**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                                 ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**FORTHE FISCAL YEAR ENDED DECEMBER 31, 2005**

**OR**

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

**FOR THE TRANSITION PERIODFROM             TO             **

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**COMMISSIONFILE NUMBER 000-31321**

**RIGHTNOW TECHNOLOGIES,INC.**

(Exact name of registrantas specified in its charter)

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

 

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

(Address of principalexecutive offices) (Zip code)

**(406) 522-4200**

(Registrant’s telephonenumber, including area code)

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

**NONE**

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

**COMMONSTOCK, PAR VALUE $0.001**

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

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

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

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

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

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

 

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

The aggregate market value of common stock held bynon-affiliates of the registrant as of June 30, 2005, the last businessday of the registrant’s most recently completed second fiscal quarter, wasapproximately $146,274,710, based on the closing sales price of the registrant’scommon stock on that date as reported by the Nasdaq National Market. For thepurposes of the foregoing calculation only, all of the registrant’s directors,executive officers and persons known to the registrant to hold ten percent orgreater of the registrant’s outstanding common stock have been excluded in thatsuch persons may be deemed to be affiliates. This determination of affiliatestatus is not a determination for other purposes.

The number of shares outstanding of the registrant’scommon stock as of February 28, 2006 was 31,955,075.

**DOCUMENTS INCORPORATED BY REFERENCE:**

Information required by Items 10 through 14 of Part IIIof this Form 10-K, to the extent not set forth herein, isincorporated herein by reference to portions of the registrant’s definitiveproxy statement for the registrant’s 2006 Annual Meeting of Stockholders, whichwill be filed with the Securities and Exchange Commission not later than 120days after the end of the fiscal year ended December 31, 2005. Except withrespect to the information specifically incorporated by reference in this Form 10-K,the registrant’s definitive proxy statement is not deemed to be filed as a partof this Form 10-K.

 

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**RightNow Technologies, Inc.**

**Annual Report on Form 10-K**

For The Fiscal Year Ended December 31,2005

Table of Contents

| PART I   |   |                                                                                                                     |   |   |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item  1.      |   | Business                                                                                                                 |   | 4      |
| Item  1A.     |   | Risk  Factors                                                                                                            |   | 12     |
| Item 1B.      |   | Unresolved Staff  Comments                                                                                               |   | 25     |
| Item  2.      |   | Properties                                                                                                               |   | 25     |
| Item  3.      |   | Legal  Proceedings                                                                                                       |   | 25     |
| Item 4.       |   | Submission of  Matters to a Vote of Security Holders                                                                     |   | 25     |
| PART II  |   |                                                                                                                     |   |   |
| Item 5.       |   | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |   | 26     |
| Item 6.       |   | Selected  Financial Data                                                                                                 |   | 28     |
| Item 7.       |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                              |   | 29     |
| Item 7A.      |   | Quantitative  and Qualitative Disclosures about Market Risk                                                              |   | 45     |
| Item 8.       |   | Financial  Statements and Supplementary Data                                                                             |   | 45     |
| Item 9.       |   | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                    |   | 45     |
| Item 9A.      |   | Controls and  Procedures                                                                                                 |   | 45     |
| Item 9B.      |   | Other Information                                                                                                        |   | 47     |
| PART III |   |                                                                                                                     |   |   |
| Item 10.      |   | Directors and  Executive Officers of the Registrant                                                                      |   | 48     |
| Item 11.      |   | Executive  Compensation                                                                                                  |   | 48     |
| Item 12.      |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                         |   | 48     |
| Item 13.      |   | Certain  Relationships and Related Transactions                                                                          |   | 48     |
| Item 14.      |   | Principal  Accountant Fees and Services                                                                                  |   | 48     |
| PART IV  |   |                                                                                                                     |   |   |
| Item 15.      |   | Exhibits and  Financial Statement Schedules                                                                              |   | 49     |
|          |   | Signatures                                                                                                               |   | 51     |

 

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**CAUTIONARY STATEMENT**

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

*All statementsincluded or incorporated by reference in this report, other than statements orcharacterizations of historical fact, are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Theseforward-looking statements are based on our current expectations, estimates andprojections about our industry, management’s beliefs, and certain assumptionsmade by us, all of which are subject to change. Forward-looking statements canoften be identified by words such as “anticipates,” “expects,” “intends,” “plans,”“predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,”“could,” “potential,” “continue,” “ongoing,” similar expressions, andvariations or negatives of these words, and include, but are not limited to,statements regarding projected results of operations, market acceptance andperformance of our products, our ability to retain and hire key executives,sales and technical personnel and other employees in the numbers, with thecapabilities, and at the compensation levels needed to implement our businessand product plans, the competitive nature of and anticipated growth in ourmarkets, our accounting estimates, assumptions and judgments, the impact of taxaccounting elections, and management’s future strategic plans. Theseforward-looking statements are not guarantees of future results and are subjectto risks, uncertainties and assumptions that are difficult to predict and thatcould cause our actual results to differ materially and adversely from thoseexpressed in any forward-looking statement. The risks and uncertaintiesreferred to above include, but are not limited to, risks associated with ourbusiness model; our ability to develop or acquire, introduce, market and gainmarket acceptance for new products and enhancements to existing products in acost-effective and timely manner; the gain or loss of key customers;competitive pressures and other similar factors such as the availability andpricing 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; fluctuations in our operating results fromthe impact of stock-based compensation expense; interruptions or delays in ourhosting operations; breaches of our security measures; our ability to expand,retain and motivate our employees and manage our growth; the impact ofpotential acquisitions, if any; and various other factors, some of which aredescribed under the section below entitled “Risk Factors”, in Item 1A of thisreport. These forward-looking statements speak only as of the date of thisReport. We undertake no obligation to revise or update publicly anyforward-looking statement for any reason, except as otherwise required by law.*

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**Part I**

**Item 1.**                        Business

**OVERVIEW**

RightNow Technologies provides industry-leadingon-demand customer relationship management (CRM) software. Offered either on a hosted basis (deployed in ourfacilities and accessed on-demand by our clients), or on a non-hosted basis(deployed in our clients’ facilities), our integrated suite of CRM solutions,including customer service software,marketing automation software and sales force automation software,help our clients deliver exceptional customer service designed to set themapart from their competitors. Oursolutions reduce the complexity of traditional enterprise CRM,delivering a faster route to business value through lower total cost ofownership and a shorter time to deployment. Our value-added services, includingbusiness process optimization and lifetime product tune-ups, improve ourcustomers’ efficiency, increase user adoption and enable a maximum return onCRM investments. A critical element to our offering is the reliability andscalability of our data centers, which in the year ended December 31,2005, serviced 744 million customer interactions directly through our CRMsolutions, as compared to 502 million interactions in 2004. RightNow’s morethan 1,400 clients worldwide include British Airways, British Telecom, CiscoSystems, Continental Tire North America, John Deere, Nikon and the SocialSecurity Administration.

In August 2005, RightNow released RightNow CRM7.5. Unlike other CRM solutions, which provide functionality through separatecomponents that may not be integrated, RightNow CRM’s three components—RightNowMarketingTM, RightNow SalesTM and RightNow ServiceTM—are engineered with a commondatabase, common business rules management, and a common workflow engine.By automating such a broad range of processes and eliminating the boundariesbetween customer-facing departments, we believe RightNow CRM provides criticaland tangible business advantages: marketing leads can be automatically routedto salespeople, data from service interactions can be used to improve marketingcampaign targeting, and salespeople can avoid being surprised by open serviceincidents and/or active marketing promotions. RightNow CRM 7.5 supports a widerange of communication channels: phone, email, web, chat, automated voice, andshort message service (SMS).

In June 2005, RightNow acquired the technologyand certain employees of voice automation provider, Convergent Voice, makingRightNow the only CRM solutions provider offering packaged voice applications. Usingour patented technology, all or part of the knowledgebase information can bemade available to customers through the voice interface, freeing agent time. Rapidlydeployed and easily modified, RightNow Voice reduces costs by automating asignificant percentage of calls, and provides an additional means to deliverconsistent answers across all service channels. Our voice solution includes aportfolio of voice-enabled CRM applications that include: Voice Interface toKnowledge Base, Voice Interface to Incident Management, Voice Interface toLocator, Status Applications (Order, Rebate, Repair), Password Reset, Surveyand One Number Routing.

RightNow was incorporatedin Montana in September 1995 and reincorporated in Delaware in August 2000.Our principal executive offices are located at 40 Enterprise Boulevard,Bozeman, Montana 59718-9300, and our telephone number is (406) 522-4200.We have regional field offices in Chicago, Illinois, Dallas, Texas, San Mateo,California, Princeton, New Jersey, and Rochester, New York, and a liaison officein Tokyo, Japan. We also have subsidiary offices in London, England, Munich,Germany, and Sydney, Australia. Our internet address is **http://www.rightnow.com**.Our annual reports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, amendments to those reports and otherSecurities and Exchange Commission, or SEC, filings are available free ofcharge through our website as soon as reasonably practicable after such reportsare electronically filed with, or furnished to, the SEC. Our common stocktrades on the Nasdaq National Market under the symbol RNOW. The inclusion ofour 

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internetaddress in the report does not include or incorporate by reference into thisreport any information contained on, or accessible through, our website.

**PRODUCTS AND SERVICES**

Our solutions are basedupon a single application platform designed to be easy to implement, use andmaintain, and to support multiple customer interaction points in businessoperations. Our solutions integrate with traditional enterprise and/or backoffice applications, and are available in 19 languages. RightNow Service,RightNow Marketing, and RightNow Sales each have custom analytics and reportingcapabilities.

**RightNow ServiceTM**

First released in 1997,RightNow Service is the flagship product suite in our portfolio of CRMsolutions and generates approximately 90% of our revenue. Built upon a singleknowledgebase, the RightNow Service suite provides a multi-language,multi-channel customer service solution that captures customer interactionsfrom both traditional and online channels. Our knowledgebase automaticallylearns from these customer interactions to deliver relevant content, therebyimproving service efficiency and increasing customer satisfaction.

**Features of RightNow Service**

*CompleteMulti-Channel Solution—**blends traditional and online channelsso customer service agents can manage inquiries from customers through email,web form, live chat or phone.*

*Streamlined,Single Desktop Application—**consolidates* andeliminates redundant and disparate applications.

*ComputerTelephony Integration (CTI)—**integrates***the customer service agent desktop application andtelephony infrastructure; delivers automatic customer look-ups and screen pops.

*CustomAnalytics and Reporting—**standard,***pre-built reports and a custom reporting engine captureservice quality statistics, including average response time, first contactresolution rates, service level achievement rates and customer service agenteffectiveness. Reports can be automatically scheduled to run on specifictimetables, to head off service and product issues with exception-basednotification.

*OfferManagement—**provides*automatic delivery ofrelevant sales offers or promotions, based on each customer’s profile andpurchase history.

*RightNowVoice—**joins* voice processing technologieswith access to the RightNow knowledge base, so customers can quickly findanswers to their questions.

*OnlineSelf-Service—**provides*24 x 7 access to acentralized, fully searchable knowledge base delivered over the Internet.

*IntelligentKnowledge Base—*self-learning,customer driven and wholly integrated, the knowledge base dynamically capturesand presents relevant information to both customer service agents and customers.RightNow 7.5 includes SmartGuideTM which provides decision tree functionalityfor end-users and customer service agents to find answers in the knowledgebase.

*Incident Queuing and Routing—*with both business and escalation rules, controls howemail is routed based on customer service agent skill sets, customer history,agent availability, or other attributes.

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**RightNow MarketingTM**

RightNow Marketing suite is designed to deliver thefunctionality needed to manage marketing campaigns from idea to execution. Itprovides flexibility to manage multi-channel, multi-stage campaigns—withoutrelying on outside resources to execute every initiative. With RightNowMarketing, customer service organizations can preempt service inquiries byproactively targeting customers with relevant, personalized communications.

RightNow Marketingautomates standard campaign activities, optimizing resources and dramaticallyreducing the marketing team’s effort.

**Features of RightNow Marketing**

*Campaign Executionand Management—*provides theability to create and manage multi-channel, multi-stage marketing campaignsfrom one central location.

*CampaignTracking—**provides*end-to-end tracking frommarketing execution to sales generation.

*CustomAnalytics and Reporting—**real-time,*pre-builtreports provided out-of-the-box to measure success of marketing campaigns. Reportscan be customized to meet unique business requirements.

*EmailMarketing—**provides* the ability to createpersonalized, targeted email marketing messages.

*EventTriggering—**automatically*sends personal emailsin response to any contact activity.

*Webforms—**enable* profileadministration, lead generation and customer surveys.

**RightNow SalesTM**

RightNow Sales improvesthe accuracy of sales forecasting and reporting with real-time visibility intosales pipeline data. RightNow Sales simplifies the sales process so that salesorganizations can easily manage accounts, track leads, organize contacts andcreate selling opportunities. Traditional sales processes such as contactmanagement, forecasting, quote generation and opportunity status are fullyintegrated, saving sales representatives’ time and shortening sales cycles.

**Features of RightNow Sales**

*Opportunityand Pipeline Management—**allows* the user tosee the entire sales pipeline and individual opportunity details all on onescreen.

*Contact,Account and Task Management—**users*can enter,update and track all relevant contact and deal information all in one place.

*LeadManagement—**allows* users to optimize lead flowacross marketing and sales organizations.

*Forecasting—**opportunity* levelforecasting is flexible to accommodate a unique approach in aggregating andanalyzing the sales pipeline.

*CustomAnalytics and Reporting—**provides*analysis ofthe total forecast overview with details by region, sales representative andopportunity, and provides for the creation of custom reports to support uniquebusiness processes.

*MicrosoftOutlook Integration—**synchronizes*emails, tasks andcontacts between Microsoft Outlook and RightNow Sales.

*Automatic Contract, Quoteand Proposal Generation—**provides*accurate,customer-ready contracts, quotes and proposals.

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**Professional Services**

Our Professional Servicesorganization combines project management with technical and business-focusedconsulting services to our clients. Using proven methods and customer-centricbest practices, our Professional Services group is experienced in aligningRightNow products across many industries, drawing on in-depth knowledge andpractical expertise gained from thousands of implementations. Professionalservices helps customers determine strategic business objectives, alignbusiness processes and define success metrics as well as helping with rapidsystem configuration and deployment while adjusting business solutions toensure full user adoption. We also provide tune-up services to our clientswhich consist of an audit of their solution against our library of bestpractices.

**Sales and Marketing**

RightNow products and services are sold predominantlythrough our direct sales organization and, to a smaller extent, throughindirect channels. The sales organization consists of new business groups,calling on potential clients and qualifying client leads, and installed basegroups, focusing on managing existing client relationships, and furtherpenetrating those relationships. We have regional field operations offices inMontana, California, Illinois, Texas, New Jersey, England, Australia, andGermany, and a sales liaison office in Japan. See Note 1(c) of the Notesto Consolidated Financial Statements for more information regarding ourgeographic areas.

*Pilot Program*

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

Indirect channels consist mainly of relationships withresellers of our solutions. On December 31, 2005, we had relationshipswith over 30 indirect channel distributors. Domestically, our indirect channelconsists primarily of relationships with outsourcers and referral partners whorefer leads to us. Outsourcers represent a developing indirect channel for oursolutions that we intend to expand. We currently have relationships withseveral outsourcers, including Convergys, ICT and KPN/SNT. We have dedicatedstaff in our sales organization calling on and servicing these partners. In thefuture, we intend to establish additional strategic relationships with verticalmarket distribution partners, telephony infrastructure partners, fulfillmentpartners and independent software vendor/original equipment manufacturingpartners in adjacent markets. In international markets where we do not have adirect selling presence, we rely on system integrators and resellers to sellour solutions. This strategy is primarily employed in Europe, New Zealand andAsia. We intend to continue to broaden our distribution to 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 future productand service direction, manages generation of client leads, and directs publicand industry analyst relations. To expand our client base, we have alsodeveloped and will continue to increase innovative marketing initiatives, suchas our client roundtables, where existing clients host forums with potentialclients and exchange ideas about best practices.

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**Clients**

As of December 31, 2005, we had more than 1,400active clients in various industries, including technology, financial andinsurance, consumer products, telecommunications and travel and hospitality, aswell as government agencies and educational institutions. For the year endedDecember 31, 2005, approximately 40% of our revenue was generated fromentities with over $1 billion in annual revenue, 45% of our revenue wasgenerated from entities with less than $1 billion in annual revenue and 15% ofour revenue was generated from government/educational institutions. No singleclient accounted for more than 10% of our revenue in the year endedDecember 31, 2005.

**Product Development and Technology**

Our product development efforts are focused onimproving and enhancing our existing solutions and service offerings as well asdeveloping new proprietary technology. Our product development philosophyincorporates our long-term strategic view of our market and incorporatescustomer feedback to improve and enhance our products. We currently aredeveloping products and solutions to broaden our offerings within the CRMmarket. We have an applied research group that focuses on knowledgebase,artificial intelligence and novel applications of current research for use withinour solutions. Although we allow our clients to run multiple versions of oursoftware, our development efforts are focused on the current and futurereleases of our products. Our research and development expenses totaledapproximately $5.9 million in 2003, $7.8 million in 2004, and$10.4 million in 2005.

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

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

*Integrationwith Other Enterprise Applications.**  *Our hosted and non-hosted clientsare able to integrate 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), RPC (remoteprocedure call), and API (application program interface); application leveltriggers that raise real-time events to trigger integration actions with othersystems; user interface “custom tabs” that allow the integration of otherapplications into our solution; and “pass through” authentication that allowsour solution to inherit user credentials from other applications to identifyand enforce access to our clients’ web sites. In addition, pre-packagedconnectors are available for integration with other third-party applications.

*UserInterface.**  *Althoughour user interface is based upon an industry standard Internet web browser, wehave developed techniques to deliver a look and feel similar to the thickclient user interfaces utilized in traditional client/server products. Thisincludes support for functionality not normally associated with web browserinterfaces such as graphical drag and drop, cascading menus, and efficientpop-up dialogs. We also have addressed the typical performance concernsassociated with browser-based applications by reducing visible page turnsand their associated delays. Consequently, our clients benefit from the ease of

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administration andmaintenance of a web application while still enjoying the user experience of alocally-installed desktop application.

*Software Architecture.**  *Our solution has been developedusing a logical three-tier Internet architecture consisting of presentation,application logic and data management layers. Because of the tiered separation,our solution is designed to be highly scalable, allowing expansion at thepresentation and application logic tiers and at the data management tier. Wehave experience deploying our solution in highly available, highly scalable,load-balanced web server and clustered database server configurations. Wesupport most commonly available operating systems (Linux, Microsoft WindowsServer) and databases (Oracle, Microsoft SQL Server, MySQL).

**Intellectual Property**

Our success depends to a significant degree upon thedevelopment and protection of our software and other proprietary technologyrights. We believe we have a strong base of intellectual property. As of February 28,2006, our base of intellectual property included six issued U.S. patents, oneissued United Kingdom patent, and eleven pending U.S. patents, five U.S.trademark registrations, and ten foreign trademark registrations. The majorityof our patent applications concern our knowledgebase technology, includingprocesses relating to the relative usefulness ranking and the order of displayof retrieved information in the knowledgebase; the ability of the knowledgebaseto suggest related information to a user accessing the knowledgebase; and theability of the knowledgebase to produce a relational map of help informationitems based on the historical usage patterns of customers accessing theknowledgebase. We also have one issued U.S. patent and two U.S. patentapplications that relate to our voice technology.

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

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

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

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

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

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

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

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

Our five registered trademarks in the United Statesare RIGHTNOW, RIGHT NOW, RIGHTNOW TECHNOLOGIES (stylized), SMARTASSISTANT ANDLOCATOR. We use our “RightNow” mark as a descriptor of all of our products.These marks continue indefinitely subject to continuous use and payment ofregistration fees at the statutorily required intervals. We also use thefollowing common law marks “RightNow Metrics,” “RightNow Outbound,” “RightNowMarketing”, RightNow Sales”, “RightNow Service”, “Top-Line”, “Proactive”, “Top-LineCustomer Service”, “Proactive Customer Service”, “SmartSense”, “SmartConversion”,“ProServices”, “RightNow Live”, “RightPractices”, “RightStart”, “Talk RightNow”,“RightFit”, “Multi-View Technology”, and “SmartAttribute Technology”. Othertrademarks, trade names or service marks appearing in this report are theproperty of their respective holders.

