**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**





**For
      the Fiscal Year Ended January 31, 2006**





**Commission
      File Number 000-31989**








**CONVERA
      CORPORATION**


(Exact
      name of registrant as specified in its charter)










**Delaware**
            
            **54-1987541**(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                No.)





**1921
                Gallows Road, Suite 200, Vienna, Virginia**
            
            **22182**(Address
                of principal executive offices)
            
            (Zip
                Code)





Registrant's
      telephone number, including area code: **(703) 761 -
      3700**





Securities
      registered pursuant to Section 12(b) of the Act:
**None**




Securities
      registered pursuant to Section 12(g) of the Act: **Common
      Stock**





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




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the
      Act.    Yes  No ü





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports) and (2) has been subject to the filing requirements for
      the past 90 days. Yes  ü  No
      __




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein and will not be contained, to the best
      of
      registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. __





Indicate
      by check mark whether the registrant is a large accelerated filer, accelerated
      filer, or a non-accelerated filer. See definition of “accelerated filer and
      large accelerated filer” in Rule 12b-2 of the Exchange Act.




Large
      Accelerated Filer  Accelerated
      Filer ü  Non-Accelerated
      Filer




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes  No ü





The
      aggregate market value of the voting stock held by non-affiliates of the
      registrant as of July 31, 2005 (based on the closing sales price as reported
      on
      the NASDAQ National Market System) was $201,536,203.





The
      number of shares outstanding of the registrant's Class A common stock as of
      March 22, 2006 was 52,269,750.





DOCUMENTS
      INCORPORATED BY REFERENCE


Portions
      of the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders
      are incorporated by reference into Part III.








The
      Index
      to Exhibits begins on Page 36








**CONVERA
      CORPORATION**




**ANNUAL
      REPORT ON FORM 10-K**


**FOR
      THE FISCAL YEAR ENDED JANUARY 31, 2006**




**TABLE
      OF CONTENTS**




Page**PART
                I**Item
                1.
            Business
            1Item
                1A.
            Risk
                Factors
            12Items
                1B.
            Unresolved
                Staff
                Comments
            19Item
                2.
            Properties
            19Item
                3.
            Legal
                Proceedings
            19Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            19**PART
                II**Item
                5.
            Market
                for Registrant's Common Equity, Related Stockholder
                Matters and Issuer Purcdhases of Equity Securities
            20Item
                6.
            Selected
                Financial Data
            21Item
                7.
            Management's
                Discussion and Analysis of Financial Condition
                and Results of Operations
            22Item
                7A.
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            32Item
                8.
            Financial
                Statements and Supplementary
                Data
            33Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting
                and Financial Disclosure
            33Item
                9A.
            Controls
                and Procedures
            33Item
                9B.
            Other
                Information
            33**PART
                III**Item
                10.
            Directors
                and Executive Officers of the
                Registrant
            34Item
                11.
            Executive
                Compensation
            34Item
                12.
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            34Item
                13.
            Certain
                Relationships and Related
                Transactions
            34Item
                14.
            Principal
                Accounting Fees and Services
            34**PART
                IV**Item
                15.
            Exhibits
                and Financial Statement
                Schedules
            35





Table
          of Contents


**PART
      I**





**Item
      1.****Business**




**FORWARD-LOOKING
      STATEMENTS**





The
      statements contained in this report that are not purely historical are
“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, including
      without limitation statements about the expectations, beliefs, intentions or
      strategies regarding the future of Convera Corporation (“Convera” or the
“Company.”) Words such as “expects,” “intends,” “plans,” “projects,” “believes,”
“estimates,” and similar expressions are used to identify these forward-looking
      statements. These include, among others, statements relating to the Company's
      future expectations, performance, plans, and prospects, as well as assumptions
      about future events. All forward-looking statements included in this report
      are
      based on information available to the Company on the date hereof, and the
      Company assumes no obligation to update any such forward-looking statements.
      The
      forward-looking statements contained herein involve risks and uncertainties
      discussed under the heading “Risk Factors” below. The Company’s actual results
      could differ materially from those anticipated in these forward-looking
      statements as a result of such factors, including those set forth in this
      report.








**Overview**




Convera
      designs, develops, markets, implements and supports search and categorization
      software solutions that enable a broad range of mission critical applications
      within government agencies and commercial enterprises. These applications
      include knowledge management, enterprise portals, intelligence gathering and
      analysis, safety and national security, law enforcement, research and discovery,
      regulatory compliance and customer service. Convera believes its enterprise
      solution, RetrievalWare, offer customers the ability to manage vast stores
      of
      unstructured information by providing highly scalable, fast, accurate and secure
      search capabilities across more than 200 forms of text, video, image and audio
      information, in more than 45 languages. Convera also offers professional
      services for its software solutions to ensure Convera products integrate
      seamlessly into customer environments. Training, consulting and maintenance
      services are also provided to facilitate optimal use of its
      technologies.





Convera
      maintains a portfolio of patented and proprietary technologies. Its core
      technologies include: advanced computational linguistics and semantic networking
      that leverage lexical knowledge using built-in knowledge bases to search not
      only for specific word meanings, but also for related terms and concepts;
      Adaptive Pattern Recognition Processing (“APRP”) that identifies patterns in
      digital data, providing the capability to build content-based analysis and
      retrieval applications for any type of digital information; and intelligent
      real-time video analysis that detects scene changes as they occur. The Company’s
      most recent software release, RetrievalWare 8, includes technical advancements
      such as categorization, dynamic classification, profiling and distributed
      indexing capabilities. In addition, the Company has embarked on an advanced
      Web
      indexing development effort focused on applying portions of the Company’s
      existing core technology to also locate contextually relevant information on
      the
      World Wide Web (the “Web”). This next-generation search technology, called
      Excalibur, achieved its initial development milestone in October 2004 by
      creating an “Alpha” stage, search platform for open-source Web content. On
      November 1, 2005 the Company announced that the Excalibur Web offering was
      commercially available as the technology had advanced to then contain more
      than
      4 billion documents in the index and a redundant hosting environment was
      established with AT&T.





As
      of
      January 31, 2006 and 2005, Allen Holding, Inc., together with Allen &
Company Incorporated, Herbert A. Allen and certain related parties (collectively
      “Allen & Company”) beneficially owned approximately 47% and more than 50% of
      the voting power of Convera, and would therefore in each instance be able to
      effectively control the outcome of matters requiring a stockholder vote.
      RetrievalWare and Screening Room are registered trademarks of Convera
      Corporation or its subsidiaries in the United States and other
      countries.




The
      Company can be contacted via email at *invest@convera.com* and
      visited at its web site, *www.convera.com* .
      On our
      web site, we post the following filings as soon as reasonably practicable after
      they are electronically filed with or furnished to the Securities and Exchange
      Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q,
      our current reports on Form 8-K, our proxy statement on Form 14A related to
      our
      annual stockholder’s meeting
      and any amendments to those reports or statements filed or furnished pursuant
      to
      Section 13(a) of 15(d) of the Securities Exchange Act of 1934, as amended.
      All
      such filings on our web site are available free of charge. Information on the
      Convera web site is not part of this Form 10-K.


1
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          of Contents






**Business
      Strategy**





The
      Company licenses its software products directly to government agencies and
      commercial enterprises throughout North America, Europe and other parts of
      the
      world. The Company also distributes its software products through license
      agreements with systems integrators, Original Equipment Manufacturers (“OEMs”),
      value-added resellers, and other strategic partners. The Company’s technology
      may also be customized to meet the specific needs of its customers. Further,
      the
      Company continues to focus a substantial amount of resources on further
      penetration of the national security, defense, law enforcement and intelligence
      gathering community with the United States and its allies, while limiting its
      selling and marketing efforts to commercial customers for the RetrievalWare
      enterprise application. The Company has also increased its efforts with regard
      to its Excalibur Web offering. Convera has begun focusing much of its selling
      and marketing resources on establishing distribution channels for Excalibur.
      The
      Company is again targeting the government marketplace, as well as the media
      and
      publishing sectors for Excalibur at this time. This strategy is expected to
      capitalize on customer requirements within these market segments seeking both
      Intranet and Web-based search and categorization technologies to manage the
      vast
      amounts of content within their environments. The Company may elect to seek
      additional and/or alternative market segments for the Excalibur offering over
      the coming quarters.





Convera
      continues to conduct international sales activities through Convera Technologies
      International, Limited (“CTIL”), its wholly owned subsidiary in the United
      Kingdom.





**Convera
      Products**




**Products**




Convera
      develops, markets, licenses, services and supports its enterprise software
      product RetrievalWare, which offers customers mission-critical search and
      categorization solutions powering a broad range of applications including
      enterprise portals, knowledge management, intelligence gathering, profiling,
      corporate policy compliance, regulatory compliance, and customer service. These
      applications are utilized within corporate intranets, Internet e-commerce,
      online publishing and OEM market segments.





Convera’s
      products are designed to address the search and categorization needs of a
      diverse customer base within government agencies and commercial enterprises
      on a
      global basis. From supporting the most demanding requirements of the
      intelligence and law enforcement communities within government agencies, to
      providing the enterprise search backbone of Fortune 500 companies, Convera
      products are often a critical part of customers’ information management
      infrastructure.





RetrievalWare
      is a secure, highly scalable software platform for mission-critical, search
      and
      categorization applications. The RetrievalWare distributed architecture provides
      a high performance, high scalability infrastructure for indexing, searching,
      categorizing and linking information across a broad range of content sources.





Convera
      products are best suited for organizations that face the following
      challenges:





·
            Searching
                a large collection of unstructured information assets distributed
                in
                information silos across the
                enterprise;


·
            Dealing
                with large volumes of incoming unstructured data on a daily
                basis;


·
            Searching
                disparate collections of documents and records regardless of their
                format,
                including scanned paper, text, audio, video, images and relational
                databases;


·
            Tightly
                integrating the search solution as part of the corporate security
                infrastructure;


·
            Providing
                a robust, scalable and highly available information discovery platform;
                and


·
            Searching
                information that exists in multiple
                languages.





With
      the
      release of RetrievalWare 8, Convera enhanced its software product offering
      with
      new categorization and classification capabilities, as well as tools for
      developing and deploying taxonomies, and architectural enhancements


that
      allow RetrievalWare to easily fit within J2EE and Web Services environments.





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          of Contents


Convera’s
      Categorization and Dynamic Classification software introduced with RetrievalWare
      8 allows enterprises and government agencies to more easily search and browse
      unstructured information from diverse user perspectives and roles. It also
      allows organization to more easily discover hidden information that is most
      relevant to queries against large repositories of information.





Convera’s
      Cartridge and Classification Workbench allows enterprises to develop, import,
      change and integrate various taxonomies and semantic networks that may be used
      for organizing and accessing an enterprise’s unstructured content. This new
      suite of tools also helps enterprises measure the quality of the taxonomies
      being used to organize their information assets. This provides predictive
      insight into the user’s satisfaction that will result from the search and
      categorization solution being deployed.





RetrievalWare
      8 was built using the modern Application Server Architecture, effectively
      supporting those customers who have chosen to adopt the Service Oriented
      Application Architecture within their enterprises. The support of open
      Application Programming Interfaces (“APIs”) like Java Services and Web Services
      APIs allows RetrievalWare 8 to be integrated into a variety of enterprise
      applications with relative ease.








The
      RetrievalWare 8 product line includes:





RetrievalWare®
      Search (Base Product)





Optional
      Components :


RetrievalWare®
      Categorization and Dynamic Classification;


RetrievalWare®
      Profiling;


RetrievalWare®
      Cartridge & Classification Workbench


Language
      Cartridges;


Domain
      Cartridges;


Taxonomy
      Cartridges;


RetrievalWare®
      Synchronizers;


Internet
      Spider;


RetrievalWare®
      FileRoom;


Screening
      Room®;


Screening
      Room® Capture;


RetrievalWare®
      SDK;


Screening
      Room® API’s; and


Visual
      RetrievalWare®.








**RetrievalWare®
      Search (Base Product)**




RetrievalWare
      provides a secure, scalable information retrieval and knowledge discovery
      infrastructure utilizing advanced indexing, search and categorization
      technology. The RetrievalWare distributed process architecture enables
      government agencies and commercial enterprises to integrate information assets
      into a single point of access, to navigate that information and to collaborate
      on retrieved information to achieve mission-critical objectives. By utilizing
      multi-mode searching built around Convera’s proprietary semantic network
      technologies, pattern matching (APRP) and Boolean search, RetrievalWare empowers
      users to securely access and retrieve mission critical information assets across
      multiple data types.





With
      Convera’s semantic networks and natural language processing, users can easily
      find needed information without having to specify exact keywords. RetrievalWare
      incorporates syntax, morphology and the actual meaning of words in its search
      algorithms. The baseline semantic network in the English language version of
      RetrievalWare gives users a built-in knowledge base of approximately 500,000
      word meanings, 50,000 language idioms and 1.6 million word associations. Users
      submit plain English queries that are automatically expanded to include related
      terms and concepts, thereby increasing the likelihood that highly relevant
      content will be retrieved. RetrievalWare also supports domain specific semantic
      networks to further enhance search precision and recall in specific fields
      of interest,
      including: Biology, Chemistry, Computers, Electronics, Finance, Food Science,
      Geography, Geology, Health Sciences, Information Science, Law, Mathematics,
      Medical, Military, Petroleum, Natural Gas & Petrochemicals, Pharmaceutical,
      Pharmacology, Physics, Plastics, Rubber and Telecommunications. Other
      disciplines can be supported through the use of Convera tools that enable the
      development of enterprise-specific semantic networks.





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APRP
      identifies patterns in digital information. In text applications, it allows
      users to retrieve relevant information regardless of spelling errors contained
      in queries or the existence of inconsistencies in the searched data that may
      be
      caused by errors in optical character recognition processes. The software works
      at high speed and supports the rapid development of multi-language
      text-retrieval systems.





RetrievalWare
      supports more than 200 document formats stored on file servers, in groupware
      systems, relational databases, document management systems, intranets and the
      Internet. RetrievalWare provides real time profiling which enables users to
      automatically receive incoming documents of interest. The RetrievalWare
      Profiling Server filters, stores and distributes incoming data from many sources
      including real-time news feeds, relational databases, paper repositories and
      the
      RetrievalWare Internet Spider.





Convera
      provides what it believes was the industry’s first enterprise search product to
      offer multimedia and cross-lingual search as off-the-shelf product features.
      By
      providing users with a single product that simultaneously searches and organizes
      all data types (such as text, video, image and audio files) in multiple
      languages from a single user interface, customers do not have to buy and piece
      together several disparate systems to manage multiple data types and languages.





RetrievalWare
      provides access to both unstructured and structured information across
      enterprise networks, workgroup LANs, and intranets. The software may be deployed
      on a single server or across any number of distributed physical servers.
      RetrievalWare server solutions can be run on multiple platforms including
      leading UNIX, LINUX and Windows platforms.





The
      RetrievalWare 8 product line includes the following optional
      components:





**Categorization
      and Dynamic Classification**




The
      RetrievalWare Categorization and Dynamic Classification solution enables
      enterprises to bring consistency and scalability to the organization and access
      of information assets through the use of stable, industry standard taxonomies.
      RetrievalWare uses one or more taxonomies to extract concepts and context from
      information assets. These assets can then be organized into specific views
      that
      reflect the personalized knowledge requirements, roles and perspectives of
      each
      user. This approach to organizing information facilitates knowledge discovery
      and collaboration among knowledge workers.





**Profiling**




RetrievalWare
      Profiling automatically detects, routes and stores relevant documents in
      user-defined profiles, thus accelerating the timely discovery of relevant
      information as it enters the RetrievalWare environment.





**Cartridge
      & Classification Workbench**




Convera’s
      Cartridge & Classification Workbench enables the use of manual and automated
      tools to streamline taxonomy classification development, benchmarking, and
      deployment. These tools reduce taxonomy development and deployment times as
      well
      as maintenance costs.





**Language,
      Domain and Taxonomy Cartridges**




RetrievalWare
      provides highly accurate and relevant search and categorization results based
      upon its linguistic processing capability. Through the use of robust semantic
      networks and taxonomies that cover many languages and domain specific fields
      of
      interest, RetrievalWare recognizes and processes words, phrases and concepts
      in
      the context in which they exist. The result is a comprehensive search and
      retrieval solution enabling basic keyword search, advanced natural language
      and
      conceptual search, as well as information categorization in many languages and
      fields of interest. Language, Domain and Taxonomy Cartridges are provided as
      pre-packaged optional components to RetrievalWare. Convera also provides
      development tools that allow customers, partners or integrators to develop,
      edit
      and customize cartridge content for specific business solutions.





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          of Contents


**Synchronizers**




RetrievalWare
      Synchronizers provide document-level secure access for users to search multiple
      native repositories from a single point of access. Supported repositories
      include Lotus Notes, Microsoft Exchange, Documentum, FileNET Panagon, native
      file systems and major relational database management systems including
      Microsoft SQL Server, Oracle, DB2, Sybase, Informix, Teradata and any
      ODBC-compliant database.




**Internet
      Spider**




Internet
      Spider is a multimedia, high-performance Web spider/crawler for augmenting
      the
      retrieval capabilities of RetrievalWare, for stand-alone use, or for integration
      with other applications. In addition to HTML-based Web pages, Internet Spider
      retrieves word processing, PDF and multimedia assets including audio, video
      and
      images. It is highly configurable and multi-threaded and can provide deep,
      broad
      and repetitive crawling. Users who want immediate notification when items of
      interest arrive can post Agent Profiles to pull links to related documents
      to
      their desktops. C omponents
      can be deployed on multiple machines for optimum performance and
      bandwidth.





**FileRoom**




RetrievalWare
      FileRoom is an optional component that allows loading, indexing, viewing and
      managing scanned documents, images and text. Users access FileRoom through
      a
      hierarchy consisting of FileRoom documents, where each tier in the hierarchy
      is
      a container for storing documents. Users can directly view the scanned image
      of
      a retrieved document from FileRoom. Graphs, diagrams, handwritten notations
      and
      signatures in the retrieved document are immediately accessible. Document-level
      security lets organizations control user access at the FileRoom (library),
      cabinet, drawer, folder and document level.




**Screening
      Room®**




Screening
      Room is an optional product to RetrievalWare Search that enables a comprehensive
      solution for video asset management. It provides scalable access, search and
      retrieval of video assets, both analog and digital, from any desktop. Used
      in
      conjunction with RetrievalWare Search, it provides for real-time capturing,
      encoding, analyzing, cataloging, browsing, searching and retrieving of video,
      as
      well as related captured text (closed captions or speech-to-text conversions)
      and metadata, over corporate intranets/extranets. Designed to manage video
      content in Internet portal and corporate intranet environments, Screening Room
      also supports media, broadcast and entertainment video asset management
      solutions. It
      enables users to easily capture analog or digital video, automatically create
      an
      intelligent video storyboard, and play it back in any of the industry’s standard
      video file formats. Screening Room users then can automatically browse, search
      and retrieve precisely what video clips they are looking for without having
      to
      play or watch the video in its entirety.





Screening
      Room consists of four components: Screening Room Capture, Screening Room
      Metadata Edit, Screening Room Explorer and Screening Room Video Asset Server.
      Screening Room Capture ingests, analyzes and storyboards analog or digital
      video
      assets, including live feeds. It also extracts, indexes and searches associated
      metadata such as captured text (both closed-caption text and spoken audio
      content converted to text), keyframe images of significant scenes and
      annotations. Screening Room Metadata Edit enables users to browse, search,
      edit
      and annotate storyboards. In addition, users can select and compile clips from
      multiple video assets to create new derivative works, export files and metadata
      in industry-standard XML format or output rough-cut edit segments to Edit
      Decision Lists (“EDLs”) for import into high-end offline editing systems.
      Screening Room Explorer allows user access to catalogs of video assets through
      any standard Web browser. The Video Asset Server indexes
      and s tores
      captured video assets for instantaneous browsing, or search and retrieval via
      RetrievalWare.





**Screening
      Room Capture (Stand-alone)**




Screening
      Room Capture (Stand-alone) can be deployed as a stand-alone product. It provides
      the ability to log, analyze and encode video, and save the data and video assets
      in a non-proprietary (XML) format. Screening Room Capture
      does not require purchase of the entire RetrievalWare or Screening Room system,
      enabling loading of video assets and metadata into a third party database or
      content management system, or otherwise re-purposing the asset. Screening Room
      Capture is also a suitable component for sale to OEM customers.




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          of Contents


**RetrievalWare
      SDK**




The
      RetrievalWare SDK (Software Developer’s Kit) is a comprehensive set of tools for
      building advanced search-based solutions. At its core is highly scalable,
      distributed client/server architecture. Independent server processes maximize
      the efficiency and reliability of document loading, indexing and query handling,
      and support security and encryption/decryption features. Dedicated server
      processes enable integration of text search and relational database storage
      capabilities through an open database management system (“DBMS”) gateway. The
      client environment is optimized for the development of graphical interfaces
      using industry standard tools such as Java and Visual Basic. RetrievalWare
      delivers Visual Basic custom controls, remote procedure calls and open server
      capabilities, as well as engine-level, high-level and client/server application
      program interfaces (“APIs”). These features speed the development of systems
      that can support thousands of users and contain custom
      functionality.





**Screening
      Room and Screening Room Capture APIs**




The
      Screening Room and Screening Room Capture APIs enable developers to integrate
      and control the Screening Room components from other programs and applications.





**Visual
      RetrievalWare**




Leveraging
      the APRP technology, Visual RetrievalWare is a visual retrieval engine and
      a
      comprehensive image-processing library that enables the development of
      client/server systems for indexing and retrieving digital images. Users can
      search for visual information directly from their intranet, a corporate
      database, the Internet, or other sources using images or video clips as clues.
      Visual data is reduced to a searchable index that is typically less than 10%
      of
      the size of the original image and is automatically recognized based on its
      shape, color and texture. Users submit queries using examples of visual data
      or
      by authoring a visual clue with a graphical product. Based on the shape, color
      and texture of the visual clue, a list of similar or exact matches is returned.
      The product delivers its advanced retrieval capabilities in an open, scalable
      and secure architecture designed for ease of implementation, integration or
      extension.





**Excalibur
      Web Offering**





During
      fiscal year 2005, the Company initiated a research and development project
      aimed
      at applying portions of the Company’s existing technology to searching and
      indexing contextually relevant information on the World Wide Web. This
      next-generation search technology achieved its initial development milestone
      in
      October 2004 by creating an “Alpha” stage search platform for open-source or
      Web-based content. As of February 1, 2005 the Company’s efforts advanced to
“Beta” stage as the technology contained more than 1 billion documents in the
      index. On November 1, 2005 the Company announced that the Excalibur Web offering
      was commercially available as the technology had advanced to then contain more
      than 4 billion documents in the index and a redundant hosting environment was
      established with AT&T.





The
      Excalibur Web offering has been developed to add structure to the Web through
      the use of proprietary taxonomies and ontologies, semantic analysis and deep
      knowledge resources capable of providing end-users with more relevant search
      results. The technology also supports complex queries, offers built in video
      and
      image search, and provides geo-locational data. Excalibur may be used in concert
      with RetrievalWare, Convera’s enterprise search solution, or with an
      organization’s existing internal applications to create an integrated portal
      offering “blended” results from both Intranet and Web-based searches.





The
      Excalibur Web offering utilizes advanced semantic analysis in combination with
      broad and deep knowledge resources to better understand the meaning of Web
      content as well as the user query. It has incorporated a large set of
      commercially recognized taxonomies in addition to privately compiled taxonomies
      and thesauri to create a large and very granular Web index. These two core
      design features enable Excalibur to draw dynamic connections between topically
      or contextually related content resulting in a better understanding of the
      nature of the query along with the relevancy of the content.


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The
      Excalibur Web Search platform offers blended results - incorporating information
      from the web at large, as well as from multiple proprietary sources - enabling
      content providers and web portals to readily consolidate relevant content and
      information. End users are presented with relevant search results in a
      comprehensive, consolidated manner, regardless of the repository source. Search
      results may be further personalized in the form of “profiles” in which users can
      choose and save the particular elements they would like to use in a particular
      search or situation. The profiles can be triggered to create an “event” or send
      an “alert” when new or relevant information is received. All results can be
      presented to the user through an integrated, intuitive and dynamic page layout
      that is designed, controlled and branded by the website or portal owner.





