingthese uses, the remaining net proceeds from the offering are invested inshort-term, interest-bearing, investment-grade securities.

26

----

**Purchases of EquitySecurities by the Issuer or Affiliated Purchasers**

We did not repurchase anyof our common stock in the fourth quarter of 2006.

**Item 6.**                        SelectedConsolidated Financial Data

Thefollowing selected consolidated financial data should be read in conjunctionwith the Consolidated Financial Statements and Notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andother financial data included elsewhere in this report. The consolidatedstatement of operations data for the years ended December 31, 2006, 2005and 2004, and the consolidated balance sheet data at December 31, 2006 and2005, are derived from audited consolidated financial statements includedelsewhere in this report. The consolidated statement of operations data for theyears ended December 31, 2003 and 2002, and the consolidated balance sheetdata at December 31, 2004, 2003 and 2002, are derived from audited consolidatedfinancial statements not included in this report. The historical results arenot necessarily indicative of results to be expected in any future period.

| ** **                                       | ** ** | **Year Ended December 31,**                         | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2002**                                                           | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statements of  Operations Data:** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenue:                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                    |       | $                                                                  | 23,338     |   | $ | 29,300 |   | $ | 49,764 |   | $ | 67,944 |   | $ | 86,257 |   |
| Professional services                            |       | 3,603                                                              |       | 6,579 |   | 12,000 |   | 19,204 |   | 24,131 |   |
| Total revenue                                    |       | 26,941                                                             |       | 35,879 |   | 61,764 |   | 87,148 |   | 110,388 |   |
| Cost of revenue:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                    |       | 4,279                                                              |       | 5,263 |   | 6,741 |   | 9,111 |   | 13,260 |   |
| Professional services                            |       | 2,156                                                              |       | 3,740 |   | 7,206 |   | 11,956 |   | 19,110 |   |
| Total cost of revenue                            |       | 6,435                                                              |       | 9,003 |   | 13,947 |   | 21,067 |   | 32,370 |   |
| Gross profit                                     |       | 20,506                                                             |       | 26,876 |   | 47,817 |   | 66,081 |   | 78,018 |   |
| Operating expenses:                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Sales and marketing                              |       | 15,939                                                             |       | 20,809 |   | 31,986 |   | 42,683 |   | 61,504 |   |
| Research and development                         |       | 4,117                                                              |       | 5,915 |   | 7,807 |   | 10,428 |   | 14,478 |   |
| General and administrative                       |       | 2,842                                                              |       | 3,518 |   | 4,621 |   | 6,445 |   | 9,578 |   |
| Total operating expenses                         |       | 22,898                                                             |       | 30,242 |   | 44,414 |   | 59,556 |   | 85,560 |   |
| Income (loss)  from operations                   |       | (2,392                                                             | )          | (3,366 | ) | 3,403 |   | 6,525 |   | (7,542 | ) |
| Interest and  other income , net                 |       | (357                                                               | )          | (215 | ) | 146 |   | 1,646 |   | 3,064 |   |
| Income (loss)  before income taxes               |       | (2,749                                                             | )          | (3,581 | ) | 3,549 |   | 8,171 |   | (4,478 | ) |
| Provision for  income taxes                      |       | —                                                             |       | (539 | ) | (100 | ) | (478 | ) | (530 | ) |
| Net income (loss)                                |       | (2,749                                                             | )          | (4,120 | ) | 3,449 |   | 7,693 |   | (5,008 | ) |
| Preferred stock  accretion                       |       | (33                                                                | )          | (13 | ) | (8 | ) | — |   | — |   |
| Net income (loss)  allocated to common stock     |       | $                                                                  | (2,782     | ) | $ | (4,133 | ) | $ | 3,441 |   | $ | 7,693 |   | $ | (5,008 | ) |
| Net income (loss) per  share(1):                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | $                                                                  | (0.19      | ) | $ | (0.28 | ) | $ | 0.17 |   | $ | 0.25 |   | $ | (0.16 | ) |
| Diluted                                          |       | (0.19                                                              | )          | (0.28 | ) | 0.12 |   | 0.23 |   | (0.16 | ) |
| Shares used in the  computation(1):              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | 14,284                                                             |       | 14,560 |   | 20,738 |   | 30,631 |   | 32,241 |   |
| Diluted                                          |       | 14,284                                                             |       | 14,560 |   | 29,177 |   | 33,695 |   | 32,241 |   |

----

(1)          SeeNote 1 of Notes to Consolidated Financial Statements for an explanation ofthe calculation of basic and diluted income (loss) per share and for anexplanation of the determination of the number of weighted average shares usedfor such calculations.

27

----

| ** **                                 | ** ** | **December 31,**   | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2002**                | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| **Consolidated Balance Sheet  Data:**      |       |                    |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                 |       | $                       | 8,038      |   | $ | 8,360 |   | $ | 18,944 |   | $ | 40,874 |   | $ | 39,208 |   |
| Short-term  investments                    |       | —                  |       | — |   | 31,188 |   | 23,314 |   | 39,127 |   |
| Working capital  (deficit)                 |       | (6,082                  | )          | (9,024 | ) | 32,732 |   | 45,156 |   | 50,374 |   |
| Total assets                               |       | 23,102                  |       | 29,386 |   | 88,309 |   | 123,676 |   | 178,242 |   |
| Deferred revenue                           |       | 24,683                  |       | 35,553 |   | 49,125 |   | 67,923 |   | 114,578 |   |
| Long-term debt,  less current portion      |       | 940                     |       | 484 |   | — |   | 117 |   | 85 |   |
| Redeemable convertible  preferred stock    |       | 32,373                  |       | 32,398 |   | — |   | — |   | — |   |
| Total stockholders’  equity (deficit) |       | (41,291                 | )          | (45,254 | ) | 31,101 |   | 44,655 |   | 47,474 |   |
|                                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

***Cautionary Statement***

*The following discussion and analysis of our financialcondition and results of operations should be read in conjunction with thefinancial statements and related notes in this report. This discussion containsforward-looking statements that involve risks and uncertainties. Theseforward-looking statements are based on our current expectations, estimates andprojections about our industry, management’s beliefs, and certain assumptionsmade by us, all of which are subject to change. Forward-looking statements canoften be identified by words such as “anticipates,” “expects,” “intends,” “plans,”“predicts,” “believes,” “seeks,” “ estimates,” “may,” “will,” “should,” “would,”“could,” “potential,” “continue,” “ongoing,” similar expressions, andvariations or negatives of these words and include, but are not limited to,statements regarding projected results of operations and management’s futurestrategic plans. Our actual results could differ significantly from thoseprojected in the forward-looking statements as a result of factors, includingthose discussed under “Risk Factors” and elsewhere in this report. We assume noobligation to update the forward-looking statements or such risk factors.*

***Overview***

We are a leading provider of customer experiencemanagement software solutions for companies of all sizes.  Our on demand software is designed to gobeyond traditional customer relationship management (“CRM”) solutions to helpcompanies improve their customer experiences, while reducing operating costs. Oursoftware solutions support a business’s external customer-facing channels aswell as sales, marketing and customer service operations.

We released our initial version of RightNow Service in1997. This product addressed the new customer service needs resulting from theincreasing use of the Internet as a customer service channel. Since then, wehave significantly enhanced product features and functionality to addresscustomer service needs across multiple communication channels, including web,interactive voice, email, chat, telephone and proactive outbound emailcommunications. We have also added several products that are complementary toour RightNow Service solution, including RightNow Marketing, RightNow Sales,and RightNow Feedback which automate aspects of marketing campaigns salesoperations, and customer monitoring. In May 2005, we purchased the assetsof Convergent Voice, and added voice enabled-CRM capabilities to our productportfolio. In May 2006, we purchased Salesnet, Inc., a provider ofsalesforce automation solutions. To date, approximately 80% to 90% of ourrevenue has been generated by the RightNow Service suite.

During 2006, we signed 329new customers and added approximately 200 customers through our acquisition ofSalesnet, Inc., to bring our customer base to approximately 1,800. Ourproducts served more than 1 billion customer interactions, or unique sessionshosted by our solutions. Our software solutions are 

28

----

availableeither on a hosted basis, where they are deployed in our co-location facilitiesand accessed on demand by our clients, or on a non-hosted basis, where ourclients deploy them in their own facilities. Approximately 86% of our clientshave elected the hosted option as of December 31, 2006. We distribute oursolutions primarily through direct sales efforts and to a lesser extent throughindirect channels.

***2007 Business Model Changes***

To better align with industry practice, we havechanged the nature of the majority of our product offerings beginning in 2007from software license arrangements to service arrangements (e.g. a “subscription”or “hosting” services). As the industry and business models for “software as aservice” or “on demand” have evolved, the standard form of arrangements areservice agreements rather than licenses of software that can be hosted. Webelieve providing offerings in this manner will ultimately increase our marketpenetration.

Accordingly, our terms of sale have been revised toprovide a hosting service where the customer accesses the software and data viathe Internet. Our previous terms of sale provided the customer a softwarelicense, and customer choice to have the software hosted by us, by themselvesor by someone else. We believe that revenue recognition for servicearrangements will not be materially different from our previous term licensearrangements, as revenue under either type of contract is generally recognizedratably over the period of the agreement. We also believe that additions todeferred revenue will be less than recent history because, under serviceagreements, only the amount currently due from the customer is recorded toaccounts receivable and deferred revenue. Under license agreements, we recordthe full customer commitment to receivables and deferred revenue whether or notcurrently due because we have the contractual right to collect the entirearrangement fee.

In addition, in 2007 we have begun to essentiallydiscontinue selling perpetual software licenses, which represented 21% of ourrevenue for 2006. Although we expect to ultimately increase the lifetime valueof our customer arrangements through subscriptions, the substantial eliminationof perpetual license sales will materially and adversely impact our operatingresults for 2007 when compared to 2006 as perpetual revenue has generally beenrecognized in full upon delivery of the license.

Lastly, our policy forsubscription contract acquisition costs, such as sales commissions, is torecognize them in proportion to the revenue recognized under the subscriptionarrangement. Since we expect the majority of new business to be subscriptionsin 2007, we believe this policy will have a material and beneficial impact onour 2007 and 2008 operating results. Commissions paid on sales of licenses in2007 will continue to be expensed when earned.

***Sources of Revenue***

Our revenue is comprised of fees for software, hostingand support, and fees for professional services.

Software, hosting and support revenue includes feesearned under software license agreements and subscription services agreements. Licenseagreements typically include a software license, hosting services, and supportservices. Our hosting services provide remote management and maintenance of oursoftware and customers’ data which is physically located in third partyfacilities. Customers access “hosted” software and data via secure Internetconnection. Support services include technical assistance for our softwareproducts and unspecified product upgrades on a when and if available basis.

License agreements can be over time (a “term” license)or perpetual. For term licenses, software, hosting and support revenue isrecognized ratably over the length of the agreement. The majority of ourrevenue over the past three years has been from the sale of two-year termlicenses. Perpetual license revenue is recorded in full upon delivery of thelicense, and the hosting and support elements are 

29

----

recognized ratably overthe contractual period. Perpetual license revenue has ranged from 21% to 25% ofour revenue during the past three years.

Subscription agreements, which we began to sell in2006 when we acquired Salesnet, Inc., include a bundled fee to access thesoftware and data via our hosting services, and support services. Subscriptionrevenue is recorded ratably over the length of the agreement.

We refer to “recurring revenue” in this report, whichincludes software, hosting and support revenue from term license andsubscription agreements, and post contract support services.

Our sales agreements generally include capacity-basedfees, which are measured primarily by web pages served, user seats,outgoing email transactions, or minutes used, and certain fixed fees. A numberof our agreements provide for additional fees for usage above establishedlevels, which are billed and recognized into revenue when earned.

Professional services revenue is comprised of revenuefrom consulting, education and development services, and reimbursement ofrelated travel costs. Consulting and education services include implementationand best practices consulting. Development services include customizations andintegrations for a client’s specific business application. Professionalservices revenue ranged from 19% to 22% of total revenue in the past threeyears.

Professional services are sold with initial licenseagreements and periodically over the client engagement. The average deploymenttime for our clients is approximately 50 days. Our typical education coursesare billed on a per person, per class basis.

Depending on the size andcomplexity of the client project, our consulting or development servicescontracts are either fixed price/fixed scope or, less frequently, billed on atime and materials basis. We have determined that the professional serviceselement of our software arrangements is not essential to the functionality ofthe software.

***Cost of Revenue and Operating Expenses***

*Costof Revenue.**  *Costof revenue consists primarily of salaries and related expenses (such asemployee benefits and payroll taxes) for our hosting, support and professionalservices organizations, third-party costs and equipment depreciation relatingto our hosting services, third-party costs for voice enabled CRM applications,travel expenses related to providing professional services to our clients,amortization of acquired intangible assets and allocated overhead. We allocatemost overhead expenses, such as office supplies, computer supplies, utilities,rent, depreciation for furniture and equipment, payroll taxes and employeebenefits, based on headcount. As a result, overhead expenses are reflected ineach cost of revenue and operating expense category.  Beginning January 1, 2006, cost ofrevenue also includes stock-based compensation expense.

Our hosting costs are affected by the percentage ofclients who license our products on a hosted basis and the number of times ourclients and their customers use our solutions, which we refer to as customerinteractions. As a result of economies of scale in our hosting infrastructureand declines in computer hardware and telecommunications costs, we were able toreduce hosting costs as a percentage of total revenue in 2003, 2004 and 2005. Hostingcosts increased slightly in 2006, mostly due to the addition of a Europeanhosting center which was in service in the quarter ended September 30,2006. As our client base and solutions usage grows, we intend to continue toinvest additional resources in our hosting services, technical support andprofessional services.

*Salesand Marketing Expenses.**  *Sales and marketing expenses consist primarily ofsalaries and related expenses for employees in sales and marketing, includingcommissions and bonuses, advertising, marketing events, corporatecommunications, product management expenses, travel costs and allocatedoverhead. 

30

----

Beginning January 1,2006, sales and marketing expenses also include stock-based compensationexpense. We expense our sales commissions on license arrangements when earned,which is typically at the time the related sale is invoiced to the client. Forsubscription arrangements, we expense the related sales commission inproportion to the revenue recognized. Since the majority of our historicalrevenue has been from license arrangements recognized over time, we haveexperienced a delay between increasing sales and marketing expenses and therecognition of corresponding revenue. We expect significant additionalincreases in sales and marketing expenses in absolute dollars as we continue tohire additional sales and marketing personnel and increase the level ofmarketing activities.

*Researchand Development Expenses.**  *Research and development expenses consist primarilyof salary and related expenses for development personnel and costs related tothe development of new products, enhancement of existing products, translationfees, quality assurance, testing and allocated overhead. Beginning January 1,2006, research and development expenses also include stock-based compensationexpense. To date, we have not capitalized any software development costsbecause the timing of the commercial releases of our products has substantiallycoincided with the attainment of technological feasibility. As a result,research and development costs have been expensed as incurred. We intend tocontinue to expand and enhance our product offerings. To accomplish this, weplan to hire additional personnel and, from time to time, contract with thirdparties. We expect that research and development expenses will increase inabsolute dollars as we seek to expand our technology and product offerings.

*General and AdministrativeExpenses.*   General and administrative expensesconsist primarily of salary and related expenses for management, finance andaccounting, legal, information systems and human resources personnel,professional fees, other corporate expenses and allocated overhead. Beginning January 1,2006, general and administrative expenses also include stock-based compensationexpense. We anticipate that we will incur additional employee salaries andrelated expenses, professional service fees and insurance costs related to thegrowth of our business and operations.

***Critical Accounting Policies and Estimates***

Our financial statementsand accompanying notes are prepared in accordance with accounting principlesgenerally accepted in the United States. Preparing financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses. These assumptions areaffected by management’s application of accounting policies. Our criticalaccounting policies include revenue recognition, valuation of receivables anddeferred tax assets, and accounting for share-based compensation.

***Revenue Recognition***

We account for the majority of our sales arrangementsin accordance with the American Institute of Certified Public AccountantsStatement of Position (“SOP”) 97-2, *Software RevenueRecognition*, and SOP 98-9, Modification of SOP 97-2, *Software Revenue Recognition With Respect to Certain Transactions*.The application of these rules requires judgment, including theidentification of individual elements in multiple element arrangements, whetherthere is objective and reliable evidence of fair value, including vendorspecific objective evidence (“VSOE”) of fair value, for some or all elements. Customersmay receive certain elements upon delivery or over time. For example, our termlicense arrangements are “bundled” to include a software license which isdelivered immediately, and hosting and support services, which are deliveredcontinuously over the length of the agreement. Fair value for each element doesnot exist since none are sold separately, and consequently, the revenue isrecognized ratably over the length of the agreement. Under a perpetual licensearrangement, VSOE of the hosting and support elements is based on the price chargedat renewal when sold separately, and therefore the license element isrecognized immediately into revenue upon delivery using the residual method,and the hosting and support elements are recognized ratably over thecontractual term.

31

----

We acquired Salesnet, Inc. in May 2006 andwe account for its sales arrangements under Emerging Issues Task Force Issue No. 00-21,*Revenue Arrangements with Multiple Deliverables*(“EITF 00-21”). Under these arrangements, fees charged for access to thesoftware, hosting services, and support services are recognized ratably overthe length of the agreement, and fees charged for professional services arerecognized when delivered. We believe the fees for professional servicesqualify for separate accounting because: a) the services have value to thecustomer on a stand-alone basis; b) objective and reliable evidence of fairvalue exists for these services; and c) performance of the services isconsidered probable and does not involve unique customer acceptance criteria.

Beginning in 2007, we changed the nature of ourproduct offerings from license arrangements to subscription servicearrangements. Subscription arrangements do not provide the customer acontractual right to take possession of the software without significantpenalty. We expect to account for sales of subscription service arrangementsunder EITF 00-21 as described above.

Changes to the elements in our sales arrangements, orour ability to establish VSOE or fair value for those elements, may result in amaterial change to the amount of revenue recorded in a given period.

Our standard payment termsare net 30, although payment within 90 days is considered normal. We provideextended payment terms in certain circumstances. In such cases, judgment is requiredin determining whether our fee is fixed or determinable and the appropriatetiming of revenue recognition. Changes to our practice of providing extendedpayment terms or providing concessions following a sale, may result in amaterial change to the amount of revenue recorded in a given period.

***Allowance for doubtful accounts***

We regularly assess thecollectibility of outstanding customer invoices and, in so doing, we maintainan allowance for estimated losses resulting from the non-collection of customerreceivables. In estimating this allowance, we consider factors such as:historical collection experience; a customer’s current creditworthiness;customer concentration; age of the receivable balance; and general economicconditions that may affect a customer’s ability to pay. Actual customercollections could differ from our estimates and exceed our related lossallowance.

***Income Taxes***

We record income taxes under the asset and liabilitymethod. Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect of a change intax rates on deferred tax assets and liabilities is recognized in income in theperiod that includes the enactment date. When applicable, a valuation allowanceis established to reduce any deferred tax asset when it is determined that itis more likely than not that some portion of the deferred tax asset will not berealized.

We have established avaluation allowance equal to our net deferred tax assets due to uncertaintiesregarding the realization of our net operating loss carryforwards, tax credits,and deductible timing differences. The uncertainty of realizing these benefitsis based primarily on our lack of taxable earnings.

***Share-Based Compensation***

We have adopted theprovisions of Statement of Financial Accounting Standards No. 123(R), *Share Based Payment*, (“SFAS 123R”) beginning January 1,2006 utilizing the modified prospective method. This statement requires thecost of share-based payment arrangements to be recorded in the statement ofoperations. Prior to 2006, the estimated cost of share-based paymentarrangements was disclosed in a 

32

----

footnoteto the financial statements. Share-based compensation amounts are affected byour stock price as well as our assumptions regarding the expected volatility ofour stock, our employee stock option exercise behaviors, and the related incometax effects. Our assumptions are based primarily on our historical information,some of which was developed when we were a private company.

***Recently Issued Accounting Standards***

In March 2006, the Emerging Issues Task Forceissued EITF No. 06-03, *How Taxes Collected andRemitted to Government Authorities Should be Presented in Income Statement(That is, Gross versus Net Presentation)*. The issue addresses hownondiscretionary amounts assessed by government authorities in connection witha transaction with a customer, such as sales, use, value added, and some excisetaxes, should be presented in the financial statements. The conclusion is thatthe presentation of taxes within the scope of this issue on either a gross(included in revenues and costs) or net (excluded from revenues) basis is anaccounting policy decision. The Company’s policy is to present revenue on a netbasis.