We also incorporate anumber of third party software products into our software pursuant to relevantlicenses. Some of the software is proprietary and some is open source. We usethird party software for, among other things, spell checking certain foreignlanguages, improving graphics in our analytics module, language parsing, andlocating and indexing documents on websites, and secure data transfer. Thesefunctions are peripheral in nature, we are not substantially dependent uponthese third party software licenses and we believe the licensed software isgenerally replaceable, by either licensing or purchasing similar software fromanother vendor or building the software function ourselves.

**Competition**

The CRM software market consists of three major marketsegments: (1) customer service, (2) sales force automation and (3) marketingautomation. Within this segmentation, vendors are offering solutions througheither on-demand or traditional on-premise delivery methods. We compete in allsegments of the CRM software market, and believe that we are the leader inon-demand customer service within that market.

The market for CRM solutions is highly competitive andfragmented, and is subject to rapidly changing technology, shifting clientrequirements, frequent introductions of new products and services, andincreased marketing activities of other industry participants. Competition hasincreased with our release of RightNow 7.5. We expect the intensity ofcompetition to increase in the future as existing competitors continue todevelop their capabilities, as new companies enter our market and as we furtherexpand into the CRM market.

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

We expect to compete with these and additionalcompanies as we further expand into the CRM market, and as more companiesexpand into the customer service segment. In addition, our solutions 

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compete with CRM systemsthat are developed and maintained internally by businesses, as well as CRMproducts or services that are developed, or bundled with other products orservices, and installed on a client’s premises by software vendors. We alsoface competition from outsourced contact center providers who bundle solutionsand agent labor in their service offerings. To the extent our competitors havean existing relationship with a potential client, that client may be unwillingto switch vendors due to the time and financial commitments already made withour competitors.

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

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

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

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

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

·       Broadproduct functionality to meet complex client process requirements;

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

·       Speedand ease of implementation;

·       Easeof use and associated high rates of utilization;

·       Systemperformance, security, scalability, flexibility and reliability;

·       Easeof integration with existing applications and data;

·       Availabilityand quality of implementation, consulting and education services;

·       Qualityof client care;

·       Competitivesales and marketing capabilities; and

·       Financialstability and reputation of the vendor.

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

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**Employees**

As of December 31,2005, we had 530 full-time employees. Of the total employees, we had 216 insales and marketing, 109 in software development, 97 in professional services,43 in technical support, 46 in finance and administration and 19 in hostingoperations. None of our employees are represented by a labor union. We believethat our relationship with our employees is good.

**Item 1A.**                RiskFactors

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

***We may not be able to sustain or increase ourprofitability in the future.***

We may not be able tosustain or increase our profitability in the future. Prior to 2004, we incurredsignificant operating losses of approximately $4.1 million in 2003,$2.7 million in 2002 and $15.3 million in 2001. As of December 31,2005, we had an accumulated deficit of approximately $33 million. We expect tocontinue to incur significant sales and marketing, research and development andgeneral and administrative expenses as we expand our operations and, as aresult, we will need to generate significant revenue to maintain profitability.Even if we continue to achieve profitability, we may not be able to increaseprofitability on a quarterly or annual basis in the future, which may cause theprice of our stock to decline.

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

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

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

·       changesin the volume and mix of term and perpetual licenses sold in a particularquarter, because perpetual license revenue is recorded into revenue upondelivery whereas term licenses are recorded into revenue ratably over theperiod of license;

·       ourpolicy of expensing sales commissions at the time of invoice, while themajority of our revenue is recognized ratably over future periods;

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

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

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

·       changesin our pricing policies or those of our competitors;

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

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

·       thepurchasing and budgeting cycles of our clients; and

·       generaleconomic, industry and market conditions.

Because the sales cycle for the evaluation andimplementation of our solutions typically ranges from 60 to 180 days, wemay also experience a delay between increasing operating expenses and thegeneration of corresponding revenue, if any. Moreover, because 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 foregoingfactors, and the other risks discussed in this report, you should not rely onquarter-to-quarter comparisons of our results of operations as an indication ofour future performance.

***If our efforts toenhance existing solutions, introduce new solutions or expand the applicationsfor our products and solutions to broader CRM markets do not succeed, ourability to grow our business will be adversely affected.***

Approximately 90% of ourrevenue is derived from RightNow Service, a suite of solutions used to optimizecustomer service operations. If we are unable to successfully develop and sellnew and enhanced versions of RightNow Service, or introduce new products andsolutions for the customer service market, our financial performance willsuffer. Although to date the majority of business has been focused on providingsolutions for customer service operations, we recently introduced RightNow CRM7.5 and voice-enabled CRM applications to expand our solution offerings. Ourefforts to expand beyond the customer service market may not be successfulbecause certain of our competitors have far greater experience and brandrecognition in the broader segments of the CRM market. In addition, our effortsto expand our on-demand software solutions beyond the customer service marketmay divert management resources from our existing operations and require us tocommit significant financial resources to a market where we are unproven, whichmay harm our business, financial condition and results of operations.

***We face intensecompetition, and our failure to compete successfully could make it difficult forus to add and retain clients and could reduce or impede the growth of ourbusiness.***

The market for customer relationship managementsolutions is highly competitive and fragmented, and is subject to rapidlychanging technology, shifting client requirements, frequent introductions ofnew products and services, and increased marketing activities of other industryparticipants. Competition has intensified with our most recent product releases.Increased competition could result in pricing pressure, reduced sales, lowermargins or the failure of our solutions to achieve or maintain broad marketacceptance. If we are unable to compete effectively, it will be difficult forus to add and retain clients, and our business, financial condition and resultsof operations will be seriously harmed.

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We face competitionfrom:

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

·       CRMsystems that are developed and maintained internally by businesses;

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

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

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

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

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

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

***The market for ouron-demand application services is at an early stage of development, and if itdoes not develop or develops more slowly than we expect, our business will beharmed.***

The market foron-demand application services is at an early stage of development, and it isuncertain whether these application services will achieve and sustain highlevels of demand and market acceptance. Our success will depend to asubstantial extent on the willingness of companies to increase their use ofon-demand application services in general and for on-demand customerrelationship management applications in particular. Many companies have investedsubstantial personnel and financial resources to integrate traditionalenterprise software into their businesses, and therefore may be reluctant orunwilling to migrate to on-demand application services. While we have supportedand 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-demandsecurity capabilities and reliability;

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

·       ourability to meet the needs of broader segments of the CRM market or otheron-demand markets;

·       thelevel of customization we offer;

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

·       concernswith purchasing critical CRM solutions from a company with a history ofoperating losses that only recently turned profitable; and

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

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

***Failure toeffectively develop and expand our sales and marketing capabilities could harmour ability to increase our client base and achieve broader market acceptanceof our solutions.***

Increasing our client baseand achieving broader market acceptance of our solutions will depend to asignificant extent on our ability to expand our sales and marketing operations.We plan to continue to expand our direct sales force and engage additionalthird-party channel partners, both domestically and internationally. Thisexpansion will require us to invest significant financial and other resources.Our business will be seriously harmed if our efforts do not generate acorresponding significant increase in revenue. We may not achieve anticipatedrevenue growth from expanding our direct sales force if we are unable to hireand develop talented direct sales personnel, if our new direct sales personnelare unable to achieve desired productivity levels in a reasonable period oftime, or if we are unable to retain our existing direct sales personnel. Wealso may not achieve anticipated revenue growth from our third-party channelpartners if we are unable to attract and retain additional motivated channelpartners, if any existing or future channel partners fail to successfullymarket, resell, implement or support our solutions for their customers, or ifthey represent multiple providers and devote greater resources to market,resell, implement and support competing products and services.

***The majority of oursolutions are sold pursuant to term license agreements, and if our existingclients elect not to renew their licenses or to renew their licenses on termsless favorable to us, our business, financial condition and results ofoperations will be adversely affected.***

The majority of oursolutions are sold pursuant to term license agreements that are subject torenewal every two years or less and our clients have no obligation to renewtheir licenses. Because our clients may elect not to renew, we may not be ableto 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.

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***We have experiencedrapid growth in recent periods. If we fail to manage our growth effectively, wemay be unable to execute our business plan, maintain high levels of service oradequately address competitive challenges.***

We have substantially expanded our overall business,headcount and operations in recent periods. We have increased our total numberof full-time employees to 530 at December 31, 2005 from 403 atDecember 31, 2004. 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 challengethat we expect to face in the course of our expansion is to maintain the highlevel of customer service to which our clients have become accustomed. To date,we have focused on providing personalized account management and customerservice on a frequent basis to ensure our clients are effectively leveragingthe capabilities of our solution. We believe that much of our success to datehas been the result of high client satisfaction, attributable in part to thisfocus on client service. To the extent our client base grows, we will need toexpand our account management, client service and other personnel, and thirdparty channel partners, in order to enable us to continue to maintain highlevels of client service and satisfaction. If we are not able to continue toprovide high levels of client service, our reputation, as well as our business,financial condition and results of operations, could be harmed.

***If there areinterruptions or delays in our hosting services through third-party error, ourown error or the occurrence of unforeseeable events, delivery of our solutionscould become impaired, which could harm our relationships with clients andsubject us to liability.***

As of December 31, 2005, approximately 87% of ourclients were using our hosting services for deployment of our softwareapplications. We provide our hosting services for our non-voice applicationsthrough computer hardware that we own and that is currently located inthird-party web hosting co-location facilities maintained and operated inCalifornia and New Jersey. We provide hosting services for our voiceapplications through a third-party hosting facility based in Georgia, usinghardware owned and operated by the third party. We do not maintain long-termsupply contracts with any of our hosting providers, and providers do notguarantee that our clients’ access to hosted solutions will be uninterrupted,error-free or secure. Our operations depend on our providers’ ability toprotect their and our systems in their facilities against damage orinterruption from natural disasters, power or telecommunications failures,criminal acts and similar events. Our back-up computer hardware and systemslocated in our Montana headquarters (non-voice) and in New York (voice) havenot been tested under actual disaster conditions and may not have sufficientcapacity to recover all data and services in the event of an outage occurringsimultaneously at all hosting facilities. In the event that our hostingfacility arrangements were terminated, or there was a lapse of service oraccidental or willful damage to such facilities, we could experience lengthyinterruptions in our hosting service as well as delays and/or additionalexpense in arranging new facilities and services. Any or all of these eventscould cause our clients to lose access to their important data. In addition,the failure by our third-party hosting facilities to meet our capacityrequirements could result in interruptions in our service or impede our abilityto scale our operations.

Design and mechanicalerrors, spikes in usage volume and failure to follow system protocols andprocedures could cause our systems to fail, resulting in interruptions in ourclients’ service to their customers. Any interruptions or delays in our hostingservices, whether as a result of third-party error, our own error, naturaldisasters or security breaches, whether accidental or willful, could harm ourrelationships with clients and our reputation. This in turn could reduce ourrevenue, subject us to liability, cause us to issue credits or pay penalties orcause clients to fail to renew their licenses, any of which could 

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adverselyaffect our business, financial condition and results of operations. In theevent of damage or interruption, our insurance policies may not adequatelycompensate us for any losses that we may incur.

***If the security ofour clients’ confidential information contained in our systems or stored by useof our software is breached or otherwise subjected to unauthorized access, ourhosting service or our software may be perceived as not being secure andclients may curtail or stop using our hosting service and our solutions.***

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

***We have significantinternational sales and are subject to risks associated with operating ininternational markets.***

International salescomprised 26%, 27%, and 24% of our revenue for the years ended December 31,2005, 2004, and 2003, respectively. We intend to continue to pursue and expandour international business activities. 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 andelsewhere abroad, terrorist attacks and security concerns in general;

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

·       fluctuationsin currency exchange rates;

·       longercollection periods and difficulties in collecting receivables from foreignentities;

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

·       reducedprotection for our intellectual property in some countries;

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

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

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

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affectour future international sales and, consequently, affect our business,financial condition and results of operations.

***If we fail torespond effectively to rapidly changing technology and evolving industrystandards, particularly in the on-demand CRM industry, our solutions may becomeless competitive or obsolete.***

The CRM industry ischaracterized by rapid technological advances, changes in client requirements,frequent new product and service introductions and enhancements, changes inprotocols and evolving industry standards. Our hosted business model and theon-demand CRM market are relatively new and may evolve even more rapidly thanthe rest of the CRM market. Competing products and services based on newtechnologies or new industry standards may perform better 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 database technologiesand to integrate with our clients’ systems as they change and evolve.Furthermore, uncertainties about the timing and nature of new network platformsor technologies, or modifications to existing platforms or technologies, couldincrease 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.

***Our failure toattract and retain qualified or key personnel may prevent us from effectivelydeveloping, marketing, selling, integrating and supporting our products.***

Our success and futuregrowth depends to a significant degree upon the skills, experience, performanceand continued service of our senior management, engineering, sales, marketing,service, support and other key personnel. Specifically, we believe that ourfuture success is highly dependent on Greg Gianforte, our founder, Chairman andChief Executive Officer. In addition, we do not have employment agreements withany of 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 “key person” life insurancepolicies on any of our key employees except Mr. Gianforte. This lifeinsurance policy would not be sufficient to compensate us for the loss of hisservices. Our future success also depends in large part upon our ability toattract, train, integrate, motivate and retain highly skilled employees,particularly sales, marketing and professional services personnel, softwareengineers, product trainers, and senior personnel. Competition for thesepersonnel is intense, especially for engineers with high levels of expertise indesigning and developing software and for senior sales executives.

***If our solutionsfail to perform properly or if they contain technical defects, our reputationwill be harmed, our market share would decline and we could be subject toproduct liability claims.***

Our software products may contain undetected errors ordefects that may result in product failures, slow response times, or otherwisecause our products to fail to perform in accordance with client expectations.Because our clients use our products for important aspects of their business,any errors or defects in, or other performance problems with, our productscould hurt our reputation and may damage our clients’ businesses. If thatoccurs, we could lose future sales, or our existing clients could elect to notrenew or to delay or withhold payment to us, which could result in an increasein our provision for doubtful accounts and an increase in collection cycles foraccounts receivable. Clients also may make warranty claims against us, whichcould result in the expense and risk of litigation. Product performanceproblems 

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could result in loss ofmarket share, failure to achieve market acceptance and the diversion ofdevelopment resources. If one or more of our products fails to perform orcontains a technical defect, a client may assert a claim against us forsubstantial damages, whether or not we are responsible for the product failureor defect. We do not currently maintain any warranty reserves.

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

***If we are unable toprotect our intellectual property rights, our competitive position could beharmed or we could be required to incur significant expenses to enforce ourrights.***

Our success depends to asignificant degree upon the protection of our software and other proprietarytechnology rights. We rely on trade secret, copyright and trademark laws,patents and confidentiality agreements with employees and third parties, all ofwhich offer only limited protection. The steps we have taken to protect ourintellectual property may not prevent misappropriation of our proprietaryrights or the reverse engineering of our solutions. We may not be able toobtain any further patents or trademarks, and our pending applications may notresult in the issuance of patents or trademarks. Any of our issued patents maynot be broad enough to protect our proprietary rights or could be successfullychallenged by one or more third parties, which could result in our loss of theright to prevent others from exploiting the inventions claimed in thosepatents. Furthermore, legal standards relating to the validity, enforceabilityand scope of protection of intellectual property rights in other countries areuncertain and may afford little or no effective protection of our proprietarytechnology. Consequently, we may be unable to prevent our proprietarytechnology from being exploited abroad, which could diminish internationalsales or require costly efforts to protect our technology. Policing theunauthorized use of our products, trademarks and other proprietary rights isexpensive, difficult and, in some cases, impossible. Litigation may benecessary in the future to enforce or defend our intellectual property rights,to protect our trade secrets or to determine the validity and scope of theproprietary rights of others. Such litigation could result in substantial costsand diversion of management resources, either of which could harm our business.Accordingly, despite our efforts, we may not be able to prevent third partiesfrom infringing upon or misappropriating our intellectual property.

***Our productdevelopment efforts may be constrained by the intellectual property of others,and we may become subject to claims of intellectual property infringement,which could be costly and time-consuming.***

The software and Internet industries are characterizedby the existence of a large number of patents, trademarks and copyrights, andby frequent litigation based upon allegations of infringement or otherviolations of intellectual property rights. As we seek to extend our CRMproduct and service offerings, we may be constrained by the intellectualproperty rights of others. We have in the past been named as a defendant in alawsuit alleging intellectual property infringement, and we may again in thefuture have to defend against intellectual property lawsuits. We may notprevail in any 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 our license agreements typically require us to indemnify our clientsfrom any claim or finding of intellectual property infringement, any suchlitigation or successful infringement claims could 

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adversely affect ourbusiness, financial condition and results of operations. Any efforts tore-engineer our products, obtain licenses from third parties on favorable termsor license a substitute technology may not be successful and, in any case, maysubstantially increase our costs and harm our business, financial condition andresults of operations. Further, our software products contain open sourcesoftware components that are licensed to us under various public domainlicenses. While we believe we have complied with our obligations under thevarious applicable licenses for open source software that we use, there islittle or no legal precedent governing the interpretation of many of the termsof certain of these licenses and therefore the potential impact of such termson our business is somewhat unknown. Use of open source standards also may makeus more vulnerable to competition because the public availability of opensource software could make it easier for new market entrants and existingcompetitors to introduce similar competing products quickly and cheaply.

***Future acquisitionscould disrupt our business and harm our financial condition and results ofoperations.***

In order to expandour addressable market, we may decide to acquire additional businesses,products and technologies. In May 2005, we acquired the intellectualproperty and other assets of Convergent Voice, Inc., our first acquisitionsince becoming a public company. Acquisitions could require significant capital infusions and couldinvolve many risks, including, but not limited to, the following:

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

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

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

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

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

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

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

We cannot assure you that we will be able to identifyor consummate any future acquisitions on favorable terms, or at all. If we dopursue any future acquisitions, it is possible that we may not realize theanticipated benefits from the acquisitions or that the financial markets orinvestors will negatively view the acquisitions. Even if we successfullycomplete an acquisition, it could adversely affect our business, financialcondition and results of operations.

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***Changes in theaccounting treatment of stock options will adversely affect our results ofoperations.***

The Financial AccountingStandards Board recently issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment* (“SFAS 123R”).SFAS 123R requires that the compensation cost relating to share-based paymenttransactions be recognized in financial statements based on the fair value ofthe equity or liability instruments issued, and is effective for annual periodsbeginning after June 15, 2005. SFAS 123R replaces SFAS No. 123,Accounting for *Stock-Based Compensation*,and supersedes Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB25”). SFAS 123R requires us to value our employee stock option grants, transactionsunder our Employee Stock Purchase Plan, and other possible equity-basedtransactions, pursuant to a fair value formula, and then amortize that valueagainst our reported earnings over the vesting period in effect for thosetransactions. We currently account for stock-based awards to employees inaccordance with APB 25, and have adopted the disclosure-only alternativeof SFAS 123. This change in accounting treatment, beginning January 1,2006, will materially and adversely affect our reported results of operationsas the stock-based compensation expense will be charged directly against ourreported earnings. We do not expect this accounting change to materially affectour liquidity because equity-based compensation is a non-cash expense.

***Volatility in theprice of our common stock may adversely affect our ability to predict the fairvalue of our stock awards and the resulting stock-based compensation expense.***

The fair value of stockawards under SFAS 123R is estimated using several factors, including theunderlying price of the stock option, which is not known until the date ofgrant, and Company assumptions of expected stock price volatility, the expectedterm of the award, and other factors. These factors can cause significantvariations in the estimated fair value of the awards, and therefore causesignificant fluctuations in our operating results. For example, the estimatedfair value of stock options granted in our third quarter ended September 30,2005 was $6.93 per share. However, due to an increase in the underlying priceof our common stock, the estimated fair value of a like award granted in ourfourth quarter ended December 31, 2005 would have increased 67% to $11.57per share. Volatility in the market value of our stock could cause us to incursignificantly higher or lower stock-based compensation expense in futureperiods. The trading price of our common stock depends in part on our abilityto accurately forecast our results, and if we were to miss our forecasts, wemay lose credibility with investors and research analysts, which in turn couldcause the price of our common stock to decline.

