##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                     to                      .
 Commission file number: 000-50463
 Callidus Software Inc.
 (Exact name of registrant as specified in its charter)
 Delaware
    
    77-0438629(State or Other Jurisdiction of 
Incorporation or Organization)
    
    (I.R.S. Employer
Identification Number)
 Callidus Software Inc.
160 West Santa Clara Street, Suite 1500
San Jose, CA 95113  (Address of principal executive offices, including zip code)  (408) 808-6400  (Registrants Telephone Number, including area code)
 þ o
  o o þ
 o þ




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##### 



TABLE OF CONTENTS
 PART I. FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 4. Controls and Procedures
    
    
    38PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    38Item 1A. Risk Factors
    
    
    39Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    49Item 6. Exhibits
    
    
    49Signatures
    
    
    49Exhibit Index
    
    
    50EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
   2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1 Financial Statements
 CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amount)
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,157
    
    
    $
    23,705Short-term investments
    
    
    39,054
    
    
    
    40,000Accounts receivable, net
    
    
    15,510
    
    
    
    11,063Prepaids and other current assets
    
    
    3,164
    
    
    
    1,581Total current assets
    
    
    71,885
    
    
    
    76,349Property and equipment, net
    
    
    3,173
    
    
    
    2,801Deposits and other assets
    
    
    1,233
    
    
    
    1,494Total assets
    
    $
    76,291
    
    
    $
    80,644LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    752
    
    
    $
    756Accrued payroll and related expenses
    
    
    4,417
    
    
    
    6,383Accrued expenses
    
    
    2,600
    
    
    
    2,043Deferred revenue
    
    
    11,370
    
    
    
    12,205Total current liabilities
    
    
    19,139
    
    
    
    21,387Deferred rent
    
    
    677
    
    
    
    377Long-term deferred revenue
    
    
    594
    
    
    
    729Other liabilities
    
    
    70
    
    
    
    Total liabilities
    
    
    20,480
    
    
    
    22,493Stockholders equity:Common stock, $0.001 par value; 100,000 shares authorized;
28,132 and 26,854 shares issued and outstanding at
September 30, 2006 and December 31, 2005, respectively
    
    
    28
    
    
    
    27Additional paid-in capital
    
    
    192,108
    
    
    
    186,232Deferred stock-based compensation
    
    
    
    
    
    
    (445
    )Accumulated other comprehensive income
    
    
    332
    
    
    
    171Accumulated deficit
    
    
    (136,657
    )
    
    
    (127,834
    )Total stockholders equity
    
    
    55,811
    
    
    
    58,151Total liabilities and stockholders equity
    
    $
    76,291
    
    
    $
    80,644
  3




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##### Table of Contents



CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(Unaudited)Revenues:License revenues
    
    $
    5,776
    
    
    $
    5,787
    
    
    $
    18,669
    
    
    $
    10,582Maintenance and service revenues
    
    
    11,649
    
    
    
    11,311
    
    
    
    33,377
    
    
    
    33,632Total revenues
    
    
    17,425
    
    
    
    17,098
    
    
    
    52,046
    
    
    
    44,214Cost of revenues:License revenues
    
    
    105
    
    
    
    76
    
    
    
    389
    
    
    
    259Maintenance and service revenues(1)
    
    
    8,205
    
    
    
    7,748
    
    
    
    24,570
    
    
    
    22,703Total cost of revenues
    
    
    8,310
    
    
    
    7,824
    
    
    
    24,959
    
    
    
    22,962Gross profit
    
    
    9,115
    
    
    
    9,274
    
    
    
    27,087
    
    
    
    21,252Operating expenses:Sales and marketing(1)
    
    
    5,570
    
    
    
    5,208
    
    
    
    17,929
    
    
    
    13,358Research and development(1)
    
    
    3,612
    
    
    
    3,109
    
    
    
    10,832
    
    
    
    9,124General and administrative(1)
    
    
    3,195
    
    
    
    2,232
    
    
    
    9,274
    
    
    
    6,931Total operating expenses
    
    
    12,377
    
    
    
    10,549
    
    
    
    38,035
    
    
    
    29,413Operating loss
    
    
    (3,262
    )
    
    
    (1,275
    )
    
    
    (10,948
    )
    
    
    (8,161
    )Interest expense
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (20
    )Interest and other income, net
    
    
    754
    
    
    
    411
    
    
    
    1,997
    
    
    
    1,092Loss before provision for income taxes
    
    
    (2,508
    )
    
    
    (868
    )
    
    
    (8,951
    )
    
    
    (7,089
    )Provision for income taxes
    
    
    
    
    
    
    38
    
    
    
    
    
    
    
    29Loss before cumulative effect of a change in
accounting principle
    
    
    (2,508
    )
    
    
    (906
    )
    
    
    (8,951
    )
    
    
    (7,118
    )Cumulative effect of a change in accounting
principle
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    Net loss
    
    $
    (2,508
    )
    
    $
    (906
    )
    
    $
    (8,823
    )
    
    $
    (7,118
    )Net loss per share  basicLoss before cumulative effect of a change in
accounting principle
    
    $
    (0.09
    )
    
    $
    (0.03
    )
    
    $
    (0.33
    )
    
    $
    (0.27
    )Cumulative effect of a change in accounting
principle
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net loss per share
    
    $
    (0.09
    )
    
    $
    (0.03
    )
    
