** **

**UNITED STATES SECURITIES and EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

**(Mark One)**

**ý****ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**FOR THEFISCAL YEAR ENDED DECEMBER 31, 2004**

 

**OR**

 

**o****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**FOR THETRANSITION PERIOD FROM               TO               **

 

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**COMMISSIONFILE NUMBER 000-31321**

 

**RIGHTNOWTECHNOLOGIES, INC.**

(Exact name ofregistrant as specified in its charter)

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

 

**40ENTERPRISE BLVD, BOZEMAN, MONTANA 59718**

(Address ofprincipal executive offices) (Zip code)

 

**(406)522-4200**

(Registrant’stelephone number including area code)

 

Securities registeredpursuant to Section 12(b) of the Act:

**NONE**

 

Securities registeredpursuant to Section 12(g) of the Act:

**COMMONSTOCK**

 

Indicateby check mark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý    No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements incorporatedby reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).    Yes o    No  ý

 

Theaggregate market value of common stock held by non-affiliates of the registrantas of June 30, 2004, the last business day of the registrant’s most recentlycompleted second fiscal quarter, was approximately $19,402,978.  Market value is based on the number of sharesoutstanding, on an as-converted basis, less shares held by officers, directors,and 10% or greater stockholders, multiplied by $7.  The $7 per share market value was our initialpublic offering price on August 5, 2004.

 

Thenumber of shares outstanding of the registrant’s common stock as of February28, 2005 was 29,952,446.

 

DOCUMENTSINCORPORATED BY REFERENCE: None

 

 

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**RightNowTechnologies, Inc.**

 

**AnnualReport on Form 10-K**

 

For The Fiscal Year EndedDecember 31, 2004

 

Table of Contents

 
| PART I    |                                                                                                                | 4      |
|-----------|---------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.   | Business                                                                                                            | 4      |
| Item  2.  | Properties                                                                                                          | 16     |
| Item 3.   | Legal Proceedings                                                                                                   | 17     |
| Item  4.  | Submission  of Matters to a Vote of Security Holders                                                                | 17     |
|      |                                                                                                                |   |
| PART II   |                                                                                                                | 18     |
| Item  5.  | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 18     |
| Item 6.   | Selected  Financial Data                                                                                            | 21     |
| Item  7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 22     |
|      | Risk  Factors                                                                                                       | 36     |
| Item  7A. | Quantitative  and Qualitative Disclosures about Market Risk                                                         | 52     |
| Item  8.  | Financial  Statements and Supplementary Data                                                                        | 52     |
| Item  9.  | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                               | 53     |
| Item 9A.  | Controls and  Procedures                                                                                            | 53     |
| Item 9B.  | Other Information                                                                                                   | 53     |
|      |                                                                                                                |   |
| PART  III |                                                                                                                | 54     |
| Item  10. | Directors  and Executive Officers of the Registrant                                                                 | 54     |
| Item 11.  | Executive Compensation                                                                                              | 60     |
| Item  12. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                | 64     |
| Item  13. | Certain  Relationships and Related Transactions                                                                     | 67     |
| Item 14.  | Principal  Accountant Fees and Services                                                                             | 68     |
|      |                                                                                                                |   |
| PART IV   |                                                                                                                | 69     |
| Item  15. | Exhibits  and Financial Statement Schedules                                                                         | 69     |
|      | Signatures                                                                                                          | 71     |

 

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CAUTIONARY STATEMENT

 

*All statements included or incorporated byreference in this report, other than statements or characterizations ofhistorical fact, are forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995.  These forward-looking statements are based onour current expectations, estimates and projections about our industry,management’s beliefs, and certain assumptions made by us, all of which aresubject to change.  Forward-lookingstatements can often 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, the impact of taxaccounting elections, and management’s future strategic plans.  These forward-looking statements are notguarantees of future results and are subject to risks, uncertainties andassumptions that are difficult to predict and that could cause our actualresults to differ materially and adversely from those expressed in anyforward-looking statement.  The risks anduncertainties referred to above include, but are not limited to, risksassociated with our business model; our ability to develop or acquire,introduce, market and gain market acceptance for new products and enhancementsto existing products in a cost-effective and timely manner; the gain or loss ofkey customers; competitive pressures and other factors such as the availabilityand pricing of competing products and technologies and the resulting effects onsales and pricing of our products; the rate at which our present and futurecustomers adopt our existing and future products and services; our ability toexpand operations; possible fluctuations in our operating results including ourrevenue mix and our rate of growth; interruptions or delays in our hostingoperations; breaches of our security measures; our ability to expand, retainand motivate our employees and manage our growth; the impact of potentialacquisitions, if any; and various other factors, some of which are describedunder the section below entitled “Risk Factors” at the end of Item 7 of thisReport.  These forward-looking statementsspeak only as of the date of this Report. We undertake no obligation to revise or update publicly anyforward-looking statement for any reason.*

 

**Part I**

 

## **Item 1. BUSINESS**

 

**Overview**

 

We are a leading provider of on-demandsoftware solutions for the customer relationship management, or CRM,market.   We offer a broad suite ofsolutions to

 

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address the customer service, sales and marketing requirements oflarge, medium and small enterprises. Our comprehensive customer servicesolution features a self-learning knowledgebase to ensure accurate andconsistent interactions with customers. Our solution is designed to seamlesslysupport multiple communications channels, including web, interactive voice,e-mail, chat, telephone and proactive outbound e-mail communications, creatinga comprehensive record of customer interactions. The information from thesecustomer interactions can be leveraged with our recently released sales andmarketing solutions to more accurately target marketing efforts and enhance revenueopportunities for our customers.   Weoffer our solutions primarily through a multi-tenant, hosted on-demand modelthat reduces the cost and risk associated with deploying traditional enterpriseCRM software. We provide value-added services such as business processoptimization and product tune-ups throughout the lifecycle of our relationshipwith our clients. We currently have more than 1,200 active clients acrossvarious industries. In the year ended December 31, 2004, our on-demand clientsserviced 502 million customer interactions directly through our customerservice solutions, as compared to 249 million customer interactions in 2003.

 

In November 2004, we released RightNow 7.0, abroad suite of on demand CRM solutions for customer service, sales andmarketing.  RightNow 7.0 is comprised ofthree applications, with various add-on capabilities, built on a common base:RightNow ServiceTM, an award-winning multi-channel customer service and supportapplication; RightNow SalesTM, a robust sales force automation application; andRightNow MarketingTM, a multi-channel marketing automation application.

 

We were incorporated in Montana in September1995 and reincorporated in Delaware in August 2000.  Our principal executive offices are locatedat 40 Enterprise Boulevard, Bozeman, Montana 59718-9300, and our telephonenumber is (406) 422-4200.  We have branchoffices in Dallas, TX, San Mateo, CA, and Princeton, NJ, and a liaison officein Tokyo, Japan.  We also have subsidiaryoffices in London, England, and Sydney, Australia.  In January 2005 we re-activated a subsidiaryoffice in Munich, Germany.  Our web siteis located at http://www.rightnow.com. Information contained on, or that can be accessed through, our web sitedoes not constitute a part of this report.

 

**Products and Services**

 

Our suite of CRM solutions is based upon asingle application platform that is designed to be easy to implement, use andmaintain, that supports multiple customer interaction points in a business’operations, and that integrates seamlessly with traditional enterprise and/orback office applications. We also offer professional services to help ourclients optimize the effectiveness of our solutions within their enterprise.Our solutions are available either on a hosted basis, where they are deployedin our co-location facilities and accessed on-demand by our clients, or on anon-hosted basis, where our clients deploy them in their own facilities. Oursolutions are available in 14 languages.

 

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***RightNow Service***

 

RightNow Service is the flagship solution inour suite of customer service solutions and generates approximately 90% of ourrevenue.   RightNow Service was firstreleased in 1997 with new capabilities added in subsequent releases.  At the core of RightNow Service is our self-learningknowledgebase, which provides a comprehensive and unified customer servicesolution across multiple customer interaction channels, including web,interactive voice, e-mail, chat and telephone. We have developed severalproprietary approaches to knowledge management that enable our solution toautomatically learn what information is important and relevant withoutrequiring frequent manual intervention of a knowledge expert. In this manner,the knowledgebase structure and content is customer-driven and managedautomatically as our solution is used. As a result, our clients are able toserve their customers more efficiently and quickly while providing increasedcustomer satisfaction.

 

RightNow Service has the followingcapabilities that may be combined in a number of different configurations toaddress the specific business process needs of our clients, and all of whichcan be integrated with our clients’ other mission-critical enterpriseapplications:

 

*Web Self-ServicePortal.*  Ourself-service capability enables our clients to offer a dynamically updatedselection of information delivered to customers of our clients over the web. Ascustomers interact with our solution, our proprietary knowledgebase technologyautomatically prioritizes and organizes answers in the knowledgebase toanticipate future customer questions. If customers are unable to find answersto their questions, they may submit their questions over the web, e-mail theirquestions, initiate a live chat with a customer service representative, or CSR,or request a telephone callback from a CSR.

 

*RightNow Voice.*  Our voice self-service interface allowscustomers of our clients with the RightNow Service knowledgebase to offertelephone self-service using the same knowledgebase as is used by the webself-service feature. This application uses proprietary technology to providecallers access to frequently asked questions and keyword searching throughspeech recognition.

 

*Web-Site Search*.  This feature allows customers accessing thesearch capability through the Web Portal to receive content from specifiedportions of a company’s Internet or intranet sites.  These results are presented along withknowledgebase content.

 

*Intelligent AgentDesktop*.  TheIntelligent Agent Desktop is our CSR interface into RightNow Service.  Agents may create, review or update incidentsand customer data received via phone, email, or Web Portal, as well asinformation from other systems through internet-based access.  This component provides, within an Internetweb browser-based interface, a configurable view of the CSR work queue, allinformation associated with an inquiry, including a complete interactionhistory for the inquiry and

 

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customer information specified by our client’s business process, aswell as information on the organization and individual requesting service,including prior service history. In addition the CSR receives access to theknowledge base, and routing rules to provide a complete call center and emailresponse management solution.

 

*Offer Advisor*.  The Offer Advisor allows CSRs to presentadditional suggestions to customers for revenue generation or servicequality.  Offers may be determined eitherby rules and/or through our real-time knowledgebase assessment of customerinformation.  Should the agent select anoffer, the tool provides a short script to assist the agent in presenting theoffer to the customer.

 

*Computer TelephonyIntegration (CTI) Toolbar*.  This element of the solution allows CSRs topick up telephone calls, transfer, conference and dial out within the desktop.

 

*Chat andCollaboration.* Our solution allows a customer to chat live (online) or co-browse withCSRs, by request or through automatic escalation.  Support staff can “push” web pages to avisitor within a dialogue as well as escort users though a website and completeweb forms for the customer.

 

*Closed-IncidentMetrics*.  Thiscapability provides CSRs with the ability to conduct surveys following closedincidents to track resolution and satisfaction.

 

# ***RightNow Sales***

 

RightNow Sales is an integral component of our suite of CRM solutions,and was released in November 2004.  Thesolution automates the sales process functions as well as leverages theinformation from customer service interactions captured in RightNow Service to driverevenue opportunities for our clients. RightNow Sales has the following modules that can be purchasedindividually or in combination to enhance sales productivity for our clients.

 

Sales Force Automation (*SFA) Desktop*.  The SFA desktop is our sales professionalinterface into the solution.  Using thisinterface, sales professionals may: manage contacts, accounts andopportunities; create and manage sales forecasts; plan, manage and executesales strategies; create and send quotes; and review service or marketingactivities with that customer.  Theinterface includes configurable dashboards, or computer screen presentations,so key opportunity, account and task information is readily accessible,allowing quick views of relevant information, such as in-quarter opportunities,and simultaneous views of specific opportunity details. 

 

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*RightNow Locator.*  RightNow Locator is an Internet-basedlocation finder solution that provides online consumers with maps, drivingdirections, contact information and other location specific information tofacilitate offline transaction completion at a retailer’s physical store.

 

***RightNow Marketing***

 

RightNow Marketing is the third component inour suite of CRM solutions and was released first as RightNow Outbound in late 2003and re-released as RightNow Marketing in November 2004.*** *** RightNow Marketingprovides tools for marketers to easily create and execute multi-channel,multi-stage campaigns, target existing and prospective customers with the mostrelevant offers, and evaluate the effectiveness and financial impact ofmarketing programs.

 

*RightNow Marketing.*  RightNow Marketing enables marketingorganizations and professionals to leverage information about customers andprospects gained from such sources as online inquiries, service interactions,advertisement responses and sales calls, to deliver individualized, targetede-mail marketing messages and/or web marketing strategies. RightNow Marketingalso enables customer service organizations to pre-empt service inquiries byproactively targeting customers with relevant, personalized communications.When combined with RightNow Service, clients can also use flexible workflowrules and auto-response capabilities to manage resulting e-mail replies. Inaddition, a graphical campaign editor allows clients to produce multi-stagecampaigns for sales lead routing, up-sell and cross-sell opportunities, andgeneral customer communications.

 

*RightNow Metrics.*  RightNow Metrics is a survey and measurementtool that allows businesses to design and disseminate custom surveys toexternal and internal parties to gather information for business decisions andto measure service quality. All survey responses are automatically tabulatedand graphed and can then be used by businesses to measure performance, measurereaction to new or improved products, services and programs, identify productand service enhancements, or collect market intelligence on customerdemographics

 

***RightNow Analytics***

 

RightNow Analytics incorporates asophisticated real-time management report capability that is fully integratedacross multiple customer interaction channels to all easy tracking, reportingand analysis.  A flexible user interfaceoffers standard reports, the ability to modify the standard reports, create newreports, create exception-based notification alerts, and customize dashboardpresentations.  RightNow Analytics alsoprovides robust output options such as Adobe Acrobat (“.pdf”) formattedreports, and graphical displays with “drilldown” capability to enable views ofthe underlying data.  RightNow Analyticsis currently included with the RightNow Service, Sales and Marketing modules.

 

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***Hosting Services andTechnical Support***

 

Our products are available on a hosted basisor can be implemented and maintained by our clients in their own facilities.Our products have been specifically designed to be installed in a hostedfashion in order to minimize implementation requirements and reduce cost ofownership and support. Our Hosting Management System, or HMS, enablesbusinesses to monitor and manage their hosted CRM application. Through HMS, weare able to provide our clients individual control of their site within ourhosted environment, including the ability to reliably manage and control theirindividual upgrade process for new software versions. HMS automatically handlesupgrades without RightNow system administrator involvement which has allowed usto efficiently and effectively manage thousands of instances of our solution inour hosted environment. Our Hosting Operations Group manages the onlinedelivery of our software, including designing and testing the architecture,establishing and maintaining security policies, constant monitoring of the datacenter operations and maintaining and upgrading the HMS.

 

We serve our clients from two, geographicallyseparate, third-party, hosting co-location facilities located on the East andWest coasts of the United States, and a third disaster recovery facility inMontana.  Within the East and West coastfacilities we operate four independent pods to manage time-zone specificmaintenance for customers in Europe, Asia Pacific and North America.  We contract with AT&T and SAVVISCommunications Corporation which provide the co-location facilities on the Eastand West coasts of the United States, respectively. Under the terms of ourarrangements, AT&T and SAVVIS provide the physical space and security,access to the Internet and professional services as requested. We own andoperate the hardware and software on which our applications run in theco-location facilities. Our agreements were entered into with one to two yearterms with fees payable monthly.  Onecontract expires in 2005 and the other in 2006, at which time we will seek torenew the contracts on comparable terms. The two co-location facilities aredesigned to withstand earthquakes and are supported by on-site backupgenerators in the event of power failures. To facilitate loss recovery, weoperate a multi-tiered system configuration with load balanced web server pools,replicated database servers and fault tolerant storage devices. We perform bothreal-time and nightly backups, and maintain multiple backups. Every hosted siteis secured by redundant firewalls, constant monitoring and physically securedbuildings with cameras, recorded tapes, biometric access screening,escort-controlled access, intrusion detection systems and guards.

 

Our multi-tenant architecture is capable ofsupporting many different versions of our solution running on the same systemand database server. In multi-tenancy, security is of critical importance. Weensure the security of our client’s implementation by using separate datastores for each client and operating system level controls to ensure that oneclient cannot gain access to another’s data.

 

Our Technical Support Group assists ourclients with upgrades and troubleshooting, and promotes clientself-sufficiency. The Japanese market is supported

 

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through a partner located in Japan. Certain European partners providefirst level technical support for their markets.

 

Additionally, we have developed a proprietarybusiness activity monitoring system called the “Customer Success Index.” Keyvital signs of our clients’ customer service operations are monitored daily andtranslated into a 0-100 score. These scores are made available to all membersof our support and sales organizations to monitor the on-going success of everycustomers’ use of our solution.

 

***ProfessionalServices***

 

Our Professional Services Group providesconsulting, education and development services. The group’s consultants,trainers, project managers and application engineers help our clients achievesignificant business benefit from our solution through a process of guideddiscovery, rapid prototyping, testing and deployment. By complementing ourclient’s project team with our product experts, we are able to quickly move oursolutions into production, allowing our clients to see a faster return on theirinvestment. Our average deployment timeframe is 50 days.

 

We offer consulting and implementationservices to our clients to facilitate the adoption of our products andsolutions. We also provide tune-up services to our clients which consist of anaudit of their solution against our library of best practices. We score eachone of our client sites on how well they take advantage of our best practicesand then make recommendations on which best practices (specific to theirsolution) they should implement to improve their performance. Our educationprogram consists of a variety of traditional classroom, computer-based andremote education tailored to our client’s needs. We also offer customizationservices that allow our clients to tailor our application to meet their uniquebusiness needs through the use of our XML (extensible markup language) APIs(application programming interfaces), and custom tabs. These functions usecommon web services standards to integrate with other applications, includingcustomer relationship management, enterprise resource planning, computertelephony integration, system configuration management and e-commerceapplications.

 

**Sales and Marketing**

 

We sell our products primarily through ourdirect sales organization and to a lesser extent through indirect channels. Ourdirect sales organization is separated into new business and installed basesales groups. In our new business sales group, we employ personnel to makeinitial calls to potential clients and qualify client leads, and direct salesrepresentatives to close sales with clients and arrange client support. Ourinstalled base sales organization focuses on managing existing clientrelationships, further penetrating those relationships and cross-selling andup-selling into those relationships. We currently have regional fieldoperations offices in Montana, Texas, California, New Jersey, England,Australia, and Germany, and a sales liaison office in Japan. See Note 1(c)of Notes to Consolidated Financial Statements for more information regardingour geographic areas.

 

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We offer pilot programs whereby a prospectiveclient can deploy our full solution suite to either a test group or theirentire customer base to ensure our solutions meet their needs prior tocommitting to any license fees. A pilot program typically lasts 30 to60 days. The prospective client’s objectives are quantified and resultsmeasured during the period. As a result of this program, we believe we haveexperienced shorter sales cycles, higher closure rates and larger deal sizes.

 

Our indirect channels consist primarily ofrelationships with resellers of our solutions. At December 31, 2004, wehad relationships with over 30 indirect channel distributors. Domestically, ourindirect channel consists primarily of relationships with outsourcers andreferral partners who refer leads to us. Outsourcers represent a developingindirect channel for our solutions that we intend to expand.  We currently have relationships with severaloutsourcers, including Convergys, ICT and KPN/SNT. We have dedicated staff inour sales organization calling on and servicing these partners. In the future,we intend to establish additional strategic relationships with vertical marketdistribution partners, telephony infrastructure partners, fulfillment partnersand independent software vendor/original equipment manufacturing partners inadjacent markets. In international markets where we do not have a directselling presence, we rely on system integrators and resellers to sell oursolutions. This strategy is primarily employed in Europe, New Zealand and Asia.We intend to continue to broaden our distribution to the Japanese marketthrough resellers. We also have partners in Europe, including Dimension Data,Siemens and Unisys who provide sales coverage for certain European countries.We intend to expand our European partner channel in countries where we do nothave a local presence.

 

Our marketing department coordinates futureproduct and service direction, manages generation of client leads, and managespublic and industry analyst relations. We also have developed and will continueto expand innovative marketing initiatives to expand our client base, such asour client roundtables, where existing clients host forums with potentialclients and exchange ideas about customer service best practices.

 

**Clients**

 

As of December 31, 2004, we had morethan 1,200 active clients in various industries, including technology,financial and insurance, consumer products, telecommunications and travel andhospitality, as well as government agencies and educational institutions.  For the year ended December 31, 2004,approximately 39% of our revenue was generated from entities with over$1 billion in annual revenue, 47% of our revenue was generated fromentities with less than $1 billion in annual revenue and 14% of ourrevenue was generated from government/educational institutions.  No single client accounted for more than 5%of our revenue in the year ended December 31, 2004.

 

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**Product Development and Technology**

 

Our product development efforts are focusedon improving and enhancing our existing solutions and service offerings as wellas developing new proprietary technology. Our product development philosophyincorporates our long-term strategic view of our market and incorporatescustomer feedback to improve and enhance our products. We currently aredeveloping products and solutions to broaden our offerings within customerservice and other segments of the CRM market. We have an applied research groupthat focuses on knowledgebase, artificial intelligence and novel applicationsof current research for use within our solutions. Although we allow our clientsto run multiple versions of our software, our development efforts are focusedon the current and future releases of our products. Our research anddevelopment expenses totaled approximately $7.8 million in 2004,$5.9 million in 2003, and $4.1 million in 2002.

 

We believe we have significant technologyexpertise in developing and deploying highly scalable and reliable on-demandcustomer service applications. All of our products have been designed usingindustry standards for the Internet and are designed to meet the followinggoals: cost efficient deployment, highly configurable, scaleable, easilyintegrated, multi-tenant and capable of being internationalized. The followingarchitectural components form the foundation for the delivery of a variety offeatures within our solution:

 

*Self-learningKnowledgebase.* Knowledgebase technologies are used within our solution to provideself-service and automatic e-mail response to users and as an automatedassistant for our clients’ CSRs. Core technologies in the area of theknowledgebase include automatic learning and decay of the relevancy andrelatedness of information, natural language processing, word-stemmingalgorithms, information clustering and classification algorithms, andinformation retrieval technologies.

 

*Integration withOther Enterprise Applications.*  Our hosted and non-hosted clients are able tointegrate our solution with their other mission-critical enterpriseapplications through several techniques, including: web services that provide areal-time, two-way, web-based XML (extended mark-up language) API (applicationprogram interface); application level triggers that raise real-time events totrigger integration actions with other systems; user interface “custom tabs”that allow the integration of other applications into our solution; and “passthrough” authentication that allows our solution to inherit user credentialsfrom other applications to identify and enforce access to our clients’ websites. In addition, pre-packaged connectors are available for integration withother third-party applications.

 

*User Interface.*  Although our user interface is based upon anindustry standard Internet web browser, we have developed techniques to delivera look and feel similar to the thick client user interfaces utilized intraditional client/server products. This includes support for functionality notnormally associated with web browser interfaces such as

 

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graphical drag and drop, cascading menus, and efficient pop-up dialogs.We also have addressed the typical performance concerns associated withbrowser-based applications by reducing visible page turns and their associateddelays. Consequently, our clients benefit from the ease of administration andmaintenance of a web application while still enjoying the user experience of alocally-installed desktop application.

 

*SoftwareArchitecture.* Our solution has been developed using a logical three-tier Internetarchitecture consisting of presentation, application logic and data managementlayers. Because of the tiered separation, our solution is highly scalable,allowing expansion at the presentation and application logic tiers and at thedata management tier. We have experience deploying our solution in highlyavailable, highly scalable, load-balanced web server and clustered databaseserver configurations. We support most commonly available operating systems(Linux, Sun Solaris, Microsoft Windows Server) and databases (Oracle, MicrosoftSQL Server, MySQL).

 

**Intellectual Property**

 

Our success depends to a significant degreeupon the development and protection of our software and other proprietarytechnology rights. We believe we have a strong base of intellectualproperty.  As of February 2005, our baseof intellectual property included five issued and eight pending U.S. patents,three U.S. trademark registrations, five pending U.S. trademark application,ten foreign trademark registrations and one pending foreign trademarkapplications. The majority of our patent applications concern our knowledgebasetechnology, including processes relating to the relative usefulness ranking andthe order of display of retrieved information in the knowledgebase; the abilityof the knowledgebase to suggest related information to a user accessing theknowledgebase; and the ability of the knowledgebase to produce a relational mapof help information items based on the historical usage patterns of customersaccessing the knowledgebase.

 

The following is a summary of our issued USpatents:

 

*Implicit Rating ofRetrieved Information in an Information Search System.*  This process relates to an information searchand retrieval system through a network, such as the Internet, in which therelative usefulness ranking and the order of display of the retrievedinformation in the knowledgebase is adjusted based on actions taken by a user.This patent continues until April 2020.

 

*Temporal Updates ofRelevancy Rating of Retrieved Information in an Information Search System.*  This process relates to an information searchand retrieval system through a network, such as the Internet, in which therelative usefulness ranking and the order of display of the retrievedinformation in the knowledgebase is adjusted based on the amount of time elapsedsince the particular information was last accessed. This patent continues untilApril 2020.

 

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*Usage Based Strengthbetween Related Information in an Information Retrieval System. *This patent, whichissued in January 2005, describes an information retrieval system in whichinformation is displayed based on navigation behavior of previous users.  This patent continues until January 2025.

 

*System and Methodfor Generating a Dynamic Interface via a Communications Network.*  Our most recent patent, issued in February2005, describes a system for dynamically adapting selections in an automaticphone support system.  This inventionenables the provision of information from a dynamic knowledgebase via atelephone channel.  This patent continuesuntil February 2025.

 

*Display Screen for aComputer.*  Thisis a design patent relating to the user interface to our software. This patentcontinues until March 2016.

 

Our three registered trademarks in the UnitedStates are RIGHTNOW, RIGHTNOW TECHNOLOGIES (stylized) and SMARTASSISTANT. Eachof these marks is important to RightNow Service. We use our “RightNow” mark asa descriptor of all of our products. These marks continue indefinitely subjectto continuous use and payment of registration fees at the statutorily requiredintervals. We also use the following common law marks “Locator,” “RightNowMetrics,” “RightNow Outbound,” “RightNow Marketing”, RightNow Sales”, “RightNowService”, “Top-Line”, “Proactive”, “SmartSense”, “SmartConversion”, “ProServices”,“RightNow Live”, “RightPractices”, “RightStart”, “Talk RightNow”, and “SmartAttributeTechnology”. Other trademarks, trade names or service marks appearing in thisreport are the property of their respective holders.

 

We also incorporate a number of third party software products intoRightNow Service pursuant to relevant licenses. Some of the software isproprietary and some is open source. We use third party software for, amongother things, spell checking certain foreign languages, improving graphics inour analytics module, language parsing, and locating and indexing documents onwebsites. These functions are peripheral in nature, we are not substantiallydependent upon these third party software licenses and we believe the licensedsoftware is generally replaceable, by either licensing or purchasing similarsoftware from another vendor or building the software function ourselves.

 

**Competition**

 

The CRM software market consists of threeseparate market segments: (1) customer service, (2) sales forceautomation and (3) marketing automation. Within this segmentation, vendorsare offering solutions through either on-demand or traditional on-premisedelivery methods. We compete in all segments of the CRM software market, andbelieve that we are the leader in on-demand customer service within thatmarket.

 

The market for CRM solutions is highlycompetitive and fragmented, and is subject to rapidly changing technology,shifting client requirements, frequent

 

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introductions of new products and services, and increased marketingactivities of other industry participants. Competition has increased with our release of RightNow 7.0.  We expect the intensity of competition toincrease in the future as existing competitors continue to develop theircapabilities, as new companies enter our market and as we further expand intothe CRM market.

 

We face competition from other companiescurrently providing customer service solutions, some of which offer hostedservices, including Amdocs Limited, BMC Software Corporation, E.piphany, Inc.,eGain Communications Corporation, FrontRange Solutions, Inc., IBMCorporation, Kana Software, Inc., Microsoft Corporation, OracleCorporation, SAP AG, salesforce.com, inc. and Siebel Systems, Inc. Wealso expect to compete with these and other companies as we further expand intothe CRM market, and as they and others expand into the customer servicesegment. In addition, our solutions compete with CRM systems that are developedand maintained internally by businesses, as well as CRM products or servicesthat are developed, or bundled with other products or services, and installedon a client’s premises by software vendors. We also face competition fromoutsourced contact center providers who bundle solutions and agent labor intheir service offerings. To the extent our competitors have an existingrelationship with a potential client, that client may be unwilling to switchvendors due to the time and financial commitments already made with ourcompetitors.

 

Many of our current and potential competitorshave longer 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.