Convera
      owns and operates the Excalibur Web offering infrastructure as either a hosted
      search service deployed at one or more Tier 1 co-location facilities, or under
      a
      software licensing model. The Excalibur Web search service is expected to be
      delivered through partnerships with Web sites, Web portals and other customer
      relationships in which high quality, advanced Web search is a priority.
      Excalibur Web search is offered as an unbranded search capability offering
      site
      owners' greater control over viewers and Web “stickiness”, along with the
      opportunity to develop, deliver and control their own content and advertising
      channels.





Excalibur
      is planned to provide a multi-lingual Web index of over 4 billion pages. Layered
      on top of this index are additional knowledge resources, described below, which
      enable Excalibur to dynamically identify connections between topically and
      contextually related content. Excalibur delivers search results that are
      vertical, personal and focused.





**Knowledge
      Resources**





**Taxonomies**  -
      Excalibur uses a collective taxonomic resource of more than 5 million categories
      (or taxonomic nodes) covering commercial, technical and social realms of both
      vertical and general interest. This taxonomic knowledge base comprises much
      publicly available as well as privately compiled taxonomy augmented by the
      Company’s years of information retrieval and knowledge management expertise
      involving thousands of large-scale search projects worldwide. All of these
      taxonomic resources are used to index the Web providing data organization and
      precision of response.





**Entities** -
      Excalibur identifies and extracts entities (people, places, things) using
      large-scale, proprietary resources of known entities in addition to dynamic
      entity detection rules that identify and extract likely entities. For example,
      Excalibur recognizes that “George Bush” is the 43 rd President
      of the United States and not just a proper noun, two adjacent terms, or a shrub
      that might be named George. The Company believes that the breadth, depth and
      sophistication of Excalibur’s entity recognition are some of the factors driving
      improved accuracy and relevance of results.





**Ontologies** -
      An
      ontology provides a powerful semantic model that logically groups and represents
      related information. Excalibur employs ontologic representations to define
      connections between topically related content and then to dynamically present
      relevant content in the context most closely related to a user’s search. An
      entertainment focused ontology would understand that celebrities have
      biographical information, official web sites, discographies, gossip, awards,
      events and so on. A sports oriented ontology would understand that a given
      sport
      has teams, rosters, game schedules, news, gossip, fantasy teams, scores and
      results, and so. For each case, the ontology helps to define the various types
      of information that would interest a user on a given subject.





**Facets** -
      Excalibur utilizes hundreds of pre-defined facets to identify relevant aspects
      of different subject areas or ontological groupings that are likely to be of
      interest to a broad cross section of users. For example, facets chosen to define
      the context for a music celebrity might include: news, controversy (or scandal),
      books, CDs, DVDs, biography, film clips and so on. Alternatively, facets
      defining a context for a politician might include: news, poll results, blogs,
      events and biographical information. Facets are linked through one or more
      ontologies and are triggered when conceptually related results are found in
      response to a Web search. Facets may be dynamically personalized to create
      a
      specific user profile or customized to search for a particularly focused and
      comprehensive set of results.


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**Verticalization** -
      Excalibur results are vertically oriented, allowing users to achieve a very
      focused yet comprehensive search result. For example, a search for thyroid
      disease should return results that include information about diagnosis,
      research, experts, news and so on. Thyroid disease should also be understood
      as
      an “endocrine disease” with many related terms and concepts, both more general
      and more specific. This breadth of information can only be represented through
      the incorporation of large-scale vertically oriented taxonomies. By employing
      deep taxonomic analysis, Excalibur understands scientific and technical subject
      matter at a level of granularity and specificity that is unique when compared
      to
      existing Web-scale analysis.




**Personalization** -
      Excalibur strives to solve the enormous and complex task of consolidating
      billions of pages of Web content and independent information sources to find
      and
      present the most relevant results in a compelling and personalized manner.
      It
      does this by understanding what is actually intended by the query and returning
      not just the most relevant list of results, but also information originated
      by
      related facets. Presenting information in this way provides the user with a
      broader, but better focused view of information that is more informative and
      easier to digest. Because these facets can be individually selected, mixed
      and
      matched for a specific search, web masters or end users can create highly
      personalized profiles and alert mechanisms at will. The profiles can be easily
      defined through the Excalibur GUI (graphical user interface) or its web services
      interface. In this way, users can define and update the profiles most useful
      to
      them. They can also define the timing and sequence of alerting mechanisms that
      will keep them abreast of events and news most relevant to them. Excalibur’s
      ontology and faceting mechanism can be exposed through personalization tools
      that allow personalization and customization at various levels. For example,
      if
      a user wanted a specific profile to find information related to vacationing
      and
      dining in New York, they could select relevant facets for Reviews, Opinions,
      Events, FAQ’s and associate these with a stored search for “restaurants” in “New
      York, NY”. Running this profile or setting an alert would allow the user to
      locate the latest information regarding dining out in New York, including
      content from the Web as well as any number of related third  party
      content sources.




**Authority** - One of
      Excalibur’s features is its use of content analysis and authority determination
      mechanisms. This analysis attempts to comprehend the editorial quality of
      content and its embedded meaning in a manner that is more insightful and less
      subject to manipulation that existing ranking methods. These ranking mechanisms
      eliminate low-value or low-quality content and return content with the highest
      possible quality regardless of its popularity or obscurity. Multiple elements
      including source, author, genre, density and specificity are collectively
      weighed to determine authority and value.




**Blending** -
      Excalibur’s blending mechanism is supported through direct and indirect access
      to non-Web and proprietary content sources, including valued third  party
      content channels, content partners and advertisers. This is useful to
      organizations that wish to combine search results from the general Internet
      along with information residing within specific controlled datasets or datasets
      they license from content producers and aggregators. Leveraging these sources
      in
      a process that is transparent to the user, Excalibur can return “blended”
results, enabling content providers or users to comb for the best, most relevant
      information using the terms and contexts most familiar to them. At the same
      time, Excalibur safeguards “protected” data by building in a number of tunable
      access restrictions, insuring that only designated users or websites can search
      these data repositories and that the data will not be readily distributed across
      the worldwide web.




**Multi-Lingual** - The
      same set of knowledge resources and language processing capabilities that power
      Excalibur search over English language content, is planned to be extended and
      optimized to other languages including Spanish, French, German, Dutch,
      Portuguese, Chinese, Japanese, Korean and so on. This is facilitated through
      a
      large-scale translation operation that translates concepts and terminology
      into
      their cross-lingual equivalents. This means that the millions of categories
      and
      related semantic resources applied to understanding content in one language
      are
      reproduced and consistently applied to understanding the content of other
      languages - uniformly and reliably delivering authoritative results across
      multiple languages.




**Localization** -
      Excalibur Web search enables global localization services. It uses a large
      set
      of consolidated geographical and geospatial resources totaling more than five
      million unique data points. These resources are used during indexing and results
      generation to correlate content with locations worldwide. Geographic reference
      data might include: country, city, population, place names, longitude, latitude,
      ZIP codes (where applicable), and so on. Collectively, these resources allow
      Excalibur to provide results localization with enhanced granularity.




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**Multimedia
      Search** -
      Excalibur incorporates multimedia search of images and video. Convera’s
“Screening Room” functionality facilitates this full-scale video indexing and
      search capability. Screening Room ingests video to create a storyboard of key
      frames and associated metadata including time/date/source along with cctext.
      Screening Room also incorporates manually created metadata - such as clip notes
      or frame notes. Excalibur’s multimedia image crawler also identifies images and
      associated descriptive information (meta data) to enable highly relevant search
      results across various media types available on the Web. This capability insures
      that Excalibur can retrieve and display relevant information from news or video
      archives, as well as other multimedia repositories.




**Mining
      On-Demand** -
      Excalibur optionally provides a set of mining and analysis tools designed to
      provide greater insight and perspective over the search processes. This set
      of
      tools enable users to dynamically classify content into various views according
      to their own unique requirements. The tools provide timeline analysis,
      storyboarding, clustering, and itinerary generation tools to connect
      information, people and events across time and space.







**Technical
      Support, Professional Services and Education**




Convera
      provides technical support and maintenance to customers through its technical
      support personnel located in the Company’s Columbia, Maryland; Carlsbad,
      California; and through certain product distributors. Technical support consists
      of bug fixes, telephone support and upgrades or enhancements of particular
      software product releases when and if they become generally available. Technical
      support typically is provided to customers under a renewable annual contract.
      All Convera service plan customers have access to the Convera Online Technical
      Support Web site that provides the latest product information, general service
      updates and Web forums for technical discussions. The Web site also provides
      electronic forms for opening technical support cases and suggesting product,
      service and Company enhancements.





The
      Company also provides on-site consulting services to its customers through
      employees and independent consultants who have been trained and certified by
      the
      Company. Consulting services are offered as a package or on a time-and-materials
      or fixed price basis. The Company conducts training seminars at its offices
      in
      Vienna, Virginia; Carlsbad, California; and Bracknell, United Kingdom, as well
      as on-site training for its customers and distribution channel partners.
      Training customers typically pay on a per-course basis for regularly scheduled
      classes and on a per-day basis for on-site or dedicated courses.







**Marketing
      and Distribution**




The
      Company’s sales and marketing strategy focuses on the licensing of Convera
      products to customers both through a direct sales force and through distribution
      partners and OEMs. Members of the North American direct sales team are primarily
      located throughout the United States, and the majority of the international
      direct sales team is located in the United Kingdom. Distribution throughout
      the
      Europe, Middle East, Africa and Asia Pacific regions is also covered by a
      network of reseller partners. The Company typically licenses its RetrievalWare
      products to end-users as either an enterprise-wide or work-group level solution.
      The Excalibur Web offering may be sold as a hosted service in addition to the
      license model.





The
      Company generally has three license types: OEM, reseller and end-user. Each
      of
      these license types generally includes the same standard terms regarding such
      things as confidentiality, infringement, indemnification and limitations of
      liability. OEM licenses generally stipulate royalties due to the Company based
      on the sale of the OEM customer’s product incorporating the Company’s
      technology. OEM contracts generally require the customer to pay some of the
      royalties in advance of the sale of their integrated product. Reseller licenses
      generally include a predetermined discount or margin that the reseller is
      required to pay the Company based on their sales of the Company’s products to
      their customers. Reseller agreements are occasionally structured to include
      minimum amounts due from the resellers in advance of their sales to end user
      customers. This is generally in consideration for some type of exclusivity
      arrangement in a particular territory. Generally, arrangements with OEM
      customers and resellers are structured as term licenses ranging from two to
      five
      years. This provides future revenue opportunities to the Company through term
      renewals. End-user license agreements are generally structured as perpetual
      software licenses for a specific number of users and/or for use on a specific
      number of servers. Payment terms generally tend to be shorter on end user
      perpetual licenses compared to those of OEM licenses. Hosted service
      arrangements, specifically
      for the Excalibur Web offering, will utilize similar standard terms as noted
      above regarding such things as confidentiality, infringement, indemnification
      and limitations of liability and theses contracts are also expected to be
      primarily structured based on a combination of usage and/or documents
      thresholds.





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Convera
      focuses its sales and marketing efforts on enterprises that have large, rapidly
      changing content collections in diverse formats and have large numbers of
      knowledge workers. In that regard, the Company concentrates a significant amount
      of sales and marketing resources on vertical markets such as government agencies
      and media & publishing concerns. In addition, the Company has begun to adopt
      a direct selling model with respect to its Excalibur Web offering while also
      exploring the prospect of strategic partners or resellers who may provide
      increased distribution, access to incremental human resources and possible
      hosting facility alternatives.





Marketing
      efforts focus on building brand awareness and establishing demand for the
      Company’s products and include public relations, trade show participation,
      electronic marketing campaigns, and advertising and telemarketing/lead
      management activities. The Company’s web site, *www.convera.com* ,
      is an
      integral part of its marketing and sales efforts, but information on the
      Company's Web site is not a part of this Form 10-K. Through the web site,
      prospective customers can learn about Convera’s suite of products and services
      and view online demonstrations. Existing customers can enroll in training
      courses and access password-protected areas for technical and other customer
      support.







**Product
      Development and Advanced Research**




The
      Company’s research and development program focuses on enhancing and expanding
      the capabilities of its products and services to address emerging markets and
      customer requirements. Over time and as the technology evolves, RetrievalWare
      is
      expected to remain the basic building block of a modular suite of products
      as
      previously described for enterprise customers over the near-term. In addition
      to
      providing seamless access to both structured and unstructured data in the
      enterprise, this modular approach simplifies system administration for the
      customer and makes it easier for Convera to update existing features and add
      new
      components such as support for new data types and taxonomies for specific
      vertical markets. The Excalibur Web offering is an open-source search
      technology, capable of searching and indexing Web-based content, however, it
      may
      also evolve to offer certain internal search and categorization features similar
      to that of RetrievalWare.





Certain
      elements of the Company’s software products are supplied to the Company by other
      independent software vendors under license agreements with varying terms.
      Pursuant to these agreements, the Company makes periodic royalty payments
      generally based on either actual or anticipated revenues or units. The
      technologies acquired by the Company in this manner include word processing
      filters, optical character recognition engines, dictionaries, language
      analyzers, spider and thesauri in electronic form, image and audio processing,
      and face and speech recognition technologies.








**Protection
      of Proprietary Technology**




The
      Company regards its software as proprietary and relies primarily on a
      combination of patents, copyright, trademark and trade secret laws of general
      applicability, employee confidentiality and invention assignment agreements,
      software distribution protection agreements and other intellectual property
      protection methods to safeguard its technology and software products. The
      Company holds one patent related to its current business strategy. This
      patent, which concerns multimedia document retrieval, expires on August 24,
      2018. The Company owns several other patents and patent applications unrelated
      to its current business strategy.  The Company is actively engaged in
      seeking additional patents specifically related to its Excalibur Web offering.
      The Company has undertaken to protect all significant marks used to identify
      the
      Company's core software products and related services. The Company owns U.S.
      trademark registrations or pending applications for its material trademarks,
      including CONVERA, RETRIEVALWARE, SCREENING ROOM and
      EXCALIBUR.  Renewals are due at various
      dates between July 2008 and August 2013. In addition, the Company
      owns numerous foreign applications and registrations for its material
      trademarks.





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**Competition**




Competition
      in the information technology industry in general and the software development
      industry in particular, is intense. Convera competes primarily in the search
      and
      categorization software market which all Convera products and services address.
      Within this market, there are current and potential competitors who are larger
      and more established than Convera and have significantly greater financial,
      technical, marketing and other resources.





Convera
      considers its principal competitive advantages to be an environment that: (1)
      is
      scalable due to the distributed-processing architecture, (2) provides more
      accurate results due to the semantic network and APRP technologies, (3) provides
      more comprehensive results due to its ability to manage and retrieve information
      in multiple languages and in rich media file formats and (4) offers the ability
      to provide “blended” search results involving data derived from an
      organization’s internal data repositories with open source or Web-based content
      through the use of the Company’s Excalibur Web offering.





There
      can
      be no assurance that the Company will be able to compete successfully against
      current or future competitors or that competition will not materially affect
      the
      Company’s operating results and financial condition in an adverse
      manner.








**Government
      Regulation**




The
      Company’s activities currently are subject to no particular regulation by
      governmental agencies other than those routinely imposed on corporate businesses
      and no such regulation is now anticipated.








**Segment
      Information**




At
      the
      conclusion of fiscal 2005, the Company determined that it had two reportable
      segments. Management viewed the core software products business (e.g.,
      RetrievalWare) separately from its Excalibur Web offering. Substantially all
      of
      the Company’s revenues for fiscal 2006 were derived from third party customers
      from within the core software products business. For fiscal year 2006, revenues
      earned from the Excalibur Web offering totaled approximately $20,000.





Revenues
      derived from contracts and orders issued by agencies of the U.S. Government
      were
      approximately $11.3 million, $11.6 million and $15.2 million, respectively,
      in
      the fiscal years ended January 31, 2006, 2005 and 2004. These revenues,
      expressed as a percentage of total revenues for the aforementioned fiscal years,
      were approximately 54%, 45% and 52%, respectively.




Financial
      information is located in the consolidated financial statements beginning on
      page F-4. Additional information related to segment reporting can be found
      in
      Note 13 to the consolidated financial statements contained herein.





**Employees**




The
      Company had 179 employees at January 31, 2006, of whom 89 were in research
      and
      development; 30 in sales and marketing; 27 in finance and administration, 18
      in
      technical support, professional services and training and 15 in web hosting
      operations. The employees are not covered by collective bargaining agreements,
      and the management of the Company considers relations with employees to be
      good.
      Competition for qualified personnel within the Company’s industry is intense.
      There can be no assurance that the Company will be able to continue to attract,
      hire or retain qualified personnel, and the inability to do so could have a
      material adverse effect upon the Company’s operating results and financial
      condition.








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**Item
      1A.****Risk
      Factors**




An
      investment in our common stock involves substantial risks and uncertainties
      and
      our actual results and future trends may differ materially from our past
      performance due to a variety of factors, including, without limitation, the
      risk
      factors identified below.  The
      risks
      and uncertainties described below are not the only risks and uncertainties
      we
      face. Additional risks and uncertainties not presently known to us or that
      we
      currently deem immaterial also may impair our business operations. If any of
      the
      following risks actually occur, our business, results of operations and
      financial condition would suffer. In that event, the trading price of our common
      stock could decline, and our stockholders may lose part or all of their
      investment in our common stock. The discussion below and elsewhere in this
      report also includes forward-looking statements, and our actual results may
      differ substantially from those discussed in these forward-looking statements
      as
      a result of the risks discussed below.





**We
      have had a history of operating losses and will likely incur future
      losses;** **if our losses continue and we are unable to achieve profitability, our stock
      price will likely suffer.**





We
      have
      operated at a loss for each of the past three fiscal years. For the fiscal
      years
      ended January 31, 2006, 2005, and 2004, our net losses were approximately $14.3
      million, $19.8 million, and $18.1 million, respectively. These losses include
      expenditures associated with selling software products, further developing
      software products during these years and developing our Excalibur Web offering.
      We expect that our losses will continue for the foreseeable future as we
      continue to invest in Excalibur and these other programs and, accordingly,
      we
      cannot assure you that we will be able to achieve or maintain profitability
      in
      the future. Our failure to achieve and sustain our profitability will negatively
      impact the market price of our common stock.





**Our
      ability to achieve profitability is highly dependent on our Excalibur Web
      offering and if Excalibur fails to achieve market acceptance we will be unable
      to grow our business and achieve profitability.**




We
      have
      expended significant financial resources, as well as management attention,
      on
      Excalibur and expect that our expenditures on Excalibur will continue to be
      significant. We believe
      that our future profitability will depend on our ability to successfully market,
      and achieve market acceptance for, Excalibur, our Web offering. The
      degree of market acceptance of Excalibur will depend upon a number of factors,
      including:




·
            the
                advantages of Excalibur over competing
                products;




·
            our
                ability to innovate and develop new features for
                Excalibur;




·
            customer
                needs for search products;




·
            the
                price and cost-effectiveness of Excalibur;
                and




·
            the
                strength of sales, marketing and distribution
                support.





We
      are
      aware of a significant number of competing well-established search products
      offered by companies with significantly greater financial and marketing
      resources than us. Even if Excalibur achieves market acceptance, we may not
      be
      able to maintain that market acceptance over time if competing products are
      introduced that are viewed as more effective or are more favorably received
      than
      Excalibur. If Excalibur does not achieve and maintain market acceptance, we
      will
      not be able to generate sufficient revenue to attain profitability.





**While
      we believe we will have sufficient funds for our operations for at least the
      next twelve months, it is possible that we will** **need additional capital** **during
      or after that time.** **** **We
      may need additional capital in the future, and it may not be available on
      acceptable terms, or at all, and if we do not receive any necessary additional
      capital, it could harm our financial condition and future
      prospects.**





As
      of
      March 15, 2006, our balances of cash, cash equivalents and short-term
      investments were approximately $65.4 million. We believe our
      current balance
      of cash , cash
      equivalents and
      short-term investments, combined with any funds generated from our
      operations will be
      sufficient to meet our working capital and capital expenditure requirements
      for
      at least the next twelve
      months based
      upon our estimates of funds required to operate our business during such
      period .
      However, during
      or after
      that time, we may need to raise additional funds for the following
      purposes:


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·
            to
                fund our operations, including sales, marketing and research and
                development programs including the Excalibur Web
                offering;


·
            to
                fund any growth we may experience;


·
            to
                enhance and/or expand the range of products and services we
                offer;


·
            to
                increase our promotional and marketing activities;
                or


·
            to
                respond to competitive pressures and/or perceived opportunities,
                such as
                investment, acquisition and international expansion
                activities.





We
      cannot
      reassure our investors that if we need additional capital that it will be
      available, and if so, on terms beneficial to us. Historically, we have obtained
      external financing primarily from sales of our common stock. To the extent
      we
      raise additional capital by issuing equity securities, our shareholders may
      experience substantial dilution. If we are unable to obtain additional capital,
      we may then attempt to preserve our available resources by various methods
      including deferring the creation or satisfaction of commitments, reducing
      expenditures on our research and development programs or otherwise scaling
      back
      our operations. If we were unable to raise such additional capital or defer
      certain costs as described above, that inability would have an adverse effect
      on
      our financial position, results of operations and prospects.





**We
      experience quarterly fluctuations in our operating results, which may adversely
      affect our stock price** **.**





Our
        quarterly operating results have varied substantially in the past. F or
        example, our total revenues for the four quarters of fiscal year 2006 were
        $5.1
        million, $7.8 million, $4.5 million and $3.6 million respectively, and the
        price
        per share of our common stock during those quarters ranged from $3.92 to
        $20.20. Our
        quarterly operating results are likely to continue to vary substantially
        from
        quarter to quarter in the future, due to a variety of factors including the
        following:
 
 ·
              the
                  ability of Excalibur, our new Web offering to achieve market
                  acceptance;
 ·
              the
                  downturn in capital spending by customers as a result of general
                  economic
                  conditions;
 ·
              the
                  level of customer demand for our products and services, including
                  Excalibur;
 ·
              the
                  delay or deferral of customer
                  implementations;
 ·
              the
                  budget cycles of our customers;
 ·
              seasonality
                  of individual customer buying
                  patterns;
 ·
              an
                  increase in competition in the software and search
                  industries;
 ·
              the
                  size and timing of individual
                  transactions;
 ·
              the
                  timing of new software introductions and software enhancements
                  by us and
                  our competitors;
 ·
              changes
                  in operating expenses and
                  personnel;
 ·
              changes
                  in accounting principles, such as a requirement that stock options
                  be
                  included in compensation, which would increase our expense and
                  have a
                  negative effect on earnings;
 ·
              the
                  overall trend towards industry consolidation;
                  and
 ·
              changes
                  in general economic and geo-political conditions and specific economic
                  conditions in the computer and software
                  industries.






In
      particular, our period-to-period operating results have historically been
      dependent upon the timing of the closing of significant license agreements.
      Since purchasing our software products often requires significant capital
      investment, our customers may defer or decide not to make their purchases.
      This
      means sales can involve sales cycles of six months or more. We derive a
      significant portion of our revenues from sales to agencies of the U.S.
      Government, and, therefore, the budget cycle of the U.S. Government impacts
      our
      total revenues. In certain financial quarters, we may derive a significant
      portion of our revenues from a single customer. For example, revenues derived
      from one customer accounted for approximately 14% of our total revenues in
      fiscal year 2006. We have historically recorded a significant portion of our
      total quarterly license revenues in the third month of a quarter, with a
      concentration of these revenues occurring in the last half of that third month.
      We expect these revenue patterns to continue. Despite these uncertainties in
      our
      revenue patterns, we base our operating expenses upon anticipated revenue
      levels, and we incur these expenses on an approximately ratable basis throughout
      a quarter. As a result, if expected revenues are deferred or otherwise not
      realized in a quarter for any reason, our business, operating results and
      financial condition would be materially adversely affected.


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In
      addition, steps which we have taken or may take in the future to control
      operating expenses may hamper our development, sales and marketing efforts
      and,
      ultimately, our operating results. For instance, we aligned our resources
      through a number of reorganizations during fiscal years 2002 through 2005 to
      attempt to focus on markets that have been consistently successful for us.
      These
      reorganizations were intended to streamline our professional services, customer
      support and sales organizations by reducing the number of our employees, improve
      the productivity of each of those organizations and reduce management personnel
      and other overhead costs in our marketing, development and administrative
      organizations. However, the loss of key personnel in such restructurings and
      any
      severance and other costs incurred in such restructurings could negatively
      affect our quarterly operating results and adversely affect our stock
      price.