    $
    (0.32
    )
    
    $
    (0.27
    )Net loss per share  dilutedLoss before cumulative effect of a change in
accounting principle
    
    $
    (0.09
    )
    
    $
    (0.03
    )
    
    $
    (0.33
    )
    
    $
    (0.27
    )Cumulative effect of a change in accounting
principle
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net loss per share
    
    $
    (0.09
    )
    
    $
    (0.03
    )
    
    $
    (0.32
    )
    
    $
    (0.27
    )Shares used in basic per share computation
    
    
    27,888
    
    
    
    26,425
    
    
    
    27,500
    
    
    
    26,636Shares used in diluted per share computation
    
    
    27,888
    
    
    
    26,425
    
    
    
    27,500
    
    
    
    26,636
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##### Table of Contents



CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS  (Continued)
(In thousands, except per share data)
 
 (1)
    
    Effective January 1, 2006, the Company adopted FASB Statement No. 123R (revised
2004), Share-BasedPayment (SFAS 123R) under the modified prospective method. Accordingly, for
the three and nine months ended September 30, 2006, stock-based compensation was accounted for under SFAS
123R, while for the three and nine months ended September 30, 2005, stock-based compensation was accounted
for under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees.See Note 6  Stock-based Compensation. The amounts above include stock-based
compensation as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Cost of maintenance and service revenues
    
    $
    250
    
    
    $
    (2
    )
    
    $
    760
    
    
    $
    89Sales and marketing
    
    
    264
    
    
    
    55
    
    
    
    794
    
    
    
    244Research and development
    
    
    217
    
    
    
    1
    
    
    
    682
    
    
    
    227General and administrative
    
    
    335
    
    
    
    (3
    )
    
    
    1,429
    
    
    
    354
  5




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##### Table of Contents



CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 Nine Months EndedSeptember 30,2006
    
    
    2005(Unaudited)Cash flows from operating activities:Net loss
    
    $
    (8,823
    )
    
    $
    (7,118
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and other amortization
    
    
    1,380
    
    
    
    1,226Provision for doubtful accounts and sales returns
    
    
    598
    
    
    
    476Stock-based compensation
    
    
    3,665
    
    
    
    914Non-cash expenses associated with non-employee options and warrants
    
    
    
    
    
    
    4Loss on disposal of property
    
    
    10
    
    
    
    2Cumulative effect of a change in accounting principle
    
    
    (128
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (4,998
    )
    
    
    2,302Prepaids and other current assets
    
    
    (1,305
    )
    
    
    250Other assets
    
    
    
    
    
    
    (229
    )Accounts payable
    
    
    25
    
    
    
    (838
    )Accrued payroll and related expenses
    
    
    (1,990
    )
    
    
    62Accrued expenses
    
    
    675
    
    
    
    359Deferred revenue
    
    
    (1,009
    )
    
    
    1,662Net cash used in operating activities
    
    
    (11,900
    )
    
    
    (928
    )Cash flows from investing activities:Purchases of investments
    
    
    (39,926
    )
    
    
    (22,685
    )Proceeds from maturities and sale of investments
    
    
    40,950
    
    
    
    31,250Purchases of property and equipment
    
    
    (1,511
    )
    
    
    (782
    )Change in deposits
    
    
    (8
    )
    
    
    Net cash (used in) provided by investing activities
    
    
    (495
    )
    
    
    7,783Cash flows from financing activities:Repayments of long-term debt
    
    
    
    
    
    
    (519
    )Net proceeds from issuance of common stock and warrants
    
    
    2,784
    
    
    
    2,942Net cash provided by financing activities
    
    
    2,784
    
    
    
    2,423Effect of exchange rates on cash and cash equivalents
    
    
    63
    
    
    
    (120
    )Net (decrease) increase in cash and cash equivalents
    
    
    (9,548
    )
    
    
    9,158Cash and cash equivalents at beginning of period
    
    
    23,705
    
    
    
    7,651Cash and cash equivalents at end of period
    
    $
    14,157
    
    
    $
    16,809Supplemental disclosures of cash flow information:Cash paid for income taxes
    
    $
    
    
    
    $
    58Cash paid for interest
    
    $
    
    
    
    $
    16
  6




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CALLIDUS SOFTWARE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Summary of Significant Accounting Policies
 Basis of Presentation
     Reclassifications
  Cumulative Effect of a Change in Accounting Principle
  7




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Principles of Consolidation
  Use of Estimates
  Valuation Accounts
   Balance at
    
    Provision,
    
    
    
    
    
    Balance atBeginning
    
    Net of
    
    
    
    
    
    End ofof Period
    
    Recoveries
    
    Write-Offs
    
    PeriodAllowance for doubtful accountsThree months ended September 30, 2006
    
    $
    553
    
    
    $
    (90
    )
    
    $
    
    
    
    $
    463Three months ended September 30, 2005
    
    
    40
    
    
    
    (5
    )
    
    
    
    
    
    
    35Nine months ended September 30, 2006
    
    
    480
    
    
    
    (12
    )
    
    
    (5
    )
    
    
    463Nine months ended September 30, 2005
    
    
    320
    
    
    
    34
    
    
    
    (319
    )
    
    
    35
 8




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##### Table of Contents



Balance at
    
    
    
    
    
    Remediation
    
    Balance atBeginning
    
    
    
    
    