SFAS 157, *Fair Value Measurements*,defines fair value, establishes a framework for measuring fair value in GAAP,and enhances disclosures about fair value measurements. This statement applieswhen other accounting pronouncements require fair value measurements; it doesnot require new fair value measurements. SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those years. We do not believe adoption of SFAS 157 willhave a material effect on our financial statements.

In July 2006, theFinancial Accounting Standard Board issued FASB Interpretation 48, *Accounting for Income Tax Uncertainties* (“FIN 48”). FIN 48defines the threshold for recognizing the benefits of tax return positions inthe financial statements as “more-likely-than-not” to be sustained by thetaxing authority. The recently issued literature also provides guidance on thederecognition, measurement and classification of income tax uncertainties,along with any related interest and penalties. FIN 48 also includes guidanceconcerning accounting for income tax uncertainties in interim periods andincreases the level of disclosures associated with any recorded income taxuncertainties. FIN 48 is effective for fiscal years beginning after December 15,2006. The differences between the amounts recognized in the statements offinancial position prior to the adoption of FIN 48 and the amounts reportedafter adoption will be accounted for as a cumulative-effect adjustment recordedto the beginning balance of retained earnings. We believe there will be nomaterial impact to our consolidated financial position or results of operationsupon adoption of FIN 48.

33

----

**Results ofOperations**

Thefollowing table sets forth certain consolidated statements of operations datafor each of the periods indicated, expressed as a percentage of total revenue:

| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenue:                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                                       | 81         | % |   |   | 78 | % |   |   | 78 | % |   |
| Professional services                     |       |                                       | 19         |   |   |   | 22 |   |   |   | 22 |   |   |
| Total revenue                             |       |                                       | 100        |   |   |   | 100 |   |   |   | 100 |   |   |
| Cost of revenue:                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                                       | 11         |   |   |   | 10 |   |   |   | 12 |   |   |
| Professional services                     |       |                                       | 12         |   |   |   | 14 |   |   |   | 17 |   |   |
| Total cost of revenue                     |       |                                       | 23         |   |   |   | 24 |   |   |   | 29 |   |   |
| Gross profit                              |       |                                       | 77         |   |   |   | 76 |   |   |   | 71 |   |   |
| Operating  expenses:                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                       |       |                                       | 51         |   |   |   | 49 |   |   |   | 56 |   |   |
| Research and development                  |       |                                       | 13         |   |   |   | 12 |   |   |   | 13 |   |   |
| General and administrative                |       |                                       | 7          |   |   |   | 7 |   |   |   | 9 |   |   |
| Total operating expenses                  |       |                                       | 71         |   |   |   | 68 |   |   |   | 78 |   |   |
| Income (loss)  from operations            |       |                                       | 6          |   |   |   | 8 |   |   |   | (7 | ) |   |
| Interest and  other income (expense), net |       |                                       | —     |   |   |   | 2 |   |   |   | 3 |   |   |
| Income (loss)  before income taxes        |       |                                       | 6          |   |   |   | 10 |   |   |   | (4 | ) |   |
| Provision for  income taxes               |       |                                       | —     |   |   |   | (1 | ) |   |   | (1 | ) |   |
| Net income (loss)                         |       |                                       | 6          | % |   |   | 9 | % |   |   | (5 | )% |   |

 

The followingtable sets forth our on demand customer interactions and our revenue by typeand geography expressed as a percentage of total revenue for each of theperiods indicated.

| ** **                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Customer  interactions (in millions)           |       |                                       | 502        |   |   |   | 744 |   |   | 1,050 |   |
| Revenue by type:                               |       |                                       |       |   |   |   |   |   |   |   |   |
| Recurring (term licenses, hosting and support) |       |                                       | 59         | % |   |   | 53 | % |   | 57 | % |
| Perpetual licenses                             |       |                                       | 22         |   |   |   | 25 |   |   | 21 |   |
| Professional services                          |       |                                       | 19         |   |   |   | 22 |   |   | 22 |   |
| Revenue by  geography in:                      |       |                                       |       |   |   |   |   |   |   |   |   |
| United States                                  |       |                                       | 73         | % |   |   | 74 | % |   | 74 | % |
| Europe                                         |       |                                       | 21         |   |   |   | 18 |   |   | 19 |   |
| Asia Pacific                                   |       |                                       | 6          |   |   |   | 8 |   |   | 7 |   |

 

***Overview of 2006***

Total revenue for 2006 increased 27% over 2005,consisting of similar percentage gains in both software, hosting and supportrevenue and professional services revenue. Within software, hosting andsupport, recurring revenue increased 38% during 2006 while perpetual licenserevenue increased only 4%. Recurring revenue increased in 2006 due to growth inthe number of customers and higher average revenue per customer. We believeperpetual license revenue grew at a much slower pace due to an acceleratedmarket adoption of on demand, or “software as a service”, where customers wouldrather rent the software and hosting service over time as opposed to owning asoftware license outright.

34

----

We added 520 customers to our base in 2006, of whichapproximately 200 were included as part of our acquisition of Salesnet, Inc.in May, 2006. Total active customers at December 31, 2006 wereapproximately 1,800. Revenue per customer improved from the release of newproducts and customer purchases of additional capacity. Sales to customersgreater than $1 billion in annual revenues and the public sector made upapproximately 56% of total revenue in 2006, up from approximately 55% of totalrevenue in 2005 and 53% in 2004.

During 2006 we continued to invest in our operationsby adding capacity and a new European data center for our hosting operations,sales and marketing personnel to focus on new customer acquisition,professional services personnel to support our solution offerings, and softwaredevelopers to broaden and enhance our solution offerings. These investments,and the addition of $4.6 million of stock-based compensation expense in 2006,caused total expenses to increase 46% during 2006. The increase in operatingexpenses combined with a lower proportion of perpetual license revenue resultedin an operating loss of 7% of revenue in 2006.

For the year ended December 31, 2006, wegenerated $27 million of cash from operations compared to $15 million of cashin 2005, and increased our deferred revenue to $115 million at December 31,2006 from $68 million one year earlier, mostly due to increases in the numberand average size of sales transactions in 2006.

As of December 31,2006 we had an accumulated deficit of $38.3 million. This deficit and ourhistorical operating losses were primarily the result of costs incurred in thedevelopment, sales and marketing of our products and for general andadministrative purposes.

***Years Ended December 31, 2004, 2005 and 2006***

***Revenue***

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
| ** **                      | ** ** | **(Amounts in thousands)**       | ** ** |
| Software, hosting and  support: |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Recurring                       |       | $                                          | 36,220     |   | $ | 46,056 |   |   | 27 | % |   | $ | 63,448 |   |   | 38 | % |   |
| Perpetual                       |       | 13,544                                     |       | 21,888 |   |   | 62 |   |   | 22,809 |   |   | 4 |   |   |
| Professional  services          |       | 12,000                                     |       | 19,204 |   |   | 60 |   |   | 24,131 |   |   | 26 |   |   |
| Total revenue                   |       | $                                          | 61,764     |   | $ | 87,148 |   |   | 41 | % |   | $ | 110,388 |   |   | 27 | % |   |

 

Total revenue for 2006 was $110.4 million, an increaseof $23.2 million, or 27%, over total revenue of $87.1 million for 2005.

Software, hosting and support revenue, consisting ofrecurring revenue and perpetual license revenue, increased $18.4 million, or27%, over software, hosting and support revenue of $67.9 million for 2005. Recurringrevenue, comprised of term licenses, hosting and support, gained 38% over 2005primarily due to a 24% increase in the average number of customers and an 11%increase in average revenue per customer. Total active customers increased toapproximately 1,800 at December 31, 2006 as compared to approximately1,500 at the end of 2005, due in part to our acquisition of Salesnet, Inc.in May, 2006, and from our focus on new customer acquisition in our sales andmarketing organizations.  Average revenueper customer increased as a result of sales of new products, capacity upgrades,and contract renewals. New product sales increased 125% in 2006 over 2005 andincluded RightNow Voice, RightNow Sales, and RightNow Marketing. Customerinteractions, a measure of unique customer sessions hosted in our data centers,exceeded 1 billion in 2006, a 43% increase over 2005. Our client retention ratewas approximately 90% in 2006 and 2005.

35

----

Beginning January 1, 2006, software, hosting andsupport revenue includes the value of certain tools that had been categorizedas professional services revenue in prior periods. This change in revenueclassification follows the transfer of ongoing development and supportresponsibility for these tools from the professional services organization tothe product development organization effective January 1, 2006.

Perpetual license revenue increased $921,000, or 4%,in 2006 over 2005, and decreased as a percentage of total revenue to 21% in2006 from 25% in 2005. The mix of perpetual license revenue affects ourprofitability in any given period since it is recorded in full into revenueupon delivery instead of being recorded ratably into revenue over time, as isthe case with term licenses. Over the past eight quarters, perpetual licenserevenue has ranged from 17% to 29% of total revenue, but has consistentlydecreased as a percent of our overall new business. We believe this decreaseresults from accelerating customer adoption of on demand software. Beginning in2007, we changed the nature of our sales arrangements from software licenses tosubscriptions, which is expected to largely eliminate new sales of perpetuallicenses. Consequently, we expect a substantial decline in perpetual revenue in2007 when compared to 2006.

Professional services revenue increased $4.9 million,or 26%, in 2006 over 2005, due to growth in the average number of customers andgrowth in average professional services revenue per customer. Average revenueper customer increased during 2006 and 2005 primarily due to our focus onexpanding services offered in conjunction with our broader product offerings. Wealso increased our capacity to deliver professional services by growingheadcount in that organization to 138 at December 31, 2006 from 96 at December 31,2005.

The mix of professional services revenue affects ourprofitability from period-to-period due to the lower gross profit earned onprofessional services as compared to the gross profit earned on software,hosting and support revenue. Professional services revenue represented 22% oftotal revenue in 2006 and 2005 as compared to 19% of revenue in 2004. We expectprofessional services revenue to range between 20% and 25% of total revenue inthe future.

Total revenue for 2005 was $87.1 million, anincrease of $25.4 million, or 41%, over total revenue of$61.8 million for 2004.

Software, hosting and support revenue for 2005 was$67.9 million, an increase of $18.2 million or 37% over software,hosting and support revenue of $49.8 million for 2004. Recurring software,hosting and support revenue grew 27% in 2005 to $46.1 million from $36.2million in 2004, primarily due to a 8% increase in average revenue per client,combined with an 18% increase in average number of clients. Average revenue perclient increased from the release of new products, capacity upgrades, andcontract renewals. New products introduced in recent years representedapproximately 10% of total sales in 2005, and included sales of RightNowMarketing, RightNow Sales, and RightNow Voice. Growth in average number ofclients occurred because of an emphasis within our sales organization on newclient acquisition, combined with our 90% annualized client retention rate.

Perpetual software license revenue increased 62% in2005 to $21.9 million, up from $13.5 million in 2004. We believe perpetuallicense revenue increased in 2005 because of the growing strategic importanceof our products in client organizations, our growing proportion of businesswith large enterprises, and longer client planning horizons.

Professional services revenue increased 60% to $19.2million in 2005 from $12 million in 2004. Average professional services revenueper client increased 36% during 2005, while average number of clients increased18%. Revenue per client increased in 2005 largely as a result of our focus onexpanding services offered in conjunction with the broader product offerings. Weincreased our professional services staff to 96 employees at December 31,2005 from 71 employees at December 31, 2004.

36

----

Revenue from Europeancustomers grew to $20.6 million in 2006 from $15.5 million in 2005 and $12.8 millionin 2004, and revenue from Asia Pacific clients grew to $7.3 million from $7.2million in 2005 and $3.8 million in 2004. Total revenue outside the UnitedStates was 26%, 26% and 27% of total revenue in 2006, 2005 and 2004,respectively. The increase in revenue outside the United States occurredprimarily from expansion of our international sales and marketing activities.

***Cost of Revenue***

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
| ** **                     | ** ** | **(Amounts in thousands)**       | ** ** |
| Software, hosting  and support |       | $                                          | 6,741      |   | $ | 9,111 |   |   | 35 | % |   | $ | 13,260 |   |   | 46 | % |   |
| Professional  services         |       | 7,206                                      |       | 11,956 |   |   | 66 |   |   | 19,110 |   |   | 60 |   |   |
| Total cost of revenue          |       | $                                          | 13,947     |   | $ | 21,067 |   |   | 51 | % |   | $ | 32,370 |   |   | 54 | % |   |

 

Total cost of revenue for 2006 was $32.4 million, anincrease of $11.3 million, or 54%, over total cost of revenue of $21.1 millionin 2005.

Cost of software, hosting and support increased $4.1million, or 46%, in 2006 over 2005 due to capacity additions to our hostingdata centers, including a new data center in London, England, staff additions,and increased hosting volume. Capacity additions to our data centers increaseddepreciation expense in 2006 by $1.3 million over 2005. Salaries and relatedexpenses (i.e. payroll taxes, benefits, bonuses) increased $1.3 million in 2006over 2005 due to growth in headcount. Average employee count in our hosting andtechnical support operations was 68 in 2006 as compared to 58 in 2005. Customerinteractions through our data centers increased 43% in 2006 over 2005, whichincreased third party hosting provider costs by $758,000. 2006 costs alsoinclude stock-based compensation expenses of $193,000. As a percent of theassociated revenue, software, hosting and support costs were 15% in 2006 ascompared to 13% in 2005 due to a lower proportion of perpetual revenue to totalrevenue in 2006 and the cost increases noted above.

Cost of professional services increased $7.2 million,or 60%, in 2006 over 2005 primarily due to employee staff additions and use ofthird party providers for large consulting engagements and capacity management.Average employee count in our professional services organization grew to 124 in2006 from 87 in 2005, which increased salaries and related expenses by $4.4million, and increased travel and entertainment expenses by $836,000. Employeeadditions in 2006 were primarily for delivery consultants located near ourcustomers and technical personnel. Third party fees for certain largeconsulting engagements and capacity management increased contract servicesexpenses by $1.0 million in 2006 over 2005. 2006 professional services costsalso include $471,000 of stock-based compensation expense. As a percent of theassociated revenue, professional services costs increased to 79% in 2006 from62% in 2005 due to the revenue reclassification noted above under the revenuediscussion, increased use of third party providers for large consultingengagements, and the addition of stock-based compensation expense in 2006. Employeetraining and customer scheduling requirements can cause the cost ofprofessional services to fluctuate as a percentage of revenue. We expectprofessional services costs to range between 80% and 85% of the associatedrevenue in 2007.

Total cost of revenue for 2005 was $21.1 million, anincrease of $7.2 million or 51%, over total cost of revenue of $13.9 millionfor 2004.

Cost of software, hosting and support revenueincreased 35% to $9.1 million in 2005 from $6.7 million in 2004. Cost growthduring 2005 resulted from staff additions which increased salaries and relatedexpenses by $1.5 million, hosting capacity additions which increaseddepreciation expense and third-party hosting services by $597,000, andincreased amortization expenses of $124,000 related to the purchase of 

37

----

Convergent Voice in May 2005.The average employee count in our hosting and support operations was 58 in 2005as compared to 43 in 2004. As a percent of the associated revenue, cost ofsoftware, hosting and support declined slightly in 2005 despite significantgrowth in the volume of customer interactions during the year, primarily due toeconomies of scale achieved in providing hosting and support services over abroader base of customers.

Professional services costof revenue increased 66% in 2005 to $12 million from $7.2 million in 2004,primarily due to employee growth. The average number of employees in ourprofessional services organization was 87 during 2005 as compared to 51 in2004, which increased salaries and related expenses by $4.3 million, andincremental travel and living expenses increased $216,000. Professionalservices cost of revenue increased slightly to 62% of the related revenue in2005 from 60% in 2004.

***Operating Expenses***

| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
| ** **                  | ** ** | **(Amounts in thousands)**       | ** ** |
| Sales and  marketing        |       | $                                          | 31,986     |   | $ | 42,683 |   |   | 33 | % |   | $ | 61,504 |   |   | 44 | % |   |
| Research and  development   |       | 7,807                                      |       | 10,428 |   |   | 34 |   |   | 14,478 |   |   | 39 |   |   |
| General and  administrative |       | 4,621                                      |       | 6,445 |   |   | 39 |   |   | 9,578 |   |   | 49 |   |   |
| Total operating expenses    |       | $                                          | 44,414     |   | $ | 59,556 |   |   | 34 | % |   | $ | 85,560 |   |   | 44 | % |   |

 

*Sales and MarketingExpenses*

Sales and marketing expenses of $61.5 million in 2006were 44%, or $18.8 million, greater than expenses of $42.7 million in 2005. Averageemployee count in our sales and marketing organizations increased to 251 in2006 from 195 in 2005, which increased salaries and related expenses by $7.3million, and increased travel and entertainment expenses by $1.6 million. Employeeadditions in 2006 were primarily for direct sales personnel, sales engineers,business development representatives, and marketing personnel. Higher salesvolume in 2006, as measured by revenue plus the change in deferred revenue,increased sales incentive costs by $4.8 million in 2006 over 2005. We alsoincreased expenses for advertising and promotional activities by $2.0 millionin 2006 over 2005. 2006 stock-based compensation expense for our sales andmarketing employees was $1.9 million.

As noted above under “2007 Business Model Changes,” wechanged the nature of our sales arrangements from licenses to subscriptionsbeginning in 2007. Under license arrangements, we expense sales incentives whenearned, which is typically upon contract signing. Under subscriptionarrangements, we defer the related sales incentive costs and expense them inproportion to the revenue recognized. Since we expect the majority of our newsales in 2007 to be subscriptions, this accounting treatment, on its own, wouldbe expected to decrease sales and marketing expenses as a percent of totalrevenue in 2007 as compared to 2006. However, because of the move to largelyeliminate perpetual revenue in 2007 and expected additional investment in salesand marketing personnel and programs in 2007, we expect full year 2007 salesand marketing expenses to remain approximately constant as a percent of revenuewhen compared to 2006.

Sales and marketingexpenses of $42.7 million in 2005 were 33%, or $10.7 million, greater thanexpenses of $32.0 million in 2004. The average employee count in our sales andmarketing organizations grew to 195 in 2005 from 147 in 2004, causing salariesand related expenses to increase $6.3 million. Higher sales volume in 2005increased sales incentive costs by $2.0 million in 2005 over 2004. In addition,we incurred $1.4 million of incremental consulting services in 2005, primarilyrelated to public relations programs and initiatives.

38

----

*Research and DevelopmentExpenses*

Research and development expenses increased $4.1million, or 39%, in 2006 over 2005 primarily due to employee staff additions. Averageemployee count in our research and development organization increased to 125 in2006 from 100 in 2005, which increased salaries and related expenses by $2.9million. Principal activities during 2006 included the development of ournewest product, RightNow 8, which was made generally available to customers in February 2007.Stock-based compensation expense in 2006 for our research and developmentemployees was $834,000.

Research and developmentexpenses increased $2.6 million, or 34%, to $10.4 million in 2005 from $7.8million in 2004. Substantially all of the expense increase resulted from growthin employee salaries and related expenses in 2005.  The average number of employees in ourresearch and development organization was 100 in 2005 as compared to 79 in2004.

*General andAdministrative Expenses*

General and administrative expenses increased $3.1million, or 49%, in 2006 over 2005 mostly due to staff additions andstock-compensation expense. Average employees in our general and administrativeorganization were 59 in 2006 as compared to 41 in 2005, which increasedsalaries and related expenses by $1.5 million. Employee additions in 2006 wereprimarily for finance, accounting and information technology personnel. 2006stock-based compensation expense for general and administrative employees andboard of directors was $1.2 million.

General and administrativeexpenses increased $1.8 million, or 39%, to $6.4 million in 2005 from $4.6 millionin 2004 due to employee additions and incremental third-party costs for auditand compliance. Average employee count in our general and administrativeorganization in 2005 was 41 compared to 31 in 2004, which caused salaries andrelated expenses to increase $938,000 during 2005. Audit and related compliancecosts increased $540,000 in 2005, mostly due to 2005 being the initial year ofour required internal controls reporting under the Sarbanes-Oxley Act of 2002.

*Stock-BasedCompensation Expense*

We adopted the provisionsof SFAS 123R, *Share Based Payment*, beginning January 1,2006 using the modified prospective method. Financial statements for prioryears have not been restated to conform to the 2006 presentation. Totalstock-based compensation expense for 2006 was $4.6 million, which has beenrecorded to each cost of revenue and operating expense category. We estimatethe fair value of stock options issued to employees and non-employee directorsusing the Black-Scholes-Merton option pricing model, which involves complexassumptions regarding our stock price volatility and the expected stock optionexercise behavior of our employees. For 2007, we expect total stock-basedcompensation expense of approximately $6.5 million. The actual expense coulddiffer materially from this estimate due to differences between actualexperience and our assumptions as to the number of option awards granted orforfeited, changes in our stock price volatility and expected term of optionawards, and changes in our stock price.