**We
      are in an extremely competitive market, and if we fail to compete effectively
      or
      respond to rapid technological change, our revenues and market share will be
      adversely affected**





Our
      business environment and the search and software industries in general are
      characterized by intense competition, rapid technological changes, changes
      in
      customer requirements and emerging new market segments. Our competitors include
      many companies that are larger and more established and have substantially
      more
      resources than us. Current and potential competitors have established or may
      establish cooperative relationships among themselves or with third parties
      to
      increase the ability of their products to address the needs of the markets
      which
      we serve. Accordingly, it is possible that new competitors or alliances among
      competitors may emerge and rapidly acquire significant market share. Increased
      competition may result in price reductions, reduced gross margins and loss
      of
      market share, any of which could have a material adverse effect on our business,
      financial condition or results of operations.





In
      order
      for our strategy to succeed and to remain competitive, we must leverage our
      core
      technology to develop new product offerings, update existing features and add
      new components to our current products such as support for new datatypes and
      taxonomies for specific vertical markets. These development efforts are
      expensive, and we plan to fund these developments with our existing capital
      resources, and other sources, such as equity issuances and borrowings, which
      may
      be available to us. If these developments do not generate substantial revenues,
      our business and results of operations will be adversely affected. We cannot
      assure you that we will successfully develop any new products, complete them
      on
      a timely basis or at all, achieve market acceptance or generate significant
      revenues with them.





**We
      design our products to work with certain systems and changes to these systems
      may render our products incompatible with these systems, and we may be unable
      to
      sell our products**





Our
      ability to sell our products depends on the compatibility of our products with
      other software and hardware products. These products may change or new products
      may appear that are incompatible with our products. If we fail to adapt our
      products to remain compatible with other vendors' software and hardware products
      or fail to adapt our products as quickly as our competitors, we may be unable
      to
      sell our products.





**Our
      software products are complex and may contain errors that could damage our
      reputation and decrease sales**





Our
      complex software products may contain errors that people may detect at any
      point
      in the products’ life cycles. We cannot assure you that, despite our testing and
      quality assurance efforts and similar efforts by current and potential
      customers, errors will not be found. The discovery of an error may result in
      loss of or delay in market acceptance and sales.





**We
      derive a significant portion of our revenues from sales to U.S. Government
      agencies, which are subject to budget cuts and, consequently, a change in the
      size and timing of our U.S. Government contracts may materially affect our
      operating results**





For
      the
      year ended January 31, 2006, total revenues derived from sales to agencies
      of
      the U.S. Government were approximately $11.3 million, representing 54% of total
      revenues. For the year ended January 31, 2005, revenues derived from sales
      to
      agencies of the U.S. Government were approximately $11.6 million, or 45% of
      total revenues. While the U.S. Government has recently increased spending on
      defense, information systems and homeland security initiatives, some government
      agencies have realized budget reductions which may adversely impact their
      purchasing decisions
      and timing. We are actively pursuing several opportunities for business with
      certain U.S. Government agencies. While the nature and timing of these
      opportunities, as well as the ability to complete business transactions related
      to these opportunities, is subject to certain risks and uncertainties,
      successful completion of any of these transactions could have a material impact
      on our future operating results and financial position. There can be no
      assurance that we will complete any of these potential
      transactions.





14
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          of Contents


**As
      a U.S. Government contractor, we are subject to a number of procurement rules
      and regulations.**





We
      must
      comply with and are affected by laws and regulations relating to the award,
      administration and performance of U.S. Government contracts. Government contract
      laws and regulations affect how we do business with our customers and, in some
      instances, impose added costs on our business. In some instances, these laws
      and
      regulations impose terms or rights that are more favorable to the government
      than those typically available to commercial parties in negotiated transactions.
      A violation of specific laws and regulations could result in the imposition
      of
      fines and penalties or the termination of our contracts or debarment from
      bidding on contracts.





**We
      depend on international sales, particularly in the United Kingdom,
      and**  **any
      economic downturn, changes in laws, changes in currency exchange rates or
      political unrest in the United Kingdom or in other countries could have a
      material adverse effect on our business**





For
      the
      year ended January 31, 2006, total revenues derived from international sales
      were approximately $5.2 million, representing approximately 25% of total
      revenues. For the year ended January 31, 2005, revenues derived from
      international sales were approximately $7.5 million, representing approximately
      29% of total revenues. Most of our international sales are in the United
      Kingdom. Our
      international operations have historically exposed us to longer accounts
      receivable and payment cycles and fluctuations in currency exchange rates.
      International sales are made mostly from our U.K. subsidiary and are denominated
      in British pounds or Euros. As of January 31, 2006, approximately 6% and 11%
      of
      our total consolidated accounts receivable were denominated in British pounds
      and Euros, respectively. Additionally, our exposure to foreign exchange rate
      fluctuations arises in part from intercompany accounts in which royalties on
      our
      foreign subsidiary’s sales are charged to our foreign subsidiary and recorded as
      intercompany receivables on our books. We are also exposed to foreign exchange
      rate fluctuations as the financial results of our foreign subsidiary are
      translated into U.S. dollars in consolidation. Since exchange rates vary, those
      results when translated may vary from expectations and adversely impact overall
      expected profitability.




Our
      international operations expose us to a variety of other risks that could
      seriously impede our financial condition and growth. These risks include the
      following:





·
            potentially
                adverse tax consequences;


·
            difficulties
                in complying with regulatory requirements and
                standards;


·
            trade
                restrictions and changes in
                tariffs;


·
            import
                and export license requirements and restrictions;
                and


·
            uncertainty
                of the effective protection of our intellectual property rights in
                certain
                foreign countries.





If
      any of
      these risks described above materialize, our international sales could decrease
      and our foreign operations could suffer.





**Our
      Excalibur Web offering relies on a third party hosting facility, and any failure
      or interruption in the services provided by this third party could harm our
      ability to operate our business and damage our reputation.**





We
      rely
      on AT&T for both our primary and back-up hosting facilities to support our
      Excalibur Web offering. We do not control the operation of these AT&T
      facilities and each may be subject to damage or interruption from earthquakes,
      floods, fires, power loss, telecommunications failures or similar events. These
      facilities may also be subject to break-ins, sabotage, intentional acts of
      vandalism or similar misconduct. Despite precautions taken at these facilities,
      the occurrence of a natural disaster, cessation of operations by our third-party
      web hosting provider or its decision to close a facility without adequate notice
      or other unanticipated problems at either facility could result in lengthy
      interruptions in our service. In addition, the failure by these facilities
      to
      provide our required data communications
      capacity could result in interruptions in our service. Interruptions in our
      service may cause us to lose revenue, cause us to issue credits or refunds
      and
      cause customers to terminate their contracts with us. Our business and
      reputation will be adversely affected if our customers and potential customers
      believe our Excalibur service is unreliable.





15
 Table
          of Contents


**We
      depend on proprietary technology licensed from third parties; if we lose these
      licenses, it could delay shipments of products incorporating this technology
      and
      could be costly**





Our
      products use certain technology that we license from third parties, generally
      on
      a nonexclusive basis. We believe that there are alternative sources for each
      of
      the material components of technology we license from third parties. However,
      the termination of any of these licenses, or the failure of the third-party
      licensors to adequately maintain or update their products, could delay our
      ability to ship these products while we seek to implement technology offered
      by
      alternative sources. Any required replacement licenses could prove costly.
      Also,
      any delay, to the extent it becomes extended or occurs at or near the end of
      a
      fiscal quarter, could harm our quarterly results of operations. While it may
      be
      necessary or desirable in the future to obtain other licenses relating to one
      or
      more of our products or relating to current or future technologies, we cannot
      assure that we will be able to do so on commercially reasonable terms or at
      all.





**Because
      of the technical nature of our business, our intellectual property is extremely
      important to our business, and adverse changes to our intellectual property
      could harm our competitive position**





We
      believe that our success depends, in part, on our ability to protect our
      proprietary rights and technology. Historically, we have relied on a combination
      of copyright, patents, trademark and trade secret laws, employee confidentiality
      and invention assignment agreements, distribution and OEM software protection
      agreements and other methods to safeguard our technology and software products.
      Risks associated with our intellectual property, include the
      following:





·
            pending
                patent applications may not be
                issued;


·
            intellectual
                property laws may not protect our intellectual property
                rights;


·
            third
                parties may challenge, invalidate, or circumvent any patent issued
                to
                us;


·
            rights
                granted under patents issued to us may not provide competitive advantages
                to us;


·
            unauthorized
                parties may attempt to obtain and use information that we regard
                as
                proprietary despite our efforts to protect our proprietary
                rights;


·
            others
                may independently develop similar technology or design around any
                patents
                issued to us; and


·
            effective
                protection of intellectual property rights may be limited or unavailable
                in some foreign countries in which we
                operate.





**We
      may in the future be subject to intellectual property rights claims, which
      are
      costly to defend, could require us to pay damages and could limit our ability
      to
      use certain technologies in the future.**





Companies
      in the software and technology industries own large numbers of patents,
      copyrights, trademarks and trade secrets and frequently enter into litigation
      based on allegations of infringement or other violations of intellectual
      property rights. We face the possibility of intellectual property rights claims
      against us. Our technologies may not be able to withstand any third-party claims
      or rights against their use. Any intellectual property claims, with or without
      merit, could be time-consuming, expensive to litigate or settle and could divert
      management resources and attention.




With
      respect to any intellectual property rights claim, we may have to pay damages
      or
      stop using technology if it is ultimately found by a court to be in violation
      of
      a third party’s rights. We may have to seek a license for the technology, which
      may not be available on reasonable terms and may significantly increase our
      operating expenses. The technology also may not be available for license to
      us
      at all. As a result, we may also be required to develop alternative
      non-infringing technology, which could require significant effort and expense.
      If we cannot license or develop technology for the infringing aspects of our
      business, we may be forced to limit our product and service offerings and may
      be
      unable to compete effectively. Any of these results could harm our operating
      results.


16
 Table
          of Contents


**We
      depend on our key personnel, the loss of whom would adversely affect our
      business, and we may have difficulty attracting and retaining skilled
      employees**





Our
      success depends to a significant degree upon the continued contributions of
      our
      key management, marketing, technical and operational personnel. We generally
      do
      not utilize employment agreements for our key employees. The loss of the
      services of one or more key employees could have a material adverse effect
      on
      our operating results. We also believe that our future success will depend
      in
      large part upon our ability to attract and retain additional highly skilled
      management, technical, marketing, product development, operational personnel
      and
      consultants. Competition for such personnel, particularly software developers,
      professional service consultants and other technical personnel, is intense,
      and
      pay scales in the software industry have significantly increased. There can
      be
      no assurance that we will be successful in attracting and retaining such
      personnel.





**Our
      stock price may fluctuate which may make it difficult to resell shares of our
      stock**





The
      market price of our common stock has been highly volatile. For example, in
      the
      fourth quarter of fiscal year 2006, the market price per share of our common
      stock ranged from $7.85 to $20.20. This volatility may adversely affect the
      price of our common stock, and our stockholders may not be able to resell their
      shares of common stock following periods of volatility because of the market's
      adverse reaction to this volatility. We anticipate that this volatility, which
      frequently affects the stock of software companies, will continue. Factors
      that
      could cause such volatility include:





·
            future
                announcements concerning us or our
                competitors;


·
            quarterly
                variations in our operating
                results;


·
            actual
                or anticipated announcements of technical innovations or new product
                developments by us or our
                competitors;


·
            general
                conditions in our industry;


·
            developments
                concerning litigation; and


·
            worldwide
                economic and financial conditions.





On
      occasion, the equity markets, and in particular the markets for software
      companies have experienced significant price and volume fluctuations. These
      fluctuations have affected the market price for many companies' securities
      and
      may be unrelated to the companies' operating performance.





**We
      may not be able to use net operating loss carryforwards**





As
      of
      January 31, 2006, we had net operating loss carryforwards of approximately
      $185
      million. The deferred tax assets representing the benefits of these
      carryforwards have been offset completely by a valuation allowance due to our
      lack of an earnings history. The realization of the benefits of these
      carryforwards depends on sufficient taxable income in future years. Lack of
      future earnings could adversely affect our ability to utilize these
      carryforwards. Additionally, past or future changes in our ownership and control
      could limit the ability to utilize these carryforwards. Despite the
      carryforwards, we may have income tax liability in future years due to the
      application of the alternative minimum tax rules of the United States Internal
      Revenue Code.





**Our
      amended and restated certificate of incorporation, bylaws, ownership and
      Delaware law contain provisions that could discourage a third party from
      acquiring us and consequently decrease the market value of an investment in
      our
      stock**





Some
      provisions of our amended and restated certificate of incorporation and bylaws
      and of Delaware law could delay or prevent a change of control or changes in
      our
      management that a stockholder might consider favorable. Any delay or prevention
      of a change of control or change in management could cause the market price
      of
      our common stock to decline.





17
 Table
          of Contents


**Allen
      Holding Inc. and related parties exercise voting control over a significant
      percentage of our outstanding shares, and our other shareholders may not have
      an
      effective say in any matters upon which our shareholders
      vote**





As
      of
      March 1, 2006, Allen Holding Inc., together with Allen & Company
      Incorporated, Herbert A. Allen and certain related parties (collectively “Allen
& Company”) beneficially owned approximately 43% of our voting power, and
      would therefore be able to effectively control the outcome of matters requiring
      a stockholder vote. These matters could include offers to acquire us and
      elections of directors. Allen & Company may have interests which are
      different than the interests of our other stockholders.


18
 Table
          of Contents


**Item
      1B.****Unresolved
      Staff Comments**





There
      are
      no material unresolved SEC staff comments as of the date of this
      report.








**Item
      2.****Properties**





The
      Company’s corporate headquarters facility is occupied under a lease agreement
      that expires in December 2007 for a total of approximately 13,200 square feet
      of
      space in an office building located at 1921 Gallows Road, Vienna, Virginia
      22182.





The
      Company’s principal development and customer support centers are located in
      Carlsbad, California and Columbia, Maryland. The Company leases additional
      space
      in Montreal, Canada, and Bracknell, United Kingdom. During fiscal 2006 the
      Company closed its office in Frankfurt, Germany.





The
      Company believes that its facilities are maintained in good operating condition
      and are adequate for its operations.








**Item
      3.****Legal
      Proceedings**





On
      November 1, 2001, DSMC, Incorporated ("DSMCi") filed a complaint against the
      Company in the U.S. District Court for the District of Columbia in which it
      alleged that the Company misappropriated DSMCi's trade secrets, and engaged
      in
      civil conspiracy with the NGT Library, Inc. ("NGTL"), an affiliate of the
      National Geographic Society, to obtain access to DSMCi's trade secrets, and
      was
      unjustly enriched by the Company's alleged access to and use of such trade
      secrets. In its complaint, DSMCi seeks $5 million in actual damages and $10
      million in punitive damages from the Company. DSMCi subsequently amended its
      complaint to add copyright infringement-related claims. NGTL intervened in
      the
      litigation as a co-defendant with Convera, and filed counterclaims against
      DSMCi. Convera moved to compel arbitration of DSMCi's claims; the District
      Court
      denied the motion, and Convera filed an interlocutory appeal. The D.C. Circuit,
      in November 2003, ruled that it did not have jurisdiction to consider the
      appeal. During December 2005 DSMCi and NGTL entered into a Settlement Agreement
      and Release.  The U.S. District Court dismissed claims against NGTL on
      December 23, 2005. The litigation between the Company and DSMCi is currently
      in
      the summary judgment phase in the District Court.  The
      Company has investigated the claims and continues to believe that the claims
      are
      without merit.





In
      connection with this litigation, the Company brought an arbitration claim
      against NGTL on September 13, 2005, seeking indemnification for its defense
      costs and potential liability pursuant to an indemnity provision in a service
      agreement between NGTL and the Company. In response, NGTL brought a cross claim
      against the Company under the same contract provision for indemnification of
      NGTL’s respective costs and liability. This arbitration is in its early stage.





In
      addition, from time to time, the Company is a party to various legal
      proceedings, claims, disputes and litigation arising in the ordinary course
      of
      business, including that noted above. The Company believes that the ultimate
      outcome of these matters, individually and in the aggregate, will not have
      a
      material adverse affect on its financial position, operations or cash flow.
      However, because of the nature and inherent uncertainties of litigation, should
      the outcome of these actions or future actions be unfavorable, Convera’s
      financial position, operations and cash flows could be materially adversely
      affected.








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





None.


19
 Table
          of Contents


**PART
      II**





**Item
      5.****Market
      for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
      of Equity Securities**





The
      Company's Class A common stock is traded in the over--the-counter market and
      is
      listed on the National Market System of the NASDAQ Stock Market under the symbol
      “CNVR.”





The
      following table sets forth the high and low sale prices for Convera common
      stock
      for the period from February 1, 2004 through January 31, 2006, as reported
      by
      the National Market System of NASDAQ. The number of shareholders of record
      as of
      January 31, 2006 was 928. The Company has never declared or paid dividends
      on
      its common stock and anticipates that, for the foreseeable future, it will
      not
      pay dividends on its common stock.




High
            
            LowFiscal
                2006 (February 1, 2005 - January 31, 2006)First
                Quarter
            
            $
            6.06
            
            $
            4.37Second
                Quarter
            
            
            8.83
            
            
            3.92Third
                Quarter
            
            
            15.00
            
            
            8.71Fourth
                Quarter
            
            
            20.20
            
            
            7.85Fiscal
                2005 (February 1, 2004 - January 31, 2005)First
                Quarter
            
            $
            5.40
            
            $
            2.87Second
                Quarter
            
            
            3.40
            
            
            2.16Third
                Quarter
            
            
            4.47
            
            
            2.17Fourth
                Quarter
            
            
            5.05
            
            
            3.70





The
      following table sets forth, as of January 31, 2006, information with respect
      to
      the Company’s equity compensation plans:




Plan
                  Category
              Number
                  of
                Securities
                  to be Issued Upon Exercise of Outstanding Options, Warrants and
                  Rights
                (a)
              Weighted-Average
                  Exercise Price of Outstanding Options, Warrants and Rights
                  (1)
                (b)
              Number
                  of Securities Remaining Available for Future Issuance Under Equity
                  Compensation Plans (excluding securities reflected in column
                  (a))
                (c)Equity
                  compensation plans approved by security holders:1.
                  Convera Stock Option Plan
              9,695,022
              $5.25
              334,3482.
                  Convera Employee Stock Purchase Plan
              
              -
              674,353Equity
                  compensation plans not approved by security holders:
              None
              Not
                  Applicable
              Not
                  Applicable





(1)
      For
      purposes of calculating the weighted-average exercise price, deferred shares
      have been excluded because there is no exercise price.


20
 Table
          of Contents


**Item
      6.****Selected
      Financial Data**





The
      selected financial data presented below have been derived from the Company’s
      consolidated financial statements. The balance sheet data as of January 31,
      2006
      and 2005, and the statement of operations data for the fiscal years ended
      January 31, 2006, 2005 and 2004 should be read in conjunction with the
      consolidated financial statements and notes thereto included elsewhere in this
      Annual Report on Form 10-K.





Fiscal
                Years Ended January 31,2006
            
            2005
            
            2004
            
            2003
            
            2002Statement
                of Operations Data:
            
            (in
                thousands, except per share data)Revenues
            
            $
            21,008
            
            $
            25,698
            
            $
            29,251
            
            $
            23,614
            
            $
            34,228Operating
                expenses:Cost
                of revenues (1)
            
            
            7,267
            
            
            6,708
            
            
            8,570
            
            
            10,697
            
            
            22,307Sales
                and marketing
            
            
            8,190
            
            
            14,476
            
            
            18,124
            
            
            20,018
            
            
            33,747Research
                and product development
            
            
            8,346
            
            
            13,801
            
            
            11,981
            
            
            11,639
            
            
            22,500General
                and administrative
            
            
            11,113
            
            
            9,764
            
            
            10,564
            
            
            8,642
            
            
            10,214Amortization
                of goodwill (2)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            86,291Amortization
                of other intangible assets (2)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            9,088Amortization
                of Capitalized R&D costs
            
            
            1,012
            
            
            -
            
            
            -
            
            
            -
            
            
            -Incentive
                bonus payments to employees
            
            
            -
            
            
            -
            
            
            -
            
            
            (138
            )
            
            6,681Restructuring
                (recoveries) charges
            
            
            (57
            )
            
            944
            
            
            621
            
            
            2,337
            
            
            8,128Reduction
                in goodwill
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            675,896Reduction
                in other long-lived assets
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            78,528Acquired
                in-process research and development
            
            
            -
            
            
            -
            
            
            -
            
            
            126
            
            
            -35,871
            
            
            45,693
            
            
            49,860
            
            
            53,321
            
            
            953,380Operating
                loss
            
            
            (14,863
            )
            
            (19,995
            )
            
            (20,609
            )
            
            (29,707
            )
            
            (919,152
            )Other
                income, net
            
            
            602
            
            
            175
            
            
            2,550
            
            
            636
            
            
            4,191Net
                loss before income taxes
            
            
            (14,261
            )
            
            (19,820
            )
            
            (18,059
            )
            
            (29,071
            )
            
            (914,961
            )Income
                tax benefit
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            4,452Net
                loss
            
            $
            (14,261
            )
            $
            (19,820
            )
            $
            (18,059
            )
            $
            (29,071
            )
            $
            (910,509
            )Net
                loss per common share - basic and diluted
            
            $
            (0.33
            )
            $
            (0.56
            )
            $
            (0.57
            )
            $
            (1.01
            )
            $
            (20.08
            )Weighted-average
                number of common shares outstanding - basic and diluted
            
            
            43,088
            
            
            35,433
            
            
            31,486
            
            
            28,854
            
            
            45,349Balance
                Sheet Data (at end of period)Cash
                and cash equivalents
            
            $
            37,741
            
            $
            17,766
            
            $
            30,530
            
            $
            10,412
            
            $
            17,628Working
                capital
            
            
            35,240
            
            
            15,550
            
            
            26,737
            
            
            24,363
            
            
            51,691Total
                assets
            
            
            64,217
            
            
            36,294
            
            
            45,695
            
            
            49,139
            
            
            78,106Long-term
                obligations
            
            
            4,115
            
            
            9
            
            
            -
            
            
            -
            
            
            -Accumulated
                deficit
            
            
            (1,070,706
            )
            
            (1,056,445
            )
            
            (1,036,625
            )
            
            (1,018,540
            )
            
            (989,429
            )Total
                shareholders’ equity (3)
            
            
            50,841
            
            
            25,149
            
            
            31,368
            
            
            32,372
            
            
            57,876


(1)
            FY06
                amount excludes amortization of capitalized R&D costs shown separately
                below.


(2)
            Amortization
                for the 2002 fiscal year primarily related to the business combination
                with Intel’s IMS division.


(3)
            No
                dividends have been declared or paid on the Company’s common
                stock.


21
 Table
          of Contents


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





**Overview**





The
      Company principally earns revenues from the licensing of its software products
      and the provision of services in deployment of the Company’s technology to
      government agencies and commercial businesses throughout North America, Europe
      and other parts of the world. The Company licenses its software to end users
      directly and also distributes its software products through license agreements
      with value-added resellers, system integrators, original equipment manufacturers
      and other strategic partners. Revenues are generated from software licenses
      with
      customers and from the related sale of product maintenance, training and
      professional services. Additions to the number of authorized users, licenses
      issued for additional products and the renewal of product maintenance
      arrangements by customers pursuant to existing licenses also provide revenues
      to
      the Company. Under software maintenance contracts, customers are typically
      entitled to receive telephone support, software bug fixes and upgrades or
      enhancements of particular software products when and if they are released.
      With
      respect to the Company’s Excalibur Web offering, revenues may be derived from
      either a license model as described, or from a hosted service
      offering.





The
      Company believes its RetrievalWare product has unique capabilities supporting
      the needs of customers within government agencies that will enable it to
      capitalize on current market opportunities and achieve its operational goals.
      Going forward, the Company expects to focus a substantial amount of resources
      on
      further penetration of the national security, defense, law enforcement and
      intelligence gathering community with the United States and its allies. An
      important objective in this market is to upgrade existing installations of
      older
      versions of RetrievalWare to the RetrievalWare 8 platform that includes
      technical advancements such as categorization, dynamic classification, profiling
      and distributed indexing software capabilities.