***The requiredadoption of SFAS 123R makes stock options a less attractive form of employeecompensation, and our use of alternative forms of employee compensation inresponse to SFAS 123R could adversely affect our ability to attract and retainpersonnel.***

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

***We may not be ableto secure additional financing on favorable terms, or at all, to meet ourfuture capital needs.***

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

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

**Risks Related to Our Industry**

***The success of ourproducts and our hosted business depends on the continued growth and acceptanceof the Internet as a business and communications tool, and the relatedexpansion of the Internet infrastructure.***

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

Federal, state or foreign government bodies oragencies have in the past adopted, and may in the future adopt, laws orregulations affecting data privacy, the solicitation, collection, processing oruse of personal or consumer information, the use of the Internet as acommercial medium and the use of 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 hasexperienced, and is expected to continue to experience, significant user andtraffic growth, which has, at times, caused user frustration with slow accessand download times. If Internet activity grows faster than Internetinfrastructure or if the Internet infrastructure is otherwise unable to supportthe demands placed on it, or if hosting capacity becomes scarce, our businessgrowth may be adversely affected.

***Privacy concernsand laws or other domestic or foreign regulations may adversely affect ourbusiness or reduce sales of our solutions.***

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

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burdens imposed by, suchlaws and regulations that are applicable to the businesses of our clients maylimit 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 to allowour clients to use our solutions most effectively. Even the perception of privacyconcerns, whether or not valid, may inhibit market acceptance of our products.

The European Union has also adopted a directive thatrequires member states to impose restrictions on the collection and use ofpersonal data that are far more stringent, and impose more significant burdenson subject businesses, than current privacy standards in the United States. Allof these domestic and international legislative and regulatory initiatives mayadversely affect our clients’ ability to collect and/or use demographic andpersonal information from their customers, which could reduce demand for oursolutions.

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

***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 Controlling theAssault of Non-Solicited Pornography and Marketing Act of 2003, or CAN-SPAMAct, became effective. The CAN-SPAM Act regulates the transmission and contentof commercial 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 have been enacted in many of the international jurisdictions in whichwe do business, including Europe, Australia, and Canada. In addition, Internetservice providers and licensors of software products have introduced a varietyof systems and products to filter out certain types of commercial e-mail,without any common protocol to determine whether the recipient desired toreceive the e-mail being blocked. As a result, it is difficult for us todetermine in advance whether or not e-mails generated by our clients using oursolutions will be permitted by spam filters to reach the intended recipients.

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

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***General economicconditions could adversely affect our clients’ ability or willingness topurchase our products, which could materially and adversely affect our resultsof operations.***

Our clients consist oflarge and small companies in nearly all industry sectors and geographies.Potential new clients or existing clients could defer purchases of our productsbecause of unfavorable macroeconomic conditions, such as rising interest rates,fluctuations in currency exchange rates, industry or national economic downturns,industry purchasing patterns, and other factors.  Our ability to grow revenues may be adverselyaffected by unfavorable economic conditions.

**RisksRelated to Ownership of Our Common Stock**

***The significantcontrol over stockholder voting matters and our office leases that may beexercised by our founder and Chief Executive Officer will limit your ability toinfluence corporate actions and may require us to find alternative office spaceto lease or buy in the future.***

At December 31, 2005, Greg Gianforte, our founderand Chief Executive Officer, and his spouse, Susan Gianforte, togetherbeneficially owned approximately 36% of our currently outstanding common stockand, together with our other officers and directors, beneficially ownedapproximately 52% of our currently outstanding common stock. In addition, noneof the shares of common stock held by Mr. Gianforte and Mrs. Gianforteare subject to vesting restrictions. As a result, Mr. Gianforte and Mrs. Gianforte,acting alone or together with some of our other officers and directors, will beable to control all matters requiring stockholder approval, including theelection of directors, management changes and approval of significant corporatetransactions. This concentration of ownership may have the effect of delaying,preventing or deterring a change in control of RightNow, could deprive ourstockholders of an opportunity to receive a premium for their common stock aspart of a sale of RightNow and might reduce the market price of our commonstock.

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

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

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

·       authorizingthe board to issue preferred stock;

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

·       limitingthe persons who may call special meetings of stockholders;

·       prohibitingcertain transactions under certain circumstances with interested stockholders;

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

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·       prohibitingstockholder action by written consent.

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

**Item 1B.**               UnresolvedStaff Comments

None.

**Item 2.**                        Properties

Our corporateheadquarters, including our principal administrative, marketing, technicalsupport and research and development facilities, are located in Bozeman,Montana, where we lease approximately 30,000 square feet with a term thatexpires in March 2011, and approximately 22,000 square feet under twoleases with terms that expire in March and June 2010. In October 2005,we entered into an agreement to lease an additional 29,000 square feet inBozeman beginning later in 2006 when construction is complete. The lease termis expected to be seven years. We also currently occupy a number of domesticand international sales and service offices in California, Illinois, NewJersey, New York, Texas, Australia, Germany, Japan and the United Kingdom,where we lease an aggregate of approximately 47,000 square feet under multipleleases, which have terms that expire between May 2006 and March 2011.We believe that our current facilities are suitable and adequate to meet ourcurrent needs, and that suitable additional or substitute space will beavailable as needed to accommodate expansion of our operations. SeeNote 11(a) to the Consolidated Financial Statements and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—ContractualObligations and Commitments” for information regarding our lease obligations.

**Item 3.**                        LegalProceedings

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

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

No matters were submitted to a vote of securityholders during the fourth quarter of 2005.

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**Part II**

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

**Market Information for Common Stock**

Ourcommon stock is traded on the Nasdaq National Market under the symbol RNOW. Thetable below reflects the quarterly high and low per share sales prices of ourcommon stock for the period August 5, 2004, the first day of publictrading of our common stock, through December 31, 2005, as reported by theNasdaq National Market. These prices represent prices among dealers, do notinclude retail markups, markdowns or commissions, and may not represent actualtransactions. Prior to August 5, 2004, there was no established publictrading market for our common stock.

| **Quarter Ended**             | ** ** | ** ** | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** |
|------------------------------------|------------|------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Year ended  December 31, 2004 |       |       |       |            |       |            |       |            |       |
| Common stock price per  share:     |       |       |       |            |       |            |       |            |       |
| High                               |       | —     |       | —          |       | $               | 12.98      |            | $          | 20.99           |       |
| Low                                |       | —     |       | —          |       | 6.67            |       | 12.15           |       |
| Year ended  December 31, 2005 |       |       |       |            |       |            |       |            |       |
| Common stock price per  share:     |       |       |       |            |       |            |       |            |       |
| High                               |       | $          | 17.70      |            | $          | 12.44           |       | $               | 15.00      |            | $          | 20.06 |   |
| Low                                |       | 10.99      |       | 7.45            |       | 10.78           |       | 12.62           |       |
|                                    |            |            |            |                 |            |                 |            |                 |            |                 |            |  |  |  |  |

 

**Holders**

On February 28, 2006,there were approximately 113 holders of record of our common stock.

**Dividends**

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

**UnregisteredSales of Equity Securities**

During the three monthsended December 31, 2005, we issued and sold 29,261shares of our commonstock to one of our former lenders upon their exercise of certain warrants,previously issued in connection with our equipment and commercial bankfinancing arrangements, pursuant to the net exercise provision of such warrants.The sale and issuance of these shares of our common stock were determined to beexempt from registration under the Securities Act of 1933, as amended, inreliance on Section 4(2) of the Securities Act, as a transaction byan issuer not involving a public offering, where the purchaser wassophisticated and represented its intention to acquire the securities forinvestment purposes only and not with a view to or for sale in connection withany distribution thereof, and where the purchaser received or had access toadequate information about us.

**Useof Proceeds from Sales of Registered Securities**

In August 2004, we completed the initial publicoffering of our common stock, par value $0.001 per share. The managingunderwriters in the offering were Morgan Stanley & Co. Incorporated,Thomas Weisel Partners LLC, Adams Harkness and D.A. Davidson & Co. Theshares of common stock sold in the offering were registered under theSecurities Act of 1933, as amended, on a Registration Statement on 

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Form S-1 (Reg.File No. 333-115331) that was declared effective by the Securitiesand Exchange Commission on August 5, 2004.

Our initial public offering commenced on August 5,2004. Under the registration statement, we registered 7,245,000 shares ofcommon stock, including shares subject to the underwriters’ over-allotmentoption, on behalf of RightNow and a selling stockholder, for an aggregateoffering price of $50,715,000 and a per share price to the public of $7.00. Ofthe total shares registered, 6,416,961 shares, including shares sold uponexercise of the underwriters’ over-allotment option, were sold by us for anaggregate offering price of $44,918,727 and a per share price to the public of$7.00, and 321,945 shares, including shares sold upon exercise of theunderwriters’ over-allotment option, were sold by the selling stockholder foran aggregate offering price of $2,253,615 and a per share price to the publicof $7.00. The offering terminated following the sale of the shares describedabove.

The aggregate net proceeds to us from the offering,after deducting $3.3 million in underwriting discounts and commissions and $1.8million in other costs incurred in connection with the offering, were$39,972,000. 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.

In May 2005, we spent$1 million of the offering proceeds for the acquisition of the assets ofConvergent Voice. We currently intend to use the remaining proceeds for generalcorporate purposes as described in the prospectus for the offering. Pendingthese uses, the net proceeds from the offering are invested in short-term,interest-bearing, investment-grade securities.

**Purchasesof Equity Securities by the Issuer or Affiliated Purchasers**

We did not repurchase anyof our common stock in the fourth quarter of 2005.

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**Item 6.        SelectedConsolidated Financial Data**

Thefollowing selected consolidated financial data should be read in conjunctionwith the Consolidated Financial Statements and Notes thereto and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andother financial data included elsewhere in this report. The consolidatedstatement of operations data for the years ended December 31, 2005, 2004and 2003, and the consolidated balance sheet data at December 31, 2005 and2004 are derived from audited consolidated financial statements includedelsewhere in this report. The consolidated statement of operations data for theyears ended December 31, 2002 and 2001, and the consolidated balance sheetdata at December 31, 2003, 2002 and 2001 are derived from audited consolidatedfinancial statements not included in this report. The historical results arenot necessarily indicative of results to be expected in any future period.

| ** **                                       | ** ** | **Year Ended December 31,**                         | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2001**                                                           | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statements of  Operations Data:** |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenue:                                         |       |                                                               |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                    |       | $                                                                  | 18,998     |   | $ | 23,338 |   | $ | 29,300 |   | $ | 49,764 |   | $ | 67,944 |   |
| Professional services                            |       | 2,009                                                              |       | 3,603 |   | 6,579 |   | 12,000 |   | 19,204 |   |
| Total revenue                                    |       | 21,007                                                             |       | 26,941 |   | 35,879 |   | 61,764 |   | 87,148 |   |
| Cost of revenue:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Software, hosting and support                    |       | 4,636                                                              |       | 4,279 |   | 5,263 |   | 6,741 |   | 9,111 |   |
| Professional services                            |       | 1,335                                                              |       | 2,156 |   | 3,740 |   | 7,206 |   | 11,956 |   |
| Total cost of revenue                            |       | 5,971                                                              |       | 6,435 |   | 9,003 |   | 13,947 |   | 21,067 |   |
| Gross profit                                     |       | 15,036                                                             |       | 20,506 |   | 26,876 |   | 47,817 |   | 66,081 |   |
| Operating expenses:                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Sales and marketing                              |       | 22,050                                                             |       | 15,939 |   | 20,809 |   | 31,986 |   | 42,683 |   |
| Research and development                         |       | 4,584                                                              |       | 4,117 |   | 5,915 |   | 7,807 |   | 10,428 |   |
| General and administrative                       |       | 3,973                                                              |       | 2,842 |   | 3,518 |   | 4,621 |   | 6,445 |   |
| Total operating expenses                         |       | 30,607                                                             |       | 22,898 |   | 30,242 |   | 44,414 |   | 59,556 |   |
| Income (loss)  from operations                   |       | (15,571                                                            | )          | (2,392 | ) | (3,366 | ) | 3,403 |   | 6,525 |   |
| Interest and  other income (expense), net        |       | 229                                                                |       | (357 | ) | (215 | ) | 146 |   | 1,646 |   |
| Income (loss)  before income taxes               |       | (15,342                                                            | )          | (2,749 | ) | (3,581 | ) | 3,549 |   | 8,171 |   |
| Provision for  income taxes                      |       | —                                                             |       | — |   | (539 | ) | (100 | ) | (478 | ) |
| Net income (loss)                                |       | (15,342                                                            | )          | (2,749 | ) | (4,120 | ) | 3,449 |   | 7,693 |   |
| Preferred stock  accretion                       |       | —                                                             |       | (33 | ) | (13 | ) | (8 | ) | — |   |
| Net income (loss)  allocated to common stock     |       | $                                                                  | (15,342    | ) | $ | (2,782 | ) | $ | (4,133 | ) | $ | 3,441 |   | $ | 7,693 |   |
| Earnings (loss) per  share(1):                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | $                                                                  | (1.10      | ) | $ | (0.19 | ) | $ | (0.28 | ) | $ | 0.17 |   | $ | 0.25 |   |
| Diluted                                          |       | (1.10                                                              | )          | (0.19 | ) | (0.28 | ) | 0.12 |   | 0.23 |   |
| Shares used in the  computation(1):              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                            |       | 14,006                                                             |       | 14,284 |   | 14,560 |   | 20,738 |   | 30,631 |   |
| Diluted                                          |       | 14,006                                                             |       | 14,284 |   | 14,560 |   | 28,940 |   | 33,695 |   |

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

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| ** **                                 | ** ** | **December 31,**   | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2001**                | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| **Consolidated Balance Sheet  Data:**      |       |                    |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                 |       | $                       | 6,258      |   | $ | 8,038 |   | $ | 8,360 |   | $ | 18,944 |   | $ | 40,874 |   |
| Short-term  investments                    |       | —                  |       | — |   | — |   | 31,188 |   | 23,314 |   |
| Working capital  (deficit)                 |       | (6,553                  | )          | (6,082 | ) | (9,024 | ) | 32,732 |   | 45,156 |   |
| Total assets                               |       | 18,625                  |       | 23,102 |   | 29,386 |   | 88,309 |   | 123,676 |   |
| Deferred revenue                           |       | 18,875                  |       | 24,683 |   | 35,553 |   | 49,125 |   | 67,923 |   |
| Long-term debt,  less current portion      |       | 1,185                   |       | 940 |   | 484 |   | — |   | 117 |   |
| Redeemable  convertible preferred stock    |       | 32,340                  |       | 32,373 |   | 32,398 |   | — |   | — |   |
| Total stockholders’  equity (deficit) |       | (38,683                 | )          | (41,291 | ) | (45,254 | ) | 31,101 |   | 44,655 |   |
|                                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

*The following discussion and analysis of our financialcondition and results of operations should be read in conjunction with “SelectedConsolidated Financial Data” and our financial statements and related notesappearing elsewhere in this report. This discussion contains forward-lookingstatements that involve risks and uncertainties. Our actual results coulddiffer significantly from those projected in the forward-looking statements asa result of certain factors, including those discussed in “Risk Factors,” “Business”and elsewhere in this report. We assume no obligation to update theforward-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 RightNow Service in1997 to address the new customer service needs resulting from increasing use ofthe Internet as a customer service channel. Since then, we have significantlyenhanced product features and functionality to address customer service needsacross multiple communication channels, including web, interactive voice,e-mail, chat, telephone and proactive outbound e-mail communications. We havealso added several products complementary to our RightNow Service solution,including RightNow Marketing and RightNow Sales, which automate aspects ofmarketing campaigns and sales operations. In May 2005, we purchased theassets of Convergent Voice, and added voice-self-service capabilities to ourproduct portfolio. To date, more than 90% of our revenue has been generated bythe RightNow Service suite.

Our client base currently consists of more than 1,400active clients who in the year ended December 31, 2005 served more than740 million customer interactions, or unique sessions hosted by oursolutions. Our solutions, whether sold pursuant to term or perpetual licenses,are available either on a hosted basis, where they are deployed in ourco-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% forthe years ended December 31, 2005 and 2004, and 84% for the year ended December 31,2003.

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

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***Sources of Revenue***

Our revenue is comprised of fees for term andperpetual licenses of our software, fees for hosting and support related to ourlicenses, and fees for professional services. Our term license agreements aregenerally two years in length, but can range from six months to four years, andinclude software and related upgrades, and hosting and support services overthe term of the agreement. The majority of our revenue in each of our lastthree years was derived from two-year term license agreements. We also offermonthly term license agreements that contain a minimum commitment period of atleast 12 months, are paid monthly, and include our software and relatedupgrades, and hosting and support services. Customers may also purchaseperpetual software licenses, which are typically sold with annual maintenancecontracts that provide software upgrades, and hosting and support services.

Hosting and support services provide maintenance andmanagement of our software at a third party facility, technical support for oursoftware products, and unspecified product upgrades on a when and if availablebasis.

Professional services revenue is comprised of revenuefrom consulting, education and development services, and reimbursement ofrelated travel costs. Consulting and education services include implementationand best practices consulting. Development services include customizations andintegrations for a client’s specific business application.

Our software license agreements include capacity-basedfees, which are measured primarily by web pages served and user seats, andcertain fixed fees. A number of our agreements provide for additional fees forusage above established levels, which are billed and recognized into revenuewhen earned.

Professional services, consisting of consulting,education and development services, are sold with initial license agreementsand periodically over the client engagement. The average deployment time forour clients is 60 days. We typically invoice clients for the entire amount atthe beginning of the agreement with payment generally due within 30 days forour term and perpetual license agreements, or due monthly for our monthlyagreements. Our typical education courses are billed on a per person, per classbasis.

Depending on the size andcomplexity of the client project, our consulting or development servicescontracts are either fixed price/fixed scope or, less frequently, billed on atime and materials basis. We have determined that the professional serviceselement of our software arrangements is not essential to the functionality ofthe software. We have also determined that our professional services: a) areavailable from other vendors; b) do not involve a significant degree of risk orunique acceptance criteria; and c) qualify for separate accounting as we havesufficient experience in providing such services.

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

*Costof Revenue.**  *Costof revenue consists primarily of salaries and related expenses (i.e. bonuses,employee benefits and payroll taxes) for our hosting, support and professionalservices organizations, third-party costs and equipment depreciation relatingto our hosting services, third-party costs for interactive voice self-serviceapplications, travel expenses related to providing professional services to ourclients, amortization of acquired intangible assets and allocated overhead. Weallocate most overhead expenses, such as office supplies, computer supplies,utilities, rent, depreciation for furniture and equipment, payroll taxes andemployee benefits, based on headcount. As a result, overhead expenses arereflected in each cost of revenue and operating expense category.

Our hosting costs are affected by the percentage ofclients who license our products on a hosted basis and the number of times ourclients and their customers use our solutions, which we refer to as customerinteractions. As a result of economies of scale in our hosting infrastructureand declines in computer hardware and telecommunications costs, we were able toreduce hosting costs as a percentage of total 

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revenue in 2003, 2004 and2005, despite significant increases in the number of hosted clients and thelevel of customer interactions.

As our client base and solutions usage grows, weintend 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. During2003, 2004 and 2005, 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.

*Salesand Marketing Expenses.**  *Sales and marketing expenses consist primarily ofsalaries and related expenses for employees in sales and marketing, includingcommissions and bonuses, advertising, marketing events, corporatecommunications, product management expenses, travel costs and allocatedoverhead. We expense our sales commissions at the time the related sale isinvoiced to the client and we recognize the majority of our revenue from ouragreements ratably over the terms of the licenses. Accordingly, we generallyexperience a delay between increasing sales and marketing expenses and therecognition of corresponding revenue. We expect significant increases in salesand marketing expenses in absolute dollars as we hire additional sales andmarketing personnel and increase the level of marketing activities.

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

*General and AdministrativeExpenses.*   General and administrative expensesconsist primarily of salary and related expenses for management, finance andaccounting, legal, information systems and human resources personnel,professional fees, other corporate expenses and allocated overhead. 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.

***Critical Accounting Policies and Estimates***

Our financial statements and accompanying notes areprepared in accordance with accounting principles generally accepted in theUnited States. Preparing financial statements requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses. These assumptions are affected bymanagement’s application of accounting policies. Our critical accountingpolicies include: revenue recognition; valuation of receivables and deferredtax assets; and accounting for equity-based compensation.