 

New companies are entering the CRM softwaremarket, the on-demand applications market and the on-demand CRM market, orexpanding from any one of these markets to the others. We expect that newcompetitors, such as enterprise software vendors and online service providersthat have traditionally 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 the principal factors thatgenerally determine a company’s competitive advantage in the on-demand customerservice and broader CRM markets include the following:

 

•                  Low total cost of ownership and easily demonstrablecost-effective benefits for clients;

•                  Effectiveness in improving the quality of clients’customer service departments;

 

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•                  Broad product functionality to meet complex clientprocess requirements;

•                  Ability to leverage information from customerinteractions to more accurately target marketing efforts and enhance revenueopportunities;

•                  Speed and ease of implementation;

•                  Ease of use and associated high rates ofutilization;

•                  System performance, security, scalability,flexibility and reliability;

•                  Ease of integration with existing applications anddata;

•                  Availability and quality of implementation,consulting and education services;

•                  Quality of client care;

•                  Competitive sales and marketing capabilities; and

•                  Financial stability and reputation of the vendor.

 

We cannot assure you that we will besuccessful in all or any of these areas that we believe contribute tocompetitive advantage, or that we will be able to compete successfully againstcurrent or potential competitors, or that competition will not have a materialadverse effect on our business, financial condition and results of operations.

 

**Employees**

 

As of December 31, 2004, we had 403full-time employees. Of the total employees, we had 163 in sales and marketing,88 in software development, 71 in professional services, 31 in technicalsupport, 35 in finance and administration and 15 in hosting operations. None ofour employees are represented by a labor union. We believe that ourrelationship with our employees is good.

 

**Item2.  Properties**

 

Our corporate headquarters, including ourprincipal administrative, marketing, technical support and research anddevelopment facilities, are located in Bozeman, Montana, where we leaseapproximately 30,000 square feet with a term that expires in March 2011,and approximately 13,000 square feet under two leases with terms that expire inMarch and April 2005.  We expect torenew the leases that expire in March and April 2005 on similar terms.  We plan to enter into a five-year lease forapproximately 13,000 square feet of additional office space in Bozeman,Montana, that will be available in mid-2005. We also currently occupy a numberof domestic and international sales and service offices in California, NewJersey, Texas, Australia, Japan and the United Kingdom, where we lease anaggregate of approximately 29,000 square feet under multiple leases, which haveterms that expire between November 2005 and March 2011.  We believe that our current facilities aresuitable and adequate to meet our current needs, and that suitable additionalor substitute space will be available as needed to accommodate expansion of ouroperations. See Note 9(a) to the Consolidated Financial Statements and “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Contractual Obligations and Commitments” for information regardingour lease obligations.

 

16

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**Item 3. Legal Proceedings**

 

From time to time, we are involved in legalproceedings arising in the ordinary course of business.  We believe that the resolution of thesematters will not have a material effect on our consolidated financial position,results of operations or liquidity.

 

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

 

No matters were submitted to a vote of security holders during thefourth quarter of 2004.

 

17

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### **Part II**

 

**Item 5.**                       Market for Registrant’s CommonEquity, Related Stockholder Matters, and Issuer Purchases of Securities

 

#### **Market Information for Common Stock**

 

Our common stock is traded on the NasdaqNational Market under the symbol RNOW. The table below reflects the quarterly high and low per share salesprices of our common stock for the period August 5, 2004, the first day ofpublic trading of our common stock, through December 31, 2004, as reported bythe Nasdaq National Market.  These pricesrepresent prices among dealers, do not include retail markups, markdowns or commissions,and may not represent actual transactions. Prior to August 5, 2004, there was no established public trading marketfor our common stock.

 
| ** **                       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------|------------|----------|------------|---------|------------|
| Quarter ended September 30, 2004 |       | $        | 12.98      |    | $          | 6.67 |   |
| Quarter ended December 31, 2004  |       | 20.99    |       | 12.15   |       |
|                                  |            |          |            |         |            |  |  |

 

**Holders**

 

On February 14, 2005, there wereapproximately 250 holders of record of our common stock.

 

**Dividends**

 

We have never declared or paid cash dividendson our capital stock since converting from an S corporation to a C corporationat the end of 1999.  We currently intendto retain future earnings, if any, to finance the growth and development of ourbusiness, and therefore do not anticipate paying any cash dividends in theforeseeable future.  Furthermore, ourbank credit facility with our secured lender currently prohibits us from payingcash dividends on our common stock without the bank’s prior written consent.

 

**Unregistered Sales of Equity Securities**

 

None.

 

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**Use of Proceeds from Sales of RegisteredSecurities**

 

In August 2004, we completed the initialpublic offering of our common stock, par value $0.001 per share. The managingunderwriters in the offering were Morgan Stanley & Co. Incorporated, ThomasWeisel Partners LLC, Adams Harkness and D.A. Davidson & Co. The shares ofcommon stock sold in the offering were registered under the Securities Act of1933, as amended, on a Registration Statement on Form S-1 (Reg. File No.333-115331) that was declared effective by the Securities and ExchangeCommission on August 5, 2004.

 

The offering commenced on August 5, 2004.Under the registration statement, we registered 7,245,000 shares of commonstock, including shares subject to the underwriters’ over-allotment option, onbehalf of RightNow and a selling stockholder, for an aggregate offering priceof $50,715,000 and a per share price to the public of $7.00. Of the totalshares registered, 6,416,961 shares, including shares sold upon exercise of theunderwriters’ over-allotment option, were sold by us for an aggregate offeringprice of $44,918,727 and a per share price to the public of $7.00, and 321,945shares, including shares sold upon exercise of the underwriters’ over-allotmentoption, were sold by the selling stockholder for an aggregate offering price of$2,253,615 and a per share price to the public of $7.00. The offering terminatedfollowing the sale of the shares described above.

 

In connection with the offering of the sharessold by us, we paid an aggregate of $3.3 million in underwriting discounts andcommissions to the underwriters. In addition, the following table sets forththe costs and expenses, other than underwriting discounts and commissions,incurred by us in connection with the offering, including the shares offered bythe selling stockholder (in thousands).

 
| Legal fees and expenses            |   | $   | 709    |   |
|------------------------------------|--------|-----|--------|--------|
| Accounting fees and expenses       |   | 369 |   |
| Printing and engraving expenses    |   | 349 |   |
| Nasdaq National Market listing fee |   | 100 |   |
| SEC registration fee               |   | 11  |   |
| NASD filing fee                    |   | 9   |   |
| Transfer agent and registrar fees  |   | 5   |   |
| Blue Sky fees and expenses         |   | 9   |   |
| Miscellaneous expenses             |   | 240 |   |
| Total expenses of offering         |   | $   | 1,801  |   |

 

After deducting the underwriting discountsand commissions and the estimated offering expenses described above, wereceived net proceeds from the offering of approximately $40 million. We didnot receive any proceeds from the sale of shares by the selling stockholder. Wecurrently intend to use the offering net proceeds for general corporatepurposes as described in the prospectus for the offering. We are currentlyassessing the specific uses and allocations for these net proceeds. Pendingthese uses, the net proceeds from the offering are invested in short-term,interest-bearing, investment-grade

 

19

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securities. None of the expenses and none of our net proceeds from theoffering were paid directly or indirectly to any director, officer, generalpartner of RightNow or their associates, persons owning 10% or more of anyclass of equity securities of RightNow, or an affiliate of RightNow.

 

**Purchases of Equity Securities by the Issueror Affiliated Purchasers**

 

We did not repurchase any of our common stockin the fourth quarter of 2004.

 

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**Item 6.        SelectedConsolidated Financial Data**

 

The following selected consolidated financialdata should be read in conjunction with the Consolidated Financial Statementsand Notes thereto and with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and other financial data includedelsewhere in this report.  Theconsolidated statement of operations data for the years ended December 31,2004, 2003 and 2002, and the consolidated balance sheet data at December 31,2004 and 2003 are derived from audited consolidated financial statementsincluded elsewhere in this report.  Theconsolidated statement of operations data for the years ended December 31, 2001and 2000, and the consolidated balance sheet data at December 31, 2002, 2001and 2000 are derived from audited consolidated financial statements notincluded in this report.  The historicalresults are not necessarily indicative of results to be expected in any futureperiod.

 
| ** **                                      | ** ** | **Year Ended December 31,**               | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                      | ** ** | **2000**                                  | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statements of Operations Data:** |       |                                      |       |   |   |   |   |   |   |   |   |
| Revenue:                                        |       |                                      |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                   |       | $                                         | 10,549     |   | $ | 18,998 |   | $ | 23,338 |   | $ | 29,300 |   | $ | 49,764 |   |
| Professional services                           |       | 758                                       |       | 2,009 |   | 3,603 |   | 6,579 |   | 12,000 |   |
| Total revenue                                   |       | 11,307                                    |       | 21,007 |   | 26,941 |   | 35,879 |   | 61,764 |   |
| Cost of revenue:                                |       |                                      |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                   |       | 3,306                                     |       | 4,636 |   | 4,279 |   | 5,263 |   | 6,741 |   |
| Professional services                           |       | 485                                       |       | 1,335 |   | 2,156 |   | 3,740 |   | 7,206 |   |
| Total cost of revenue                           |       | 3,791                                     |       | 5,971 |   | 6,435 |   | 9,003 |   | 13,947 |   |
| Gross profit                                    |       | 7,516                                     |       | 15,036 |   | 20,506 |   | 26,876 |   | 47,817 |   |
| Operating expenses:                             |       |                                      |       |   |   |   |   |   |   |   |   |
| Sales and marketing                             |       | 20,756                                    |       | 22,050 |   | 15,939 |   | 20,809 |   | 31,986 |   |
| Research and development                        |       | 3,639                                     |       | 4,584 |   | 4,117 |   | 5,915 |   | 7,807 |   |
| General and administrative                      |       | 3,375                                     |       | 3,973 |   | 2,842 |   | 3,518 |   | 4,621 |   |
| Total operating expenses                        |       | 27,770                                    |       | 30,607 |   | 22,898 |   | 30,242 |   | 44,414 |   |
| Income (loss) from operations                   |       | (20,254                                   | )          | (15,571 | ) | (2,392 | ) | (3,366 | ) | 3,403 |   |
| Interest and other income (expense), net        |       | 607                                       |       | 229 |   | (357 | ) | (215 | ) | 146 |   |
| Income (loss) before income taxes               |       | (19,647                                   | )          | (15,342 | ) | (2,749 | ) | (3,581 | ) | 3,549 |   |
| Provision for income taxes                      |       | —                                    |       | — |   | — |   | (539 | ) | (100 | ) |
| Net income (loss)                               |       | (19,647                                   | )          | (15,342 | ) | (2,749 | ) | (4,120 | ) | 3,449 |   |
| Preferred stock accretion                       |       | —                                    |       | — |   | (33 | ) | (13 | ) | (8 | ) |
| Net income (loss) allocated to common stock     |       | $                                         | (19,647    | ) | $ | (15,342 | ) | $ | (2,782 | ) | $ | (4,133 | ) | $ | 3,441 |   |
| Earnings (loss) per share(1):                   |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic                                           |       | $                                         | (1.42      | ) | $ | (1.10 | ) | $ | (0.19 | ) | $ | (0.28 | ) | $ | 0.17 |   |
| Diluted                                         |       | (1.42                                     | )          | (1.10 | ) | (0.19 | ) | (0.28 | ) | 0.12 |   |
| Shares used in the computation (1):             |       |                                      |       |   |   |   |   |   |   |   |   |
| Basic                                           |       | 13,810                                    |       | 14,006 |   | 14,284 |   | 14,560 |   | 20,738 |   |
| Diluted                                         |       | 13,810                                    |       | 14,006 |   | 14,284 |   | 14,560 |   | 28,940 |   |
|                                                 |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          See Note 1 of Notesto Consolidated Financial Statements for an explanation of the calculation ofbasic and diluted earnings (loss) per share and for an explanation of thedetermination of the number of weighted average shares used for suchcalculations.

 
| ** **                                | ** ** | **December 31,**    | ** ** |
|-------------------------------------------|------------|---------------------|------------|
| ** **                                | ** ** | **2000**            | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **(In  thousands)** | ** ** |
| **Consolidated Balance Sheet Data:**      |       |                |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                 |       | $                   | 17,128     |   | $ | 6,258 |   | $ | 8,038 |   | $ | 8,360 |   | $ | 18,944 |   |
| Short-term investments                    |       | —              |       | — |   | — |   | — |   | 31,188 |   |
| Working capital (deficit)                 |       | 9,033               |       | (6,553 | ) | (6,082 | ) | (9,024 | ) | 32,732 |   |
| Total assets                              |       | 28,741              |       | 18,625 |   | 23,102 |   | 29,386 |   | 88,309 |   |
| Deferred revenue                          |       | 17,160              |       | 18,875 |   | 24,683 |   | 35,553 |   | 49,125 |   |
| Long-term debt, less current portion      |       | —              |       | 1,185 |   | 940 |   | 484 |   | — |   |
| Redeemable convertible preferred stock    |       | 31,075              |       | 32,340 |   | 32,373 |   | 32,398 |   | — |   |
| Total stockholders’ equity (deficit) |       | (23,345             | )          | (38,683 | ) | (41,291 | ) | (45,254 | ) | 31,101 |   |
|                                           |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

*The followingdiscussion and analysis of our financial condition and results of operationsshould be read in conjunction with “Selected Consolidated Financial Data” andour financial statements and related notes appearing elsewhere in thisreport.  This discussion containsforward-looking statements that involve risks and uncertainties. Our actualresults could differ significantly from those projected in the forward-lookingstatements as a result of certain factors, including those discussed in “RiskFactors,” “Business” and elsewhere in this report. We assume no obligation toupdate the forward-looking statements or such factors.*

* *

**Overview**

 

We are a leading provider of on-demand softwaresolutions for the customer relationship management market. We offer a broadsuite of solutions to address the customer service, sales and marketingrequirements of large, medium and small enterprises.

 

We released our initial version of RightNowService in 1997. This product addressed the new customer service needsresulting from the increasing use of the Internet as a customer servicechannel. Since then, we have significantly enhanced product features andfunctionality to address customer service needs across multiple communicationchannels, including web, interactive voice, e-mail, chat, telephone andproactive outbound e-mail communications. We have also added several productscomplementary to our RightNow Service solution, including RightNow Metrics andRightNow Locator. In 2003, we introduced an e-mail marketing automationsolution, RightNow Outbound.  In October2004, we introduced RightNow CRM 7.0, an integrated solution for customerservice, sales and marketing organizations. To date more than 90% of our revenue has been generated by RightNowService.

 

Our client base currently consists of morethan 1,200 active clients who in the year ended December 31, 2004 servedmore than 500 million customer interactions, or unique sessions hosted byour solutions. Our solutions, whether sold pursuant to term or perpetuallicenses, are available either on a hosted basis, where they are deployed inour co-location facilities and accessed on demand by our clients, or on anon-hosted basis, where our clients deploy them in their own facilities. Thepercentage of our clients electing the hosted option was approximately 87% atDecember 31, 2004, an increase from approximately 50% at December 31,1999.

 

We distribute our solutions primarily throughdirect sales efforts and to a lesser extent through indirect channels.

 

***Sourcesof Revenue***

 

Our revenue is comprised of fees for term and perpetual licenses of oursoftware, fees for hosting and support related to our licenses, and fees forprofessional services.  Our term licenseagreements, which are generally two years in length but can range from sixmonths to four years, include our software and related upgrades, hosting andsupport for the term of the agreement. The majority of our revenue in each ofour last three years was derived from two-year term license agreements.  We also offer monthly term license agreementsthat contain a minimum commitment period of at least 12 months and include oursoftware and related upgrades, hosting and support.  Perpetual licenses are typically sold withannual maintenance contracts that include upgrades, hosting and support.

 

Hosting and support agreements provide maintenance and management ofour software at a third party facility, technical support for our softwareproducts, and unspecified product upgrades on a when and if available basis.

 

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Professional services revenue is comprised of revenue from consulting,education and development services, and reimbursement of related travelcosts.  Consulting and education servicesinclude implementation and best practices consulting.  Development services include customizationsand integrations for a client’s specific business application.

 

Our software license agreements include capacity-based fees, which aremeasured primarily by web pages served and user seats, and certain fixed fees.A number of our agreements provide for additional fees for usage aboveestablished levels, which are billed and recognized into revenue when earned.

 

Professional services, consisting of consulting, education anddevelopment services, are sold with initial license agreements and periodicallyover the client engagement. The average deployment time for our clients is 50days. We typically invoice clients for the entire amount at the beginning ofthe agreement with payment generally due within 30 days for our term andperpetual license agreements, or due monthly for our monthly agreements.  Our typical education courses are billed on aper person, per class basis.

 

Depending on the size and complexity of the client project, ourconsulting or development services contracts are either fixed price/fixed scopeor, less frequently, billed on a time and materials basis. We have determinedthat the professional services element of our software arrangements is not essentialto the functionality of the software.  Wehave also determined that our professional services: a) are available fromother vendors; b) do not involve a significant degree of risk or uniqueacceptance criteria; and c) qualify for separate accounting as we havesufficient experience in providing such services.

 

***Costof Revenue and Operating Expenses***

* *

*Cost of Revenue.  *Cost of revenueconsists primarily of salaries and related expenses for our hosting, supportand professional services organizations, third-party costs and equipmentdepreciation relating to our hosting services, third-party costs forinteractive voice self-service applications, travel expenses related toproviding professional services to our clients, amortization of acquired intangibleassets and allocated overhead. We allocate most overhead expenses, such asoffice supplies, computer supplies, utilities, rent, depreciation for furnitureand equipment, payroll taxes and employee benefits, based on headcount. As aresult, overhead expenses are reflected in each cost of revenue and operatingexpense category.

 

**Our hosting costs are affected by thepercentage of clients who license our products on a hosted basis and the numberof times our clients and their customers use our solutions, which we refer toas customer interactions. As a result of economies of scale in our hostinginfrastructure and declines in computer hardware and telecommunications costs,we were able to reduce hosting costs as a percentage of total revenue in 2002,2003 and 2004, despite significant increases in the number of hosted clientsand the level of customer interactions.**

 

**As our client base and solutions usage grows,we intend to continue to invest additional resources in our hosting services,technical support and professional services. We expect our professionalservices costs to increase in absolute dollars as we increase our professionalservices as a percentage of total revenue. Because cost as a percentage ofrevenue is higher for professional services revenue than for software, hostingand support revenue, an increase in professional services as a percentage oftotal revenue reduces gross profit as a percentage of total revenue. During2002, 2003 and 2004, increases in gross profit as a percentage of total revenueresulting from economies of scale in hosting and technical support werepartially offset by increases in professional services as a percentage of totalrevenue.**

 

*Sales and Marketing Expenses. *Sales and marketingexpenses consist primarily of salaries and related expenses for employees insales and marketing, including commissions and bonuses, advertising, marketingevents, corporate communications, product management expenses, travel costs andallocated overhead. We expense our sales commissions at the time the relatedsale is invoiced to the client and we recognize the majority of our revenuefrom our agreements ratably over the terms of the licenses. Accordingly, wegenerally experience a delay between increasing sales and marketing expensesand the recognition of

 

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corresponding revenue. We expect significant increases in sales andmarketing expenses in absolute dollars as we hire additional sales andmarketing personnel and increase the level of marketing activities.

 

*Research and Development Expenses. *Research anddevelopment expenses consist primarily of salary and related expenses fordevelopment personnel and costs related to the development of new products,enhancement of existing products, translation fees, quality assurance, testingand allocated overhead. To date, we have not capitalized any softwaredevelopment costs because the timing of the commercial releases of our productshas substantially coincided with the attainment of technological feasibility.As a result, research and development costs have been expensed as incurred. Weintend to continue to expand and enhance our product offerings. To accomplishthis, we plan to hire additional personnel and, from time to time, contractwith third parties. We expect that research and development expenses willincrease in absolute dollars as we seek to expand our technology and productofferings.

 

*General and Administrative Expenses*.  General and administrative expenses consistprimarily of salary and related expenses for management, finance andaccounting, legal, information systems and human resources personnel,professional fees, other corporate expenses and allocated overhead. We expectthat general and administrative expenses will increase as we continue to addpersonnel in connection with the growth of our business. We anticipate that wewill also incur additional employee salaries and related expenses, professionalservice fees and insurance costs related to the growth of our business andcompliance with the requirements of a public company.

 

***CriticalAccounting Policies and Estimates***

 

Our financial statements and accompanying notes are prepared inaccordance with accounting principles generally accepted in the UnitedStates.  Preparing financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses.  These assumptions are affected by management’sapplication of accounting policies.  Ourcritical accounting policies include: revenue recognition; valuation ofreceivables and deferred tax assets; and accounting for equity-basedcompensation.

 

We believe the following critical accounting policies require us tomake significant judgments and estimates in the preparation of our consolidatedfinancial statements:

 

### **RevenueRecognition**

 

Software, hosting and support revenue is comprised of fees from termand perpetual licenses of the Company’s software, hosting and support.  To date we have not entered into anarrangement solely for the license of products and, therefore we have notdemonstrated vendor specific objective evidence, or VSOE, of fair value of thelicense element.  Consequently, werecognize revenue for the fees associated with the term license and the relatedhosting and support ratably over the term of the agreement, which is generallytwo years, but can range between six months and four years.  We have established VSOE for the annualhosting and support elements sold with each perpetual license based on the pricepaid when sold separately.  Accordingly,we recognize revenue for each perpetual license using the residual method inaccordance with Statement of Position (SOP) 98-9, *Modification of SOP 97-2, Software Revenue Recognition With Respect toCertain Transactions*.

 

We begin to recognize revenue from the licensing, hosting and supportof our products when all the following criteria are met: a) we have enteredinto a legally binding agreement with the client; b) our products and serviceshave been delivered or made available to the client; c) our fee for providingthe products and services is determinable; and d) we believe collection of ourfee is reasonably probable.

 

Amounts that have been invoiced to clients are recorded to accounts orterm receivables and deferred revenue. Deferred revenue is then recognized into revenue when earned.

 

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### **Valuation ofReceivables**

 

**We regularly assess the collectibility ofoutstanding customer invoices and, in so doing, we maintain an allowance forestimated losses resulting from the non-collection of customerreceivables.  In estimating thisallowance, we consider factors such as: historical collection experience; acustomer’s current creditworthiness; customer concentration; age of thereceivable balance; and general economic conditions that may affect a customer’sability to pay.  Actual customercollections could differ from our estimates and exceed our related lossallowance.**

 

### **Income Taxes**

 

We record income taxes under the asset and liability method.  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences areexpected to be recovered or settled.  Theeffect of a change in tax rates on deferred tax assets and liabilities isrecognized in income in the period that includes the enactment date.  When applicable, a valuation allowance isestablished to reduce any deferred tax asset when it is determined that it ismore likely than not that some portion of the deferred tax asset will not berealized.

 

We have established a valuation allowance equal to the net deferred taxasset due to uncertainties regarding the realization of our net operating losscarryforwards, tax credits, and deductible timing differences.  The uncertainty of realizing these tax benefitsis based primarily on our lack of historical earnings.

 

### **Equity-BasedCompensation**

 

We account for our employee stock-based compensation using theintrinsic value method in accordance with Accounting Principles Board Option,or APB, No. 25, *Accounting for Stock Issuedto Employees*, and we make pro forma disclosure regarding employeestock-based compensation using the fair value method in accordance withStatement of Financial Accounting Standards, or SFAS, No. 123, *Accounting for Stock-Based Compensation*,and SFAS No. 148, *Accounting for Stock-BasedCompensation – Transition and Disclosure*.  We account for equity instruments issued tonon-employees in accordance with the provisions of SFAS No. 123 and EmergingIssues Task Force, or EITF No. 96-18, *Accountingfor Instruments that are Issued to Other Than Employees for Acquiring, or inConjunction with Selling Goods or Services*.

 

**In measuring the cost of equity-basedcompensation, we make assumptions regarding our stock price volatility and theaverage expected life of our outstanding stock options.  Our assumptions are based on historicalinformation, some of which was developed when we were a private company.  Actual results could differ from ourassumptions.**

 

## **Recently Issued Accounting Standards**

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), *Share-Based Payment,*which replaces SFAS123 and supersedes Accounting Principles Board Opinion No. 25.  Public companies are required to apply 123Ras of the first interim or annual reporting period that begins after June 15,2005.  123R covers a wide range ofshare-based compensation, including share options, restricted share plans,performance-based awards, share appreciation rights, and employee share purchaseplans.  The statement requires therecognition of compensation cost related to share-based payment plans to berecognized in financial statements based on the fair value of the equity orliability instruments issued.  We expectadoption of the provisions of 123R beginning in our third fiscal quarter endingSeptember 30, 2005 will

 

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materially and adversely affect our reported results of operationsbecause the stock-based compensation expense will be charged directly againstour reported earnings. We do not expect the accounting change to materiallyaffect our liquidity because equity-based compensation is a non-cash expense.

 

**Results of Operations**

 

The following table sets forth certainconsolidated statements of operations data for each of the periods indicated,expressed as a percentage of total revenue:

 
| ** **                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue:                                 |       |                        |       |   |   |   |   |
| Software, hosting and support            |       | 87                          | %          | 82 | % | 81 | % |
| Professional services                    |       | 13                          |       | 18 |   | 19 |   |
| Total revenue                            |       | 100                         |       | 100 |   | 100 |   |
| Cost of revenue:                         |       |                        |       |   |   |   |   |
| Software, hosting and support            |       | 16                          |       | 15 |   | 11 |   |
| Professional services                    |       | 8                           |       | 10 |   | 12 |   |
| Total cost of revenue                    |       | 24                          |       | 25 |   | 23 |   |
| Gross profit                             |       | 76                          |       | 75 |   | 77 |   |
| Operating expenses:                      |       |                        |       |   |   |   |   |
| Sales and marketing                      |       | 59                          |       | 58 |   | 51 |   |
| Research and development                 |       | 15                          |       | 16 |   | 13 |   |
| General and administrative               |       | 11                          |       | 10 |   | 7 |   |
| Total operating expenses                 |       | 85                          |       | 84 |   | 71 |   |
| Income (loss) from operations            |       | (9                          | )          | (9 | ) | 6 |   |
| Interest and other income (expense), net |       | (1                          | )          | (1 | ) | — |   |
| Income (loss) before income taxes        |       | (10                         | )          | (10 | ) | 6 |   |
| Provision for income taxes               |       | —                      |       | (1 | ) | — |   |
| Net income (loss)                        |       | (10                         | )%         | (11 | )% | 6 | % |

 

The following table sets forth our on-demandcustomer interactions, percentage of clients hosting, and our revenue by typeand geography expressed as a percentage of total revenue for each of theperiods indicated.

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customer interactions (in millions)             |       | 146                         |       | 249 |   | 502 |   |
| Percentage of clients hosting                   |       | 82                          | %          | 84 | % | 87 | % |
| Revenue by type:                                |       |                        |       |   |   |   |   |
| Recurring (term licenses, hosting and  support) |       | 74                          | %          | 67 | % | 59 | % |
| Perpetual licenses                              |       | 13                          |       | 15 |   | 22 |   |
| Professional services                           |       | 13                          |       | 18 |   | 19 |   |
| Revenue by geography in:                        |       |                        |       |   |   |   |   |
| United States                                   |       | 81                          | %          | 76 | % | 73 | % |
| Europe                                          |       | 15                          |       | 18 |   | 21 |   |
| Asia Pacific                                    |       | 4                           |       | 6 |   | 6 |   |

 

***Overviewof 2004 and Outlook***

 

Revenue for 2004 increased 72% over2003.  Gross profit for 2004 was 77% oftotal revenue, up from 75% of total revenue for 2003.  The improved revenue and gross profit in 2004resulted in operating income of $3.5 million for 2004 as compared to anoperating loss of $3.6 million for 2003.

 

26

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The increase in revenue for the year endedDecember 31, 2004 over 2003 resulted primarily from higher revenue per clientand growth in the number of our clients. Revenue per client improved primarily due to the release of broaderproduct offerings that were launched in late 2003 and 2004, and a correspondingincrease in service offerings.  During2004 we continued to invest in our operations by adding sales personnel tofocus on new client acquisition, professional services personnel to support oursolution offerings, and software developers to broaden and enhance our solutionofferings.

 

For the year ended December 31, 2004, wegenerated $6.7 million of cash from operations compared to $4.3 million of cashin 2003, and increased our deferred revenue to $49.1 million at December 31,2004 from $35.6 million one year earlier. In 2004, we signed 311 new customers to bring our total active client baseto 1,232, or 19% more than the 1,036 active clients at December 31, 2003.

 

During the third quarter of 2004, we raisedapproximately $40 million through our initial public offering of commonstock.  In the fourth quarter of 2004, wereleased RightNow 7.0, a broad suite of software solutions for customerservice, sales and marketing functions.