Further,
      the Company expects to increase its development, selling & marketing efforts
      with regard to its Excalibur Web offering. Excalibur is an advanced effort
      aimed
      at applying portions of the Company’s existing technology to searching and
      indexing contextually relevant information on the Web. The Company launched
      the
      Excalibur platform on November 1, 2005 and has begun to focus on creating
      distribution channels for this new technology. In concert with the Excalibur
      Web
      offering, Convera has entered into a hosting facility agreement with AT&T
      and as of January 31, 2006, has established two hosting centers (San Diego,
      CA
      and Dallas, TX). The Company will look to focus a majority of its selling and
      marketing efforts on the government and intelligence gathering community as
      well
      as the media and publishing sector for the Excalibur Web offering. This selling
      and marketing strategy is designed to capitalize on the alignment between
      customer requirements seeking both Intranet and Web-based search and
      categorization technologies. Operating costs for this advanced development
      effort totaled approximately $8.1 million for fiscal 2006, while capital
      expenditures totaled approximately $6.6 million for the year ended January
      31,
      2006. Going-forward, cash outlays will be limited to equipment, personnel and
      general operating costs, including marketing activities. The Company expects
      to
      continue to increase its investment in Excalibur and may also elect to seek
      additional funding sources for this effort. The Company may also elect to seek
      additional and/or alternative market segments for the Excalibur offering over
      the coming quarters.





Management’s
      primary objective is to achieve profitability and positive cash flow from
      operations without hampering development, sales and marketing efforts. The
      Company is committed to investing in the enhancement of its products to meet
      the
      needs of its customers and prospects. To achieve its main objective, the Company
      continually evaluates revenue opportunities to determine the market sectors
      in
      which the Company should concentrate its sales and marketing efforts. The
      Company’s business environment and the search software industry in general are
      characterized by intense competition, rapid technological changes, changes
      in
      customer requirements and emerging new market segments. The Company competes
      within the commercial sector where its market position has not been as strong
      as
      it has been within the government sector. As such, the Company has elected
      to
      focus the majority of its efforts within the commercial setting on the media
      and
      publishing sectors. The Company believes this segment may afford greater
      opportunities when compared to addressing a wide array of commercial market
      segments. The Company’s competitors include many companies that are larger and
      more established and have substantially more resources. Accordingly, it is
      possible that new competitors or alliances among competitors may emerge and
      rapidly acquire significant market share. Increased competition may result
      in
      price reductions, reduced gross margins and loss of market share, any of which
      could have a material adverse effect on the Company’s business, financial
      condition or results of operations. To address the competition, the Company
      will
      continue to invest in research and development to advance its leadership
      position in linguistic analysis, scalability, performance,
      and taxonomy development and deployment. The Company may also make additional
      investments in specific product features to better serve the needs of customers
      looking for online customer service and support solutions and with regard to
      the
      Excalibur Web offering, may elect to create a public search portal.





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In
      2002
      and 2003, the Company’s results of operations were impacted by the general
      downturn in the economy, which resulted in a lengthier sales cycle, particularly
      in the commercial marketplace. Further, reduced information technology budgets
      and customer cash constraints caused by the difficult business environment
      negatively impacted our business. Through a number of reorganizations during
      fiscal years 2002 through 2005, the Company aligned its resources in an effort
      to ensure it continued to capitalize on markets that have been consistently
      successful, including the federal government, and to focus its resources on
      those areas of the commercial sector that present vertical market opportunities.
      The reorganizations, which are described in this section and elsewhere in this
      Form 10-K, were intended to streamline the professional services, customer
      support and sales organizations by reducing the number of employees, improve
      the
      productivity of each of those organizations and reduce management personnel
      and
      other overhead costs in the marketing, development and administrative
      organizations within the Company.





On
      August
      18, 2004, the Company announced that it further streamlined its expense
      structure. As
      part
      of the restructuring, the Company reduced its personnel related costs,
      eliminated certain marketing programs, renegotiated real estate obligations
      and
      decreased other general operating expenses. The
      Company recorded a restructuring charge of $518,000 during the third quarter
      of
      fiscal 2005 related to this effort. Further, o n
      December 10, 2004 the Company announced an additional re-alignment of its
      operational infrastructure. This
      action included a general workforce reduction (including the transfer of certain
      resources to the Company’s Excalibur Web offering), facility consolidations,
      reduced marketing related expenses and decreased other general operating costs.
      As part of this restructuring, the Company also announced that it would increase
      its focus on accelerating its Excalibur development activities and would seek
      to
      advance the Company’s existing presence in the high-end search market,
      specifically within the government and intelligence gathering community as
      well
      as the media and publishing sectors. The Company recorded a net restructuring
      charge of $426,000 during the fourth quarter of fiscal 2005 related to this
      effort. The Company will continue to invest in its Excalibur Web offering,
      such
      that on a consolidated basis, the Company is expected to remain in a net loss
      position until such time as Excalibur is accepted into the commercial
      marketplace and certain levels of revenue are attained. A detailed review of
      the
      numerous risks and challenges facing the Company is contained in the Risk
      Factors section beginning on page 12.








**Critical
      Accounting Policies**





Convera’s
      consolidated financial statements have been prepared in accordance with
      accounting principles generally accepted in the United States. For a
      comprehensive discussion of the Company’s accounting policies, see Note 2 in the
      accompanying consolidated financial statements included in this Form 10-K.
      Convera does not have any material ownership interest in any entities that
      are
      not wholly owned and consolidated subsidiaries of the Company. The preparation
      of these financial statements requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Management bases those estimates, including those related
      to
      bad debts, goodwill and other intangible assets, restructuring costs, income
      taxes and litigation, on historical experience and other factors that are
      believed to be reasonable under the circumstances, the results of which form
      the
      basis for making judgments about the carrying value of assets, liabilities
      and
      equity that are not readily apparent from other sources. Actual results may
      differ from these estimates under different assumptions or conditions.





Convera
      believes the following accounting policies affect the more significant judgments
      and estimates used in the preparation of the Company’s financial condition and
      results of operations.





Revenue
      Recognition





Convera’s
      recognition of revenues requires judgment, particularly in the areas of
      collectibility and whether the fee is fixed and determinable at the time the
      sales are made. The Company bases its judgment on a variety of factors,
      including the payment and other terms of the individual customer contracts,
      credit history of the customer, prior dealings with specific customers, and
      certain other factors. If the Company determines that the price under the contract
      is fixed and determinable, and that collectibility is reasonably assured, then
      the Company recognizes revenue related to the software license at the time
      of
      sale. To the extent the Company determines that the price of a sales agreement
      is not fixed, the Company delays revenue recognition until payments under the
      contract become due. Alternatively, to the extent the Company determines that
      the collection of payments under the contract is not reasonably assured, the
      Company delays revenue recognition until the payments under the contract are
      received. Thus, the assessment as to whether the fee is fixed and determinable
      at the time of sale and that the fees are collectible is critical in determining
      the extent of the revenue recognized in a given period.





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The
      revenue associated with other elements of the contract, such as maintenance,
      training and professional services, are deferred and recognized as those
      elements are delivered. Generally, the Company receives payments for maintenance
      fees in advance and they are non-refundable. Maintenance revenues are recognized
      ratably over the term of the applicable maintenance agreement, which is
      typically twelve months.





Customization
      work is sometimes required to ensure that the Company’s software functionality
      meets the requirements of its customers. In those instances where the Company’s
      revenues are generated from fixed price contracts related to this customization
      work, then revenue is generally recognized using the percentage of completion
      method based on the relationship of actual costs incurred to total costs
      estimated over the duration of the contract. These cost estimates underlie
      the
      Company’s determinations as to overall contract profitability and the timing of
      revenue recognition. Further, the Company believes that this method of
      recognition is closely aligned with the evolution of the work product as
      defined. If the Company does not accurately estimate the resources required
      or
      the scope of the work to be performed, or does not manage its projects properly
      within the planned periods of time or satisfy its obligations under the
      contracts, then actual results may differ from projected results and losses
      on
      contracts may need to be recognized.





Hosted
      service revenues associated with the Excalibur Web offering are recognized
      straight-line over the term of the applicable service agreement.





Provision
      for Doubtful Accounts





Convera
      maintains an allowance for doubtful accounts for estimated losses resulting
      from
      the inability of its customers to make required payments. A considerable amount
      of judgment is required in assessing the ultimate realization of individual
      accounts receivable balances. The allowance for doubtful accounts is determined
      based on an analysis of the Company’s historical collection experience and the
      Company’s portfolio of customers taking into consideration the general economic
      environment as well as the industry in which the Company operates. To the extent
      Convera does not recognize deterioration in its customers’ financial condition
      in the period it occurs, or to the extent Convera does not accurately estimate
      its customers’ ability to pay, the amount of bad debt expense recognized in a
      given reporting period will be impacted.





Goodwill
      and Other Intangible Assets





Convera’s
      prior acquisitions of other companies resulted in the acquisition of certain
      intangible assets and goodwill. Goodwill resulting from these acquisitions
      is
      associated with the Company’s core software products reporting segment. In
      accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets”, the impairment of goodwill is assessed
      on an annual basis or whenever changes in circumstances indicate that the fair
      value of the Company is less than the carrying value. This assessment is
      performed by comparing the market value of the Company’s outstanding common
      stock with the carrying amount of the Company’s net assets. If the market value
      exceeds the carrying amount of the Company’s net assets, impairment of goodwill
      does not exist. If the market value is less than the carrying amount of the
      Company’s net assets, the Company will perform further analysis and may be
      required to record an impairment.





The
      Company evaluates all of its long-lived assets, including intangible assets
      other than goodwill, for impairment in accordance with the provisions of SFAS
      No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS
      No. 144 requires that long-lived assets and intangible assets other than
      goodwill be evaluated for impairment whenever events or changes in circumstances
      indicate that the carrying value of an asset may not be recoverable based on
      expected undiscounted cash flows attributable to that asset. Should events
      indicate that any of the Company’s assets are impaired; the amount of such
      impairment will be measured as the difference between the carrying
      value and the fair value of the impaired asset and recorded in earnings during
      the period of such impairment.





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Deferred
      Taxes





Convera
      records a valuation allowance to reduce its deferred tax assets to the amount
      that is more likely than not to be realized. Realization of the deferred tax
      assets is principally dependent upon the achievement of projected future taxable
      income. If the estimates and related assumptions change in the future, the
      Company may be required to adjust its valuation allowance against its deferred
      tax assets, resulting in a benefit or a charge to income in the period such
      determination is made. As of January 31, 2006, the Company has recorded a full
      valuation allowance against the net deferred tax asset.





Stock-Based
      Compensation





SFAS
      No.
      123, “Accounting for Stock-Based Compensation” (“SFAS 123”), allows companies to
      account for stock-based compensation either under the provisions of SFAS No.
      123
      or under the provisions of Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”), as amended by FASB
      Interpretation No. 44, “Accounting for Certain Transactions Involving Stock
      Compensation (an interpretation of APB Opinion No. 25).” The Company has elected
      to account for its stock-based compensation in accordance with the provisions
      of
      APB 25. Stock options originally granted under the Company’s stock option plans
      have an exercise price equal to the market value of the underlying common stock
      on the date of grant, and accordingly no employee compensation cost related
      to
      the initial grant of options is included in expenses. Stock option modifications
      associated with a change in employee status to a nonemployee have been accounted
      for as a new award and measured using the intrinsic value method under APB
      25,
      resulting in the inclusion of compensation expense in the January 31, 2004
      consolidated statement of operations. Nonvested shares of stock (referred to
      as
      deferred stock) granted under the Company’s stock option plan are measured at
      fair value on the date of grant based on the number of shares granted and the
      quoted price of the Company’s common stock. Such value is recognized as
      compensation expense over the corresponding service period. If an employee
      leaves the Company prior to the vesting of the deferred stock, the estimate
      of
      compensation expense recorded in previous periods is adjusted by decreasing
      compensation expense in the period of forfeiture.








**Results
      of Operations**





For
      the
      fiscal year ended January 31, 2006, total revenues were $21.0 million, a
      decrease of 18% compared to revenues of $25.7 million in fiscal year 2005.
      The
      net loss for fiscal year 2006 was $14.3 million, or $0.33 per common share,
      compared to $19.8 million, or $0.56 per common share, in the prior year. For
      the
      fiscal year ended January 31, 2005, total revenues decreased 12% from total
      revenues of $29.3 million in fiscal year 2004. The net loss for fiscal year
      2004
      was $18.1 million, or $0.57 per common share.


25
 Table
          of Contents





The
      following charts summarize the components of revenues and the categories of
      expenses, including the amounts expressed as a percentage of total revenues,
      for
      each of the three fiscal years in the period ended January 31, 2006 (dollars
      in
      thousands):




***Components
                  of Revenue and Expenses***
              
              ***Increase
                  (Decrease) from 2005 to 2006***
              
              ***Increase
                  (Decrease) from 2004 to 2005******Fiscal
                  years ended January 31,******2006***
              
              
              ***2005***
              
              
              ***2004****Revenues:*
              
              $
              
              %
              
              
              $
              
              %
              
              
              $
              
              %
              
              *%*
              
              *%**License*
              
              $
              10,573
              
              
              50
              %
              
              $
              14,360
              
              
              56
              %
              
              $
              18,322
              
              63
              %
              
              -26
              %
              
              -22
              %*Services*
              
              
              2,399
              
              
              12
              %
              
              
              3,746
              
              
              15
              %
              
              
              4,338
              
              15
              %
              
              -36
              %
              
              -14
              %*Maintenance*
              
              
              8,036
              
              
              38
              %
              
              
              7,592
              
              
              29
              %
              
              
              6,591
              
              22
              %
              
              6
              %
              
              15
              %*Total
                  revenues*
              
              $
              21,008
              
              
              100
              %
              
              $
              25,698
              
              
              100
              %
              
              $
              29,251
              
              100
              %
              
              -18
              %
              
              -12
              %*Expenses:**Cost
                  of license revenue*
              
              $
              1,383
              
              
              6
              %
              
              $
              1,658
              
              
              6
              %
              
              $
              1,822
              
              6
              %
              
              -17
              %
              
              -9
              %*Cost
                  of services revenue*
              
              
              4,903
              
              
              23
              %
              
              
              3,332
              
              
              13
              %
              
              
              4,715
              
              16
              %
              
              47
              %
              
              -29
              %*Cost
                  of maintenance revenue*
              
              
              981
              
              
              5
              %
              
              
              1,718
              
              
              7
              %
              
              
              2,033
              
              7
              %
              
              -43
              %
              
              -15
              %*Total
                  cost of revenues (1)*
              
              
              7,267
              
              
              34
              %
              
              
              6,708
              
              
              26
              %
              
              
              8,570
              
              29
              %
              
              8
              %
              
              -22
              %*Sales
                  & marketing*
              
              
              8,190
              
              
              39
              %
              
              
              14,476
              
              
              56
              %
              
              
              18,124
              
              62
              %
              
              -43
              %
              
              -20
              %*Research
                  and product development*
              
              
              8,346
              
              
              40
              %
              
              
              13,801
              
              
              54
              %
              
              
              11,981
              
              41
              %
              
              -40
              %
              
              15
              %*General
                  and administrative*
              
              
              11,113
              
              
              53
              %
              
              
              9,764
              
              
              38
              %
              
              
              10,564
              
              36
              %
              
              14
              %
              
              -8
              %*Amortization
                  of capitalized R&D costs*
              
              
              1,012
              
              
              5
              %
              
              
              -
              
              
              -
              
              
              
              -
              
              -
              
              
              -
              
              
              -*Restructuring
                  charges*
              
              
              (57
              )
              
              -
              
              
              
              944
              
              
              4
              %
              
              
              621
              
              2
              %
              
              -106
              %
              
              52
              %*Total
                  expenses*
              
              $
              35,871
              
              
              171
              %
              
              $
              45,693
              
              
              178
              %
              
              $
              49,860
              
              170
              %
              
              -21
              %
              
              -8
              %*Operating
                  loss*
              
              $
              (14,863
              )
              
              
              
              
              $
              (19,995
              )
              
              
              
              
              $
              (20,609
              )
              
              
              
              -26
              %
              
              -3
              %*Other
                  income, net*
              
              
              602
              
              
              
              
              
              
              175
              
              
              
              
              
              
              2,550*Net
                  loss before income taxes*
              
              $
              (14,261
              )
              
              
              
              
              $
              (19,820
              )
              
              
              
              
              $
              (18,059
              )*Income
                  tax benefit*
              
              
              -
              
              
              
              
              
              
              -
              
              
              
              
              
              
              -*Net
                  loss*
              
              $
              (14,261
              )
              
              
              
              
              $
              (19,820
              )
              
              
              
              
              $
              (18,059
              )
 (1)
        FY06
        total e xcludes
        amortization of capitalized R&D costs shown separately
        below

















26
 Table
          of Contents


Revenues





License
      revenues for the year ended January 31, 2006 decreased 26% to $10.6 million
      from
      $14.4 million in fiscal year 2005 and decreased 22% in fiscal year 2005 from
      $18.3 million in fiscal year 2004. The average deal size for fiscal year 2006
      was approximately $164,000 representing a 26% increase when compared to the
      prior fiscal year. Approximately 63 license transactions were realized during
      fiscal year 2006, a 42% decrease compared to approximately 109 for fiscal year
      2005. The average deal size in fiscal year 2004 was approximately $110,000
      and
      was comprised of approximately 165 total deals closed. The decrease in total
      license revenues in fiscal year 2006 compared to fiscal year 2005 is primarily
      attributed to three factors: 1) A shift in marketing and selling efforts towards
      the recently released Excalibur Web offering, 2) A decrease in international
      transactions due primarily to a large compliance related transaction recognized
      during the first quarter of fiscal 2005 and the absence of a like-sized
      transaction in fiscal 2006, and 3) A decrease in the commercial RetrievalWare
      business segment due to management’s prior decision to temper its selling and
      marketing activities within this market segment. Federal license revenues
      increased slightly compared to the prior fiscal year. The decrease in total
      license revenues for fiscal year 2005 compared to fiscal year 2004 is primarily
      attributable to a $3.4 million federal enterprise transaction recognized during
      the third quarter of fiscal 2004 and the absence of a like-sized transaction
      in
      fiscal 2005 coupled with lengthier sales cycles.





Services
      revenues, which include professional services, training, and hosted Web services
      were $2.4 million for the year ended January 31, 2006, a 36% decrease when
      compared to services revenues of $3.7 million for fiscal year 2005. Services
      revenues for fiscal 2005 decreased 14% versus services revenues of $4.3 million
      for fiscal year 2004. The decline in fiscal year 2006 services revenues versus
      fiscal year 2005 was due primarily to a decline in professional services
      revenues in our federal and commercial business segments resulting from the
      conclusion of two major engagements. Those declines were offset by improvements
      in professional services revenues in our international operations. The decline
      in fiscal year 2005 professional services revenues versus fiscal year 2004
      was
      primarily due to the completion of two major contracts from within the Company’s
      international operation, which was partially offset by one U.S. commercial
      engagement. Federal professional services revenues for fiscal year 2005 mirrored
      fiscal year 2004.





Maintenance
      revenues were $8.0 million for the year ended January 31, 2006, compared to
      $7.6
      million and $6.6 million for fiscal years 2005 and 2004. The increase in
      maintenance revenues during the prior two fiscal years can be attributed
      to  the
      fiscal year 2005 implementation of new maintenance renewal processes and a
      continued emphasis on identifying lapsed renewals from within the existing
      customer base.





Revenues
      from international operations are generated from software licenses with various
      European commercial and government customers and a well-established European
      reseller network. The Company's international sales operation, Convera
      Technologies International, Ltd. (“CTIL”), is headquartered in the United
      Kingdom. CTIL satellite offices in Paris, France and Munich, Germany were closed
      during fiscal year 2005. International revenues from CTIL decreased 30% to
      $5.2
      million in fiscal year 2006 from $7.5 million in fiscal year 2005 due to a
      decrease in license revenues as a result of the aforementioned large compliance
      related transaction recognized during the first quarter of fiscal 2005 and
      the
      absence of a like-sized transaction in fiscal 2006. In fiscal year 2005,
      international revenues increased 4% from $7.2 million in fiscal year 2004 due
      to
      increases in license and maintenance revenue offset by a decline in services
      revenue.





Revenues derived
      from contracts and orders issued by agencies of the U.S. Government were
      approximately 54%, 45%, and 52%, of total revenues for fiscal years 2006, 2005,
      and 2004, respectively. In fiscal year 2006 one customer accounted for
      approximately 14% of revenues. One reseller customer accounted for approximately
      17% of revenues in fiscal year 2005.





Operating
      Expenses





*Cost
      of Revenues*





Cost
      of
      license revenues decreased 17% to $1.4 million for the year ended January 31,
      2006, and decreased 9% to $1.7 million in fiscal year 2005. As a percentage
      of
      license revenues, cost of license revenues was 13% for fiscal year 2006, 12%
      for
      fiscal year 2005, and 10% for fiscal year 2004. The decrease in cost of license
      revenues over the last three fiscal years can be primarily attributed to a
      decrease in third party royalty obligations.


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 Table
          of Contents


Cost
      of
      services revenues increased 47% to $4.9 million for the year ended January
      31,
      2006 from $3.3 million in fiscal year 2005. Cost of services revenues decreased
      29% in fiscal year 2005 from $4.7 million in fiscal year 2004. The increase
      in
      cost of services revenues during fiscal 2006 as compared to fiscal 2005 is
      attributed to costs associated with the management of two AT&T hosting
      facilities from the period of November 1, 2005 (attainment of commercial
      availability) through January 31, 2006 for the Excalibur Web offering. Cost
      of
      professional services revenues for fiscal year 2006 was consistent with the
      prior year. The decrease in cost of services revenues in fiscal year 2005 versus
      2004 is attributable to a reduction in the overall number of employees
      responsible for the management and delivery of professional services.





Cost
      of
      maintenance revenues for the year ended January 31, 2006 decreased 43% to $1.0
      million from fiscal 2005 and decreased 15% to $1.7 million in fiscal year 2005
      when compared to fiscal year 2004. As a percentage of maintenance revenues,
      cost
      of maintenance revenues was 12%, 23%, and 31% in fiscal years 2006, 2005, and
      2004 respectively. The decrease in cost of maintenance revenues in fiscal years
      2006 and 2005 is attributed to lower personnel-related costs resulting from
      the
      restructuring actions undertaken in fiscal year 2005.





*Sales
      & Marketing*





Sales
      and
      marketing expenses decreased 43% to $8.2 million for the year ended January
      31,
      2006 from $14.5 million in fiscal year 2005. In fiscal year 2005, sales and
      marketing expenses decreased 20% to $14.5 million from $18.1 million in fiscal
      year 2004. As a percentage of total revenues, sales and marketing expenses
      were
      39%, 56%, and 62% in fiscal years 2006, 2005, and 2004 respectively. The
      decrease in sales and marketing expenses for fiscal year 2006 is attributed
      to
      lower personnel-related costs stemming from the fiscal 2005 restructurings
      that
      resulted in a 47% year-over-year decrease in average monthly headcount, and
      lower marketing programs costs. The decrease in sales and marketing expenses
      for
      fiscal year 2005 is attributed to lower personnel costs stemming from the
      aforementioned restructurings, a decreased emphasis on the commercial enterprise
      sector for the RetrievalWare product line, reduced marketing program costs
      (e.g., trade shows, advertising, etc.) and a decrease in bad debt
      expense.





*Research
      and Development*





Reported
      research and product development costs decreased 40% to $8.3 million for the
      year ended January 31, 2006 from $13.8 million in fiscal year 2005, representing
      40% and 54% of total revenues respectively. As previously disclosed, the Company
      adopted FAS 86 during the first quarter of fiscal 2006, resulting in the
      capitalization of approximately $8.1 million of research and development costs
      for the first three quarters of fiscal year 2006. Absent the adoption of FAS
      86,
      gross research and development costs grew 19% in fiscal year 2006 when compared
      to $13.8 million for fiscal year 2005. This increase is attributed to costs
      associated with the establishment and management of two AT&T hosting
      facilities and certain consulting fees for the period of February 1, 2005
      (attainment of technological feasibility) through October 31, 2005 for the
      Excalibur Web offering. For fiscal year 2005, research and product development
      costs increased 15% from $12.0 million as reported in fiscal year 2004. The
      increase in fiscal year 2005 research and development expenses was due to
      increased personnel-related costs associated with Excalibur Web activities,
      which accounted for approximately $4.2 million of fiscal year 2005
      costs.