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Webelieve the following critical accounting policies require us to makesignificant judgments and estimates in the preparation of our consolidatedfinancial statements:

**Revenue Recognition**

We account for our sales arrangements in accordancewith the American Institute of Certified Public Accountants Statement ofPosition (“SOP”) 97-2, *Software Revenue Recognition*,and SOP 98-9, Modification of SOP 97-2, *SoftwareRevenue Recognition With Respect to Certain Transactions*. Theapplication of these SOPs requires judgment, including the identification ofindividual elements in multiple element arrangements, and whether vendorspecific objective evidence (“VSOE”) exists for those elements. Customers mayreceive certain elements upon delivery or over time. For example, under oursales arrangements customers typically receive the software license at thebeginning of the term, and receive hosting and support services continuouslyover the length of the agreement. Under our term arrangements, revenues for thesoftware, hosting and support elements are aggregated and recognized ratablyover the length of the agreement because VSOE of the individual elements doesnot exist. Under a perpetual license arrangement, VSOE of the hosting andsupport elements does exist and therefore the license element is recognizedimmediately upon delivery using the residual method, and the hosting andsupport elements are recognized ratably over the contractual term. Changes tothe elements in our software arrangements, the ability to identify VSOE forthose elements, and the fair value of the respective elements could materiallyaffect the amount of our earned and deferred revenue

Our standard payment termsare net 30, although payment within 90 days is considered normal. We do provideextended payment terms in certain circumstances. In such cases, judgment isrequired in determining whether our fee is fixed and determinable and theappropriate timing of revenue recognition. Changes in business practices forproviding extended payment terms and/or providing concessions following a sale,may effect our assessment of fixed and determinable fees and result in amaterial change to the amount of revenue recorded in a given period.

**Valuation of Receivables**

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

**Income Taxes**

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

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

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**Equity-Based Compensation**

We account for our employee stock-based compensationusing the intrinsic value method in accordance with Accounting Principles BoardOption, or APB, No. 25, *Accounting forStock Issued to Employees*, and we make pro forma disclosureregarding employee stock-based compensation using the fair value method inaccordance with Statement of Financial Accounting Standards, or SFAS, No. 123,*Accounting for Stock-Based Compensation*,and SFAS No. 148, *Accounting forStock-Based Compensation—Transition and Disclosure*. We account forequity instruments issued to non-employees in accordance with the provisions ofSFAS No. 123 and Emerging Issues Task Force, or EITF No. 96-18,*Accounting for Instruments that are Issuedto Other Than Employees for Acquiring, or in Conjunction with Selling Goods orServices*.

In measuring the cost ofequity-based compensation, we make assumptions regarding our stock pricevolatility and the average expected life of our outstanding stock options. Ourassumptions are primarily based on historical information, some of which wasdeveloped when we were a private company. Actual results could differ from ourassumptions.

**RecentlyIssued Accounting Standards**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123(revised 2004) (“SFAS 123R”), *Share-BasedPayment,*which replaces SFAS 123 and supersedes AccountingPrinciples Board Opinion No. 25. Public companies are required to apply123R as of the first annual reporting period that begins after June 15,2005. 123R covers a wide range of share-based compensation, including shareoptions, restricted share plans, performance-based awards, share appreciationrights, and employee share purchase plans. The statement requires therecognition of compensation cost related to share-based payment plans to berecognized in financial statements based on the grant date fair value of theequity or liability instruments issued. We expect adoption of the provisions of123R on January 1, 2006 will materially and adversely affect our reportedresults of operations because the stock-based compensation expense will becharged directly against our reported earnings. We do not expect the accountingchange to materially affect our liquidity because equity-based compensation isa non-cash expense.

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No 153, *Exchanges of Non-monetaryAssets* (“SFAS 153”), an amendment of APB Opinion No. 29. SFAS153 eliminates the exception for non-monetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of non-monetaryassets that do not have commercial substance. SFAS 153 is effective for non-monetaryasset exchanges beginning in our first quarter of 2006. We do not believe theadoption of SFAS 153 will have a material effect on our financial statements.

In May 2005, the FASB issued SFAS No 154, *Accounting for Changes and Error Corrections* (“SFAS 154”),effective for fiscal years beginning after December 15, 2005. Thisstatement replaces APB Opinion No. 20, *Accounting Changes*,and SFAS No. 3, *Reporting AccountingChanges in Interim Financial Statements*, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. SFAS No. 154 applies to all voluntary changes in accountingprinciple and changes required by an accounting pronouncement in the unusualinstance that the pronouncement does not include specific transition guidance. UnderSFAS 154, changes are required to be retrospectively applied to prior financialstatements unless it is impractical to quantify the historical effect of thechange. We do not believe the adoption of SFAS 154 will have a material effecton our financial statements.

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**Results of Operations**

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

| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue:                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                                       | 82         | % |   |   | 81 | % |   |   | 78 | % |   |
| Professional services                     |       |                                       | 18         |   |   |   | 19 |   |   |   | 22 |   |   |
| Total revenue                             |       |                                       | 100        |   |   |   | 100 |   |   |   | 100 |   |   |
| Cost of revenue:                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support             |       |                                       | 15         |   |   |   | 11 |   |   |   | 10 |   |   |
| Professional services                     |       |                                       | 10         |   |   |   | 12 |   |   |   | 14 |   |   |
| Total cost of revenue                     |       |                                       | 25         |   |   |   | 23 |   |   |   | 24 |   |   |
| Gross profit                              |       |                                       | 75         |   |   |   | 77 |   |   |   | 76 |   |   |
| Operating expenses:                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                       |       |                                       | 58         |   |   |   | 51 |   |   |   | 49 |   |   |
| Research and development                  |       |                                       | 16         |   |   |   | 13 |   |   |   | 12 |   |   |
| General and administrative                |       |                                       | 10         |   |   |   | 7 |   |   |   | 7 |   |   |
| Total operating expenses                  |       |                                       | 84         |   |   |   | 71 |   |   |   | 68 |   |   |
| Income (loss)  from operations            |       |                                       | (9         | ) |   |   | 6 |   |   |   | 8 |   |   |
| Interest and  other income (expense), net |       |                                       | (1         | ) |   |   | — |   |   |   | 2 |   |   |
| Income (loss)  before income taxes        |       |                                       | (10        | ) |   |   | 6 |   |   |   | 10 |   |   |
| Provision for  income taxes               |       |                                       | (1         | ) |   |   | — |   |   |   | (1 | ) |   |
| Net income (loss)                         |       |                                       | (11        | )% |   |   | 6 | % |   |   | 9 | % |   |

 

Thefollowing table sets forth our on-demand customer interactions, percentage ofclients hosting, and our revenue by type and geography expressed as apercentage of total revenue for each of the periods indicated.

| ** **                                     | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Customer  interactions (in millions)           |       |                                       | 249        |   |   |   | 502 |   |   |   | 744 |   |   |
| Percentage of  clients hosting                 |       |                                       | 84         | % |   |   | 87 | % |   |   | 87 | % |   |
| Revenue by type:                               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Recurring (term licenses, hosting and support) |       |                                       | 67         | % |   |   | 59 | % |   |   | 53 | % |   |
| Perpetual licenses                             |       |                                       | 15         |   |   |   | 22 |   |   |   | 25 |   |   |
| Professional services                          |       |                                       | 18         |   |   |   | 19 |   |   |   | 22 |   |   |
| Revenue by geography in:                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| United States                                  |       |                                       | 76         | % |   |   | 73 | % |   |   | 74 | % |   |
| Europe                                         |       |                                       | 18         |   |   |   | 21 |   |   |   | 18 |   |   |
| Asia Pacific                                   |       |                                       | 6          |   |   |   | 6 |   |   |   | 8 |   |   |

 

***Overview of 2005 and Outlook***

Revenue for 2005 increased 41% over 2004 primarilyfrom higher revenue per client and growth in the number of our clients. Revenueper client improved due to the release of broader product and serviceofferings, and client purchases of additional capacity. During 2005 wecontinued to invest in our operations by adding sales personnel to focus on newclient acquisition, professional services personnel to support our solutionofferings, and software developers to broaden and enhance our solutionofferings. Overall 

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perpetual software licenserevenue grew at a faster rate than total revenue in 2005, resulting in anincrease in operating income to 8% of total revenue in 2005 from 6% ofoperating income in 2004.

We signed 312 new customers in 2005 to bring our totalactive client base to more than 1,400. Our annual customer retention rate in2005 exceeded 90%. Sales to clients with annual revenues greater than $1billion, and government/educational clients, increased to 55% of our totalsales in 2005, up from 53% in 2004

For the year ended December 31, 2005, wegenerated $14.9 million of cash from operations compared to $6.7 million ofcash in 2004, and increased our deferred revenue to $67.9 million at December 31,2005 from $49.1 million one year earlier.

As of December 31,2005 we had an accumulated deficit of $33.3 million. This deficit and ourhistorical operating losses were primarily the result of costs incurred in thedevelopment, sales and marketing of our products and for general andadministrative purposes. We intend to continue to invest in our sales andmarketing activities, product development and 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 Ended December 31, 2003, 2004 and 2005***

***Revenue***

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** |
| ** **                     | ** ** | **(Amounts in thousands)**       | ** ** |
| Software, hosting  and support |       | $                                          | 29,300     |   | $ | 49,764 |   |   | 70 | % |   | $ | 67,944 |   |   | 37 | % |   |
| Professional  services         |       | 6,579                                      |       | 12,000 |   |   | 82 |   |   | 19,204 |   |   | 60 |   |   |
| Total revenue                  |       | $                                          | 35,879     |   | $ | 61,764 |   |   | 72 | % |   | $ | 87,148 |   |   | 41 | % |   |

 

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

Software, hosting and support revenue for 2005 was$67.9 million, an increase of $18.2 million or 37% over software,hosting and support revenue of $49.8 million for 2004. Recurring software,hosting and support revenue grew 27% in 2005 to $46.1 million from $36.2million in 2004, due to a 16% increase in average revenue per client, combinedwith an 18% increase in average number of clients. Average revenue per clientincreased from the release of new products, capacity upgrades, and contractrenewals. New products introduced in recent years represented approximately 10%of total sales in 2005, and included sales of RightNow Marketing, RightNowSales, and RightNow Voice. Client interactions, a measure of the volume ofunique sessions hosted by our software, grew approximately 50% during 2005.  Growth in average number of clients occurredbecause of an emphasis within our sales organization on new client acquisition,combined with our 90% plus client retention rate.

Perpetual software license revenue increased 62% in2005 to $21.9 million, up from $13.5 million in 2004. 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 perpetuallicense revenue increased in 2005 because of the growing strategic importanceof our products in client organizations, growing acceptance of on-demandapplications in the large business market segment, and longer client planninghorizons.

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

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

Revenue from European customers grew to $15.5 millionin 2005 from $12.8 million in 2004, and revenue from Asia Pacific clients grewto $7.2 million in 2005 from $3.8 million in 2004. Total revenue outside theUnited States was 26% and 27% of total revenue in 2005 and 2004, respectively. Theincrease in revenue outside the United States occurred primarily from expansionof our international sales and marketing activities.

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

Software, hosting and support revenue for 2004 was$49.8 million, an increase of $20.5 million or 70% over software, hosting andsupport revenue of $29.3 million for 2003. The increase resulted from a 46%increase in revenue per client, and a 16% increase in average number of clients.Recurring revenue per client increased 30% in 2004 over 2003 due to contractupgrades and renewals, and the release of new products in late 2003. Clientinteractions, a measure of the volume of unique customer sessions hosted by oursoftware, grew more than 100% in 2004 over 2003. The increase in average numberof clients occurred primarily from emphasis within our sales organization onnew client acquisitions. During 2004, term licenses accounted for 59% of ourtotal revenue, as compared to 67% of our total revenue in 2003. Perpetualsoftware license revenue was 22% of total revenue in 2004 as compared to 15% oftotal revenue in 2003.

Professional services revenue for 2004 was$12 million, an increase of $5.4 million or 82%, over professionalservice revenue of $6.6 million for 2003. Professional services revenueincreased to 19% of total revenue in 2004 from 18% in 2003. Average professionalservices revenue per client increased 57% in 2004 over 2003, while averagenumber of clients increased 16%. Average revenue per client increased in 2004largely as a result of our focus on expanding service offerings provided inconjunction with the broader product offerings. We increased our professionalservices staff to 71 employees at December 31, 2004 from 41 employees at December 31,2003.

Revenue in Europe and AsiaPacific for the year ended December 31, 2004 was $16.6 million or 27%of total revenue, compared to $8.7 million or 24% of total revenue in2003. The increase in revenue outside of the United States resulted fromexpansion of our international sales and marketing activities.

***Cost of Revenue***

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** |
| ** **                     | ** ** | **(Amounts in thousands)**       | ** ** |
| Software, hosting  and support |       | $                                          | 5,263      |   | $ | 6,741 |   |   | 28 | % |   | $ | 9,111 |   |   | 35 | % |   |
| Professional  services         |       | 3,740                                      |       | 7,206 |   |   | 93 |   |   | 11,956 |   |   | 66 |   |   |
| Total cost of revenue          |       | $                                          | 9,003      |   | $ | 13,947 |   |   | 55 | % |   | $ | 21,067 |   |   | 51 | % |   |

 

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

Cost of software, hosting and support revenueincreased 35% to $9.1 million in 2005 from $6.7 million in 2004. Cost growthduring 2005 resulted from staff additions which increased salaries and relatedexpenses (i.e. bonuses, employee benefits and payroll taxes) by $1.5 million,hosting capacity additions which increased depreciation expense and third-partyhosting services by $597,000, and increased amortization expenses of $124,000related to the purchase of Convergent Voice in May 2005. The averageemployee count in our hosting and support operations was 58 in 2005 as comparedto 43 in 2004. In 2005 we appointed a Vice President of Customer Delivery whosecosts are included in this category. As a percent of the associated revenue,cost of software, hosting and support declined slightly in 2005 despitesignificant growth in the volume of customer interactions during the year,primarily due to economies of scale achieved in providing hosting and supportservices over a broader base of customers. We intend to open a European hostingcenter and continue to increase our overall hosting capacity in 2006.

Professional services cost of revenue increased 66% in2005 to $12 million from $7.2 million in 2004, primarily due to employee growth.The average number of employees in our professional services organization was87 during 2005 as compared to 51 in 2004, which increased salaries and relatedexpenses by $4.3 million, and incremental travel and living expenses increased$216,000. Professional services cost of revenue increased slightly to 62% ofthe related revenue in 2005 from 60% in 2004. New hire training requirementsand customer scheduling of implementation can cause the cost of professionalservices revenue to fluctuate as a percent of revenue. The professionalservices group often develops tools to assist with new customers installations,and as the tools become commonly used, they are typically transferred to theproduct group and incorporated into our software. These tools might consist ofconnectors to other general-use applications, and customization tools. Beginningin 2006, we expect to transfer several such tools to the product group,resulting in a reclassification of the associated revenue from professionalservices to software, hosting and support. This reclassification is expected tolower the margin on professional services activities. Consequently, we expectthe cost of professional service to range between 65% and 75% of the relatedrevenue in the future.

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

The cost of software, hosting and support increased28% to $6.7 million in 2004 from $5.3 million in 2003. The growth in costs wasdriven by staff additions which increased salaries and related employee costsby $473,000, higher third-party hosting service costs of $316,000, increasedequipment depreciation and amortization expenses of $261,000, and incrementalthird-party costs of security monitoring and interactive voice self-service of$245,000. The average employee count in our hosting and support operations was43 in 2004 as compared to 34 in 2003. As a percent of the associated revenue,cost of 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 $7.2million in 2004 from $3.7 million in 2003 mostly due to growth in professionalservices staff. We had, on average, 51 employees in our professional servicesgroup in 2004 as compared to 32 employees in 2003. The employee growth addedapproximately $2.6 million in salaries and related expenses and approximately$715,000 in additional travel and living expenses. Professional services costsincreased to 60% of the associated revenue in 2004 from 57% in 2003, due tointernal requirements for training and education and customer schedulingrequirements. We plan to further expand our professional services organizationand these costs may continue to vary as a percentage of professional servicesrevenue in the future.

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***Operating Expenses***

| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| ** **                  | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** |
| ** **                  | ** ** | **(Amounts in thousands)**       | ** ** |
| Sales and  marketing        |       | $                                          | 20,809     |   | $ | 31,986 |   |   | 54 | % |   | $ | 42,683 |   |   | 33 | % |   |
| Research and  development   |       | 5,915                                      |       | 7,807 |   |   | 32 |   |   | 10,428 |   |   | 34 |   |   |
| General and  administrative |       | 3,518                                      |       | 4,621 |   |   | 31 |   |   | 6,445 |   |   | 39 |   |   |
| Total operating expenses    |       | $                                          | 30,242     |   | $ | 44,414 |   |   | 47 | % |   | $ | 59,556 |   |   | 34 | % |   |

 

***Sales and Marketing Expenses***

Sales and marketing expenses of $42.7 million in 2005were 33%, or $10.7 million, greater than expenses of $32 million in 2004. Theaverage employee count in our sales and marketing organizations grew to 195 in2005 from 147 in 2004, causing salaries and related expenses to increase $6.3million. Higher sales volume in 2005 increased sales incentive costs by $2million in 2005 over 2004. In addition, we incurred $1.4 million of incrementalconsulting services in 2005, primarily related to public relations programs andinitiatives.

Sales and marketingexpenses of $32 million in 2004 were 54%, or $11.2 million, greater thanexpenses of $20.8 million in 2003 mostly due to employee additions. We had, onaverage, 147 employees in our sales and marketing organization in 2004 comparedto 113 in 2003. The employee growth added approximately $5.3 million insalaries and related expenses, and $782,000 in travel and living expenses. Inaddition, sales incentive costs increased by $4.6 million in 2004 over 2003 dueto higher sales volume.

***Research and Development Expenses***

Research and development expenses increased $2.6million, or 34%, to $10.4 million in 2005 from $7.8 million in 2004. Substantiallyall of the expense increase resulted from growth in employee salaries andrelated expenses in 2005.  The averagenumber of employees in our research and development organization was 100 in2005 as compared to 79 in 2004.

Research and developmentexpenses in 2004 were $7.8 million, an increase of $1.9 million or 32% morethan costs of $5.9 million in 2003. We added 22 employees to our research anddevelopment staff during 2004, which increased salaries and related expenses byapproximately $1.5 million.  We alsoincurred higher third-party development costs for language translations andtechnical manuals. Average employee count in our research and development groupwas 79 in 2004 as compared to 64 in 2003.

*General andAdministrative Expenses*

General and administrative expenses increased $1.8million, or 39%, to $6.4 million in 2005 from $4.6 million in 2004 due toemployee additions and incremental third-party costs for audit and compliance. Averageemployee count in our general and administrative organization in 2005 was 41compared to 31 in 2004, which caused salaries and related expenses to increase$938,000 during 2005. Audit and related compliance costs increased $540,000 in2005, mostly due to 2005 being the initial year of our required internalcontrols reporting under the Sarbanes-Oxley Act of 2002.

General and administrativeexpenses increased $1.1 million, or 31%, to $4.6 million in 2004 from $3.5million in 2003. Employee additions to our general and administrative groupadded $609,000 of salaries and related expenses during the year, while legaland other third-party fees added $450,000. The increase in legal and otherprofessional services was due to fees to obtain technology and patent licensesand the compliance requirements of being a public company. Average employeecount in our general and administrative group was 31 in 2004 as compared to 24in 2003.

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*Stock-BasedCompensation Expense*

Beginning January 1,2006, we have adopted the provisions of SFAS 123R and have begun to recordstock-based compensation expense in our operating statement under the modifiedprospective method. Financial statements for prior years will not be restatedto conform to the 2006 presentation. We estimate the total compensation chargefor 2006 will be approximately $5 million, which will be recorded to each costof revenue and operating expense category. Our estimate of stock-basedcompensation is affected by our stock price as well as complex assumptionsregarding our stock price volatility and the expected stock option exercisebehavior of our employees. Actual stock-based compensation expenses coulddiffer materially from our estimate.

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

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** |
| ** **                                      | ** ** | **(Amounts in thousands)**       | ** ** |
| Interest income                                 |       | $                                          | 142        |   | $ | 390 |   |   | 174 | % |   | $ | 1,670 |   |   | 328 | % |   |
| Interest expense                                |       | (371                                       | )          | (249 | ) |   | (33 | ) |   | (5 | ) |   | n/m |   |   |
| Other income  (expense)                         |       | 14                                         |       | 5 |   |   | (64 | ) |   | (19 | ) |   | n/m |   |   |
| Total interest and other  income (expense), net |       | $                                          | (215       | ) | $ | 146 |   |   | 168 | % |   | $ | 1,646 |   |   | n/m |   |   |

 

Interest income increased328% in 2005 as compared to 2004 due to a full year of interest earnings on ourcash and short-term investments for 2005. We received approximately $40 millionin proceeds from our initial public offering in August 2004, which hasbeen invested in short-term, investment-grade, interest-bearing securities. Interestexpense declined in 2005 due to the pay-off of our then-outstanding debt in thethird quarter of 2004. Other income (expense) consists primarily of gains orlosses on asset sales and foreign currency transaction gains or losses, whichindividually and in aggregate have been immaterial for the past three years.