    Service
    
    End ofof Period
    
    Provision
    
    Claims
    
    PeriodSales return reserveThree months ended September 30, 2006
    
    $
    281
    
    
    $
    112
    
    
    $
    (104
    )
    
    $
    289Three months ended September 30, 2005
    
    
    305
    
    
    
    191
    
    
    
    (177
    )
    
    
    319Nine months ended September 30, 2006
    
    
    310
    
    
    
    610
    
    
    
    (631
    )
    
    
    289Nine months ended September 30, 2005
    
    
    537
    
    
    
    442
    
    
    
    (660
    )
    
    
    319
 Restricted Cash
  Revenue Recognition
   Evidence of an Arrangement.
 Delivery.
 Fixed or Determinable Fee.
 Collection is Deemed Probable.
 Perpetual Licensing.
 9




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##### Table of Contents



Residual Method. Software
Revenue Recognition, Software Revenue Recognition with Respect to Certain
Transactions.
  Contract Accounting Method. Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.
 Accounting for Performance of Construction-Type and
Certain Production-Type Contracts.
 Maintenance Revenue.
 10




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##### Table of Contents



Professional Service Revenue.
 On-Demand Revenue.
 Revenue Recognition Revenue Arrangements with Multiple
Deliverables.
   Net Loss Per Share
  11




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##### Table of Contents



Three Months Ended September 30,
    
    Nine Months Ended September 30,2006
    
    2005
    
    2006
    
    2005Stock options
    
    
    6,996
    
    
    
    5,371
    
    
    
    6,829
    
    
    
    4,949Stock subject to repurchase
    
    
    
    
    
    
    28
    
    
    
    16
    
    
    
    13Warrants
    
    
    11
    
    
    
    114
    
    
    
    69
    
    
    
    58Totals
    
    
    7,007
    
    
    
    5,513
    
    
    
    6,914
    
    
    
    5,020
  Recent Accounting Pronouncements
 How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation).
 Accounting for Uncertainty
in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes.
 Fair Value Measurements
 12




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##### Table of Contents



2. Investments
  Unrealized
    
    
    UnrealizedSeptember 30, 2006
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueAuction rate securities and preferred stock
    
    $
    30,775
    
    
    $
    
    
    
    $
    
    
    
    $
    30,775Corporate notes and obligations
    
    
    15,881
    
    
    
    
    
    
    
    (11
    )
    
    
    15,870US government and agency obligations
    
    
    1,000
    
    
    
    
    
    
    
    (2
    )
    
    
    998Investments in debt and equity securities
    
    $
    47,656
    
    
    $
    
    
    
    $
    (13
    )
    
    $
    47,643
 Unrealized
    
    
    UnrealizedDecember 31, 2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueAuction rate securities and preferred stock
    
    $
    20,575
    
    
    $
    
    
    
    $
    
    
    
    $
    20,575Corporate notes and obligations
    
    
    11,997
    
    
    
    
    
    
    
    (35
    )
    
    
    11,962US government and agency obligations
    
    
    12,500
    
    
    
    
    
    
    
    (56
    )
    
    
    12,444Investments in debt and equity securities
    
    $
    45,072
    
    
    $
    
    
    
    $
    (91
    )
    
    $
    44,981
 September 30,
    
    
    December 31,2006
    
    
    2005Recorded as:Cash equivalents
    
    $
    8,589
    
    
    $
    4,981Short-term investments
    
    
    39,054
    
    
    
    40,000$
    47,643
    
    
    $
    44,981
  13




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3. Commitments and Contingencies
      Accounting for Contingencies
 Other Contingencies
  Guarantors Accounting
and Disclosure
 14




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##### Table of Contents



Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others.
 4. Segment, Geographic and Customer Information
 Disclosures about Segments of an Enterprise and Related Information
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005United States
    
    $
    13,718
    
    
    $
    16,497
    
    
    $
    41,933
    
    
    $
    41,268Europe
    
    
    2,589
    
    
    
    394
    
    
    
    4,902
    
    
    
    1,232Asia Pacific
    
    
    1,118
    
    
    
    207
    
    
    
    5,211
    
    
    
    1,714$
    17,425
    
    
    $
    17,098
    
    
    $
    52,046
    
    
    $
    44,214
   Three Months Ended September 30,
    
    Nine Months Ended September 30,2006
    
    2005
    
    2006
    
    2005Customer 1
    
    
    18
    %
    
    
    
    %
    
    
    6
    %
    
    
    
    %Customer 2
    
    
    12
    %
    
    
    12
    %
    
    
    14
    %
    
    
    11
    %Customer 3
    
    
    3
    %
    
    
    25
    %
    
    
    5
    %
    
    
    10
    %Customer 4
    
    
    2
    %
    
    
    9
    %
    
    
    3
    %
    
    
    12
    %
 5. Comprehensive Loss
  15




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Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net loss
    
    $
    (2,508
    )
    
    $
    (906
    )
    
    $
    (8,823
    )
    
    $
    (7,118
    )Other comprehensive income (loss):Change in unrealized loss on
investments, net
    
    
    18
    
    
    
    58
    
    
    
    78
    
    
    
    133Change in cumulative
translation
adjustments
    
    
    
    
    
    
    (22
    )
    
    
    83
    
    
    
    (132
    )Comprehensive loss
    
    $
    (2,490
    )
    
    $
    (870
    )
    
