**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

#### **FORM 10-Q**

| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                         |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                 |
| ** ** | ** ** | **For the  quarterly period ended September 30, 2006**                                                                                                               |
|       |       |                                                                                                                                                                 |
| **or**     |
|       |
| **£** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                        |
|       |       |                                                                                                                                                                 |
| ** ** | ** ** | **For the  transition period  from                     to** |

 

**000-31321**

(Commission File No.)

**RIGHTNOWTECHNOLOGIES, INC.**

(Exact Name of Registrant as Specified in Its Charter)

| **Delaware**                     | ** ** | **81-0503640**       |
|----------------------------------|------------|----------------------|
| (State or Other  Jurisdiction of |       | (I.R.S. Employer     |
| Incorporation or  Organization)  |       | Identification  No.) |

 

**40Enterprise Boulevard**

###### **Bozeman, Montana59718-9300**

(Address of Principal Executive Offices) (Zip Code)

**(406)522-4200**

 (Registrant’sTelephone Number, Including Area Code)

**N/A**

(Former Name, Former Address and Former Fiscal Year,if Changed Since Last Report)

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  x   No  o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o      Acceleratedfiler x      Non-acceleratedfiler  o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes  o   No  x

The number ofshares outstanding of the registrant’s common stock, $0.001 par value, as ofOctober 31, 2006 was 32,432,455.

 

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**RightNowTechnologies, Inc.**

**Quarterly Report on Form 10-Q**

**For the Quarterly Period EndedSeptember 30, 2006**

**INDEX**
| **Part I.                     FINANCIAL INFORMATION** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Item 1. Financial  Statements (unaudited)                                                                                                                 |       |
|                                                                                                                                                      | a)         | Condensed consolidated  balance sheets |   |
|                                                                                                                                                      | b)         | Condensed  consolidated statements of operations |   |
|                                                                                                                                                      | c)         | Condensed  consolidated statements of cash flows |   |
|                                                                                                                                                      | d)         | Notes to  condensed consolidated financial statements |   |
|                                                                                                                                                      |       |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                                      |       |
|                                                                                                                                                      |       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                                                       |       |
|                                                                                                                                                      |       |
| Item 4. Controls and  Procedures                                                                                                                          |       |
|                                                                                                                                                      |       |
| **Part II.                   OTHER INFORMATION**                | ** ** |
| Item 1. Legal Proceedings                                                                                                                                 |       |
|                                                                                                                                                      |       |
| Item  1A. Risk Factors                                                                                                                                    |       |
|                                                                                                                                                      |       |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                                                      |       |
|                                                                                                                                                      |       |
| Item 3.  Defaults Upon Senior Securities                                                                                                                  |       |
|                                                                                                                                                      |       |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                                                              |       |
|                                                                                                                                                      |       |
| Item 5. Other Information                                                                                                                                 |       |
|                                                                                                                                                      |       |
| Item  6. Exhibits                                                                                                                                         |       |
|                                                                                                                                                      |       |
| **SIGNATURES**                                                                                                                                            |       |

 

2

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**Part I.  FINANCIAL INFORMATION**