 

As of December 31, 2004 we had an accumulateddeficit of $41 million.  This deficit andour historical operating losses were primarily the result of costs incurred inthe development, sales and marketing of our products and for general andadministrative purposes.  We intend tocontinue to invest in our sales and marketing activities, product developmentand business infrastructure.  Duringperiods of investment and growth, because the majority of expenses are recordedas incurred and the majority of revenue is deferred, we anticipate that anygrowth in revenue will be largely offset by an increase in cost of revenue andoperating expenses.

 

***Years EndedDecember 31, 2002, 2003 and 2004***

 

***Revenue***
| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|-----------------------------|------------|
| **(Amounts in thousands)**    | ** ** | **2002**                    | ** ** | **2003** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
| Software, hosting and support |       | $                           | 23,338     |   | $ | 29,300 |   | 26 | % | $ | 49,764 |   | 70 | % |
| Professional services         |       | 3,603                       |       | 6,579 |   | 83 |   | 12,000 |   | 82 |   |
| Total revenue                 |       | $                           | 26,941     |   | $ | 35,879 |   | 33 | % | $ | 61,764 |   | 72 | % |

 

Total revenue for 2004 was$61.8 million, an increase of $25.9 million, or 72%, over totalrevenue of $35.9 million for 2003.

 

Software, hosting and support revenue for2004 was $49.8 million, an increase of $20.5 million or 70% oversoftware, hosting and support revenue of $29.3 million for 2003.  The revenue growth resulted from a 46%increase in revenue per client, combined with a 16% increase in average numberof clients.  Recurring revenue per clientincreased 30% in 2004 over 2003 due to contract upgrades and renewals, and therelease of new products in late 2003. Client interactions, a measure of the volume of unique sessions hostedby our software, grew more than 100% in 2004 over 2003.    Growth in average number of clientsoccurred primarily from emphasis within our sales organization on new clientacquisition. We had 1,232 active clients at December 31, 2004 compared to1,036 active clients at December 31, 2003.

 

Perpetual software license revenue in thesecond, third and fourth quarters of 2004 ranged from 21% to 26% of totalrevenue as compared to a range of 12% to 18% of total revenue in priorquarters.  As a result, perpetualsoftware license revenue in 2004 increased to 22% of total revenue as comparedto 15% in 2003.  The mix of perpetuallicense revenue may affect our profitability in any given period since it isrecorded into revenue in full upon delivery instead of being ratably recognizedinto revenue over time, as is the case with term licenses.  We believe perpetual license revenueincreased in 2004 because of the growing strategic importance of our productsin client organizations, and also because our client planning horizons havelengthened.

 

27

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Professional services revenue increased 82%to $12 million in 2004 from $6.6 million in 2003.  Average professional services revenue perclient increased 57% in 2004 over 2003, while average number of clientsincreased 16%.  Revenue per clientincreased in 2004 largely as a result of our focus on expanding serviceofferings provided in conjunction with the broader product offerings.  We increased our professional services staffto 71 employees at December 31, 2004 from 41 employees at December 31, 2003.

 

The mix of professional services revenue alsoaffects our profitability from period-to-period due to the lower gross profitearned on professional services as compared to the gross profit earned onsoftware, hosting and support revenue. We expect professional services revenue to gradually increase as apercent of total revenue in 2005 from our emphasis on providing, andanticipated client demand for, best practice consulting services.

 

Revenue from European customers grew to $12.8million in 2004 from $6.5 million in 2003, and revenue from Asia Pacificclients grew to $3.8 million in 2004 from $2.3 million in 2003.  Total revenue outside the United States was27% of total revenue in 2004 and 24% of total revenue in 2003.  The increase in revenue outside the UnitedStates occurred primarily from expansion of our international sales andmarketing activities.

 

Total revenue for 2003 was $35.9 million, anincrease of $9 million, or 33%, over total revenue of $26.9 million for 2002.

 

Software, hosting and support revenue for2003 was $29.3 million, an increase of $6 million or 26% over software, hostingand support revenue of $23.3 million for 2002. The increase resulted from a 35% increase in revenue per client,partially offset by a 7% decrease in average number of clients.  The increase in revenue per client was primarilydue to our emphasis on deploying our solution broadly within the clientorganization as evidenced by an increase in customer interactions.  The decrease in average number of clients wasprimarily due to our emphasis within the sales organization on existing clientrelationships instead of new client acquisition.  We had 1,036 active clients at December 31,2003 compared to 953 active clients at December 31, 2002.  During 2003, term licenses accounted for 67%of our total revenue, as compared to 74% of our total revenue in 2002.  Perpetual software license revenue was 15% oftotal revenue in 2003 as compared to 13% of total revenue in 2002.

 

Professional services revenue for 2003 was$6.6 million or 18% of total revenue, an increase of $3.0 million or82% over professional service revenue of $3.6 million for 2002, which was 13%of total revenue. The increase resulted from a 96% increase in professionalservices revenue per client, partially offset by a 7% decrease in averagenumber of clients. The increase in professional services revenue per client isprimarily due to an increase in service offerings for deployment over thelifecycle of the client engagement.

 

Revenue in Europe and Asia Pacific for theyear ended December 31, 2003 was $8.7 million or 24% of total revenuefor the year, compared to $5.0 million or 19% of total revenue in 2002.The increase in revenue outside of the United States resulted from expansion ofour international sales and marketing activities.

 

***Costof Revenue***

 
| ** **                    | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------|------------|-----------------------------|------------|
| **(Amounts in thousands)**    | ** ** | **2002**                    | ** ** | **2003** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
| Software, hosting and support |       | $                           | 4,279      |   | $ | 5,263 |   | 23 | % | $ | 6,741 |   | 28 | % |
| Professional services         |       | 2,156                       |       | 3,740 |   | 74 |   | 7,206 |   | 93 |   |
| Total cost of revenue         |       | $                           | 6,435      |   | $ | 9,003 |   | 40 | % | $ | 13,947 |   | 55 | % |

 

28

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Total cost of revenue for 2004 was $13.9million, an increase of $4.9 million, or 55%, over total cost of revenue of$9.0 million for 2003.

 

The cost of software, hosting and supportincreased 28% to $6.7 million in 2004 from $5.3 million in 2003.  The growth in costs was driven by staffadditions which increased salaries and related employee costs by $473,000,higher third-party hosting service costs of $316,000, increased equipment depreciationand amortization expenses of $261,000, and incremental third-party costs ofsecurity monitoring and interactive voice self-service of $245,000.  The average employee count in our hosting andsupport operations was 43 in 2004 as compared to 34 in 2003.  As a percent of the associated revenue, costof software, hosting and support declined to 14% in 2004 from 18% in 2003,primarily due to economies of scale achieved in providing hosting and supportservices over a broader base of customers. We increased our hosting capacitywith the completion of our Asia Pacific and Europe/Middle-East/Asia pods withinour existing data centers in California and New Jersey in 2004.

 

Professional services costs increased 93% to$7.2 million in 2004 from $3.7 million in 2003 mostly due to growth inprofessional services staff.  We had, onaverage, 51 employees in our professional services group in 2004 as compared to32 employees in 2003.  The employeegrowth added approximately $2.6 million in salaries and related expenses andapproximately $715,000 in additional travel and living expenses.  Professional services costs increased to 60%of the associated revenue in 2004 from 57% in 2003, due to internalrequirements for training and education and customer scheduling requirements.  We plan to further expand our professionalservices organization and these costs may continue to vary as a percentage ofprofessional services revenue in the future.

 

The total cost of revenue for 2003 was$9.0 million, an increase of $2.6 million, or 40%, over total cost ofrevenue of $6.4 million for 2002.

 

The cost of revenue for software, hosting andsupport in 2003 was $5.3 million, an increase of $984,000 or 23%, over thecost of such revenue of $4.3 million in 2002. Cost of revenue forsoftware, hosting and support increased in absolute dollars largely due toincreased expenses required to support additional clients and significantlyhigher levels of our clients’ customer interactions. Incremental 2003 expensesincluded salaries and related costs of $471,000, depreciation and amortizationexpenses of $282,000 and third party services of $131,000. Cost of revenuedeclined for software hosting and support slightly as a percentage of totalrevenue to 15% in 2003 from 16% in 2002 as a result of economies of scale inhosting and technical support.  Averageemployee count in hosting and support was 34 in 2003 and 29 in 2002.

 

The cost of revenue for professional servicesin 2003 was $3.7 million, an increase of $1.6 million, or 73%, overthe cost of such revenue of $2.2 million in 2002. This increase wasattributable to an increase in professional services staff to support expandedservice offerings. Incremental expenses included salaries and related costs of$1.4 million and travel costs of $248,000. Average employee count in our professional services group was 32 in 2003compared to 21 in 2002.

 

***OperatingExpenses***

 
| ** **                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| **(Amounts in thousands)** | ** ** | **2002**                    | ** ** | **2003** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
| Sales and marketing        |       | $                           | 15,939     |   | $ | 20,809 |   | 31 | % | $ | 31,986 |   | 54 | % |
| Research and development   |       | 4,117                       |       | 5,915 |   | 44 |   | 7,807 |   | 32 |   |
| General and administrative |       | 2,842                       |       | 3,518 |   | 24 |   | 4,621 |   | 31 |   |
| Total operating expenses   |       | $                           | 22,898     |   | $ | 30,242 |   | 32 | % | $ | 44,414 |   | 47 | % |

 

29

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## ***Sales and Marketing Expenses***

 

Sales and marketing expenses of $32 millionin 2004 were 54%, or $11.2 million, greater than expenses of $20.8 million in2003 mostly due to employee additions. We had, on average, 147 employees in our sales and marketingorganization in 2004 compared to 113 in 2003. The employee growth added approximately $5.3 million in salaries andrelated expenses, and $782,000 in travel and living expenses.  In addition, sales incentive costs increasedby $4.6 million in 2004 over 2003 from higher sales volume.

 

Sales and marketing expenses for 2003 were$20.8 million, an increase of $4.9 million or 31% over sales andmarketing expenses of $15.9 million in 2002. Approximately$2.6 million of this increase was due to higher salaries and related costsdue to the addition of 25 full-time sales and marketing employees in 2003.Sales and marketing expenses also included higher commission expense of$1.2 million associated with the higher sales, and an increase of $525,000in public relations and client outreach programs.  Average employee count in our sales andmarketing organization was 113 in 2003 and 102 in 2002.

 

#### ***Research and Development Expenses***

 

#### **Research and development expenses in 2004were $7.8 million, an increase of $1.9 million or 32% more than costs of $5.9million in 2003.  We added 22 employeesto our research and development staff during 2004, which increased salaries andrelated expenses by approximately $1.5 million.   We also incurred higher third-partydevelopment costs for language translations and technical manuals.  Average employee count in our research anddevelopment group was 79 in 2004 as compared to 64 in 2003.**

#### ** **

#### **Research and development expenses in 2003were $5.9 million, an increase of $1.8 million or 44% over researchand development expenses of $4.1 million in 2002. The increase in researchand development expenses was due to additional salaries and related costs as weincreased the number of our research and development employees in order toexpand and deepen our software offerings. Average employee count in our research and development group was 64 in2003 compared to 45 in 2002.**

#### ** **

*General and Administrative Expenses*

 

General and administrative expenses increased$1.1 million, or 31%, to $4.6 million in 2004 from $3.5 million in 2003.  Employee additions to our general and administrativegroup added $609,000 of salaries and related expenses during the year, whilelegal and other third-party fees added $450,000.  The increase in legal and other professionalservices was due to fees to obtain technology and patent licenses and thecompliance requirements of being a public company.  Average employee count in our general andadministrative group was 31 in 2004 as compared to 24 in 2003.

 

General and administrative expenses for 2003were $3.5 million, an increase of $676,000 or 24% over general andadministrative expenses of $2.8 million for 2002. The absolute dollarincrease was largely due to a $302,000 increase in salaries and relatedexpenses to support our business growth, and a $214,000 increase in legal feesrelated to obtaining technology licenses and patent rights.  Average employee count in our general andadministrative group was 24 in 2003 compared to 22 in 2002.

 

***Interest and Other Income (Expense), Net***

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| **(Amounts in thousands)**                      | ** ** | **2002**                    | ** ** | **2003** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
| Interest income                                 |       | $                           | 108        |   | $ | 142 |   | 31 | % | $ | 390 |   | 174 | % |
| Interest expense                                |       | (485                        | )          | (371 | ) | (24 | ) | (249 | ) | (33 | ) |
| Other                                           |       | 20                          |       | 14 |   | (30 | ) | 5 |   | (64 | ) |
| Total interest and other income (expense),  net |       | $                           | (357       | ) | $ | (215 | ) | (40 | )% | $ | 146 |   | 168 | % |

 

Net interest and other income was $146,000 in2004 as compared to net interest expense of ($215,000) in 2003.  Interest income grew to $390,000 in 2004mostly due to the investment of proceeds from our

 

30

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initial public offering in short-term, interest-earningsecurities.  Interest expense declined in2004 to ($249,000) mostly due to the full pay down of debt balances during theyear.

 

Net interest and other expense was ($215,000)in 2003, a decrease in expense of $142,000 or 40% from ($357,000) in 2002. Thisdecrease resulted primarily from reducing debt principal balances by$2.4 million during 2003.

 

***Provision for Income Taxes***

 

The provision for income taxes of ($100,000) in 2004 was approximately3% of pre-tax income, and consisted of foreign tax withholdings, federal andstate alternative minimum taxes, and state minimum taxes paid.  Our 2004 effective income tax rate was lowerthan the statutory rate primarily due to the utilization of net operating losscarry forwards.  Our effective tax ratein 2005 will depend on a number of factors, such as the amount of stockcompensation expense to be recorded in the latter part of the year under SFAS123R, the level of business in state and foreign tax jurisdictions, management’sexpectation of the realization of deferred tax assets and the associatedvaluation allowance, and other factors.

 

In filing our 2003 U.S. Federal income taxreturn in September 2004, we elected to change our method of taxaccounting as it relates to prepaid revenues, in accordance with the provisionsof Internal Revenue Service Revenue Procedure 2004-34.  The election allows the deferral of incomeover the term of the agreements, subject to certain limitations, resulting in acloser alignment of our taxable income with our book income.  The election has the effect of increasing ournet operating loss carry forwards by $8.4 million and decreasing deductibletiming differences by the same amount. There was no affect on our overall deferred tax assets.

 

At December 31, 2004, we had $18.3million of net deferred tax assets that have been reserved in full by avaluation allowance.  In the future, ifavailable evidence indicates that it is more likely than not that some or allof our deferred taxes are realizable, we will record a income tax benefit inthe amount of the asset recognized.  Atthat time, our effective income tax rate will likely increase.

 

The provision for income taxes of $539,000 in2003 represented state income taxes incurred due to the suspension of the useof operating loss carryforwards, other state minimum taxes and the recording ofa valuation allowance against foreign tax credits. There was no income taxexpense or benefit in 2002.

 

**Quarterly Results of Operations**

 

The following table sets forth selectedunaudited quarterly consolidated statements of operations data for each of theeight quarters through December 31, 2004. This information is unauditedbut, in management’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.

 

This information should be read inconjunction with the audited consolidated financial statements and relatednotes included elsewhere in this report. We believe that quarter-to-quartercomparisons of our financial results are not necessarily meaningful and shouldnot be relied upon as an indication of future performance.

 

31

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| ** **                                | ** ** | **Mar 31,  2003**              | ** ** | **Jun 30,  2003** | ** ** | **Sep 30,  2003** | ** ** | **Dec 31,  2003** | ** ** | **Mar 31,  2004** | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                | ** ** | **(Unaudited) (In thousands)** | ** ** |
| Revenue:                                  |       |                           |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Software,  hosting and support            |       | $                              | 6,276      |              | $          | 6,940             |       | $                 | 7,457      |              | $          | 8,627             |       | $                 | 10,720     |              | $          | 11,709 |   | $ | 12,976 |   | $ | 14,359 |   |
| Professional  services                    |       | 1,531                          |       | 1,304             |       | 1,763             |       | 1,981             |       | 2,137             |       | 3,053             |       | 3,450             |       | 3,360             |       |
| Total  revenue                            |       | 7,807                          |       | 8,244             |       | 9,220             |       | 10,608            |       | 12,857            |       | 14,762            |       | 16,426            |       | 17,719            |       |
| Cost of  revenue:                         |       |                           |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Software,  hosting and support            |       | 1,225                          |       | 1,337             |       | 1,342             |       | 1,359             |       | 1,579             |       | 1,636             |       | 1,729             |       | 1,797             |       |
| Professional  services                    |       | 736                            |       | 765               |       | 967               |       | 1,272             |       | 1,310             |       | 1,573             |       | 1,979             |       | 2,344             |       |
| Total cost  of revenue                    |       | 1,961                          |       | 2,102             |       | 2,309             |       | 2,631             |       | 2,889             |       | 3,209             |       | 3,708             |       | 4,141             |       |
| Gross profit                              |       | 5,846                          |       | 6,142             |       | 6,911             |       | 7,977             |       | 9,968             |       | 11,553            |       | 12,718            |       | 13,578            |       |
| Operating  expenses:                      |       |                           |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Sales and  marketing                      |       | 4,402                          |       | 4,696             |       | 5,389             |       | 6,322             |       | 6,848             |       | 8,037             |       | 8,055             |       | 9,046             |       |
| Research and  development                 |       | 1,439                          |       | 1,480             |       | 1,489             |       | 1,507             |       | 1,805             |       | 1,807             |       | 2,028             |       | 2,167             |       |
| General and  administrative               |       | 766                            |       | 795               |       | 978               |       | 979               |       | 1,153             |       | 1,016             |       | 1,164             |       | 1,288             |       |
| Total operating  expenses                 |       | 6,607                          |       | 6,971             |       | 7,856             |       | 8,808             |       | 9,806             |       | 10,860            |       | 11,247            |       | 12,501            |       |
| Income  (loss) from operations            |       | (761                           | )          | (829              | )          | (945              | )          | (831              | )          | 162               |       | 693               |       | 1,471             |       | 1,077             |       |
| Interest and  other income (expense), net |       | (117                           | )          | (35               | )          | (65               | )          | 2                 |       | (64               | )          | (46               | )          | 30                |       | 226               |       |
| Income  (loss) before income taxes        |       | (878                           | )          | (864              | )          | (1,010            | )          | (829              | )          | 98                |       | 647               |       | 1,501             |       | 1,303             |       |
| Provision  for income taxes               |       | (3                             | )          | —            |       | —            |       | (536              | )          | (18               | )          | (13               | )          | (61               | )          | (8                | )          |
| Net income  (loss)                        |       | $                              | (881       | )                 | $          | (864              | )          | $                 | (1,010     | )                 | $          | (1,365            | )          | $                 | 80         |              | $          | 634 |   | $ | 1,440 |   | $ | 1,295 |   |

 

 

The following table sets forth, for each of theperiods indicated, the percentage of total revenue represented by selecteditems in our consolidated statements of operations:

 
| ** **                         | ** ** | **Mar 31,  2003** | ** ** | **Jun 30,  2003** | ** ** | **Sep 30,  2003** | ** ** | **Dec 31,  2003** | ** ** | **Mar 31,  2004** | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** |
|------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                         | ** ** | **(Unaudited)**   | ** ** |
| Revenue:                           |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Software,  hosting and support     |       | 80                | %          | 84                | %          | 81                | %          | 81                | %          | 83                | %          | 79                | %          | 79                | %          | 81                | %          |
| Professional  services             |       | 20                |       | 16                |       | 19                |       | 19                |       | 17                |       | 21                |       | 21                |       | 19                |       |
| Total  revenue                     |       | 100               |       | 100               |       | 100               |       | 100               |       | 100               |       | 100               |       | 100               |       | 100               |       |
| Cost of  revenue:                  |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Software,  hosting and support     |       | 16                |       | 16                |       | 15                |       | 13                |       | 12                |       | 11                |       | 11                |       | 10                |       |
| Professional  services             |       | 9                 |       | 9                 |       | 10                |       | 12                |       | 10                |       | 11                |       | 12                |       | 13                |       |
| Total cost  of revenue             |       | 25                |       | 25                |       | 25                |       | 25                |       | 22                |       | 22                |       | 23                |       | 23                |       |
| Gross profit                       |       | 75                |       | 75                |       | 75                |       | 75                |       | 78                |       | 78                |       | 77                |       | 77                |       |
| Operating  expenses:               |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Sales and  marketing               |       | 57                |       | 57                |       | 58                |       | 60                |       | 53                |       | 55                |       | 49                |       | 52                |       |
| Research and  development          |       | 18                |       | 18                |       | 16                |       | 14                |       | 14                |       | 12                |       | 12                |       | 12                |       |
| General and  administrative        |       | 10                |       | 10                |       | 11                |       | 9                 |       | 9                 |       | 7                 |       | 7                 |       | 7                 |       |
| Total  operating expenses          |       | 85                |       | 85                |       | 85                |       | 83                |       | 76                |       | 74                |       | 68                |       | 71                |       |
| Income  (loss) from operations     |       | (10               | )          | (10               | )          | (10               | )          | (8                | )          | 2                 |       | 4                 |       | 9                 |       | 6                 |       |
| Interest and  other expense, net   |       | (1                | )          | —            |       | (1                | )          | —            |       | (1                | )          | —            |       | —            |       | 1                 |       |
| Income  (loss) before income taxes |       | (11               | )          | (10               | )          | (11               | )          | (8                | )          | 1                 |       | 4                 |       | 9                 |       | 7                 |       |
| Provision  for income taxes        |       | —            |       | —            |       | —            |       | (5                | )          | —            |       | —            |       | —            |       | —            |       |
| Net income  (loss)                 |       | (11               | )%         | (10               | )%         | (11               | )%         | (13               | )%         | 1                 | %          | 4                 | %          | 9                 | %          | 7                 | %          |
|                                    |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |  |  |  |  |

 

The following table sets forth our deferredrevenue and cash generated (used) from operations, our on-demand customerinteractions and percentage of clients hosting and our revenue by type andgeography expressed as a percentage of total revenue, for each of the periodsindicated:

 
| ** **                                      | ** ** | **Mar 31,  2003** | ** ** | **Jun 30,  2003** | ** ** | **Sep 30,  2003** | ** ** | **Dec 31,  2003** | ** ** | **Mar 31,  2004** | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                      | ** ** | **(Unaudited)**   | ** ** |
| Deferred  revenue  (in thousands)               |       | $                 | 27,803     |              | $          | 30,571            |       | $                 | 32,160     |              | $          | 35,553            |       | $                 | 36,729     |              | $          | 40,777 |   | $ | 44,491 |   | $ | 49,125 |   |
| Cash  provided by operations  (in thousands)    |       | 578               |       | 495               |       | 2,438             |       | 808               |       | 333               |       | 2,022             |       | 1,063             |       | 3,320             |       |
| Customer  interactions  (in millions)           |       | 53                |       | 56                |       | 63                |       | 77                |       | 102               |       | 110               |       | 140               |       | 150               |       |
| Percentage  of clients hosting                  |       | 83                | %          | 83                | %          | 85                | %          | 84                | %          | 85                | %          | 85                | %          | 86                | %          | 87                | %          |
|                                            |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Revenue by  type:                               |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Recurring  (term licenses, hosting and support) |       | 68                | %          | 69                | %          | 67                | %          | 63                | %          | 66                | %          | 56                | %          | 58                | %          | 55                | %          |
| Perpetual  licenses                             |       | 12                |       | 15                |       | 14                |       | 18                |       | 17                |       | 23                |       | 21                |       | 26                |       |
| Professional  services                          |       | 20                |       | 16                |       | 19                |       | 19                |       | 17                |       | 21                |       | 21                |       | 19                |       |
| Revenue by  geography:                          |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |              |       |
| Americas                                        |       | 82                | %          | 77                | %          | 67                | %          | 77                | %          | 71                | %          | 74                | %          | 76                | %          | 71                | %          |
| Europe                                          |       | 16                |       | 15                |       | 25                |       | 16                |       | 19                |       | 24                |       | 19                |       | 20                |       |
| Asia Pacific                                    |       | 2                 |       | 8                 |       | 8                 |       | 7                 |       | 10                |       | 2                 |       | 5                 |       | 9                 |       |
|                                                 |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |                   |            |  |  |  |  |  |  |  |  |

 

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Total revenue increased sequentially in eachof the quarters presented primarily due to increases in the number of newclients, increases in the average transaction sizes, contract renewals anddeferred revenue recognition. Professional services revenue as a percentage ofthe total revenue increased in the quarters ended June 30, 2004 and September 30,2004 as we expanded our service offerings, and decreased in the quarters ended June 30,2003 and December 31, 2004 due to a lower number of development andconsulting services performed. Cost of revenue for software, hosting andsupport trended lower in the six quarters ended December 31, 2004 due toincreasing efficiencies in our hosting and technical support operationsresulting from the higher volume of our clients’ customer interactions.

 

The mix of term and perpetual softwarelicenses sold in each quarter impacts our quarterly results of operations. Forexample, in the quarters ended June 30, 2004, September 30, 2004, andDecember 31, 2004, perpetual licenses represented a higher proportion ofour revenue than in other periods because, we believe, our products arebecoming increasingly important in our client operations and our clientplanning horizons have lengthened. Accordingly, revenue was favorably impacted in those quarters and totaloperating expenses, particularly research and development and general andadministrative, as a percentage of total revenue in those quarters, were lower.

 

Sales and marketing expenses in absolutedollars were higher in the quarters ended June 30, 2004, September 30,2004 and December 31, 2004 due to higher rates of commissions earned onnew agreements for the quarter. However, sales and marketing expenses as apercentage of revenue were lower in each of the quarters in 2004 compared to2003 due to higher rates of sales productivity.

 

The amount and timing of our operatingresults generally will vary from quarter to quarter depending on our level ofactual and anticipated business activities. Factors affecting quarterlyoperating results can include, but are not limited to:

 

•                  our ability to retain and increase sales to existingclients, attract new clients and satisfy our clients’ requirements;

•                  changes in the volume and mix of term and perpetuallicenses sold in a particular quarter, because perpetual license revenue isrecorded in full into revenue upon delivery whereas term license revenue isrecorded ratably over time;

•                  our policy of expensing sales commissions at thetime of invoice, while the majority of our revenue is deferred and recognizedratably over future periods;

•                  changes in the mix of revenue between professionalservices and software, hosting and support;

•                  changes in the mix of voice self-service applicationsold and/or usage volume, and the corresponding third party fees for voiceprocessing;

•                  the timing and success of new product introductionsor upgrades by us or our competitors;

•                  changes in our pricing policies or those of ourcompetitors;

•                  our ability to expand our operations, and the amountand timing of expenditures related to this expansion;

•                  the cost and availability of hosting services atco-location facilities;

•                  our ability to continue to realize efficiencies fromour hosting and technical support operations;

•                  changes in the payment terms for our products andservices;

•                  the purchasing and budgeting cycles of our clients;

•                  the rate of success of our domestic andinternational expansion;

•                  our ability to retain, recruit and hire keyexecutives and technical and sales and marketing personnel;

•                  costs related to the development or acquisition oftechnologies, products or businesses;

•                  seasonality in certain of our clients’ purchasinghabits; and

•                  general economic, industry and market conditions.

 

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Our revenue and operating results aredifficult to forecast and may fluctuate, and we believe that quarter-to-quartercomparisons of our operating results will not necessarily be meaningful. As aresult, you should not rely upon them as an indication of our futureperformance. We do not consider our business to be seasonal, although we seesome patterns of increased purchasing when our clients’ fiscal years areending. Our U.S. federal government clients’ fiscal years end in September andmost of our Japanese clients’ fiscal years end in March.

 

**Liquidity and Capital Resources**

 
| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| **(Amounts in thousands)**             | ** ** | **2002**                         | ** ** | **2003** | ** ** | **Percent  Change** | ** ** | **2004** | ** ** | **Percent  Change** | ** ** |
|                                   |       |                             |       |   |   |   |   |   |   |   |   |
| Deferred  revenue                      |       | $                                | 24,683     |   | $ | 35,553 |   | 44 | % | $ | 49,125 |   | 38 | % |
| Cash  provided by operating activities |       | 1,943                            |       | 4,319 |   | 122 |   | 6,738 |   | 56 |   |
|                                        |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 

We have historically funded our operationswith cash from operations, equity financings and debt borrowings.  In August 2004 we completed our initialpublic offering of approximately 6.4 million shares of common stock andreceived net proceeds of approximately $40.0 million.  The offering proceeds are invested ininterest-earning securities.  During thequarter ended September 30, 2004, we repaid all of our outstandinglong-term debt.