*General
      and Administrative*





General
      and administrative expenses grew by 14% to $11.1 million for the year ended
      January 31, 2006 from $9.8 million in fiscal year 2005, representing 53% and
      38%
      of total revenues, respectively. In fiscal year 2005, general and administrative
      expenses decreased 8% from $10.6 million in fiscal year 2004. The increase
      in
      fiscal year 2006 general and administrative costs is due to higher accountancy
      fees associated with the Company’s required Section 404 compliance efforts under
      the Sarbanes-Oxley Act. The decrease in fiscal year 2005 general and
      administrative costs is due to reduced employee-related costs resulting from
      the
      restructurings as implemented across the year and reduced other general
      operating costs.





*Amortization
      of capitalized research & product development costs*




For
      the
      year ending January 31, 2006, the Company amortized approximately $1.0 million
      of previously capitalized research and product development costs in accordance
      with FAS 86 associated with the Excalibur Web offering. With commercial
      availability of the Excalibur Web offering being achieved on November 1, 2005,
      amortization of the
      previously capitalized research & product development costs totaling
      approximately $8.1 million commenced. This amortization is expected to continue
      over a 24-month period, and as such, each of the next seven quarters is expected
      to incur a similar $1 million amortization charge.





28
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          of Contents


*Restructuring
      charges*





During
      fiscal year 2006 the Company recorded a $57,000 restructuring credit to account
      for the reversal of previously accrued utilities expense for the Hillsboro,
      Oregon facility. The early termination of that lease caused this
      reversal.





During
      fiscal year 2005 the Company effected a re-alignment of its operational
      infrastructure to align its expense structure with expected future revenue
      streams. Restructurings in both the third and fourth quarters of fiscal 2005
      totaling $0.9 million were implemented to reduce operating expenses through
      general workforce reductions, facility consolidations, reduced marketing related
      expenses and decreased other general operating costs. In connection with these
      restructurings, the Company reduced its workforce by 77 employees worldwide,
      including 23 employees from within the engineering group, 30 from the sales
      and
      marketing group, 19 from the professional services group, and five from the
      general and administrative group.





The
      Company paid approximately $0.8 million, $1.6 million, and $1.9 million against
      the restructuring reserve in the fiscal years ended January 31, 2006, 2005
      and
      2004, respectively. As of January 31, 2006, there are no outstanding severance
      obligations. As of January 31, 2005 unpaid amounts of $0.1 million representing
      employee severance benefits and $0.7 million representing facility-related
      charges, had been classified as a current restructuring reserve in the
      accompanying consolidated balance sheet.





*Other
      income*





Other
      income increased to $0.6 million in fiscal year 2006 from $0.2 million in fiscal
      year 2005 due to a higher average quarterly cash balance and higher interest
      yields. Other income decreased to $0.2 million in fiscal year 2005 from $2.6
      million in fiscal year 2004.





29
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          of Contents


**Contractual
      Obligations**




The
      Company has obligations under certain contractual arrangements to make future
      payments for goods and services. These contractual obligations secure the future
      rights to various assets and services to be used in the normal course of
      operations. For example, the Company is contractually committed to make certain
      minimum lease payments for the use of property under operating lease agreements.
      In accordance with applicable accounting rules, the future rights and
      obligations pertaining to firm commitments such as operating lease obligations
      and certain purchase obligations under contracts are not reflected as assets
      or
      liabilities on the accompanying consolidated balance sheet.




As
      of
      January 31, 2006, the Company had the following contractual obligations
      associated with its lease commitments, debt facility and other contractual
      obligations for the periods indicated below:





**Contractual
                Obligations**
            
            **Payments
                Due By Fiscal Period (in thousands)**Total
            
            2007
            
            2008-2009
            
            2010-2011
            
            2012
                and thereafterOperating
                leases
            
            $
            2,417
            
            $
            1,570
            
            $
            847
            
            $
            -
            
            $
            -Debt
                facility
            
            
            5,750
            
            
            1,604
            
            
            3,712
            
            
            434
            
            
            -Other
                contractual obligations
            
            
            808
            
            
            638
            
            
            170
            
            
            -
            
            
            -Total
            
            $
            8,975
            
            $
            3,812
            
            $
            4,729
            
            $
            434
            
            $
            -





·
            Operating
                lease obligations — represents the minimum lease rental payments
                under non-cancelable leases, primarily for the Company’s office space and
                operating equipment in various locations around the
                world.





·
            Debt
                facility - represents the required amounts of principal and interest
                payments due.





·
            Other
                contractual obligations — represents the principal amounts due on
                outstanding contractual obligations relating to hosting agreements
                between
                the Company and AT&T related to the Excalibur Web
                offering






**Liquidity
      and Capital Resources**




The
      Company’s combined balance of cash, cash equivalents and short-term investments
      at January 31, 2006 as compared to January 31, 2005 is summarized below (in
      thousands).




January
                  31, 2006
              
              January
                  31, 2005
              
              ChangeCash
                  and cash equivalents
              
              $
              37,741
              
              $
              17,766
              
              $
              19,975Investments
              
              
              71
              
              
              71
              
              
              -Total
              
              $
              37,812
              
              $
              17,837
              
              $
              19,975




As
      of
      January 31, 2006, the Company’s balances of cash, cash equivalents and
      short-term investments were $37.8 million. The
      Company believes that its current balance of cash, cash equivalents,
      investments, funds generated from operations, if any, and the proceeds from
      its
      February 2006 private placement (see note 17 to the financial statements,
      Subsequent Events) will be sufficient to fund the Company's current projected
      cash needs for at least the next twelve months. Historically the Company has
      primarily been financed by sales of its common stock. If the actions taken
      by
      management are not effective in achieving profitable operating results, the
      Company may be required to pursue additional expense reductions and/or external
      sources of financing in the future to support its operations and capital
      requirements. There can be no assurances that external sources of financing
      will
      be available if required, or that such financing will be available on terms
      acceptable to the Company.





On
      March
      23, 2005 the Company secured a $5 million term loan from Silicon Valley Bank,
      the primary subsidiary of Silicon Valley Bancshares (NASDAQ: SIVB). The
      four-year, term facility provided financing for capital purchases including
      those for its Excalibur Web offering. The loan was retired on February 28,
      2006,
      concurrent with the private placement completed on February 28, 2006 (see note
      17 to the financial statements, Subsequent Events).


30
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          of Contents





Cash
      Flows Used inOperating
      Activities





In
      fiscal
      year 2006, the Company’s operating activities utilized $8.4 million of net cash
      and cash equivalents, compared to $19.9 million in fiscal year 2005. Net cash
      used in operating activities was $15.5 million in fiscal year 2004. The fiscal
      year 2006 net loss of $14.3 million was offset by non-cash charges totaling
      approximately $5.7 million, consisting primarily of depreciation of $2.9
      million, equity compensation expense of $1.6 million and amortization of $1.3
      million. A reduction to accounts receivable provided $2.0 million. Cash was
      also
      provided from a reduction in prepaid expenses and other of $0.7 million and
      an
      increase to deferred revenues of $0.1 million. Decreases to accounts payable,
      accrued expenses, accrued bonuses used cash of $2.0 million while paydown of
      the
      restructuring reserve used net cash of $0.8 million. The fiscal year 2005 net
      loss of $19.8 million was offset by non-cash charges totaling $2.8 million,
      consisting primarily of depreciation of $1.6 million, equity compensation
      expense of $1.4 million and amortization of developed technologies of $0.3
      million. A reversal to the provision for doubtful accounts and a non-cash
      restructuring credit reduced the non-cash charges by $0.4 million and $0.1
      million, respectively. Cash was provided from a reduction in prepaid expenses
      and other of $0.9 million and an increase to deferred revenues of $0.5 million.
      An increase to accounts receivable used cash of $0.6 million. Decreases to
      accounts payable, accrued expenses, accrued bonuses and the restructuring
      reserve used net cash of $2.1 million. A decrease to other long-term liabilities
      used $1.6 million. The fiscal year 2004 net loss of $18.1 million was offset
      by
      non-cash charges totaling $2.8 million, consisting primarily of depreciation
      of
      $1.7 million, equity compensation expense of $0.8 million and amortization
      of
      developed technologies of $0.3 million. Cash was provided from a reduction
      in
      accounts receivable of $1.5 million and a decrease in prepaid expense and other
      of $1.0 million. A decrease in accounts payable, accrued expense and accrued
      bonuses and an increase in other long-term liabilities used net cash of $2.3
      million. A decrease in the restructuring reserve used $1.3 million, while an
      increase in deferred revenues contributed $0.9 million of net cash.





Cash
      Flows Used in Investing Activities





In
      fiscal
      year 2006 cash flows from investing activities used $15.0 million, consisting
      of
      $6.9 million for purchases of equipment and leasehold improvements and $8.1
      million for capitalized software development costs required under FAS 86. Of
      the
      $6.9 million used for purchases of equipment and leasehold improvements,
      approximately $6.6 million was related to the Excalibur Web offering. In fiscal
      year 2005 cash flows from investing activities used $5.0 million for purchases
      of equipment and leasehold improvements. Of this, $4.1 million was related
      to
      the Excalibur Web offering. Cash flows from investing activities provided the
      Company $19.5 million of cash in fiscal year 2004. Net cash provided from the
      maturity of U.S. Treasury bills provided cash of $20.0 million, while purchases
      of equipment and leasehold improvements used cash of $0.5 million





Cash
      Flows Provided by Financing Activities





Financing
      activities provided cash of $43.4 million during the fiscal year ended January
      31, 2006. Approximately $28.8 million of net proceeds were received through a
      July
      2005 private placement of 6,555,556 newly-issued shares of common stock to
      two
      investors. The Company sold 5,555,556 shares directly to the Legg Mason
      Opportunity Trust, a series of Legg Mason Investment Trust, Inc., a registered
      investment company, at $4.50 per share. The other 1 million shares were
      purchased by an affiliate of Herbert A. Allen, a significant stockholder and
      director of the Company, at $4.84 per share, the market price at the time of
      the
      sale. An
      additional $5.0 million was secured from a March 2005, four-year, term loan
      financing from Silicon Valley Bank. The exercise of employee stock options
      provided approximately $9.7 million while approximately $215,000 was provided
      by
      the issuance of stock under the employee stock purchase plan offset by the
      repurchase of shares totaling $225,000. Financing activities provided cash
      of
      $12.2 million in fiscal year 2005. A private
      placement of 3,433,333 newly-issued shares of common stock to several investors,
      including affiliates of Allen & Company Incorporated, a significant
      stockholder of the company, and certain directors resulted in net proceeds
      of
      $10.3 million. The shares were priced on September 7, 2004 at $3.00 per share,
      representing a premium to the $2.80 closing market price on such date.
      Additionally, cash of a pproximately
      $0.2 million was provided by the issuance of stock under the employee stock
      purchase plan offset by the repurchase of shares totaling $121,000. Cash of
      $1.8
      million was provided from the exercise of employee stock options. Financing
      activities provided approximately $16.8 million of cash in fiscal year 2004,
      including net proceeds of $16.0 million from a private placement and proceeds
      of
      $0.8 million from the issuance of stock under the employee stock purchase plan,
      the issuance of warrants and the exercise of stock options





31
 Table
          of Contents


**Other
      Factors**





Inflation





The
      Company believes that inflation has not had a material effect on the results
      of
      its operations to date.








**Recent
      Pronouncements**





On
      December 16, 2004, the Financial Accounting Standards Board ("FASB") issued
      SFAS
      No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), which is a
      revision of SFAS No. 123. SFAS No. 123(R) Supersedes APB No. 25, and amends
      SFAS
      No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R)
      is
      similar to the approach described in SFAS No. 123; however, SFAS No. 123(R)
      requires all share-based payments to employees, including grants of employee
      stock options, to be recognized in the statements of operations based on their
      fair values. Pro forma disclosure is no longer an alternative upon adopting
      SFAS
      No. 123(R). The Company will adopt SFAS No. 123(R) on February 1, 2006. SFAS
      No.
      123(R) permits public companies to adopt its requirements using one of two
      methods: i. A "modified prospective" method in which compensation cost is
      recognized beginning with the effective date (a) based on the requirements
      of
      SFAS No. 123(R) for all share-based payments granted after the effective date
      and (b) based on the requirements of SFAS No. 123(R) for all awards granted
      to
      employees prior to the effective date of SFAS 123(R) that remain unvested on
      the
      effective date. ii. A "modified retrospective" method which includes the
      requirements of the modified prospective method described above, but also
      permits entities to restate based on the amounts previously recognized under
      SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior
      periods presented or (b) prior interim periods of the year of adoption. The
      Company will implement SFAS No. 123(R) in the first quarter or fiscal year
      2007
      and intends to use the modified prospective method.








**Item
      7A.****Quantitative
      and Qualitative Disclosures about Market Risk**





The
      Company's market risk is principally confined to changes in foreign currency
      exchange rates and potentially adverse effects of differing tax structures.
      International revenues from CTIL, the Company's foreign sales subsidiary located
      in the United Kingdom were approximately 25% of total revenues in fiscal year
      2006. International sales are made predominantly from the Company's foreign
      subsidiary and are typically denominated in British pounds, EUROs or U.S.
      Dollars. As of January 31, 2006, approximately 6% and 11% of total consolidated
      accounts receivable were denominated in British pounds and EUROs, respectively.
      The majority of these receivables are due within 90 days of the end of fiscal
      year 2006, and all receivables are due within one year. Additionally, the
      Company is exposed to potential foreign currency gains or losses resulting
      from
      intercompany accounts that are not of a long-term nature. The Company is also
      exposed to foreign exchange rate fluctuations as the financial results of CTIL
      are translated into U.S. dollars in consolidation. As exchange rates vary,
      those
      results when translated may vary from expectations and adversely impact overall
      expected profitability.





As
      of
      January 31, 2006, less than one percent of the Company’s cash and cash
      equivalents were denominated in British pounds and EUROs, respectively. Cash
      equivalents consist of funds deposited in money market accounts with original
      maturities of three months or less. Short-term investments consist primarily
      of
      U.S. Government treasury bills and are carried at amortized cost. The Company
      also has a certificate of deposit for $71,000, which is pledged to collateralize
      a letter of credit required for a leased facility. Given the relatively short
      maturity periods of cash equivalents and short-term investments, the cost of
      these investments approximates their fair values and the Company’s exposure to
      fluctuations in interest rates is limited.








32
 Table
          of Contents


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





Financial
      statements and supplementary data of the Company are submitted as a separate
      section of this Form 10-K.








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





None.








**Item
      9A.****Controls
      and Procedures**








(a)
            Evaluation
                of Disclosure Controls





As
      of the
      end of the period covered by this Annual Report on Form 10-K, the Company,
      under
      the supervision and with the participation of its management, including the
      Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
      of the design and operation of the Company’s “disclosure controls and
      procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act
      of 1934 (the “Exchange Act”)). Based on that evaluation, the Chief Executive
      Officer and Chief Financial Officer concluded that the Company’s disclosure
      controls and procedures were effective to provide reasonable assurance that
      information required to be disclosed in the Company's Exchange Act reports
      is
      recorded, processed, summarized and reported within the time periods specified
      by the Securities and Exchange Commission, and that material information
      relating to the Company and its consolidated subsidiaries is accumulated and
      communicated to management, including the Chief Executive Officer and Chief
      Financial Officer, as appropriate to allow timely decisions regarding required
      disclosure.





(b)
            Management’s
                Report on Internal Control over Financial
                Reporting





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Exchange Act Rules
      13a-15(f). Our management conducted an evaluation of the effectiveness of our
      internal control over financial reporting based on the framework in Internal
      Control—Integrated Framework issued by the Committee of Sponsoring Organizations
      of the Treadway Commission. Based on this evaluation under the framework in
      Internal Control—Integrated Framework, our management concluded that our
      internal control over financial reporting was effective as of January 31,
      2006.




Our
      management’s assessment of the effectiveness of our internal control over
      financial reporting as of January 31, 2006, has been audited by Ernst &
Young LLP, an independent registered public accounting firm, as stated in their
      report which is included herein.





(c)
            Changes
                in Internal Controls





There
      were no changes in the Company’s internal control over financial reporting that
      occurred during the fourth quarter of fiscal 2006 that have materially affected,
      or are reasonably likely to materially affect, the Company’s internal control
      over financial reporting.





**Item
      9B.****Other
      Information**





None




33
 Table
          of Contents


**PART
      III**





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





Information
      regarding directors and executive officers of the Company will be included
      in
      the Company's definitive Proxy Statement for the 2006 Annual Meeting of
      Shareholders and is incorporated in this report by reference.





The
      Company has adopted a written code of conduct and ethics (the "Code") which
      is
      applicable to all of the Company's officers, directors and employees, including
      the Company's Chief Executive Officer and Chief Financial Officer (collectively,
      the "Senior Officers"). In accordance with the rules and regulations of the
      Securities and Exchange Commission and the rules of the NASDAQ Stock Market,
      a
      copy of the Code has been posted on the Company's website at www.convera.com .
      The
      Company intends to disclose any changes in or waivers from the Code applicable
      to any Senior Officers on its website or by filing a Form 8-K.








**Item
      11.****Executive
      Compensation**





Information
      regarding executive compensation will be included in the Company’s definitive
      Proxy Statement for the 2006 Annual Meeting of Shareholders and is incorporated
      in this report by reference.








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





Information
      regarding security ownership of certain beneficial owners and management and
      related stockholder matters will be included in the Company’s definitive Proxy
      Statement for the 2006 Annual Meeting of Shareholders and is incorporated in
      this report by reference.








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





Information
      concerning certain relationships and related transactions, if any, will be
      included in the Company’s definitive Proxy Statement for the 2006 Annual Meeting
      of Shareholders and is incorporated in this report by reference.








**Item
      14.****Principal
      Accounting Fees and Services**





Information
      regarding principal accounting fees and services will be included in the
      Company’s definitive Proxy Statement for the 2006 Annual Meeting of Shareholders
      and is incorporated in this report by reference.














34
 Table
          of Contents


**PART
      IV**





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





**(a)**  **Documents
      filed as part of Form 10-K**





**1.**  **Financial
      Statements:**





The
                following financial statements of the Company are submitted in a
                separate
                section pursuant to the requirements of Form 10-K, Part I, Item 8
                and Part
                IV, Items 14(a) and 14(d):





Index
      to
      Consolidated Financial Statements


Report
      of
      Independent Registered Public Accounting Firm


Consolidated
      Balance Sheets


Consolidated
      Statements of Operations and Comprehensive Loss


Consolidated
      Statements of Shareholders' Equity


Consolidated
      Statements of Cash Flows


Notes
      to
      Consolidated Financial Statements




**2.**  **Schedules
      Supporting Financial Statements:**


All
      schedules are omitted because they are not required, are inapplicable, or the
      information is otherwise shown in the consolidated financial statements or
      notes
      to the consolidated financial statements.




3.  Exhibits





See
      Exhibit Index on the following page.


35
 Table
          of Contents








**Exhibit
      Index**





Exhibit
                No.
            Exhibit
                Title
            
            Incorporated
                by Reference fromthe
                Following Documents3.1
            Amended
                and Restated Certificate of Incorporation of Convera
            
            Form
                S-4 (Registration No. 333-50172), November 17, 20003.2
            By-laws
                of Convera (Amended and Restated)
            
            Form
                10-K, April 30, 20033.3
            Amendment
                to By-Laws
            
            Filed
                Herewith10.1
            1995
                Incentive Plan, dated November 1995
            
            Proxy
                Statement dated October 16, 1995 for Annual Meeting of
                Shareholders10.2
            Convera
                Stock Option Plan
            
            Form
                8-K, May 3, 200010.3
            Office
                Lease (1808 Aston Avenue, Carlsbad, California) commencing November
                1,
                2001
            
            Form
                10-K, April 30, 200210.4
            Amended
                and Restated Convera Corporation 1996 Employee Stock Purchase
                Plan
            
            Definitive
                Form 14C, December 18, 200110.5
            Employment
                Agreement with John R. Polchin, dated April 1, 2004
            
            Form
                10-Q, June 14, 200410.6
            Office
                Lease Amendment (1921 Gallows Road, Vienna Virginia) commencing October
                6,
                2004
            
            Form
                10-Q, December 12, 200410.7
            AT&T
                Master Agreement dated August 24, 2004
            
            Form
                10-K, April 1, 200510.8
            Office
                Lease (Radius Court, London Road, Bracknell,
                Berkshire United Kingdom) commencing March 21, 2005
            
            Filed
                Herewith10.9
            Office
                Sublease (Sublandlord - MWH Americas, 6760
                Alexander Bell Drive, Columbia Maryland) commencing June 1,
                2005
            
            Filed
                Herewith10.10
            Office
                Lease (6760 Alexander Bell Drive, Columbia
                Maryland) commencing August 20, 2005
            
            Filed
                Herewith10.11
            Employment
                Agreement with Kurt Gastrock dated October
                25, 2005
            
            Filed
                Herewith10.12
            Employment
                Agreement with Patrick C. Condo dated
                October 24, 2005
            
            Filed
                Herewith21.01
            Subsidiaries
                of Convera
            
            Form
                10-K, April 30, 200423.01
            Consent
                of Independent Registered Public Accounting
                Firm
            
            Filed
                Herewith31.1
            Certification
                of Chief Executive Officer pursuant to
                Rule 13a-14(a)/15d-14(a)
            
            Filed
                Herewith31.2
            Certification
                of Chief Financial Officer pursuant to
                Rule 13a-14(a)/15d-14(a)
            
            Filed
                Herewith32.1
            Certification
                of Chief Executive Officer, pursuant to 18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002
            
            Filed
                Herewith32.2
            Certification
                of Chief Financial Officer, pursuant to 18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002
            
            Filed
                Herewith


36
 Table
          of Contents




**SIGNATURES**





Pu  
      Persuant to the requirements of Section 13 or 15(d) of the Securities Exchange
      Act of 1934, the registrant has duly caused this Report to be signed on its
      behalf by the undersigned, thereunto duly authorized.




CONVERA
      CORPORATION







By: /s/Patrick
      C. Condo


Patrick
      C.
      Condo


President
      and Chief
      Executive Officer




Date:
      March 30, 2006





Pu  
      Persuant to the requirements of the Securities Exchange Act of 1934, this report
      has been signed below by the following persons on behalf of the registrant
      and
      in the capacities and on the dates indicated.





Signature
            
            Title
            
            Date/s/Patrick
                C. Condo
            
            President,
                Chief Executive Officer, and Director
            
            March
                30, 2006Patrick
              C. Condo
            
            (Principal
                Executive Officer and Principal Financial and Accounting
                Officer)/s/Ronald
                J. Whittier
            
            Chairman
                of the Board
            
            March
                30, 2006Ronald
                J. Whittier/s/Herbert
                A. Allen
            
            Director
            
            March
                30, 2006Herbert
                A. Allen/s/Herbert
                A. Allen, III
            
            Director
            
            March
                30, 2006Herbert
                A. Allen, III/s/Stephen
                D. Greenberg
            
            Director
            
            March
                30, 2006Stephen
                D. Greenberg/s/Eli
                S. Jacobs
            
            Director
            
            March
                30, 2006Eli
                S. Jacobs/s/Donald
                R. Keough
            
            Director
            
            March
                30, 2006Donald
                R. Keough/s/Ajay
                Menon
            
            Director
            
            March
                30, 2006Ajay
                Menon/s/
                Sidney Pollack
            
            Director
            
            March
                30, 2006Sidney
                Pollack/s/
                Carl J. Rickertson
            
            Director
            
            March
                30, 2006Carl
                J. Rickertson/s/
                Jeffrey White
            
            Director
            
            March
                30, 2006Jeffrey
                White





37
 Table
          of Contents








**Index
                to Consolidated Financial
                Statements**
            **Page**Management’s
                report on Internal Control over Financial
                Reporting
            F-1Reports
                of Independent Registered Public Accounting
                Firm
            F-2Consolidated
                Balance Sheets
              As
                of January 31, 2006 and 2005
            F-4Consolidated
                Statements of Operations and Comprehensive
                Loss
              For
                the fiscal years ended January 31, 2006, 2005 and
                2004
            F-5Consolidated
                Statements of Shareholders'
                Equity
              For
                the fiscal years ended January 31, 2006, 2005 and
                2004
            F-6Consolidated
                Statements of Cash Flows
              For
                the fiscal years ended January 31, 2006, 2005 and
                2004
            F-7Notes
                to Consolidated Financial Statements
            F-8











38
 Index
          to Consolidated Financial Statements


**MANAGEMENT’S
      REPORT ON INTERNAL CONTROL OVER FINANCIAL
      REPORTING**




The
      management of Convera Corporation (the “Company”) is responsible for
      establishing and maintaining adequate internal control over financial reporting
      and for the assessment of the effectiveness of internal control over financial
      reporting. As defined by the SEC, internal control over financial reporting
      is a
      process designed under the supervision of the Company’s principal executive,
      principal financial and principal accounting officers, and effected by the
      Company’s board of directors, management and other personnel, to provide
      reasonable assurance regarding the reliability of financial reporting and the
      preparation of financial statements in accordance with generally accepted
      accounting principles.