##### **Item 1. Financial Statements**

**RightNowTechnologies, Inc.**

**CondensedConsolidated Balance Sheets**

(In thousands) (Unaudited)
| ** **                                          | ** ** | **December 31,  2005** | ** ** | **September 30,  2006** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| **Assets**                                          |       |                        |       |                         |       |
| Cash and cash  equivalents                          |       | $                           | 40,874     |                         | $          | 38,114 |   |
| Short-term investments                              |       | 23,314                      |       | 36,906                       |       |
| Accounts receivable                                 |       | 25,462                      |       | 25,347                       |       |
| Term receivables,  current                          |       | 15,376                      |       | 22,587                       |       |
| Allowance for doubtful  accounts                    |       | (2,209                      | )          | (3,225                       | )          |
| Receivables, net                                    |       | 38,629                      |       | 44,709                       |       |
| Prepaid and other  current assets                   |       | 1,993                       |       | 2,874                        |       |
| Total current assets                                |       | 104,810                     |       | 122,603                      |       |
|                                                |       |                        |       |                         |       |
| Property and equipment,  net                        |       | 6,451                       |       | 8,470                        |       |
| Term receivables,  non-current                      |       | 10,697                      |       | 22,193                       |       |
| Intangible assets, net                              |       | 1,487                       |       | 9,187                        |       |
| Other                                               |       | 231                         |       | 115                          |       |
| **Total Assets**                                    |       | $                           | 123,676    |                         | $          | 162,568 |   |
|                                                |       |                        |       |                         |       |
|                                                |       |                        |       |                         |       |
| **Liabilities and Stockholders’  Equity**      | ** ** | ** **                  | ** ** | ** **                   | ** ** |
| Accounts payable                                    |       | $                           | 2,308      |                         | $          | 2,420 |   |
| Commissions and bonuses  payable                    |       | 2,910                       |       | 4,001                        |       |
| Other accrued  liabilities                          |       | 5,733                       |       | 6,171                        |       |
| Current portion of  long-term debt                  |       | 30                          |       | 35                           |       |
| Current portion of  deferred revenue                |       | 48,673                      |       | 59,218                       |       |
| Total current  liabilities                          |       | 59,654                      |       | 71,845                       |       |
|                                                |       |                        |       |                         |       |
| Long-term debt, less  current portion               |       | 117                         |       | 113                          |       |
| Deferred revenue, less  current portion             |       | 19,250                      |       | 43,402                       |       |
|                                                |       |                        |       |                         |       |
| Stockholders’ equity:                          |       |                        |       |                         |       |
| Common stock                                        |       | 32                          |       | 32                           |       |
| Additional  paid-in capital                         |       | 78,312                      |       | 83,428                       |       |
| Accumulated  other comprehensive loss               |       | (401                        | )          | (250                         | )          |
| Accumulated  deficit                                |       | (33,288                     | )          | (36,002                      | )          |
| Total  stockholders’ equity                    |       | 44,655                      |       | 47,208                       |       |
| **Total Liabilities and Stockholders’ Equity** |       | $                           | 123,676    |                         | $          | 162,568 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

3

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**RightNowTechnologies, Inc.**

**CondensedConsolidated Statements of Operations**

(In thousands,except per share amounts) (Unaudited)
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenue:                           |       |                                                 |       |                                                |       |   |   |   |   |
| Software, hosting and support      |       | $                                                    | 18,005     |                                                | $          | 23,754 |   | $ | 48,743 |   | $ | 63,700 |   |
| Professional services              |       | 5,149                                                |       | 6,334                                               |       | 13,831 |   | 17,927 |   |
| Total revenue                      |       | 23,154                                               |       | 30,088                                              |       | 62,574 |   | 81,627 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenue:                   |       |                                                 |       |                                                |       |   |   |   |   |
| Software, hosting and support      |       | 2,253                                                |       | 3,667                                               |       | 6,593 |   | 9,597 |   |
| Professional services              |       | 3,026                                                |       | 4,969                                               |       | 8,601 |   | 14,014 |   |
| Total cost of revenue              |       | 5,279                                                |       | 8,636                                               |       | 15,194 |   | 23,611 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Gross profit                       |       | 17,875                                               |       | 21,452                                              |       | 47,380 |   | 58,016 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Operating  expenses:               |       |                                                 |       |                                                |       |   |   |   |   |
| Sales and marketing                |       | 11,248                                               |       | 16,535                                              |       | 31,262 |   | 45,113 |   |
| Research and development           |       | 2,937                                                |       | 3,740                                               |       | 7,524 |   | 10,346 |   |
| General and administrative         |       | 1,627                                                |       | 2,333                                               |       | 4,623 |   | 7,098 |   |
| Total operating expenses           |       | 15,812                                               |       | 22,608                                              |       | 43,409 |   | 62,557 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  from operations     |       | 2,063                                                |       | (1,156                                              | )          | 3,971 |   | (4,541 | ) |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Interest and  other income, net    |       | 440                                                  |       | 740                                                 |       | 1,063 |   | 2,180 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  before income taxes |       | 2,503                                                |       | (416                                                | )          | 5,034 |   | (2,361 | ) |
| Provision for  income taxes        |       | (160                                                 | )          | (103                                                | )          | (331 | ) | (353 | ) |
| Net income  (loss)                 |       | $                                                    | 2,343      |                                                | $          | (519 | ) | $ | 4,703 |   | $ | (2,714 | ) |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net income  (loss) per share:      |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                              |       | $                                                    | 0.08       |                                                | $          | (0.02 | ) | $ | 0.16 |   | $ | (0.08 | ) |
| Diluted                            |       | $                                                    | 0.07       |                                                | $          | (0.02 | ) | $ | 0.14 |   | $ | (0.08 | ) |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Shares used in  the computation:   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                              |       | 30,802                                               |       | 32,316                                              |       | 30,287 |   | 32,144 |   |
| Diluted                            |       | 33,667                                               |       | 32,316                                              |       | 33,541 |   | 32,144 |   |