***Provision for Income Taxes***

The provision for income taxes of $478,000 in 2005,and $100,000 in 2004, was approximately 6% and 3% of pre-tax income,respectively. The provision consists primarily of the federal alternativeminimum tax, foreign withholding taxes, and various state income taxes. Oureffective tax rate in 2005 and 2004 differs from the federal statutory rateprimarily due to the utilization of net operating loss carryforwards, federalalternative minimum taxes, foreign rate differentials, and non-deductible mealand entertainment expenses. The provision for income taxes in 2003 was$539,000, or 15% of the pre-tax loss for that year. Our effective rate for 2003differed from the federal statutory rate primarily due to our net operatinglosses and foreign tax credits not being realizable. Our effective tax rate in2006 will depend on a number of factors, such as the amount and mix ofstock-based compensation expense to be recorded under SFAS 123R, the level ofbusiness in state and foreign tax jurisdictions, management’s expectation ofthe realization of deferred tax assets and the associated valuation allowance,and other factors.

At December 31, 2005,we had $25.6 million of net deferred tax assets that have been reserved in fullby a valuation allowance. In the future, if available evidence indicates thatit is more likely than not that some or all of our deferred tax assets arerealizable, an adjustment to decrease the valuation allowance would increaseeither income or contributed capital in the period such determination was made.If and when that happens, our effective income tax rate will increase to moreclosely approximate the federal statutory rate.

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**Quarterly Results of Operations**

The following table sets forth selected unauditedquarterly consolidated statements of operations data for each of the eightquarters through December 31, 2005. This information is unaudited but, inmanagement’s opinion, has been prepared on the same basis as the auditedconsolidated financial statements and related notes included elsewhere in thisreport and includes all adjustments, consisting only of normal recurringadjustments that our management considers necessary for a fair presentation ofthe information for the quarters presented.

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

| ** **                                | ** ** | **Mar 31,  2004**                   | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **(Unaudited) (In thousands)** | ** ** |
| Revenue:                                  |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Software, hosting and support             |       | $                                        | 10,720     |                   | $          | 11,709                 |       | $                      | 12,976     |                   | $          | 14,359                 |       | $                      | 13,874     |                   | $          | 16,864 |   | $ | 18,005 |   | $ | 19,201 |   |
| Professional services                     |       | 2,137                                    |       | 3,053                  |       | 3,450                  |       | 3,360                  |       | 4,468                  |       | 4,214                  |       | 5,149                  |       | 5,373                  |       |
| Total revenue                             |       | 12,857                                   |       | 14,762                 |       | 16,426                 |       | 17,719                 |       | 18,342                 |       | 21,078                 |       | 23,154                 |       | 24,574                 |       |
| Cost of revenue:                          |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Software, hosting and support             |       | 1,579                                    |       | 1,636                  |       | 1,729                  |       | 1,797                  |       | 2,064                  |       | 2,276                  |       | 2,253                  |       | 2,518                  |       |
| Professional services                     |       | 1,310                                    |       | 1,573                  |       | 1,979                  |       | 2,344                  |       | 2,696                  |       | 2,879                  |       | 3,026                  |       | 3,355                  |       |
| Total cost of revenue                     |       | 2,889                                    |       | 3,209                  |       | 3,708                  |       | 4,141                  |       | 4,760                  |       | 5,155                  |       | 5,279                  |       | 5,873                  |       |
| Gross profit                              |       | 9,968                                    |       | 11,553                 |       | 12,718                 |       | 13,578                 |       | 13,582                 |       | 15,923                 |       | 17,875                 |       | 18,701                 |       |
| Operating  expenses:                      |       |                                     |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Sales and marketing                       |       | 6,848                                    |       | 8,037                  |       | 8,055                  |       | 9,046                  |       | 9,457                  |       | 10,557                 |       | 11,248                 |       | 11,421                 |       |
| Research and development                  |       | 1,805                                    |       | 1,807                  |       | 2,028                  |       | 2,167                  |       | 2,161                  |       | 2,426                  |       | 2,937                  |       | 2,904                  |       |
| General and administrative                |       | 1,153                                    |       | 1,016                  |       | 1,164                  |       | 1,288                  |       | 1,410                  |       | 1,586                  |       | 1,627                  |       | 1,822                  |       |
| Total operating expenses                  |       | 9,806                                    |       | 10,860                 |       | 11,247                 |       | 12,501                 |       | 13,028                 |       | 14,569                 |       | 15,812                 |       | 16,147                 |       |
| Income from  operations                   |       | 162                                      |       | 693                    |       | 1,471                  |       | 1,077                  |       | 554                    |       | 1,354                  |       | 2,063                  |       | 2,554                  |       |
| Interest and  other income (expense), net |       | (64                                      | )          | (46                    | )          | 30                     |       | 226                    |       | 292                    |       | 331                    |       | 440                    |       | 583                    |       |
| Income before  income taxes               |       | 98                                       |       | 647                    |       | 1,501                  |       | 1,303                  |       | 846                    |       | 1,685                  |       | 2,503                  |       | 3,137                  |       |
| Provision for  income taxes               |       | (18                                      | )          | (13                    | )          | (61                    | )          | (8                     | )          | (45                    | )          | (126                   | )          | (160                   | )          | (147                   | )          |
| Net income                                |       | $                                        | 80         |                   | $          | 634                    |       | $                      | 1,440      |                   | $          | 1,295                  |       | $                      | 801        |                   | $          | 1,559 |   | $ | 2,343 |   | $ | 2,990 |   |

 

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

| ** **                       | ** ** | **Mar 31,  2004** | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
|----------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **(Unaudited)**        | ** ** |
| Revenue:                         |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support    |       |                   | 83         | %                      |       |                   | 79         | %                      |       |                   | 79         | %                      |       |                   | 81         | %                      |       |   | 76 | % |   |   | 80 | % |   |   | 78 | % |   |   | 78 | % |   |
| Professional services            |       |                   | 17         |                   |       |                   | 21         |                   |       |                   | 21         |                   |       |                   | 19         |                   |       |   | 24 |   |   |   | 20 |   |   |   | 22 |   |   |   | 22 |   |   |
| Total revenue                    |       |                   | 100        |                   |       |                   | 100        |                   |       |                   | 100        |                   |       |                   | 100        |                   |       |   | 100 |   |   |   | 100 |   |   |   | 100 |   |   |   | 100 |   |   |
| Cost of revenue:                 |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Software, hosting and support    |       |                   | 12         |                   |       |                   | 11         |                   |       |                   | 11         |                   |       |                   | 10         |                   |       |   | 11 |   |   |   | 11 |   |   |   | 10 |   |   |   | 10 |   |   |
| Professional services            |       |                   | 10         |                   |       |                   | 11         |                   |       |                   | 12         |                   |       |                   | 13         |                   |       |   | 15 |   |   |   | 14 |   |   |   | 13 |   |   |   | 14 |   |   |
| Total cost of revenue            |       |                   | 22         |                   |       |                   | 22         |                   |       |                   | 23         |                   |       |                   | 23         |                   |       |   | 26 |   |   |   | 25 |   |   |   | 23 |   |   |   | 24 |   |   |
| Gross profit                     |       |                   | 78         |                   |       |                   | 78         |                   |       |                   | 77         |                   |       |                   | 77         |                   |       |   | 74 |   |   |   | 75 |   |   |   | 77 |   |   |   | 76 |   |   |
| Operating expenses:              |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing              |       |                   | 53         |                   |       |                   | 55         |                   |       |                   | 49         |                   |       |                   | 52         |                   |       |   | 51 |   |   |   | 50 |   |   |   | 48 |   |   |   | 47 |   |   |
| Research and development         |       |                   | 14         |                   |       |                   | 12         |                   |       |                   | 12         |                   |       |                   | 12         |                   |       |   | 12 |   |   |   | 12 |   |   |   | 13 |   |   |   | 12 |   |   |
| General and administrative       |       |                   | 9          |                   |       |                   | 7          |                   |       |                   | 7          |                   |       |                   | 7          |                   |       |   | 8 |   |   |   | 7 |   |   |   | 7 |   |   |   | 7 |   |   |
| Total operating expenses         |       |                   | 76         |                   |       |                   | 74         |                   |       |                   | 68         |                   |       |                   | 71         |                   |       |   | 71 |   |   |   | 69 |   |   |   | 68 |   |   |   | 66 |   |   |
| Income from  operations          |       |                   | 2          |                   |       |                   | 4          |                   |       |                   | 9          |                   |       |                   | 6          |                   |       |   | 3 |   |   |   | 6 |   |   |   | 9 |   |   |   | 10 |   |   |
| Interest and  other expense, net |       |                   | (1         | )                      |       |                   | —     |                   |       |                   | —     |                   |       |                   | 1          |                   |       |   | 1 |   |   |   | 2 |   |   |   | 2 |   |   |   | 2 |   |   |
| Income before  income taxes      |       |                   | 1          |                   |       |                   | 4          |                   |       |                   | 9          |                   |       |                   | 7          |                   |       |   | 4 |   |   |   | 8 |   |   |   | 11 |   |   |   | 12 |   |   |
| Provision for  income taxes      |       |                   | —     |                   |       |                   | —     |                   |       |                   | —     |                   |       |                   | —     |                   |       |   | — |   |   |   | (1 | ) |   |   | (1 | ) |   |   | — |   |   |
| Net income                       |       |                   | 1          | %                      |       |                   | 4          | %                      |       |                   | 9          | %                      |       |                   | 7          | %                      |       |   | 4 | % |   |   | 7 | % |   |   | 10 | % |   |   | 12 | % |   |

 

Thefollowing table sets forth our deferred revenue and cash provided byoperations, our on-demand customer interactions and percentage of clientshosting and our revenue by type and geography expressed as a percentage oftotal revenue, for each of the periods indicated:

| ** **                                     | ** ** | **Mar 31,  2004** | ** ** | **Jun 30,  2004** | ** ** | **Sep 30,  2004** | ** ** | **Dec 31,  2004** | ** ** | **Mar 31,  2005** | ** ** | **Jun 30,  2005** | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **(Unaudited)**        | ** ** |
| Deferred revenue  (in thousands)               |       | $                      | 36,729     |                   | $          | 40,777                 |       | $                      | 44,491     |                   | $          | 49,125                 |       | $                      | 52,810     |                   | $          | 57,368 |   | $ | 63,752 |   | $ | 67,923 |   |
| Cash provided by  operations (in thousands)    |       | 333                    |       | 2,022                  |       | 1,063                  |       | 3,320                  |       | 3,239                  |       | 2,564                  |       | 5,248                  |       | 3,844                  |       |
| Customer  interactions (in millions)      |       | 102                    |       | 110                    |       | 140                    |       | 150                    |       | 166                    |       | 176                    |       | 188                    |       | 214                    |       |
| Percentage of  clients hosting                 |       | 85                     | %          | 85                     | %          | 86                     | %          | 87                     | %          | 86                     | %          | 86                     | %          | 87                     | %          | 87                     | %          |
| Revenue by type:                               |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Recurring (term licenses, hosting and support) |       | 66                     | %          | 56                     | %          | 58                     | %          | 55                     | %          | 58                     | %          | 51                     | %          | 51                     | %          | 53                     | %          |
| Perpetual licenses                             |       | 17                     |       | 23                     |       | 21                     |       | 26                     |       | 18                     |       | 29                     |       | 27                     |       | 25                     |       |
| Professional services                          |       | 17                     |       | 21                     |       | 21                     |       | 19                     |       | 24                     |       | 20                     |       | 22                     |       | 22                     |       |
| Revenue by  geography:                         |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |                   |       |
| Americas                                       |       | 71                     | %          | 74                     | %          | 76                     | %          | 71                     | %          | 75                     | %          | 79                     | %          | 75                     | %          | 68                     | %          |
| Europe                                         |       | 19                     |       | 24                     |       | 19                     |       | 20                     |       | 15                     |       | 16                     |       | 16                     |       | 23                     |       |
| Asia Pacific                                   |       | 10                     |       | 2                      |       | 5                      |       | 9                      |       | 10                     |       | 5                      |       | 9                      |       | 9                      |       |
|                                                |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

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Total revenue increased sequentially in each of thequarters presented primarily due to increases in the number of new clients,increases in the average transaction sizes, contract renewals and deferredrevenue recognition. We believe professional services revenue has generallyincreased as a percent of total revenue due to the expansion of our serviceofferings, but varies from quarter-to-quarter due to customer schedulingrequirements, and training and education of newly hired personnel. Cost ofrevenue for software, hosting and support, as a percent of total revenue,trended slightly lower in the past eight quarters due to increasingefficiencies in our hosting and technical support operations. The generallyhigher mix of professional services revenue causes professional service coststo be higher as a percent of total revenue.

The mix of term and perpetual software licenses soldin each quarter impacts our quarterly results of operations. For example, inthe quarters ended March 31, 2004 and 2005, perpetual licenses representeda lower proportion of total revenue than in other periods, and consequently,income from operations was also lower in those periods. We believe there areseasonal aspects to our customers’ purchasing behavior, which results in typicallylower perpetual license sales in the first quarter of the calendar year.

Sales and marketing expenses have increased inabsolute dollar costs, but have generally declined as a percent of totalrevenue during the past eight quarters mostly due to revenue growth. For thequarters ended September 30, 2004, September 30, 2005, andDecember 31, 2005, sales and marketing expenses were lower as a percentageof revenue due to the timing of employee additions and marketing campaigns, andrelatively lower commissions expense. Consequently, operating income in thosequarters was unusually high. We expect that during periods of investment andgrowth, because the majority of our revenue is deferred and the majority ofexpenses are recorded as incurred, any increases in revenue will be largelyoffset by corresponding increases in cost of revenue and operating expenses.

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

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

·       changesin the volume and mix of term and perpetual licenses sold in a particularquarter, because perpetual license revenue is recorded into revenue upondelivery whereas term licenses are recorded into revenue ratably over theperiod of the license;

·       ourpolicy of expensing sales commissions at the time of invoice, while themajority of our revenue is deferred and recognized ratably over future periods;

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

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

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

·       changesin our pricing policies or those of our competitors;

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

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

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·       ourability to continue to realize efficiencies from our hosting and technicalsupport operations;

·       changesin the payment terms for our products and services;

·       thepurchasing and budgeting cycles of our clients;

·       therate of success of our domestic and international expansion;

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

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

·       seasonalityin certain of our clients’ purchasing habits; and

·       generaleconomic, industry and market conditions.

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

**Liquidityand Capital Resources**

| ** **                             | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **Percent  Change** | ** ** |
| ** **                             | ** ** | **(Amounts in thousands)**       | ** ** |
| Deferred revenue                       |       | $                                          | 35,553     |   | $ | 49,125 |   |   | 38 | % |   | $ | 67,923 |   |   | 38 | % |   |
| Cash provided by  operating activities |       | 4,319                                      |       | 6,738 |   |   | 56 |   |   | 14,895 |   |   | 121 |   |   |
|                                        |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

At December 31, 2005, cash and cash equivalents,and short-term investments, totaled $64.2 million. In addition to our cash andshort-term investments, other sources of liquidity at December 31, 2005included a $3.0 million bank line of credit facility, under which there were noborrowings in 2005.

Operating activities provided $14.9 million of cashduring the year ended December 31, 2005, as compared to $6.7 million ofcash from operations in 2004. The majority of our cash from operations in 2005and 2004 was from growth in deferred revenue, net income, and non-cash charges,partially offset by growth in receivables. We typically bill customers on net 30-dayterms at the beginning of the license period, which is reflected in accountsreceivable and deferred revenue.  Inperiods of increasing sales, we would expect growth in accounts receivable anddeferred 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 accounts receivablerepresented approximately 5% and 6% of current accounts and term receivables atDecember 31, 2005 and 2004, respectively. Accounts written off in 2005were constant as a percentage of new billings from the previous year. Weregularly assess the adequacy of the allowance for doubtful accounts. Actualwrite-offs could exceed our estimates and adversely affect operating cash flowsin the future.

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Cash required for income taxes was $239,000 in 2005and $100,000 in 2004. We do not expect to pay significant cash income taxes in2006, primarily because of the availability of net operating loss carryforwardsthat may be utilized to offset taxable income.

Investing activities provided $1.9 million during2005, mostly due to the liquidation of short-term investments, compared torequiring $35.5 million in 2004 mostly for the purchase of short-terminvestments. Capital asset additions were $5 million in 2005 and $3.6 millionin 2004, consisting of equipment acquisitions for our hosting operations andemployee growth. Intangible asset additions in 2005 of $1 million consistedprimarily of the assets acquired from Convergent Voice. We expect to spendbetween $8 million and $10 million for capital asset additions in 2006.

Financing activities provided $5.4 million in 2005 and$39.2 million in 2004. In 2004 we received $40.0 million of proceeds from ourinitial public offering of common stock. Other financing sources included theexercise of employee stock options under our equity incentive plan and stockpurchases under our employee stock purchase plan. We had borrowed $1.7 millionunder long-term debt agreements during the first six months of 2004, andsubsequently paid down all outstanding long-term debt during the third quarterof 2004.  In 2005, we borrowed $162,000related to tenant improvements at our headquarters office facility.

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

**Off-Balance Sheet Arrangements**

As of December 31,2005, we did not have any significant off-balance-sheet arrangements, asdefined in Item 303(a)(4)(ii) of Regulation S-K promulgated by theSEC.

**ContractualObligations and Commitments**

Thefollowing table summarizes our contractual payment obligations and commitmentsas of December 31, 2005:

| ** **                        | ** ** | **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      |       | $                                         | 10,108     |   |   | $ | 2,119 |   |   |   | $ | 3,788 |   |   |   | $ | 2,850 |   |   |   | $ | 1,351 |   |   |
| Obligations under  capital leases |       | 147                                       |       |   | 30 |   |   |   | 65 |   |   |   | 52 |   |   |   | — |   |   |
| Purchase  obligations             |       | 2,110                                     |       |   | 883 |   |   |   | 583 |   |   |   | 583 |   |   |   | 61 |   |   |
| Total                             |       | $                                         | 12,365     |   |   | $ | 3,032 |   |   |   | $ | 4,436 |   |   |   | $ | 3,485 |   |   |   | $ | 1,412 |   |   |
|                                   |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We lease our officefacilities and certain office equipment under operating lease agreements thatexpire at various dates through 2013. Obligations under capital leases pertainto certain tenant improvements in our main office facility. Purchaseobligations consist of agreements with third parties to provide co-locationservices for hosting operations. Except for these hosting service agreements,we generally do not enter into binding purchase commitments.

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

***Foreign Currency Exchange Risk***

Our results of operationsand cash flows are subject to fluctuation due to changes in foreign currencyexchange rates, particularly changes in the Euro, British pound, Australiandollar and Japanese yen, because our contracts are frequently denominated inlocal currency. In the future, we may utilize foreign currency forward andoption contracts to manage currency exposures. We do not currently have anysuch contracts in place, nor did we enter into any such contracts during theyears ended December 31, 2004 or December 31, 2005.

***Interest Rate Sensitivity***

Net proceeds from ourinitial public offering of common stock are invested in short-term,interest-bearing securities, which are subject to credit and interest rate risk.Our portfolio is investment-grade and diversified among issuers and securitytypes to reduce credit risk. We manage our interest rate risk by maintaining alarge portion of our investment portfolio in instruments with short maturitiesor frequent interest rate resets. We also manage interest rate risk bymaintaining sufficient cash and cash equivalents such that we are able to holdinvestments until maturity. If market interest rates were to increase by 100basis points from the level at December 31, 2005, the fair value of our portfoliowould decline by approximately $135,000.

**Item 8.**                        FinancialStatements and Supplementary Data

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

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

None.

**Item 9a.**                 Controlsand Procedures

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

Our management,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, has evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934). Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, as of December 31,2005 our disclosure controls and procedures were effective in timely alertingthem to the material information relating to RightNow (or its consolidatedsubsidiaries) required to be included in the reports we file or submit underthe Securities Exchange Act of 1934.