The
      Company’s internal control over financial reporting is supported by written
      policies and procedures, that (1) pertain to the maintenance of records that,
      in
      reasonable detail, accurately and fairly reflect the transactions and
      dispositions of the Company’s assets; (2) provide reasonable assurance that
      transactions are recorded as necessary to permit preparation of financial
      statements in accordance with generally accepted accounting principles, and
      that
      receipts and expenditures of the Company are being made only in accordance
      with
      authorizations of the Company’s management and directors; and (3) provide
      reasonable assurance regarding prevention or timely detection of unauthorized
      acquisition, use or disposition of the Company’s assets that could have a
      material effect on the financial statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Projections of any evaluation of effectiveness
      to future periods are subject to the risk that controls may become inadequate
      because of changes in conditions, or that the degree of compliance with the
      policies or procedures may deteriorate.





Management
      of the Company conducted an assessment of the effectiveness of the Company’s
      internal control over financial reporting as of January 31, 2006 based on
      criteria established in Internal Control—Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission (“the COSO
      Framework”). Based on this assessment, management has concluded that the
      Company’s internal control over financial reporting was effective as of January
      31, 2006.





Management’s
      assessment of the effectiveness of the Company’s internal control over financial
      reporting as of January 31, 2006, has been audited by Ernst & Young LLP, the
      registered public accounting firm that audited the Company’s consolidated
      financial statements, as stated in their report, a copy of which is included
      in
      this Annual Report on Form 10-K.











F-1
 Index
          to Consolidated Financial
          Statements


REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








Board
      of
      Directors and Shareholders


Convera
      Corporation





We
      have
      audited the accompanying consolidated balance sheets of Convera Corporation
      as
      of January 31, 2006 and 2005, and the related consolidated statements of
      operations, shareholders’ equity, and cash flows for each of the three years in
      the period ended January 31, 2006. These consolidated financial statements
      are
      the responsibility of the Company’s management. Our responsibility is to express
      an opinion on these consolidated financial statements based on our
      audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, 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 financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Convera Corporation
      at
      January 31, 2006 and 2005, and the consolidated results of its operations and
      its cash flows for each of the three years in the period ended January 31,
      2006,
      in conformity with U.S. generally accepted accounting principles.





We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Convera Corporation’s
      internal control over financial reporting as of January 31, 2006, based on
      criteria established in Internal Control-Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission and our report
      dated March 21, 2006 expressed an unqualified opinion thereon.




/s/
      ERNST
& YOUNG LLP





McLean,
      Virginia


March
      21,
      2006

















F-2
 Index
          to Consolidated Financial
          Statements


REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








Board
      of
      Directors and Shareholders


Convera
      Corporation





We
      have
      audited management’s assessment, included in the accompanying Management’s
      Annual Report on Internal Control Over Financial Reporting, that Convera
      Corporation maintained effective internal control over financial reporting
      as of
      January 31, 2006, based on criteria established in Internal Control—Integrated
      Framework issued by the Committee of Sponsoring Organizations of the Treadway
      Commission (the COSO criteria). Convera Corporation’s management is responsible
      for maintaining effective internal control over financial reporting and for
      its
      assessment of the effectiveness of internal control over financial reporting.
      Our responsibility is to express an opinion on management’s assessment and an
      opinion on the effectiveness of the company’s internal control over financial
      reporting based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, management’s assessment that Convera Corporation maintained effective
      internal control over financial reporting as of January 31, 2006, is fairly
      stated, in all material respects, based on the COSO criteria. Also, in our
      opinion, Convera Corporation maintained, in all material respects, effective
      internal control over financial reporting as of January 31, 2006, based
      on **** the
      COSO
      criteria **.**





We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheets of Convera
      Corporation as of January 31, 2006 and 2005, and the related consolidated
      statements of operations, shareholders’ equity, and cash flows for each of the
      three years in the period ended January 31, 2006 of Convera Corporation and
      our
      report dated March 21, 2006 expressed an unqualified opinion
      thereon.




/s/
      ERNST
& YOUNG LLP





McLean,
      Virginia


March
      21,
      2006





F-3
 Index
          to Consolidated Financial
          Statements


**CONVERA
      CORPORATION****AND
      SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


(in
      thousands, except per share data)


As
                  of January 31,ASSETS
              
              2006
              
              2005Current
                  Assets:Cash
                  and cash equivalents
              
              $
              37,741
              
              $
              17,766Short
                  term investments
              
              
              71
              
              
              71Accounts
                  receivable, net of allowance for doubtful accounts of $218 and
                  $537,
                  respectively
              
              
              4,364
              
              
              6,530Prepaid
                  expenses and other
              
              
              2,396
              
              
              2,390Total
                  current assets
              
              
              44,572
              
              
              26,757Equipment
                  and leasehold improvements, net of accumulated depreciation of
                  $15,683 and
                  $13,940, respectively
              
              
              9,152
              
              
              5,145Other
                  assets
              
              
              819
              
              
              1,551Capitalized
                  research and development costs
              
              
              7,102
              
              
              -Goodwill
              
              
              2,275
              
              
              2,275Other
                  intangible assets, net of accumulated amortization of $1,049 and
                  $780,
                  respectively
              
              
              297
              
              
              566Total
                  assets
              
              $
              64,217
              
              $
              36,294LIABILITIES
                  AND SHAREHOLDERS’ EQUITYCurrent
                  Liabilities:Accounts
                  payable
              
              
              1,367
              
              
              1,967Accrued
                  expenses
              
              
              2,680
              
              
              4,055Restructuring
                  reserve
              
              
              -
              
              
              835Deferred
                  revenues
              
              
              3,931
              
              
              4,279Current
                  maturities of long-term debt
              
              
              1,283
              
              
              -Total
                  current liabilities
              
              
              9,261
              
              
              11,136Deferred
                  revenues - long-term
              
              
              398
              
              
              9Long-term
                  debt, net of current portion
              
              
              3,717
              
              
              -Total
                  liabilities
              
              
              13,376
              
              
              11,145Commitments
                  and ContingenciesShareholders'
                  Equity:Common
                  stock Class A, $0.01 par value, 100,000,000 shares authorized;
                  47,803,186
                  and 38,740,215 shares issued,respectively;
                  47,128,833 and 38,013,807 shares outstanding, respectively
              
              
              477
              
              
              387Treasury
                  stock at cost, 674,353 and 726,408 shares,respectively
              
              
              (1,558
              )
              
              (1,678
              )Additional
                  paid-in-capital
              
              
              1,124,068
              
              
              1,084,269Accumulated
                  deficit
              
              
              (1,070,706
              )
              
              (1,056,445
              )Accumulated
                  other comprehensive loss
              
              
              (1,440
              )
              
              (1,384
              )Total
                  shareholders' equity
              
              
              50,841
              
              
              25,149Total
                  liabilities and shareholders' equity
              
              $
              64,217
              
              $
              36,294





See
      accompanying notes .


F-4
 Index
          to Consolidated Financial
          Statements


**CONVERA
      CORPORATION****AND
      SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**


(in
      thousands, except share and per share data)




For
                  the Fiscal Years Ended January 31,2006
              
              2005
              
              2004Revenues:License
              
              $
              10,573
              
              $
              14,360
              
              $
              18,322Services
              
              
              2,399
              
              
              3,746
              
              
              4,338Maintenance
              
              
              8,036
              
              
              7,592
              
              
              6,59121,008
              
              
              25,698
              
              
              29,251Operating
                  expenses:Cost
                  of revenues (excluding amortization of capitalized research and
                  development costs shown separately below):License
              
              
              1,383
              
              
              1,658
              
              
              1,822Services
              
              
              4,903
              
              
              3,332
              
              
              4,715Maintenance
              
              
              981
              
              
              1,718
              
              
              2,033Sales
                  and marketing
              
              
              8,190
              
              
              14,476
              
              
              18,124Research
                  and product development
              
              
              8,346
              
              
              13,801
              
              
              11,981General
                  and administrative
              
              
              11,113
              
              
              9,764
              
              
              10,564Amortization
                  of capitalized research and development costs
              
              
              1,012
              
              
              -
              
              
              -Restructuring
                  (recoveries) charges
              
              
              (57
              )
              
              944
              
              
              621Total
                  operating expenses
              
              
              35,871
              
              
              45,693
              
              
              49,860Operating
                  loss
              
              
              (14,863
              )
              
              (19,995
              )
              
              (20,609
              )Other
                  income, net
              
              
              602
              
              
              175
              
              
              2,550Net
                  loss before income taxes
              
              
              (14,261
              )
              
              (19,820
              )
              
              (18,059
              )Income
                  tax benefit
              
              
              -
              
              
              -
              
              
              -Net
                  loss
              
              $
              (14,261
              )
              $
              (19,820
              )
              $
              (18,059
              )Basic
                  and diluted net loss per common share
              
              $
              (0.33
              )
              
              (0.56
              )
              
              (0.57
              )Weighted-average
                  number of common shares outstanding - basic and diluted
              
              
              43,088,677
              
              
              35,432,754
              
              
              31,486,032Comprehensive
                  loss:Net
                  loss
              
              
              (14,261
              )
              
              (19,820
              )
              
              (18,059
              )Foreign
                  currency translation adjustment
              
              
              (56
              )
              
              (29
              )
              
              (539
              )Comprehensive
                  loss
              
              $
              (14,317
              )
              $
              (19,849
              )
              $
              (18,598
              )





See
      accompanying notes .


F-5
 Index
          to Consolidated Financial
          Statements


**CONVERA
      CORPORATION****AND
      SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS’ EQUITY**


(in
      thousands, except share data)





Common
                Stock
            
            
            
            Treasury
                Stock
            
            Additional
              Paid-in
            
            Accumulated
            
            Accumulated
              Other
              Compre-
              hensive
              IncomeShares
            
            Amount
            
            Warrants
            
            Shares
            
            Amount
            
            Capital
            
            Deficit
            
            (Loss)
            
            TotalBalance,
                January 31, 2003
            
            
            29,880,217
            
            $
            299
            
            
            -
            
            
            (877,155
            )
            $
            (2,026
            )
            $
            1,053,455
            
            $
            (1,018,540
            )
            $
            (816
            )
            $
            32,372Private
                placement
            
            
            4,714,111
            
            
            47
            
            
            -
            
            
            -
            
            
            -
            
            
            15,978
            
            
            -
            
            
            -
            
            
            16,025Issuance
                of common stock upon exercise of options
            
            
            61,016
            
            
            1
            
            
            -
            
            
            -
            
            
            -
            
            
            250
            
            
            -
            
            
            -
            
            
            251Issuance
                of treasury stock for Employee Stock Purchase Plan
            
            
            -
            
            
            -
            
            
            -
            
            
            63,898
            
            
            147
            
            
            26
            
            
            (26
            )
            
            -
            
            
            147Issuance
                of warrants to third party
            
            
            -
            
            
            -
            
            
            137,711
            
            
            -
            
            
            -
            
            
            383
            
            
            -
            
            
            -
            
            
            383Amortization
                of deferred stock compensation expense
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            788
            
            
            -
            
            
            -
            
            
            788Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (539
            )
            
            (539
            )Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (18,059
            )
            
            -
            
            
            (18,059
            )Balance,
                January 31, 2004
            
            
            34,655,344
            
            $
            347
            
            
            137,711
            
            
            (813,257
            )
            $
            (1,879
            )
            $
            1,070,880
            
            $
            (1,036,625
            )
            $
            (1,355
            )
            $
            31,368Private
                placement
            
            
            3,433,333
            
            
            34
            
            
            -
            
            
            -
            
            
            -
            
            
            10,266
            
            
            -
            
            
            -
            
            
            10,300Issuance
                of common stock upon exercise of options
            
            
            465,469
            
            
            5
            
            
            --
            
            
            -
            
            
            -
            
            
            1,835
            
            
            -
            
            
            -
            
            
            1,840Issuance
                of treasury stock for Employee Stock Purchase Plan
            
            
            -
            
            
            -
            
            
            -
            
            
            86,849
            
            
            201
            
            
            (6
            )
            
            -
            
            
            -
            
            
            195Exercise
                of warrants by third party
            
            
            84,744
            
            
            -
            
            
            (137,711
            )
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Amortization
                of deferred stock compensation expense
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,416
            
            
            -
            
            
            -
            
            
            1,416Stock
                compensation
            
            
            101,325
            
            
            1
            
            
            -
            
            
            -
            
            
            -
            
            
            (122
            )
            
            -
            
            
            -
            
            
            (121
            )Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (29
            )
            
            (29
            )Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (19,820
            )
            
            
            
            
            (19,820
            )Balance,
                January 31, 2005
            
            
            38,740,215
            
            $
            387
            
            
            -
            
            
            (726,408
            )
            $
            (1,678
            )
            $
            1,084,269
            
            $
            (1,056,445
            )
            $
            (1,384
            )
            $
            25,149Private
                placement.......
            
            
            6,555,556
            
            
            65
            
            
            -
            
            
            -
            
            
            -
            
            
            28,700
            
            
            -
            
            
            -
            
            
            28,765Issuance
                of common stock upon exercise of options
            
            
            2,406,090
            
            
            24
            
            
            --
            
            
            -
            
            
            -
            
            
            9,646
            
            
            -
            
            
            -
            
            
            9,670Issuance
                of treasury stock for Employee Stock Purchase Plan
            
            
            -
            
            
            -
            
            
            -
            
            
            52,055
            
            
            120
            
            
            95
            
            
            -
            
            
            -
            
            
            215Amortization
                of deferred stock compensation expense
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,584
            
            
            -
            
            
            -
            
            
            1,584Stock
                compensation
            
            
            101,325
            
            
            1
            
            
            -
            
            
            -
            
            
            -
            
            
            (226
            )
            
            -
            
            
            -
            
            
            (225
            )Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (56
            )
            
            (56
            )Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (14,261
            )
            
            -
            
            
            (14,261
            )Balance,
                January 31, 2006
            
            
            47,803,186
            
            $
            477
            
            
            -
            
            
            (674,353
            )
            $
            (1,558
            )
            $
            1,124,068
            
            $
            (1,070,706
            )
            $
            (1,440
            )
            $
            50,841





**** See
      accompanying notes .





F-6
 Index
          to Consolidated Financial
          Statements


**CONVERA
      CORPORATION****AND
      SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(in
      thousands)




For
                  the Fiscal Years Ended January 31,2006
              
              2005
              
              2004Cash
                  Flows from Operating Activities:Net
                  loss
              
              $
              (14,261
              )
              $
              (19,820
              )
              $
              (18,059
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
              
              
              2,903
              
              
              1,584
              
              
              1,660(Benefit)
                  provision for doubtful accounts
              
              
              (10
              )
              
              (401
              )
              
              80Amortization
              
              
              1,281
              
              
              269
              
              
              269Stock
                  compensation expense
              
              
              1,584
              
              
              1,416
              
              
              788Non-cash
                  restructuring credit
              
              
              (57
              )
              
              (137
              )
              
              -Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              2,038
              
              
              (560
              )
              
              1,470Prepaid
                  expenses and other
              
              
              718
              
              
              860
              
              
              984Accounts
                  payable, accrued expenses and accrued bonuses
              
              
              (1,968
              )
              
              (1,471
              )
              
              (3,904
              )Restructuring
                  reserve
              
              
              (776
              )
              
              (533
              )
              
              (1,313
              )Deferred
                  revenues
              
              
              118
              
              
              526
              
              
              903Other
                  long-term liabilities
              
              
              -
              
              
              (1,647
              )
              
              1,647Net
                  cash used in operating activities
              
              
              (8,430
              )
              
              (19,914
              )
              
              (15,475
              )Cash
                  Flows from Investing Activities:Purchase
                  of investments
              
              
              -
              
              
              -
              
              
              (14,960
              )Proceeds
                  from maturities of investments
              
              
              -
              
              
              -
              
              
              34,942Purchases
                  of equipment and leasehold improvements
              
              
              (6,915
              )
              
              (4,959
              )
              
              (470
              )Capitalized
                  research and development costs
              
              
              (8,095
              )
              
              -
              
              
              -Net
                  cash (used in) provided by investing activities
              
              
              (15,010
              )
              
              (4,959
              )
              
              19,512Cash
                  Flows from Financing Activities:Proceeds
                  from borrowings of long-term debt
              
              
              5,000
              
              
              -
              
              
              -(Payments
                  for the purchase) proceeds from the issuance of common stock,
                  net
              
              
              (10
              )
              
              73
              
              
              147Proceeds
                  from the private placement of stock, net
              
              
              28,765
              
              
              10,300
              
              
              16,025Proceeds
                  from the issuance of warrants
              
              
              -
              
              
              -
              
              
              383Proceeds
                  from the exercise of stock options
              
              
              9,670
              
              
              1,840
              
              
              251Net
                  cash provided by financing activities
              
              
              43,425
              
              
              12,213
              
              
              16,806Effect
                  of exchange rate changes on Cash and Cash Equivalents
              
              
              (10
              )
              
              (104
              )
              
              (725
              )Net
                  increase (decrease) in Cash and Cash Equivalents
              
              
              19,975
              
              
              (12,764
              )
              
              20,118Cash
                  and Cash Equivalents, beginning of year
              
              
              17,766
              
              
              30,530
              
              
              10,412Cash
                  and Cash Equivalents, end of year
              
              $
              37,741
              
              $
              17,766
              
              $
              30,530




See
      accompanying notes .


F-7
 Index
          to Consolidated Financial
          Statements





**CONVERA
      CORPORATION A****ND
      SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(dollars
      in thousands, except share and per share data)





**(1)**  **THE
      COMPANY**





**Operations
      and Organization**





Convera
      Corporation (“Convera” or the “Company”) was established through the combination
      on December 21, 2000 of the former Excalibur Technologies Corporation
      (“Excalibur”) and Intel Corporation’s (“Intel”) Interactive Media Services
      (“IMS”) division (the “Combination”).





As
      of
      January 31, 2006 Allen Holding, Inc., together with Allen & Company
      Incorporated, Herbert A. Allen and certain related parties (collectively “Allen
& Company”) beneficially owned approximately 47% of the voting power of
      Convera. As of January 31, 2005 and 2004, Allen & Company beneficially owned
      more than 50% of the voting power of Convera.





Convera
      principally earns revenues from the licensing of its software products and
      the
      provision of services in deployment of the Company’s technology to government
      agencies and commercial businesses throughout North America, Europe and other
      parts of the world. The Company licenses its software to end users directly
      and
      also distributes its software products through license agreements with system
      integrators, original equipment manufacturers, resellers and other strategic
      partners. Revenues are generated from software licenses with customers and
      from
      the related sale of product maintenance, training and professional services.
      Further, during fiscal year 2005, the Company embarked on an advanced Web
      indexing development effort focused on applying portions of the Company’s
      existing technology to also locate contextually relevant information on the
      World Wide Web (the “Web”). On November 1, 2005 the Company announced that the
      Excalibur Web offering was commercially available as the technology had advanced
      to then contain more than 4 billion documents in the index and a redundant
      hosting environment was established with AT&T. The Company began focusing
      much of its selling and marketing resources on establishing distribution
      channels for this technology. The Company is targeting both the commercial
      and
      the government sectors for the Excalibur Web offering at this time. Excalibur
      revenues may be derived from either a license model as described, or from a
      hosted service offering.





The
      Company’s operations are subject to certain risks and uncertainties including,
      but not limited to, the effect of general business and economic trends; the
      ability to continue funding operating losses and achieve profitability; the
      ability of Excalibur to gain market acceptance; the availability of additional
      capital financing on terms acceptable to the Company, if at all; fluctuations
      in
      operating results including impacts from reduced corporate IT spending and
      lengthier sales cycles; reduced customer demand for the Company’s products and
      services; continued success in technological advances and development including
      the Excalibur Web offering; the delay or deferral of customer software
      implementations; the potential for U.S. Government agencies from which the
      Company has historically derived a significant portion of its revenues to be
      subject to budget cuts; a dependence on international sales; actual and
      potential competition by entities with greater financial resources, experience
      and market presence than the Company; reliance on third party hosting facilities
      for our Excalibur Web offering; changes in software and hardware products that
      may render the Company’s products incompatible with these systems; the potential
      for errors in its software products that may result in loss of or delay in
      market acceptance and sales; the dependence on proprietary technology licensed
      from third parties; possible adverse changes to the Company’s intellectual
      property which could harm its competitive position; the need to retain key
      personnel; the ability of the Company to use net operating loss carryforwards;
      and the present ownership structure of the Company which includes Allen Holdings
      Inc. and related parties who exercise voting control of the Company such that
      other shareholders will not have an effective say in any matters upon which
      its
      shareholders vote. Although
      management believes that its current cash position is sufficient to sustain
      operations through January 31, 2007, should cash needs dictate, additional
      cost
      saving measures could be enacted to conserve cash.





F-8
 Index
          to Consolidated Financial
          Statements





**(2)**  **SIGNIFICANT
      ACCOUNTING POLICIES**





**Principles
      of Consolidation**





The
      consolidated financial statements include the accounts of Convera Corporation
      and its wholly owned subsidiaries. All significant intercompany transactions
      and
      accounts have been eliminated.








**Use
      of Estimates**





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenues and expenses during the reporting period.
      Actual results could differ from those estimates.





**Revenue
      Recognition**





The
      Company recognizes revenue in accordance with American Institute of Certified
      Public Accountants ’ Statement of Position 97-2, Software Revenue Recognition, as amended by
      Statement of Position 98-9, Software Revenue Recognition, with respect to
      certain transactions.





Revenue
      from the sale of software licenses is recognized upon shipment of product,
      provided that the fee is fixed and determinable, persuasive evidence of an
      arrangement exists and collection of the resulting receivable is considered
      probable. Historically, the Company has not experienced significant returns
      or
      exchanges of its products.





Revenue
      from training and professional services is recognized when the services are
      performed. Such services are sold as part of a bundled software license
      agreement as well as separately to customers who have previously purchased
      software licenses. When training or professional services that are not essential
      to the functionality of the software are sold as part of a bundled license
      agreement, the fair value of these services, based on the price charged for
      the
      services when sold separately, is deferred and recognized when the services
      are
      performed.





To
      the
      extent that a discount exists in a multiple element or “bundled” arrangement
      that includes a software license, the Company attributes that discount entirely
      to the delivered elements utilizing the residual method as described in
      paragraph 12 of SOP 97-2 as amended by SOP 98-9. The Company generally utilizes
      the residual methodology for recognizing revenue related to multi-element
      software agreements. Under the residual methodology, the Company recognizes
      the
      arrangement fee as follows: (a) the total fair value of the undelivered
      elements, as indicated by vendor-specific objective evidence, is deferred and
      (b) the difference between the total arrangement fee and the amount deferred
      for
      the undelivered elements is recognized as revenue related to the delivered
      elements. This assumes that (a) all other applicable revenue recognition
      criteria in SOP 97-2 are met and (b) the fair value of all of the undelivered
      elements is less than the arrangement fee.