 

At December 31, 2004, cash and cashequivalents, and short-term investments, totaled $50.1 million.   In addition to our cash and short-terminvestments, other sources of liquidity at December 31, 2004 included a$3.0 million bank line of credit facility, under which there were no borrowingsin 2004.

 

Operating activities provided $6.7 million ofcash during the year ended December 31, 2004, as compared to $4.3 millionof cash from operations in 2003.  Thefourth quarter of 2004 represented our eleventh consecutive quarter of cashpositive operations.  The majority of ourcash from operations in 2004 was from growth in deferred revenue, net income,and non-cash charges, partially offset by growth in receivables.  Cash from operations in 2003 was generated bygrowth in deferred revenue.  We typicallybill customers on net 30-day terms at the beginning of the license period,which is reflected in accounts receivable and deferred revenue.   In periods of increasing sales, we wouldexpect growth in accounts receivable and deferred revenue which, historically,has provided funding for operations.  Achange in the billing practice resulting in delayed payment terms could have amaterial adverse effect on cash provided from operating activities and growthin deferred revenue.

 

The allowance for uncollectible accountsreceivable represented 6% of current accounts and term receivables at December 31,2003 and 2004.  Accounts written off in2004 increased $289,000 over 2003, and were constant as a percentage of newbillings from year-to-year.  We regularlyassess the adequacy of the allowance for doubtful accounts.  Actual write-offs could exceed our estimatesand adversely affect operating cash flows in the future.

 

Cash required for income taxes was $100,000in 2004 and $402,000 in 2003.  We do notexpect to pay significant cash income taxes in 2005.

 

Investing activities required $35.5 millionin cash during the year December 31, 2004 compared to $1.7 million in2003.  The 2004 figure included netpurchases of $31.2 million in short-term investments, $3.6 million in equipmentacquisitions, and $691,000 of intangible asset acquisitions.  We expect to spend approximately $5 millionfor equipment and intangible asset acquisitions in 2005.

 

Financing activities provided $39.2 millionin 2004, which included $40.0 million of proceeds from our initial publicoffering of common stock, and approximately $1.2 million of proceeds from theexercise of employee stock options and purchases under our employee stockpurchase plan.  We had

 

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borrowed $1.7 million under long-term debtagreements during the first six months of 2004, and subsequently paid down alloutstanding long-term debt during the third quarter 2004.

 

We believe our existing cash and short-terminvestments, together with funds generated from operations, should besufficient to fund operating and investment requirements for at least****the next twelve months.   Our future capital requirements will dependon many factors, including our rate of revenue growth and expansion of oursales and marketing activities, the possible acquisition of complementaryproducts or businesses, the timing and extent of spending required for researchand development efforts, and the continuing market acceptance of ourproducts.  To the extent that availablefunds are insufficient to fund our future activities, we may need to raiseadditional funds through public or private equity or debt financings.  Additional equity or debt financing may notbe available on terms favorable to us or at all.

 

**Off-Balance Sheet Arrangements**

 

As of December 31, 2004, we did not haveany significant off-balance-sheet arrangements, as defined in Item303(a)(4)(ii) of Regulation S-K promulgated by the SEC.

 

# **Contractual Obligations and Commitments**

 

The following table summarizes ourcontractual payment obligations and commitments as of December 31, 2004:

 
| ** **                   | ** ** | **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 |       | $                          | 5,506      |   | $ | 1,265 |   | $ | 1,897 |   | $ | 1,577 |   | $ | 767 |   |
| Purchase  obligations        |       | 856                        |       | 621 |   | 235 |   | — |   | — |   |
| Total                        |       | $                          | 6,362      |   | $ | 1,886 |   | $ | 2,132 |   | $ | 1,577 |   | $ | 767 |   |

 

We lease our office facilities and certainoffice equipment under operating lease agreements that expire at various datesthrough 2011. Purchase obligations consist of agreements with third parties toprovide co-location services for hosting operations, which do not havecontractual payment obligations beyond one year. Except for these hostingservice agreements, we generally do not enter into binding purchasecommitments.

 

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**RISK FACTORS**

 

*Before deciding topurchase, hold or sell our common stock, you should carefully consider therisks described below, in addition to the other cautionary statements and risksdescribed elsewhere and the other information contained in this Report and inour other filings with the SEC, including our reports on Forms 10-Q and 8-K.The risks and uncertainties described below are not the only ones we face.Additional risks and uncertainties not presently known to us or that wecurrently deem immaterial may also affect our business. If any of these knownor unknown risks or uncertainties actually occurs with material adverse effectson RightNow, our business, financial condition and results of operations couldbe seriously harmed. In that event, the market price for our common stock coulddecline and you may lose all or part of your investment.*

 

**Risks Related to Our Business**

 

***Althoughwe experienced our first year of profitability in 2004, we may not be able tosustain or increase our profitability in the future.***

 

Although we achieved profitability in 2004,we may not be able to continue to achieve profitability and have historicallyincurred operating losses in all prior years. We incurred net losses ofapproximately $4.1 million in 2003, $2.7 million in 2002 and$15.3 million in 2001. As of December 31, 2004, we had an accumulateddeficit of approximately $41 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 maintain profitability. Even if wecontinue to achieve profitability, we may not be able to increase profitabilityon a quarterly or annual basis in the future, which may cause the price of ourstock to decline.

 

***Ourquarterly results of operations may fluctuate in the future.***

 

Our quarterly revenue and results ofoperations may fluctuate as a result of a variety of factors, many of which areoutside of our control.  If our quarterlyrevenue or results of operations fall below the expectations of investors orsecurities analysts, the price of our common stock could declinesubstantially.  Fluctuations in ourresults of operations may be due to a number of factors, including, but notlimited to, those listed below and identified throughout this “Risk Factors”section:

 

•                  our ability to retain and increase sales to existingclients, attract new clients and satisfy our clients’ requirements;

 

•                  changes in the volume and mix of term and perpetuallicenses sold in a particular quarter, because perpetual license revenue isrecorded in full into revenue upon delivery whereas term license revenue isrecorded ratably over time;

 

•                  our policy of expensing sales commissions at thetime of invoice, while the majority of our revenue is recognized ratably overfuture periods;

 

•                  changes in the mix of revenue between professionalservices and software, hosting and support;

 

•                  changes in the mix of voice self-serviceapplications sold and/or usage volume, and the corresponding third party feesfor voice processing;

 

•                  the timing and success of new product introductionsor upgrades by us or our competitors;

 

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•                  changes in our pricing policies or those of ourcompetitors;

 

•                  the amount and timing of expenditures related toexpanding our operations;

 

•                  changes in the payment terms for our products andservices; and

 

•                  the purchasing and budgeting cycles of our clients.

 

Because the sales cycle for the evaluationand implementation of our solutions typically ranges from 60 to 180 days,we may also experience a delay between increasing operating expenses and thegeneration of corresponding revenue, if any. Moreover, because the majority ofour clients purchase term licenses, and we recognize revenue from theselicenses over the term of the agreement, downturns or upturns in sales may notbe immediately reflected in our operating results. Most of our expenses, suchas salaries and third-party hosting co-location costs, are relatively fixed inthe short-term, and our expense levels are based in part on our expectationsregarding future revenue levels. As a result, if revenue for a particularquarter is below our expectations, we may not be able to proportionally reduceoperating expenses for that quarter, causing a disproportionate effect on ourexpected results of operations for that quarter.

 

Due to the foregoing factors, and the otherrisks discussed in this report, you should not rely on quarter-to-quartercomparisons of our results of operations as an indication of our futureperformance.

 

***Ifour efforts to enhance existing solutions, introduce new solutions or expandthe applications for our products and solutions to broader CRM markets do notsucceed, our ability to grow our business will be adversely affected.***

 

Approximately 90% of our revenue is derivedfrom RightNow Service, a suite of solutions used to optimize customer serviceoperations. If we are unable to successfully develop and sell new and enhancedversions of RightNow Service, or introduce new products and solutions for thecustomer service market, our financial performance will suffer. Although todate we have focused our business on providing solutions for customer serviceoperations, we recently introduced RightNow CRM 7.0 to expand our solutionofferings to the sales and marketing segments of the CRM market. Our efforts toexpand beyond the customer service market may not be successful because certainof our competitors have far greater experience and brand recognition in thebroader segments of the CRM market. In addition, our efforts to expand ouron-demand software solutions beyond the customer service market may divertmanagement resources from our existing operations and require us to commitsignificant financial resources to a market where we are unproven, which mayharm our business, financial condition and results of operations.

 

***Weface intense competition, and our failure to compete successfully could make itdifficult for us to add and retain clients and could reduce or impede thegrowth of our business.***

 

The market for customer relationshipmanagement solutions is highly competitive and fragmented, and is subject torapidly changing technology, shifting client requirements, frequentintroductions of new products and services, and increased

 

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marketing activities of other industry participants. Competition hasintensified with our release of RightNow CRM 7.0.  Increased competition could result in pricingpressure, reduced sales, lower margins or the failure of our solutions toachieve or maintain broad market acceptance. If we are unable to competeeffectively, it will be difficult for us to add and retain clients, and ourbusiness, financial condition and results of operations will be seriouslyharmed.

 

We face competition from:

 

•                  companies currently providing customer servicesolutions, some of whom offer hosted services, including Amdocs Limited, BMCSoftware Corporation, E.piphany, Inc., eGain Communications Corporation,FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc.,Microsoft Corporation, Oracle Corporation, SAP AG, salesforce.com, inc.and Siebel Systems, Inc.;

 

•                  CRM systems that are developed and maintainedinternally by businesses;

 

•                  CRM products or services that are developed, orbundled with other products or services, and installed on a client’s premisesby software vendors;

 

•                  outsourced contact center providers who bundlesolutions and agent labor in their service offerings; and

 

•                  new companies entering the CRM software market, theon-demand applications market and the on-demand CRM market, or expanding fromany one of these markets to the others.

 

Many of our current and potential competitorshave longer 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 our current andpotential competitors have established or may establish business, financial orstrategic relationships among themselves or with existing or potential clients,alliance partners or other third parties, or may combine and consolidate tobecome more formidable competitors with better resources. We also expect thatnew competitors, such as enterprise software vendors and online serviceproviders that have traditionally focused on enterprise resource planning orback office applications, will continue to enter the on-demand CRM market withcompeting products as the on-demand CRM market develops and matures. It ispossible that these new competitors could rapidly acquire significant marketshare.

 

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***Themarket for our on-demand application services is at an early stage ofdevelopment, and if it does not develop or develops more slowly than we expect,our business will be harmed.***

 

The market for on-demand application servicesis at an early stage of development, and it is uncertain whether theseapplication services will achieve and sustain high levels of demand and marketacceptance. Our success will depend to a substantial extent on the willingnessof companies to increase their use of on-demand application services in generaland for on-demand customer service applications in particular. Many companieshave invested substantial personnel and financial resources to integratetraditional enterprise software into their businesses, and therefore may bereluctant or unwilling to migrate to on-demand application services. While wehave supported and continue to support 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:

 

•                  on-demand security capabilities and reliability;

 

•                  concerns with entrusting a third party to store andmanage critical customer data;

 

•                  our ability to meet the needs of broader segments ofthe CRM market or other on-demand markets;

 

•                  the level of customization we offer;

 

•                  our ability to continue to achieve and maintain highlevels of client satisfaction;

 

•                  concerns with purchasing critical CRM solutions froma company with a history of operating losses that only recently turnedprofitable; and

 

•                  the price, performance and availability of competingproducts and services.

 

If businesses do not perceive the benefits ofour on-demand solutions, 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.

 

***Failureto effectively develop and expand our sales and marketing capabilities couldharm our ability to increase our client base and achieve broader marketacceptance of our solutions.***

 

Increasing our client base and achievingbroader market acceptance of our solutions will depend to a significant extenton our ability to expand our sales and marketing operations. We plan tocontinue to expand our direct sales force and engage additional third-party channelpartners, both domestically and internationally. This expansion will require usto invest significant financial and other resources. Our business will beseriously harmed if our efforts do not generate a corresponding significant

 

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increase in revenue. We may not achieve anticipated revenue growth fromexpanding our direct sales force if we are unable to hire and develop talenteddirect sales personnel, if our new direct sales personnel are unable to achievedesired productivity levels in a reasonable period of time, or if we are unableto retain our existing direct sales personnel. We also may not achieveanticipated revenue growth from our third-party channel partners if we areunable to attract and retain additional motivated channel partners, if anyexisting or future channel partners fail to successfully market, resell,implement or support our solutions for their customers, or if they representmultiple providers and devote greater resources to market, resell, implementand support competing products and services.

 

***Themajority of our solutions are sold pursuant to term license agreements, and ifour existing clients elect not to renew their licenses or to renew theirlicenses on terms less favorable to us, our business, financial condition and resultsof operations will be adversely affected.***

 

The majority of our solutions are soldpursuant to term license agreements that are subject to renewal every two yearsor less and our clients have no obligation to renew their licenses. Because alarge portion of our clients are in their first or second terms, we are notable to consistently and accurately predict future renewal rates. Our clients’renewal rates may decline or fluctuate as a result of a number of factors,including their level of satisfaction with our solutions, their ability tocontinue their operations or invest in customer service, or the availabilityand pricing of competing products. If large numbers of existing clients do notrenew their licenses, or renew their licenses on terms less favorable to us,and if we cannot replace or supplement those non-renewals with new licensesgenerating the same or greater level of revenue, our business, financialcondition and results of operations will be adversely affected.

 

***Wehave experienced rapid growth in recent periods. If we fail to manage ourgrowth effectively, we may be unable to execute our business plan, maintainhigh levels of service or adequately address competitive challenges.***

 

We have substantially expanded our overallbusiness, headcount and operations in recent periods. We have increased ourtotal number of full-time employees to 403 at December 31, 2004 from 322at December 31, 2003. To achieve our business objectives, we will need tocontinue to expand our business at a rapid pace. This expansion has placed, andis expected to continue to place, a significant strain on our managerial,administrative, operational, financial and other resources. We anticipate thatthis expansion will require substantial management effort and significantadditional investment in our infrastructure. If we are unable to successfullymanage our growth, our business, financial condition and results of operationswill be adversely affected.

 

Part of the challenge that we expect to facein the course of our expansion is to maintain the high level of customerservice to which our clients have become accustomed. To date, we have focusedon providing personalized account management and customer service on a frequentbasis to ensure our clients are effectively leveraging

 

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the capabilities of our solution. We believe that much of our successto date has been the result of high client satisfaction, attributable in partto this focus on client service. To the extent our client base grows, we willneed to expand 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.

 

***Ifthere are interruptions or delays in our hosting services through third-partyerror, our own error or the occurrence of unforeseeable events, delivery of oursolutions could become impaired, which could harm our relationships withclients and subject us to liability.***

 

As of December 31, 2004, approximately87% of our clients were using our hosting services for deployment of oursoftware applications. We provide our hosting services through computerhardware that we own and that is currently located in third-party web hostingco-location facilities maintained and operated in California and New Jersey. Wedo not maintain long-term supply contracts with either of our co-locationproviders, and neither provider guarantees that our clients’ access to hostedsolutions will be uninterrupted, error-free or secure. Our operations depend onour co-location providers’ ability to protect their and our systems in theirfacilities against damage or interruption from natural disasters, power ortelecommunications failures, criminal acts and similar events. Our back-upcomputer hardware and systems located in our Montana headquarters have not beentested under actual disaster conditions and may not have sufficient capacity torecover all data and services in the event of an outage occurringsimultaneously at both the California and New Jersey co-location facilities. Inthe event that our co-location facility arrangements were terminated, or therewas a lapse of service or accidental or willful damage to such facilities, wecould experience lengthy interruptions in our hosting service as well as delaysand/or additional expense in arranging new facilities and services. Any or allof these events could cause our clients to lose access to their important data.In addition, the failure by our third-party co-location facilities to meet ourcapacity requirements could result in interruptions in our service or impedeour ability to scale our operations.

 

We architect the system infrastructure andprocure and own the computer hardware used at our hosting co-locationfacilities. Design and mechanical errors, spikes in usage volume and failure tofollow system protocols and procedures could cause our systems to fail,resulting in interruptions in our clients’ service to their customers. Anyinterruptions or delays in our hosting services, whether as a result ofthird-party error, our own error, natural disasters or security breaches,whether accidental or willful, could harm our relationships with clients andour reputation. This in turn could reduce our revenue, subject us to liability,cause us to issue credits or pay penalties or cause clients to fail to renewtheir licenses, any of which could adversely affect our business, financialcondition and results of operations. In the event of damage or interruption,our insurance policies may not adequately compensate us for any losses that wemay incur.

 

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***Ifthe security of our clients’ confidential information contained in our systemsor stored by use of our software is breached or otherwise subjected tounauthorized access, our hosting service or our software may be perceived asnot being secure and clients may curtail or stop using our hosting service andour solutions.***

 

Our hosting systems and our software storeand transmit proprietary information and critical data belonging to our clientsand their customers. Any accidental or willful security breaches or otherunauthorized access could expose us to a risk of information loss, litigationand other possible liabilities. If security measures are breached because ofthird-party action, employee error, malfeasance or otherwise, or if designflaws in our software are exposed and exploited, and, as a result, a thirdparty obtains unauthorized access to any of our clients’ data, ourrelationships with clients and our reputation will be damaged, our business maysuffer and we could incur significant liability. Because techniques used toobtain unauthorized access or to sabotage systems change frequently andgenerally are not recognized until launched against a target, we and ourthird-party hosting co-location facilities may be unable to anticipate thesetechniques or to implement adequate preventative measures.

 

***Wehave significant international sales and are subject to risks associated withoperating in international markets.***

 

International sales comprised 27%, 24% and19% of our revenue for the years December 31, 2004, 2003 and 2002,respectively. We intend to continue to pursue and expand our internationalbusiness activities, and have recently started sales operations in Germany andFrance.  Adverse political and economicconditions could make it difficult for us to increase our international salesor to operate abroad. International operations are subject to many inherentrisks, including:

 

•                  political, social and economic instability,including conflicts in the Middle East and elsewhere, terrorist attacks andsecurity concerns in general;

 

•                  adverse changes in tariffs and other protectionistlaws and business practices that favor local competitors;

 

•                  fluctuations in currency exchange rates;

 

•                  longer collection periods and difficulties incollecting receivables from foreign entities;

 

•                  exposure to different legal standards and burdens ofcomplying with a variety of foreign laws, including employment, tax, privacyand data protection laws and regulations;

 

•                  reduced protection for our intellectual property insome countries;

 

•                  expenses associated with localizing products forforeign countries, including translation into foreign languages; and

 

•                  import and export license requirements andrestrictions of the United States and each other country in which we operate.

 

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We believe that international sales willcontinue to represent a significant portion of our revenue for the foreseeablefuture, and that continued growth will require further expansion of ourinternational operations. A substantial percentage of our international salesare denominated in the local currency. As a result, an increase in the relativevalue of the dollar could make our products more expensive and potentially lessprice competitive in international markets. We typically do not engage in anytransactions as a hedge against risks of loss due to foreign currencyfluctuations. Any of these factors may adversely affect our futureinternational sales and, consequently, affect our business, financial conditionand results of operations.

 

***Ifwe fail to respond effectively to rapidly changing technology and evolvingindustry standards, particularly in the on-demand CRM industry, our solutionsmay 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 faster, or cost less, than oursolutions and could render our solutions less competitive or obsolete. Inaddition, because our solutions are designed to operate on a variety of networkhardware and software platforms using a standard Internet web browser, we willneed to continuously modify and enhance our solutions to keep pace with changesin Internet-related hardware, software, communication, browser and databasetechnologies and to integrate with our clients’ systems as they change andevolve. Furthermore, uncertainties about the timing and nature of new networkplatforms or technologies, or modifications to existing platforms or technologies,could increase our research and development expenses. 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.

 

***Ourfailure to attract and retain qualified or key personnel may prevent us fromeffectively developing, marketing, selling, integrating and supporting ourproducts.***

 

Our success and future growth depends to asignificant degree upon the skills, experience, performance and continuedservice of our senior management, engineering, sales, marketing, service,support and other key personnel. Specifically, we believe that our futuresuccess is highly dependent on Greg Gianforte, our founder, Chairman and ChiefExecutive Officer. In addition, we do not have employment agreements with anyof our senior management or key personnel that require them to remain ouremployees and, therefore, they could terminate their employment with us at anytime without penalty. If we lose the services of Mr. Gianforte or any ofour other key personnel, our business will be severely disrupted and we may beunable to operate effectively. We do not maintain

 

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“key person” life insurance policies on any of our key employees exceptMr. Gianforte. This life insurance policy would not be sufficient tocompensate us for the loss of his services. Our future success also depends inlarge part upon our ability to attract, train, integrate, motivate and retainhighly 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.

 

***Ifour solutions fail to perform properly or if they contain technical defects,our reputation will be harmed, our market share would decline and we could besubject to product liability claims.***

 

Our software products may contain undetectederrors or defects that may result in product failures, slow response times, orotherwise cause our products to fail to perform in accordance with clientexpectations. Because our clients use our products for important aspects oftheir business, any errors or defects in, or other performance problems with,our products could hurt our reputation and may damage our clients’ businesses.If that occurs, we could lose future sales, or our existing clients could electto not renew or to delay or withhold payment to us, which could result in anincrease in our provision for doubtful accounts and an increase in collectioncycles for accounts receivable. Clients also may make warranty claims againstus, which could result in the expense and risk of litigation. Productperformance problems could result in loss of market share, failure to achievemarket acceptance and the diversion of development resources. If one or more ofour products fails to perform or contains a technical defect, a client mayassert a claim against us for substantial damages, whether or not we areresponsible for the product failure or defect. We do not currently maintain anywarranty reserves.

 

Product liability claims could require us tospend significant time and money in litigation or to pay significantsettlements or damages. Although we maintain general liability insurance,including coverage for errors and omissions, this coverage may not besufficient to cover liabilities resulting from such product liability claims.Also, our insurer may disclaim coverage. Our liability insurance also may notcontinue to be available to us on reasonable terms, in sufficient amounts, orat all. Any product liability claims successfully brought against us wouldcause our business to suffer.

 

***Ifwe are unable to protect our intellectual property rights, our competitiveposition could be harmed or we could be required to incur significant expensesto enforce our rights.***

 

Our success depends to a significant degreeupon the protection of our software and other proprietary technology rights. Werely on trade secret, copyright and trademark laws, patents and confidentialityagreements with employees and third parties, all of which offer only limitedprotection. The steps we have taken to protect our intellectual property maynot prevent misappropriation of our proprietary rights or the reverseengineering of our solutions. We may not be able to obtain any further patentsor trademarks, and our pending applications may not result in the issuance ofpatents or

 

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trademarks. Any of our issued patents may not be broad enough toprotect our proprietary rights or could be successfully challenged by one ormore third parties, which could result in our loss of the right to preventothers from exploiting the inventions claimed in those patents. Furthermore,legal standards relating to the validity, enforceability and scope ofprotection of intellectual property rights in other countries are uncertain andmay afford little or no effective protection of our proprietary technology.Consequently, we may be unable to prevent our proprietary technology from beingexploited abroad, which could diminish international sales or require costlyefforts to protect our technology. Policing the unauthorized use of ourproducts, trademarks and other proprietary rights is generally expensive,difficult and, in some cases, impossible. Litigation may be necessary in thefuture to enforce or defend our intellectual property rights, to protect ourtrade secrets or to determine the validity and scope of the proprietary rightsof others. Such litigation could result in substantial costs and diversion ofmanagement resources, either of which could harm our business. Accordingly,despite our efforts, we may not be able to prevent third parties frominfringing upon or misappropriating our intellectual property.

 

***Ourproduct development efforts may be constrained by the intellectual property ofothers, and we may become subject to claims of intellectual propertyinfringement, which could be costly and time-consuming.***

 

The software and Internet industries arecharacterized by the existence of a large number of patents, trademarks andcopyrights, and by frequent litigation based upon allegations of infringementor other violations of intellectual property rights. As we seek to extend ourCRM product and service offerings, we may be constrained by the intellectualproperty of others. We have in the past been named as a defendant in lawsuitsalleging intellectual property infringement, and we may again in the futurehave to defend against intellectual property lawsuits. We may not prevail inany future intellectual property infringement litigation given the complextechnical issues and inherent uncertainties in litigation. Any claims,regardless of their merit, could be time-consuming and distracting tomanagement, 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 many of our license agreements 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, suchas the GNU General Public License. While we believe we have complied with ourobligations under the various applicable licenses for open source software thatwe use, there is little or no legal precedent governing the interpretation ofmany of the terms of certain of these licenses and therefore the potentialimpact of such

 

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terms on our business is somewhat unknown. Use of open source standardsalso may make us more vulnerable to competition because the public availabilityof open source software could make it easier for new market entrants andexisting competitors to introduce similar competing products quickly andcheaply.

 

***Futureacquisitions could disrupt our business and harm our financial condition andresults of operations.***

 

In order to expand our addressable market, wemay decide to acquire additional businesses, products and technologies. We havenot made any acquisitions to date, and therefore our ability as an organizationto make acquisitions is unproven. Acquisitions could require significantcapital infusions and could involve many risks, including, but not limited to,the following:

 

•                  an acquisition may negatively impact our results ofoperations because it may require incurring large one-time charges, substantialdebt or liabilities; it may require the amortization or write down of amountsrelated to deferred compensation, goodwill and other intangible assets; or itmay cause adverse tax consequences, substantial depreciation or deferredcompensation charges;

 

•                  we may encounter difficulties in assimilating andintegrating the business, technologies, products, personnel or operations ofcompanies that we acquire, particularly if key personnel of the acquiredcompany decide not to work for us;

 

•                  our existing and potential clients and the customersof the acquired company may delay purchases due to uncertainty related to anacquisition;

 

•                  an acquisition may disrupt our ongoing business,divert resources, increase our expenses and distract our management;

 

•                  the acquired businesses, products or technologiesmay not generate sufficient revenue to offset acquisition costs;

 

•                  we may have to issue equity securities to completean acquisition, which would dilute our stockholders and could adversely affectthe market price of our common stock; and

 

•                  acquisitions may involve the entry into a geographicor business market in which we have little or no prior experience.

 

We cannot assure you that we will be able toidentify or consummate any future acquisitions on favorable terms, or at all.If we do pursue any acquisitions, it is possible that we may not realize theanticipated benefits from the acquisitions. It is also possible that the financial markets or investors willnegatively view the acquisitions. Even if we successfully complete anacquisition, it could adversely affect our business, financial condition andresults of operations.

 

 

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***Wemay not be able to secure additional financing on favorable terms, or at all,to meet our future capital needs.***

 

We may require additional capital to respondto business challenges, including the need to develop new solutions or enhanceour existing solutions, enhance our operating infrastructure, fund expansion,respond to competitive pressures and acquire complementary businesses, productsand technologies. Absent sufficient cash flow from operations, we may need toengage in equity or debt financings to secure additional funds to meet ouroperating and capital needs. In addition, even though we may not needadditional 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.

 

***Changesin the accounting treatment of stock options will adversely affect our resultsof operations.***

 

The Financial Accounting Standards Boardrecently issued Statement of Financial Accounting Standards No. 123(revised 2004), *Share-Based Payment*(“SFAS123R”)*.  *The statement requires that thecompensation cost relating to share-based payment transactions be recognized infinancial statements based on the fair value of the equity or liabilityinstruments used, and is effective for interim and annual periods beginningafter June 15, 2005.  SFAS 123Rreplaces FASB Statement 123, *Accounting forStock-Based Compensation*, and supercedes APB No. 25, *Accounting for Stock Issued to Employees*.  SFAS 123R requires us to value our employeestock option grants, transactions under our Employee Stock Purchase Plan, andother possible equity-based transactions, pursuant to a fair value formula, andthen amortize that value against our reported earnings over the vesting periodin effect for those transactions. We currently account for stock-based awardsto employees in accordance with Accounting Principles Board (“APB”) OpinionNo. 25, *Accounting for Stock Issued toEmployees*, and provide the disclosure-only alternative ofSFAS 123. This change in accounting treatment will materially andadversely affect our reported results of operations because the stock-basedcompensation expense would be charged directly against our reported earnings.We do not expect the accounting change to materially affect our liquiditybecause equity-based compensation is a non-cash expense.  For an illustration of the effect of such achange on our recent results of operations, see Note 1(p) of Notes toConsolidated Financial Statements.

 

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**Risks Related to Our Industry**

 

***Thesuccess of our products and our hosted business depends on the continued growthand acceptance of the Internet as a business and communications tool, and therelated expansion of the Internet infrastructure.***

 

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

 

Federal, state or foreign government bodiesor agencies 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 e-mail 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 e-mail. 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 has experienced, and is expectedto continue to experience, significant user and traffic growth, which has, attimes, caused user frustration with slow access and download times. If Internetactivity grows faster than Internet infrastructure or if the Internetinfrastructure is otherwise unable to support the demands placed on it, or ifhosting capacity becomes scarce, our business growth may be adversely affected.