    $
    (8,662
    )
    
    $
    (7,117
    )
 6. Stock-based Compensation
 Share-Based Payment Accounting for
Stock-Based Compensation Accounting for Stock Issued to Employees,
    16




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Expense Summary
   Three
    
    
    NineMonths
    
    
    MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2005
    
    
    2005Net loss as reported
    
    $
    (906
    )
    
    $
    (7,118
    )Add: Stock-based employee compensation expense under APB
No. 25 included in reported net loss, net of tax
    
    
    51
    
    
    
    914Less: Stock-based employee compensation expense determined
under the fair value method for all awards, net of tax
    
    
    (730
    )
    
    
    (2,355
    )Pro forma net loss
    
    $
    (1,585
    )
    
    $
    (8,559
    )Basic and diluted net loss per share, as reported
    
    $
    (0.03
    )
    
    $
    (0.27
    )Pro forma basic and diluted net loss per share
    
    $
    (0.06
    )
    
    $
    (0.32
    )
 Determination of Fair Value
  17




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##### Table of Contents



Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Stock Option PlansExpected life (in years)
    
    
    3.50
    
    
    
    3.17
    
    
    
    2.50 to 6.00
    
    
    
    3.10Risk-free interest rate
    
    4.69% to 5.07%
    
    
    3.98
    %
    
    4.36% to 5.11%
    
    
    3.81
    %Volatility
    
    
    54
    %
    
    
    69
    %
    
    54% to 60%
    
    
    69
    %Employee Stock Purchase PlanExpected life (in years)
    
    
    0.50 to 1.00
    
    
    
    0.98
    
    
    
    0.49 to 1.00
    
    
    
    0.98Risk-free interest rate
    
    5.08% to 5.17%
    
    
    3.76
    %
    
    4.68% to 5.17%
    
    
    3.73
    %Volatility
    
    37% to 39%
    
    
    49
    %
    
    36% to 43%
    
    
    50
    %
 Stockholder-Approved Stock Option Plans
     18




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##### Table of Contents



WeightedShares
    
    
    
    
    
    
    Weighted
    
    
    AverageAvailable
    
    
    
    
    
    
    Average
    
    
    Remaining
    
    
    Aggregatefor
    
    
    Number of
    
    
    Exercise
    
    
    Contractual
    
    
    IntrinsicGrant
    
    
    Shares
    
    
    Price
    
    
    Term (Years)
    
    
    Value(in thousands)Outstanding as of December 31, 2005
    
    
    2,886,508
    
    
    
    5,325,143
    
    
    $
    4.11Authorized
    
    
    1,381,375
    
    
    
    Granted
    
    
    (2,349,992
    )
    
    
    2,349,992
    
    
    
    4.63Exercised
    
    
    
    
    
    
    (519,376
    )
    
    
    1.53Forfeited
    
    
    432,622
    
    
    
    (432,622
    )
    
    
    4.68Expired
    
    
    161,068
    
    
    
    (161,068
    )
    
    
    9.24Outstanding as of September 30, 2006
    
    
    2,511,581
    
    
    
    6,562,069
    
    
    $
    4.33
    
    
    
    7.23
    
    
    $
    7,239Vested and Expected to Vest as
of September 30, 2006
    
    
    
    
    
    
    6,001,244
    
    
    $
    4.32
    
    
    
    7.23
    
    
    $
    6,946Exercisable as of September 30, 2006
    
    
    
    
    
    
    2,684,620
    
    
    $
    4.08
    
    
    
    6.86
    
    
    $
    4,827
  Employee Stock Purchase Plan
  Other Plan Awards
  19




---



##### Table of Contents



th
 WeightedShares
    
    
    
    
    
    
    Weighted
    
    
    AverageAvailable
    
    
    
    
    
    
    Average
    
    
    Remaining
    
    
    Aggregatefor
    
    
    Number of
    
    
    Exercise
    
    
    Contractual
    
    
    IntrinsicGrant
    
    
    Shares
    
    
    Price
    
    
    Term (Years)
    
    
    Value(in thousands)Outstanding as of December 31, 2005
    
    
    
    
    
    
    1,000,000
    
    
    $
    3.45Exercised
    
    
    
    
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    
    
    
    
    Outstanding as of September 30, 2006
    
    
    
    
    
    
    1,000,000
    
    
    $
    3.45
    
    
    
    8.67
    
    
    $
    1,410Vested and Expected to Vest as
of September 30, 2006
    
    
    
    
    
    
    1,000,000
    
    
    $
    3.45
    
    
    
    8.67
    
    
    $
    1,410Exercisable as of September 30, 2006
    
    
    
    
    
    
    333,333
    
    
    $
    3.45
    
    
    