Certain
      of the Company’s customers are Original Equipment Manufacturers (OEMs) and
      resellers. OEM contracts generally stipulate prepaid royalties due at varying
      dates as well as royalties due to the Company on the sale of the customer's
      integrated product over a specified contract term, generally ranging from two
      to
      five years.  With prepaid royalties, the Company recognizes revenue upon
      shipment of the software and/or software developer's kit, as appropriate,
      provided the payment terms are considered normal and customary for these types
      of arrangements, the fee is considered fixed and determinable, and all other
      criteria within SOP 97-2 have been met.  To the extent the
      OEM product sales exceed the level provided for by the guaranteed
      prepaid royalty and additional royalties are due, the Company generally
      recognizes the additional royalties as the sales occur and are reported to
      the Company. Reseller contracts generally stipulate royalties due to the Company
      on the resale of the Company's products and call for a guaranteed minimum
      royalty payment in exchange for the right to sell the Company's products within
      a specified territory over a specified period of time.  The Company
      recognizes the prepaid royalties as revenue upon delivery of the initial copy
      of
      the software, provided the payment terms are considered normal and customary
      for
      these types of arrangements, the fee is considered fixed and determinable,
      and
      all other criteria within SOP 97-2 have been met. To the extent the reseller's
      product sales exceed the level provided for by the guaranteed minimum royalty
      and additional royalties
      are due, the Company generally recognizes the additional royalties as the
      reseller sales occur and are reported to the Company.





F-9
 Index
          to Consolidated Financial
          Statements


Customization
      work is sometimes required to ensure that the Company’s software functionality
      meets the requirements of its customers. Under these circumstances, the
      Company’s revenues are derived from fixed price contracts and revenue is
      recognized using the percentage of completion method based on the relationship
      of actual costs incurred to total costs estimated over the duration of the
      contract. Further, the Company believes that this method of recognition is
      closely aligned with the evolution of the work product as defined. Estimated
      losses on such contracts are charged against earnings in the period such losses
      are identified.





Maintenance
      revenue related to customer support agreements is deferred and recognized
      ratably over the term of the respective agreements. Customer support agreements
      generally include bug fixes, telephone support and product release upgrades
      on a
      when and if available basis. When the Company provides a software license and
      the related customer support arrangement for one bundled price, the fair value
      of the customer support, based on the price charged for that element when sold
      separately, is deferred and recognized ratably over the term of the respective
      agreement.





Deferred
      revenue consists of deferred training and professional services revenues,
      deferred maintenance revenues and deferred license revenues.





Hosted
      service revenues associated with the Excalibur Web offering are recognized
      straight-line over the term of the applicable service agreement.





The
      Company incurs shipping and handling costs which are recorded in cost of license
      revenues.





**Research
      and Development Costs**





Software
      development costs are included in research and development and are expensed
      as
      incurred. Statement of Financial Accounting Standards (“SFAS”) No. 86,
“Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise
      Marketed” requires the capitalization of certain software development costs once
      technological feasibility is established, which for the Company generally occurs
      upon completion of a working model. Capitalization ceases when the products
      are
      available for general release to customers, at which time amortization of the
      capitalized costs begins on a straight-line basis over the estimated product
      life, or on the ratio of current revenues to total projected product revenues,
      whichever is greater. Historically, the period between achieving technological
      feasibility and the general availability of the Company’s core software products
      has been short, and software development costs qualifying for capitalization
      have been insignificant. Accordingly, the Company has not capitalized any
      software development costs related to its core software products, that being
      the
      RetrievalWare product suite. The Company’s new Excalibur Web offering
      encountered a longer period between technological feasibility and the attainment
      of commercial availability. The Excalibur Web offering was determined to have
      reached technological feasibility as of January 31, 2005. As a result, the
      Company began capitalizing software development costs related to the Excalibur
      Web offering during the first quarter of fiscal year 2006 and continued to
      do so
      until such time as “commercial availability” was determined. Effective November
      1, 2005, based on commercial availability, capitalization of software
      development costs associated with the Excalibur Web offering ceased and
      amortization of previously capitalized software development costs for this
      offering commenced. This amortization is expected to continue over a twenty-four
      month period, the estimated useful life of the existing product.





**Advertising**





Advertising
      costs are expensed as incurred and included with sales and marketing in the
      consolidated statements of operations and comprehensive loss. The Company
      incurred approximately $55, $197 and $449 in advertising costs for the years
      ended January 31, 2006, 2005 and 2004, respectively.





**Stock-based
      Compensation**





SFAS
      No.
      123, “Accounting for Stock-Based Compensation” (“SFAS 123”), allows companies to
      account for stock-based compensation either under the provisions of SFAS No.
      123
      or under the provisions of Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”), as amended by FASB
      Interpretation No. 44, “Accounting for Certain Transactions Involving Stock
      Compensation (an interpretation of APB Opinion No. 25).”
The
      Company has elected to account for its stock-based compensation in accordance
      with the provisions of APB 25. Stock options originally granted under the
      Company’s stock option plans have an exercise price equal to the market value of
      the underlying common stock on the date of grant, and accordingly no employee
      compensation cost related to the initial grant of options is included in
      expenses. Stock option modifications associated with a change in employee status
      to a nonemployee have been accounted for as a new award and measured using
      the
      intrinsic value method under APB 25, resulting in the inclusion of compensation
      expense in the January 31, 2004 consolidated statement of operations. Nonvested
      shares of stock (referred to as deferred stock) granted under the Company’s
      stock option plan are measured at fair value on the date of grant based on
      the
      number of shares granted and the quoted price of the Company’s common stock.
      Such value is recognized as compensation expense over the corresponding service
      period. If an employee leaves the Company prior to the vesting of the deferred
      stock, the estimate of compensation expense recorded in previous periods is
      adjusted by decreasing compensation expense in the period of forfeiture.





F-10
 Index
          to Consolidated Financial
          Statements


Had
      compensation cost for the Company’s stock-based compensation plans been
      determined based on the fair value at the grant dates for awards made under
      the
      respective plans in fiscal years 2006, 2005 and 2004 consistent with the method
      of SFAS No. 123, the Company’s net loss and basic and diluted net loss per
      common share would have been increased to the pro forma amounts indicated
      below.





2006
            
            2005
            
            2004Net
                loss, as reported
            
            $
            (14,261
            )
            $
            (19,820
            )
            $
            (18,059
            )Stock-based
                compensation, as reported
            
            
            1,419
            
            
            1,416
            
            
            788Total
                stock-based compensation determined under fair value based method
                for all
                awards
            
            
            (5,539
            )
            
            (6,274
            )
            
            (6,773
            )Pro
                forma net loss
            
            $
            (18,381
            )
            $
            (24,678
            )
            $
            (24,044
            )Basic
                and diluted net loss per common share,as
                reported
            
            
            ($0.33
            )
            
            ($0.56
            )
            
            ($0.57
            )Basic
                and diluted net loss per common share,pro
                forma
            
            
            ($0.43
            )
            
            ($0.70
            )
            
            ($0.76
            )





The
      pro
      forma net loss after applying the provisions of SFAS No. 123 is not necessarily
      representative of the effects on reported net loss for future years due to,
      among other things, vesting period of the stock options and the fair value
      of
      additional options in future years.





The
      fair
      value of each option was estimated on the date of grant using the Black-Scholes
      option-pricing model. The following table shows the assumptions used for the
      grants that occurred in each fiscal year.





2006
            
            2005
            
            2004Expected
                volatility
            80%
            
            90%
            
            96%Risk
                free interest rates
            3.9%
                to 4.4%
            
            3.1%
                to 3.8%
            
            2.5%
                to 3.3%Dividend
                yield
            None
            
            None
            
            NoneExpected
                lives
            5
                years
            
            5
                years
            
            5
                years





The
      weighted average fair value per share for stock option grants that were awarded
      in fiscal years 2006, 2005 and 2004 was $4.40, $3.20 and $3.01, respectively.
      See Note 11 for additional information related to the Company’s stock
      compensation plans.





During
      fiscal year 2004, pursuant to the Company’s 2000 Stock Option Plan, several
      senior officers of the Company were awarded an aggregate of 1,800,000 shares
      of
      deferred stock with a five-year cliff vesting provision. Pursuant to a May
      2003
      deferred stock agreement as amended in May 2004, Mr. Condo was awarded 600,000
      deferred shares of the Company's common stock. Under the amended agreement,
      150,000 shares of common stock vest on each consecutive one-year anniversary
      of
      the date of grant as long as Mr. Condo remains continuously employed with the
      Company through such vesting date. Notwithstanding such vesting schedule, all
      of
      the deferred shares will vest on the earlier occurrence of Mr. Condo's
      termination of employment without cause, death or disability or a change of
      control of the Company. On May 20, 2004, and 2005, in accordance with the terms
      of the amended deferred stock agreement, tranches totaling 150,000 shares each
      vested. On both of these vest dates the Company withheld 48,675 of the shares
      at
      a cost of approximately $121,000 and $225,000, respectively, to fulfill Mr.
      Condo’s tax obligation with respect to the
      award. The deferred stock covering the remaining 700,000 shares, which is held
      by several senior officers, has a five-year cliff vesting provision, or vests
      immediately upon a change in control. The weighted-average fair value of the
      awards granted in fiscal year 2004 was $4.84 per share, based on the market
      price of the Company’s stock on the date of award. Compensation cost for Mr.
      Condo’s stock award is expensed on a straight-line basis over the four-year
      vesting period. Compensation cost for the remaining 700,000 shares is expensed
      on a straight-line basis over the five-year vesting period. In October 2005
      an
      additional 200,000 shares of deferred stock were awarded to a new senior
      officer. This grant also carries a five-year cliff vesting provision, or vest
      immediately upon a change in control followed (a) by the officer’s continuous
      employment for a period of 12 months or (b) within 12 months by a termination
      of
      employment without cause, or a substantial diminution of the officer's duties
      and responsibilities compared to that immediately prior to the change of
      control. The fair value of the awards granted in October 2005 was $12.76 per
      share, based on the market price of the Company’s stock on the date of the
      award. Compensation expense, net of reversals for terminated employees, recorded
      by the Company in fiscal year 2006 was $1.4 million. Compensation expense of
      $979 and $440 is included in general and administrative costs and research
      and
      development costs, respectively, in the accompanying consolidated statements
      of
      operations and comprehensive loss. As of January 31, 2006, an aggregate of
      1,200,000 shares of deferred stock were outstanding.





F-11
 Index
          to Consolidated Financial
          Statements


**Net
      Loss Per Common Share**





The
      Company follows SFAS No. 128, “Earnings Per Share,” for computing and presenting
      net loss per share information. Basic loss per common share is computed by
      dividing net loss available to common stockholders by the weighted average
      number of common shares outstanding for the period. Diluted loss per common
      share excludes common stock equivalent shares and unexercised stock options
      as
      the computation would be anti-dilutive. A reconciliation of the net loss
      available to common stockholders and the number of shares used in computing
      basic and diluted net loss per share is in Note 10.





**Translation
      of Foreign Financial Statements**





The
      functional currency of the Company’s foreign subsidiaries is their local
      currency. Accordingly, assets and liabilities of the Company’s foreign
      subsidiary are translated into U.S. dollars at exchange rates in effect at
      the
      balance sheet date. Income and expense items are translated at average rates
      for
      the period. Foreign currency translation adjustments are accumulated in a
      separate component of shareholders’ equity. Foreign currency transaction
      (losses) gains recorded in operating expenses were ($56), $81 and $741 for
      the
      years ended January 31, 2006, 2005 and 2004, respectively.





**Financial
      Instruments**





The
      carrying value of the Company’s financial instruments, including cash and cash
      equivalents, short-term investments, accounts receivable, accounts payable
      and
      accrued expenses, approximates their fair value.





**Concentrations
      of Credit Risk**





Financial
      instruments that potentially subject the Company to concentrations of credit
      risk consist primarily of cash equivalents, short-term investments and accounts
      receivable. Management believes that the Company’s investment policy limits the
      Company’s exposure to concentrations of credit risk. The Company sells its
      products primarily to government agencies and to major corporations, including
      distributors that serve a wide variety of U.S. and foreign markets. The Company
      extends credit to its corporate customers based on an evaluation of the
      customer’s financial condition, generally without requiring a deposit or
      collateral. Exposure to losses on receivables is principally dependent on each
      customer’s financial condition. The Company monitors its exposure for credit
      losses and maintains an allowance for anticipated losses. The allowance for
      doubtful accounts is determined based on an analysis of the Company’s historical
      collection experience and the Company’s portfolio of customers taking into
      consideration the general economic environment as well as the industry in which
      the Company operates.





F-12
 Index
          to Consolidated Financial
          Statements


**Valuation
      Accounts**





Balance
                at Beginningof
                Period
            
            Charged
                (Credited) to Costs andExpenses
            
            Uncollectible
                Accounts Written Off, Net ofRecoveries
            
            Balance
                at End ofPeriodYear
                Ended January 31, 2006:Deducted
                from asset accounts:Allowance
                for doubtful accounts
            
            $
            537
            
            $
            (10
            )
            $
            (309
            )
            $
            218Year
                Ended January 31, 2005:Deducted
                from asset accounts:Allowance
                for doubtful accounts
            
            $
            1,793
            
            $
            (401
            )
            $
            (855
            )
            $
            537Year
                Ended January 31, 2004:Deducted
                from asset accounts:Allowance
                for doubtful accounts
            
            $
            1,569
            
            $
            80
            
            $
            144
            
            $
            1,793





**Cash
      and Cash Equivalents**





The
      Company considers all highly liquid investments purchased with an original
      maturity of three months or less to be cash equivalents. Cash equivalents
      consist of funds deposited in money market accounts. Consequently, the carrying
      amount of cash and cash equivalents approximates this fair value. Substantially
      all cash and cash equivalents are on deposit with two major financial
      institutions.





**Short
      Term Investments**





Highly
      liquid investments with maturities of one year or less at the time of purchase
      are classified as short-term investments. Short-term investments as of January
      31, 2006 and January 31, 2005 consist of a certificate of deposit for $71,
      which
      is pledged to collateralize a letter of credit required for a leased
      facility





**Income
      Taxes**





Deferred
      taxes are provided utilizing the liability method, whereby deferred tax assets
      are recognized for deductible temporary differences and operating loss and
      tax
      credit carryforwards and deferred tax liabilities are recognized for taxable
      temporary differences. Temporary differences are the differences between the
      reported amounts of assets and liabilities for financial reporting purposes
      and
      the amounts for income tax purposes at the tax rates expected to be in effect
      when the differences reverse. Deferred tax assets and liabilities are adjusted
      for the effects of changes in tax laws and rates on the date of enactment.
      Deferred tax assets are reduced by a valuation allowance when, in the opinion
      of
      management, it is more likely than not that some portion or all of the deferred
      tax assets will not be realized. The Company provided a full valuation allowance
      against its net deferred tax assets as of January 31, 2006.





**Equipment
      and Leasehold Improvements**





Office
      furniture and computer equipment are recorded at cost. Depreciation of office
      furniture and equipment is provided on a straight-line basis over the estimated
      useful lives of the assets, generally three to five years. Amortization of
      leasehold improvements and leased assets are provided on a straight-line basis
      over the shorter of the term of the applicable lease or the useful life of
      the
      asset.





Expenditures
      for normal repairs and maintenance are charged to operations as incurred. The
      cost of property and equipment retired or otherwise disposed of and the related
      accumulated depreciation or amortization are removed from the accounts and
      any
      resulting gain or loss is reflected in current operations.


F-13
 Index
          to Consolidated Financial
          Statements


**Goodwill
      and Other Intangible Assets**





Convera’s
      prior acquisitions of other companies resulted in the acquisition of certain
      intangible assets and goodwill. Goodwill resulting from such acquisitions is
      associated with the Company’s core software products segment. In accordance with
      Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
      Other Intangible Assets”, the impairment of goodwill is assessed on an annual
      basis or whenever changes in circumstances indicate that the fair value of
      the
      Company is less than the carrying value.. This assessment is performed by
      comparing the market value of the Company’s outstanding common stock with the
      carrying amount of the Company’s net assets, including goodwill. If the market
      value exceeds the carrying amount of the Company’s net assets, impairment of
      goodwill does not exist. If the market value is less than the carrying amount
      of
      the Company’s net assets, the Company will perform further analysis and may be
      required to record an impairment. The Company continues to amortize intangible
      assets that are deemed to have a finite useful life, and amortization is being
      charged to income on a straight-line basis over the periods estimated to
      benefit. Acquired developed technology is being amortized on a straight-line
      basis over five years.





**Impairment
      of Long-Lived Assets**





The
      Company evaluates all of its long-lived assets, including intangible assets
      other than goodwill, for impairment in accordance with the provisions of SFAS
      No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS
      No. 144 requires that long-lived assets and intangible assets other than
      goodwill be evaluated for impairment whenever events or changes in circumstances
      indicate that the carrying value of an asset may not be recoverable based on
      expected undiscounted cash flows attributable to that asset. Should events
      indicate that any of the Company’s assets are impaired, the amount of such
      impairment will be measured as the difference between the carrying value and
      the
      fair value of the impaired asset and the impairment will be recorded in earnings
      during the period of such impairment.





**Reclassifications**





Certain
      amounts presented in the prior year’s financial statements have been
      reclassified to conform to the fiscal year 2006 presentation.





**Other
      Income** ****




For
      the
      year ended January 31, 2006 other income consisted of $908 of net interest
      income offset by interest expense of $306. In fiscal year 2005 other income
      consisted entirely of net interest income of $175. For the year ended January
      31, 2004 other income consisted of $204 in interest income offset by interest
      expense of $17, plus a reversal of $2,363 of accrued expenses resulting from
      a
      settlement agreement reached between the Company and another party in fiscal
      year 2004. As a result of the settlement, the Company’s liability was reduced
      from $5.6 million to $3.2 million, and the previously recorded accruals were
      reversed into other income.




**Recent
      Pronouncements**





On
      December 16, 2004, the Financial Accounting Standards Board ("FASB") issued
      SFAS
      No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), which is a
      revision of SFAS No. 123. SFAS No. 123(R) Supersedes APB No. 25, and amends
      SFAS
      No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R)
      is
      similar to the approach described in SFAS No. 123; however, SFAS No. 123(R)
      requires all share-based payments to employees, including grants of employee
      stock options, to be recognized in the statements of operations based on their
      fair values. Pro forma disclosure is no longer an alternative upon adopting
      SFAS
      No. 123(R). The Company will adopt SFAS No. 123(R) on February 1, 2006. SFAS
      No.
      123(R) permits public companies to adopt its requirements using one of two
      methods: i. A "modified prospective" method in which compensation cost is
      recognized beginning with the effective date (a) based on the requirements
      of
      SFAS No. 123(R) for all share-based payments granted after the effective date
      and (b) based on the requirements of SFAS No. 123(R) for all awards granted
      to
      employees prior to the effective date of SFAS 123(R) that remain unvested on
      the
      effective date. ii. A "modified retrospective" method which includes the
      requirements of the modified prospective method described above, but also
      permits entities to restate based on the amounts previously recognized under
      SFAS No. 123 for purposes of pro forma disclosures for either (a) all prior
      periods presented or (b) prior interim periods of the year of adoption. The
      Company will implement SFAS No. 123(R) in the first quarter of fiscal year
      2007
      and intends to use the modified prospective method.


F-14
 Index
          to Consolidated Financial
          Statements


**(3)**  **RESTRUCTURING
      CHARGES**





In
      fiscal
      years 2004 and 2005 the Company effected a re-alignment
      of its operational infrastructure by
      adopting a restructuring plan to reduce operating costs and increase
      efficiencies. These restructuring programs were composed entirely of workforce
      reductions. As a result of these restructuring programs, in conformity with
      SEC
      Staff Accounting Bulletin (SAB) No. 100, *Restructuring
      and Impairment Charges* ,
      and
      EITF No. 94-3, *Liability
      Recognition for Certain Employee Termination Benefits and Other Costs to Exit
      an
      Activity Including Certain Costs incurred in a Restructuring* ,
      the
      Company recorded restructuring charges during the years ended January 31, 2005
      and 2004. In the years ended January 31, 2006 and 2005 the Company recorded
      restructuring adjustments related to restructurings that originated in fiscal
      years 2002 through 2005.





Workforce
      Reductions





In
      connection with the restructuring programs in fiscal years 2005 and 2004 the
      Company reduced its workforce by 105 employees worldwide, including 20
      individuals from the professional services group, 33 from engineering, 27 from
      sales, 14 from marketing and 11 from the general and administrative group.
      During the fiscal years ended January 31, 2005 and 2004 the Company recorded
      restructuring charges related to terminated employee severance costs of $1,081
      and $621, respectively.





Changes
      in Estimates and Adjustments





During
      the years ended January 31, 2006 and 2005 the company recorded adjustments
      to
      previous restructuring programs of ($57) and ($137), respectively. The fiscal
      year 2005 adjustment reflects the reversal of fiscal year 2002 restructuring
      charge related to a facility closing. The adjustment in fiscal year 2006
      consisted of a reversal of $51 related to the aforementioned facility closing
      in
      fiscal year 2002 and a $6 reversal of employee termination benefits related
      to
      the restructuring in fiscal year 2005.





Restructuring
      costs and adjustments recorded are summarized as follows (in
      thousands):





**Year
                Ended January 31,****2006**
            
            **2005**
            
            **2004**Employee
                termination costs
            
            $
            -
            
            $
            1,081
            
            $
            621Change
                in estimates and assumptions
            
            
            (57
            )
            
            (137
            )
            
            -Total
            
            $
            (57
            )
            $
            944
            
            $
            621





The
      Company paid an aggregate of approximately $776, $1,616 and $1,934 against
      the
      restructuring reserve in the fiscal years ended January 31, 2006, 2005, and
      2004, respectively. As of January 31, 2006 all restructuring obligations have
      been fully settled.








**(4)**  **ACCOUNTS
      RECEIVABLE**





Accounts
      receivable, net of allowances, consist of the following as of January 31, (in
      thousands):





2006
            
            2005Billed
            
            $
            4,215
            
            $
            6,455Unbilled
            
            
            367
            
            
            6124,582
            
            
            7,067Less:
                allowance for doubtful accounts
            
            
            (218
            )
            
            (537
            )$
            4,364
            
            $
            6,530





The
      unbilled total represents the recognized sales value of performance and such
      amounts that had not been billed and were not billable to customers as of the
      balance sheet date. The billing is customarily determined by the delivery of
      milestones as set forth in the contract.


F-15
 Index
          to Consolidated Financial
          Statements





**(5)**  **EQUIPMENT
      AND LEASEHOLD IMPROVEMENTS**





Equipment
      and leasehold improvements at January 31, 2006 and 2005 consisted of the
      following:





2006
            
            2005Computer
                equipment
            
            $
            21,407
            
            $
            15,426Office
                furniture
            
            
            2,831
            
            
            2,918Leasehold
                improvements
            
            
            597
            
            
            74124,835
            
            
            19,085Less
                accumulated depreciation
            
            
            (15,683
            )
            
            (13,940
            )$
            9,152
            
            $
            5,145





Equipment
      and leasehold improvements are recorded at cost. Depreciation is calculated
      on
      the straight-line method over three years for computer equipment, five years
      for
      office furniture and over the shorter of the depreciable life or the life of
      the
      related lease for leasehold improvements. Depreciation expense for fiscal years
      2006, 2005 and 2004 was $2,903, $1,584 and $1,660, respectively.





**(** **6)**  **GOODWILL
      AND OTHER INTANGIBLE ASSETS**




Goodwill
      and other acquisition-related intangibles at fiscal year ends were as
      follows:





2006
            
            2005Goodwill
            
            $
            2,275
            
            $
            2,275Developed
                technologies
            
            $
            1,346
            
            $
            1,346Less
                accumulated amortization
            
            
            (1,049
            )
            
            (780
            )$
            297
            
            $
            566





Amortization
      expense for fiscal years 2006, 2005 and 2004 was $269, $269 and $269,
      respectively. Based on the current amount of intangible assets subject to
      amortization, the estimated amortization expense for each of the succeeding
      5
      years is as follows: 2007 - $269; 2008 - $28; --none thereafter.