***Interest and OtherIncome (Expense), Net***

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
| ** **                                      | ** ** | **(Amounts in thousands)**       | ** ** |
| Interest income                                 |       | $                                          | 390        |   | $ | 1,670 |   |   | 328 | % |   | $ | 3,036 |   |   | 82 | % |   |
| Interest expense                                |       | (249                                       | )          | (5 | ) |   | n/m |   |   | (17 | ) |   | n/m |   |   |
| Other income  (expense)                         |       | 5                                          |       | (19 | ) |   | n/m |   |   | 45 |   |   | n/m |   |   |
| Total interest and other  income (expense), net |       | $                                          | 146        |   | $ | 1,646 |   |   | n/m |   |   | $ | 3,064 |   |   | 86 | % |   |

 

39

----

Interest income increased82% in 2006 over 2005 due to growth in the average yield-to-maturity in ourinvestment portfolio, as well as growth in our cash and short-term investmentbalances. Investment yields have risen along with the periodic increases in thefederal funds rate. Our investment portfolio consists primarily of short-term,investment-grade government and corporate debt instruments. Interest incomeincreased 328% in 2005 as compared to 2004 due to a full year of interestearnings on our cash and short-term investments for 2005. We invested themajority of the $40 million proceeds from our initial public offering inAugust 2004. Interest expense for 2006 and 2005, comprised of the interestcomponent under various capital lease obligations, was substantially less than2004 due to the pay-off of our then-outstanding debt in the third quarter of2004. Other income (expense) consists primarily of gains or losses on assetsales and foreign currency transaction gains or losses, which individually and inaggregate have been insignificant for the past three years.

***Provision for Income Taxes***

The provision for income taxes of $530,000 in 2006,$478,000 in 2005, and $100,000 in 2004, consists primarily of the federalalternative minimum tax, foreign withholding taxes, and various state incometaxes. Our effective tax rate differs from the federal statutory rate primarilydue to the utilization of net operating loss carryforwards, tax credits,federal alternative minimum taxes, foreign rate differentials, and non-deductiblemeal and entertainment expenses. Our effective tax rate in 2007 will depend ona number of factors, such as the amount and mix of stock-based compensationexpense to be recorded under SFAS 123R, the level of business in state andforeign tax jurisdictions, management’s expectation of the realization ofdeferred tax assets and the associated valuation allowance, and other factors.

At December 31, 2006,we had approximately $18 million of net deferred tax assets that have beenreserved in full by a valuation allowance. In the future, if available evidenceindicates that it is more likely than not that some or all of our deferred taxassets are realizable, an adjustment to decrease the valuation allowance wouldincrease income or reduce goodwill, in the period such determination was made. Ifand when that happens, our effective income tax rate will increase to moreclosely approximate the federal statutory rate.

**Quarterly Resultsof Operations**

The following table sets forth selected unauditedquarterly consolidated statements of operations data for each of the eightquarters through December 31, 2006. This information is unaudited but, inmanagement’s opinion, has been prepared on the same basis as the auditedconsolidated financial statements and related notes included elsewhere in thisreport and includes all adjustments, consisting only of normal recurringadjustments that our management considers necessary for a fair presentation ofthe information for the quarters presented.

40

----

Thisinformation should be read in conjunction with the audited consolidatedfinancial statements and related notes included elsewhere in this report. Webelieve that quarter-to-quarter comparisons of our financial results are notnecessarily meaningful and should not be relied upon as an indication of futureperformance.

| ** **                         | ** ** | **Mar 31,  2005**                   | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,  2006** | ** ** | **Sep 30,  2006** | ** ** | **Dec 31,  2006** | ** ** |
|------------------------------------|------------|------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                         | ** ** | **(Unaudited) (In thousands)** | ** ** |
| Revenue:                           |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Software, hosting and support      |       | $                                        | 13,874     |                   | $          | 16,864                 |       | $                      | 18,005     |                   | $          | 19,201                 |       | $                      | 19,310     |                   | $          | 20,636 |   | $ | 23,754 |   | $ | 22,557 |   |
| Professional services              |       | 4,468                                    |       | 4,214                  |       | 5,149                  |       | 5,373                  |       | 5,321                  |       | 6,272                  |       | 6,334                  |       | 6,204                  |       |
| Total revenue                      |       | 18,342                                   |       | 21,078                 |       | 23,154                 |       | 24,574                 |       | 24,631                 |       | 26,908                 |       | 30,088                 |       | 28,761                 |       |
| Cost of revenue:                   |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Software, hosting and support      |       | 2,064                                    |       | 2,276                  |       | 2,253                  |       | 2,518                  |       | 2,771                  |       | 3,159                  |       | 3,667                  |       | 3,663                  |       |
| Professional services              |       | 2,696                                    |       | 2,879                  |       | 3,026                  |       | 3,355                  |       | 4,104                  |       | 4,941                  |       | 4,969                  |       | 5,096                  |       |
| Total cost of revenue              |       | 4,760                                    |       | 5,155                  |       | 5,279                  |       | 5,873                  |       | 6,875                  |       | 8,100                  |       | 8,636                  |       | 8,759                  |       |
| Gross profit                       |       | 13,582                                   |       | 15,923                 |       | 17,875                 |       | 18,701                 |       | 17,756                 |       | 18,808                 |       | 21,452                 |       | 20,002                 |       |
| Operating  expenses:               |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Sales and marketing                |       | 9,457                                    |       | 10,557                 |       | 11,248                 |       | 11,421                 |       | 13,726                 |       | 14,852                 |       | 16,535                 |       | 16,391                 |       |
| Research and development           |       | 2,161                                    |       | 2,426                  |       | 2,937                  |       | 2,904                  |       | 3,130                  |       | 3,476                  |       | 3,740                  |       | 4,132                  |       |
| General and administrative         |       | 1,410                                    |       | 1,586                  |       | 1,627                  |       | 1,822                  |       | 2,056                  |       | 2,709                  |       | 2,333                  |       | 2,480                  |       |
| Total operating expenses           |       | 13,028                                   |       | 14,569                 |       | 15,812                 |       | 16,147                 |       | 18,912                 |       | 21,037                 |       | 22,608                 |       | 23,003                 |       |
| Income (loss)  from operations     |       | 554                                      |       | 1,354                  |       | 2,063                  |       | 2,554                  |       | (1,156                 | )          | (2,229                 | )          | (1,156                 | )          | (3,001                 | )          |
| Interest and  other income, net    |       | 292                                      |       | 331                    |       | 440                    |       | 583                    |       | 672                    |       | 768                    |       | 740                    |       | 884                    |       |
| Income (loss)  before income taxes |       | 846                                      |       | 1,685                  |       | 2,503                  |       | 3,137                  |       | (484                   | )          | (1,461                 | )          | (416                   | )          | (2,117                 | )          |
| Provision for  income taxes        |       | (45                                      | )          | (126                   | )          | (160                   | )          | (147                   | )          | 44                     |       | (294                   | )          | (103                   | )          | (177                   | )          |
| Net income (loss)                  |       | $                                        | 801        |                   | $          | 1,559                  |       | $                      | 2,343      |                   | $          | 2,990                  |       | $                      | (440       | )                      | $          | (1,755 | ) | $ | (519 | ) | $ | (2,294 | ) |

 

41

----

Thefollowing table sets forth, for each of the periods indicated, the percentageof total revenue represented by selected items in our consolidated statementsof operations:

| ** **                                | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,  2006** | ** ** | **Sep 30,  2006** | ** ** | **Dec 31,  2006** | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **(Unaudited)**        | ** ** |
| Revenue:                                  |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                   | 76         | %                      |       |                   | 80         | %                      |       |                   | 78         | %                      |       |                   | 78         | %                      |       |   | 78 | % |   |   | 77 | % |   |   | 79 | % |   |   | 78 | % |   |
| Professional services                     |       |                   | 24         |                   |       |                   | 20         |                   |       |                   | 22         |                   |       |                   | 22         |                   |       |   | 22 |   |   |   | 23 |   |   |   | 21 |   |   |   | 22 |   |   |
| Total revenue                             |       |                   | 100        |                   |       |                   | 100        |                   |       |                   | 100        |                   |       |                   | 100        |                   |       |   | 100 |   |   |   | 100 |   |   |   | 100 |   |   |   | 100 |   |   |
| Cost of revenue:                          |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                   | 11         |                   |       |                   | 11         |                   |       |                   | 10         |                   |       |                   | 10         |                   |       |   | 11 |   |   |   | 12 |   |   |   | 12 |   |   |   | 12 |   |   |
| Professional services                     |       |                   | 15         |                   |       |                   | 14         |                   |       |                   | 13         |                   |       |                   | 14         |                   |       |   | 17 |   |   |   | 18 |   |   |   | 17 |   |   |   | 18 |   |   |
| Total cost of revenue                     |       |                   | 26         |                   |       |                   | 25         |                   |       |                   | 23         |                   |       |                   | 24         |                   |       |   | 28 |   |   |   | 30 |   |   |   | 29 |   |   |   | 30 |   |   |
| Gross profit                              |       |                   | 74         |                   |       |                   | 75         |                   |       |                   | 77         |                   |       |                   | 76         |                   |       |   | 72 |   |   |   | 70 |   |   |   | 71 |   |   |   | 70 |   |   |
| Operating  expenses:                      |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                       |       |                   | 51         |                   |       |                   | 50         |                   |       |                   | 48         |                   |       |                   | 47         |                   |       |   | 56 |   |   |   | 55 |   |   |   | 55 |   |   |   | 57 |   |   |
| Research and development                  |       |                   | 12         |                   |       |                   | 12         |                   |       |                   | 13         |                   |       |                   | 12         |                   |       |   | 13 |   |   |   | 13 |   |   |   | 12 |   |   |   | 14 |   |   |
| General and administrative                |       |                   | 8          |                   |       |                   | 7          |                   |       |                   | 7          |                   |       |                   | 7          |                   |       |   | 8 |   |   |   | 10 |   |   |   | 8 |   |   |   | 9 |   |   |
| Total operating expenses                  |       |                   | 71         |                   |       |                   | 69         |                   |       |                   | 68         |                   |       |                   | 66         |                   |       |   | 77 |   |   |   | 78 |   |   |   | 75 |   |   |   | 80 |   |   |
| Income (loss)  from operations            |       |                   | 3          |                   |       |                   | 6          |                   |       |                   | 9          |                   |       |                   | 10         |                   |       |   | (5 | ) |   |   | (8 | ) |   |   | (4 | ) |   |   | (10 | ) |   |
| Interest and  other income (expense), net |       |                   | 1          |                   |       |                   | 2          |                   |       |                   | 2          |                   |       |                   | 2          |                   |       |   | 3 |   |   |   | 3 |   |   |   | 2 |   |   |   | 3 |   |   |
| Income (loss)  before income taxes        |       |                   | 4          |                   |       |                   | 8          |                   |       |                   | 11         |                   |       |                   | 12         |                   |       |   | (2 | ) |   |   | (5 | ) |   |   | (2 | ) |   |   | (7 | ) |   |
| Provision for  income taxes               |       |                   | —     |                   |       |                   | (1         | )                      |       |                   | (1         | )                      |       |                   | —     |                   |       |   | — |   |   |   | (1 | ) |   |   | — |   |   |   | (1 | ) |   |
| Net income (loss)                         |       |                   | 4          | %                      |       |                   | 7          | %                      |       |                   | 10         | %                      |       |                   | 12         | %                      |       |   | (2 | )% |   |   | (6 | )% |   |   | (2 | )% |   |   | (8 | )% |   |

 

Thefollowing table sets forth our deferred revenue and cash provided byoperations, our on demand customer interactions and our revenue by type andgeography expressed as a percentage of total revenue, for each of the periodsindicated:

| ** **                                     | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,  2006** | ** ** | **Sep 30,  2006** | ** ** | **Dec 31,  2006** | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **(Unaudited)**        | ** ** |
| Deferred revenue  (in thousands)               |       | $                      | 52,810     |                   | $          | 57,368                 |       | $                      | 63,752     |                   | $          | 67,923                 |       | $                      | 80,906     |                   | $          | 87,234 |   | $ | 102,620 |   | $ | 114,578 |   |
| Cash provided by  operations (in thousands)    |       | 3,239                  |       | 2,564                  |       | 5,248                  |       | 3,844                  |       | 6,052                  |       | 6,864                  |       | 9,836                  |       | 4,291                  |       |
| Customer  interactions (in millions)           |       | 166                    |       | 176                    |       | 188                    |       | 214                    |       | 281                    |       | 223                    |       | 261                    |       | 285                    |       |
| Revenue by type:                               |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Recurring (term licenses, hosting and support) |       | 58                     | %          | 51                     | %          | 51                     | %          | 53                     | %          | 56                     | %          | 56                     | %          | 56                     | %          | 61                     | %          |
| Perpetual licenses                             |       | 18                     |       | 29                     |       | 27                     |       | 25                     |       | 22                     |       | 21                     |       | 23                     |       | 17                     |       |
| Professional services                          |       | 24                     |       | 20                     |       | 22                     |       | 22                     |       | 22                     |       | 23                     |       | 21                     |       | 22                     |       |
| Revenue by geography:                          |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Americas                                       |       | 75                     | %          | 79                     | %          | 75                     | %          | 68                     | %          | 71                     | %          | 74                     | %          | 79                     | %          | 74                     | %          |
| Europe                                         |       | 15                     |       | 16                     |       | 16                     |       | 23                     |       | 20                     |       | 20                     |       | 16                     |       | 19                     |       |
| Asia Pacific                                   |       | 10                     |       | 5                      |       | 9                      |       | 9                      |       | 9                      |       | 6                      |       | 5                      |       | 7                      |       |
|                                                |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

42

----

Total revenue has trended upward for the quarterlyperiods presented primarily due to increases in the number of new clients andaverage transaction sizes, and contract renewals. Professional services revenuehas ranged from 20% to 24% of total revenue, and generally increased in dollarterms due to the expansion of our service offerings. Quarter to quartervariations in professional services revenue occurs because of customerscheduling requirements, and training and education of newly hired personnel. Costof revenue for software, hosting and support, and professional services, as apercent of total revenue, trended higher in 2006 due to investments in hostingcapacity, the addition of stock-based compensation expense, and lower perpetuallicense revenue.

The mix of term and perpetual software licenses soldin each quarter impacts our quarterly results of operations. For example, inthe quarters ended March 31, 2005 and December 31, 2006, perpetuallicenses represented a lower proportion of total revenue than in other periods,and consequently, income from operations was also lower in those periods. Overthe past eight quarters, perpetual license revenue has trended lower as apercent of our overall new business, which we believe is caused by acceleratingcustomer adoption of on demand software. Beginning in 2007, we have essentiallyeliminated perpetual revenue from our business model and expect a substantialreduction in 2007 perpetual revenue when compared to 2006.

Sales and marketing expenses have increased inabsolute dollar costs, and increased as a percent of revenue in 2006, mostlydue to revenue growth, higher advertising and promotional expenses, theinclusion of stock-based compensation expense, and lower perpetual revenue. Forthe quarters ended September 30, 2005, and December 31, 2005, salesand marketing expenses were lower as a percentage of revenue due to the timingof employee additions and marketing campaigns, and relatively lower commissionsexpense. Consequently, operating income in those quarters was unusually high. Weexpect to substantially reduce perpetual revenue from our results for 2007, andto defer commissions expense pertaining to subscription agreements andrecognize them in proportion to the revenue recognized beginning in 2007. As apercent of revenue, we expect sales and marketing expenses to stayapproximately constant for the full year 2007 as compared to 2006.

The amount andtiming of our operating results generally will vary from quarter to quarterdepending on our level of actual and anticipated business activities. Factorsaffecting quarterly operating results can include, but are not limited to:

·       ourability to retain and increase sales to existing clients, attract new clientsand satisfy our clients’ requirements;

·       changesin the volume and mix of term and perpetual licenses sold in a particularquarter, because perpetual license revenue is recorded into revenue upon deliverywhereas term licenses are recorded into revenue ratably over the period of thelicense;

·       ourpolicy of expensing sales commissions pertaining to license arrangements whenearned, which is typically at the time of invoice, while the majority of our revenueis deferred and recognized ratably over future periods;

·       changesin the mix of revenue between professional services and software, hosting andsupport, because the gross margin on professional services is typically lowerthan the gross margin on software, hosting and support;

·       changesin the mix of voice self-service applications sold and/or usage volume, becausethe gross margin on voice self-service applications is typically lower than thegross margin on our sales, marketing and service applications;

·       thetiming and success of new product introductions or upgrades by us or ourcompetitors;

·       changesin our pricing policies or those of our competitors;

43

----

·       ourability to expand our operations, and the amount and timing of expendituresrelated to this expansion;

·       thecost and availability of hosting services at co-location facilities;

·       ourability to realize efficiencies from our hosting and technical supportoperations;

·       changesin the payment terms for our products and services;

·       thepurchasing and budgeting cycles of our clients;

·       therate of success of our domestic and international expansion;

·       ourability to retain, recruit and hire key executives and technical and sales andmarketing personnel;

·       costsrelated to the development or acquisition of technologies, products orbusinesses;

·       changesin our assumptions of stock price volatility or employee exercise behaviors, orchanges in the number of stock options granted and vesting requirements in anyparticular period, which effects the amount of stock-based compensationexpense;

·       seasonalityin certain of our clients’ purchasing habits; and

·       generaleconomic, industry and market conditions.

Our revenue and operatingresults have been difficult to forecast and may fluctuate, and we believe thatquarter-to-quarter comparisons of our operating results will not necessarily bemeaningful. As a result, you should not rely upon them as an indication of ourfuture performance. We have experienced seasonality in certain aspects of ourbusiness, including lower perpetual license sales in the U.S. in the quarterending March 31, and increased purchasing when our clients’ fiscal yearsare ending. Our U.S. federal government clients’ fiscal years end inSeptember and most of our Japanese clients’ fiscal years end in March.

**Liquidity and Capital Resources**

| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **Percent  Change** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
| ** **                             | ** ** | **(Amounts in thousands)**       | ** ** |
| Deferred revenue                       |       | $                                          | 49,125     |   | $ | 67,923 |   |   | 38 | % |   | $ | 114,578 |   |   | 69 | % |   |
| Cash provided by  operating activities |       | 6,738                                      |       | 14,895 |   |   | 121 |   |   | 27,043 |   |   | 82 |   |   |
|                                        |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We have historically funded our operations with cashfrom operations, equity financings and debt borrowings. In August 2004 wecompleted our initial public offering of approximately 6.4 million shares ofcommon stock and received net proceeds of approximately $40.0 million. Themajority of the offering proceeds are invested in short-term, investment-grade,government and corporate debt securities.

At December 31, 2006, cash and cash equivalents,and short-term investments, totaled $78.3 million. In addition to our cash andshort-term investments, other sources of liquidity at December 31, 2006included a $3.0 million bank line of credit facility, under which there were noborrowings in 2005 or 2006.

Operating activities provided $27.0 million of cashduring the year ended December 31, 2006 as compared to $14.9 million in2005 and $6.7 million in 2004. The majority of our cash from operations in allthree years was from net income (loss) adjusted for non-cash charges and growthin deferred revenue, partially offset by growth in receivables. We typicallybill customers on net 30-day terms at the beginning of the contract period,which is reflected in accounts receivable and deferred revenue.  In periods of 

44

----

increasing sales, we wouldexpect growth in accounts receivable and deferred revenue which, historically,has provided funding for operations. A change in the billing practice resultingin delayed payment terms could have a material adverse effect on cash providedfrom operating activities and growth in deferred revenue. We expect no impactto cash flow from operations as a result of our policy to defer salescommissions under subscription arrangements.

The allowance for uncollectible accounts receivablerepresented approximately 5% of current accounts and term receivables at December 31,2006 and 2005, respectively. Accounts written off in 2006 were relativelyconstant as a percentage of new billings from the previous year. We regularlyassess the adequacy of the allowance for doubtful accounts. Actual write-offscould exceed our estimates and adversely affect operating cash flows in thefuture.

We have approximately $6.6 million of payments due in2007 under contractual obligations and purchase commitments for operating andcapital leases, hosting services and other items. Total purchase commitments atDecember 31, 2006 were $18.6 million to be paid per the schedule below. Webelieve we will generate sufficient cash from operations to satisfy thesecommitments in 2007.