 

***Privacyconcerns and laws or other domestic or foreign regulations may adversely affectour business or reduce sales of our solutions.***

 

Businesses using our solutions collectpersonal information regarding their customers when those customers contactthem with customer service inquiries. A valuable component of our solutions istheir ability to allow our clients to use and analyze their customers’information to increase sales, marketing and up-sell or cross-sellopportunities. Federal, state and foreign government bodies and agencies,however, have adopted and are considering adopting laws and regulationsregarding the collection, use and disclosure of personal information obtainedfrom consumers. The costs of compliance with, and other burdens imposed by,such laws and regulations that are applicable to the businesses of our clientsmay limit the use and adoption of this component of our solutions and reduceoverall demand for our solutions. Furthermore, even where a client desires tomake full use of these features in our solutions, privacy concerns may causeour clients’ customers to resist providing the personal data necessary

 

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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. For example, regulations such as theGramm-Leach-Bliley Act, which protects and restricts the use of consumer creditand financial information, and the Children’s Online Privacy Protection Act of1998, which restricts the ability of companies to collect personal informationonline from children under the age of 13 without their parents’ consent, imposesignificant requirements and obligations on businesses that may affect the useand adoption of our solutions by existing and potential clients.

 

The European Union has also adopted adirective that requires member states to impose restrictions on the collectionand use of personal data that are far more stringent, and impose moresignificant burdens on subject businesses, than current privacy standards inthe 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 government activity, privacyadvocacy groups and the technology and direct marketing industries areconsidering various new, additional or different self-regulatory standards thatmay place additional burdens on us. If the gathering of profiling informationwere to be curtailed in this manner, customer service CRM solutions would beless effective, which would reduce demand for our solutions and harm ourbusiness.

 

***Non-solicitationconcerns, laws or regulations may adversely affect our clients’ ability toperform outbound marketing and other e-mail communications, which could reducesales of our solutions.***

 

In January 2004, the federal Controllingthe Assault of Non-Solicited Pornography and Marketing Act of 2003, or CAN-SPAMAct, became effective. The CAN-SPAM Act regulates the transmission and contentof commercial e-mails and, among other things, obligates the sender of suche-mails to provide recipients with the ability to opt-out of receiving futuree-mails from the sender, and establishes penalties for the transmission ofe-mail messages which are intended to deceive the recipient as to source orcontent. Many state legislatures also have adopted laws that impact thedelivery of commercial e-mail, and laws that regulate commercial e-mailpractices are being developed or adopted in many of the internationaljurisdictions in which we do business, including Europe and Australia. Inaddition, Internet service providers and licensors of software products haveintroduced a variety of systems and products to filter out certain types ofcommercial e-mail, without any common protocol to determine whether therecipient desired to receive the e-mail being blocked. As a result, it isdifficult for us to determine in advance whether or not e-mails generated byour clients using our solutions will be permitted by spam filters to reach theintended recipients.

 

Our RightNow Marketing solution specificallyserves the market for mass distribution marketing and other e-mailcommunications. The increasing regulation of e-mail delivery, both domesticallyand internationally, and the spam filtering practices of

 

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Internet service providers and e-mail users generally, will placesignificant additional burdens on our clients who have outbound communicationprograms, and may cause those clients to substantially change their outboundcommunications programs or abandon them altogether. The concerns and legalrequirements surrounding non-solicitation and compliance with the CAN-SPAM Actand other laws may reduce sales of our RightNow Marketing solution, may make itnecessary to redesign our RightNow Outbound solution to make it easier for ourclients to conform to the requirements of the CAN-SPAM Act and other laws andstandards, which would increase our expenses, or may make it necessary for usto redefine the market for and use of our RightNow Marketing solution, which couldreduce our revenue.

 

**Risks Related to Our Ownership and CorporateStructure**

 

***Thesignificant control over stockholder voting matters and our office leases thatmay be exercised by our founder and Chief Executive Officer will limit yourability to influence corporate actions and may require us to find alternativeoffice space to lease or buy in the future.***

 

At December 31, 2004, Greg Gianforte,our founder and Chief Executive Officer, and his spouse, Susan Gianforte, togetherbeneficially owned approximately 44.7% of our outstanding common stock and,together with our other officers and directors, beneficially ownedapproximately 68.5% of our outstanding stock. In addition, none of the sharesof common stock held by Mr. and Mrs. Gianforte are subject to vestingrestrictions. As a result, Mr. and Mrs. Gianforte, acting alone ortogether with some of our other officers or directors, will be able to controlall 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 prevent 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. Gianforte beneficiallyowns, directly or indirectly, a 50% membership interest in Genesis Partners,LLC, our landlord from whom we lease our principal offices in Bozeman, Montana.Consequently, Mr. Gianforte has significant control over any decisions byGenesis Partners regarding renewal, modification or termination of our Bozeman,Montana leases. In the event that our current leases with Genesis Partners wereterminated or otherwise could not be renewed, or came up for renewal oncommercially unreasonable terms, we would be required to find alternativeoffice space to lease or buy.

 

***Our management has broad discretion over theuse of the proceeds from our initial public offering and might not apply theproceeds of our initial public offering in ways that enhance our results ofoperations.***

 

Our management has broad discretion to usethe net proceeds from our initial public offering.  We expect to use the net proceeds from ourinitial public offering for general corporate purposes, including workingcapital and capital expenditures, and for

 

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possible investments in, or acquisitions of, complementary businesses,services or technologies.  We have notallocated these net proceeds for any specific purposes.  Our management might not be able to yield asignificant return, if any, on any investment of these net proceeds.

 

***Anti-takeoverprovisions in our charter documents and Delaware law could discourage, delay orprevent a change in control of our company and may affect the trading price ofour common stock.***

 

Provisions of our certificate ofincorporation and bylaws and Delaware law may discourage, delay or prevent amerger or acquisition that a stockholder may consider favorable and may limitthe market price of our common stock. These provisions include the following:

 

•                  establishing a classified board in which only aportion of the total board members will be elected at each annual meeting;

•                  authorizing the board to issue preferred stock;

•                  providing the board with sole authority to set thenumber of authorized directors and to fill vacancies on the board;

•                  limiting the persons who may call special meetingsof stockholders;

•                  prohibiting certain transactions under certaincircumstances with interested stockholders;

•                  requiring supermajority approval to amend certainprovisions of the certificate of incorporation; and

•                  prohibiting stockholder action by written consent.

 

It is possible that the provisions containedin our certificate of incorporation and bylaws, the existence of super votingrights held by insiders and the ability of our board of directors to issuepreferred stock without stockholder action may have the effect of delaying,deferring or preventing a change in control of our company without furtheraction by the stockholders, may discourage bids for our common stock at apremium over the market price of our common stock and may adversely affect themarket price of our common stock and the voting and other rights of the holdersof our common stock.

 

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**Item 7A.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

***Foreign Currency Exchange Risk***

 

Our results of operations and cash flows aresubject to fluctuation due to changes in foreign currency exchange rates,particularly changes in the Euro, British pound, Australian dollar and Japaneseyen, because our contracts are frequently denominated in local currency. In thefuture, we may utilize foreign currency forward and option contracts to managecurrency exposures. We do not currently have any such contracts in place, nordid we enter into any such contracts during the years ended December 31,2003 or December 31, 2004.

 

***Interest RateSensitivity***

 

Interest income and expense are sensitive tochanges in the general level of U.S. interest rates. During the year ended December 31,2004 we pre-paid, without penalty, all of our outstanding long-term debtobligations.

 

Net proceeds from our initial public offeringof common stock are invested in short-term, interest bearing, investment-gradesecurities, which are subject to credit and interest rate risk.  Our portfolio is diversified among issuersand security types to reduce credit risk. We manage our interest rate risk by maintaining a large portion of ourinvestment portfolio in instruments with 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 marketinterest rates were to increase by 100 basis points from the level at December 31,2004, the fair value of our portfolio would decline by approximately $116,000.

 

**Item 8.  Financial Statements and Supplementary Data**

 

**Our consolidated financial statements, together with our related notesand report of KPMG LLP, our independent auditors, are set forth on the pagesindicated in Item 15.**

 

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**Item 9. Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure**

 

None.

 

**Item 9A. Controls and Procedures**

 

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

 

Ourmanagement, with the participation of our Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of our disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934) as of the end of the period covered by thisreport. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that, as of the end of the period covered by thisreport, our disclosure controls and procedures were effective in timelyalerting them to the material information relating to RightNow (or itsconsolidated subsidiaries) required to be included in the reports we file orsubmit under the Securities Exchange Act of 1934.

 

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

 

During themost recent completed fiscal quarter covered by this report, there has been nochange in our internal control over financial reporting (as defined in Rules13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**Item 9B. Other Information**

 

None.

 

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**PartIII**

 

**Item 10. Directors and Executive Officers of the Registrant**

 

Our executive officers and directors, andtheir ages and positions, as of December 31, 2004, are as follows:

 
| **Name**                 | ** ** | **Age** | ** ** | **Position**                                                                |
|--------------------------|------------|---------|------------|-----------------------------------------------------------------------------|
| Greg R. Gianforte        |       | 43      |       | Chairman, Chief Executive Officer and  President                            |
| Susan J. Carstensen      |       | 42      |       | Chief Financial Officer, Vice President,  Treasurer and Assistant Secretary |
| Peter P. Dunning         |       | 53      |       | Executive Vice President of Worldwide Field  Operations                     |
| Sean C. Forbes           |       | 36      |       | Vice President of Marketing and Business  Development                       |
| Michael A. Myer          |       | 37      |       | Vice President of Product Development                                       |
| Alan A. Rassaby          |       | 48      |       | Vice President of Legal and Risk  Management, General Counsel and Secretary |
| Richard E. Allen(1)(2)   |       | 47      |       | Director                                                                    |
| Gregory M. Avis(1)(3)    |       | 46      |       | Director                                                                    |
| Roger L. Evans(2)(3)     |       | 59      |       | Director                                                                    |
| William J. Lansing(3)    |       | 46      |       | Director                                                                    |
| Margaret L. Taylor(1)(2) |       | 53      |       | Director                                                                    |

 

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(1)                                  Memberof Audit Committee

(2)                                  Memberof Compensation Committee

(3)                                  Memberof Nomination and Governance Committee

 

*Greg R. Gianforte*is our founder, Chairman, Chief Executive Officer and President. Prior tofounding RightNow in September 1995, he was the Vice President of NorthAmerican Sales of Network Associates, Inc. (formerly McAfeeAssociates, Inc.), a provider of network security and tools. Beforejoining McAfee Associates, Mr. Gianforte founded Brightwork Development, adeveloper of network management applications, in 1986, and served as Presidentof Brightwork until 1994 when Brightwork was acquired by McAfee Associates.Mr. Gianforte also beneficially owns, directly or indirectly, a membershipinterest in Genesis Partners, LLC, from whom we lease our principal offices.Mr. Gianforte holds a B.E. degree in electrical engineering and an M.S.degree in computer science from Stevens Institute of Technology.

 

*Susan J. Carstensen*has been our Chief Financial Officer, Vice President and Treasurer since October 1999and our Assistant Secretary since October 2003. She served as one of ourdirectors from October 1999 to April 2000 and as our Secretary from October 1999to October 2003. From 1995 to October 1999, Ms. Carstensen heldvarious positions in finance and audit at Powerhouse Technologies, Inc., adiversified gaming technology company, including Chief Financial Officer from1997 until June 1999. Prior to joining Powerhouse, Ms. Carstensenspent three years in financial management for

 

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Martin Marietta Astronautics Group, an aerospace and defensecontractor, and six years before that at Ernst & Young LLP.Ms. Carstensen is a Certified Public Accountant and holds B.S. and B.A.degrees in business and political science from Montana State University.

 

*Peter P. Dunning*has been our Executive Vice President of Worldwide Field Operations since August 2003.Prior to joining us, he was Executive Vice President and General Manager forthe Americas of S1 Corporation, a financial services software provider, from2002 to July 2003, President, Chairman and Chief Executive Officer ofOmnexus, NV, an online marketplace company, from 2001 to January 2002, andPresident and Chief Executive Officer of Facility Pro.com, an onlinemarketplace company, from 1999 to January 2001. From 1998 to October 1999,Mr. Dunning was Senior Vice President of Vertical Markets at OracleCorporation and from 1990 to 1997 he was Executive Vice President of the GlobalAccounts Group at SAP Corporation. Mr. Dunning holds a Bachelor ofBusiness Administration degree from the University of Georgia.

 

*Sean C. Forbes*has been our Vice President of Marketing and Business Development since November 2001.Prior to joining us, he was Vice President of Business Development for TrilogySoftware, Inc., a provider of configuration software, from 1998 to November 2001.Before Trilogy, Mr. Forbes was a consultant in the Private Equity Group ofBain & Company from 1996 to September 1998. Mr. Forbes is adecorated veteran of the United States Navy where he was a Surface WarfareOfficer. Mr. Forbes holds a B.S. degree in mechanical and aerospaceengineering from Cornell University and an M.B.A. degree from Harvard University.

 

*Michael A. Myer*has been our Vice President of Product Development since August 2000 andprior to that served as our Director of Product Development from August 1998.From 1987 to August 1998, Mr. Myer held various positions in computerresearch and product development with AT&T Corp., Lucent Technologies(previously a subsidiary of AT&T Corp.) and Bell Labs Research, alltelephony-related companies. Mr. Myer holds M.S. and B.S. degrees incomputer science from Rutgers University and an A.S. degree in computer sciencefrom Penn State University.

 

*Alan A. Rassaby*hasbeen our General Counsel and Secretary since October 2003 and our VicePresident of Legal and Risk Management since June 2000.  From 1998 to February 2000, Mr. Rassabywas the Senior Vice President, Legal and Administration for PowerhouseTechnologies, Inc., a diversified gaming technology company, and Senior VicePresident and General Counsel of Anchor Gaming, after Anchor’s acquisition ofPowerhouse.  Prior to joining Powerhouse,Mr. Rassaby was a partner in the Australian law firm of Phillips Fox Lawyersfrom 1994 to December 1998.  Mr.Rassaby holds Arts and Law degrees from the University of New South Wales inAustralia and a Master of Laws from the London School of Economics andPolitical Science of London University. He is a member of the State Bars of Victoria and New South Wales inAustralia, and of Oregon in the United States.

 

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*Richard E. Allen*has served on our board of directors since May 2004. Mr. Allen wasthe Chief Financial Officer of J.D. Edwards & Co. (now Oracle, Inc.),an enterprise application software company, from January 1990 to August 2003,and had held several senior management positions and titles since joining J.D.Edwards in August 1985. Mr. Allen served as a member of J.D. Edwards’board of directors from September 1991 to July 2003. Prior to joiningJ.D. Edwards, Mr. Allen served as controller for Luff Exploration, anoil and gas exploration and production company, from 1982 to 1985, and as asenior accountant with Coopers & Lybrand, a public accounting firm,from 1979 to 1982. Mr. Allen currently serves on the board of directors ofthree privately-held companies. Mr. Allen holds a B.A. degree in business administration with aconcentration in accounting from Colorado State University.

 

*Gregory M. Avis*has served on our board of directors since December 2000. Mr. Avishas been a managing partner of Summit Partners, a private equity and venturecapital firm, since 1990. Mr. Avis also serves on the board of directorsof Ditech Communications Corporation, a telecommunications products developer,IMPAC Medical Systems, Inc., a provider of software and services tooncology practices, and serves on the board of directors of several privatelyheld companies. Mr. Avis holds a B.A. degree, *cum laude*, in political economy from Williams College and anM.B.A. degree with Distinction from Harvard University.

 

*Roger L. Evans*has served on our board of directors since December 1999. Mr. Evanshas been associated with Greylock, a venture capital firm, since 1989, and hasbeen a general partner of Greylock Partners since 1991. Prior to joiningGreylock, he served as President and Chief Executive Officer of MicomSystems, Inc., a data communications equipment manufacturer, which he co-foundedin 1976. Mr. Evans also serves on the board of directors of CopperMountain Networks, Inc., a provider of digital subscriber line networkingsystems, and serves on the board of directors of several privately heldcompanies. Mr. Evans holds an M.A. degree in economics from King’s Collegein Cambridge, England.

 

*William J. Lansing*has served on our board of directors since April 2000. Mr. Lansinghas been Chief Executive Officer, President and a director of ValueVisionMedia, Inc., a direct marketing company, since December 2003.Mr. Lansing was a general partner of General Atlantic Partners, LLC, aprivate equity investment firm, from 2001 to December 2003. From 2000 to September 2001,Mr. Lansing was the Chief Executive Officer and a director of NBC Internet, Inc.,an Internet portal company. From 1998 to March 2000, Mr. Lansingserved in various positions for Fingerhut Companies, Inc., a directmarketing company, including President and Chief Executive Officer. From November 1996to May 1998, Mr. Lansing served as Vice President of CorporateBusiness Development for General Electric Corp. and was a member of GeneralElectric’s Corporate Executive Council. From January 1996 to October 1996,he served as Chief Operating Officer of Prodigy, Inc., an online servicecompany. From 1986 through 1995, Mr. Lansing was first an associate andlater a principal at McKinsey & Co., a management consulting company.In addition to serving on the board of directors of ValueVision Media,Mr. Lansing serves on the board of directors of

 

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Digital River, Inc., an electronic commerce solutions provider.Mr. Lansing holds a B.A. degree in English from Wesleyan University and aJ.D. degree from Georgetown University.

 

*Margaret L. Taylor*has served on our board of directors since April 2000. Ms. Taylor hasserved as President of PeopleSoft Investments, Inc., a subsidiary ofPeopleSoft, Inc., a provider of enterprise application software, since December 1999,as managing partner of B3Ventures, an investment management firm,since November 1999, and as President of Nevada Pacific Development Corp.,a consulting services firm, from 2000 to 2003. From 1999 to 2001,Ms. Taylor served as the Chief Executive Officer of Venture Builders, LLC,a consulting company for start-up businesses. From 1989 to 1999,Ms. Taylor was the Senior Vice President of PeopleSoft (now Oracle, Inc.).Prior to joining PeopleSoft in 1989, she served in various management positionsfor The Hibernia Bank of San Francisco, California and the Bank of California.Ms. Taylor also serves on the board of directors of Fair IsaacCorporation, a decision analytics company, and serves on the board of directorsof two privately held companies. Ms. Taylor holds a B.A. degree incommunications and psychology from Lone Mountain College.

 

Our executive officers are elected by ourboard of directors on an annual basis and serve at the discretion of our boardof directors until their successors have been duly elected and qualified oruntil their earlier resignation or removal. There are no family relationshipsamong any of our directors or executive officers.

 

## **Audit Committee**

 

The audit committee of our board of directorsreviews and monitors our corporate financial statements and reporting and ourinternal and external audits, including, among other things, our internalcontrols and audit functions, the results and scope of the annual audit andother services provided by our independent auditors and our compliance withlegal matters that have a significant impact on our financial statements. Ouraudit committee also consults with our management and our independent auditorsprior to the presentation of financial statements to stockholders and, asappropriate, initiates inquiries into aspects of our financial affairs. Ouraudit committee has established procedures for the receipt, retention andtreatment of complaints regarding accounting, internal accounting controls orauditing matters, and for the confidential, anonymous submission by ouremployees of concerns regarding questionable accounting or auditing matters. Inaddition, our audit committee is directly responsible for the appointment,retention, compensation and oversight of the work of our independent auditors,including approving services and fee arrangements. All related partytransactions are approved by our audit committee before we enter into them. Thecurrent members of our audit committee are Messrs. Allen and Avis andMs. Taylor.  Mr. Allen was appointedto our audit committee to fill the vacancy resulting from Mr. Lansing’sresignation from our audit committee in June 2004.

 

In addition to qualifying as independentunder the Nasdaq rules, each member of our audit committee can read and has anunderstanding of fundamental financial statements, and each qualifies asindependent under special standards established by the SEC for members of auditcommittees.

 

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Our audit committee includes at least onemember who has been determined by our board of directors to meet thequalifications of an audit committee financial expert in accordance with SECrules. Mr. Allen is the independent director who has been determined to bean audit committee financial expert. This designation is a disclosurerequirement of the SEC related to Mr. Allen’s experience and understandingwith respect to certain accounting and auditing matters. The designation doesnot impose on Mr. Allen any duties, obligations or liability that aregreater than are generally imposed on him as a member of our audit committeeand our board of directors, and his designation as an audit committee financialexpert pursuant to this SEC requirement does not affect the duties, obligationsor liability of any other member of our audit committee or board of directors.

 

## **Codeof Ethics and Business Conduct**

 

Our board of directors has adopted a code ofethics and business conduct that applies to all of our employees, officers(including our principal executive officer, principal financial officer,principal accounting officer or controller, or persons performing similarfunctions) and directors. The full text of our code of ethics and businessconduct is posted on our web site at http:/ /www.rightnow.com under theInvestor Relations section. We intend to disclose future amendments to certainprovisions of our code of ethics and business conduct, or waivers of suchprovisions, applicable to our directors and executive officers (including ourprincipal executive officer, principal financial officer, principal accountingofficer or controller, or persons performing similar functions), at the samelocation on our web site identified above. The inclusion of our web siteaddress in this report does not include or incorporate by reference theinformation on our web site into this report.

 

**Director Compensation and Other Arrangements**

 

We currently do not provide our directorswith cash compensation for their services as members of our board of directorsor any committee of our board of directors, but we have a policy to reimbursedirectors for reasonable expenses incurred in connection with their attendanceat board and committee meetings. Under our 2004 Equity Incentive Plan,non-employee directors are granted an option to purchase 30,000 shares of ourcommon stock upon appointment to our board of directors, vesting in equalinstallments quarterly over three years. At each annual stockholders’ meeting,each non-employee director who has not received an initial grant as describedabove during the same calendar year will receive an immediately vestedautomatic option grant to purchase 15,000 shares of common stock and each ofour committee chairs who has not received an initial grant as described aboveduring the same calendar year receives an additional immediately vestedautomatic option grant to purchase 5,000 shares of common stock. Each such optiongranted has an exercise price per share equal to the fair market value of ourcommon stock on the grant date, and has a maximum term of ten years.

 

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Each of Messrs. Avis, Evans and Lansingand Ms. Taylor was automatically granted options to purchase 15,000 sharesof our common stock in June 2004, 5,000 shares in June 2003 and 3,333shares in June 2002.  In addition,each of Mr. Lansing and Ms. Taylor was automatically granted optionsto purchase an additional 5,000 shares of our common stock in June 2004.These options are fully vested and immediately exercisable at the date of thisreport and have an exercise price of $1.50 per share, except for the optionsgranted in June 2004 which have an exercise price of $7.43 per share. Ourboard of directors granted an option to purchase 30,000 shares of our commonstock in May 2004 to Mr. Allen, under our 1998 Long-Term Incentive andStock Option Plan, in connection with his appointment to our board ofdirectors. This option vests and becomes exercisable in twelve installments of2,500 shares every three months from the date of grant, and has an exerciseprice of $6.375 per share.

 

**Compensation Committee Interlocks and InsiderParticipation**

 

During 2004, the compensation committee ofour board of directors consisted of Mr. Allen, Mr. Evans, andMs. Taylor, none of whom has at any time been one of our officers oremployees or an officer or employee of any of our subsidiaries. None of ourexecutive officers has ever served as a member of the board of directors orcompensation committee of any other entity that has or has had one or moreexecutive officers serving as a member of our board of directors or ourcompensation committee.

 

## **Section 16(a) Beneficial OwnershipReporting Compliance**

 

Section 16(a) of the Securities Act of1934 requires our executive officers and directors and persons who own morethan ten percent of a class of our equity securities registered under theExchange Act, to file with the SEC reports of ownership and changes inownership of common stock and other equity securities of RightNow.  Executive officers, directors and greaterthan ten percent stockholders are required by SEC regulations to furnish uswith copies of all Section 16(a) forms they file.  Based solely on review of these forms, webelieve that during the year ended December 31, 2004, each of ourexecutive officers, directors and holders of ten percent or more of our commonstock timely filed all reports required to be filed pursuant to Section 16(a)of the Exchange Act, except as described below.

 

An initial report on Form 3, one Form 4 andone Form 5 under Section 16(a) of the Securities Exchange Act of 1934 wasnot timely filed by Susan Gianforte, the spouse of our Chief Executive Officerand President, Greg Gianforte.  One giftby Mr. Gianforte was not timely reported on his Form 5.  These delayed reports covered estate planningactions taken by Mr. and Mrs. Gianforte and did not involve any transactions inour common stock for consideration.

 

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**Item 11. Executive Compensation**

 

The following table provides certaininformation regarding compensation paid or earned for services rendered to usand our subsidiaries in all capacities during the three years ended December 31,2004 by our Chief Executive Officer and each of our other four most highlycompensated executive officers whose annual salary and bonus exceeded $100,000during the year ended December 31, 2004. These individuals collectivelyare referred to in this report as our named executive officers. No otherexecutive officers who would have otherwise been includable in the followingtable on the basis of salary and bonus earned for the year ended December 31,2004 have been excluded by reason of their termination of employment or changein executive status during that year.

 

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**SummaryCompensation Table**

 
| ** **                                    | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation  Awards** | ** ** |
|-----------------------------------------------|------------|------------|------------|-------------------------|------------|-------------------------------------|------------|
| **Name and Principal  Positions**             | ** ** | **Year**   | ** ** | **Salary**              | ** ** | **Bonus**                           | ** ** | **Other  Annual  Compensation** | ** ** | **Securities  Underlying Options** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **($)**                 | ** ** | **($)(1)**                          | ** ** | **($)(2)** | ** ** | **(#)** | ** ** |
| Greg R.  Gianforte                            |       | 2004       |       | $                       | 250,000    |                                | $          | 157,481 |   | $ | 5,975 |   | — |   |
| Chairman,  Chief Executive Officer            |       | 2003       |       | 175,000                 |       | 142,933                             |       | 5,589 |   | — |   |
| and  President                                |       | 2002       |       | 148,750                 |       | 82,800                              |       | 6,197 |   | — |   |
|                                          |       |       |       |                    |       |                                |       |   |   |   |   |
| Susan J.  Carstensen                          |       | 2004       |       | 165,000                 |       | 79,075                              |       | 6,923 |   | — |   |
| Chief  Financial Officer, Vice                |       | 2003       |       | 150,000                 |       | 51,398                              |       | 6,061 |   | 133,333 |   |
| President, Treasurer and Assistant  Secretary |       | 2002       |       | 148,750                 |       | 20,020                              |       | 5,063 |   | 33,333 |   |
|                                          |       |       |       |                    |       |                                |       |   |   |   |   |
| Peter P.  Dunning                             |       | 2004       |       | 250,000                 |       | 95,649                              |       | 6,723 |   | — |   |
| Executive  Vice President of                  |       | 2003       |       | 101,442                 |       | 36,500                              |       | — |   | 533,332 |   |
| Worldwide  Field Operations                   |       | 2002       |       | —                  | (3)        | —                              | (3)        | — | (3) | — | (3) |
|                                          |       |       |       |                    |       |                                |       |   |   |   |   |
| Sean C.  Forbes                               |       | 2004       |       | 185,000                 |       | 116,311                             |       | 7,676 |   | — |   |
| Vice  President of Marketing and              |       | 2003       |       | 175,000                 |       | 97,338                              |       | 5,150 |   | — |   |
| Business  Development                         |       | 2002       |       | 175,000                 |       | 54,574                              |       | 4,821 |   | — |   |
|                                          |       |       |       |                    |       |                                |       |   |   |   |   |
| Michael A.  Myer                              |       | 2004       |       | 165,000                 |       | 81,787                              |       | 6,500 |   | — |   |
| Vice  President of Product Development        |       | 2003       |       | 150,000                 |       | 53,008                              |       | 6,090 |   | — |   |
|                                          |       | 2002       |       | 148,750                 |       | 22,680                              |       | 5,143 |   | 200,000 |   |
|                                               |            |            |            |                         |            |                                     |            |  |  |  |  |  |  |  |

 

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(1)                                  Weoffer an annual executive cash bonus plan for the benefit of our executiveofficers. The amount of eligible target bonus is established by thecompensation committee of our board of directors each year in its discretion.Actual bonuses are determined each year by the compensation committee inconjunction with an annual review of executive compensation and is basedprimarily upon us meeting our quarterly and annual financial goals in aparticular year as set out from time to time in our business plan and, to alesser extent, upon a person’s individual performance as assessed by thecompensation committee.