**(7)**  **ACCRUED
      EXPENSES**




Accrued
      expenses at January 31, 2006 and 2005 consisted of the following:





2006
            
            2005Accrued
                payroll and bonuses
            
            $
            1,325
            
            $
            1,552Accrued
                facility costs
            
            
            -
            
            
            1,625Other
            
            
            1,355
            
            
            878$
            2,680
            
            $
            4,055


F-16
 Index
          to Consolidated Financial
          Statements


**(8)**  **INCOME
      TAXES**





The
      items
      accounting for the difference between income taxes computed at the federal
      statutory rate and the provision for income taxes consisted of:




For
                  the Fiscal Years Ended January 31,2006
              
              2005
              
              2004Federal
                  benefit at statutory rate
              
              $
              (4,300
              )
              
              (35
              )%
              
              $
              (6,937
              )
              
              (35
              )%
              
              $
              (6,321
              )
              
              (35
              )%Effect
                  of:State
                  benefits, net of federal benefits
              
              
              (369
              )
              
              (3
              )%
              
              
              (595
              )
              
              (3
              )%
              
              
              (542
              )
              
              (3
              )%Expiration
                  of NOL carryforward
              
              
              1,168
              
              
              10
              %
              
              
              621
              
              
              3
              %
              
              
              -
              
              
              0
              %Effect
                  of stock option exercises
              
              
              (4,582
              )
              
              (37
              )%
              
              
              (12
              )
              
              0
              %
              
              
              (14
              )
              
              0
              %Other
              
              
              (569
              )
              
              (5
              )%
              
              
              657
              
              
              3
              %
              
              
              177
              
              
              1
              %Valuation
                  allowance
              
              
              8,652
              
              
              70
              %
              
              
              6,266
              
              
              32
              %
              
              
              6,700
              
              
              37
              %Net
                  deferred tax assets
              
              $
              -
              
              
              0
              %
              
              $
              -
              
              
              0
              %
              
              $
              -
              
              
              0
              %








Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amount of assets and liabilities for financial reporting purposes
      and
      the amounts used for income tax purposes.





The
      Company’s net deferred tax assets at January 31, 2006 and 2005 were as
      follows:




2006
            
            2005Deferred
                tax assets:Net
                operating loss carryforwards,not
                yet utilized
            
            $
            70,720
            
            $
            61,627Capitalized
                research & development costs
            
            
            14,576
            
            
            14,862Restructuring
                reserve
            
            
            -
            
            
            325Other
            
            
            2,289
            
            
            2,119Total
                deferred tax assets
            
            
            87,585
            
            
            78,933Valuation
                allowance
            
            
            (87,585
            )
            
            (78,933
            )Net
                deferred tax assets
            
            $
            -
            
            $
            -





At
      January 31, 2006 the Company had net operating loss carryforwards (“NOLs”) of
      approximately $185 million that expire at various dates through fiscal year
      2025. The use of these NOLS may be limited by Section 382 of the Internal
      Revenue Code as a result of the Combination or other equity transactions.
      Approximately $26,880 of the NOLs relate to stock option exercises, and $17,425
      and $1,470 relate to UK and Canada operations, respectively. The tax benefit
      associated with the stock option exercises will be credited to equity when
      and
      if realized.





As
      of
      January 31, 2006, the Company’s deferred tax assets exceeded the deferred tax
      liabilities. As the Company has not generated earnings and no assurance can
      be
      made of future earnings needed to utilize these assets, a valuation allowance
      in
      the amount of the net deferred tax assets has been recorded.


F-17
 Index
          to Consolidated Financial
          Statements


**(9)**  **CAPITALIZATION**





The
      authorized capital stock of Convera consists of 100 million shares of Class
      A
      voting common stock, par value $0.01 per share, 40 million shares of Class
      B
      non-voting common stock, par value $0.01 per share, and five million shares
      of
      cumulative convertible preferred stock, par value $0.01 per share.





In
      the
      second quarter of fiscal year 2006, the Company completed a private placement
      of
      6,555,556 newly issued shares of its Class A common stock to two investors.
      The
      Company sold 5,555,556 shares directly to the Legg Mason Opportunity Trust
      at a
      purchase price of $4.50 per share. The remaining 1 million shares were purchased
      by an affiliate of Herbert A. Allen, a significant stockholder and director
      of
      the Company, at a purchase price of $4.84 per share. Net proceeds to the Company
      of approximately $28.8 million were and will continue to be used for the
      continued funding of activities related to the Excalibur Web offering and for
      general corporate purposes. Allen & Company LLC, a company affiliated with
      the majority shareholder, acted as placement agent for the private placement
      and
      was paid a commission of 4% on the shares purchased directly by the Legg Mason
      Opportunity Trust.





In
      the
      third quarter of fiscal year 2005, the Company completed a private
      placement of 3,433,333 newly-issued shares of Class A common stock to several
      investors, including affiliates of Allen & Company Incorporated, a
      significant stockholder of the Company, and certain directors. The shares were
      priced on September 7, 2004 at $3.00 per share, representing a premium to the
      $2.80 closing market price on such date. Net proceeds to the Company of
      approximately $10.3 million were used to
      finance ongoing operations and for general corporate purposes, including
      potential acquisitions.





In
      the
      second quarter of fiscal year 2004, the Company completed a private placement
      of
      4,714,111 shares of its Class A common stock to a group of unaffiliated
      institutional investors. The Company sold the shares at a purchase price of
      $3.60 per share, resulting in net proceeds to the Company of approximately
      $16.0
      million. In connection with this private placement, the Company has incurred
      expenses of approximately $946, which have been recorded in equity as an offset
      against the proceeds. The Company used the net proceeds to finance ongoing
      operations and for general corporate purposes, including potential acquisitions.
      Allen & Company LLC, a company affiliated with the majority shareholder,
      acted as placement agent for the private placement and was paid a commission
      of
      5%, which is included in the offering expenses above.





No
      shares
      of the Company’s Class B common stock are issued or outstanding at January 31,
      2006.







**(10)**  **NET
      LOSS PER COMMON SHARE**





The
      following table sets forth the computation of basic and diluted net loss per
      common share:





For
                the Fiscal Years Ended January 31,2006
            
            2005
            
            2004Numerator:Net
                loss
            
            $
            (14,261
            )
            $
            (19,820
            )
            $
            (18,059
            )Denominator:Weighted
                average number of common shares outstanding - basic and
                diluted
            
            
            43,088,677
            
            
            35,432,754
            
            
            31,486,032Basic
                and diluted net loss per common share
            
            $
            (0.33
            )
            $
            (0.56
            )
            $
            (0.57
            )





Using
      the
      treasury stock method the following equity instruments were not included in
      the
      computation of diluted net loss per common share because their effect would
      be
      anti-dilutive:





For
                the Fiscal Years Ended January 31,2006
            
            2005
            
            2004Stock
                options
            
            
            3,761,226
            
            
            712,682
            
            
            199,901Deferred
                stock
            
            
            616,613
            
            
            182,597
            
            
            40,694Stock
                warrants
            
            
            -
            
            
            -
            
            
            71,551




F-18
 Index
          to Consolidated Financial
          Statements


**(11)**  **EMPLOYEE
      BENEFIT PLANS**





**Stock
      Options**





The
      Convera 2000 Stock Option Plan authorizes the granting of stock options and
      other forms of incentive compensation to purchase up to 11.25 million shares
      of
      the Company’s Class A common stock in order to attract, retain and reward key
      employees. In addition, at the closing of the Combination, Convera assumed
      Excalibur’s existing stock option plans. The various plans are administered by a
      Committee appointed by the Board of Directors, which has the authority to
      determine which officers, directors and key employees are awarded options and
      other stock based compensation pursuant to the plans and the terms and option
      exercise prices of the stock options. Of the total number of shares authorized
      for stock based compensation, options or warrants to purchase 8,495,022 shares
      and 1,200,000 deferred shares were outstanding as of January 31, 2006. The
      Company had a total of 334,348 shares of Class A common stock reserved for
      the
      issuance of warrants, deferred shares and options under the plans as of January
      31, 2006.





Each
      qualified incentive stock option granted pursuant to the plans has an exercise
      price as determined by the Committee but not less than 100% of the fair market
      value of the underlying common stock at the date of grant, a ten-year term
      and
      typically a four-year vesting period.





A
      non-qualified option granted pursuant to the plans may contain an exercise
      price
      that is below the fair market value of the common stock at the date of grant
      and/or may be immediately exercisable. The term of non-qualified options is
      usually five or ten years.





The
      following table summarizes the Company's activity for all of its stock option
      awards:





Number
                of Options
            
            Range
                of Exercise Prices
            
            Weighted-AverageExercise
                PriceBalance,
                January 31, 2003
            
            8,813,654
            
            $
            1.45
                - 52.75
            
            $
            5.25Granted
            
            
            480,310
            
            
            3.40
                -4.95
            
            
            4.09Exercised
            
            
            (61,016
            )
            
            1.70
                -4.75
            
            
            4.11Canceled
            
            
            (2,031,592
            )
            
            2.43-39.63
            
            
            5.02Balance,
                January 31, 2004
            
            
            7,201,356
            
            $
            1.45-52.75
            
            $
            5.24Granted
            
            
            3,937,150
            
            
            2.24
                -5.31
            
            
            3.20Exercised
            
            
            (465,469
            )
            
            1.45
                -4.75
            
            
            3.95Canceled
            
            
            (1,398,211
            )
            
            1.45-52.75
            
            
            4.44Balance,
                January 31, 2005
            
            
            9,274,826
            
            $
            1.60-46.06
            
            $
            4.55Granted
            
            
            2,684,000
            
            
            4.19
                - 16.09
            
            
            6.88Exercised
            
            
            (2,406,090
            )
            
            1.60
                - 10.38
            
            
            4.02Canceled
            
            
            (1,057,714
            )
            
            1.80
                - 35.50
            
            
            6.06Balance,
                January 31, 2006
            
            
            8,495,022
            
            $
            1.70-46.06
            
            $
            5.25





Options
      to purchase 3,971,846, 5,324,042 and 4,830,097 shares of the Company’s common
      stock were vested and exercisable at January 31, 2006, 2005 and 2004,
      respectively, at weighted-average exercise prices of $5.16, $5.44 and $5.64
      per
      share, respectively.


F-19
 Index
          to Consolidated Financial
          Statements


The
      following table summarizes additional information about stock options
      outstanding at January 31, 2006:





Options
                Outstanding
            
            Options
                ExercisableRange
                of Exercise Prices
            
            Number
                of
              Options
            
            Weighted-Average
                Remaining Contractual
              Life
            
            Weighted-AverageExercise
                Price
            
            NumberExercisable
            
            Weighted-AverageExercise
                Price$1.70
                to $4.07
            
            
            1,701,255
            
            
            8.13
                years
            
            $
            2.68
            
            
            406,285
            
            $
            3.13$4.14
                to $5.09
            
            
            5,650,527
            
            
            7.13
            
            
            4.54
            
            
            3,168,699
            
            
            4.43$5.31
                to $8.13
            
            
            203,628
            
            
            3.35
            
            
            7.03
            
            
            173,250
            
            
            7.19$8.19
                to $16.09
            
            
            819,562
            
            
            8.89
            
            
            12.33
            
            
            103,562
            
            
            10.42$20.52
                to $46.06
            
            
            120,050
            
            
            3.01
            
            
            23.77
            
            
            120,050
            
            
            23.778,495,022
            
            
            7.35
                years
            
            $
            5.25
            
            
            3,971,846
            
            $
            5.16








**Employee
      Stock Purchase Plan**





The
      Company’s employee stock purchase plan (“ESPP”) is available for all active
      employees and provides that participating employees may purchase common stock
      each plan quarter at a purchase price equal to the lesser of 85% of the closing
      price on the date of purchase or 85% of the closing price on the date of grant.
      Payment for the shares is made through authorized payroll deductions of up
      to
      10% of eligible annual compensation.





Of
      the
      250,000 shares of Class A common stock that were reserved for issuance, 73
      and
      152,778 shares were purchased by employees in fiscal years 2003 and 2002,
      respectively.





During
      the fourth quarter of the fiscal year ended January 31, 2002, the Convera
      shareholders approved an amendment to the ESPP authorizing an additional
      1,000,000 shares to be reserved for issuance under the plan. These shares were
      included as treasury stock as of January 31, 2002 and are released from the
      treasury as employees purchase the shares through the ESPP. During the fiscal
      years 2006, 2005, 2004 and 2003, 52,055, 86,849, 63,898 and 122,845 shares
      were
      purchased by the employees, respectively, leaving 674,353 shares in treasury
      as
      of January 31, 2006.





**Employee
      Savings Plan**





The
      Company has an employee savings plan that qualifies under Section 401(k) of
      the
      Internal Revenue Code. Under the plan, participating eligible employees in
      the
      United States may defer up to 100 percent of their pre-tax salary, but not
      more
      than statutory limits. The plan was amended in the fiscal year ended January
      31,
      2001 to allow the Company to match $0.50 on every dollar up to the maximum
      of 8%
      of the employee’s contribution on total compensation.





For
      the
      fiscal years ended January 31, 2006, 2005 and 2004, the Company contributed
      approximately $424, $483 and $477, respectively, to the employee savings plan.








F-20
 Index
          to Consolidated Financial
          Statements





**(12)**  **COMMITMENTS
      AND CONTINGENCIES**





**Lease
      Commitments**





The
      Company conducts its operations using leased facilities. The leases terminate
      at
      various dates through fiscal year 2009 with options to renew. Certain leases
      provide for scheduled rent increases and obligate the Company to pay shared
      portions of the operating expenses such as taxes, maintenance and repair costs.
      The Company also has operating leases for equipment and its foreign subsidiary
      has operating leases for automobiles that are included in the figures below.
      Future minimum rental payments under non-cancelable operating leases as of
      January 31, 2006 are as follows:





Year
                EndingJanuary
                31,2007
            
            $
            1,5702008
            
            
            7562009
            
            
            912010
                and beyond
            
            
            -$
            2,417





Total
      rental expense under operating leases was approximately $1,805, $2,743 and
      $2,982 for fiscal years 2006, 2005 and 2004, respectively.





**Contingencies**





On
      November 1, 2001, DSMC, Incorporated ("DSMCi") filed a complaint against the
      Company in the U.S. District Court for the District of Columbia in which it
      alleged that the Company misappropriated DSMCi's trade secrets, and engaged
      in
      civil conspiracy with the NGT Library, Inc. ("NGTL"), an affiliate of the
      National Geographic Society, to obtain access to DSMCi's trade secrets, and
      was
      unjustly enriched by the Company's alleged access to and use of such trade
      secrets. In its complaint, DSMCi seeks $5 million in actual damages and $10
      million in punitive damages from the Company. DSMCi subsequently amended its
      complaint to add copyright infringement-related claims. NGTL intervened in
      the
      litigation as a co-defendant with Convera, and filed counterclaims against
      DSMCi. Convera moved to compel arbitration of DSMCi's claims; the District
      Court
      denied the motion, and Convera filed an interlocutory appeal. The D.C. Circuit,
      in November 2003, ruled that it did not have jurisdiction to consider the
      appeal. During December 2005 DSMCi and NGTL entered into a Settlement Agreement
      and Release.  The U.S. District Court dismissed claims against NGTL on
      December 23, 2005. The litigation between the Company and DSMCi is currently
      in
      the summary judgment phase in the District Court.  The
      Company has investigated the claims and continues to believe that the claims
      are
      without merit.





In
      connection with this litigation, the Company brought an arbitration claim
      against NGTL on September 13, 2005, seeking indemnification for its defense
      costs and potential liability pursuant to an indemnity provision in a service
      agreement between NGTL and the Company. In response, NGTL brought a cross claim
      against the Company under the same contract provision for indemnification of
      NGTL’s respective costs and liability. This arbitration is in its early stage.





In
      addition, from time to time, the Company is a party to various legal
      proceedings, claims, disputes and litigation arising in the ordinary course
      of
      business, including that noted above. The Company believes that the ultimate
      outcome of these matters, individually and in the aggregate, will not have
      a
      material adverse affect on its financial position, operations or cash flow.
      However, because of the nature and inherent uncertainties of litigation, should
      the outcome of these actions or future actions be unfavorable, Convera’s
      financial position, operations and cash flows could be materially and adversely
      affected.


F-21
 Index
          to Consolidated Financial
          Statements





**(13)**  **SEGMENT
      REPORTING**





The
      Company is engaged in the design, development, marketing and support of search,
      retrieval and categorization solutions. All of the Company’s revenues result
      from the sale of the Company’s software products and related services for all
      fiscal year’s presented. During fiscal year 2005, the Company embarked on an
      advanced development effort focused on applying portions of its existing core
      technology to also locate contextually relevant information on the World Wide
      Web. This development effort has resulted in the Excalibur Web offering.
      Accordingly, as of January 31, 2006 the Company considers itself to have two
      reportable segments, specifically the license, implementation and support of
      its
      core software products business as well as the Web indexing segment. The
      Company’s chief operating decision-making group reviews financial information
      presented on a consolidated basis, accompanied by disaggregated information
      about revenues, expenses and relevant balance sheet items for both product
      segments and by geographic region for purposes of making operating decisions
      and
      assessing financial performance.





The
      following table reconciles the Company’s segment activity to its consolidated
      results of operations for the years ended January 31, 2006, 2005 and
      2004.





Fiscal
                Years Ended January 31,2006
            
            2005
            
            2004**Revenues
                and expenses*******Core
                Software Products (RetrievalWare)*Revenues
            
            $
            20,988
            
            $
            25,698
            
            $
            29,251Expenses,
                excluding depreciation
            
            
            (27,108
            )
            
            (40,032
            )
            
            (48,200
            )Depreciation
            
            
            (630
            )
            
            (1,267
            )
            
            (1,660
            )Net
                operating loss
            
            $
            (6,750
            )
            $
            (15,601
            )
            $
            (20,609
            )*Web
                Indexing (Excalibur)*Revenues
            
            $
            20
            
            $
            -
            
            $
            -Expenses,
                excluding depreciation
            
            
            (5,859
            )
            
            (4,063
            )
            
            -Depreciation
            
            
            (2,274
            )
            
            (331
            )
            
            -Net
                operating loss
            
            $
            (8,113
            )
            $
            (4,394
            )
            $
            -*Reconciliation
                to consolidated net loss*Net
                operating loss-both reporting segments
            
            $
            (14,863
            )
            $
            (19,995
            )
            $
            (20,609
            )Other
                income, net (unallocated)
            
            
            602
            
            
            175
            
            
            2,550Net
                loss before income taxes
            
            
            (14,261
            )
            
            (19,820
            )
            
            (18,059
            )Income
                tax benefit
            
            
            -
            
            
            -
            
            
            -Net
                loss
            
            $
            (14,261
            )
            $
            (19,820
            )
            $
            (18,059
            )





F-22
 Index
          to Consolidated Financial
          Statements


The
      following table reconciles each segments total assets to the Company’s
      consolidated total assets for the years ended January 31, 2006 and
      2005.





Fiscal
                Years Ended January 31,2006
            
            2005*Core
                Software Products (RetrievalWare)*Equipment
                and leasehold improvements, net of accumulated
                depreciation
            
            $
            934
            
            $
            1,353All
                other assets
            
            
            47,964
            
            
            31,149Total
                assets for segment
            
            $
            48,898
            
            $
            32,502*Web
                Indexing (Excalibur)*Equipment
                and leasehold improvements, net of accumulated
                depreciation
            
            $
            8,218
            
            $
            3,792All
                other assets
            
            
            7,101
            
            
            -Total
                assets for segment
            
            $
            15,319
            
            $
            3,792Consolidated
                total assets
            
            $
            64,217
            
            $
            36,294








**Operations
      by Geographic Area**





The
      following table presents information about the Company’s operations by
      geographical area:





Fiscal
                Years Ended January 31,2006
            
            2005
            
            2004Sales
                to customers:United
                States
            
            $
            15,767
            
            $
            18,171
            
            $
            21,896United
                Kingdom
            
            
            4,472
            
            
            6,608
            
            
            2,815All
                Other
            
            
            769
            
            
            919
            
            
            4,540$
            21,008
            
            $
            25,698
            
            $
            29,251Long-lived
                assets:United
                States
            
            $
            18,983
            
            $
            9,350
            
            $
            6,671All
                Other
            
            
            661
            
            
            187
            
            
            423$
            19,644
            
            $
            9,537
            
            $
            7,094








**Major
      Customers**





Revenues
      derived from contracts and orders issued by agencies of the U.S. Government
      were
      approximately $11,310 $11,600 and $15,200, respectively, in the fiscal years
      ended January 31, 2006, 2005 and 2004. These revenues, expressed as a percentage
      of total revenues for each such fiscal year, were approximately 54%, 45% and
      52%, respectively. For the fiscal year ended January 31, 2006 one customer
      accounted for approximately 14% of the Company’s total revenues. One reseller
      customer accounted for approximately 17% of the Company’s total revenues for the
      fiscal year ended January 31, 2005 and one customer accounted for 12% of the
      Company’s total revenues for the fiscal year ended January 31, 2004.








**(14)**  **SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION**




For
                the Fiscal Years Ended January 31,2006
            
            2005
            
            2004Supplemental
                Disclosures of Non-cash Investing and Financing
                Activities:Stock
                options exercised under deferred compensation arrangements
            
            $
            225
            
            $
            121
            
            $
            25




F-23
 Index
          to Consolidated Financial
          Statements




**(15)**  **SELECTED
      QUARTERLY INFORMATION (UNAUDITED)**




1stQuarter
              
              2nd
                  Quarter
              
              3rd
                  Quarter
              
              4th
                  Quarter***2006***:Revenues
              
              $
              5,078
              
              $
              7,804
              
              $
              4,512
              
              $
              3,613Operating
                  loss
              
              
              (2,495
              )
              
              (100
              )
              
              (2,732
              )
              
              (9,536
              )Restructuring
                  charges
              
              
              (56
              )
              
              -
              
              
              (1
              )
              
              -Other
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss
              
              
              (2,469
              )
              
              (25
              )
              
              (2,491
              )
              
              (9,276
              )Basic
                  and diluted loss per common share
              
              $
              (0.06
              )
              $
              (0.00
              )
              $
              (0.05
              )
              $
              (0.20
              )***2005***:Revenues
              
              $
              8,170
              
              $
              5,067
              
              $
              6,130
              
              $
              6,331Operating
                  loss
              
              
              (4,796
              )
              
              (7,079
              )
              
              (4,563
              )
              
              (3,557
              )Restructuring
                  charges
              
              
              -
              
              
              -
              
              
              518
              
              
              426Other
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss
              
              
              (4,759
              )
              
              (7,049
              )
              
              (4,518
              )
              
              (3,494
              )Basic
                  and diluted loss per common share
              
              $
              (0.14
              )
              $
              (0.21
              )
              $
              (0.13
              )
              $
              (0.09
              )










**(16)**  **LONG-TERM
      DEBT**





On
      March
      23, 2005 the Company secured a $5 million term loan from Silicon Valley Bank
      (“SVB”), the primary subsidiary of Silicon Valley Bancshares (NASDAQ: SIVB). The
      four-year, term facility was secured to provide financing for capital purchases
      including those for the Excalibur Web offering. The loan bears interest at
      7%
      per annum and is secured by a first lien on all corporate assets, excluding
      intellectual property. Scheduled monthly payments of interest only are due
      through March 2006. The balance is scheduled to be paid in 36 monthly
      installments of approximately $155 including principal and interest.
      Additionally, a balloon interest payment of $125 is due in March 2009. The
      note
      includes certain financial covenants including cash to debt ratios. The
      agreement also requires the Company to maintain a cash balance with SVB equal
      to
      twice the amount of the loan outstanding. During the fiscal year ended January
      31, 2006 the Company recorded interest expense of $306. As of January 31, 2006,
      the Company was in compliance will all required covenants. The Company retired
      this facility on February 28, 2006.








**(17)**  **SUBSEQUENT
      EVENTS**




On
      February 28, 2006 the Company completed a private placement of 5,103,333
      newly-issued shares of common stock to a group of institutional investors
      resulting in net proceeds of approximately $36.7 million. The shares were sold
      at a price of $7.50 per share, which represented a 6.58% discount to the
      Company’s trailing 10-day average closing price preceding the date of Board
      approval. Allen
      & Company LLC, a company affiliated with the majority shareholder, acted as
      placement agent for the private placement and was paid a commission of
      4%.




Concurrent
      with this private placement, the Company retired the Silicon Valley Bank term
      loan facility. The remaining balance of the private placement proceeds, which
      totaled approximately $31.6 million are to be used for general corporate
      purposes, including the Excalibur Web offering.









F-24
 Index
          to Consolidated Financial Statements