    8.67
    
    
    $
    470
  7. Related Party Transactions
  20




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion of financial condition and results of operations should be read in
conjunction with Managements Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and the Notes thereto included in our Annual
Report on Form 10-K for the year ended December 31, 2005 and with the condensed consolidated
financial statements and the related notes thereto contained elsewhere in this Quarterly Report on
Form 10-Q . This section of the Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements relate to our future plans, objectives, expectations,
intentions and financial performance and the assumptions that underlie these statements. These
forward-looking statements include, but are not limited to, statements concerning the following:
changes in and expectations with respect to maintenance and service revenues (including on-demand)
and license revenues and gross margins, future operating expense levels, the impact of quarterly
fluctuations of revenue and operating results, levels of recurring revenues, market growth
opportunities, staffing and expense levels, the adequacy of our capital resources to fund
operations and growth and the impact of our adoption of one of the fair value methods for measuring
stock-based compensation described in SFAS 123R. These statements involve known and unknown risks,
uncertainties and other factors that may cause industry trends or our actual results, level of
activity, performance or achievements to be materially different from any future results, level of
activity, performance or achievements expressed or implied by these statements. Many of these
trends and uncertainties are described in Risk Factors set forth elsewhere in this Quarterly
Report on Form 10-Q . We undertake no obligation to update forward-looking statements to reflect
events or circumstances occurring after the date of this Quarterly Report on Form 10-Q .
 Overview of the Results for the Three and Nine Months Ended September 30, 2006
   Revenue Growth
  21




---



##### Table of Contents



Increased Expenses to Support Growth Strategy
    22




---



##### Table of Contents



Growth Strategy Continues but Expense Growth Should be Slower
  Other Business Highlights
    Challenges and Risks
   Application of Critical Accounting Policies and Use of Estimates
   23




---



##### Table of Contents



Revenue Recognition
   Evidence of an Arrangement.
 Delivery.
 Fixed or Determinable Fee.
 Collection is Deemed Probable.
 Perpetual Licensing.
  Residual Method. Software Revenue
 24




---



##### Table of Contents



Recognition, Software Revenue Recognition with Respect to Certain
Transactions.
  Contract Accounting Method. Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.
 Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.
 Maintenance Revenue.
 Professional Service Revenue.
 On-Demand Revenue.
 25




---



##### Table of Contents



Revenue Recognition Revenue Arrangements with Multiple Deliverables.
   Allowance for Doubtful Accounts and Sales Return Reserve
  Revenue Recognition When
Right of Return Exists,
 26




---



##### Table of Contents



Stock-Based Compensation
 Share-Based Payment
 Income Taxes
  Recent Accounting Pronouncements
 How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in
the Income Statement (That Is, Gross versus Net Presentation).
 Accounting for Uncertainty
in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes.
 27




---



##### Table of Contents



Fair Value Measurements
  Results of Operations
 Comparison of the Three and Nine Months Ended September 30, 2006 and 2005
 Revenues, cost of revenues and gross profit
  28




---



##### Table of Contents



Three
    
    
    
    
    
    
    Three
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Total
    
    
    September 30,
    
    
    of Total
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearRevenues:License
    
    $
    5,776
    
    
    
    33
    %
    
    $
    5,787
    
    
    
    34
    %
    
    $
    (11
    )
    
    
    (0
    )%Maintenance and service
    
    
    11,649
    
    
    
    67
    %
    
    
    11,311
    
    
    
    66
    %
    
    
    338
    
    
    
    3
    %Total revenues
    
    $
    17,425
    
    
    
    100
    %
    
    $
    17,098
    
    
    
    100
    %
    
    $
    327
    
    
    
    2
    %
 Three
    
    
    
    
    
    
    Three
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Related
    
    
    September 30,
    
    
    of Related
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearCost of revenues:License
    
    $
    105
    
    
    
    2
    %
    
    $
    76
    
    
    
    1
    %
    
    $
    29
    
    
    
    38
    %Maintenance and service
    
    
    8,205
    
    
    
    70
    %
    
    
    7,748
    
    
    
    68
    %
    
    
    457
    
    
    
    6
    %Total cost of revenues
    
    $
    8,310
    
    
    
    
    
    
    $
    7,824
    
    
    
    
    
    
    $
    486Gross profit
    
    $
    9,115
    
    
    
    52
    %
    
    $
    9,274
    
    
    
    54
    %
    
    $
    (159
    )
    
    
    (2
    )%
 29




---



##### Table of Contents



Nine
    
    
    
    
    
    
    Nine
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Total
    
    
    September 30,
    
    
    of Total
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearRevenues:License
    
    $
    18,669
    
    
    
    36
    %
    
    $
    10,582
    
    
    
    24
    %
    
    $
    8,087
    
    
    
    76
    %Maintenance and service
    
    
    33,377
    
    
    
    64
    %
    
    
    33,632
    
    
    
    76
    %
    
    
    (255
    )
    
    
    (1
    )%Total revenues
    
    $
    52,046
    
    
    
    100
    %
    
    $
    44,214
    
    
    
    100
    %
    
    $
    7,832
    
    
    
    18
    %
 Nine
    
    
    
    
    
    
    Nine
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Related
    
    
    September 30,
    
    
    of Related
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearCost of revenues:License
    
    $
    389
    
    
    
    2
    %
    
    $
    259
    
    
    
    2
    %
    
    $
    130
    
    
    
    50
    %Maintenance and service
    
    
    24,570
    
    
    
    74
    %
    
    
    22,703
    
    
    
    68
    %
    
    
    1,867
    
    
    
    8
    %Total cost of revenues
    
    $
    24,959
    
    
    
    
    
    
    $
    22,962
    
    
    
    
    
    
    $
    1,997Gross profit
    
    $
    27,087
    
    
    
    52
    %
    
    $
    21,252
    
    
    
    48
    %
    
    $
    5,835
    
    
    
    27
    %
 Revenues
 License Revenues.
 Maintenance and Service Revenues.
 30




---



##### Table of Contents



Cost of Revenues and Gross Margin
 Cost of License Revenues.
 Cost of Maintenance and Service Revenues.
  Gross Margin.
 Operating Expenses
  31