Investing activities consumed $32.3 million in 2006,which included $15.8 million net purchases of short-term investments, $8.7million to acquire Salesnet, Inc., and $7.8 million for capitalexpenditures. Capital asset additions during the past three years consisted ofequipment acquisitions for our hosting operations and employee growth, and areexpected to range between $10 million and $11 million for 2007. Businessacquisitions in 2005 consumed $1 million for the assets of Convergent Voice. Investingactivities provided $1.9 million during 2005, mostly due to the liquidation ofshort-term investments.

Financing activities provided $3.1 million in 2006,$5.4 million in 2005 and $39.2 million in 2004. In 2004 we received $40.0million of proceeds from our initial public offering of common stock. Otherfinancing sources included the exercise of employee stock options under ourequity incentive plan and stock purchases under our employee stock purchaseplan. We had borrowed $1.7 million under long-term debt agreements during thefirst six months of 2004, and subsequently paid down all outstanding long-termdebt during the third quarter of 2004.  In 2005, we borrowed $162,000 related totenant improvements at our headquarters office facility.

We believe our existingcash and short-term investments, together with funds generated from operations,should be sufficient to fund operating and investment requirements for at least****the next twelve months. Our future capitalrequirements will depend on many factors, including our rate of revenue growthand expansion of our sales and marketing activities, the possible acquisitionof complementary products or businesses, the timing and extent of spendingrequired for research and development efforts, and the continuing marketacceptance of our products. To the extent that available funds are insufficientto fund our future activities, we may need to raise additional funds throughpublic or private equity or debt financings. Additional equity or debtfinancing may not be available on terms favorable to us or at all.

**Off-Balance SheetArrangements**

As of December 31,2006, we did not have any significant off-balance-sheet arrangements, asdefined in Item 303(a)(4)(ii) of Regulation S-K promulgated by theSEC.

45

----

**ContractualObligations and Commitments**

Thefollowing table summarizes our contractual payment obligations and commitmentsas of December 31, 2006:

| ** **                                  | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**            | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than   5 years** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                   | ** ** |
| Operating lease  obligations                |       | $                                         | 13,652     |   |   | $ | 3,363 |   |   |   | $ | 5,797 |   |   |   | $ | 3,717 |   |   |   | $ | 775 |   |   |
| Obligations under  capital leases           |       | 117                                       |       |   | 31 |   |   |   | 69 |   |   |   | 17 |   |   |   | — |   |   |
| Purchase  obligations—hosting services |       | 3,161                                     |       |   | 1,816 |   |   |   | 902 |   |   |   | 443 |   |   |   | — |   |   |
| Purchase  obligations—other            |       | 1,656                                     |       |   | 1,357 |   |   |   | 276 |   |   |   | 23 |   |   |   | — |   |   |
| Total                                       |       | $                                         | 18,586     |   |   | $ | 6,567 |   |   |   | $ | 7,044 |   |   |   | $ | 4,200 |   |   |   | $ | 775 |   |   |
|                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We lease our officefacilities and certain office equipment under operating lease agreements thatexpire at various dates through 2014. Obligations under capital leases pertainto certain tenant improvements in our main office facility. Purchaseobligations consist of agreements with third parties to provide co-locationservices for hosting operations, and obligations for marketing and othermiscellaneous services.

**Item 7A.**                Quantitativeand Qualitative Disclosures About Market Risk

***Foreign Currency Exchange Risk***

Our results of operationsand cash flows are subject to fluctuation due to changes in foreign currencyexchange rates, particularly changes in the Euro, British pound, Australiandollar and Japanese yen, because our contracts are frequently denominated inlocal currency. In the future, we may utilize foreign currency forward andoption contracts to manage currency exposures. We do not currently have anysuch contracts in place, nor did we enter into any such contracts during theyears ended December 31, 2005 or December 31, 2006.

***Interest Rate Sensitivity***

Net proceeds from ourinitial public offering of common stock are invested in short-term,interest-bearing securities, which are subject to credit and interest rate risk.Our portfolio is investment-grade and diversified among issuers and securitytypes to reduce credit risk. We manage our interest rate risk by maintaining alarge portion of our investment portfolio in instruments with short maturitiesor frequent interest rate resets. We also manage interest rate risk bymaintaining sufficient cash and cash equivalents such that we are able to holdinvestments until maturity. If market interest rates were to increase by 100basis points from the level at December 31, 2006, the fair value of ourportfolio would decline by approximately $205,000.

**Item 8.**                        FinancialStatements and Supplementary Data

Our consolidated financialstatements, together with our related notes and report of KPMG LLP, ourindependent registered public accounting firm, are set forth on the pages indicatedin Item 15.

**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

None.

46

----

**Item 9A.**                Controlsand Procedures

*(a)**          Evaluationof Disclosure Controls and Procedures*

Our management,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, has evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934). Based upon that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of December 31,2006 our disclosure controls and procedures were effective in ensuring thatinformation required to be disclosed by us in the reports that we file orsubmit under the Securities Exchange Act of 1934 is (i) recorded,processed, summarized and reported, within the time periods specified in the rules andforms of the Securities and Exchange Commission and (ii) accumulated andcommunicated to our management, including our principal executive and principalaccounting officers, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

*(b)**          Changesto Internal Control over Financial Reporting*

During the most recentcompleted fiscal quarter covered by this report, there has been no change inour internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934) that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

**Report ofManagement on Internal Control Over Financial Reporting**

Our management is responsible for establishing andmaintaining a system of internal control over financial reporting as defined underthe Exchange Act Rules 13a-15(f) and 15d-15(f). Internalcontrol over financial reporting is designed to provide reasonable assuranceregarding the reliability of our financial reporting and preparation offinancial statements for external purposes in accordance with U.S. generallyaccepted accounting principles. Internal control over financial reportingincludes maintaining records that in reasonable detail accurately and fairlyreflect our transactions; providing reasonable assurance that transactions arerecorded as necessary for preparation of our financial statements in accordancewith generally accepted accounting principles; providing reasonable assurancethat our receipts and expenditures are made in accordance with authorizationsof our management and directors; and providing reasonable assurance thatunauthorized acquisition, use or disposition of our assets that could have amaterial effect on our financial statements would be prevented or detected on atimely basis. Because of its inherent limitations, internal control overfinancial reporting is not intended to provide absolute assurance that amisstatement of our financial statements would be prevented or detected.

Management conducted anassessment of the effectiveness of our internal control over financialreporting based on the framework in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on this assessment, management concluded that ourinternal control over financial reporting was effective as of December 31,2006. Our independent registered public accounting firm, KPMG LLP has issued anaudit report on management’s assessment of our internal control over financialreporting and their report is included in this Item 9A below.

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of RightNowTechnologies, Inc:

We have audited management’s assessment, included inthe accompanying Report of Management on Internal Control over FinancialReporting, that RightNow Technologies, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring 

47

----

Organizations of theTreadway Commission (COSO). The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of the effectiveness to future periods aresubject to the risk that the controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2006, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by COSO. Also in our opinion, the Company maintained, in all materialrespects, effective internal control over financial reporting as of December 31,2006, based on the criteria established in *Internal Control—IntegratedFramework* issued by COSO.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of the Company and subsidiaries as of December 31,2006 and 2005, and the related consolidated statements of operations,stockholders’ equity (deficit) and comprehensive income (loss), and cash flowsfor each of the years in the three-year period ended December 31, 2006,and our report dated March 14, 2007 expressed an unqualified opinion onthose consolidated financial statements.

/s/  KPMG LLPPortland, OregonMarch 14, 2007

**Item 9B.**               OtherInformation

None.

48

----

**Part III**

**Item 10.**                 Directors,Executive Officers and Corporate Governance

*(a)**          Identificationof Directors.*

The informationunder the captions “Proposal One: Election of Directors” and “CorporateGovernance, Board Composition and Board Committees,” appearing in our proxystatement for our 2007 annual meeting of stockholders, is hereby incorporatedby reference.

*(b)**          Identificationof Executive Officers and Certain Significant Employees.*

The informationunder the caption “Executive Officers,” appearing in our proxy statement forour 2007 annual meeting of stockholders, is hereby incorporated by reference.

*(c)**           Compliancewith Section 16(a) of the Exchange Act.*

The informationunder the caption “Section 16(a) Beneficial Ownership ReportingCompliance,” appearing in our proxy statement for our 2007 annual meeting ofstockholders, is hereby incorporated by reference.

*(d)**          Codeof Ethics.*

Our board ofdirectors has adopted a code of ethics and business conduct that applies to allof our employees, officers (including our principal executive officer,principal financial officer, principal accounting officer or controller, orpersons performing similar functions) and directors. The full text of our codeof ethics and business conduct is posted on our web site at http://www.rightnow.comunder the Investor Relations section. We intend to disclose future amendmentsto certain provisions of our code of ethics and business conduct, or waivers ofsuch provisions, applicable to our directors and executive officers (includingour principal executive officer, principal financial officer, principalaccounting officer or controller, or persons performing similar functions), atthe same location on our web site identified above. The inclusion of our website address in this report does not include or incorporate by reference theinformation on, or accessible through, our web site into this report.

*(e)**           CorporateGovernance.*

The information under thecaption “Corporate Governance, Board Composition and Board Committees”,appearing in our proxy statement for our 2007 annual meeting of stockholders,is hereby incorporated by reference.

**Item 11.**                 ExecutiveCompensation

The information under thecaption “Compensation Disclosure and Analysis” “Compensation Committee Interlocks and Insider Participation,” and “CompensationCommittee Report”, appearing in our proxy statement for our 2007 annual meetingof stockholders, is hereby incorporated herein by reference.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

The information under thecaptions “Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters” and Securities Authorized for Issuance UnderEquity Compensation Plans,” appearing in our proxy statement for our 2007annual meeting of stockholders, is hereby incorporated by reference.

49

----

**Item 13.**                 CertainRelationships and Related Transactions and Director Independence

*(a)**          CertainRelationships and Related Transactions*

The informationunder the caption “Certain Relationships and Related Party Transactions”appearing in our proxy statement for our 2007 annual meeting of stockholders,is hereby incorporated by reference.

*(b)**          DirectorIndependence*

The information under thecaptions “Proposal One: Election of Directors: and “Corporate Governance, BoardComposition and Board Committees”, appearing in our proxy statement for our2007 annual meeting of stockholders, is hereby incorporated by reference.

**Item 14.**                 PrincipalAccountant Fees and Services

The****informationunder the caption “Principal Accountant Fees and Services,” and “AuditCommittee Pre-Approval of Audit and Permissible Non-Audit Services ofIndependent Auditors,” appearing in our proxy statement for our 2007 annualmeeting of stockholders, is hereby incorporated by reference.

50

----

**Part IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules

*(a)(1)**                   FinancialStatements*

|                                                                                    | ** ** | **Page** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|
| Report of  Independent Registered Public Accounting Firm                           |       |     | F-1        |   |   |
| Consolidated Financial  Statements:                                                |       |     |       |   |   |
| Balance Sheets                                                                     |       |     | F-2        |   |   |
| Statements of Operations                                                           |       |     | F-3        |   |   |
| Statements of Stockholders’ Equity (Deficit) and  Comprehensive Income (Loss) |       |     | F-4        |   |   |
| Statements of Cash Flows                                                           |       |     | F-5        |   |   |
| Notes                                                                              |       |     | F-6        |   |   |

 

*(a)(2)**                   FinancialStatement Schedules*

None.

*(a)(3)**                   Exhibits*

The following is a list of exhibits to this report.

| Exhibit  Number   | ** ** | **Description of document**                                                                                                                             |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1*              |       | Amended and restated certificate of incorporation of  the registrant.                                                                                   |
| 3.2±         |       | Amended and restated  bylaws of the registrant.                                                                                                         |
| 10.1*             |       | Form of  indemnification agreement between the registrant and its officers and  directors.                                                         |
| 10.2*             |       | Amended and restated  1998 Long-Term Incentive and Stock Option Plan.                                                                                   |
| 10.3*             |       | 2004 Equity Incentive  Plan.                                                                                                                            |
| 10.4*             |       | 2004 Employee Stock  Purchase Plan.                                                                                                                     |
| 10.5*             |       | Lease agreement dated  July 10, 2000, between Genesis Partners, LLC and the registrant  (relating to property at 40 Enterprise Blvd, Bozeman, MT). |
| 10.6*             |       | Lease agreement dated  July 10, 2000, between Genesis Partners, LLC and the registrant  (relating to property at 77 Discovery Drive, Bozeman, MT). |
| 10.7*             |       | Lease agreement dated  July 10, 2000, between Genesis Partners, LLC and the registrant  (relating to property at 45 Discovery Drive, Bozeman, MT). |
| 10.8*†       |       | Severance policy for  executive officers.                                                                                                               |
| 10.9*†       |       | Form of executive  officer offer letter and schedule of omitted material details thereto.                                                          |
| 10.10*†      |       | Form of executive  officer incentive stock option agreement and schedule of omitted material  details thereto.                                     |
| 10.11*†      |       | Form of executive  officer non-incentive stock option agreement and schedule of omitted material  details thereto.                                 |
| 10.12*            |       | Form of director  non-incentive stock option agreement and schedule of omitted material details  thereto.                                          |
| 10.13o†      |       | Form of Notice of  Grant of Stock Options and Option Agreement.                                                                                    |
| 10.14·† |       | Form of Incentive  Stock Option Agreement.                                                                                                         |
| 10.15·† |       | Form of  Non-Incentive Stock Option Agreement.                                                                                                     |

51

----

 

| 10.16**           |   | Lease agreement dated  March 28, 2005, between RightNow Technologies, Inc. and Genesis  Partners, LLC for office space located at 110 Enterprise Boulevard, Bozeman,  Montana.     |
|-------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17**           |   | Renewed lease agreement,  dated March 28, 2005, between RightNow Technologies, Inc. and  Genesis Partners, LLC for office space located at 77 Discovery Drive,  Bozeman, Montana.  |
| 10.18**           |   | Renewed lease agreement,  dated March 28, 2005, between RightNow Technologies, Inc. and  Genesis Partners, LLC for office space located at 45 Discovery Drive,  Bozeman, Montana.  |
| 10.19†       |   | Form of amended  employment offer letter for executive officers.                                                                                                                        |
| 10.22±† |   | Material differences in  form of executive officer offer letter for Jay Rising.                                                                                                              |
| 10.23±† |   | Letter from the Company  to Peter Dunning, dated October 7, 2006, terminating Mr. Dunning’s  appointment as President of Field Operations.                                    |
| 10.24±† |   | Letter agreement between  the Company and Peter Dunning, dated October 7, 2006, setting forth the  basis of Mr. Dunning’s continued employment with the Company.              |
| 21.1*             |   | Subsidiaries of the  registrant.                                                                                                                                                             |
| 23.1              |   | Consent of KPMG LLP,  Independent Registered Public Accounting Firm.                                                                                                                         |
| 31.1              |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rule 13a-14(a) or  15d-14(a). as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.       |
| 31.2              |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rule 13a-14(a) or  15d-14(a) as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.   |
| 32.1              |   | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

----

*                    Incorporatedby reference to the exhibit of the same number from the Company’s registrationstatement of Form S-1 (File No. 333-115331) initiallyfiled with the Securities and Exchange Commission on May 10, 2004, asamended.

**             Incorporated byreference to the exhibit of the same number from the Company’s current reporton Form 8-K (File No. 000-31321) filed with theSecurities and Exchange Commission on April 1, 2005.

±                Incorporated byreference to Exhibit 3.1 of the Company’s Current Report on Form 8-Kfiled with the Securities and Exchange Commission on January 25, 2006.

o               Incorporatedby reference to the exhibit of the same number from the Company’s annual reporton Form 10-K filed with the Securities and Exchange Commission on March 15,2006.

·                     Incorporatedby reference to exhibits 10.20 and 10.21 from the Company’s quarterly report onForm 10-Q filed with the Securities and Exchange Commission on May 10,2006.

±                Incorporated byreference to exhibits of the same number from the Company’s current report on Form 8-Kfiled with the Securities and Exchange Commission on October 10, 2006.

†                     Denotesmanagement contract or compensatory plan or arrangement.

*(b)**          Exhibits*

The exhibits filesas part of this report are listed in Item 15(a)(3) of this report.

*(c)**           FinancialStatement Schedules*

The financial statement schedules required byRegulation S-X and Item 8 of this report are included in the financialstatements and notes thereto listed in Item 15(a)(2) of this report.

52

----

**Signatures**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
| RIGHTNOW TECHNOLOGIES, INC. | ** **                                                                  |
|----------------------------------|-----------------------------------------------------------------------------|
| By:                              | /s/ SUSAN J. CARSTENSEN                                                     |   |
|                             | Susan J. Carstensen                                                         |   |
|                             | Chief Financial Officer, Vice President, Treasurer  and Assistant Secretary |
|                             | (Principal Financial and Accounting Officer)                                |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the Registrant and in the capacities indicated on March 14,2007.
| Signature               | ** ** | **Title**                                            |
|-------------------------|------------|------------------------------------------------------|
| /s/ GREG R. GIANFORTE   |       | Chairman, Chief  Executive Officer and President     |
| Greg R. Gianforte       |       | (Principal Executive  Officer)                       |
| /s/ RICHARD E. ALLEN    |       | Director                                             |
| Richard E. Allen        |       |                                                 |
| /s/ GREGORY M. AVIS     |       | Director                                             |
| Gregory M. Avis         |       |                                                 |
| /s/ ROGER L. EVANS      |       | Director                                             |
| Roger L. Evans          |       |                                                 |
| /s/ WILLIAM J. LANSING  |       | Director                                             |
| William J. Lansing      |       |                                                 |
| /s/ MARGARET L. TAYLOR  |       | Director                                             |
| Margaret L. Taylor      |       |                                                 |
| /s/ SUSAN J. CARSTENSEN |       | Chief Financial  Officer, Vice President, Treasurer, |
| Susan J. Carstensen     |       | and Assistant Secretary                              |
|                    |       | (Principal Financial and Accounting Officer)         |

 

53

----

**Report ofIndependent Registered Public Accounting Firm**

Board of Directors and StockholdersRightNow Technologies, Inc.:

We have audited the accompanying consolidated balancesheets of RightNow Technologies, Inc. and subsidiaries as of December 31,2006 and 2005, and the related consolidated statements of operations,stockholders’ equity (deficit) and comprehensive income (loss), and cash flowsfor each of the years in the three-year period ended December 31, 2006.These consolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of RightNow Technologies, Inc. and subsidiaries as of December 31,2006 and 2005 and the results of their operations and their cash flows for eachof the years in the three-year period ended December 31, 2006 inconformity with U.S. generally accepted accounting principles.

As discussed in Note 1 to the consolidated financialstatements, effective January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*.

We also audited, in accordance with the standards ofthe Public Company Accounting Oversight Board (United States), theeffectiveness of RightNow Technologies, Inc.’s internal control overfinancial reporting as of December 31, 2006, based on criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) and our report dated March 14 2007 expressed an unqualified opinionon management’s assessment of, and the effective operation of, internal controlover financial reporting.