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

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

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**Reportof Management on Internal Control Over Financial Reporting**

Our management is responsible for establishing andmaintaining a system of internal control over financial reporting as definedunder the Exchange Act Rules 13a-15(f) and 15d-15(f). Internalcontrol over financial reporting is designed to provide reasonable assuranceregarding the reliability of our financial reporting and preparation offinancial statements for external purposes in accordance with accountingprinciples generally accepted in the United States of America. Internal controlover financial reporting includes maintaining records that in reasonable detailaccurately and fairly reflect our transactions; providing reasonable assurancethat transactions are recorded as necessary for preparation of our financialstatements in accordance with generally accepted accounting principles;providing reasonable assurance that our receipts and expenditures are made inaccordance with authorizations of our management and directors; and providingreasonable assurance that unauthorized acquisition, use or disposition of ourassets that could have a material effect on our financial statements would beprevented or detected on a timely basis. Because of its inherent limitations,internal control over financial reporting is not intended to provide absoluteassurance that a misstatement of our financial statements would be prevented ordetected.

Management conducted anassessment of the effectiveness of our internal control over financialreporting based on the framework in *Internal Control—IntegratedFramework**issued by the Committee ofSponsoring Organizations of the Treadway Commission*. Based on thisassessment, management concluded that our internal control over financialreporting was effective as of December 31, 2005. Our independentregistered accounting firm, KPMG LLP has issued an audit report on management’sassessment of our internal control over financial reporting and their report isincluded in this Item 9A below.

**Reportof Independent Registered Public Accounting Firm**

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

We have audited management’s assessment, included inthe accompanying Report of Management on Internal Control over FinancialReporting, that RightNow Technologies, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of December 31,2005, based on criteria established in *Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO).*The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

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

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, 

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and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

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

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework**issued by the Committee of Sponsoring Organizationsof the Treadway Commission (COSO)*. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on the criteria established in *Internal Control—Integrated Framework**issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO)*.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofthe Company and subsidiaries as of December 31, 2005 and 2004, and therelated consolidated statements of operations, stockholders’ equity (deficit)and comprehensive income (loss), and cash flows for each of the years in thethree-year period ended December 31, 2005, and our report dated March 9,2006 expressed an unqualified opinion on those consolidated financialstatements.
|  | /s/ KPMG LLP |
|--|--------------|

 

Portland, OregonMarch 9, 2006

**Item 9B.**               OtherInformation

None.

47

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**Part III**

**Item 10.**                 Directorsand Executive Officers of the Registrant

*(a)**          Identificationof Directors.*

The informationunder the captions “Proposal One: Election of Directors” and “CorporateGovernance, Board Composition and Board Committees,” appearing in our proxystatement for our 2006 annual meeting of stockholders, is hereby incorporatedby reference.

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

The informationunder the caption “Executive Officers,” appearing in our proxy statement, ishereby incorporated by reference.

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

The informationunder the caption “Section 16(a) Beneficial Ownership ReportingCompliance,” appearing in our proxy statement, is hereby incorporated byreference.

*(d)**          Codeof Ethics.*

Our board of directors hasadopted a code of ethics and business conduct that applies to all of ouremployees, officers (including our principal executive officer, principalfinancial officer, principal accounting officer or controller, or personsperforming similar functions) and directors. The full text of our code ofethics and business conduct is posted on our web site athttp://www.rightnow.com under the Investor Relations section. We intend todisclose future amendments to certain provisions of our code of ethics andbusiness conduct, or waivers of such provisions, applicable to our directorsand executive officers (including our principal executive officer, principalfinancial officer, principal accounting officer or controller, or personsperforming similar functions), at the same location on our web site identifiedabove. The inclusion of our web site address in this report does not include orincorporate by reference the information on, or accessible through, our web siteinto this report.

**Item 11.**                 ExecutiveCompensation

The information under thecaptions “Executive Compensation,” “Director Compensation and OtherArrangements,” “Stock Options,” “Employment Contracts, Termination ofEmployment and Change-In-Control Agreements” and “Compensation CommitteeInterlocks and Insider Participation,” appearing in our proxy statement ishereby incorporated herein by reference.

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

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

**Item 13.**                 CertainRelationships and Related Transactions

The information under thecaption “Certain Relationships and Related Party Transactions” appearing in ourproxy statement is hereby incorporated by reference.

**Item 14.**                 PrincipalAccountant Fees and Services

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

48

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**Part IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules

*(a)(1)**                   FinancialStatements*

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

 

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

None.

*(a)(3)**                   Exhibits*

Thefollowing is a list of exhibits to this report.

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

49

----

 

| 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.                                                                                                                                          |
| 10.16**     |   | Lease agreement dated  March 28, 2005, between RightNow Technologies, Inc. and Genesis  Partners, LLC for office space located at 110 Enterprise Boulevard, Bozeman,  Montana.     |
| 10.17**     |   | Renewed lease agreement,  dated March 28, 2005, between RightNow Technologies, Inc. and  Genesis Partners, LLC for office space located at 77 Discovery Drive,  Bozeman, Montana.  |
| 10.18**     |   | Renewed lease agreement,  dated March 28, 2005, between RightNow Technologies, Inc. and  Genesis Partners, LLC for office space located at 45 Discovery Drive,  Bozeman, Montana.  |
| 21.1*       |   | Subsidiaries of the  registrant.                                                                                                                                                             |
| 23.1        |   | Consent of KPMG LLP,  Independent Registered Public Accounting Firm.                                                                                                                         |
| 31.1        |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rule 13a-14(a) or  15d-14(a). as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.       |
| 31.2        |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rule 13a-14(a) or  15d-14(a) as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.   |
| 32.1        |   | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

----

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

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

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

†                    Denotesmanagement contract or compensatory plan or arrangement.

*(b)**          Exhibits*

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

*(c)**           FinancialStatement Schedules*

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

50

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**Signatures**

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

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities indicated on March 9, 2006.

|                         | **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, and Assistant |
| Susan J. Carstensen     |          | Secretary (Principal  Financial and Accounting Officer)            |

 

51

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**Report of Independent Registered Public AccountingFirm**

Board of Directors and StockholdersRightNow Technologies, Inc.:

We have audited the accompanying consolidated balancesheets of RightNow Technologies, Inc. and subsidiaries as of December 31,2005 and 2004, and the related consolidated statements of operations,stockholders’ equity (deficit) and comprehensive income (loss), and cash flowsfor each of the years in the three-year period ended December 31, 2005.These consolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

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

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of RightNow Technologies, Inc. and subsidiaries as of December 31,2005 and 2004 and the results of their operations and their cash flows for eachof the years in the three-year period ended December 31, 2005 inconformity with U.S. generally accepted accounting principles.

Wealso audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the effectiveness of RightNow Technologies, Inc.’sinternal control over financial reporting as of December 31, 2005, basedon criteria established in *Internal Control—IntegratedFramework**issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO)* and ourreport dated March 9, 2006 expressed an unqualified opinion on management’sassessment of, and the effective operation of, internal control over financialreporting.
|  | /s/ KPMG LLP |
|--|--------------|

 

Portland, OregonMarch 9, 2006

F-1

----

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

| ** **                                                                                                                                                           | ** ** | **December 31,**                                          | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2004**                                                       | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                           | ** ** | **(In thousands, except  per share data)** | ** ** |
| **Assets**                                                                                                                                                           |       |                                                           |       |   |   |
| Current assets:                                                                                                                                                      |       |                                                           |       |   |   |
| Cash and cash equivalents                                                                                                                                            |       | $                                                              | 18,944     |   | $ | 40,874 |   |
| Short-term investments                                                                                                                                               |       | 31,188                                                         |       | 23,314 |   |
| Accounts receivable                                                                                                                                                  |       | 16,939                                                         |       | 25,462 |   |
| Term receivables, current                                                                                                                                            |       | 10,090                                                         |       | 15,376 |   |
| Total current receivables                                                                                                                                            |       | 27,029                                                         |       | 40,838 |   |
| Less allowance for doubtful accounts                                                                                                                                 |       | (1,581                                                         | )          | (2,209 | ) |
| Total current receivables, net                                                                                                                                       |       | 25,448                                                         |       | 38,629 |   |
| Prepaid and other current assets                                                                                                                                     |       | 1,255                                                          |       | 1,993 |   |
| Total current assets                                                                                                                                                 |       | 76,835                                                         |       | 104,810 |   |
| Property and equipment, net                                                                                                                                          |       | 4,393                                                          |       | 6,451 |   |
| Term receivables, non-current                                                                                                                                        |       | 5,756                                                          |       | 10,697 |   |
| Intangible assets, net                                                                                                                                               |       | 1,113                                                          |       | 1,487 |   |
| Other assets                                                                                                                                                         |       | 212                                                            |       | 231 |   |
| **Total  Assets**                                                                                                                                                    |       | $                                                              | 88,309     |   | $ | 123,676 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                       |       |                                                           |       |   |   |
| Current liabilities:                                                                                                                                                 |       |                                                           |       |   |   |
| Accounts payable                                                                                                                                                     |       | $                                                              | 1,720      |   | $ | 2,308 |   |
| Commissions and bonuses payable                                                                                                                                      |       | 2,648                                                          |       | 2,910 |   |
| Other accrued liabilities                                                                                                                                            |       | 3,715                                                          |       | 5,733 |   |
| Current portion of long-term debt                                                                                                                                    |       | —                                                         |       | 30 |   |
| Current portion of deferred revenue                                                                                                                                  |       | 36,020                                                         |       | 48,673 |   |
| Total current liabilities                                                                                                                                            |       | 44,103                                                         |       | 59,654 |   |
| Long-term debt,  less current portion                                                                                                                                |       | —                                                         |       | 117 |   |
| Deferred revenue,  net of current portion                                                                                                                            |       | 13,105                                                         |       | 19,250 |   |
| Total liabilities                                                                                                                                                    |       | 57,208                                                         |       | 79,021 |   |
| Commitments and  contingencies (Note 11)                                                                                                                             |       |                                                           |       |   |   |
| Stockholders’ equity:                                                                                                                                           |       |                                                           |       |   |   |
| Preferred stock, $0.001 par value. Authorized and  undesignated 15,000 shares at December 31, 2004, and 2005, respectively                                      |       | —                                                         |       | — |   |
| Common stock, $0.001 par value. Authorized 150,000  shares; issued and outstanding 29,119 shares and 31,872 shares at December 31,  2004 and 2005, respectively |       | 29                                                             |       | 32 |   |
| Warrants                                                                                                                                                             |       | 291                                                            |       | — |   |
| Additional paid-in capital                                                                                                                                           |       | 72,367                                                         |       | 78,312 |   |
| Accumulated other comprehensive income (loss)                                                                                                                        |       | (605                                                           | )          | (401 | ) |
| Accumulated deficit                                                                                                                                                  |       | (40,981                                                        | )          | (33,288 | ) |
| Total stockholders’ equity                                                                                                                                      |       | 31,101                                                         |       | 44,655 |   |
| **Total Liabilities and  Stockholders’ Equity**                                                                                                                 |       | $                                                              | 88,309     |   | $ | 123,676 |   |

 

See accompanying notes to consolidated financial statements

F-2

----

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

| ** **                                      | ** ** | **Year Ended December 31,**                     | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                                       | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(In thousands, except  per share data)** | ** ** |
| Revenue:                                        |       |                                                           |       |   |   |   |   |
| Software, hosting and support                   |       | $                                                              | 29,300     |   | $ | 49,764 |   | $ | 67,944 |   |
| Professional services                           |       | 6,579                                                          |       | 12,000 |   | 19,204 |   |
| Total revenue                                   |       | 35,879                                                         |       | 61,764 |   | 87,148 |   |
| Costs of revenue:                               |       |                                                           |       |   |   |   |   |
| Software, hosting and support                   |       | 5,263                                                          |       | 6,741 |   | 9,111 |   |
| Professional services                           |       | 3,740                                                          |       | 7,206 |   | 11,956 |   |
| Total cost of revenue                           |       | 9,003                                                          |       | 13,947 |   | 21,067 |   |
| Gross profit                                    |       | 26,876                                                         |       | 47,817 |   | 66,081 |   |
| Operating expenses:                             |       |                                                           |       |   |   |   |   |
| Sales and marketing                             |       | 20,809                                                         |       | 31,986 |   | 42,683 |   |
| Research and development                        |       | 5,915                                                          |       | 7,807 |   | 10,428 |   |
| General and administrative                      |       | 3,518                                                          |       | 4,621 |   | 6,445 |   |
| Total operating expenses                        |       | 30,242                                                         |       | 44,414 |   | 59,556 |   |
| Income (loss) from operations                   |       | (3,366                                                         | )          | 3,403 |   | 6,525 |   |
| Interest and other  income (expense):           |       |                                                           |       |   |   |   |   |
| Interest income                                 |       | 142                                                            |       | 390 |   | 1,670 |   |
| Interest expense                                |       | (371                                                           | )          | (249 | ) | (5 | ) |
| Other                                           |       | 14                                                             |       | 5 |   | (19 | ) |
| Total interest and other income (expense), net  |       | (215                                                           | )          | 146 |   | 1,646 |   |
| Income (loss) before provision for income taxes |       | (3,581                                                         | )          | 3,549 |   | 8,171 |   |
| Provision for  income taxes                     |       | (539                                                           | )          | (100 | ) | (478 | ) |
| Net income (loss)                               |       | (4,120                                                         | )          | 3,449 |   | 7,693 |   |
| Preferred stock  accretion                      |       | (13                                                            | )          | (8 | ) | — |   |
| Net income (loss) allocated to common stock     |       | $                                                              | (4,133     | ) | $ | 3,441 |   | $ | 7,693 |   |
| Net income (loss)  per share:                   |       |                                                           |       |   |   |   |   |
| Basic                                           |       | $                                                              | (0.28      | ) | $ | 0.17 |   | $ | 0.25 |   |
| Diluted                                         |       | (0.28                                                          | )          | 0.12 |   | 0.23 |   |
| Shares used in the  computation:                |       |                                                           |       |   |   |   |   |
| Basic                                           |       | 14,560                                                         |       | 20,738 |   | 30,631 |   |
| Diluted                                         |       | 14,560                                                         |       | 29,177 |   | 33,695 |   |

 

See accompanying notes to consolidated financial statements

F-3

----

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

| ** **                                                                                                         | ** ** | **Common stock** | ** ** | ** ** | ** ** | **Additional  paid-in** | ** ** | **Accumulated  other  comprehensive** | ** ** | **Accumulated**        | ** ** | **Total  stockholders’** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-------------------------|------------|---------------------------------------|------------|------------------------|------------|-------------------------------|------------|
| ** **                                                                                                         | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Warrants**            | ** ** | **capital**                           | ** ** | **income (loss)** | ** ** | **deficit**                   | ** ** | **equity (deficit)** | ** ** |
| 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 preferred shares 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                                                                    |       |                  | 6,416      |       |       |                    | 6          |                                  |       |                   | —     |                          |       |   | 39,966 |   |   |   | — |   |   |   | — |   |   |   | 39,972 |   |   |
| Exercise of stock  options                                                                                         |       |                  | 616        |       |       |                    | 1          |                                  |       |                   | —     |                          |       |   | 485 |   |   |   | — |   |   |   | — |   |   |   | 486 |   |   |
| Employee stock  purchase plan                                                                                      |       |                  | 98         |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | 690 |   |   |   | — |   |   |   | — |   |   |   | 690 |   |   |
| Conversion of  redeemable convertible preferred shares into common shares                                          |       |                  | 7,265      |       |       |                    | 7          |                                  |       |                   | —     |                          |       |   | 32,148 |   |   |   | — |   |   |   | — |   |   |   | 32,155 |   |   |
| Conversion of  warrants to acquire redeemable convertible preferred shares into warrants to  acquire common shares |       |                  | —     |       |       |                    | —     |                                  |       |                   | 291        |                          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 291 |   |   |
| Repurchase of  common stock                                                                                        |       |                  | (3         | )          |       |                    | —     |                                  |       |                   | —     |                          |       |   | (2 | ) |   |   | — |   |   |   | — |   |   |   | (2 | ) |   |
| Accretion of  redeemable preferred shares to redemption value                                                      |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | (8 | ) |   |   | — |   |   |   | — |   |   |   | (8 | ) |   |
| Comprehensive income:                                                                                              |       |                  |       |       |       |                    |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                         |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 3,449 |   |   |   | 3,449 |   |   |
| Unrealized loss on  available for sale investments net of tax of $0                                                |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (13 | ) |   |   | — |   |   |   | (13 | ) |   |
| Foreign currency  translation adjustment                                                                      |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (665 | ) |   |   | — |   |   |   | (665 | ) |   |
| Total  comprehensive income                                                                                        |       |                  |       |       |       |                    |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 2,771 |   |   |
| Balance at  December 31, 2004                                                                                 |       |                  | 29,119     |       |       |                    | 29         |                                  |       |                   | 291        |                          |       |   | 72,367 |   |   |   | (605 | ) |   |   | (40,981 | ) |   |   | 31,101 |   |   |
| Issuance of common stock:                                                                                          |       |                  |       |       |       |                    |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise of stock  options                                                                                         |       |                  | 2,616      |       |       |                    | 3          |                                  |       |                   | —     |                          |       |   | 4,619 |   |   |   | — |   |   |   | — |   |   |   | 4,622 |   |   |
| Employee stock  purchase plan                                                                                      |       |                  | 59         |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | 656 |   |   |   | — |   |   |   | — |   |   |   | 656 |   |   |
| Exercise of  warrants                                                                                              |       |                  | 78         |       |       |                    | —     |                                  |       |                   | (291       | )                             |       |   | 291 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Tax benefit of  stock option exercises                                                                        |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | 366 |   |   |   | — |   |   |   | — |   |   |   | 366 |   |   |
| Fair value of  options granted to non-employee                                                                     |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | 13 |   |   |   | — |   |   |   | — |   |   |   | 13 |   |   |
| Comprehensive income:                                                                                              |       |                  |       |       |       |                    |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                         |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | — |   |   |   | 7,693 |   |   |   | 7,693 |   |   |
| Unrealized loss on  available for sale investments net of tax of $0                                                |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | (67 | ) |   |   | — |   |   |   | (67 | ) |   |
| Foreign currency  translation adjustment                                                                           |       |                  | —     |       |       |                    | —     |                                  |       |                   | —     |                          |       |   | — |   |   |   | 271 |   |   |   | — |   |   |   | 271 |   |   |
| Total  comprehensive income                                                                                        |       |                  |       |       |       |                    |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 7,897 |   |   |
| Balance at  December 31, 2005                                                                                 |       |                  | 31,872     |       |       |                    | $          | 32                                    |       |                   |       | $                             | —     |   |   |   | $ | 78,312 |   |   |   | $ | (401 | ) |   |   | $ | (33,288 | ) |   |   | $ | 44,655 |   |   |

 

See accompanying notes to consolidated financial statements

F-4

----

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

| ** **                                                                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(In thousands)**                    | ** ** |
| Operating activities:                                                                     |       |                                       |       |   |   |   |   |
| Net income (loss)                                                                         |       | $                                          | (4,120     | ) | $ | 3,449 |   | $ | 7,693 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 2,474                                      |       | 2,666 |   | 3,406 |   |
| Provision for losses on accounts receivable                                               |       | 477                                        |       | 489 |   | 421 |   |
| Tax benefit of stock options exercised                                                    |       | —                                     |       | — |   | 366 |   |
| Changes in  operating assets and liabilities:                                             |       |                                       |       |   |   |   |   |
| Receivables                                                                               |       | (6,678                                     | )          | (14,644 | ) | (19,100 | ) |
| Prepaid and other current assets                                                          |       | (156                                       | )          | (733 | ) | (621 | ) |
| Accounts payable                                                                          |       | 587                                        |       | 683 |   | 744 |   |
| Commissions and bonuses payable                                                           |       | 520                                        |       | 988 |   | 309 |   |
| Other accrued liabilities                                                                 |       | 453                                        |       | 1,347 |   | 2,186 |   |
| Deferred revenue                                                                          |       | 10,655                                     |       | 13,408 |   | 19,767 |   |
| Other                                                                                     |       | 107                                        |       | (915 | ) | (276 | ) |
| Net cash provided by operating activities                                                 |       | 4,319                                      |       | 6,738 |   | 14,895 |   |
| Investing activities:                                                                     |       |                                       |       |   |   |   |   |
| Purchases of short-term investments                                                       |       | —                                     |       | (57,063 | ) | (26,581 | ) |
| Sales or maturities of short-term investments                                             |       | —                                     |       | 25,875 |   | 34,455 |   |
| Purchase of property and equipment                                                        |       | (1,584                                     | )          | (3,580 | ) | (4,969 | ) |
| Acquisition of Convergent Voice                                                           |       | —                                     |       | — |   | (1,023 | ) |
| Proceeds from sale of property and equipment                                              |       | 18                                         |       | 3 |   | 4 |   |
| Intangible asset additions                                                                |       | (150                                       | )          | (691 | ) | (20 | ) |
| Net cash provided by (used in) investing activities                                       |       | (1,716                                     | )          | (35,456 | ) | 1,866 |   |
| Financing activities:                                                                     |       |                                       |       |   |   |   |   |
| Proceeds from long-term debt                                                              |       | 1,000                                      |       | 1,675 |   | 162 |   |
| Proceeds from line of credit                                                              |       | 3,700                                      |       | — |   | — |   |
| Proceeds from  issuance of common stock:                                                  |       |                                       |       |   |   |   |   |
| Initial public offering, net of offering costs                                            |       | —                                     |       | 39,972 |   | — |   |
| Exercise of stock options and warrants                                                    |       | 88                                         |       | 486 |   | 4,622 |   |
| Employee stock purchase plan                                                              |       | —                                     |       | 690 |   | 656 |   |
| Repurchase of common stock                                                                |       | —                                     |       | (2 | ) | — |   |
| Payments on long-term debt                                                                |       | (1,433                                     | )          | (3,588 | ) | (15 | ) |
| Payments on line of credit                                                                |       | (5,700                                     | )          | — |   | — |   |
| Net cash provided by (used in) financing activities                                       |       | (2,345                                     | )          | 39,233 |   | 5,425 |   |
| Effect of foreign  exchange rates on cash and cash equivalents                            |       | 64                                         |       | 69 |   | (256 | ) |
| Net change in cash and cash equivalents                                                   |       | 322                                        |       | 10,584 |   | 21,930 |   |
| Cash and cash  equivalents at beginning of period                                         |       | 8,038                                      |       | 8,360 |   | 18,944 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                          | 8,360      |   | $ | 18,944 |   | $ | 40,874 |   |

 

See accompanying notes to consolidated financial statements

F-5

----

**RIGHTNOWTECHNOLOGIES, INC.Notes to Consolidated Financial StatementsYears ended December 31, 2003, 2004 and 2005**

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

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

RightNow Technologies, Inc.(the “Company” or “RightNow”) provides on demand customer relationshipmanagement (“CRM”) software solutions for companies of all sizes. The Company’son demand software supports multiple customer interaction points in a business’scustomer service, marketing and sales operations. Founded in 1997, RightNow isheadquartered in Bozeman, Montana, with offices located in Chicago, Illinois;Dallas, Texas; San Mateo, California; Princeton, New Jersey; Rochester, NewYork; London, England; Sydney, Australia; Munich, Germany, and a liaison officein Tokyo, Japan. The Company operates in one segment, which is the customerrelationship management software market.