---



##### Table of Contents



Three
    
    
    
    
    
    
    Three
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Total
    
    
    September 30,
    
    
    of Total
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearOperating expenses:Sales and marketing
    
    $
    5,570
    
    
    
    32
    %
    
    $
    5,208
    
    
    
    30
    %
    
    $
    362
    
    
    
    7
    %Research and development
    
    
    3,612
    
    
    
    21
    %
    
    
    3,109
    
    
    
    18
    %
    
    
    503
    
    
    
    16
    %General and administrative
    
    
    3,195
    
    
    
    18
    %
    
    
    2,232
    
    
    
    13
    %
    
    
    963
    
    
    
    43
    %Total operating expenses
    
    $
    12,377
    
    
    
    71
    %
    
    $
    10,549
    
    
    
    62
    %
    
    $
    1,828
    
    
    
    17
    %
 Nine
    
    
    
    
    
    
    Nine
    
    
    
    
    
    
    
    
    
    
    PercentageMonths
    
    
    
    
    
    
    Months
    
    
    
    
    
    
    
    
    
    
    of DollarEnded
    
    
    Percentage
    
    
    Ended
    
    
    Percentage
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    of Total
    
    
    September 30,
    
    
    of Total
    
    
    Increase
    
    
    Year over2006
    
    
    Revenues
    
    
    2005
    
    
    Revenues
    
    
    (Decrease)
    
    
    YearOperating expenses:Sales and marketing
    
    $
    17,929
    
    
    
    34
    %
    
    $
    13,358
    
    
    
    30
    %
    
    $
    4,571
    
    
    
    34
    %Research and development
    
    
    10,832
    
    
    
    21
    %
    
    
    9,124
    
    
    
    21
    %
    
    
    1,708
    
    
    
    19
    %General and administrative
    
    
    9,274
    
    
    
    18
    %
    
    
    6,931
    
    
    
    16
    %
    
    
    2,343
    
    
    
    34
    %Total operating expenses
    
    $
    38,035
    
    
    
    73
    %
    
    $
    29,413
    
    
    
    67
    %
    
    $
    8,622
    
    
    
    29
    %
 Sales and Marketing.
  Research and Development.
  32




---



##### Table of Contents



General and Administrative. SFAS 123R.
   Stock-Based Compensation
  Three
    
    Three
    
    
    
    
    
    PercentageMonths
    
    Months
    
    
    
    
    
    of DollarEnded
    
    Ended
    
    Year to Year
    
    ChangeSeptember 30,
    
    September 30,
    
    Increase
    
    Year over2006
    
    2005
    
    (Decrease)
    
    YearStock-based compensation:Cost of maintenance and service
revenues
    
    $
    250
    
    
    $
    (2
    )
    
    $
    252
    
    
    
    (12,600
    )%Sales and marketing
    
    
    264
    
    
    
    55
    
    
    
    209
    
    
    
    380
    %Research and development
    
    
    217
    
    
    
    1
    
    
    
    216
    
    
    
    21,600
    %General and administrative
    
    
    335
    
    
    
    (3
    )
    
    
    338
    
    
    
    (11,267
    )%Total stock-based compensation
    
    $
    1,066
    
    
    $
    51
    
    
    $
    1,015
    
    
    
    1,990
    %
 33




---



##### Table of Contents



Nine
    
    
    Nine
    
    
    
    
    
    
    PercentageMonths
    
    
    Months
    
    
    
    
    
    
    of DollarEnded
    
    
    Ended
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    September 30,
    
    
    Increase
    
    
    Year over2006
    
    
    2005
    
    
    (Decrease)
    
    
    YearStock-based compensation:Cost of maintenance and service
revenues
    
    $
    760
    
    
    $
    89
    
    
    $
    671
    
    
    
    754
    %Sales and marketing
    
    
    794
    
    
    
    244
    
    
    
    550
    
    
    
    225
    %Research and development
    
    
    682
    
    
    
    227
    
    
    
    455
    
    
    
    200
    %General and administrative
    
    
    1,429
    
    
    
    354
    
    
    
    1,075
    
    
    
    304
    %Total stock-based compensation
    
    $
    3,665
    
    
    $
    914
    
    
    $
    2,751
    
    
    
    301
    %
   Other Items
  Three
    
    
    Three
    
    
    
    
    
    
    PercentageMonths
    
    
    Months
    
    
    
    
    
    
    of DollarEnded
    
    
    Ended
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    September 30,
    
    
    Increase
    
    
    Year over2006
    
    
    2005
    
    
    (Decrease)
    
    
    YearOther income (expense), net:Interest expense
    
    $
    
    
    
    $
    (4
    )
    
    $
    4
    
    
    
    (100
    )%Interest and other income, net
    
    
    754
    
    
    
    411
    
    
    
    343
    
    
    
    83
    %Total other income, net
    
    $
    754
    
    
    $
    407
    
    
    $
    347
    
    
    
    85
    %Provision for income taxes
    
    $
    
    
    
    $
    38
    
    
    $
    (38
    )
    
    
    (100
    )%
 34




---



##### Table of Contents



Nine
    
    
    Nine
    
    
    
    
    
    
    PercentageMonths
    
    
    Months
    
    
    