(2)                                  Consistsof matching contributions by us under our 401(k) plan. Employees vest in theemployer matching contribution in four equal annual installments over afour-year period.

(3)                                  Mr.Dunning was hired in August 2003.

 

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**Stock Options**

 

There were nostock options or stock appreciation rights granted to our named executiveofficers in 2004.

 

**AggregatedOption Exercises in 2004 and 2004 Year-End Option Values**

 

The followingtable provides certain information concerning the number and value of shares ofour common stock represented by unexercised stock options held by our namedexecutive officers as of December 31, 2004. None of our named executiveofficers exercised any stock options in 2004. Mr. Gianforte does not holdany stock options. No stock appreciation rights were held by our namedexecutive officers at the end of such year.

 
|                 |   |         |   |         |   | **Number of Securities** |   |                     |   |            |      |
|----------------------|--------|--------------|--------|--------------|--------|--------------------------|--------|--------------------------|--------|-----------------|-----------|
|                 |   | **Shares**   |   |         |   | **Underlying**           |   | **Value of Unexercised** |   |
|                 |   | **Acquired** |   |         |   | **Unexercised Options**  |   | **In-the-Money Options** |   |
|                 |   | **on**       |   | **Value**    |   | **at 2004 Year-End**     |   | **at 2004 Year-End(1)**  |   |
| **Name**             |   | **Exercise** |   | **Realized** |   | **Exercisable**          |   | **Unexercisable**        |   | **Exercisable** |      | **Unexercisable** |   |
| Susan J.  Carstensen |   | —       |   | —       |   | 258,335                  |   | 108,331                  |   | $               | 3,994,608 |   | $ | 1,587,049 |   |
| Peter P.  Dunning    |   | —       |   | —       |   | 200,002                  |   | 333,330                  |   | $               | 2,930,029 |   | $ | 4,883,285 |   |
| Sean C.  Forbes      |   | —       |   | —       |   | 390,001                  |   | 129,998                  |   | $               | 5,713,515 |   | $ | 1,904,471 |   |
| Michael A.  Myer     |   | —       |   | —       |   | 563,000                  |   | 75,000                   |   | $               | 8,862,100 |   | $ | 1,098,750 |   |

 

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(1)          The value of unexercisedin-the-money options has been calculated based on multiplying the number ofshares underlying the options by the difference between the exercise price pershare payable upon exercise of the options and $16.15, the closing price of ourcommon stock on December 31, 2004 on the Nasdaq National Market.

 

**Employment Contracts, Termination ofEmployment and Change-in-Control Agreements**

 

We do not have employment contracts with anyof our named executive officers. Accordingly, the employment of any of ournamed executive officers may be terminated at any time at the discretion of ourboard of directors.

 

Our board ofdirectors has adopted a policy applicable to all of the members of ourexecutive management which provides that in the event of a change or loss ofposition within 12 months following a change-in-control transaction, ourChief Executive Officer will be entitled to receive a minimum of twelve months’salary and bonus as severance and any then-unvested options that were grantedto him after April 20, 2004 will be accelerated in full and become fullyvested, and any member of executive management other than our Chief ExecutiveOfficer will be entitled to receive a minimum of six months’ salary and bonusas severance and any then-unvested options that were granted to him or herafter April 20, 2004 will be accelerated in full and become fully vested.

 

All of ouroption agreements with our named executive officers provide that upon theoccurrence of a change-in-control transaction, the vesting of all of theofficer’s option shares will be automatically accelerated so that they becomecompletely vested, unless the option is assumed by the acquirer in which casethe option will become completely vested if within twelve months

 

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of the change-in-controltransaction the officer is terminated without cause or terminates his or heremployment for good reason. A change-in-control transaction includes (i) atransaction or series of transactions in which any person, entity or groupbecomes the beneficial owner of 35% or more of the combined voting power of ouroutstanding securities, (ii) a transaction in which our directors cease toconstitute a majority of the board of directors, (iii) a consolidation ormerger in which we are not the surviving entity or in which our stockholders donot have the same proportionate ownership in the surviving entity after themerger as they did immediately prior to the merger, the sale, lease, exchangeor other transfer of all or substantially all of our assets, our liquidation ordissolution or (iv) any transaction that a majority of our directorsdetermines constitutes a change-in-control. Cause includes termination ofemployment based upon (i) the willful and continued failure substantiallyto perform one’s duties and obligations (other than due to physical or mentalincapacity or good reason), (ii) a conviction or plea bargain inconnection with the actual or alleged commission of a felony or grossmisdemeanor involving moral turpitude, fraud or misappropriation of funds or(iii) the willful engagement in misconduct which causes us, our employeesor our clients substantial monetary or other injury. Good reason includesterminating one’s employment based upon (i) being assigned employmentduties or responsibilities which are not substantially comparable in responsibilityand status to the employment duties and responsibilities held immediately priorto the change-in-control transaction, (ii) a reduction in base salary asin effect immediately prior to the change-in-control transaction or(iii) being required to relocate offices more than 50 miles from one’soffice location immediately prior to the change-in-control transaction.

 

Theadministrator of our stock option plan has the authority to provide foraccelerated vesting of the shares of our common stock subject to anyoutstanding options held by any of our named executive officers in connectionwith any termination of the officer’s employment, any change-in-controltransactions or any subsequent termination of the officer’s employmentfollowing a change-in-control transaction.

 

Ms. Carstensen’soffer letter provides that if she is terminated after the occurrence of achange in greater than 50% ownership of us, she will be entitled to receive sixmonths’ salary as severance. Mr. Forbes’ offer letter provides that if heis terminated by us other than for cause or if he chooses to resign due to asignificant change in responsibilities or reporting structure, he will beentitled to receive twelve months’ salary and bonus as severance and anadditional 25% of any then-unvested option shares will be accelerated and befully vested as of his date of termination under each of our stock optionagreements with him. Mr. Dunning’s offer letter provides that if he isterminated by us other than for cause, or if he chooses to resign due to asignificant change in responsibilities or reporting structure, he will beentitled to receive twelve months’ salary and bonus as severance and anadditional 25% of any then-unvested option shares will be accelerated and befully vested as of his date of termination under each of our stock optionagreements with him. Certain of our option agreements with Ms. Carstensen,Mr. Dunning and Mr. Myer provide that upon the termination of such person’semployment other than for cause, an additional 12.5% in the case ofMs. Carstensen, and an additional 25% in the case of Mr. Dunning and Mr. Myer,of any then-unvested option shares under such agreements will be acceleratedand be fully vested as of each of their dates of termination.

 

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**Item 12. Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters**

 

The followingtable provides information concerning beneficial ownership of our common stockas of December 31, 2004, by: (a) each stockholder, or group of affiliatedstockholders, that we know owns more than 5% of our outstanding common stock;(b) each of our named executive officers; (c) each of our directors; and (d)all of our directors and executive officers as a group.

 

The followingtable lists the number of shares and percentage of shares beneficially ownedbased on 29,119,238 shares of common stock outstanding as of December 31, 2004.Beneficial ownership is determined in accordance with the rules of theSecurities and Exchange Commission, and generally includes voting power and/orinvestment power with respect to the securities held. Shares of common stocksubject to options currently exercisable or exercisable within 60 days ofDecember 31, 2004, are deemed outstanding and beneficially owned by the personholding such options for purposes of computing the number of shares andpercentage beneficially owned by such person, but are not deemed outstandingfor purposes of computing the percentage beneficially owned by any otherperson. Except as indicated in the footnotes to this table, and subject toapplicable community property laws, the persons or entities named have solevoting and investment power with respect to all shares of our common stockshown as beneficially owned by them.

 

Unless otherwiseindicated, the principal address of each of the stockholders below is c/oRightNow Technologies, Inc., 40 Enterprise Boulevard, Bozeman, Montana59718.

 
| ** **                                                             | ** ** | **Shares Beneficially  Owned Prior to Offering** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Name and Address of Beneficial  Owner**                              | ** ** | **Number**                                       | ** ** | **Percent** | ** ** |
| Greg R. Gianforte(1)                                                   |       | 13,019,965                                       |       | 44.7 | % |
| Roger L. Evans(2)(3)                                                   |       | 3,927,586                                        |       | 13.5 |   |
| Entities affiliated with Greylock(3)                                   |       | 3,877,587                                        |       | 13.3 |   |
| Gregory M. Avis(4)(5)                                                  |       | 2,326,620                                        |       | 8.0 |   |
| Entities affiliated with Summit Partners(5)                            |       | 2,276,621                                        |       | 7.8 |   |
| Michael A. Myer(6)                                                     |       | 592,638                                          |       | 2.0 |   |
| Sean C. Forbes(7)                                                      |       | 391,139                                          |       | 1.3 |   |
| Susan J. Carstensen(8)                                                 |       | 281,995                                          |       | 1.0 |   |
| Peter P. Dunning(9)                                                    |       | 200,002                                          |       | * |   |
| William J. Lansing(10)                                                 |       | 141,666                                          |       | * |   |
| Margaret L. Taylor(11)                                                 |       | 77,219                                           |       | * |   |
| Richard E. Allen(12)                                                   |       | 17,500                                           |       | * |   |
| All directors and executive officers as a  group (11 persons)(13) |       | 21,144,767                                       |       | 68.5 | % |

 

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*                           Lessthan 1% of the outstanding shares of common stock.

(1)                    Includes10,819,965 shares held by the Greg Gianforte Revocable Inter Vivos Trust datedSeptember 19, 2000 and Susan Gianforte Revocable Inter Vivos Trust DatedSeptember 19, 2000, Tenants in Common.  Includes 1,200,000 shares held by the Greg Gianforte Revocable InterVivos Trust dated September 19, 2000. Includes 1,000,000 shares held by the Irrevocable Trust of Greg R.Gianforte. Mr. Gianforte, and the Greg R. Gianforte Family Trust are thebeneficiaries of the Irrevocable Trust of Greg R. Gianforte.

 

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As co-trusteeof the Greg R. Gianforte Revocable Inter Vivos Trust dated September 19, 2000 andas co-trustee of the Susan Gianforte Revocable Inter Vivos Trust datedSeptember 19, 2000, Mrs. Gianforte may be deemed to share voting anddispositive powers over the common stock registered in the names of thosetrusts.  Mrs. Gianforte does not beneficiallyown the shares held by the Irrevocable Trust of Greg R. Gianforte.

(2)                    Includes49,999 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004. The principal address of Roger L. Evans is c/oGreylock, 880 Winter Street, Suite 300, Waltham, MA 02451.

(3)                    Consistsof 1,938,794 shares held by Greylock IX Limited Partnership, 1,800,402shares held by Greylock X Limited Partnership and 138,391 shares held byGreylock X-A Limited Partnership. Mr. Evans, one of our directors, is ageneral partner of Greylock IX GP Limited Partnership, the general partner ofGreylock IX Limited Partnership, a general partner of Greylock X GPLimited Partnership, the general partner of Greylock X Limited Partnershipand Greylock X-A Limited Partnership. Mr. Evans disclaims beneficialownership of these shares except to the extent of his pecuniary interesttherein. Mr. Evans shares voting and dispositive powers over the sharesheld by Greylock IX Limited Partnership, Greylock X Limited Partnership and GreylockX-A Limited Partnership with the other general partners of those partnerships.The principal address of entities affiliated with Greylock is 880 WinterStreet, Suite 300, Waltham, MA 02451.

(4)                    Includes49,999 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004. The principal address of Gregory M. Avis is c/o SummitPartners, 499 Hamilton Avenue, Palo Alto, CA 94301.

(5)                    Consistsof 2,031,341 shares held by Summit Accelerator Fund, L.P., 140,539 shares heldby Summit (SAF) Investors IV, L.P. and 104,741 shares held by SummitAccelerator Founders Fund L.P. Summit Partners, L.L.C. is the general partnerof Summit Accelerator Partners, L.P., which is a managing member of SummitAccelerator Partners, L.L.C., which is the general partner of SummitAccelerator Fund, L.P. and Summit Accelerator Founders Fund, L.P. SummitPartners, L.L.C. is the general partner of Summit (SAF) Investors, IV, L.P.Summit Partners, L.L.C. has voting and dispositive authority over the sharesheld by each of these entities and therefore beneficially owns such shares.Mr. Avis, one of our directors, is a member of Summit Partners, L.L.C. anddisclaims beneficial ownership of the shares held by Summit Partners except tothe extent of his pecuniary interest therein. The principal address of entitiesaffiliated with Summit Partners is 499 Hamilton Avenue, Palo Alto, CA 94301.

(6)                    Includes563,000 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004.

(7)                    Consistsof 390,001 shares underlying options exercisable as of or within 60 daysof December 31, 2004.

(8)                    Includes258,335 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004.

(9)                    Consistsof 200,002 shares underlying options exercisable as of or within 60 daysof December 31, 2004.

(10)              Includes33,333 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004. The principal address of William J. Lansing is6740 Shady Oak Road, Eden Prairie, MN 55344.

(11)              Includes33,333 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004. Includes 22,220 shares held by the Margaret L. TaylorLiving Trust. The principal address of Margaret L. Taylor is531 Lodgepole Drive, Incline Village, NV 89451.

(12)              Consistsof 7,500 shares underlying options exercisable as of or within 60 days ofDecember 31, 2004.

(13)              Includesthe information set forth in notes 1 through 12 above.  Also includes 167,500 shares underlyingoptions exercisable as of or within 60 days of December 31, 2004 that are heldby Alan A. Rassaby, our Vice President of Legal and Risk Management, GeneralCounsel and Secretary.

 

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**Securities Authorized for Issuance UnderEquity Compensation Plans**

 

The following table gives certain informationas of December 31, 2004 about our equity compensation plans.

 
| **Plan Category**                                       | ** ** | **Number of Shares to be  Issued Upon Exercise  of Outstanding  Options, Warrants and  Rights** | ** ** | **Weighted-Average  Exercise Price of  Outstanding  Options, Warrants,  and Rights** | ** ** | **Number of Shares  Remaining Available for  Issuance Under Equity  Compensation Plans  (excluding shares in  column (a))** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **(a)**                                                                                         | ** ** | **(b)**                                                                              | ** ** | **(c)**                                                                                                                     | ** ** |
| Equity compensation plans approved by  shareholders (1) |       | 5,512,024                                                                                       | (2)        | $                                                                                    | 2.89       |                                                                                                                        | 3,804,180  | (3) |
| Equity compensation plans not approved by shareholders  |       | —                                                                                          |       | —                                                                               |       | —                                                                                                                      |       |
| Total                                                   |       | 5,512,024                                                                                       |       | $                                                                                    | 2.89       |                                                                                                                        | 3,804,180  |   |

 

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(1)          Consists of the 2004Equity Incentive Plan, the 2004 Employee Stock Purchase Plan and the 1998Long-Term Incentive and Stock Option Plan. No additional option grants are being made under the 1998 Long-TermIncentive and Stock Option Plan after August 5, 2004.

 

(2)          Excludes purchase rightsaccruing under the 2004 Employee Stock Purchase Plan which has a shareholderapproved initial reserve of 750,000 shares. Under the Purchase Plan, each eligible employee may purchase up to 5,000shares of our common stock (with payroll deductions in an amount established bythe administrator not to exceed 15% of their compensation for each pay periodduring a purchase period) at semi-annual intervals on the last business day ofJune and December each year at a purchase price per share equal to that priceas established by the administrator prior to the first business day of thatpurchase period, which price may, in the discretion of the administrator, be aprice which is not fixed or determinable as of the first business day of thatpurchase period.  In no event, however,will the purchase price for any purchase period after the initial purchaseperiod be less than the lesser of 85% of the fair market value of our commonstock on the first business day and the last business day of that purchaseperiod.

 

(3)          Consistof shares available for future issuance under the 2004 Employee Stock PurchasePlan and the 2004 Equity Incentive Plan. As of December 31, 2004, an aggregate of 651,529 shares of common stockwere available for issuance under the 2004 Employee Stock Purchase Plan and anaggregate of 3,152,651 shares of common stock were available for issuance underthe 2004 Equity Incentive Plan.  Thenumber of shares of common stock reserved under our 2004 Employee StockPurchase Plan automatically increases on the first day of each year, beginningon January 1, 2005, in an amount equal to the lesser of (a) 500,000 shares or(b) 2% of the number of shares of our common stock outstanding on the last dayof the preceding year or (c) such lesser number as determined by our board ofdirectors.  The number of shares ofcommon stock reserved under our 2004 Equity Incentive Plan will automaticallybe increased on the first day of each year, beginning on January 1, 2005, in anamount equal to the lesser of (a) 1,000,000 shares or (b) 4% of the number ofshares of our common stock outstanding on the last day of the preceding year or(c) such lesser amount as determined by our board of directors.

 

66

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## **Item 13. Certain Relationships and Related Party Transactions**

## ** **

Since January 1, 2004, there has notbeen any transaction or series of similar transactions to which we were or area party in which the amount involved exceeded or exceeds $60,000 and in whichany of our directors, executive officers, holders of more than 5% of any classof our voting securities, or any member of the immediate family of any of theforegoing persons, had or will have a direct or indirect material interest,other than the transactions described below.

 

*Office Leases withGenesis Partners, LLC.* We lease approximately 29,724 square feet of office space for ourprincipal executive offices at 40 Enterprise Boulevard, Bozeman, Montana, andapproximately 3,444 square feet of office space at 45 Discovery Drive, Bozeman,Montana from Genesis Partners, LLC. We also lease approximately 9,184 squarefeet of office space at 77 Discovery Drive, Bozeman, Montana from GenesisPartners. Mr. Gianforte, our Chief Executive Officer, and Mr. Daines,our Vice President of North American Sales, beneficially own, directly orindirectly, 50% and 25% membership interests in Genesis Partners, respectively.The remaining 25% of Genesis Partners is beneficially owned by Mr. Daines’father, Clair Daines, who is a commercial real estate developer and builder.The Enterprise Boulevard lease has a 120-month term that started April 1,2001, with an option to extend for one additional 120-month period upon thesame terms and conditions except for renegotiated rent. The Discovery Driveleases have 60-month terms that started April 1, 2000 and May 1,2000, with options to extend for three additional 60-month periods upon thesame terms and conditions except for renegotiated rent. Our current rent is$35,460 per month for the Enterprise Boulevard lease; $11,107 per month for the77 Discovery Drive lease; and $4,164 per month for the 45 Discovery Drivelease, including insurance, taxes and common area maintenance, but excludingutilities. We believe that the terms of these leases are no less favorable tous than they would have been if obtained from unaffiliated third parties. Weplan to enter into another five-year lease with Genesis Partners forapproximately 13,000 square feet of additional office space in Bozeman,Montana, that will be available in mid-2005.

 

*IndemnificationAgreements.*  Wehave entered into indemnification agreements with each of our current directorsand executive officers. These agreements require us to indemnify theseindividuals to the fullest extent permitted under Delaware law againstliabilities that may arise by reason of their service to us, and to advanceexpenses incurred as a result of any proceeding against them as to which theycould be indemnified. We also intend to enter into indemnification agreementswith our future directors and executive officers.

 

67

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## **Item 14. Principal Accountants and Fees**

 

The aggregatefees billed by KPMG LLP, our registered public accounting firm, for the yearsended December 31, 2003 and 2004 were as follows:

 
| **Services rendered** | ** ** | **2003** | ** ** | **2004** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| Audit (1)             |       | $        | 73,901     |     | $          | 575,211 |   |
| Audit-related (2)     |       | 21,212   |       | —   |       |
| Tax (3)               |       | 71,904   |       | 61,906   |       |
| Other (4)             |       | 1,625    |       | —   |       |
| Total                 |       | $        | 168,642    |     | $          | 637,117 |   |

 

----

(1)          Feesbilled for the audit of the Company’s annual financial statements for the yearsended December 31, 2003 and 2004.  Auditservices for 2004 include fees for the review of financial statements includedin the Company’s registration statement on Form S-1 and quarterly report onForm 10-Q for the period ended September 30, 2004.

(2)          Audit-related fees in2003 include due diligence assistance and accounting research.

(3)          Tax fees for compliance,planning, and expatriate tax services.

(4)          Other services in 2003include fees for on-line accounting research services.

 

The Audit Committee has concluded that the non-audit services listedabove are compatible with maintaining the independence of KPMG LLP.

 

***Audit Committee Pre-Approval of Audit andPermissible Non-Audit Services of Independent Auditors***

 

The Audit Committee pre-approves all audit and permissible non-auditservices provided by the independent auditors. These services may include audit services, audit-related services, taxservices and other services.  The AuditCommittee has adopted a policy for the pre-approval of services provided by theindependent auditors.  Under the policy,pre-approval is generally provided at or near the beginning of the fiscal yearto which the services pertain.  The AuditCommittee may delegate pre-approval authority to one or more of itsmembers.  Such a member must report anydecisions to the Audit Committee at the next scheduled meeting.

 

68

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**Part IV**

 

**Item 15. Exhibits and Financial Statement Schedules**

 

*(a)(1)**             **Financial Statements*

 
| 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)*              *Financial Statement Schedules*

 

Financialstatement schedules have been omitted since they are not required, notapplicable, or the information is otherwise included in the financialstatements and notes thereto.

 

*(a)(3)**              Exhibits*

 

The following is a list of exhibits to thisreport.

 
| **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.                                                                          |
| 10.13†        |       | 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.                                                                                                                                    |
| 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). 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). 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. |

 

69

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----

* Incorporated by reference to the exhibit of the same number from theCompany’s registration statement of Form S-1 (File No. 333-115331) initiallyfiled with the Securities and Exchange Commission on May 10, 2004, as amended.

**  Incorporated by reference to Exhibit 4.2 tothe Registrant’s Registration Statement on Form S-8 (File No. 333-118515) filedwith the Securities and Exchange Commission on August 24, 2004.

†  Denotes management contract or compensatoryplan or arrangement.

 

*(b)**                               Exhibits*

 

The exhibits filed as part of this report arelisted 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.

 

70

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**Signatures**

 

**Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.**

 
| **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 Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities indicated on March 28, 2005.

 

 
| **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) |

 

71

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**Report of Independent Registered PublicAccounting Firm**

 

Board of Directors and Stockholders

RightNow Technologies, Inc.:

 

We have audited the accompanying consolidatedbalance sheets of RightNow Technologies, Inc. and subsidiaries as ofDecember 31, 2003 and 2004, and the related consolidated statements ofoperations, stockholders’ equity (deficit) and comprehensive income (loss), andcash flows for each of the years in the three-year period endedDecember 31, 2004. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance withthe standards 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 financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of RightNow Technologies, Inc. andsubsidiaries as of December 31, 2003 and 2004 and the results of theiroperations and their cash flows for each of the years in the three-year periodended December 31, 2004 in conformity with U.S. generally acceptedaccounting principles.

 
|              | /s/ KPMG LLP |   |
|-------------------|--------------|--------|
|              |         |
|              |         |
| Billings, Montana |         |
| March 21, 2005    |         |

 

F-1

----

 

**RIGHTNOWTECHNOLOGIES, INC.**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                                                                                                                                | ** ** | **December 31,**                            | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                | ** ** | **2003**                                    | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                                                                                                                                                | ** ** | **(In  thousands, except per  share data)** | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                |       |                                        |       |   |   |
| Current assets:                                                                                                                                                                                                                                                                           |       |                                        |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                                 |       | $                                           | 8,360      |   | $ | 18,944 |   |
| Short-term investments                                                                                                                                                                                                                                                                    |       | —                                      |       | 31,188 |   |
| Accounts receivable                                                                                                                                                                                                                                                                       |       | 10,415                                      |       | 16,939 |   |
| Term receivables, current                                                                                                                                                                                                                                                                 |       | 4,926                                       |       | 10,090 |   |
| Total current receivables                                                                                                                                                                                                                                                                 |       | 15,341                                      |       | 27,029 |   |
| Less allowance for doubtful accounts                                                                                                                                                                                                                                                      |       | (902                                        | )          | (1,581 | ) |
| Total current receivables, net                                                                                                                                                                                                                                                            |       | 14,439                                      |       | 25,448 |   |
| Prepaid expenses                                                                                                                                                                                                                                                                          |       | 509                                         |       | 1,255 |   |
| Total current assets                                                                                                                                                                                                                                                                      |       | 23,308                                      |       | 76,835 |   |
| Property and equipment, net                                                                                                                                                                                                                                                               |       | 2,942                                       |       | 4,393 |   |
| Term receivables, non-current                                                                                                                                                                                                                                                             |       | 2,278                                       |       | 5,756 |   |
| Intangible assets, net                                                                                                                                                                                                                                                                    |       | 623                                         |       | 1,113 |   |
| Other assets                                                                                                                                                                                                                                                                              |       | 235                                         |       | 212 |   |
|                                                                                                                                                                                                                                                                                      |       |                                        |       |   |   |
| **Total Assets**                                                                                                                                                                                                                                                                          |       | $                                           | 29,386     |   | $ | 88,309 |   |
|                                                                                                                                                                                                                                                                                      |       |                                        |       |   |   |
| **Liabilities, Redeemable Convertible Preferred Stock and Stockholders’  Equity (Deficit)**                                                                                                                                                                                          |       |                                        |       |   |   |
| Current liabilities:                                                                                                                                                                                                                                                                      |       |                                        |       |   |   |
| Accounts payable                                                                                                                                                                                                                                                                          |       | $                                           | 1,025      |   | $ | 1,720 |   |
| Commissions and bonuses payable                                                                                                                                                                                                                                                           |       | 1,636                                       |       | 2,648 |   |
| Other accrued liabilities                                                                                                                                                                                                                                                                 |       | 2,154                                       |       | 3,715 |   |
| Current portion of long-term debt                                                                                                                                                                                                                                                         |       | 1,390                                       |       | — |   |
| Current portion of deferred revenue                                                                                                                                                                                                                                                       |       | 26,127                                      |       | 36,020 |   |
| Total current liabilities                                                                                                                                                                                                                                                                 |       | 32,332                                      |       | 44,103 |   |
| Long-term debt, less current portion                                                                                                                                                                                                                                                      |       | 484                                         |       | — |   |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                                  |       | 9,426                                       |       | 13,105 |   |
| Total liabilities                                                                                                                                                                                                                                                                         |       | 42,242                                      |       | 57,208 |   |
| Commitments and contingencies                                                                                                                                                                                                                                                             |       |                                        |       |   |   |
| Redeemable convertible preferred stock:                                                                                                                                                                                                                                                   |       |                                        |       |   |   |
| Series A, $0.001 par value. Authorized, designated, issued and  outstanding 3,703 shares at December 31, 2003 (aggregate liquidation  preference of $16,165), and no shares at December 31, 2004                                                                                     |       | 16,145                                      |       | — |   |
| Series B, $0.001 par value. Authorized and designated 3,663 shares at  December 31, 2003, and no shares at December 31, 2004; issued and  outstanding 3,562 shares at December 31, 2003 (aggregate liquidation  preference of $16,030), and no shares at December 31, 2004 |       | 16,002                                      |       | — |   |
| Series B warrants                                                                                                                                                                                                                                                                         |       | 251                                         |       | — |   |
| Stockholders’ equity (deficit):                                                                                                                                                                                                                                                      |       |                                        |       |   |   |
| Preferred stock, $0.001 par value. Authorized and undesignated 7,634  and 15,000 shares at December 31, 2003, and 2004, respectively                                                                                                                                                 |       | —                                      |       | — |   |
| Common stock, $0.001 par value. Authorized 150,000 shares; issued and  outstanding 14,727 shares and 29,119 shares at December 31, 2003 and  2004, respectively                                                                                                                      |       | 15                                          |       | 29 |   |
| Warrants                                                                                                                                                                                                                                                                                  |       | —                                      |       | 291 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                |       | (912                                        | )          | 72,367 |   |
| Accumulated other comprehensive income (loss)                                                                                                                                                                                                                                             |       | 73                                          |       | (605 | ) |
| Accumulated deficit                                                                                                                                                                                                                                                                       |       | (44,430                                     | )          | (40,981 | ) |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                                                 |       | (45,254                                     | )          | 31,101 |   |
| **Total Liabilities, Redeemable Convertible Preferred Stock and  Stockholders’ Equity (Deficit)**                                                                                                                                                                                    |       | $                                           | 29,386     |   | $ | 88,309 |   |

 

See accompanying notes toconsolidated financial statements

 

F-2

----

 