/s/ KPMG LLP

Portland, OregonMarch 14, 2007

F-1

----

**RIGHTNOW TECHNOLOGIES, INC.Consolidated Balance Sheets**

| ** **                                                                                                                                                           | ** ** | **December 31,**                                          | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2005**                                                       | ** ** | **2006** | ** ** |
| ** **                                                                                                                                                           | ** ** | **(In thousands, except  per share data)** | ** ** |
| **Assets**                                                                                                                                                           |       |                                                           |       |   |   |
| Current assets:                                                                                                                                                      |       |                                                           |       |   |   |
| Cash and cash equivalents                                                                                                                                            |       | $                                                              | 40,874     |   | $ | 39,208 |   |
| Short-term investments                                                                                                                                               |       | 23,314                                                         |       | 39,127 |   |
| Accounts receivable                                                                                                                                                  |       | 25,462                                                         |       | 32,021 |   |
| Term receivables, current                                                                                                                                            |       | 15,376                                                         |       | 23,806 |   |
| Total current receivables                                                                                                                                            |       | 40,838                                                         |       | 55,827 |   |
| Less allowance for doubtful accounts                                                                                                                                 |       | (2,209                                                         | )          | (2,621 | ) |
| Total current receivables, net                                                                                                                                       |       | 38,629                                                         |       | 53,206 |   |
| Prepaid and other current assets                                                                                                                                     |       | 1,993                                                          |       | 2,498 |   |
| Total current assets                                                                                                                                                 |       | 104,810                                                        |       | 134,039 |   |
| Property and equipment, net                                                                                                                                          |       | 6,451                                                          |       | 10,073 |   |
| Term receivables, non-current                                                                                                                                        |       | 10,697                                                         |       | 24,805 |   |
| Intangible assets, net                                                                                                                                               |       | 1,487                                                          |       | 8,836 |   |
| Other assets                                                                                                                                                         |       | 231                                                            |       | 489 |   |
| **Total  Assets**                                                                                                                                                    |       | $                                                              | 123,676    |   | $ | 178,242 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                       | ** ** | ** **                                                     | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                 |       |                                                           |       |   |   |
| Accounts payable                                                                                                                                                     |       | $                                                              | 2,308      |   | $ | 4,417 |   |
| Commissions and bonuses payable                                                                                                                                      |       | 2,910                                                          |       | 4,069 |   |
| Other accrued liabilities                                                                                                                                            |       | 5,733                                                          |       | 7,588 |   |
| Current portion of long-term debt                                                                                                                                    |       | 30                                                             |       | 31 |   |
| Current portion of deferred revenue                                                                                                                                  |       | 48,673                                                         |       | 67,560 |   |
| Total current liabilities                                                                                                                                            |       | 59,654                                                         |       | 83,665 |   |
| Long-term debt,  less current portion                                                                                                                                |       | 117                                                            |       | 85 |   |
| Deferred revenue,  net of current portion                                                                                                                            |       | 19,250                                                         |       | 47,018 |   |
| Total liabilities                                                                                                                                                    |       | 79,021                                                         |       | 130,768 |   |
| Commitments and  contingencies (Note 11)                                                                                                                             |       |                                                           |       |   |   |
| Stockholders’ equity:                                                                                                                                           |       |                                                           |       |   |   |
| Preferred stock, $0.001 par value. Authorized and  undesignated 15,000 shares at December 31, 2005, and 2006, respectively                                      |       | —                                                         |       | — |   |
| Common stock, $0.001 par value. Authorized 150,000  shares; issued and outstanding 31,872 shares and 32,788 shares at  December 31, 2005 and 2006, respectively |       | 32                                                             |       | 33 |   |
| Warrants                                                                                                                                                             |       | —                                                         |       | — |   |
| Additional paid-in capital                                                                                                                                           |       | 78,312                                                         |       | 86,069 |   |
| Accumulated other comprehensive loss                                                                                                                                 |       | (401                                                           | )          | (332 | ) |
| Accumulated deficit                                                                                                                                                  |       | (33,288                                                        | )          | (38,296 | ) |
| Total stockholders’ equity                                                                                                                                      |       | 44,655                                                         |       | 47,474 |   |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                 |       | $                                                              | 123,676    |   | $ | 178,242 |   |

 

See accompanying notes to consolidated financial statements

F-2

----

**RIGHTNOW TECHNOLOGIES, INC.Consolidated Statements of Operations**

| ** **                                      | ** ** | **Year Ended December 31,**                         | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                                           | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | **(In thousands, except per share data)** | ** ** |
| Revenue:                                        |       |                                                               |       |   |   |   |   |
| Software, hosting and support                   |       | $                                                                  | 49,764     |   | $ | 67,944 |   | $ | 86,257 |   |
| Professional services                           |       | 12,000                                                             |       | 19,204 |   | 24,131 |   |
| Total revenue                                   |       | 61,764                                                             |       | 87,148 |   | 110,388 |   |
| Costs of revenue:                               |       |                                                               |       |   |   |   |   |
| Software, hosting and support                   |       | 6,741                                                              |       | 9,111 |   | 13,260 |   |
| Professional services                           |       | 7,206                                                              |       | 11,956 |   | 19,110 |   |
| Total cost of revenue                           |       | 13,947                                                             |       | 21,067 |   | 32,370 |   |
| Gross profit                                    |       | 47,817                                                             |       | 66,081 |   | 78,018 |   |
| Operating  expenses:                            |       |                                                               |       |   |   |   |   |
| Sales and marketing                             |       | 31,986                                                             |       | 42,683 |   | 61,504 |   |
| Research and development                        |       | 7,807                                                              |       | 10,428 |   | 14,478 |   |
| General and administrative                      |       | 4,621                                                              |       | 6,445 |   | 9,578 |   |
| Total operating expenses                        |       | 44,414                                                             |       | 59,556 |   | 85,560 |   |
| Income (loss) from operations                   |       | 3,403                                                              |       | 6,525 |   | (7,542 | ) |
| Interest and other  income (expense):           |       |                                                               |       |   |   |   |   |
| Interest income                                 |       | 390                                                                |       | 1,670 |   | 3,036 |   |
| Interest expense                                |       | (249                                                               | )          | (5 | ) | (17 | ) |
| Other                                           |       | 5                                                                  |       | (19 | ) | 45 |   |
| Total interest and other income (expense), net  |       | 146                                                                |       | 1,646 |   | 3,064 |   |
| Income (loss) before provision for income taxes |       | 3,549                                                              |       | 8,171 |   | (4,478 | ) |
| Provision for income taxes                      |       | (100                                                               | )          | (478 | ) | (530 | ) |
| Net income (loss)                               |       | 3,449                                                              |       | 7,693 |   | (5,008 | ) |
| Preferred stock accretion                       |       | (8                                                                 | )          | — |   | — |   |
| Net income (loss) allocated to common stock     |       | $                                                                  | 3,441      |   | $ | 7,693 |   | $ | (5,008 | ) |
| Net income (loss)  per share:                   |       |                                                               |       |   |   |   |   |
| Basic                                           |       | $                                                                  | 0.17       |   | $ | 0.25 |   | $ | (0.16 | ) |
| Diluted                                         |       | 0.12                                                               |       | 0.23 |   | (0.16 | ) |
| Shares used in the  computation:                |       |                                                               |       |   |   |   |   |
| Basic                                           |       | 20,738                                                             |       | 30,631 |   | 32,241 |   |
| Diluted                                         |       | 29,177                                                             |       | 33,695 |   | 32,241 |   |

 

See accompanying notes to consolidated financial statements

F-3

----

**RIGHTNOW TECHNOLOGIES, INC.Consolidated Statements of Stockholders’ Equity (Deficit) and ComprehensiveIncome (Loss)**

| ** **                                                                                                        | ** ** | **Common stock**                | ** ** | ** ** | ** ** | **Additional  paid-in ** | ** ** | **Accumulated  other  comprehensive  income** | ** ** | **Accumulated** | ** ** | **Total  stockholders’  equity** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|---------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Shares**                           | ** ** | **Amount** | ** ** | **Warrants**                  | ** ** | **capital**                                   | ** ** | **(loss)**      | ** ** | **deficit**                           | ** ** | **(deficit)** | ** ** |
| ** **                                                                                                        | ** ** | **(Amounts in thousands)** | ** ** | ** ** |
| Balance at December 31, 2003                                                                                 |       | 14,727                               |       |       | $          | 15                            |       |                                          |       | $               | —     |                                  |       |   | $ | (912 | ) |   |   | $ | 73 |   |   |   | $ | (44,430 | ) |   |   | $ | (45,254 | ) |   |
| Issuance of common stock:                                                                                         |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Initial public offering, net of offering   costs                                                                  |       | 6,416                                |       |       | 6          |                          |       |                                          | —     |            |       |                                  | 39,966     |   |   |   | — |   |   |   | — |   |   |   | 39,972 |   |   |
| Exercise of stock options                                                                                         |       | 616                                  |       |       | 1          |                          |       |                                          | —     |            |       |                                  | 485        |   |   |   | — |   |   |   | — |   |   |   | 486 |   |   |
| Employee stock purchase plan                                                                                      |       | 98                                   |       |       | —     |                          |       |                                          | —     |            |       |                                  | 690        |   |   |   | — |   |   |   | — |   |   |   | 690 |   |   |
| Conversion of redeemable convertible preferred shares  into common shares                                         |       | 7,265                                |       |       | 7          |                          |       |                                          | —     |            |       |                                  | 32,148     |   |   |   | — |   |   |   | — |   |   |   | 32,155 |   |   |
| Conversion of warrants to acquire redeemable  convertible preferred shares into warrants to acquire common shares |       | —                               |       |       | —     |                          |       |                                          | 291        |            |       |                                  | —     |   |   |   | — |   |   |   | — |   |   |   | 291 |   |   |
| Repurchase of common stock                                                                                        |       | (3                                   | )          |       | —     |                          |       |                                          | —     |            |       |                                  | (2         | ) |   |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Accretion of redeemable preferred shares to  redemption value                                                     |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | (8         | ) |   |   | — |   |   |   | — |   |   |   | (8 | ) |   |
| Comprehensive  income:                                                                                            |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                        |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | — |   |   |   | 3,449 |   |   |   | 3,449 |   |   |
| Unrealized loss on available for sale investments net  of tax of $0                                               |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | (13 | ) |   |   | — |   |   |   | (13 | ) |   |
| Foreign currency translation adjustment                                                                           |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | (665 | ) |   |   | — |   |   |   | (665 | ) |   |
| Total comprehensive loss                                                                                          |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 2,771 |   |   |
| Balance at December 31, 2004                                                                                 |       | 29,119                               |       |       | 29         |                          |       |                                          | 291        |            |       |                                  | 72,367     |   |   |   | (605 | ) |   |   | (40,981 | ) |   |   | 31,101 |   |   |
| Issuance  of common stock:                                                                                        |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock options                                                                                         |       | 2,616                                |       |       | 3          |                          |       |                                          | —     |            |       |                                  | 4,619      |   |   |   | — |   |   |   | — |   |   |   | 4,622 |   |   |
| Employee stock purchase plan                                                                                      |       | 59                                   |       |       | —     |                          |       |                                          | —     |            |       |                                  | 656        |   |   |   | — |   |   |   | — |   |   |   | 656 |   |   |
| Exercise of warrants                                                                                              |       | 78                                   |       |       | —     |                          |       |                                          | (291       | )               |       |                                  | 291        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Tax benefit of stock option exercises                                                                             |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | 366        |   |   |   | — |   |   |   | — |   |   |   | 366 |   |   |
| Fair value of options granted to non-employees                                                                    |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | 13         |   |   |   | — |   |   |   | — |   |   |   | 13 |   |   |
| Comprehensive  income:                                                                                            |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                        |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | — |   |   |   | 7,693 |   |   |   | 7,693 |   |   |
| Unrealized loss on available for sale investments net  of tax of $0                                               |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | (67 | ) |   |   | — |   |   |   | (67 | ) |   |
| Foreign currency translation adjustment                                                                           |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | 271 |   |   |   | — |   |   |   | 271 |   |   |
| Total comprehensive income                                                                                        |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | 7,897 |   |   |
| Balance at December 31, 2005                                                                                 |       | 31,872                               |       |       | 32         |                          |       |                                          | —     |            |       |                                  | 78,312     |   |   |   | (401 | ) |   |   | (33,288 | ) |   |   | 44,655 |   |   |
| Issuance  of common stock:                                                                                        |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock options                                                                                         |       | 904                                  |       |       | 1          |                          |       |                                          | —     |            |       |                                  | 2,531      |   |   |   | — |   |   |   | — |   |   |   | 2,532 |   |   |
| Employee stock purchase plan                                                                                      |       | 12                                   |       |       | —     |                          |       |                                          | —     |            |       |                                  | 189        |   |   |   | — |   |   |   | — |   |   |   | 189 |   |   |
| Stock-based compensation expense                                                                                  |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | 4,628      |   |   |   | — |   |   |   | — |   |   |   | 4,628 |   |   |
| Tax benefit of stock option exercises                                                                             |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | 400        |   |   |   | — |   |   |   | — |   |   |   | 400 |   |   |
| Fair value of options granted to non-employees                                                                    |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | 9          |   |   |   | — |   |   |   | — |   |   |   | 9 |   |   |
| Comprehensive  income:                                                                                            |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                                 |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | — |   |   |   | (5,008 | ) |   |   | (5,008 | ) |   |
| Unrealized loss on available for sale investments net  of tax of $0                                               |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | 60 |   |   |   | — |   |   |   | 60 |   |   |
| Foreign currency translation adjustment                                                                           |       | —                               |       |       | —     |                          |       |                                          | —     |            |       |                                  | —     |   |   |   | 9 |   |   |   | — |   |   |   | 9 |   |   |
| Total comprehensive loss                                                                                          |       |                                 |       |       |       |                          |       |                                          |       |            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   | (4,939 | ) |   |
| Balance at  December 31, 2006                                                                                |       | 32,788                               |       |       | $          | 33                            |       |                                          |       | $               | —     |                                  |       |   | $ | 86,069 |   |   |   | $ | (332 | ) |   |   | $ | (38,296 | ) |   |   | $ | 47,474 |   |   |

 

See accompanying notes to consolidated financial statements

F-4

----

**RIGHTNOW TECHNOLOGIES, INC.Consolidated Statements of Cash Flows**

| ** **                                                                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                                                                | ** ** | **(In thousands)**                    | ** ** |
| Operating activities:                                                                     |       |                                       |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                          | 3,449      |   | $ | 7,693 |   | $ | (5,008 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 2,666                                      |       | 3,406 |   | 5,681 |   |
| Stock-based compensation                                                                  |       | —                                     |       | — |   | 4,628 |   |
| Provision for losses on accounts receivable                                               |       | 489                                        |       | 421 |   | 306 |   |
| Tax benefit of stock options exercised                                                    |       | —                                     |       | 366 |   | — |   |
| Changes in  operating assets and liabilities:                                             |       |                                       |       |   |   |   |   |
| Receivables                                                                               |       | (14,644                                    | )          | (19,100 | ) | (27,487 | ) |
| Prepaid and other current assets                                                          |       | (733                                       | )          | (621 | ) | (191 | ) |
| Accounts payable                                                                          |       | 683                                        |       | 744 |   | 1,916 |   |
| Commissions and bonuses payable                                                           |       | 988                                        |       | 309 |   | 1,025 |   |
| Other accrued liabilities                                                                 |       | 1,347                                      |       | 2,186 |   | 1,541 |   |
| Deferred revenue                                                                          |       | 13,408                                     |       | 19,767 |   | 44,782 |   |
| Other                                                                                     |       | (915                                       | )          | (276 | ) | (150 | ) |
| Net cash provided by operating activities                                                 |       | 6,738                                      |       | 14,895 |   | 27,043 |   |
| Investing  activities:                                                                    |       |                                       |       |   |   |   |   |
| Purchases of short-term investments                                                       |       | (57,063                                    | )          | (26,581 | ) | (53,276 | ) |
| Sales or maturities of short-term investments                                             |       | 25,875                                     |       | 34,455 |   | 37,464 |   |
| Purchase of property and equipment                                                        |       | (3,580                                     | )          | (4,969 | ) | (7,758 | ) |
| Business acquisitions                                                                     |       | —                                     |       | (1,023 | ) | (8,731 | ) |
| Proceeds from sale of property and equipment                                              |       | 3                                          |       | 4 |   | — |   |
| Intangible asset additions                                                                |       | (691                                       | )          | (20 | ) | (13 | ) |
| Net cash provided by (used in) investing activities                                       |       | (35,456                                    | )          | 1,866 |   | (32,314 | ) |
| Financing  activities:                                                                    |       |                                       |       |   |   |   |   |
| Proceeds from long-term debt                                                              |       | 1,675                                      |       | 162 |   | — |   |
| Proceeds from  issuance of common stock:                                                  |       |                                       |       |   |   |   |   |
| Initial public offering, net of offering costs                                            |       | 39,972                                     |       | — |   | — |   |
| Exercise of stock options and warrants                                                    |       | 486                                        |       | 4,622 |   | 2,532 |   |
| Employee stock purchase plan                                                              |       | 690                                        |       | 656 |   | 189 |   |
| Excess tax benefit of stock options exercised                                             |       | —                                     |       | — |   | 400 |   |
| Repurchase of common stock                                                                |       | (2                                         | )          | — |   | — |   |
| Payments on long-term debt                                                                |       | (3,588                                     | )          | (15 | ) | (55 | ) |
| Net cash provided by financing activities                                                 |       | 39,233                                     |       | 5,425 |   | 3,066 |   |
| Effect of foreign exchange rates on cash and cash  equivalents                            |       | 69                                         |       | (256 | ) | 539 |   |
| Net change in cash and cash equivalents                                                   |       | 10,584                                     |       | 21,930 |   | (1,666 | ) |
| Cash and cash  equivalents at beginning of period                                         |       | 8,360                                      |       | 18,944 |   | 40,874 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                          | 18,944     |   | $ | 40,874 |   | $ | 39,208 |   |

 

See accompanying notes to consolidated financial statements

F-5

----

**RIGHTNOWTECHNOLOGIES, INC.Notes to Consolidated Financial StatementsYears ended December 31, 2004, 2005 and 2006**

**(1)**          BusinessDescription and Summary of Significant Accounting Policies

***(a)****          BusinessDescription*

RightNow Technologies, Inc.(the “Company” or “RightNow”) provides customer experience management softwaresolutions for companies of all sizes. The Company’s on demand software isdesigned to help companies improve their customer experiences while reducingoperating costs. RightNow’s solutions go beyond traditional customerrelationship management (“CRM”) solutions to support a business’ externalcustomer-facing channels as well as sales, marketing and customer serviceoperations. Founded in 1997, RightNow is headquartered in Bozeman, Montana,with offices located in Boston, Massachusetts; Chicago, Illinois; Dallas,Texas; San Mateo, California; Princeton, New Jersey; New York City andRochester, New York; Washington D.C.; London, England; Sydney, Australia;Munich, Germany; and Tokyo, Japan. The Company operates in one segment, whichis the customer experience management software market.

***(b)****           Basisof Consolidation*

The consolidated financial statements include the accounts of theCompany and its foreign subsidiaries. All intercompany accounts and transactionshave been eliminated in consolidation.

***(c)****            CertainRisks and Concentrations*

The Company’s revenue is derived from the license ofits software products and provision of related professional services. Themarkets in which the Company competes are highly competitive and rapidlychanging. Significant technological changes, changes in customer requirements,or the emergence of competitive products with new capabilities or technologiescould adversely affect the Company’s operating results. The Company hashistorically derived a majority of its revenue from its customer servicesoftware solutions. These products are expected to continue to account for asignificant portion of revenue for the foreseeable future. As a result of thisrevenue concentration, the Company’s business could be harmed by a decline indemand for, or in the prices of, these products or as a result of, among otherfactors, any change in pricing model, a maturation in the markets to theseproducts, increased price competition or a failure by the Company to keep upwith technological change.

Financial instruments subjecting the Company toconcentrations of credit risk consist primarily of cash and cash equivalents,short-term investments, and accounts and term receivables. The Company maintainscash, cash equivalents, and short-term investments with various domestic andforeign financial institutions. From time to time, the Company’s cash balanceswith its financial institutions may exceed insurance limits. Short-terminvestments are investment grade, interest-earning securities, and arediversified by type and industry.

The Company’s customers are worldwide withapproximately 75% of sales in the United States in each of the past threeyears. No individual customer accounted for more than 10% of the Company’srevenue in 2004, 2005 or 2006. One customer represented 11% of term receivablesat December 31, 2005, and one customer represented 13% of accountsreceivable at December 31, 2006.

Assetslocated outside North America were 11% and 12% of total assets at December 31,2005 and 2006, respectively. The loss from operations outside the United Statestotaled $3.1 million, $6.2 million, 

F-6

----

and $8.1 million for the years ended December 31,2004, 2005 and 2006, respectively. Revenue by geographical region is as follows(in thousands):

| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| United States |       | $                                          | 45,199     |   | $ | 64,409 |   | $ | 82,522 |   |
| Europe        |       | 12,792                                     |       | 15,528 |   | 20,601 |   |
| Asia Pacific  |       | 3,773                                      |       | 7,211 |   | 7,265 |   |
|          |       | $                                          | 61,764     |   | $ | 87,148 |   | $ | 110,388 |   |

 

***(d)****           Useof Estimates*

The preparation of theconsolidated financial statements requires management of the Company to make anumber of estimates and assumptions relating to the reported amount of assetsand liabilities and the disclosure of contingent assets and liabilities at thedate of the consolidated financial statements and the reported amounts ofrevenue and expenses during the period. Significant items subject to suchestimates and assumptions include: elements comprising our software, hostingand support sales arrangements and their respective fair values; the carryingamount of property and equipment and intangible assets; valuation allowancesfor receivables and deferred income tax assets; and estimates of expected termand volatility in determining stock-based compensation expense. Actual resultscould differ from those estimates.