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

The consolidated financialstatements include the accounts of the Company and its foreign subsidiaries.All intercompany accounts and transactions have been eliminated inconsolidation.

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

The Company’s revenue is derived from the license ofits software products and provision of related professional services. The marketsin which the Company competes are highly competitive and rapidly changing.Significant technological changes, changes in customer requirements, or theemergence of competitive products with new capabilities or technologies couldadversely affect the Company’s operating results. The Company has historicallyderived a majority of its revenue from its customer service software solutions.These products are expected to continue to account for a significant portion ofrevenue for the foreseeable future. As a result of this revenue concentration,the Company’s business could be harmed by a decline in demand for, or in theprices of, these products or as a result of, among other factors, any change inpricing model, a maturation in the markets to these products, increased pricecompetition or a failure by the Company to keep up with technological change.

Financial instruments subjecting the Company toconcentrations of credit risk consist primarily of cash and cash equivalents,short-term investments, and accounts and term receivables. The 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-terminvestments are investment grade, interest-earning securities, and arediversified by type and industry.

The Company’s customers are worldwide withapproximately 75% of sales in the United States in each of the past threeyears. No individual customer accounted for more than 10% of the Company’srevenue in 2003, 2004 or 2005. One customer represented more than 10% of termreceivables at December 31, 2005.

F-6

----

Assetslocated outside North America were 7% and 11% of total assets at December 31,2004 and 2005, respectively. The loss from operations outside the United Statestotaled $2.4 million, $3.1 million and $6.2 million for the yearsended December 31, 2003, 2004 and 2005, respectively. Revenue bygeographical region is as follows (in thousands):

| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| United States |       | $                                          | 27,161     |   | $ | 45,199 |   | $ | 64,409 |   |
| Europe        |       | 6,458                                      |       | 12,792 |   | 15,528 |   |
| Asia Pacific  |       | 2,260                                      |       | 3,773 |   | 7,211 |   |
|          |       | $                                          | 35,879     |   | $ | 61,764 |   | $ | 87,148 |   |

 

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

The preparation of the consolidatedfinancial statements requires management of the Company to make a number ofestimates and assumptions relating to the reported amount of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenueand expenses during the period. Significant items subject to such estimates andassumptions include: elements comprising our software, hosting and supportsales arrangements and their respective fair values; the carrying amount ofproperty and equipment and intangibles; valuation allowances for receivablesand deferred income tax assets; and estimates of expected term and volatilityin determining stock-based compensation expense. Actual results could differfrom those estimates.

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

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

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

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

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

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

Accounts receivable represents amounts currently due(within 90 days) from customers for which revenue has been recognized oris being recognized ratably in future periods, and amounts currently due undercontract billings for which revenue has not been recognized. Term receivablesinclude the remaining minimum committed amounts due from customers, for whichno revenue has been recognized. The 

F-7

----

Company performs creditevaluations when considered necessary, but generally does not requirecollateral to extend credit.

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

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

| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Balance,  beginning of year                  |       | $                                          | 519        |   | $ | 902 |   | $ | 1,581 |   |
| Provision charged to expense                 |       | 477                                        |       | 489 |   | 421 |   |
| Provision charged against deferred revenue   |       | 221                                        |       | 972 |   | 1,528 |   |
| Write-downs charged against the allowance    |       | (550                                       | )          | (841 | ) | (1,375 | ) |
| Recoveries of amounts previously charged-off |       | 235                                        |       | 59 |   | 54 |   |
| Balance, end of year                         |       | $                                          | 902        |   | $ | 1,581 |   | $ | 2,209 |   |

 

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

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

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

Intangible assets,consisting of the Company’s domain name and purchased technologies, are carriedat cost less accumulated amortization. The Company amortizes intangible assetson a straight-line basis over their estimated useful lives of three to fiveyears.

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

The Company recognizes revenue pursuant to therequirements of Statement of Position (SOP) 97-2, *SoftwareRevenue Recognition*, and SOP 98-9, Modification of SOP 97-2,*Software Revenue Recognition With Respect toCertain Transactions*, issued by the American Institute of CertifiedPublic Accountants.

The Company’s products include software, hosting andsupport services, and professional services. Software products can be licensedover time (a “term” license) or perpetually. Hosting and support servicesinvolve the remote management of the software, technical assistance, andunspecified product upgrades on a when and if available basis. Professionalservices include consulting, training and development services.

Revenue is recognized when all of the followingcriteria are met: a) the Company has entered into a legally bindingagreement with the customer; b) the software has been delivered or madeavailable to the customer; c) the Company’s fee for providing the softwareand services is determinable; and d) the Company estimates that collectionof its fee is reasonably probable.

F-8

----

The Company sells its products primarily on a termbasis. Term contracts are non-cancelable, and generally cover a period of twoyears, but can range from a period of six months to four years. For termcontracts, the Company recognizes software, hosting and support revenue ratablyover the time period covered.

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

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

License fee revenue from arrangements with resellersis recognized on a sell-through basis, which is when payment becomes due fromthe customer and delivery of the product has occurred, assuming no significantvendor obligations remain.

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

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

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

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

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

| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue by type:                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Recurring (term  licenses, support and hosting) |       |                                       | 67         | % |   |   | 59 | % |   |   | 53 | % |   |
| Perpetual  licenses                             |       |                                       | 15         |   |   |   | 22 |   |   |   | 25 |   |   |
| Professional  services                          |       |                                       | 18         |   |   |   | 19 |   |   |   | 22 |   |   |
|                                            |       |                                       | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

F-9

----

Deferred revenue represents amounts received or duefrom customers for which the revenue recognition criteria have not been met.The majority of deferred revenue is due to the ratable revenue recognition ofterm 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.

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

Sales commissions areexpensed as incurred. Commission expense was $4.0 million,$8.6 million and $10.7 million for the years ended December 31, 2003,2004 and 2005, respectively.

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

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

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

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

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

Long-lived assets,including intangible assets, are reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future net cash flows expectedto be generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the estimated fair value of the assets. Assets tobe disposed of are reported at the lower of the carrying amount or fair valueless costs to sell.

F-10

----

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

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

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted average  common shares outstanding for basic net income (loss) per share |       | 14,560                                     |       | 20,738 |   | 30,631 |   |
| Effect of  dilutive securities:                                                   |       |                                       |       |   |   |   |   |
| Redeemable convertible preferred stock                                            |       | —                                     |       | 4,328 |   | — |   |
| Employee stock options                                                            |       | —                                     |       | 4,055 |   | 3,028 |   |
| Warrants                                                                          |       | —                                     |       | 56 |   | 36 |   |
| Weighted average shares  outstanding for dilutive net income (loss) per share     |       | 14,560                                     |       | 29,177 |   | 33,695 |   |

 

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

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Redeemable  convertible preferred stock |       | 7,265                                      |       |   | — |   |   |   | — |   |   |
| Employee stock  options                 |       | 5,357                                      |       |   | 43 |   |   |   | 359 |   |   |
| Warrants                                |       | 101                                        |       |   | — |   |   |   | — |   |   |

 

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

The Company accounts for its employee stock-basedcompensation using the intrinsic value method in accordance with AccountingPrinciples Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees.* Under APB 25, when the exercise priceof an employee stock option equals the estimated market price of the underlyingstock on the date of grant, no compensation expense is recognized.

TheCompany has adopted the disclosure only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation,*and SFAS No. 148, *Accounting forStock-Based Compensation—Transition and Disclosure*. Pro formainformation regarding net income (loss) required by SFAS Nos. 123 and 148, hasbeen determined as if the Company had accounted for its stock options under theappropriate minimum value or fair value method. The per share weighted averagevalue of the stock options granted in 2003, 2004 and 2005 was $0.22, $6.05 and$7.23, respectively, at the date of grant using the Black-Scholes-Mertonvaluation model. Assumptions used to measure the fair value of options grantedto employees and directors were:

| ** **                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted average  risk free rate |       | 3.16                                       | %          | 3.51 | % | 4.12 | % |
| Expected term                    |       | 5 yrs                                      |       | 5 yrs |   | 5 yrs |   |
| Dividend yield                   |       | 0                                          | %          | 0 | % | 0 | % |
| Weighted average  volatility     |       | 0                                          | %          | 78 | % | 67 | % |

 

F-11

----

TheCompany’s Employee Stock Purchase Plan provides for two purchase periods eachyear, with purchases effected on June 30 and December 31. For thepurchase period ended December 31, 2005, terms of the plan were revised toremove the look-back option and reduce the discount so that the plan is deemednoncompensatory under SFAS 123R. The estimated fair value of shares purchased December 31,2004 and June 30, 2005 was $2.43 and $5.82, respectively, and was based onthe following assumptions:

| ** **                   | ** ** | **Purchase Period Ended** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **Dec 31, 2004**          | ** ** | **Jun 30, 2005** | ** ** |
| Risk free rate               |       |                                | 2.0        | % |   |   | 2.9 | % |   |
| Expected term                |       |                                | 0.5 yrs    |   |   |   | 0.5 yrs |   |   |
| Dividend yield               |       |                                | 0          | % |   |   | 0 | % |   |
| Weighted average  volatility |       |                                | 78         | % |   |   | 75 | % |   |

 

Hadthe Company recorded compensation expense for its stock option and employeestock purchase plans in accordance with SFAS No. 123, net income (loss)would have been (in thousands except per share data):

| ** **                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                       | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income  (loss), as reported                                                  |       | $                                          | (4,133     | ) | $ | 3,441 |   | $ | 7,693 |   |
| Add stock-based  compensation included in the determination of net income (loss) |       | 1                                          |       | — |   | 13 |   |
| Less stock-based  compensation expense determined under the fair value method    |       | (369                                       | )          | (1,289 | ) | (3,292 | ) |
| Pro forma net income  (loss)                                                     |       | $                                          | (4,501     | ) | $ | 2,152 |   | $ | 4,414 |   |
| Net income (loss)  per share                                                     |       |                                       |       |   |   |   |   |
| Basic:                                                                           |       |                                       |       |   |   |   |   |
| As reported                                                                      |       | $                                          | (0.28      | ) | $ | 0.17 |   | $ | 0.25 |   |
| Pro forma                                                                        |       | (0.31                                      | )          | 0.10 |   | 0.14 |   |
| Diluted:                                                                         |       |                                       |       |   |   |   |   |
| As reported                                                                      |       | $                                          | (0.28      | ) | $ | 0.12 |   | $ | 0.23 |   |
| Pro forma                                                                        |       | (0.31                                      | )          | 0.07 |   | 0.13 |   |

 

From time to time the Company grants options topurchase 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 isrecognized over the vesting period using the straight-line method. Theestimated fair value of options granted to non-employees in 2005 was $26,000.

In December 2004, theFinancial Accounting Standards Board issued SFAS No. 123 (revised 2004) (“123R”),*Share-Based Payment*, whichreplaces SFAS No. 123 and supersedes APB 25. The Company is required toapply 123R as of the first annual reporting period beginning after June 15,2005. 123R covers a wide range of share-based compensation, including shareoptions, restricted share plans, performance-based awards, share appreciationrights, and employee share purchase plans. The statement requires therecognition 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. The Company will adopt the provisions of 123Rbeginning January 1, 2006, using the modified prospective method and theBlack-

F-12

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Scholes-Mertonvaluation model. Compensation expense will be recorded using the straight-linemethod over the applicable vesting periods.

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

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

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

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

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

The Company expensesadvertising costs as incurred. Advertising costs were $1.3 million $1.9 millionand $2.7 million for the years ended December 31, 2003, 2004 and 2005,respectively.

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

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

**(2)**          Acquisitionof Convergent Voice Assets

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

The purchase price consisted of $1 million paid incash on May 5, 2005 to the shareholders of Convergent Voice, and $23,000of transaction costs. Approximately $936,000 of the purchase price wasallocated to identifiable intangible assets based on a discounted cash flowanalysis. The identifiable intangible assets consist primarily of developedsoftware, and will be amortized to earnings over a period of five years. Theremaining purchase price of approximately $87,000 was allocated to othertangible assets acquired based on their estimated net realizable value orreplacement cost.

Pro forma results of the business combination have notbeen provided because the effect is not material on an individual or aggregatebasis.

F-13

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

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

**(4)**          SupplementalCash Flow Information

Supplementalstatement of cash flow information follows (in thousands):

| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Supplemental disclosure  of cash flow information:  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the period for:                   |       |                                       |       |   |   |   |   |
| Interest                                            |       | $                                          | 152        |   | $ | 127 |   | $ | 5 |   |
| Income taxes                                        |       | 402                                        |       | 100 |   | 239 |   |
| 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 |   | — |   |
| Issuance of  common stock upon exercise of warrants |       | —                                     |       | — |   | 291 |   |

 

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

Thecomponents of cash and investments at December 31, 2004 and 2005 are asfollows (in thousands):

| ** **                        | ** ** | ** ** | ** ** | **Unrealized** | ** ** | **Fair  Market** | ** ** | **Cash and** | ** ** | **Short-term** | ** ** |
|-----------------------------------|------------|------------|------------|----------------|------------|------------------|------------|-------------------|------------|----------------|------------|
| **December 31, 2004**   | ** ** | ** ** | ** ** | **Cost**       | ** ** | **Gains**        | ** ** | **Losses**        | ** ** | **Value**      | ** ** | **Equivalents** | ** ** | **Investments** | ** ** |
| 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:                |       |       |       |           |       |             |       |              |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Auction rate preferreds           |       | 6,975      |       |           | —     |             |       |              | —     |           |       | 6,975 |   |   | — |   |   |   | 6,975 |   |   |
| Totals at  December 31, 2004 |       | $          | 50,145     |           |       | $                | 1          |              |       |           | $          | (14 | ) |   | $ | 50,132 |   |   | $ | 18,944 |   |   |   | $ | 31,188 |   |   |
|                                   |            |            |            |                |            |                  |            |                   |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-14

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| ** **                        | ** ** | ** ** | ** ** | **Unrealized** | ** ** | **Fair  Market** | ** ** | **Cash and** | ** ** | **Short-term** | ** ** |
|-----------------------------------|------------|------------|------------|----------------|------------|------------------|------------|-------------------|------------|----------------|------------|
| **December 31, 2005**   | ** ** | ** ** | ** ** | **Cost**       | ** ** | **Gains**        | ** ** | **Losses**        | ** ** | **Value**      | ** ** | **Equivalents** | ** ** | **Investments** | ** ** |
| Cash and cash  equivalents:       |       |       |       |           |       |             |       |              |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Cash                              |       | $          | 11,131     |           |       | $                | —     |              |       |           | $          | — |   |   | $ | 11,131 |   |   | $ | 11,131 |   |   |   | $ | — |   |   |
| Money market funds                |       | 4,392      |       |           | —     |             |       |              | —     |           |       | 4,392 |   |   | 4,392 |   |   |   | — |   |   |
| Fixed maturity  securities:       |       |       |       |           |       |             |       |              |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Commercial paper                  |       | 18,162     |       |           | 4          |             |       |              | (1         | )              |       | 18,165 |   |   | 18,165 |   |   |   | — |   |   |
| Corporate notes and bonds         |       | 1,331      |       |           | —     |             |       |              | —     |           |       | 1,331 |   |   | 680 |   |   |   | 651 |   |   |
| U.S. Government agency securities |       | 17,594     |       |           | 1          |             |       |              | (78        | )              |       | 17,517 |   |   | 3,951 |   |   |   | 13,566 |   |   |
| State and municipal securities    |       | 6,658      |       |           | —     |             |       |              | (6         | )              |       | 6,652 |   |   | 2,555 |   |   |   | 4,097 |   |   |
| Sub-total                         |       | 59,268     |       |           | 5          |             |       |              | (85        | )              |       | 59,188 |   |   | 40,874 |   |   |   | 18,314 |   |   |
| Equity securities:                |       |       |       |           |       |             |       |              |       |           |       |   |   |   |   |   |   |   |   |   |   |
| Auction rate preferreds           |       | 5,000      |       |           | —     |             |       |              | —     |           |       | 5,000 |   |   | — |   |   |   | 5,000 |   |   |
| Totals at  December 31, 2005 |       | $          | 64,268     |           |       | $                | 5          |              |       |           | $          | (85 | ) |   | $ | 64,188 |   |   | $ | 40,874 |   |   |   | $ | 23,314 |   |   |
|                                   |            |            |            |                |            |                  |            |                   |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The unrealized losses of $85,000 at December 31,2005 related to investment-grade, fixed income securities, and are primarilyattributable to changes in interest rates. Approximately $54,000 of theunrealized losses related to securities held more than one year. Managementdoes not believe any of the unrealized losses at December 31, 2005represent an other-than-temporary impairment. Realized gains or losses fromsales of available-for-sale securities in 2004 and 2005 were immaterial.

The underlying maturitiesof short-term investment balances at December 31, 2005 were approximately$18 million within one year, and $300,000 of auction rate securities thatmature after ten years. These items are classified as short-term because theyrepresent investments of cash that are available for current operations.