**RIGHTNOWTECHNOLOGIES, INC.**

**Consolidated Statements of Operations**

 
| ** **                                       | ** ** | **Year Ended December 31,**                | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share  data)** | ** ** |
|                                             |       |                                       |       |   |   |   |   |
| Revenue:                                         |       |                                       |       |   |   |   |   |
| Software, hosting and support                    |       | $                                          | 23,338     |   | $ | 29,300 |   | $ | 49,764 |   |
| Professional services                            |       | 3,603                                      |       | 6,579 |   | 12,000 |   |
| Total revenue                                    |       | 26,941                                     |       | 35,879 |   | 61,764 |   |
| Costs of revenue:                                |       |                                       |       |   |   |   |   |
| Software, hosting and support                    |       | 4,279                                      |       | 5,263 |   | 6,741 |   |
| Professional services                            |       | 2,156                                      |       | 3,740 |   | 7,206 |   |
| Total cost of revenue                            |       | 6,435                                      |       | 9,003 |   | 13,947 |   |
|                                             |       |                                       |       |   |   |   |   |
| Gross profit                                     |       | 20,506                                     |       | 26,876 |   | 47,817 |   |
|                                             |       |                                       |       |   |   |   |   |
| Operating expenses:                              |       |                                       |       |   |   |   |   |
| Sales and marketing                              |       | 15,939                                     |       | 20,809 |   | 31,986 |   |
| Research and development                         |       | 4,117                                      |       | 5,915 |   | 7,807 |   |
| General and administrative                       |       | 2,842                                      |       | 3,518 |   | 4,621 |   |
| Total operating expenses                         |       | 22,898                                     |       | 30,242 |   | 44,414 |   |
| Income (loss) from operations                    |       | (2,392                                     | )          | (3,366 | ) | 3,403 |   |
| Interest and other income (expense):             |       |                                       |       |   |   |   |   |
| Interest income                                  |       | 108                                        |       | 142 |   | 390 |   |
| Interest expense                                 |       | (485                                       | )          | (371 | ) | (249 | ) |
| Other                                            |       | 20                                         |       | 14 |   | 5 |   |
| Total interest and other income (expense),  net  |       | (357                                       | )          | (215 | ) | 146 |   |
| Income (loss) before provision for income  taxes |       | (2,749                                     | )          | (3,581 | ) | 3,549 |   |
| Provision for income taxes                       |       | —                                     |       | (539 | ) | (100 | ) |
|                                             |       |                                       |       |   |   |   |   |
| Net income (loss)                                |       | (2,749                                     | )          | (4,120 | ) | 3,449 |   |
|                                             |       |                                       |       |   |   |   |   |
| Preferred stock accretion                        |       | (33                                        | )          | (13 | ) | (8 | ) |
| Net income (loss) allocated to common stock      |       | $                                          | (2,782     | ) | $ | (4,133 | ) | $ | 3,441 |   |
|                                             |       |                                       |       |   |   |   |   |
| Net income (loss) per share:                     |       |                                       |       |   |   |   |   |
| Basic                                            |       | $                                          | (0.19      | ) | $ | (0.28 | ) | $ | 0.17 |   |
| Diluted                                          |       | (0.19                                      | )          | (0.28 | ) | 0.12 |   |
| Shares used in the computation:                  |       |                                       |       |   |   |   |   |
| Basic                                            |       | 14,284                                     |       | 14,560 |   | 20,738 |   |
| Diluted                                          |       | 14,284                                     |       | 14,560 |   | 29,177 |   |

 

See accompanying notes toconsolidated financial statements

 

F-3

----

 

**RIGHTNOWTECHNOLOGIES, INC.**

**Consolidated Statements of Stockholders’Equity (Deficit) andComprehensive Income (Loss)**

 
| ** **                                                                                                      | ** ** | **Common Stock** | ** ** | ** ** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated  Other  comprehensive** | ** ** | **Accumulated**   | ** ** | **Total  stockholders’** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|-------------------------|------------|---------------------------------------|------------|-------------------|------------|-------------------------------|------------|
| ** **                                                                                                      | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Warrants**            | ** ** | **capital**                           | ** ** | **income (loss)** | ** ** | **deficit**                   | ** ** | **equity** | ** ** |
| Balance at December 31, 2001                                                                                    |       | 14,047           |       | $          | 14         |                    | $          | —                                |       | $                 | (1,044     | )                             | $          | (92 | ) | $ | (37,561 | ) | $ | (38,683 | ) |
| Exercise of stock options                                                                                       |       | 347              |       | —     |       | —                  |       | 90                                    |       | —            |       | —                        |       | 90 |   |
| Value of stock options granted                                                                                  |       | —           |       | —     |       | —                  |       | 1                                     |       | —            |       | —                        |       | 1 |   |
| Accretion of redeemable convertible preferred  stock to redemption value                                        |       | —           |       | —     |       | —                  |       | (33                                   | )          | —            |       | —                        |       | (33 | ) |
| Comprehensive loss;                                                                                             |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       |   |   |
| Net loss                                                                                                        |       | —           |       | —     |       | —                  |       | —                                |       | —            |       | (2,749                        | )          | (2,749 | ) |
| Foreign currency translation adjustment                                                                         |       | —           |       | —     |       | —                  |       | —                                |       | 83                |       | —                        |       | 83 |   |
| Total comprehensive loss                                                                                        |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       | (2,666 | ) |
| Balance at December 31, 2002                                                                                    |       | 14,394           |       | 14         |       | —                  |       | (986                                  | )          | (9                | )          | (40,310                       | )          | (41,291 | ) |
| Exercise of stock options                                                                                       |       | 333              |       | 1          |       | —                  |       | 86                                    |       | —            |       | —                        |       | 87 |   |
| Value of stock options granted                                                                                  |       | —           |       | —     |       | —                  |       | 1                                     |       | —            |       | —                        |       | 1 |   |
| Accretion of redeemable convertible preferred  stock to redemption value                                        |       | —           |       | —     |       | —                  |       | (13                                   | )          | —            |       | —                        |       | (13 | ) |
| Comprehensive loss;                                                                                             |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       |   |   |
| Net loss                                                                                                        |       | —           |       | —     |       | —                  |       | —                                |       | —            |       | (4,120                        | )          | (4,120 | ) |
| Foreign currency translation adjustment                                                                         |       | —           |       | —     |       | —                  |       | —                                |       | 82                |       | —                        |       | 82 |   |
| Total comprehensive loss                                                                                        |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       | (4,038 | ) |
| 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                                                                 |       | 6,417            |       | 6          |       | —                  |       | 39,966                                |       | —            |       | —                        |       | 39,972 |   |
| Exercise of stock options                                                                                       |       | 616              |       | 1          |       | —                  |       | 485                                   |       | —            |       | —                        |       | 486 |   |
| Employee stock purchase plan                                                                                    |       | 97               |       | —     |       | —                  |       | 690                                   |       | —            |       | —                        |       | 690 |   |
| Conversion of redeemable convertible preferred  stock into common stock                                         |       | 7,265            |       | 7          |       | —                  |       | 32,148                                |       | —            |       | —                        |       | 32,155 |   |
| Conversion of warrants to acquire  redeemable convertible preferred stock into warrants to acquire common stock |       | —           |       | —     |       | 291                     |       | —                                |       | —            |       | —                        |       | 291 |   |
| Repurchase of common stock                                                                                      |       | (3               | )          | —     |       | —                  |       | (2                                    | )          | —            |       | —                        |       | (2 | ) |
| Accretion of redeemable convertible preferred  stock to redemption value                                        |       | —           |       | —     |       | —                  |       | (8                                    | )          | —            |       | —                        |       | (8 | ) |
| Comprehensive loss:                                                                                             |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       |   |   |
| Net income                                                                                                      |       | —           |       | —     |       | —                  |       | —                                |       |              |       | 3,449                         |       | 3,449 |   |
| Foreign currency translation adjust                                                                             |       | —           |       | —     |       | —                  |       | —                                |       | (665              | )          | —                        |       | (665 | ) |
| Unrealized loss on available for sale investments                                                               |       | —           |       | —     |       | —                  |       | —                                |       | (13               | )          | —                        |       | (13 | ) |
| Total comprehensive income                                                                                      |       |             |       |       |       |                    |       |                                  |       |              |       |                          |       | 2,771 |   |
| Balance at December 31, 2004                                                                                    |       | 29,119           |       | $          | 29         |                    | $          | 291                                   |       | $                 | 72,367     |                          | $          | (605 | ) | $ | (40,981 | ) | $ | 31,101 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-4

----

 

**RIGHTNOWTECHNOLOGIES, INC.**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | **(In thousands)**          | ** ** |
| ** **                                                                                | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating activities:                                                                     |       |                        |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                           | (2,749     | ) | $ | (4,120 | ) | $ | 3,449 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                        |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 2,324                       |       | 2,474 |   | 2,666 |   |
| Provision for losses on accounts receivable                                               |       | 259                         |       | 477 |   | 489 |   |
| (Gain) loss on sale of property and  equipment                                            |       | 2                           |       | 45 |   | 5 |   |
| Changes in operating assets and  liabilities:                                             |       |                        |       |   |   |   |   |
| Receivables                                                                               |       | (3,636                      | )          | (6,678 | ) | (14,644 | ) |
| Prepaid expenses                                                                          |       | (95                         | )          | (156 | ) | (733 | ) |
| Accounts payable                                                                          |       | (517                        | )          | 587 |   | 683 |   |
| Commissions and bonuses payable                                                           |       | 525                         |       | 520 |   | 988 |   |
| Other accrued liabilities                                                                 |       | 139                         |       | 453 |   | 1,347 |   |
| Deferred revenue                                                                          |       | 5,723                       |       | 10,655 |   | 13,408 |   |
| Other                                                                                     |       | (32                         | )          | 62 |   | (920 | ) |
| Net cash provided by operating activities                                                 |       | 1,943                       |       | 4,319 |   | 6,738 |   |
| Investing activities:                                                                     |       |                        |       |   |   |   |   |
| Purchases of short-term investments                                                       |       | —                      |       | — |   | (57,063 | ) |
| Sales or maturities of short-term  investments                                            |       | —                      |       | — |   | 25,875 |   |
| Purchase of property and equipment                                                        |       | (1,184                      | )          | (1,584 | ) | (3,580 | ) |
| Proceeds from sale of property and  equipment                                             |       | 2                           |       | 18 |   | 3 |   |
| Intangible asset additions                                                                |       | —                      |       | (150 | ) | (691 | ) |
| Net cash used in investing activities                                                     |       | (1,182                      | )          | (1,716 | ) | (35,456 | ) |
| Financing activities:                                                                     |       |                        |       |   |   |   |   |
| Proceeds from long-term debt                                                              |       | 1,000                       |       | 1,000 |   | 1,675 |   |
| Proceeds from line of credit                                                              |       | 5,000                       |       | 3,700 |   | — |   |
| Proceeds from issuance of common stock:                                                   |       |                        |       |   |   |   |   |
| Initial public offering, net of offering  costs                                           |       | —                      |       | — |   | 39,972 |   |
| Exercise of stock options                                                                 |       | 90                          |       | 88 |   | 486 |   |
| Employee stock purchase plan                                                              |       | —                      |       | — |   | 690 |   |
| Repurchase of common stock                                                                |       | —                      |       | — |   | (2 | ) |
| Payments on long-term debt                                                                |       | (854                        | )          | (1,433 | ) | (3,588 | ) |
| Payments on line of credit                                                                |       | (4,250                      | )          | (5,700 | ) | — |   |
| Net cash provided by (used in) financing  activities                                      |       | 986                         |       | (2,345 | ) | 39,233 |   |
| Effect of foreign exchange rates on cash  and cash equivalents                            |       | 33                          |       | 64 |   | 69 |   |
| Net change in cash and cash equivalents                                                   |       | 1,780                       |       | 322 |   | 10,584 |   |
| Cash and cash equivalents at beginning of  period                                         |       | 6,258                       |       | 8,038 |   | 8,360 |   |
| Cash and cash equivalents at end of period                                                |       | $                           | 8,038      |   | $ | 8,360 |   | $ | 18,944 |   |
|                                                                                      |       |                        |       |   |   |   |   |
| Supplemental disclosure of cash flow  information:                                        |       |                        |       |   |   |   |   |
| Cash paid during the period for:                                                          |       |                        |       |   |   |   |   |
| Interest                                                                                  |       | $                           | 214        |   | $ | 152 |   | $ | 127 |   |
| Income taxes                                                                              |       | 20                          |       | 402 |   | 100 |   |
| 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                                          |       | —                      |       | 12 |   | 40 |   |

 

See accompanying notes toconsolidated financial statements

 

F-5

----

 

**RIGHTNOWTECHNOLOGIES, INC.**

**Notes to Consolidated Financial Statements**

 

**Yearsended December 31, 2002, 2003 and 2004**

 

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

 

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

 

RightNow Technologies, Inc. (the “Company”or “RightNow”) provides on demand customer relationship management (“CRM”)software solutions for companies of all sizes. The Company’s on demand software supports multiple customer interactionpoints in a business’s customer service, marketing and sales operations.  Founded in 1997, RightNow is headquartered inBozeman, Montana, with offices located in Dallas, Texas; San Mateo, California;Princeton, New Jersey; London, England; Sydney, Australia; Munich, Germany, anda liaison office in Tokyo, Japan. The Company operates in one segment, which isthe customer relationship management market.

 

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

 

The consolidated financial statements includethe accounts of the Company and its foreign subsidiaries. All intercompany accountsand transactions have been eliminated in consolidation.

 

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

 

The Company’s revenue is derived from thelicense of its software products and provision of related professionalservices. The markets in which the Company competes are highly competitive andrapidly changing. Significant technological changes, changes in customerrequirements, or the emergence of competitive products with new capabilities ortechnologies could adversely affect the Company’s operating results. TheCompany has historically derived a majority of its revenue from its customerservice software solution. This product is expected to continue to account fora significant portion of revenue for the foreseeable future. As a result ofthis revenue concentration, the Company’s business could be harmed by a declinein demand for, or in the prices of, these products or as a result of, amongother factors, any change in pricing model, a maturation in the markets tothese products, increased price competition or a failure by the Company to keepup with technological change.

 

Financial instruments subjecting the Companyto concentrations of credit risk consist primarily of cash and cashequivalents, short-term investments, and trade accounts receivable. The Companymaintains cash, cash equivalents, and short-term investments with variousdomestic and foreign financial institutions. From time to time, the Company’scash balances with its financial institutions may exceed insurance limits.  Short-term investments are investment grade,interest-earning securities, and are diversified by type and industry.

 

F-6

----

 

The Company’s customers are worldwide withapproximately 70% of sales in the United States. No individual customeraccounted for more than 10% of the Company’s revenue in 2002, 2003 or 2004, orrepresented more than 10% of receivables at December 31, 2003 or 2004.

 

Assets located outside North America were 12%and 7% of total assets at December 31, 2003 and 2004, respectively.Revenue for the years ended December 31, 2002, 2003 and 2004 from foreigncustomers was 19%, 24% and 27%, respectively, of total revenue. The loss fromoperations outside the United States totaled $2.8 million,$2.4 million and $3.1 million for the years ended December 31,2002, 2003 and 2004, respectively. Revenue by geographical region is as follows (in thousands):

 
| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **    | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States |       | $                                | 21,940     |   | $ | 27,161 |   | $ | 45,199 |   |
| Europe        |       | 4,041                            |       | 6,458 |   | 12,792 |   |
| Asia Pacific  |       | 960                              |       | 2,260 |   | 3,773 |   |
|          |       | $                                | 26,941     |   | $ | 35,879 |   | $ | 61,764 |   |

 

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

 

The preparation of the consolidated financialstatements requires management of the Company to make a number of estimates andassumptions relating to the reported amount of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenue and expenses duringthe period. Significant items subject to such estimates and assumptions includethe carrying amount of property and equipment and intangibles, and valuationallowances for receivables and deferred income tax assets. Actual results coulddiffer from those estimates.

 

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

 

The Company considers all highly liquidinvestments purchased with an original maturity date of three months or less tobe cash equivalents.  Cash equivalentsare recorded at cost, which approximates market value.

 

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

 

Short-term investments in debt and equitysecurities are classified as available-for-sale and are recorded at fair marketvalue as determined by quotations from national exchanges.  Realized gains and losses are included inincome based on the specific identification method.  Unrealized gains and losses (excludingother-than-temporary impairments), net of tax, are recorded to OtherComprehensive Income, a component of stockholders’ equity.

 

Investments are considered to be impairedwhen a decline in fair market value is determined to beother-than-temporary.  If the cost of aninvestment is less than its fair value, we evaluate, among other factors,general market conditions, the duration and extent that cost is less than fairvalue, as well as our ability and intent to hold the

 

F-7

----

 

investment.  We also considerspecific adverse conditions of the investee, including industry and sectorperformance, operational and cash flow factors, 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 amountscurrently due (within 90 days) from customers for which revenue has beenrecognized or is being recognized ratably in future periods, and amountscurrently due under contract billings for which revenue has not beenrecognized. Term receivables include the remaining minimum committed amountsdue from customers, for which no revenue has been recognized. The Companyperforms credit evaluations when considered necessary, but generally does notrequire collateral to extend credit.

 

The allowance for doubtful accounts is theCompany’s best estimate of the amount of probable credit losses in the Company’sexisting receivables. The Company determines the allowance based on factorssuch as historical collection experience, customer’s current creditworthiness,customer concentration, age of accounts receivable balance and general economicconditions that may affect a customer’s ability to pay. Actual customercollections could differ from estimates. The Company reviews its allowance fordoubtful accounts on a monthly basis. 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.

 

Provisions to the allowance for doubtfulaccounts are charged to expense for accounts receivable and against deferredrevenue for term receivables. Following is a summary of the activity in theallowance for doubtful accounts (in thousands):

 
| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| Balance, beginning of year                    |       | $                                | 728        |   | $ | 519 |   | $ | 902 |   |
| Provision charged to expense                  |       | 259                              |       | 477 |   | 489 |   |
| Provision charged against deferred revenue    |       | 76                               |       | 221 |   | 972 |   |
| Write-downs charged against the allowance     |       | (619                             | )          | (550 | ) | (841 | ) |
| Recoveries of amounts previously  charged-off |       | 75                               |       | 235 |   | 59 |   |
| Balance, end of year                          |       | $                                | 519        |   | $ | 902 |   | $ | 1,581 |   |

 

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

 

Property and equipment, including softwarepurchased for internal use, are stated at cost less accumulated depreciationand amortization. Depreciation and amortization is computed using thestraight-line method over the estimated useful lives of the assets, generallythree to seven years. Repairs and maintenance are expensed as incurred.

 

F-8

----

 

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

 

Intangible assets, consisting of theCompany’s domain name and purchased technologies, are carried at cost lessaccumulated amortization. The Company amortizes intangible assets on astraight-line basis over their estimated useful lives of three to five years.

 

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

 

Software, hosting and support revenue iscomprised of fees from term and perpetual licenses of the Company’s software,hosting and support. The Company recognizes revenue for the fees associatedwith term licenses and the related hosting and support ratably over the term ofthe arrangement, generally two years, but can range between six months and fouryears. To date, the Company has not entered into an arrangement solely for thelicense of its products, and therefore, has not established vendor specificobjective evidence (VSOE) of fair value for the license element.  The Company has established VSOE for thehosting and support elements sold with perpetual licenses based on pricescharged upon renewal.  Accordingly,revenue is recognized for the fees associated with a perpetual license upondelivery if all other revenue recognition criteria are met using the residualmethod in accordance with Statement of Position (SOP) 98-9, *Modification of SOP 97-2, Software RevenueRecognition With Respect to Certain Transactions*.

 

Hosting and support agreements providemaintenance and management of our software at third party facilities, technicalsupport for our software products, and unspecified product upgrades on a whenand if available basis. Basic hosting and support is included with the termlicense package and the initial perpetual license support packages. Basichosting and support services included in the initial perpetual license supportpackage are recognized ratably over the term provided in the arrangement.

 

Revenue is recognized when all of thefollowing criteria at met: a) the Company has entered into a legallybinding agreement with the customer; b) the software has been delivered ormade available to the customer; c) the Company’s fee for providing thesoftware and services is determinable; and d) the Company estimates thatcollection of its fee is reasonably probable.

 

If an arrangement includes a right ofacceptance or a right to cancel, revenue is recognized when acceptance isreceived or the right to cancel has expired. If the fee for the license has anypayment term that is due in excess of the Company’s normal payment terms (over90 days), the fee is considered to not be fixed or determinable. Accordingly,the amount of revenue recognized (a) for perpetual license arrangements islimited to the amount due from the customer, or (b) for term licensearrangements is limited to the lesser of the amount due from the customerduring each reporting period or a ratable portion of the total unallocatedarrangement fee.

 

F-9

----

 

License fee revenue from arrangements withresellers is recognized on a sell-through basis, which is when payment becomesdue from the customer and delivery of the product has occurred, assuming nosignificant vendor obligations remain.

 

Certain customers have license agreementsthat provide for usage above fixed minimums. Usage above fixed minimumsrequires payment of additional license fees if the Company’s software is usedby more than a specified number of users or for more than a specified number ofinteractions. Fixed minimums are recognized as revenue ratably over the term ofthe arrangement. Usage fees above fixed minimums are recognized as revenue whensuch amounts are reported to the Company and billed.

 

Professional services revenue is primarilycomprised of revenue from consulting services, education and developmentservices. Consulting services include implementation, upgrade and bestpractices services consulting. Education services include both group andindividual courses. Development services include building of non-complexcustomizations and integrations services for the customer’s specificapplication. Professional services revenue is recognized upon delivery. TheCompany has determined that the service elements of its software arrangementsare not essential to the functionality of the software. The Company has alsodetermined that its professional services (a) are available from othervendors, (b) do not involve a significant degree of risk or uniqueacceptance criteria, and (c) qualify for separate accounting as theCompany has sufficient experience in providing such services.

 

VSOE of fair value of services in multipleelement arrangements is based upon rates for consulting, education anddevelopment services, which the Company has charged in stand-alone contractsfor services.

 

The following table sets forth revenue byproduct or service as a percentage of total revenue:

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenue by type:                                |       |                             |       |   |   |   |   |
| Recurring (term licenses, support and  hosting) |       | 74                               | %          | 67 | % | 59 | % |
| Perpetual licenses                              |       | 13                               |       | 15 |   | 22 |   |
| Professional services                           |       | 13                               |       | 18 |   | 19 |   |
|                                            |       | 100                              | %          | 100 | % | 100 | % |

 

Deferred revenue represents amounts receivedor due from customers for which the revenue recognition criteria have not beenmet. The majority of deferred revenue is due to the ratable revenue recognitionof term licenses and support contracts. Deferred revenue is recognized intorevenue when the Company provides its products and services, provided that allother revenue recognition criteria noted above are met. The Company does notprovide refunds for customer cancellations.

 

F-10

----

 

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

 

Sales commissions are expensed as incurred.Commission expense was $2.9 million, $4.0 million and $8.6 millionfor the years ended December 31, 2002, 2003 and 2004, respectively.

 

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

 

Research and development expenditures areexpensed as incurred. Statement of Financial Accounting Standards (SFAS)No. 86, *Accounting for the Costs ofComputer Software to Be Sold, Leased or Otherwise Marketed,* requirescapitalization 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 income taxes under theasset and liability method. 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.

 

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

 

Long-lived assets, including intangibleassets, are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable.Recoverability of assets to be held and used is measured by a comparison of thecarrying amount of an asset to future net cash flows expected to be generatedby the asset. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amount of theassets exceeds the estimated fair value of the assets. Assets to be disposed ofare reported at the lower of the carrying amount or fair value less costs tosell.

 

F-11

----

 

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

 

A reconciliation of the denominator used inthe calculation of basic and diluted net income (loss) per share is as follows(in thousands):

 
| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average common shares outstanding  for basic net income (loss) per share |       | 14,284                           |       | 14,560 |   | 20,738 |   |
| Effect of dilutive securities:                                                    |       |                             |       |   |   |   |   |
| Redeemable convertible preferred stock                                            |       | —                           |       | — |   | 4,328 |   |
| Employee stock options                                                            |       | —                           |       | — |   | 4,055 |   |
| Warrants                                                                          |       | —                           |       | — |   | 56 |   |
| Weighted average shares outstanding for  dilutive net income (loss) per share     |       | 14,284                           |       | 14,560 |   | 29,177 |   |

 

The following common stock equivalents wereexcluded from the computation of diluted earnings (loss) per share because theyhad an anti-dilutive impact (in thousands):

 
| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                             | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Redeemable convertible preferred stock |       | 7,265                            |       | 7,265 |   | — |   |
| Employee stock options                 |       | 4,806                            |       | 5,357 |   | 43 |   |
| Warrants                               |       | 87                               |       | 101 |   | — |   |

 

F-12

----

 

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

 

The Company accounts for its employeestock-based compensation using the intrinsic value method in accordance withAccounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees.*Under APB 25, when the exercise price of an employee stock option equals theestimated market price of the underlying stock on the date of grant, nocompensation expense is recognized.

 

The Company has adopted the disclosure onlyprovisions of SFAS No. 123, *Accountingfor Stock-Based Compensation,* and SFAS No. 148, *Accounting for Stock-Based Compensation–Transitionand Disclosure*. Pro forma information regarding net income (loss)required by SFAS Nos. 123 and 148, has been determined as if the Company hadaccounted for its stock options under the appropriate minimum value or fairvalue method. The per share weighted average value of the stock options grantedin 2002, 2003 and 2004 was $0.24, $0.22 and $6.05, respectively, at the date ofgrant using the appropriate option pricing model. Assumptions used to measurethe value of options granted to employees and directors using the Black-Scholesvaluation model were:

 
| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                      | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average risk free rate |       | 3.62                        | %          | 3.16 | % | 3.51 | % |
| Expected term                   |       | 5 yrs                       |       | 5 yrs |   | 5 yrs |   |
| Dividend yield                  |       | 0                           | %          | 0 | % | 0 | % |
| Weighted average volatility     |       | 0                           | %          | 0 | % | 78 | % |

 

Assumptionsused to measure the value of shares purchased under the Employee Stock PurchasePlan were: risk free interest rate of 2%, expected term of 5 months, dividendyield of zero, and volatility of 78%.

 

Had the Company recorded compensation expensefor its stock option and employee stock purchase plans in accordance with SFASNo. 123, net income (loss) would have been (in thousands except per sharedata):

 
| ** **                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                          | ** ** | **2002**                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                          | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss), as reported                                                      |       | $                           | (2,749     | ) | $ | (4,120 | ) | $ | 3,449 |   |
| Less total stock-based compensation expense  determined under the fair value method |       | (506                        | )          | (369 | ) | (1,289 | ) |
| Pro forma net income (loss)                                                         |       | $                           | (3,255     | ) | $ | (4,489 | ) | $ | 2,160 |   |
| Net income (loss) per share                                                         |       |                        |       |   |   |   |   |
| Basic:                                                                              |       |                        |       |   |   |   |   |
| As reported                                                                         |       | $                           | (0.19      | ) | $ | (0.28 | ) | $ | 0.17 |   |
| Pro forma                                                                           |       | (0.23                       | )          | (0.31 | ) | 0.10 |   |
| Diluted:                                                                            |       |                        |       |   |   |   |   |
| As reported                                                                         |       | $                           | (0.19      | ) | $ | (0.28 | ) | $ | 0.12 |   |
| Pro forma                                                                           |       | (0.23                       | )          | (0.31 | ) | 0.07 |   |
|                                                                                     |            |                             |            |  |  |  |  |  |  |  |  |

 

F-13

----

 

From time to time the Company grants optionsto purchase stock to certain of its consultants. The Company accounts forconsultant stock options in accordance with SFAS 123 and Emerging IssuesTask Force Consensus Issue No. 96-18 (EITF 96-18), *Accounting for Equity Instruments that are Issued toOther Than Employees for Acquiring, or in Conjunction With Selling, Goods orServices*. Compensation expense for the grant of stock options toconsultants is determined based on the estimated fair value of the stockoptions at the measurement date as defined in EITF 96-18 and is recognized overthe vesting period.

 

In December 2004, the Financial AccountingStandards Board issued SFAS No. 123R (“123R”), *Share-BasedPayment*, which replaces SFAS No. 123 and supercedes APB 25.  The Company is required to apply 123R as ofthe first interim or annual reporting period that begins after June 15,2005.  123R covers a wide range ofshare-based compensation, including share options, restricted share plans,performance-based awards, share appreciation rights, and employee sharepurchase plans.  The statement requiresthe recognition of compensation cost related to share-based payment plans to berecognized in financial statement based on the fair value of the equity orliability instruments issued.  We expectto adopt the provisions of 123R beginning in our third fiscal quarter ending September30, 2005.

 

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

 

For non-U.S. operations, the functionalcurrency is the local currency. Assets and liabilities of those operations aretranslated into U.S. dollars using year-end exchange rates; income and expensesare translated using the average exchange rates for the reporting period.Translation adjustments are deferred in accumulated other comprehensive loss, aseparate component of stockholders’ deficit. Realized foreign currencytransaction gains and losses are included in other income and expense.