***(e)****            CashEquivalents*

The Company considers allhighly liquid investments purchased with an original maturity date of threemonths or less to be cash equivalents. Cash equivalents are recorded at cost,which approximates market value.

***(f)****             Short-TermInvestments*

Short-term investments in debt and equity securitiesare classified as available-for-sale and are recorded at fair market value asdetermined by quotations from national exchanges. Realized gains and losses areincluded in income based on the specific identification method. Unrealizedgains and losses (excluding other-than-temporary impairments), net of tax, arerecorded to Other Comprehensive Income (Loss), a component of stockholders’equity.

Investments are consideredto be impaired when a decline in fair market value is determined to beother-than-temporary. If the cost of an investment exceeds its fair value, weevaluate, among other factors, general market conditions, the duration andextent that cost is less than fair value, as well as our ability and intent tohold the investment. We also consider specific adverse conditions of theinvestee, including industry and sector performance, operational and cash flowfactors, and rating agency actions. Once a decline in fair market value isdetermined to be other-than-temporary, an impairment charge is recorded and anew cost basis for the investment is established.

***(g)****           AccountsReceivable and Term Receivables*

Accounts receivable represents amounts currently due(within 90 days) from customers for which revenue has been recognized oris being recognized ratably in future periods, and amounts currently due undercontract billings for which revenue has not been recognized. Term receivables includethe remaining minimum committed amounts due from customers, for which norevenue has been recognized. The Company performs credit evaluations whenconsidered necessary, but generally does not require collateral to extendcredit.

F-7

----

The allowance for doubtful accounts is the Company’sbest estimate of the amount of probable credit losses in the Company’s existingreceivables. The Company determines the allowance based on factors such ashistorical collection experience, customer’s current creditworthiness, customerconcentration, age of accounts receivable balance and general economicconditions that may affect a customer’s ability to pay. Actual customercollections could differ from estimates. Account balances are charged to theallowance after all means of collection have been exhausted and the potentialfor recovery is considered remote. The Company does not have any off-balancesheet credit exposure related to its customers.

Provisionsto the allowance for doubtful accounts are charged to expense for accountsreceivable and against deferred revenue for term receivables. Following is asummary of the activity in the allowance for doubtful accounts (in thousands):

| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Balance,  beginning of year                  |       | $                                          | 902        |   | $ | 1,581 |   | $ | 2,209 |   |
| Provision charged to expense                 |       | 489                                        |       | 421 |   | 306 |   |
| Provision charged against deferred revenue   |       | 972                                        |       | 1,528 |   | 1,407 |   |
| Write-downs charged against the allowance    |       | (841                                       | )          | (1,375 | ) | (1,442 | ) |
| Recoveries of amounts previously charged-off |       | 59                                         |       | 54 |   | 141 |   |
| Balance, end of year                         |       | $                                          | 1,581      |   | $ | 2,209 |   | $ | 2,621 |   |

 

***(h)****          Propertyand Equipment*

Property and equipment,including software purchased for internal use, are stated at cost lessaccumulated depreciation and amortization. Depreciation and amortization iscomputed using the straight-line method over the estimated useful lives of theassets, generally three to seven years. Repairs and maintenance are expensed asincurred.

***(i)****             IntangibleAssets*

Intangible assets includepurchased technologies and goodwill. Purchased technologies are carried at costless accumulated amortization. The Company amortizes these assets on astraight-line basis over their estimated useful lives of three to five years. Goodwillis the excess of cost over the fair value of the net identifiable assetsacquired in business acquisitions. Goodwill is not amortized, but is evaluatedfor impairment at least annually and more often if indicators of potentialimpairment exist.

***(j)****              RevenueRecognition*

The majority of our revenue is generated from thedelivery of software licenses, hosting and support services, and professionalservices. Revenue under these arrangements is recognized pursuant to therequirements of Statement of Position (SOP) 97-2, *SoftwareRevenue Recognition*, SOP 98-9, Modification of SOP 97-2,*Software Revenue Recognition With Respect toCertain Transactions*, issued by the American Institute of CertifiedPublic Accountants. We acquired Salesnet, Inc. in May 2006 andaccount for those subscription services arrangements under Emerging Issues TaskForce Issue No. 00-21, *Revenue Arrangements withMultiple Deliverables*.

Our software products can be licensed over time (a “term”license) or perpetually. Hosting and support services involve the remotemanagement of the software, technical assistance, and unspecified productupgrades on a when and if available basis. Professional services includeconsulting, training and development services.

Revenue is recognized when all of the followingcriteria are met: a) the Company has entered into a legally bindingagreement with the customer; b) the software has been delivered or madeavailable to the 

F-8

----

customer; c) theCompany’s fee for providing the software and services is fixed anddeterminable; and d) collection of the Company’s fee is probable.

The Company sells its products primarily on a termbasis. Term contracts are non-cancelable, and generally cover a period of twoyears, but can range from a period of six months to five years. Term contractsprovide the right to use our software on another entity’s hardware withoutsignificant penalty. For term contracts, the Company recognizes software,hosting and support revenue ratably over the time period covered.

Sales of perpetual software licenses include hostingand support services for a period of time, typically one year. The Company hasestablished vendor specific objective evidence for the hosting and supportelements of perpetual license sales, based on the prices charged when soldseparately. Accordingly, revenue for the perpetual software license element isdetermined using the residual method and is recognized upon delivery. Revenuefor the hosting and support elements is recognized ratably over the contractualtime period.

With the acquisition of Salesnet, Inc., theCompany also provides subscription services arrangements. Subscriptionarrangements include access to our software via the Internet, and hosting andsupport services. The Company follows the guidance of Emerging Issues TaskForce 00-03, *Application of AICPAStatement of Position 97-2 to Arrangements That Include the Right to UseSoftware Stored on Another Entity’s Hardware*, where customers do nothave the right to locate our software on another entity’s hardware withoutsignificant penalty. Subscription revenues are typically recognized monthly asthe services are provided.

The Company’s policy is to record revenue net of anyapplicable sales, use or excise taxes.

If an arrangement includes a right of acceptance or aright to cancel, revenue is recognized when acceptance is received or the rightto cancel has expired. If the fee for the license has any payment term that isdue in excess of the Company’s normal payment terms (over 90 days), thefee is considered to not be fixed or determinable, and the amount of revenuerecognized (a) for perpetual license arrangements is limited to the amountcurrently due from the customer, or (b) for term license arrangements islimited to the lesser of the amount currently due from the customer or aratable portion of the total unallocated arrangement fee.

Certain customers have license agreements that providefor usage above fixed minimums. Usage above fixed minimums requires payment ofadditional fees if the Company’s software is used by more than a specifiednumber of users or for more than a specified number of interactions. Fixedminimums are recognized as revenue ratably over the term of the arrangement.Usage fees above fixed minimums are recognized as revenue when such amounts areknown and billed.

Separate contracts with the same customer that areentered into at or near the same time are generally presumed to have beennegotiated together and are combined and accounted for as a single arrangement.

Professional services revenue is recognized asperformed, based on hours incurred. The Company has determined that the serviceelements of its software arrangements are not essential to the functionality ofthe software. The Company has also determined that its professional services (a) areavailable from other vendors, (b) do not involve a significant degree ofrisk or unique acceptance criteria, and (c) qualify for separateaccounting as the Company has sufficient experience in providing such services.

VSOE of fair value of services in multiple elementarrangements is based upon rates for consulting, education and developmentservices, which the Company has charged in stand-alone contracts for services.

F-9

----

Thefollowing table sets forth revenue by product or service as a percentage oftotal revenue:

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenue by type:                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Recurring (term  licenses, support and hosting) |       |                                       | 59         | % |   |   | 53 | % |   |   | 57 | % |   |
| Perpetual licenses                              |       |                                       | 22         |   |   |   | 25 |   |   |   | 21 |   |   |
| Professional  services                          |       |                                       | 19         |   |   |   | 22 |   |   |   | 22 |   |   |
|                                            |       |                                       | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

Deferred revenuerepresents amounts received or due from customers for which the revenuerecognition criteria have not been met. The majority of deferred revenueresults from the up front billing of term contracts while revenue is recognizedratably over the contractual term. Deferred revenue is recognized into revenuewhen the Company provides its products and services, assuming all other revenuerecognition criteria noted above are met. The Company does not provide refundsfor customer cancellations.

***(k)****           SalesCommissions*

Sales commissions paid forterm and perpetual license arrangements are expensed when earned, which istypically at the time the related sale is invoiced. Sales commissions paid onsubscription agreements are deferred and charged to expense in proportion tothe revenue recognized. Commission expense was $8.6 million, $10.7million, and $15.4 million for the years ended December 31, 2004, 2005 and2006, respectively. Deferred commissions at December 31, 2006 were$213,000.

***(l)****              Researchand Development*

Research and developmentexpenditures are expensed as incurred. Statement of Financial AccountingStandards (SFAS) No. 86, *Accounting forthe Costs of Computer Software to Be Sold, Leased or Otherwise Marketed,*requires capitalization of certain software development costs subsequent to theestablishment of technological feasibility. Based on the Company’s productdevelopment process, technological feasibility is established upon completionof a working model. To date, the period between achieving technologicalfeasibility and general availability of such software has been short andsoftware development costs qualifying for capitalization have been immaterial.Accordingly, the Company has not capitalized any software development costs.

***(m)****       IncomeTaxes*

The Company records incometaxes under the asset and liability method as prescribed under Statement ofFinancial Accounting Standards No. 109, *Accountingfor Income Taxes*. Deferred tax assets and liabilities are recognizedfor the future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. Whenapplicable, a valuation allowance is established to reduce any deferred taxasset when it is determined that it is more likely than not that some portionof the deferred tax asset will not be realized.

F-10

----

***(n)****          Impairmentof Long-Lived Assets*

Long-lived assets,including intangible assets, are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future net cash flows expectedto be generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the estimated fair value of the assets. Assets tobe disposed of are reported at the lower of the carrying amount or fair valueless costs to sell. Goodwill is tested for impairment at least annually, andmore frequently if indicators of potential impairment exist. No impairments oflong-lived assets has been identified in any of the periods presented.

***(o)****           NetIncome (Loss) Per Share*

Areconciliation of the denominator used in the calculation of basic and dilutednet income (loss) per share is as follows (in thousands):

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Weighted average  common shares outstanding for basic net income (loss) per share |       | 20,738                                     |       | 30,631 |   | 32,241 |   |
| Effect of dilutive  securities:                                                   |       |                                       |       |   |   |   |   |
| Redeemable convertible preferred stock                                            |       | 4,328                                      |       | — |   | — |   |
| Employee stock options                                                            |       | 4,055                                      |       | 3,028 |   | — |   |
| Warrants                                                                          |       | 56                                         |       | 36 |   | — |   |
| Weighted average shares  outstanding for dilutive net income (loss) per share     |       | 29,177                                     |       | 33,695 |   | 32,241 |   |

 

Thefollowing common stock equivalents were excluded from the computation ofdiluted earnings (loss) per share because they had an anti-dilutive impact (inthousands):

| ** **              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Employee stock  options |       |                                       | 43         |   |   |   | 359 |   |   | 3,913 |   |
|                         |            |                                            |            |  |  |  |  |  |  |  |  |

 

***(p)****           Stock-BasedCompensation*

On January 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standards No. 123(R), *Share Based Payment*, (“SFAS 123R”), for its stock-basedcompensation plans. Under SFAS 123R, stock-based compensation costs arerecognized based on the estimated fair value at the grant date for allstock-based awards. The Company estimates grant date fair values using theBlack-Scholes-Merton option pricing model, which requires assumptions of thelife of the award and the stock price volatility over the term of the award. TheCompany records compensation cost of stock-based awards using the straight linemethod, which is recorded into earnings over the vesting period of the award. Pursuantto the income tax provisions included in SFAS 123R, the Company has elected the“short cut method” of computing its hypothetical pool of additional paid-incapital that is available to absorb future tax benefit shortfalls.

The Company previously accounted for its stock-basedcompensation plans under the intrinsic value recognition and measurementprovisions of Accounting Principles Board Opinion No. 25 (“APB 25”), *Accounting for Stock Issued to Employees*, and relatedinterpretations, and adopted the disclosure-only provisions of Statement ofFinancial Accounting Standards No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*, as amended by Statement of FinancialAccounting Standards No. 148 (“SFAS 148”), 

F-11

----

*Accountingfor Stock-Based Compensation—Transition and Disclosures*. UnderAPB 25, no compensation expense was recorded in earnings for the Company’sstock-based awards. The pro forma effects on net income and earnings per sharefor stock-based awards were instead disclosed in the footnotes to theconsolidated financial statements in accordance with SFAS 123.

The Company has elected touse the modified prospective transition method as permitted under SFAS 123R andtherefore has not restated its financial results for prior periods. Under thistransition method, compensation cost recorded in the year ended December 31,2006 includes the cost for all stock-based awards granted prior to, but not yetvested as of December 31, 2005, based on the grant-date fair valueestimated in accordance with the original provisions of SFAS 123. Compensationexpense for all stock-based awards granted after December 31, 2005 wasbased on the grant-date fair value estimated in accordance with the provisionsof SFAS 123R.

***(q)****           ForeignCurrency Translation*

For non-U.S. operations,the functional currency is the local currency. Assets and liabilities of thoseoperations are translated into U.S. dollars using year-end exchange rates;income and expenses are translated using the average exchange rates for thereporting period. Translation adjustments are deferred in accumulated othercomprehensive loss, a separate component of stockholders’ equity. Realizedforeign currency transaction gains and losses are included in other income andexpense.

***(r)****            ComprehensiveIncome (Loss)*

Comprehensive lossincludes net income or loss, as well as other changes in stockholders’ equitythat result from transactions and economic events other than those withstockholders. Additional elements of other comprehensive income or loss areattributable to foreign currency translation adjustments and unrealized gainsor losses on short-term investments.

***(s)****            AdvertisingCosts*

The Company expensesadvertising costs as incurred. Advertising costs were $1.9 million, $2.7million and $4.5 million for the years ended December 31, 2004, 2005 and2006, respectively.

***(t)****             Reclassifications*

Certain amounts in theconsolidated financial statements and notes thereto have been reclassified toconform to the current period presentation.

**(2)**          Acquisitions

*Convergent Voice*

In May 2005, the Company purchased theintellectual property and other assets, and hired certain personnel, ofConvergent Voice. Convergent Voice developed certain voice automationtechnologies that in combination with the Company’s applications enable: a)telephone queries of the Company’s knowledgebase; b) submission of questions byphone that can be subsequently answered either electronically or by returnphone call; and c) submission of queries that access back office systems, suchas an order processing system, to obtain the status of an order.

The purchase priceconsisted of $1 million paid in cash on May 5, 2005 to the shareholders ofConvergent Voice, and $23,000 of transaction costs. Approximately $936,000 ofthe purchase price was allocated to identifiable intangible assets based on adiscounted cash flow analysis. The identifiable intangible assets consistprimarily of developed software, and will be amortized to earnings over aperiod of 

F-12

----

fiveyears. The remaining purchase price of approximately $87,000 was allocated toother tangible assets acquired based on their estimated net realizable value orreplacement cost.

*Salesnet, Inc.*

On May 22, 2006, the Company acquired theoutstanding common and preferred stock of Salesnet, Inc. (“Salesnet”), aprovider of on demand sales force automation solutions, for $8.7 million in netcash paid at closing. The acquisition added several hundred clients to theCompany’s customer base, and is expected to accelerate the product developmentof the Company’s sales force automation product set, and increase the Company’sdomain expertise in sales automation. The acquisition is being accounted forunder the purchase method of accounting and, accordingly, the results ofSalesnet are included in the condensed consolidated financial statements sincethe acquisition date.

TheCompany has allocated the purchase price to the Salesnet assets acquired andliabilities assumed at estimated fair values, after considering a number offactors, including the use of an independent appraisal. The purchase price andpurchase price allocation are as follows (amounts in thousands):

| Cash  consideration                       |   | $      | 9,015  |   |
|-------------------------------------------|--------|--------|--------|--------|
| Direct  acquisition costs                 |   | 182    |   |
| Total purchase  price                     |   | $      | 9,197  |   |
| Purchase price  allocation:               |   |   |   |
| Cash and cash  equivalents                |   | $      | 466    |   |
| Accounts  receivable                      |   | 407    |   |
| Property and  equipment                   |   | 264    |   |
| Other assets                              |   | 208    |   |
| Intangible assets                         |   | 8,488  |   |
| Accounts payable  and accrued liabilities |   | (358   | )      |
| Deferred revenue                          |   | (252   | )      |
| Capitalized lease  obligations            |   | (26    | )      |
| Total purchase price                      |   | $      | 9,197  |   |

 

Thecomponents of the intangible assets listed in the above table as of theacquisition date are as follows (amounts in thousands):

| Goodwill                   |   | $     | 4,358  |   |
|----------------------------|--------|-------|--------|--------|
| Customer  relationships    |   | 3,250 |   |
| Technology                 |   | 740   |   |
| Trade name and  trademarks |   | 140   |   |
| Intangible assets          |   | $     | 8,488  |   |

 

The excess of the purchase price over the estimatedfair value of the net assets acquired of $4.4 million has been recorded asgoodwill, which is deemed to have an indefinite useful life and, accordingly,will not be amortized, but will be subject to periodic impairment testing infuture periods. The customer relationships and technology intangible assetswill be amortized over a period of four years using the straight-line method.The trade name and trademarks will be amortized over a period of three yearsusing the straight-line method.

Pro forma results of the business combinations havenot been provided because the effect is not material on an individual oraggregate basis.

F-13

----

**(3)**          InitialPublic Offering of Common Stock

In August 2004, theCompany completed the sale of approximately 6.4 million shares of common stock,including the underwriters’ exercise of an over-allotment option, at a publicoffering price of $7.00 per share. Net proceeds of the offering were $40million after deducting underwriters’ commissions and other offering expenses. Outstandingshares of Series A and Series B redeemable convertible preferredstock were automatically converted into shares of common stock, on aone-for-one basis, at the closing of the offering. In addition, warrants toacquire shares of Series B redeemable convertible preferred stock wereautomatically converted into warrants to acquire common stock.