    
    
    
    of DollarEnded
    
    
    Ended
    
    
    Year to Year
    
    
    ChangeSeptember 30,
    
    
    September 30,
    
    
    Increase
    
    
    Year over2006
    
    
    2005
    
    
    (Decrease)
    
    
    YearOther income (expense), net:Interest expense
    
    $
    
    
    
    $
    (20
    )
    
    $
    20
    
    
    
    (100
    )%Interest and other income, net
    
    
    1,997
    
    
    
    1,092
    
    
    
    905
    
    
    
    83
    %Total other income, net
    
    $
    1,997
    
    
    $
    1,072
    
    
    $
    925
    
    
    
    86
    %Provision for income taxes
    
    $
    
    
    
    $
    29
    
    
    $
    (29
    )
    
    
    (100
    )%Cumulative effect of a change
in accounting principle
    
    $
    128
    
    
    $
    
    
    
    $
    128
    
    
    
    100
    %
 Interest Expense and Interest and Other Income, Net
   Provision for Income Taxes
  Cumulative Effect of a Change in Accounting Principle
  Liquidity and Capital Resources
  35




---



##### Table of Contents



Net Cash Used in Operating Activities.
 Nine Months Ended September 30,2006
    
    
    2005Cash collections
    
    $
    47,012
    
    
    $
    49,327Payroll related costs
    
    
    (41,121
    )
    
    
    (33,585
    )Professional services costs
    
    
    (6,084
    )
    
    
    (4,233
    )Employee expense reports
    
    
    (4,970
    )
    
    
    (6,221
    )Facilities related costs
    
    
    (2,724
    )
    
    
    (2,820
    )Third-party royalty payments
    
    
    (483
    )
    
    
    (562
    )Other
    
    
    (3,530
    )
    
    
    (2,834
    )Net cash used in operating activities
    
    $
    (11,900
    )
    
    $
    (928
    )
  Net Cash Used in/Provided by Investing Activities.
 Net Cash Provided by Financing Activities.
 Contractual Obligations and Commitments
  36




---



##### Table of Contents



Payments due by PeriodRemaining
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2011Contractual Obligations
    
    Total
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    and beyondOperating lease
commitments
    
    $
    9,069
    
    
    $
    553
    
    
    $
    2,363
    
    
    $
    2,441
    
    
    $
    2,219
    
    
    $
    1,493
    
    
    $
    Unconditional
purchase commitments
    
    $
    322
    
    
    $
    138
    
    
    $
    146
    
    
    $
    38
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk.
  Expected Maturity

    
    Total
    
    Total1 Year
    
    More Than
    
    Principal
    
    Fairor Less
    
    1 Year
    
    Amount
    
    ValueAvailable-for-sale securities
    
    $
    47,656
    
    
    $
    
    
    
    $
    47,656
    
    
    $
    47,643Weighted average interest rate
    
    
    5.25
    %
    
    
    
    %
 37




---



##### Table of Contents



Foreign Currency Exchange Risk.
 
 Item 4. Controls and Procedures
  
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
    38




---



##### Table of Contents



Item 1A. Risk Factors
 We operate in a dynamic and rapidly changing environment that involves numerous risks and
uncertainties that could cause actual results to differ materially from the results contemplated by
the forward-looking statements contained in this Quarterly Report on Form 10-Q . Because of the
following factors, as well as other variables affecting our operating results, past financial
performance should not be considered a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future periods.
 RISKS RELATED TO OUR BUSINESS
 We have a history of losses, and we cannot assure you that we will achieve and sustain profitability.
  Our quarterly license revenues are dependent on a relatively small number of
transactions involving sales of our products to new customers, and any delay or
failure in closing one or more of these transactions could adversely affect our
results of operations.
  39




---



##### Table of Contents



Our success depends upon our ability to develop new products and enhance our
existing products. Failure to successfully introduce new or enhanced products
may adversely affect our operating results.
  
    
    Rapid technological advances in hardware and software development;
    
    evolving standards in computer hardware, software technology and communications infrastructure;
    
    changing customer needs; and
    
    frequent new product introductions and enhancements.
  Our quarterly revenues and operating results are unpredictable and are likely
to continue to fluctuate substantially, which may harm our results of
operations.
    
    
    The discretionary nature of our customers purchase and budget cycles and changes in their
budgets for software and related purchases;
    
    the priority our customers place on the purchase of our products as compared to other
information technology and capital acquisitions;
    
    market acceptance of our new on-demand services;
    
    competitive conditions in our industry, including new products, product announcements and
discounted pricing or special payment terms offered by our competitors;
    
    our ability to hire, train and retain appropriate sales and professional services staff;
    
    varying size, timing and contractual terms of orders for our products, which may delay the
recognition of revenues;
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
    
    indeterminate and often lengthy sales cycles;
    
    strategic decisions by us or our competitors, such as acquisitions, divestitures,
spin-offs, joint ventures, strategic investments or changes in business strategy;
    
    merger and acquisition activities among our customers which may alter their buying patterns;
    
    our ability to timely complete our service obligations related to product sales;
    
    the utilization rate of our professional services personnel and the degree to which we use
third-party consulting services;
    
    the extent to which our customers elect to engage us versus third parties for configuration
and implementation engagements;
    
    changes in the average selling prices of our products;
    
    timing of product development and new product initiatives;
    
    customers concerns regarding Sarbanes-Oxley Section 404 compliance and implementing large,
enterprise-wide deployments of products, including our products; and
    
    changes in the mix of revenues attributable to higher-margin product license revenues as
opposed to substantially lower-margin service revenues.
 Our products have long sales cycles, which makes it difficult to plan our expenses and forecast our results.
  