 

***(r)******                                   ComprehensiveLoss***

 

Comprehensive loss includes net income orloss, as well as other changes in stockholders’ equity that result fromtransactions and economic events other than those with stockholders. Additionalelements of other comprehensive income or loss are attributable to foreigncurrency translation adjustments and unrealized gains or losses on short-terminvestments.

 

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

 

The Company expenses advertising costs asincurred. Advertising costs were $798,000, $605,000 and $973,000 for the yearsended December 31, 2002, 2003 and 2004, respectively.

 

F-14

----

** **

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

 

In August 2004 the Company completed the saleof approximately 6.4 million shares of common stock, including theunderwriters’ exercise of an over-allotment option, at a public offering priceof $7.00 per share.  Net proceeds of theoffering were $40 million after deducting underwriters’ commissions and otheroffering expenses.  Outstanding shares ofSeries A and Series B redeemable convertible preferred stock were automaticallyconverted into shares of common stock, on a one-for-one basis, at the closingof the offering.  In addition, warrantsto acquire shares of Series B redeemable convertible preferred stock wereautomatically converted into warrants to acquire common stock.

 

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

 

The components of cash and investments atDecember 31, 2004 are as follows (in thousands):

 
| ** **                        | ** ** | **Cost**   | ** ** | **Unrealized** | ** ** | **Fair   Market   Value** | ** ** | **Cash and   Equivalents** | ** ** | **Short-term   Investments** | ** ** |
|-----------------------------------|------------|------------|------------|----------------|------------|---------------------------|------------|----------------------------|------------|------------------------------|------------|
| **Gains**                         | ** ** | **Losses** |
| Cash and cash equivalents:        |       |       |       |           |       |                      |       |                       |       |                         |       |   |   |
| Cash                              |       | $          | 2,086      |           | $          | —                    |       | $                          | —     |                         | $          | 2,086 |   | $ | 2,086 |   | $ | — |   |
| Money market funds                |       | 6,022      |       | —         |       | —                    |       | 6,022                      |       | 6,022                        |       | — |   |
| Fixed maturity securities:        |       |       |       |           |       |                      |       |                       |       |                         |       |   |   |
| Commercial paper                  |       | 10,698     |       | —         |       | (1                        | )          | 10,697                     |       | 10,697                       |       | — |   |
| Corporate notes and bonds         |       | 4,945      |       | —         |       | (4                        | )          | 4,941                      |       | —                       |       | 4,941 |   |
| U.S. Government agency securities |       | 5,790      |       | 1              |       | (9                        | )          | 5,782                      |       | —                       |       | 5,782 |   |
| State and municipal securities    |       | 12,690     |       | —         |       | —                    |       | 12,690                     |       | —                       |       | 12,690 |   |
| Other                             |       | 939        |       | —         |       | —                    |       | 939                        |       | 139                          |       | 800 |   |
| Sub-total                         |       | 43,170     |       | 1              |       | (14                       | )          | 43,157                     |       | 18,944                       |       | 24,213 |   |
|                              |       |       |       |           |       |                      |       |                       |       |                         |       |   |   |
| Equity securities:                |       |       |       |           |       |                      |       |                       |       |                         |       |   |   |
| Preferred stocks                  |       | 6,975      |       | —         |       | —                    |       | 6,975                      |       | —                       |       | 6,975 |   |
|                              |       |       |       |           |       |                      |       |                       |       |                         |       |   |   |
| Total                             |       | $          | 50,145     |           | $          | 1                         |       | $                          | (14        | )                            | $          | 50,132 |   | $ | 18,944 |   | $ | 31,188 |   |

 

 

Of the unrealized losses of $14,000 atDecember 31, 2004, none had exceeded more than one year and none are consideredto be other-than-temporarily impaired. There were no realized gains or losses from sales of available-for-salesecurities in 2004.

 

The underlying maturities of short-terminvestment balances were approximately $3.1 million within one year, $3.8million between one and five years, and $17.3 million beyond ten years.  These items are classified as short-termbecause they represent investments of cash that is available for currentoperations.

 

F-15

----

 

**(4)****                                 Propertyand Equipment, Net**

 

Property and equipment, net are as follows(in thousands):

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------|------------|
| ** **                          | ** ** | **2003**         | ** ** | **2004** | ** ** |
|                                |       |             |       |   |   |
| Computer equipment                  |       | $                | 5,237      |   | $ | 7,815 |   |
| Software purchased for internal use |       | 1,844            |       | 2,543 |   |
| Equipment                           |       | 726              |       | 888 |   |
| Furniture and fixtures              |       | 700              |       | 868 |   |
| Total cost                          |       | 8,507            |       | 12,114 |   |
| Less accumulated depreciation       |       | (5,565           | )          | (7,721 | ) |
|                                |       | $                | 2,942      |   | $ | 4,393 |   |

 

**(5)****                                 Intangibleassets**

 

The following table sets forth informationregarding intangible assets (in thousands):

 
| ** **                            | ** ** | **Domain   Name** | ** ** | **Purchased   Technologies** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|-------------------|------------|------------------------------|------------|-----------|------------|
| As of December 31, 2003:         |       |              |       |                         |       |      |       |
| Gross carrying value                  |       | $                 | 236        |                         | $          | 988       |       | $ | 1,224 |   |
| Accumulated amortization              |       | (157              | )          | (444                         | )          | (601      | )          |
| Net carrying value                    |       | $                 | 79         |                         | $          | 544       |       | $ | 623 |   |
| As of December 31, 2004:         |       |              |       |                         |       |      |       |
| Gross carrying value                  |       | $                 | 236        |                         | $          | 1,829     |       | $ | 2,065 |   |
| Accumulated amortization              |       | (204              | )          | (748                         | )          | (952      | )          |
| Net carrying value                    |       | $                 | 32         |                         | $          | 1,081     |       | $ | 1,113 |   |
| Weighted-average amortization period: |       |              |       |                         |       |      |       |
| (in years)                            |       | 5.0               |       | 4.6                          |       | 4.6       |       |
| Aggregate amortization expense:       |       |              |       |                         |       |      |       |
| 2003                                  |       | $                 | 47         |                         | $          | 193       |       | $ | 240 |   |
| 2004                                  |       | 47                |       | 304                          |       | 351       |       |
| Estimated amortization expense:       |       |              |       |                         |       |      |       |
| 2005                                  |       | $                 | 32         |                         | $          | 421       |       | $ | 453 |   |
| 2006                                  |       | —            |       | 300                          |       | 300       |       |
| 2007                                  |       | —            |       | 161                          |       | 161       |       |
| 2008                                  |       | —            |       | 161                          |       | 161       |       |
| 2009                                  |       | —            |       | 38                           |       | 38        |       |

 

F-16

----

 

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

 

Long-term debt consists of the following (inthousands):

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|------------------|------------|
| ** **                                         | ** ** | **2003**         | ** ** | **2004** | ** ** |
|                                               |       |             |       |   |   |
| 8.4% to 9.4% equipment loans, paid during  2004    |       | $                | 494        |   | $ | — |   |
| Prime plus 1.5% equipment loans, paid  during 2004 |       | 1,380            |       | — |   |
|                                               |       | 1,874            |       | — |   |
| Less current portion                               |       | 1,390            |       | — |   |
| Long-term debt, excluding current portion          |       | $                | 484        |   | $ | — |   |

 

In 2004 all long-term debt was paid infull.  In January 2004 the Companyamended its agreement with a commercial bank to provide a revolving line ofcredit agreement through January 2005 limited to the lesser of $3.0 million orthe borrowing base as defined.  Advancesbear interest, payable monthly, at prime plus 1% (6.25% at December 31,2004).  The revolving line of credit issecured by substantially all the assets of the Company, except those securedunder its existing equipment loans and contains restrictions on, among otherthings, working capital, profitability, bank accounts, other liens and theacquisition or sale of assets. There was no amount outstanding under therevolving line of credit at December 31, 2003 or December 31, 2004.

 

**(7)****                                 RedeemableConvertible Preferred Stock**

 

The Company sold approximately 7.3 millionshares of Series A and Series B redeemable convertible preferred stock in 1999,2000 and 2001, for net proceeds of approximately $32.1 million.  These preferred shares had certainliquidation, dividend, and redemption rights senior to common shares.  The Company did not declare or pay dividends,or redeem any Series A and Series B preferred shares while they wereoutstanding.  The Series A and Series Bpreferred shares automatically converted into shares of common stock, on aone-for-one basis, in conjunction with the Company’s initial public offering ofcommon stock in August 2004 (see Note 2).

 

The Company has authorized 15 million sharesof preferred stock, $.001 par value, which may be issued from time to time byits board of directors without further action by stockholders.  Shares of preferred stock may be issued withdividend, redemption, voting or other rights senior to existing commonshares.  There were no outstanding sharesof preferred stock at December 31, 2004.

 

F-17

----

 

**(8)****                                 StockOptions and Warrants**

 

The Company’s 1998 Long-Term Incentive andStock Option Plan, as amended, and the 2004 Equity Incentive Plan (the “Plans”)provide for stock options to be granted to employees, consultants, independentcontractors, officers and directors.  The2004 Equity Incentive Plan was adopted by the Board of Directors in May 2004and by stockholders in June 2004, and became effective in conjunction with theinitial public offering.  Except fordirector automatic grants, options are granted at the discretion of theCompany’s Board of Directors, at an exercise price and term determined by theBoard of Directors. Exercise prices are not less than fair market value at thedate of grant, and the term of options is not greater than ten years.  Options generally vest over a period of fouryears in eight equal increments.  Changesin the shares granted for stock options for the years ended December 31,2002, 2003 and 2004, are summarized as follows (option shares in thousands):

 
| ** **                                | ** ** | **Shares   available   for grant** | ** ** | **Outstanding   options** | ** ** | **Weighted   average exercise   price per share** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|---------------------------|------------|---------------------------------------------------|------------|
| Balance at December 31, 2001              |       | 1,782                              |       | 5,719                     |       | $                                                 | 2.69       |   |
| Granted                                   |       | (928                               | )          | 928                       |       | 1.50                                              |       |
| Exercised                                 |       | —                             |       | (347                      | )          | 0.26                                              |       |
| Forfeited, expired, exchanged or canceled |       | 1,494                              |       | (1,494                    | )          | 6.26                                              |       |
| Balance at December 31, 2002              |       | 2,348                              |       | 4,806                     |       | 1.52                                              |       |
| Granted                                   |       | (1,271                             | )          | 1,271                     |       | 1.50                                              |       |
| Exercised                                 |       | —                             |       | (333                      | )          | 0.26                                              |       |
| Forfeited, expired, exchanged or canceled |       | 387                                |       | (387                      | )          | 1.49                                              |       |
| Balance at December 31, 2003              |       | 1,464                              |       | 5,357                     |       | 1.60                                              |       |
| Reserved for issuance                     |       | 3,500                              |       | —                    |       | —                                            |       |
| Granted                                   |       | (887                               | )          | 887                       |       | 9.26                                              |       |
| Exercised                                 |       | —                             |       | (616                      | )          | 0.79                                              |       |
| Forfeited, expired, exchanged or canceled |       | 116                                |       | (116                      | )          | 2.95                                              |       |
| Balance at December 31, 2004              |       | 4,193                              |       | 5,512                     |       | $                                                 | 2.89       |   |

 

The followingtable summarizes information about the stock options outstanding atDecember 31, 2004 (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                           |       | 388                      |       | $                                         | 0.08       |   | 3.7 |   | 388 |   | $ | 0.08 |   |
| $0.15 -  $0.90                  |       | 1,013                    |       | 0.28                                      |       | 4.7 |   | 1,013 |   | 0.28 |   |
| $1.50                           |       | 2,760                    |       | 1.50                                      |       | 7.4 |   | 1,560 |   | 1.50 |   |
| $1.80 -  $7.35                  |       | 680                      |       | 5.50                                      |       | 7.7 |   | 331 |   | 4.76 |   |
| $7.43 - $9.00                   |       | 152                      |       | 8.04                                      |       | 9.2 |   | 83 |   | 7.68 |   |
| $9.10 -  $18.90                 |       | 519                      |       | 12.58                                     |       | 8.2 |   | 197 |   | 10.50 |   |
|                            |       | 5,512                    |       | $                                         | 2.89       |   | 6.8 |   | 3,572 |   | $ | 1.94 |   |

 

F-18

----

 

In 2002, the Company offered a stock optionexchange program to five employees, under which a total of 752,561 options werecancelled and exchanged for 423,331 new options. The original options weregranted at fair market value of the Company’s common stock on the date ofgrant, with exercise prices ranging from $1.50 to $10.50 per share. The optionssubject to the exchange were granted at the fair market value of the Company’scommon stock ($1.50 per share) on the replacement grant date.  The terms of the exchange program qualifiedas a fixed plan and no compensation expense was recorded.

 

In January 2003 and February 2004,in connection with amendments to their equipment and commercial bank loans (seenote 4), the Company issued warrants to purchase 13,333 shares and 14,666shares, respectively, of Series B preferred stock at an exercise price of$4.50 per share. The warrants are exercisable through the later of five yearsfrom the date of grant or three years after closing of an initial publicoffering by the Company. The January 2003 and February 2004 warrantswere recorded at their fair values of $12,000 and $40,000, respectively, usingthe following assumptions

 
| ** **                       | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Value of underlying common stock |       | $        | 4.50       |     | $          | 4.50 |   |
| Risk free rate                   |       | 3. 9     | %          | 4.9      | %          |
| Expected term                    |       | 10 yrs   |       | 10 yrs   |       |
| Dividend yield                   |       | 0        | %          | 0        | %          |
| Volatility                       |       | 100      | %          | 100      | %          |
|                                  |            |          |            |          |            |  |  |

 

All outstanding warrants to purchase Series Bredeemable convertible preferred stock were automatically converted intowarrants to purchase common stock as a result of the conversion of preferredstock in conjunction with the Company’s initial public offering in August 2004(see Note 2).

 

F-19

----

 

**(9)****                                 Commitmentsand Contingencies**

 

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

 

The Company leases its office facilities andcertain office equipment under various non-cancelable operating leaseagreements with various expiration dates through 2011. Future minimum paymentsfor the next five years and thereafter as of December 31, 2004, underthese leases, are as follows:

 

| 2005       |   | $         | 1,265,000 |   |
|------------|--------|-----------|-----------|--------|
| 2006       |   | 1,030,000 |      |
| 2007       |   | 867,000   |      |
| 2008       |   | 816,000   |      |
| 2009       |   | 761,000   |      |
| Thereafter |   | 766,000   |      |

 

Rent expense was $1.0 million,$1.2 million and $1.4 in 2002, 2003 and 2004, respectively.

 

The Company leases a portion of its officefacilities from a development group, of which the Company’s chief executiveofficer is a 50% member and the Company’s Vice President of North AmericanSales is a 25% member. During 2002, 2003 and 2004, the Company paid $563,000,$562,000 and $605,000, respectively, to the development group under theseleases.

 

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

 

The Company has agreements with third partiesto provide 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 as ofDecember 31, 2004 under these arrangements were $621,000 for 2005 and$235,000 for 2006.

 

***(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 includecertain provisions for indemnifying customers against liabilities if it’sproducts or services infringe a third-party’s intellectual property rights. Todate, the Company 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.

 

F-20

----

 

The Company has entered into service levelagreements with a small number of its customers warranting certain levels ofuptime reliability and permitting those customers to receive credits orterminate their agreements in the event that the Company fails to meet thoselevels. To date, the Company has not provided credits, or cancelled anyagreements related to these service level agreements.

 

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

 

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

 

From time to time, the Company is involved inlegal proceedings arising in the ordinary course of business. The Companybelieves that the resolution of these matters will not have a material effecton the Company’s consolidated financial position, results of operations or liquidity.

 

**(10)****                          IncomeTaxes**

 

The domestic and foreign components of income(loss) before provision for income taxes consists of the following (inthousands):

 
| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| United States |       | $                                | 10         |   | $ | (1,213 | ) | $ | 6,614 |   |
| Foreign       |       | (2,759                           | )          | (2,368 | ) | (3,065 | ) |
|          |       | $                                | (2,749     | ) | $ | (3,581 | ) | $ | 3,549 |   |

 

 

The components of the income tax provisionare as follows (in thousands):

 
| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|-----------------------------|------------|
| ** ** | ** ** | **2003**                    | ** ** | **2004** | ** ** |
| Current:   |       |                        |       |   |   |
| Federal    |       | $                           | —     |   | $ | — |   |
| Foreign    |       | —                      |       | — |   |
| State      |       | 233                         |       | 6 |   |
|       |       | 233                         |       | 6 |   |
| Deferred:  |       |                        |       |   |   |
| Federal    |       | 306                         |       | 94 |   |
| Foreign    |       | —                      |       | — |   |
| State      |       | —                      |       | — |   |
|       |       | $                           | 539        |   | $ | 100 |   |

 

The provision for income taxes for the yearsended December 31, 2004 includes of a valuation allowance against foreign taxespaid and minimum state tax payments.  

 

F-21

----

 

The 2003 provision for income taxes includes the effect of a temporarysuspension from using operating loss carryforwards in California, state minimumtaxes, and a valuation allowance against foreign tax credits not previouslyreserved. There was no income tax expense or benefit for the year endedDecember 31, 2002.

 

The reconciliation of income tax attributableto operations computed at the U.S. Federal statutory income tax rate of 34% toincome tax expense is as follows:

 
| ** **                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                 | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| Statutory Federal tax rate                                                 |       | (34                              | )%         | (34 | )% | 34 | % |
| State income taxes, net of federal benefit                                 |       | (3                               | )          | 7 |   | — |   |
| Net operating loss carryforward                                            |       | —                           |       | — |   | (41 | ) |
| Net operating losses and temporary  differences, no tax benefit recognized |       | 31                               |       | 30 |   | — |   |
| Tax credits                                                                |       | —                           |       | 8 |   | 3 |   |
| Foreign tax rate differential                                              |       | 4                                |       | 3 |   | 3 |   |
| Nondeductible meals & entertainment  expense                           |       | 1                                |       | 1 |   | 3 |   |
| Other                                                                      |       | 1                                |       | — |   | 1 |   |
|                                                                       |       | —                           | %          | 15 | % | 3 | % |

 

Deferred tax components are as follows (inthousands):

 
| ** **                       | ** ** | **At December 31,** | ** ** |
|----------------------------------|------------|--------------------------|------------|
| ** **                       | ** ** | **2003**                 | ** ** | **2004** | ** ** |
| Deferred tax assets:             |       |                     |       |   |   |
| Net operating loss carryforwards |       | $                        | 14,293     |   | $ | 14,154 |   |
| Deferred revenue                 |       | 2,292                    |       | 2,450 |   |
| Tax credits                      |       | 734                      |       | 1,079 |   |
| Other                            |       | 553                      |       | 1,042 |   |
| Total deferred tax assets        |       | 17,872                   |       | 18,725 |   |
| Valuation allowance              |       | (17,440                  | )          | (17,386 | ) |
| Net deferred tax assets          |       | 432                      |       | 1,339 |   |
| Deferred tax liabilities:        |       |                     |       |   |   |
| Fixed assets and intangibles     |       | (151                     | )          | (589 | ) |
| Other                            |       | (281                     | )          | (750 | ) |
| Total deferred tax liabilities   |       | (432                     | )          | (1,339 | ) |
| Net deferred tax assets          |       | $                        | —     |   | $ | — |   |

 

In conjunction with filing its 2003 incometax return in September 2004, the Company elected to change its method of taxaccounting for prepaid, term license agreements in accordance with theprovisions of IRS Revenue Procedure 2004-34. The election allows the deferral of income over the term of theagreements, subject to certain limitations. The tax accounting change has no effect on the Company’s overall currentor deferred income tax assets or liabilities, but it did increase net operatingloss carryforwards and decrease deductible timing differences by $8.4million.  The effect of the change in taxaccounting is included in the above table.

 

F-22

----

 

The ultimaterealization of deferred tax assets is dependent upon the existence of, orgeneration of, taxable income in the periods when those temporary differencesand net operating loss carryforwards are deductible. Management considers thescheduled reversal of deferred tax liabilities, taxes paid in carryback years,projected future taxable income, available tax planning strategies, and otherfactors in making this assessment.  Basedon available evidence, management does not believe it is more likely than notthat any or all of the deferred tax assets will be realized.  Accordingly, the Company has established avaluation allowance equal to the net deferred tax assets. The valuationallowance increased by $1.8 million, and $2.5 million during 2002 and2003, respectively, and decreased by $54,000 in 2004.

 

The Company will provide United States incometaxes on the earnings of foreign subsidiaries unless the subsidiaries’ earningsare considered to be permanently invested outside the United States. To theextent that the foreign earnings previously treated as permanently reinvestedare repatriated, the related United States tax liability may be reduced by anyforeign income taxes paid on those earnings. At December 31, 2003 and2004, there were no accumulated earnings in foreign subsidiaries.

 

At December 31, 2004, the Company haddomestic Federal and state net operating loss carryforwards of approximately$24 million and $23 million, respectively. Federal net operating loss carryforwards expire between 2020 and 2023,and state net operating losses expire between 2007 and 2013. In addition, theCompany has federal research and development credits and foreign tax creditsavailable to reduce future domestic income taxes. The research and developmentcredits will expire at various dates through 2023. The foreign tax credits willexpire at various dates through 2009. Under the Tax Reform Act of 1986, asamended, the amounts of and benefits from net operating loss carryforwards andresearch and development credits may be impaired or limited in certaincircumstances. Events which cause limitations in the amount of net operatinglosses that the Company may utilize in any one year include, but are notlimited to, a cumulative ownership change of more than 50%, as defined, over athree year period.  The Company believes nosuch ownership change has occurred. The Company also has approximately$17 million of foreign net operating loss carryforwards that are notsubject to expiration.

 

The accumulated benefits associated with theexercise of stock options have provided a deferred benefit of approximately$1.6 million, which has been fully offset by a valuation allowance. Thedeferred tax benefit associated with the employee stock options will becredited to additional paid-in capital if and when realized.

 

F-23

----

 

**(11)****                          FairValue of Financial Instruments**

 

The fair value of non-derivative financialinstruments has been determined by using available market information andappropriate market valuation methodologies. The values provided are representative of fair values as of December 31,2003 and 2004, and do not reflect subsequent changes in interest, tax orcurrency exchange rates, or other variables that may affect the determinationof fair value.  The following methods andassumptions were used to estimate fair values.

 

*Cash equivalents*:  The carrying amounts of these itemsapproximated fair value due to their short maturities.

 

*Accounts and term receivables - current*:  The carrying amount of accounts receivableapproximates fair value due to the expected collection of these items within 90days.

 

*Term receivables – noncurrent*:  Fair value for term receivables due beyondone year from December 31, 2003 and 2004, has been estimated by discounting thecarrying amount by an appropriate rate of interest for the period of time theitems are expected to be outstanding.

 

*Debt*:  The carrying amount of these itemsapproximates fair value as interest rates on a majority of these items arevariable.

 
| ** **                         | ** ** | **2003**             | ** ** | **2004**        | ** ** |
|------------------------------------|------------|----------------------|------------|-----------------|------------|
| **In thousands**                   | ** ** | **Carrying   Value** | ** ** | **Fair  Value** | ** ** | **Carrying   Value** | ** ** | **Fair   Value** | ** ** |
| Cash and cash equivalents          |       | $                    | 8,360      |            | $          | 8,360 |   | $ | 18,944 |   | $ | 18,944 |   |
| Accounts receivable                |       | 10,415               |       | 10,415          |       | 16,939 |   | 16,939 |   |
| Term receivables – current    |       | 4,926                |       | 4,926           |       | 10,090 |   | 10,090 |   |
| Term receivables – noncurrent |       | 2,278                |       | 2,114           |       | 5,756 |   | 5,136 |   |
| Debt                               |       | 1,874                |       | 1,874           |       | — |   | — |   |
|                                    |            |                      |            |                 |            |  |  |  |  |  |  |  |  |

 

**(12)****                          EmployeeBenefit Plans**

 

The Company has a voluntary definedcontribution retirement plan qualifying under Section 401(k) of theInternal Revenue Code of 1986. The plan covers substantially all full-timeemployees. Under the terms of the plan, participants may contribute up to thelower of 12% of their salary or the statutorily prescribed limit to the plan.Employees are eligible after 90 days of service. At its discretion, theCompany may make matching contributions. The Company made matchingcontributions during 2002, 2003 and 2004 of $298,000, $327,000, and $542,000respectively. The Company also has retirement benefit plans elated to itsforeign subsidiaries. Amounts expensed under these plans were $59,000, $97,000and $165,000 during 2002, 2003 and 2004, respectively.

 

The Company has a medical, dental and visionbenefit plan and a short-term disability program covering full-time employeesof the Company and their dependents. The plan is a partially self-funded planunder which 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 contributions to the plan were$834,000, $964,000 and $877,000 during 2002, 2003 and 2004, respectively.  During 2004 the plan maintained individualand aggregate stop loss insurance policies on the medical portion of the planof $90,000 and $1.8 million (based on actual plan participants, adjustedmonthly), respectively, to mitigate losses.

 

F-24

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In July 2004 the Company adopted the 2004Employee Stock Purchase Plan (“Plan”) which became effective in conjunctionwith the initial public offering of common stock.  The Plan is administered by the compensationcommittee of the board of directors and is intended to qualify as an employeestock purchase plan within the meaning of Section 423 of the Internal RevenueCode.  Under the terms of the plan,substantially all employees are eligible to purchase shares of RightNow commonstock through periodic after-tax payroll deductions at a purchase priceestablished by the administrator. Payroll deductions are limited to 15% of the employee’s regularcompensation for each purchase period. Purchase periods are consecutive six-month periods ending on the lastday in June and December each year.   Thepurchase price for the initial purchase period was the lesser of the initialpublic offering price or 85% of the fair market value of RightNow common stockon December 31, 2004.  Under the Plan,approximately 97,000 shares of common stock were purchased in the initialpurchase period ended December 31, 2004.

 

# **(13)  Quarterly Results (Unaudited)**

#  

Quarterly results of operations are as follows (in thousands, exceptper share amounts):

 
| ** **                   | ** ** | **Year Ended December 31, 2003** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **First   Quarter**              | ** ** | **Second   Quarter** | ** ** | **Third   Quarter** | ** ** | **Fourth   Quarter** | ** ** |
| ** **                   | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating statement data:    |       |                             |       |   |   |   |   |   |   |
| Total revenue                |       | $                                | 7,807      |   | $ | 8,244 |   | $ | 9,220 |   | $ | 10,608 |   |
| Gross profit                 |       | 5,846                            |       | 6,142 |   | 6,911 |   | 7,977 |   |
| Net loss                     |       | (881                             | )          | (864 | ) | (1,010 | ) | (1,365 | ) |
|                         |       |                             |       |   |   |   |   |   |   |
| Net income (loss) per share: |       |                             |       |   |   |   |   |   |   |
| Basic                        |       | $                                | (0.06      | ) | $ | (0.06 | ) | $ | (0.07 | ) | $ | (0.09 | ) |
| Diluted                      |       | (0.06                            | )          | (0.06 | ) | (0.07 | ) | (0.09 | ) |
|                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **Year Ended December 31, 2004** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **First   Quarter**              | ** ** | **Second   Quarter** | ** ** | **Third   Quarter** | ** ** | **Fourth   Quarter** | ** ** |
| ** **                | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating statement data: |       |                             |       |   |   |   |   |   |   |
| Total revenue             |       | $                                | 12,857     |   | $ | 14,762 |   | $ | 16,426 |   | $ | 17,719 |   |
| Gross profit              |       | 9,968                            |       | 11,553 |   | 12,718 |   | 13,578 |   |
| Net income                |       | 80                               |       | 634 |   | 1,440 |   | 1,295 |   |
|                      |       |                             |       |   |   |   |   |   |   |
| Net income per share:     |       |                             |       |   |   |   |   |   |   |
| Basic                     |       | $                                | 0.01       |   | $ | 0.04 |   | $ | 0.06 |   | $ | 0.04 |   |
| Diluted                   |       | 0.00                             |       | 0.02 |   | 0.05 |   | 0.04 |   |
|                           |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-25

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**Exhibit Index**

 
| **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.                                                                          |
| 10.13†        |       | 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.                                                                                                                                    |
| 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). 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). 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. |

 

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* Incorporated by reference to the exhibit of the same number from theCompany’s registration statement of Form S-1 (File No. 333-115331) initiallyfiled with the Securities and Exchange Commission on May 10, 2004, as amended.

**  Incorporated by reference to Exhibit 4.2 tothe Registrant’s Registration Statement on Form S-8 (File No. 333-118515) filedwith the Securities and Exchange Commission on August 24, 2004.

†  Denotes management contract or compensatoryplan or arrangement.

 

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