**(4)**          SupplementalCash Flow Information

Supplementalstatement of cash flow information follows (in thousands):

| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Supplemental disclosure  of cash flow information:  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the period for:                   |       |                                       |       |   |   |   |   |
| Interest                                            |       | $                                          | 127        |   | $ | 5 |   | $ | 17 |   |
| Income taxes                                        |       | 100                                        |       | 239 |   | 280 |   |
| Non-cash  financing activities:                     |       |                                       |       |   |   |   |   |
| Conversion of preferred stock into common stock     |       | $                                          | 32,155     |   | $ | — |   | $ | — |   |
| Conversion of  warrants to acquire preferred stock  |       |                                       |       |   |   |   |   |
| into warrants to acquire common stock               |       | 291                                        |       | — |   | — |   |
| Issuance of warrants to acquire preferred stock     |       | 40                                         |       | — |   | — |   |
| Issuance of  common stock upon exercise of warrants |       | —                                     |       | 291 |   | — |   |

 

**(5)**          Cashand Cash Equivalents, and Short-Term Investments

Thecomponents of cash and investments at December 31, 2005 and 2006 are asfollows (in thousands):

| ** **                        | ** ** | ** ** | ** ** | **Unrealized** | ** ** | **Fair  Market ** | ** ** | **Cash and  Cash** | ** ** | **Short-term** | ** ** |            |
|-----------------------------------|------------|------------|------------|----------------|------------|------------------------|------------|-------------------------|------------|----------------|------------|-----------------|
| **December 31, 2005**   | ** ** | ** ** | ** ** | **Cost**       | ** ** | **Gains**              | ** ** | **Losses**              | ** ** | **Value**      | ** ** | **Equivalents** | ** ** | **Investments** | ** ** |   |
| Cash and cash  equivalents:       |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Cash and money market funds       |       | $          | 15,523     |           |       | $                      | —     |                    |       |           | $          | —          |   |   | $ | 15,523 |   |   | $ | 15,523 |   |   |   | $ | — |   |   |
| Fixed maturity  securities:       |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Commercial paper                  |       | 18,162     |       |           | 4          |                   |       |                    | (1         | )              |       | 18,165          |   |   | 18,165 |   |   |   | — |   |   |
| Corporate notes and bonds         |       | 1,331      |       |           | —     |                   |       |                    | —     |           |       | 1,331           |   |   | 680 |   |   |   | 651 |   |   |
| U.S. Government agency securities |       | 17,594     |       |           | 1          |                   |       |                    | (78        | )              |       | 17,517          |   |   | 3,951 |   |   |   | 13,566 |   |   |
| State and municipal securities    |       | 6,658      |       |           | —     |                   |       |                    | (6         | )              |       | 6,652           |   |   | 2,555 |   |   |   | 4,097 |   |   |
| Sub-total                         |       | 59,268     |       |           | 5          |                   |       |                    | (85        | )              |       | 59,188          |   |   | 40,874 |   |   |   | 18,314 |   |   |
| Equity  securities:               |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Auction rate preferred stocks     |       | 5,000      |       |           | —     |                   |       |                    | —     |           |       | 5,000           |   |   | — |   |   |   | 5,000 |   |   |
| Totals at December 31, 2005  |       | $          | 64,268     |           |       | $                      | 5          |                    |       |           | $          | (85             | ) |   | $ | 64,188 |   |   | $ | 40,874 |   |   |   | $ | 23,314 |   |   |
|                                   |            |            |            |                |            |                        |            |                         |            |                |            |                 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-14

----

 

| ** **                        | ** ** | ** ** | ** ** | **Unrealized** | ** ** | **Fair  Market ** | ** ** | **Cash and  Cash** | ** ** | **Short-term** | ** ** |            |
|-----------------------------------|------------|------------|------------|----------------|------------|------------------------|------------|-------------------------|------------|----------------|------------|-----------------|
| **December 31,  2006**       | ** ** | ** ** | ** ** | **Cost**       | ** ** | **Gains**              | ** ** | **Losses**              | ** ** | **Value**      | ** ** | **Equivalents** | ** ** | **Investments** | ** ** |   |
| ** **                        |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents:       |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Cash and money market funds       |       | $          | 19,811     |           |       | $                      | —     |                    |       |           | $          | —          |   |   | $ | 19,811 |   |   | $ | 19,811 |   |   |   | $ | — |   |   |
| Fixed maturity  securities:       |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Commercial paper                  |       | 16,873     |       |           | 27         |                   |       |                    | —     |           |       | 16,900          |   |   | 16,401 |   |   |   | 499 |   |   |
| Corporate notes and bonds         |       | 4,730      |       |           | 3          |                   |       |                    | (5         | )              |       | 4,728           |   |   | 800 |   |   |   | 3,928 |   |   |
| U.S. Government agency securities |       | 22,378     |       |           | 1          |                   |       |                    | (33        | )              |       | 22,346          |   |   | 2,196 |   |   |   | 20,150 |   |   |
| State and municipal securities    |       | 1,975      |       |           | —     |                   |       |                    | —     |           |       | 1,975           |   |   | — |   |   |   | 1,975 |   |   |
| Sub-total                         |       | 65,767     |       |           | 31         |                   |       |                    | (38        | )              |       | 65,760          |   |   | 39,208 |   |   |   | 26,552 |   |   |
| Equity  securities:               |       |       |       |           |       |                   |       |                    |       |           |       |            |   |   |   |   |   |   |   |   |   |
| Auction rate preferred stocks     |       | 12,575     |       |           | —     |                   |       |                    | —     |           |       | 12,575          |   |   | — |   |   |   | 12,575 |   |   |
| Totals at  December 31, 2006 |       | $          | 78,342     |           |       | $                      | 31         |                    |       |           | $          | (38             | ) |   | $ | 78,335 |   |   | $ | 39,208 |   |   |   | $ | 39,127 |   |   |
|                                   |            |            |            |                |            |                        |            |                         |            |                |            |                 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The unrealized losses of $38,000 at December 31,2006 related to investment-grade, fixed income securities, and are primarilyattributable to changes in interest rates. Approximately $30,000 of theunrealized losses related to securities held more than one year. Managementdoes not believe any of the unrealized losses at December 31, 2006represent an other-than-temporary impairment. Realized gains and losses fromsales of available-for-sale securities in 2004, 2005 and 2006 wereinsignificant.

Underlying maturities ofshort-term investments in debt instruments at December 31, 2006 wereapproximately $16.6 million within one year, $8.0 million between one and fiveyears, and $2.0 beyond ten years. These items are classified as short-termbecause they represent investments of cash that are available for currentoperations.

**(6)**          Propertyand Equipment, Net

Propertyand equipment, net are as follows (in thousands):

| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Computer  equipment                  |       | $                     | 10,525     |   | $ | 14,043 |   |
| Software  purchased for internal use |       | 3,615                 |       | 5,641 |   |
| Equipment                            |       | 1,012                 |       | 1,174 |   |
| Furniture and  fixtures              |       | 994                   |       | 1,328 |   |
| Leasehold  improvements              |       | 185                   |       | 191 |   |
| Total cost                           |       | 16,331                |       | 22,377 |   |
| Less accumulated  depreciation       |       | (9,880                | )          | (12,304 | ) |
|                                 |       | $                     | 6,451      |   | $ | 10,073 |   |

 

F-15

----

**(7)**          Intangibleassets

Thefollowing table sets forth information regarding intangible assets (inthousands):

| ** **                                       | ** ** | **Goodwill** | ** ** | **Customer  Relationships** | ** ** | **Purchased  Technologies** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|--------------|------------|-----------------------------|------------|-----------------------------|------------|-----------|------------|
| As of December 31,  2005:                   |       |         |       |                        |       |                        |       |      |       |   |   |   |   |   |   |
| Gross carrying value                             |       |         | $          | —                      |       |                        |       | $         | —     |   |   |   | $ | 3,021 |   |   | $ | 3,021 |   |
| Accumulated amortization                         |       |         | —     |                        |       |                        | —     |      |       |   | (1,534 | ) |   | (1,534 | ) |
| Net carrying value                               |       |         | $          | —                      |       |                        |       | $         | —     |   |   |   | $ | 1,487 |   |   | $ | 1,487 |   |
| As of  December 31, 2006:                   |       |         |       |                        |       |                        |       |      |       |   |   |   |   |   |   |
| Gross carrying value                             |       |         | $          | 4,358                       |       |                        |       | $         | 3,250      |   |   |   | $ | 3,914 |   |   | $ | 11,522 |   |
| Accumulated amortization                         |       |         | —     |                        |       |                        | (496       | )         |       |   | (2,190 | ) |   | (2,686 | ) |
| Net carrying value                               |       |         | $          | 4,358                       |       |                        |       | $         | 2,754      |   |   |   | $ | 1,724 |   |   | $ | 8,836 |   |
| Weighted-average amortization period: (in years) |       |         | n/a        |                        |       |                        | 4.0        |      |       |   | 4.5 |   |   | 4.2 |   |
| Aggregate  amortization expense:                 |       |         |       |                        |       |                        |       |      |       |   |   |   |   |   |   |
| 2005                                             |       |         | $          | —                      |       |                        |       | $         | —     |   |   |   | $ | 582 |   |   | $ | 582 |   |
| 2006                                             |       |         | —     |                        |       |                        | 496        |      |       |   | 655 |   |   | 1,151 |   |
| Estimated  amortization expense:                 |       |         |       |                        |       |                        |       |      |       |   |   |   |   |   |   |
| 2007                                             |       |         | $          | —                      |       |                        |       | $         | 813        |   |   |   | $ | 580 |   |   | $ | 1,393 |   |
| 2008                                             |       |         | —     |                        |       |                        | 812        |      |       |   | 581 |   |   | 1,393 |   |
| 2009                                             |       |         | —     |                        |       |                        | 812        |      |       |   | 429 |   |   | 1,241 |   |
| 2010                                             |       |         | —     |                        |       |                        | 317        |      |       |   | 134 |   |   | 451 |   |
| 2011                                             |       |         | —     |                        |       |                        | —     |      |       |   | — |   |   | — |   |

 

**(8)**          Long-TermDebt and Credit Facility

Long-termdebt consists of the following (in thousands):

| ** **                                                                                                                                                | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Obligations under  capital leases for tenant improvements to leased property, payable monthly in  installments of $3 through May 2010 at 6% interest |       | $                     | 147        |   | $ | 116 |   |
| Less current  portion                                                                                                                                     |       | 30                    |       | 31 |   |
| Long-term debt,  excluding current portion                                                                                                                |       | $                     | 117        |   | $ | 85 |   |

 

In 2005, the Company entered into an office leaseagreement that included $162,000 of tenant improvements, which have beencapitalized and will be repaid to the landlord over the initial lease term offive years. The improvements are being amortized over an expected useful lifeof seven years since the Company expects to renew the office lease upon itsinitial term expiration in 2010. In 2006, the Company assumed $26,000 ofcapital lease obligations as part of its acquisition of Salesnet, Inc.,which were paid in full during 2006.

During 2005 and 2006, theCompany had a $3.0 million working capital line of credit agreement with acommercial bank. Advances under the line bear a variable rate of interest whichapproximates the prime lending rate, and are payable monthly. The workingcapital line of credit is secured by substantially all of the United Statesdollar-denominated accounts receivable of the Company. There were no advancesunder the line during 2005 or 2006.

F-16

----

**(9)**          RedeemableConvertible Preferred Stock

The Company has authorized15 million shares of preferred stock, $.001 par value, which may be issued fromtime to time by its board of directors without further action by stockholders. Sharesof preferred stock may be issued with dividend, redemption, voting or otherrights senior to existing common shares. There were no outstanding shares ofpreferred stock at December 31, 2005 or 2006.

**(10)**   Stock-BasedCompensation

The Company’s 1998 Long-Term Incentive and StockOption Plan, as amended, and the 2004 Equity Incentive Plan (the “equity plans”)provide for stock options to be granted to employees, consultants, independentcontractors, officers and directors. The equity plans have been approved bystockholders. Except for automatic grants to directors, options are granted atthe discretion of the Company’s board of directors, at an exercise price andterm determined by the board. However, exercise prices are not less than thefair market value at the date of grant, and the term of the options is notgreater than ten years. Options generally vest over a period of four years ineight equal increments. The Company also has an employee stock purchase plan (“ESPP”)that allows employees to purchase shares of common stock at a discount to thefair market value at the date of purchase. Purchase periods under the ESPP areconsecutive six-month periods ending on the last day in June and December eachyear. Shares issued to satisfy stock option exercises and ESPP are newly issued.At December 31, 2006, the Company had approximately 3.6 million sharesavailable for future issuance under the equity plans and ESPP.

Compensation expense recognized in the statement ofoperations for the year ended December 31, 2006 is based on awardsultimately expected to vest and reflects an estimate of awards that will beforfeited. SFAS 123R requires forfeitures to be estimated at the time of grantand revised, if necessary, in subsequent periods if actual forfeitures differfrom those estimates.

Thefollowing table illustrates the stock-based compensation expense resulting fromstock-based awards included in the consolidated statement of operations(amounts in thousands):

| ** **                                             | ** ** | **2006** | ** ** |
|--------------------------------------------------------|------------|----------|------------|
| Stock-based compensation expense:            |       |     |       |
| Cost of software, hosting and support                  |       | $        | 193        |   |
| Cost of professional services                          |       | 471      |       |
| Sales and marketing                                    |       | 1,929    |       |
| Research and development                               |       | 834      |       |
| General and administrative                             |       | 1,201    |       |
| Stock-based compensation expense before income taxes   |       | 4,628    |       |
| Income tax provision (benefit)                         |       | —   |       |
| Stock-based  compensation expense, net of income taxes |       | $        | 4,628      |   |

 

No stock-based compensation expense was capitalizedduring the year ended December 31, 2006.

F-17

----

Thefollowing table presents the impact of our adoption of SFAS 123R on selectedline items from our consolidated financial statements for the year endedDecember 31, 2006 (amounts in thousands, except per-share amounts):

| ** **                                       | ** ** | **December 31, 2006**             | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **As reported  under  SFAS 123R** | ** ** | **If reported  under  APB 25** | ** ** |
| Condensed consolidated  statement of operations: |       |                                        |       |   |   |   |   |   |   |
| Loss from operations                             |       |                                        | $          | (7,542 | ) |   |   | $ | (2,914 | ) |   |
| Income (loss) before income taxes                |       |                                        | (4,478     | ) |   |   | 150 |   |   |
| Net loss                                         |       |                                        | (5,008     | ) |   |   | (380 | ) |   |
| Net loss per share:                              |       |                                        |       |   |   |   |   |   |   |
| Basic                                            |       |                                        | $          | (0.16 | ) |   |   | $ | (0.01 | ) |   |
| Diluted                                          |       |                                        | (0.16      | ) |   |   | (0.01 | ) |   |
| Condensed  consolidated statement of cash flows: |       |                                        |       |   |   |   |   |   |   |
| Cash provided by  operating activities           |       |                                        | $          | 27,043 |   |   |   | $ | 27,443 |   |   |
| Cash provided by  financing activities           |       |                                        | 3,066      |   |   |   | 2,666 |   |   |

 

Unrecognized compensation expense of outstanding stockoptions at December 31, 2006 was approximately $9.2 million, which isexpected to be recognized over a weighted-average period of 2.6 years.

Thefollowing table illustrates the effect on reported net income and net incomeper share for the years ended December 31, 2004 and 2005 as if the Companyhad applied the fair value recognition provisions of SFAS 123 to stock-basedawards (in thousands, except per-share data):

| ** **                                                                       | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income as reported                                                           |       | $        | 3,441      |     | $          | 7,693 |   |
| Add stock-based  compensation included in the determination of net income (loss) |       | —   |       | 13       |       |
| Less stock-based  compensation expense determined under the fair value method    |       | (1,289   | )          | (3,292   | )          |
| Pro forma net  income                                                            |       | $        | 2,152      |     | $          | 4,414 |   |
| Net income per  share:                                                           |       |     |       |     |       |
| Basic                                                                            |       |     |       |     |       |
| As reported                                                                      |       | $        | 0.17       |     | $          | 0.25 |   |
| Pro forma                                                                        |       | 0.10     |       | 0.14     |       |
| Diluted:                                                                         |       |     |       |     |       |
| As reported                                                                      |       | $        | 0.12       |     | $          | 0.23 |   |
| Diluted                                                                          |       | 0.07     |       | 0.13     |       |

 

F-18

----

The estimated weighted-average fair value per shareof stock options granted in 2004, 2005 and 2006 was $6.05, $7.23 and$8.43, respectively. The estimated fair value of shares purchased under theESPP for the six months ended December 31, 2004 and June 30, 2005 was$2.43 and $5.82, respectively. For the purchase periods ending June 30,2006 and December 31, 2006 and 2005, no compensation cost was recognizedin the accompanying statement of operations because the terms of the plan weredeemed noncompensatory under SFAS 123R. Assumptions used to obtain theestimated fair values were:  

| ** **                      | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Employee stock options          |       |     |       |     |       |     |       |
| Weighted average risk free rate |       | 3.5      | %          | 4.1      | %          | 4.7      | %          |
| Weighted average expected term  |       | 5.0 yrs  |       | 5.0 yrs  |       | 4.4 yrs  |       |
| Weighted average volatility     |       | 78       | %          | 67       | %          | 57       | %          |
| Dividend yield                  |       | 0        | %          | 0        | %          | 0        | %          |
| Employee Stock  Purchase Plan   |       |     |       |     |       |     |       |
| Risk free rate                  |       | 2.0      | %          | 2.9      | %          | —   |       |
| Expected term                   |       | 0.5 yrs  |       | 0.5 yrs  |       | —   |       |
| Volatility                      |       | 78       | %          | 75       | %          | —   |       |
| Dividend yield                  |       | 0        | %          | 0        | %          | —   |       |

 

Key assumptions used to estimate the fair value ofstock awards are as follows:

*RiskFree Rate:*   The risk-free rate is determined byreference to U.S. Treasury yields at or near the time of grant for time periodssimilar to the expected term of the award.

*ExpectedTerm:*   The expected term represents the periodthat the Company’s stock-based awards are expected to be outstanding and isestimated based on historical experience of similar awards, givingconsideration to the contractual term of the awards, vesting schedules andexpectations of employee exercise behavior.

*Volatility:*   TheCompany’s estimate of expected volatility is based on a combination of theCompany’s historical volatility and peer-company volatilities. The Company hasa limited history of volatility, as well as limited traded options from whichto derive implied volatility. The Company believes the combination of itshistorical and peer-company volatilities is more representative of future stockprice trends than its historical volatility alone.

*DividendYield:*   The dividend yield assumption is based onthe Company’s history and expectation of dividend payouts.

F-19

----

Activityunder the Company’s stock option plans was as follows (option shares inthousands):

| ** **                                                | ** ** | **Shares  available  for grant** | ** ** | **Shares  Underlying  Outstanding  options** | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Aggregate  intrinsic  value  (in thousands)** | ** ** | **Weighted  average  remaining  contractual life  (in years)** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Balance at  December 31, 2003                        |       |                                  | 1,464      |                                         |       |                                                       | 5,357      |                                                 |       |                                                                     | $          | 1. 60 |   |   |   |   |   |   |   |   |   |   |
| Additional reserve for the 2004 Equity Incentive  Plan(1) |       |                                  | 2,504      |                                         |       |                                                       | —     |                                                 |       |                                                                     | —     |   |   |   |   |   |   |   |   |   |   |
| Granted                                                   |       |                                  | (887       | )                                            |       |                                                       | 887        |                                                 |       |                                                                     | 9.26       |   |   |   |   |   |   |   |   |   |   |
| Exercised                                                 |       |                                  | —     |                                         |       |                                                       | (616       | )                                                    |       |                                                                     | 0.79       |   |   |   |   |   |   |   |   |   |   |
| Forfeited, expired, exchanged or canceled(2)              |       |                                  | 72         |                                         |       |                                                       | (116       | )                                                    |       |                                                                     | 2.95       |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2004                        |       |                                  | 3,153      |                                         |       |                                                       | 5,512      |                                                 |       |                                                                     | 2.89       |   |   |   |   |   |   |   |   |   |   |
| Annual reserve addition(3)                                |       |                                  | 1,000      |                                         |       |                                                       | —     |                                                 |       |                                                                     | —     |   |   |   |   |   |   |   |   |   |   |
| Granted                                                   |       |                                  | (1,263     | )                                            |       |                                                       | 1,263      |                                                 |       |                                                                     | 12.39      |   |   |   |   |   |   |   |   |   |   |
| Exercised                                                 |       |                                  | —     |                                         |       |                                                       | (2,616     | )                                                    |       |                                                                     | 1.77       |   |   |   |   |   |   |   |   |   |   |
| Forfeited, expired, exchanged or canceled(2)              |       |                                  | 117        |                                         |       |                                                       | (261       | )                                                    |       |                                                                     | 7.63       |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2005                        |       |                                  | 3,007      |                                         |       |                                                       | 3,898      |                                                 |       |                                                                     | $          | 6.41 |   |   |   |   |   |   |   |   |   |   |
| Annual reserve addition(3)                                |       |                                  | 1,000      |                                         |       |                                                       | —     |                                                 |       |                                                                     | —     |   |   |   |   |   |   |   |   |   |   |
| Granted                                                   |       |                                  | (1,205     | )                                            |       |                                                       | 1,205      |                                                 |       |                                                                     | 16.74      |   |   |   |   |   |   |   |   |   |   |
| Exercised                                                 |       |                                  | —     |                                         |       |                                                       | (904       | )                                                    |       |                                                                     | 2.80       |   |   |   |   |   |   |   |   |   |   |
| Forfeited, expired, exchanged or canceled(2)              |       |                                  | 227        |                                         |       |                                                       | (286       | )                                                    |       |                                                                     | 12.71      |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2006                        |       |                                  | 3,029      |                                         |       |                                                       | 3,913      |                                                 |       |                                                                     | $          | 9.96 |   |   |   | $ | 29,023 |   |   |   | 7.4 |   |   |
| Vested or expected to vest at December 31, 2006      |       |                                  |       |                                         |       |                                                       | 3,420      |                                                 |       |                                                                     | $          | 9.33 |   |   |   | $ | 27,474 |   |   |   | 7.2 |   |   |
| Exercisable at  December 31, 2006                    |       |                                  |       |                                         |       |                                                       | 1,845      |                                                 |       |                                                                     | $          | 6.58 |   |   |   | $ | 19,731 |   |   |   | 6.1 |   |   |

----

(1)          The additional reservefor the 2004 Equity Incentive Plan became effective upon the completion of ourinitial public offering of common stock on August 5, 2004. These shareswere added to then existing number of shares available for grant under the 1998Long-Term Incentive and Stock Option Plan to arrive at a total of 3,500,000shares available for grant. All subsequently granted option shares have beenmade under the 2004 Equity Incentive Plan.

(2)          Shares forfeited, expired,exchanged or canceled under the 1998 Long-Term Equity Incentive and StockOption Plan are not available for re-grant under the 2004 Equity IncentivePlan.