**(6)**          Propertyand Equipment, Net

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

| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Computer  equipment                  |       | $                     | 7,815      |   | $ | 10,525 |   |
| Software  purchased for internal use |       | 2,543                 |       | 3,615 |   |
| Equipment                            |       | 888                   |       | 1,012 |   |
| Furniture and  fixtures              |       | 845                   |       | 994 |   |
| Leasehold  improvements              |       | 23                    |       | 185 |   |
| Total cost                           |       | 12,114                |       | 16,331 |   |
| Less accumulated  depreciation       |       | (7,721                | )          | (9,880 | ) |
|                                 |       | $4,393                |       | $ | 6,451 |   |
|                                      |            |                       |            |  |  |  |  |

 

F-15

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**(7)**          Intangibleassets

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

| ** **                             | ** ** | **Domain  Name** | ** ** | **Purchased  Technologies** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------|------------|-----------------------------|------------|-----------|------------|
| 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 |   |
| As of  December 31, 2005:         |       |             |       |                        |       |      |       |   |   |   |   |
| Gross carrying value                   |       |             | $          | 236                         |       |      |       | $ | 2,785 |   |   | $ | 3,021 |   |
| Accumulated amortization               |       |             | (236       | )                           |       |      | (1,298     | ) |   | (1,534 | ) |
| Net carrying value                     |       |             | $          | —                      |       |      |       | $ | 1,487 |   |   | $ | 1,487 |   |
| Weighted-average  amortization period: |       |             |       |                        |       |      |       |   |   |   |   |
| (in years)                             |       |             | 5.0        |                        |       |      | 4.3        |   |   | 4.3 |   |
| Aggregate amortization expense:        |       |             |       |                        |       |      |       |   |   |   |   |
| 2004                                   |       |             | $          | 47                          |       |      |       | $ | 304 |   |   | $ | 351 |   |
| 2005                                   |       |             | 32         |                        |       |      | 550        |   |   | 582 |   |
| Estimated amortization expense:        |       |             |       |                        |       |      |       |   |   |   |   |
| 2006                                   |       |             | $          | —                      |       |      |       | $ | 524 |   |   | $ | 524 |   |
| 2007                                   |       |             | —     |                        |       |      | 368        |   |   | 368 |   |
| 2008                                   |       |             | —     |                        |       |      | 308        |   |   | 308 |   |
| 2009                                   |       |             | —     |                        |       |      | 224        |   |   | 224 |   |
| 2010                                   |       |             | —     |                        |       |      | 62         |   |   | 63 |   |

 

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

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

| ** **                                                                                                                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Obligation under  capital lease for tenant improvements to leased property, payable monthly in  installments of $3 through May 2010 at 6% interest  |       |                  | $          | — |   |   | $ | 147 |   |
| Less current  portion                                                                                                                                         |       |                  | —     |   |   | 30 |   |
| Long-term debt,  excluding current portion                                                                                                                    |       |                  | $          | — |   |   | $ | 117 |   |

 

In 2005 the Company entered into an office leaseagreement that included $162,000 of tenant improvements, which have beencapitalized and will be repaid to the landlord over the initial lease term offive years. The improvements are being amortized over an expected useful lifeof seven years. The Company expects to renew the office lease upon its initialterm expiration in 2010.

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

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**(9)**          RedeemableConvertible Preferred Stock

The Company sold approximately 7.3 million shares ofSeries A and Series B redeemable convertible preferred stock in 1999,2000 and 2001, for net proceeds of approximately $32.1 million. These preferredshares had certain liquidation, dividend, and redemption rights senior tocommon shares. The Company did not declare or pay dividends, or redeem anySeries A and Series B preferred shares while they were outstanding.The Series A and Series B preferred shares automatically convertedinto shares of common stock, on a one-for-one basis, in conjunction with theCompany’s initial public offering of common stock in August 2004.

The Company has authorized15 million shares of preferred stock, $.001 par value, which may be issued fromtime to time by its board of directors without further action by stockholders.Shares of preferred stock may be issued with dividend, redemption, voting orother rights senior to existing common shares. There were no outstanding sharesof preferred stock at December 31, 2004 or 2005.

**(10)**   StockOptions and Warrants

TheCompany’s 1998 Long-Term Incentive and Stock Option Plan, as amended, and the2004 Equity Incentive Plan (the “Plans”) provide for stock options to begranted to employees, consultants, independent contractors, officers anddirectors. The 2004 Equity Incentive Plan was adopted by the Board of Directorsin May 2004 and by stockholders in June 2004, and became effective inconjunction with the initial public offering. Except for director automaticgrants, options are granted at the discretion of the Company’s Board ofDirectors, at an exercise price and term determined by the Board of Directors.Exercise prices are not less than fair market value at the date of grant, andthe term of options is not greater than ten years. Options generally vest overa period of four years in eight equal increments. Changes in the shares grantedfor stock options for the years ended December 31, 2003, 2004 and 2005,are summarized as follows (option shares in thousands):

| ** **                                                | ** ** | **Shares  available  for grant** | ** ** | **Outstanding  options** | ** ** | **Weighted  average exercise  price per share** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------------------------------------------------------|------------|
| 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 |   |   |
| Additional reserve for the 2004 Equity Incentive  Plan(1) |       |                                  | 2,504      |                     |       |                                                           | —     |   |   |   | — |   |   |
| Granted                                                   |       |                                  | (887       | )                        |       |                                                           | 887        |   |   |   | 9.26 |   |   |
| Exercised                                                 |       |                                  | —     |                     |       |                                                           | (616       | ) |   |   | 0.79 |   |   |
| Forfeited, expired, exchanged or canceled(2)         |       |                                  | 72         |                     |       |                                                           | (116       | ) |   |   | 2.95 |   |   |
| Balance at  December 31, 2004                        |       |                                  | 3,153      |                     |       |                                                           | 5,512      |   |   |   | 2.89 |   |   |
| Annual reserve addition(3)                                |       |                                  | 1,000      |                     |       |                                                           | —     |   |   |   | — |   |   |
| Granted                                                   |       |                                  | (1,263     | )                        |       |                                                           | 1,263      |   |   |   | 12.39 |   |   |
| Exercised                                                 |       |                                  | —     |                     |       |                                                           | (2,616     | ) |   |   | 1.77 |   |   |
| Forfeited, expired, exchanged or canceled(2)         |       |                                  | 117        |                     |       |                                                           | (261       | ) |   |   | 7.63 |   |   |
| Balance at  December 31, 2005                        |       |                                  | 3,007      |                     |       |                                                           | 3,898      |   |   |   | $ | 6.41 |   |   |

----

(1)          The additional reservefor the 2004 Equity Incentive Plan became effective upon the completion of ourinitial public offering of common stock on August 5, 2004. These shareswere added to then 

F-17

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existing number of sharesavailable for grant under the 1998 Long-Term Incentive and Stock Option Plan toarrive at a total of 3,500,000 shares available for grant. All subsequentlygranted option shares have been made under the 2004 Equity Incentive Plan.

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

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

Thefollowing table summarizes information about the stock options outstanding at December 31,2005 (option shares in thousands):

| ** **                     | ** ** | **Options outstanding** | ** ** | **Options exercisable**           | ** ** |
|--------------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| **Exercise  price range** | ** ** | **Number  outstanding**      | ** ** | **Weighted  average  exercise  price** | ** ** | **Weighted  average  remaining  contractual  life** | ** ** | **Numberm  currently  exercisable** | ** ** | **Weighted  average  exercise  price** | ** ** |
| $0.08 - $0.45                  |       |                         | 503        |                                   |       |   | $ | 0.26 |   |   |   | 3.3 |   |   |   | 503 |   |   |   | $ | 0.26 |   |   |
| $0.90 - $1.50                  |       |                         | 1,316      |                                   |       |   | 1.50 |   |   |   | 6.9 |   |   |   | 726 |   |   |   | 1.49 |   |   |
| $1.51 - $7.35                  |       |                         | 397        |                                   |       |   | 5.96 |   |   |   | 7.4 |   |   |   | 186 |   |   |   | 5.60 |   |   |
| $7.36 - $10.50                 |       |                         | 512        |                                   |       |   | 9.05 |   |   |   | 7.9 |   |   |   | 233 |   |   |   | 9.42 |   |   |
| $10.51 - $12.81                |       |                         | 493        |                                   |       |   | 12.22 |   |   |   | 9.3 |   |   |   | 119 |   |   |   | 11.89 |   |   |
| $12.82 - $13.87                |       |                         | 529        |                                   |       |   | 13.83 |   |   |   | 9.4 |   |   |   | 42 |   |   |   | 13.75 |   |   |
| $13.88 - $19.44                |       |                         | 148        |                                   |       |   | 17.22 |   |   |   | 9.4 |   |   |   | 10 |   |   |   | 17.77 |   |   |
|                           |       |                         | 3,898      |                                   |       |   | $ | 6.41 |   |   |   | 7.4 |   |   |   | 1,819 |   |   |   | $ | 3.64 |   |   |

 

In January 2003and February 2004, in connection with amendments to their equipment andcommercial bank loans outstanding at that time, the Company issued warrants topurchase 13,333 shares and 14,666 shares, respectively, of Series Bpreferred stock at an exercise price of $4.50 per share. The warrants are exercisablethrough the later of five years from the date of grant or three years afterclosing of an initial public offering by the Company. The January 2003 andFebruary 2004 warrants were recorded at their estimated fair values of$12,000 and $40,000, respectively, using the 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 warrantsto purchase Series B redeemable convertible preferred stock wereautomatically converted into warrants to purchase common stock in conjunctionwith the Company’s initial public offering in August 2004. During 2005,all outstanding warrants were exercised, pursuant to the net exerciseprovisions of the agreements, resulting in the issuance of 77,678 shares ofcommon stock.

F-18

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**(11)**   Commitmentsand Contingencies

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

TheCompany leases its office facilities and certain office equipment under variousnon-cancelable operating lease agreements with various expiration dates through2013. Future minimum payments for the next five years and thereafter as of December 31,2005, under these leases, are as follows:

| 2006       |   | $         | 2,119,000 |   |
|------------|--------|-----------|-----------|--------|
| 2007       |   | 2,002,000 |      |
| 2008       |   | 1,786,000 |      |
| 2009       |   | 1,627,000 |      |
| 2010       |   | 1,223,000 |      |
| Thereafter |   | 1,351,000 |      |

 

Rent expense was $1.2 million, $1.4 millionand $1.9 million in 2003, 2004 and 2005, respectively. Rent expense isdetermined using the straight-line method of the minimum expected rent paidover the term of the agreement. The Company has no contingent rent agreements.

The Company leases aportion of its office facilities from a development group, of which the Company’schief executive officer is a 50% member and the Company’s Vice President ofDelivery is a 25% member. During 2003, 2004 and 2005, the Company paid$562,000, $605,000 and $742,000, respectively, to the development group underthese leases.

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

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

Future minimum payments asof December 31, 2005 under these arrangements were $883,000 for 2006,$291,000 per year from 2007 through 2010, and $61,000 thereafter.

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

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

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

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

The Company has alsoagreed to indemnify its directors and executive officers for costs associatedwith any fees, expenses, judgments, fines and settlement amounts incurred byany of these persons in any action or proceeding to which any of those personsis, or is threatened to be, made a party by reason of the person’s service as adirector or officer, including any action by the Company, arising out of thatperson’s services as the Company’s director of officer or that person’sservices provided to any other company or enterprise at the Company’s request.

F-19

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

From time to time, theCompany is involved in legal proceedings arising in the ordinary course ofbusiness. The Company believes that the resolution of these matters will nothave a material effect on the Company’s consolidated financial position,results of operations or liquidity.

**(12)**   IncomeTaxes

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

| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| United States |       | $                                          | (1,213     | ) | $ | 6,614 |   | $ | 14,386 |   |
| Foreign       |       | (2,368                                     | )          | (3,065 | ) | (6,215 | ) |
|          |       | $                                          | (3,581     | ) | $ | 3,549 |   | $ | 8,171 |   |

 

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

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Current:       |       |                                       |       |   |   |   |   |
| Federal        |       | $                                          | —     |   | $ | — |   | $ | 454 |   |
| Foreign        |       | 196                                        |       | 94 |   | 76 |   |
| State          |       | 233                                        |       | 6 |   | (52 | ) |
| Total current  |       | 429                                        |       | 100 |   | 478 |   |
| Deferred:      |       |                                       |       |   |   |   |   |
| Federal        |       | $                                          | 110        |   | $ | — |   | $ | — |   |
| Foreign        |       | —                                     |       | — |   | — |   |
| State          |       | —                                     |       | — |   | — |   |
| Total deferred |       | 110                                        |       | — |   | — |   |
|           |       | $                                          | 539        |   | $ | 100 |   | $ | 478 |   |

 

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

| ** **                                               | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                               | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Statutory Federal  tax rate                              |       |                                       | (34        | )% |   |   | 34 | % |   |   | 34 | % |   |
| Net operating  loss tax benefits (realized) not realized |       |                                       | 30         |   |   |   | (41 | ) |   |   | (40 | ) |   |
| U.S. Federal  alternative minimum tax                    |       |                                       | —     |   |   |   | — |   |   |   | 6 |   |   |
| State income taxes,  net of federal benefit              |       |                                       | 7          |   |   |   | — |   |   |   | (1 | ) |   |
| Foreign taxes                                            |       |                                       | 8          |   |   |   | 3 |   |   |   | 1 |   |   |
| Foreign tax rate  differential                           |       |                                       | 3          |   |   |   | 3 |   |   |   | 4 |   |   |
| Nondeductible  meals & entertainment expense    |       |                                       | 1          |   |   |   | 3 |   |   |   | 2 |   |   |
| Other                                                    |       |                                       | —     |   |   |   | 1 |   |   |   | — |   |   |
|                                                     |       |                                       | 15         | % |   |   | 3 | % |   |   | 6 | % |   |

 

F-20

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Deferredtax components are as follows (in thousands):

| ** **                       | ** ** | **At December 31,** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **2004**                      | ** ** | **2005** | ** ** |
| Deferred tax assets:             |       |                          |       |   |   |
| Net operating loss carryforwards |       | $                             | 14,154     |   | $ | 20,951 |   |
| Deferred revenue                 |       | 2,450                         |       | 3,876 |   |
| Tax credits                      |       | 1,079                         |       | 1,550 |   |
| Other                            |       | 1,042                         |       | 1,492 |   |
| Total deferred tax assets        |       | 18,725                        |       | 27,869 |   |
| Valuation allowance              |       | (17,386                       | )          | (25,633 | ) |
| Net deferred tax assets          |       | 1,339                         |       | 2,236 |   |
| Deferred tax  liabilities:       |       |                          |       |   |   |
| Fixed assets and intangibles     |       | (589                          | )          | (350 | ) |
| Other                            |       | (750                          | )          | (1,886 | ) |
| Total deferred tax liabilities   |       | (1,339                        | )          | (2,236 | ) |
| Net deferred tax  assets         |       | $                             | —     |   | $ | — |   |

 

The ultimate realization of deferred tax assets isdependent upon the existence, or generation, of taxable income in the periodswhen those temporary differences and net operating loss carryforwards aredeductible. Management considers the scheduled reversal of deferred taxliabilities, taxes paid in carryback years, projected future taxable income,available tax planning strategies, and other factors in making this assessment.Based on available evidence, management does not believe it is more likely thannot that any or all of the deferred tax assets will be realized. Accordingly,the Company has established a valuation allowance equal to the net deferred taxassets. The valuation allowance increased by $2.5 million in 2003, decreased by$54,000 in 2004, and increased by $8.2 million in 2005.

The Company will provide United States income taxes onthe earnings of foreign subsidiaries unless the subsidiaries’ earnings areconsidered to be permanently invested outside the United States. To the extentthat the foreign earnings previously treated as permanently reinvested arerepatriated, the related United States tax liability may be reduced by anyforeign income taxes paid on those earnings. At December 31, 2004 and2005, there were no accumulated earnings in foreign subsidiaries.

At December 31, 2005, the Company had domesticFederal and state net operating loss carryforwards of approximately$36.9 million and $35.5 million, respectively. Federal net operating losscarryforwards expire between 2021 and 2025, and state net operating lossesexpire between 2006 and 2025. In addition, the Company has federal research anddevelopment credits and foreign tax credits available to reduce future domesticincome taxes. The research and development credits expire between 2019 and2024. The foreign tax credits expire between 2007 and 2015. The Company alsohas approximately $20.3 million of foreign net operating losscarryforwards that are not subject to expiration. Under the Tax Reform Act of1986, as amended, the amounts of and benefits from net operating losscarryforwards and research and development credits may be impaired or limitedin certain circumstances. Events which cause limitations in the amount of netoperating losses that the Company may utilize in any one year include, but arenot limited to, a cumulative ownership change of more than 50%, as defined,over a three year period. The Company believes no such ownership change hasoccurred through December 31, 2005.

The accumulated benefitsassociated with the exercise of stock options have provided a deferred benefitof approximately $13.1 million, which has been fully offset by a valuationallowance. The deferred tax benefit associated with the employee stock optionswill be credited to additional paid-in capital if and when realized.

F-21

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**(13)**   FairValue of Financial Instruments

Thecarrying amounts of cash and cash equivalents, accounts receivable and accountspayable approximated their fair values at December 31, 2004 and 2005. Thefair values of remaining financial instruments on the Company’s consolidatedbalance sheets were:

| ** **                       | ** ** | **2004**              | ** ** | **2005**        | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------|------------|
| ** **                       | ** ** | **Carrying  Value**   | ** ** | **Fair  Value** | ** ** | **Carrying  Value** | ** ** | **Fair  Value** | ** ** |
| ** **                       | ** ** | **In thousands** | ** ** |
| Term receivables—current    |       |                  | 10,090     |            |       | 10,090 |   |   | 15,376 |   |   | 15,376 |   |
| Term receivables—noncurrent |       |                  | 5,756      |            |       | 5,136 |   |   | 10,697 |   |   | 9,412 |   |
| Debt                             |       |                  | —     |            |       | — |   |   | 147 |   |   | 141 |   |

 

The values providedare representative of fair values as of December 31, 2004 and 2005, and donot reflect subsequent changes in interest, tax or currency exchange rates, orother variables that may affect the determination of fair value. The followingmethods and assumptions were used to estimate fair values:

*Termreceivables—current:**  *Thecarrying amount approximated fair value at the respective dates due to therelative short maturities of this item.

*Termreceivables—noncurrent:*   Fair value for termreceivables due beyond one year from December 31, 2004 and 2005, has beenestimated by discounting the carrying amount by a current rate of interest forthe period of time the items are expected to be outstanding.

*Debt:*   Thefair value of long-term debt has been estimated by discounting the carryingamount by a current rate of interest for the period of time the debt isexpected to be outstanding.

**(14)**   EmployeeBenefit Plans

The Company has a voluntary defined contributionretirement plan qualifying under Section 401(k) of the InternalRevenue Code of 1986. The plan covers substantially all full-time employees.Under the terms of the plan, participants may contribute up to the lower of 12%of their salary or the statutorily prescribed limit to the plan. Employees areeligible after 90 days of service. At its discretion, the Company may makematching contributions. The Company made matching contributions during 2003,2004 and 2005 of $327,000, $542,000, and $680,000, respectively. The Companyalso has retirement benefit plans related to its foreign subsidiaries. Amountsexpensed under these plans were $97,000, $165,000, and $274,000 during 2003, 2004and 2005, respectively.

The Company has a medical, dental and vision benefitplan and a short-term disability program covering full-time employees of theCompany and their dependents. The plan is a partially self-funded plan underwhich participant claims are obligations of the plan. The plan is fundedthrough employer and employee contributions at a level sufficient to pay forthe benefits provided by the plan. The Company contributions to the plan were$964,000, $877,000, and $1.2 million during 2003, 2004 and 2005, respectively. During2005 the plan maintained individual and aggregate stop loss insurance policieson the medical portion of the plan of $75,000 and $2.1 million (based onactual plan participants, adjusted monthly), respectively, to mitigate losses.

In July 2004the Company adopted the 2004 Employee Stock Purchase Plan (“Plan”) which becameeffective in conjunction with the initial public offering of common stock. ThePlan is administered by the compensation committee of the board of directorsand is intended to qualify as an employee stock purchase plan within themeaning of Section 423 of the Internal Revenue Code. Under the terms ofthe plan, substantially all employees are eligible to purchase shares ofRightNow common stock through periodic after-tax payroll deductions at apurchase price established by the administrator. Payroll deductions are limitedto 15% of the employee’s regular compensation for each purchase period. Purchase

F-22

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periods are consecutive six-month periods ending onthe last day in June and December each year. Activity under the planfor 2004 and 2005 was as follows:

| ** **                | ** ** | **Purchase Date** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **Dec 31,**       | ** ** | **Jun 30,** | ** ** | **Dec 31,** | ** ** |
| ** **                | ** ** | **2004**               | ** ** | **2005** | ** ** | **2005** | ** ** |
| Purchase price  per share |       | $                      | 7.00       |   | $ | 10.22 |   | $ | 17.54 |   |
| Shares purchased          |       | 98,471                 |       | 51,629 |   | 7,322 |   |
|                           |            |                        |            |  |  |  |  |  |  |  |

 

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

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

| ** **                | ** ** | **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 |   |

 

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

 

F-23

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