    
    The complex nature of our products and services;
    
    the need to educate potential customers about the uses and benefits of our products and services;
    
    the requirement that a potential customer invest significant resources in connection with the
purchase and implementation of our products and services;
    
    budget cycles of our potential customers that affect the timing of purchases;
    
    customer requirements for competitive evaluation and internal approval before purchasing our
products and services;
    
    potential delays of purchases due to announcements or planned introductions of new products and
services by us or our competitors; and
    
    the lengthy approval processes of our potential customers, many of which are large organizations.
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If our on-demand service offering is unsuccessful, our business and operating
results could be adversely affected.
  If we are unable to increase sales of new product licenses, our maintenance and
service revenues will be materially and adversely affected.
  Professional services comprise a substantial portion of our revenues and to the
extent our customers choose to use other services providers, our revenues and
operating results may decline.
  We continue to expand our international operations but we do not have
substantial experience in international markets, and may not achieve the
expected results.
  
    
    Unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
    
    differing ability to protect our intellectual property rights;
    
    differing labor regulations;
    
    greater difficulty in supporting and localizing our products;
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
    
    greater difficulty in establishing, staffing and managing foreign operations; and
    
    fluctuating exchange rates.
  Our latest product features and functionality may require existing customers to
migrate from their existing versions to more recent versions of our software.
If existing customers fail or delay to migrate, our revenues may be harmed.
  If we do not compete effectively with competitors, our revenues may not grow and could decline.
    Our maintenance and service revenues produce substantially lower gross margins
than our license revenues, and decreases in license revenues relative to
service revenues have harmed, and may again harm, our overall gross margins in
the future.
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
    
    Competitive pricing pressure on the rates that we can charge for our professional services;
    
    the complexity of the customers information technology environment;
    
    the resources directed by customers to their implementation projects; and
    
    the extent to which outside consulting organizations provide services directly to customers.
   Managing large-scale deployments of our products requires substantial technical
implementation and support by us or third-party service providers. Failure to
meet these requirements could cause a decline or delay in recognition of our
revenues and an increase in our expenses.
    A substantial majority of our revenues are derived from TrueComp and related
products and services and a decline in sales of these products and services
could adversely affect our operating results and financial condition.
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If we reduce prices or alter our payment terms to compete successfully, our
margins and operating results may be adversely affected.
  Our products depend on the technology of third parties licensed to us and the
loss or inability to maintain these licenses or errors in such software could
result in increased costs or delayed sales of our products.
  Errors in our products could be costly to correct, adversely affect our
reputation and impair our ability to sell our products.
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
    
    Lost or delayed market acceptance and sales of our products;
    
    product liability suits against us;
    
    diversion of development resources; and
    
    substantially greater service and warranty costs.
 Our revenues might be harmed by resistance to adoption of our software by
information technology departments.
  We recently experienced changes in our senior management team. The loss of key
personnel or the inability of replacements to quickly and successfully perform
in their new roles could adversely affect our business.
  We may lose sales opportunities and our business may be harmed if we do not
successfully develop and maintain strategic relationships to implement and sell
our products.
  If we fail to adequately protect our proprietary rights and intellectual
property, we may lose valuable assets, experience reduced revenues and incur
costly litigation to protect our rights.
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Our results of operations may be adversely affected if we are subject to a
protracted infringement claim or one that results in a significant damage
award.
  
    
    Require costly litigation to resolve;
    
    absorb significant management time;
    
    cause us to enter into unfavorable royalty or license agreements;
    
    require us to discontinue the sale of all or a portion of our products;
    
    require us to indemnify our customers or third-party systems integrators; or
    
    require us to expend additional development resources to redesign our products.
  If we do not adequately manage and evolve our financial reporting and
managerial systems and processes, our ability to manage and grow our business
may be harmed.
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RISKS RELATED TO OUR STOCK
 Our stock price is likely to remain volatile.
  
    
    Our operating performance and the performance of other similar companies;
    
    announcements by us or our competitors of significant contracts, results of
operations, projections, new technologies, acquisitions, commercial relationships,
joint ventures or capital commitments;
    
    changes in our management team;
    
    publication of research reports about us or our industry by securities analysts; and
    
    developments with respect to intellectual property rights.
  Future sales of substantial amounts of our common stock by us or our existing
stockholders could cause our stock price to fall.
  Provisions in our charter documents, our stockholder rights plan and Delaware
law may delay or prevent an acquisition of our company.
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Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
   
 Item 6. Exhibits
 (a) Exhibits
 ExhibitNumber
    
    Description31.1
    
    302 Certification31.2
    
    302 Certification32.1
    
    906 Certification
 Availability of this Report
  
 SIGNATURES
  CALLIDUS SOFTWARE INC.By:
    /s/ RONALD J. FIORRonald J. FiorChief Financial Officer,
Senior Vice President, Finance and Operations 49




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EXHIBIT INDEX
 TO
CALLIDUS SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
 ExhibitNumber
    
    Description31.1
    
    302 Certification31.2
    
    302 Certification32.1
    
    906 Certification
 50