(3)          The 2004 EquityIncentive Plan provides for an automatic, annual increase on the first of eachyear in an amount equal to the lesser of; a) 1,000,000 shares, b) 4% of thenumber of outstanding common shares on the last day of the previous fiscalyear, or c) such lesser amount as determined by the board of directors. Theautomatic annual increase has been approved by shareholders through December 31,2014.

F-20

----

Thefollowing table summarizes information about the stock options outstanding at December 31,2006 (option shares in thousands):

| ** **                     | ** ** | **Options outstanding** | ** ** | **Options exercisable**           | ** ** |
|--------------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| **Exercise  price range** | ** ** | **Number  outstanding**      | ** ** | **Weighted  average  exercise  price** | ** ** | **Weighted  average  remaining  contractual  life** | ** ** | **Number  currently  exercisable** | ** ** | **Weighted  average  exercise  price** | ** ** |
| $0.08 - $0.90                  |       |                         | 241        |                                   |       |   | $ | 0.34 |   |   |   | 2.6 |   |   |   | 241 |   |   |   | $ | 0.34 |   |   |
| $1.50 - $1.50                  |       |                         | 847        |                                   |       |   | 1.50 |   |   |   | 5.8 |   |   |   | 614 |   |   |   | 1.50 |   |   |
| $1.51 - $8.90                  |       |                         | 599        |                                   |       |   | 7.38 |   |   |   | 7.3 |   |   |   | 347 |   |   |   | 6.92 |   |   |
| $8.91 - $12.81                 |       |                         | 561        |                                   |       |   | 11.71 |   |   |   | 7.3 |   |   |   | 306 |   |   |   | 11.32 |   |   |
| $12.82 - $14.72                |       |                         | 589        |                                   |       |   | 13.94 |   |   |   | 8.6 |   |   |   | 156 |   |   |   | 13.84 |   |   |
| $14.73 - $16.58                |       |                         | 658        |                                   |       |   | 16.23 |   |   |   | 9.5 |   |   |   | 123 |   |   |   | 16.31 |   |   |
| $16.59 - $19.44                |       |                         | 418        |                                   |       |   | 18.58 |   |   |   | 9.2 |   |   |   | 58 |   |   |   | 18.96 |   |   |
|                           |       |                         | 3,913      |                                   |       |   | $ | 9.96 |   |   |   | 7.4 |   |   |   | 1,845 |   |   |   | $ | 6.58 |   |   |

 

The total intrinsic value of options exercised in2004, 2005 and 2006 was $2.8 million, $32.3 million and $12.4 million,respectively.

From time to time the Company may grant stock optionsto consultants. The Company accounts for consultant stock options in accordancewith SFAS 123 and Emerging Issues Task Force Consensus Issue No. 96-18(“EITF 96-18”), *Accounting for EquityInstruments that are Issued to Other Than Employees for Acquiring, or inConjunction With Selling, Goods or Services*. Compensation expensefor the grant of stock options to consultants is determined based on theestimated fair value of the stock options at the measurement date as defined inEITF 96-18 and is recognized over the vesting period.

In February 2004,in connection with amendments to equipment and commercial bank loansoutstanding at that time, the Company issued warrants to purchase 14,666 sharesof Series B preferred stock at an exercise price of $4.50 per share. Thewarrants were exercisable through the later of five years from the date ofgrant or three years after closing of an initial public offering by theCompany. The warrants were recorded at the estimated fair value $40,000, usingthe following assumptions:

| ** **                        | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|
| Value of  underlying common stock |       | $        | 4.50       |   |
| Risk free rate                    |       | 4.9      | %          |
| Expected term                     |       | 10 yrs   |       |
| Dividend yield                    |       | 0        | %          |
| Volatility                        |       | 100      | %          |
|                                   |            |          |            |  |

 

All outstanding warrantsto purchase Series B redeemable convertible preferred stock wereautomatically converted into warrants to purchase common stock in conjunctionwith the Company’s initial public offering in August 2004. During 2005,all outstanding warrants were exercised, pursuant to the net exerciseprovisions of the agreements, resulting in the issuance of 77,678 shares ofcommon stock.

F-21

----

**(11)**   Commitmentsand Contingencies

***(a)****          OperatingLeases*

TheCompany leases its office facilities and certain office equipment under variousnon-cancelable operating lease agreements with various expiration dates through2014. Future minimum payments for the next five years and thereafter as of December 31,2006, under these leases, are as follows:

| 2007       |   | $         | 3,363,000 |   |
|------------|--------|-----------|-----------|--------|
| 2008       |   | 2,971,000 |      |
| 2009       |   | 2,826,000 |      |
| 2010       |   | 2,328,000 |      |
| 2011       |   | 1,389,000 |      |
| Thereafter |   | 775,000   |      |

 

Rent expense was $1.4 million, $1.9 million and$2.8 million in 2004, 2005 and 2006, respectively. Rent expense is determinedusing the straight-line method of the minimum expected rent paid over the termof the agreement. The Company has no contingent rent agreements.

The Company leases aportion of its office facilities from a development group, of which the Company’schief executive officer is a 50% member and the Company’s Vice President ofDelivery is a 25% member. During 2004, 2005 and 2006, the Company paid$605,000, $742,000 and $833,000, respectively, to the development group underthese leases.

***(b)****           HostingServices*

The Company has agreements with third parties toprovide co-location services for hosting operations. The agreements requirepayment of a minimum amount per month for a fixed period of time in return forwhich the hosting service provider provides certain guarantees of networkavailability.

Future minimum payments asof December 31, 2006 under these arrangements were $1.8 million in 2007,$600,000 in 2008, $295,000 per year for 2009 and 2010, and $148,000 in 2011.

***(c)****            Warrantiesand Indemnification*

The Company’s on demand application service istypically warranted to perform in accordance with its user documentation.

The Company’s arrangements generally include certainprovisions for indemnifying customers against liabilities if its products orservices infringe a third-party’s intellectual property rights. To date, theCompany has not incurred any material costs as a result of suchindemnifications and has not accrued any liabilities related to suchobligations in the accompanying consolidated financial statements.

The Company has entered into service level agreementswith a small number of its customers warranting certain levels of uptimereliability and permitting those customers to receive credits or terminatetheir agreements in the event that the Company fails to meet those levels. Todate, the Company has not provided material credits, or cancelled anyagreements related to these service level agreements.

The Company has also agreed to indemnify its directorsand executive officers for costs associated with any fees, expenses, judgments,fines and settlement amounts incurred by any of these persons in any action orproceeding to which any of those persons is, or is threatened to be, made aparty by reason of the person’s service as a director or officer, including anyaction by the Company, arising out of that person’s services as the Company’sdirector of officer or that person’s services provided to any other company orenterprise at the Company’s request.

F-22

----

***(d)****           Litigation*

From time to time, theCompany is involved in legal proceedings arising in the ordinary course ofbusiness. The Company believes that the resolution of these matters will nothave a material effect on the Company’s consolidated financial position,results of operations or liquidity. Legal fees are charged to expense asincurred, unless the probability of incurring a loss is high and the amount canbe reasonably estimated, in which case the estimated loss is accrued.

**(12)**   IncomeTaxes

Thedomestic and foreign components of income (loss) before provision for incometaxes consist of the following (in thousands):

| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| United States |       | $                                          | 6,614      |   | $ | 14,386 |   | $ | 3,655 |   |
| Foreign       |       | (3,065                                     | )          | (6,215 | ) | (8,133 | ) |
|          |       | $                                          | 3,549      |   | $ | 8,171 |   | $ | (4,478 | ) |

 

Thecomponents of the income tax provision are as follows (in thousands):

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Current:       |       |                                       |       |   |   |   |   |
| Federal        |       | $                                          | —     |   | $ | 454 |   | $ | 120 |   |
| Foreign        |       | 94                                         |       | 76 |   | 80 |   |
| State          |       | 6                                          |       | (52 | ) | 330 |   |
| Total current  |       | 100                                        |       | 478 |   | 530 |   |
| Deferred:      |       |                                       |       |   |   |   |   |
| Federal        |       | —                                     |       | — |   | — |   |
| Foreign        |       | —                                     |       | — |   | — |   |
| State          |       | —                                     |       | — |   | — |   |
| Total deferred |       | —                                     |       | — |   | — |   |
|           |       | $                                          | 100        |   | $ | 478 |   | $ | 530 |   |

 

Thereconciliation of income tax attributable to operations computed at the U.S.Federal statutory income tax rate of 34% to income tax expense is as follows:

| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Statutory Federal  tax rate                              |       |                                       | 34         | % |   |   | 34 | % |   |   | (34 | )% |   |
| Net operating  loss tax benefits (realized) not realized |       |                                       | (41        | ) |   |   | (40 | ) |   |   | 54 |   |   |
| Tax credits                                              |       |                                       | —     |   |   |   | — |   |   |   | (37 | ) |   |
| Stock-based  compensation                                |       |                                       | —     |   |   |   | — |   |   |   | 11 |   |   |
| U.S. Federal  alternative minimum tax                    |       |                                       | —     |   |   |   | 6 |   |   |   | 3 |   |   |
| State income  taxes, net of federal benefit              |       |                                       | —     |   |   |   | (1 | ) |   |   | 5 |   |   |
| Foreign taxes                                            |       |                                       | 3          |   |   |   | 1 |   |   |   | 2 |   |   |
| Foreign tax rate  differential                           |       |                                       | 3          |   |   |   | 4 |   |   |   | 6 |   |   |
| Nondeductible  meals & entertainment expense    |       |                                       | 3          |   |   |   | 2 |   |   |   | 4 |   |   |
| Other                                                    |       |                                       | 1          |   |   |   | — |   |   |   | (2 | ) |   |
|                                                     |       |                                       | 3          | % |   |   | 6 | % |   |   | 12 | % |   |

 

F-23

----

Deferredtax components are as follows (in thousands):

| ** **                       | ** ** | **At December 31,** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **2005**                      | ** ** | **2006** | ** ** |
| Deferred tax assets:             |       |                          |       |   |   |
| Net operating loss carryforwards |       | $                             | 6,978      |   | $ | 10,591 |   |
| Deferred revenue                 |       | 3,695                         |       | 4,196 |   |
| Stock compensation               |       | —                        |       | 907 |   |
| Tax credits                      |       | 1,550                         |       | 639 |   |
| Other                            |       | 1,408                         |       | 3,592 |   |
| Total deferred tax assets        |       | 13,631                        |       | 19,925 |   |
| Valuation allowance              |       | (12,533                       | )          | (17,903 | ) |
| Net deferred tax assets          |       | 1,098                         |       | 2,022 |   |
| Deferred tax  liabilities:       |       |                          |       |   |   |
| Fixed assets and intangibles     |       | (325                          | )          | (1,056 | ) |
| Other                            |       | (773                          | )          | (966 | ) |
| Total deferred tax liabilities   |       | (1,098                        | )          | (2,022 | ) |
| Net deferred tax  assets         |       | $                             | —     |   | $ | — |   |

 

The ultimate realization of deferred tax assets is dependentupon the existence, or generation, of taxable income in the periods when thosetemporary differences and net operating loss carryforwards are deductible.Management considers the scheduled reversal of deferred tax liabilities, taxespaid in carryback years, projected future taxable income, available taxplanning strategies, and other factors in making this assessment. Based onavailable evidence, management does not believe it is more likely than not thatany or all of the deferred tax assets will be realized. Accordingly, theCompany has established a valuation allowance equal to the net deferred taxassets. The valuation allowance increased by $3.3 million and $5.4 millionin 2005 and 2006, respectively.

At December 31, 2006, the Company had domesticFederal and state net operating loss carryforwards of approximately$41.9 million and $43.6 million, respectively. Federal net operating losscarryforwards expire at various dates between 2021 and 2025, while state netoperating loss carryforwards expire between 2007 and 2025. In addition, theCompany has federal and state research and development credits and foreign taxcredits available to reduce future domestic income taxes. The federal and stateresearch and development credits expire between 2019 and 2025, and between 2015and 2020, respectively. The foreign tax credits expire between 2007 and 2016.The Company also has approximately $27.9 million of foreign net operatingloss carryforwards that are not subject to expiration.

Under the Tax Reform Act of 1986, as amended, theamounts of and benefits from net operating loss carryforwards and research anddevelopment credits may be impaired or limited in certain circumstances. Eventswhich cause limitations in the amount of net operating losses that the Companymay utilize in any one year include, but are not limited to, a cumulativeownership change of more than 50%, as defined, over a three year period. TheCompany believes its acquisition of Salesnet, Inc. in May, 2006constitutes an ownership change to that entity, and therefore the availabilityof Salesnet, Inc.’s net operating loss carryforwards will be limited infuture years.

As part of the acquisition of Salesnet, Inc. inMay, 2006, the Company recognized deferred tax assets and liabilities for thedifference between the assigned book values and the respective tax bases forthe acquired assets and liabilities. A full valuation allowance of $3.3 millionwas also recognized at the acquisition date due to the uncertainty ofrealization of the net deferred tax assets. The potential future realization ofthese deferred tax assets will be first recorded to reduce to zero any goodwillthat arose from the acquisition.

F-24

----

Our deferred tax assets asof December 31, 2005 and 2006 have been reduced to reflect the 2006adoption of Statement of Financial Accounting Standards No. 123(R), *Share-Based Payment*, (“SFAS 123R”). In periods subsequent tothe adoption of SFAS 123R, net operating loss carryforwards and otherattributes. created by excess tax benefits from the exercise of stock optionsare not recorded as deferred tax assets. Instead such amounts are recorded asan addition to stockholders’ equity if and when they are utilized. Deferred taxassets and the related valuation allowance in the above presentation have beenreduced by $13.1 million and $16.8 million, as of December 31, 2005 and2006, respectively, for the effect of excess tax deductions from stock options.As the deferred tax assets created by equity compensation are fully offset by avaluation allowance, there were no changes to our deferred tax provision forany years presented as a result of our adoption of SFAS 123R.

**(13)**   FairValue of Financial Instruments

Thecarrying amounts of cash and cash equivalents, accounts receivable and accountspayable approximated their fair values at December 31, 2005 and 2006. Thefair values of remaining financial instruments on the Company’s consolidatedbalance sheets were:

| ** **                        | ** ** | **2005**              | ** ** | **2006**        | ** ** |
|-----------------------------------|------------|-----------------------|------------|-----------------|------------|
| ** **                        | ** ** | **Carrying  Value**   | ** ** | **Fair  Value** | ** ** | **Carrying  Value** | ** ** | **Fair  Value** | ** ** |
| ** **                        | ** ** | **In thousands** | ** ** |
| Term receivables—current     |       | $                     | 15,376     |            | $          | 15,376 |   | $ | 23,806 |   | $ | 23,806 |   |
| Term  receivables—noncurrent |       | 10,697                |       | 9,412           |       | 24,805 |   | 20,690 |   |
| Debt                              |       | 147                   |       | 141             |       | 116 |   | 117 |   |
|                                   |            |                       |            |                 |            |  |  |  |  |  |  |  |  |

 

The values provided are representative of fair valuesas of December 31, 2005 and 2006, and do not reflect subsequent changes ininterest, tax or currency exchange rates, or other variables that may affectthe determination of fair value. The following methods and assumptions wereused to estimate fair values:

*Term receivables—current*: The carrying amount approximated fair value at therespective dates due to the relative short maturities of this item.

*Term receivables—noncurrent*:  Fair valuefor term receivables due beyond one year from December 31, 2005 and 2006,has been estimated by discounting the carrying amount by a current rate ofinterest for the period of time the items are expected to be outstanding.

*Debt*: The fair valueof long-term debt has been estimated by discounting the carrying amount by acurrent rate of interest for the period of time the debt is expected to beoutstanding.

**(14)**   EmployeeBenefit Plans

The Company has a voluntary defined contributionretirement plan qualifying under Section 401(k) of the InternalRevenue Code of 1986. The plan covers substantially all full-time employees.Under the terms of the plan, participants may contribute up to the lower of 12%of their salary or the statutorily prescribed limit to the plan. Employees areeligible after 90 days of service. At its discretion, the Company may makematching contributions. The Company made matching contributions during 2004,2005 and 2006 of $542,000, $680,000 and $936,000, respectively. The Companyalso has retirement benefit plans related to its foreign subsidiaries. Amountsexpensed under these plans were $165,000, $274,000 and $275,000 during 2004,2005 and 2006, respectively.

The Company has a medical, dental and vision benefitplan and a short-term disability program covering full-time employees of theCompany and their dependents. The plan is a partially self-funded plan underwhich participant claims are obligations of the plan. The plan is fundedthrough employer and employee contributions at a level sufficient to pay forthe benefits provided by the plan. The Company 

F-25

----

contributions to the planwere $877,000, $1.2 million and $2.0 million during 2004, 2005 and 2006,respectively. During 2006 the plan maintained individual and aggregate stoploss insurance policies on the medical portion of the plan of $75,000 and$2.8 million (based on actual plan participants, adjusted monthly),respectively, to mitigate losses.

In July 2004the Company adopted the 2004 Employee Stock Purchase Plan (“Plan”) which becameeffective in conjunction with the initial public offering of common stock. ThePlan is administered by the compensation committee of the board of directorsand is intended to qualify as an employee stock purchase plan within themeaning of Section 423 of the Internal Revenue Code. Under the terms ofthe plan, substantially all employees are eligible to purchase shares ofRightNow common stock through periodic after-tax payroll deductions at apurchase price established by the administrator. Payroll deductions are limitedto 15% of the employee’s regular compensation for each purchase period. Theadministrator may set the purchase price equal to or discounted from fairmarket value on the first or last day of each purchase period. Purchase periodsare consecutive six-month periods ending on the last day in June and December eachyear. For the purchase periods ended December 31, 2005 and 2006, and June 30,2006, the plan was deemed noncompensatory because the terms were no morefavorable than those available to all holders of our common stock. Activityunder the plan for 2004, 2005 and 2006 was as follows:

| ** **                | ** ** | **Purchase Date** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **Dec 31,**       | ** ** | **Jun 30,** | ** ** | **Dec 31,** | ** ** | **Jun 30,** | ** ** | **Dec 31,** | ** ** |
| ** **                | ** ** | **2004**               | ** ** | **2005** | ** ** | **2005** | ** ** | **2006** | ** ** | **2006** | ** ** |
| Purchase price  per share |       | $                      | 7.00       |   | $ | 10.22 |   | $ | 17.54 |   | $ | 15.85 |   | $ | 16.36 |   |
| Shares purchased          |       | 98,471                 |       | 51,629 |   | 7,322 |   | 6,830 |   | 4,957 |   |
|                           |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**(15)**   Quarterly Results (Unaudited)

Quarterlyresults of operations are as follows (in thousands, except per share amounts):

| ** **                 | ** ** | **Year Ended December 31, 2005** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|
| ** **                 | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth   uarter** | ** ** |
| Operating  statement data: |       |                                                 |       |   |   |   |   |   |   |
| Total revenue              |       | $                                                    | 18,342     |   | $ | 21,078 |   | $ | 23,154 |   | $ | 24,574 |   |
| Gross profit               |       | 13,582                                               |       | 15,923 |   | 17,875 |   | 18,701 |   |
| Net income                 |       | 801                                                  |       | 1,559 |   | 2,343 |   | 2,990 |   |
| Net income per share:      |       |                                                 |       |   |   |   |   |   |   |
| Basic                      |       | $                                                    | 0.03       |   | $ | 0.05 |   | $ | 0.08 |   | $ | 0.09 |   |
| Diluted                    |       | 0.02                                                 |       | 0.05 |   | 0.07 |   | 0.09 |   |

 

| ** **                   | ** ** | **Year Ended December 31, 2006** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|
| ** **                   | ** ** | **First  Quarter**                                   | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth   uarter** | ** ** |
| Operating  statement data:   |       |                                                 |       |   |   |   |   |   |   |
| Total revenue                |       | $                                                    | 24,631     |   | $ | 26,908 |   | $ | 30,088 |   | $ | 28,761 |   |
| Gross profit                 |       | 17,756                                               |       | 18,808 |   | 21,452 |   | 20,002 |   |
| Net income (loss)            |       | (440                                                 | )          | (1,755 | ) | (519 | ) | (2,294 | ) |
| Net income (loss) per share: |       |                                                 |       |   |   |   |   |   |   |
| Basic                        |       | $                                                    | (0.01      | ) | $ | (0.05 | ) | $ | (0.02 | ) | $ | (0.07 | ) |
| Diluted                      |       | (0.01                                                | )          | (0.05 | ) | (0.02 | ) | (0.07 | ) |

 

F-26

----