 

See accompanying notes to condensedconsolidated financial statements.

4

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**RightNowTechnologies, Inc.**

**CondensedConsolidated Statements of Cash Flows**

(In thousands)(Unaudited)
| ** **                                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                            | ** ** | **2006** | ** ** |
| **Operating  activities:**                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income  (loss)                                                   |       | $                                                   | 4,703      |   | $ | (2,714 | ) |
| Non-cash  adjustments:                                               |       |                                                |       |   |   |
| Depreciation and amortization                                        |       | 2,462                                               |       | 3,998 |   |
| Stock-based compensation                                             |       | —                                              |       | 3,575 |   |
| Provision for uncollectible accounts receivable                      |       | 260                                                 |       | 51 |   |
| Changes in  operating accounts, net of business acquisitions:        |       |                                                |       |   |   |
| Receivables                                                          |       | (14,340                                             | )          | (16,529 | ) |
| Prepaid expenses and other current assets                            |       | (586                                                | )          | (384 | ) |
| Accounts payable                                                     |       | 405                                                 |       | (64 | ) |
| Commissions and bonuses payable                                      |       | 732                                                 |       | 967 |   |
| Other accrued liabilities                                            |       | 2,023                                               |       | 244 |   |
| Deferred revenue                                                     |       | 15,283                                              |       | 33,509 |   |
| Other                                                                |       | 109                                                 |       | 99 |   |
| Cash provided by operating activities                                |       | 11,051                                              |       | 22,752 |   |
|                                                                 |       |                                                |       |   |   |
| **Investing  activities:**                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net change in  short-term investments                                |       | 10,303                                              |       | (13,527 | ) |
| Acquisition of  property and equipment                               |       | (3,272                                              | )          | (4,930 | ) |
| Business  acquisitions, net of cash acquired                         |       | (1,035                                              | )          | (8,731 | ) |
| Other                                                                |       | 8                                                   |       | (10 | ) |
| Cash provided by  (used in) investing activities                     |       | 6,004                                               |       | (27,198 | ) |
|                                                                 |       |                                                |       |   |   |
| **Financing  activities:**                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from  long-term debt                                        |       | 162                                                 |       | — |   |
| Proceeds from  issuance of common stock under employee benefit plans |       | 3,572                                               |       | 1,362 |   |
| Payments on  long-term debt                                          |       | (8                                                  | )          | (23 | ) |
| Cash provided by  financing activities                               |       | 3,726                                               |       | 1,339 |   |
|                                                                 |       |                                                |       |   |   |
| Effect of  foreign exchange rates on cash and cash equivalents       |       | (131                                                | )          | 347 |   |
|                                                                 |       |                                                |       |   |   |
| Increase  (decrease) in cash and cash equivalents                    |       | 20,650                                              |       | (2,760 | ) |
|                                                                 |       |                                                |       |   |   |
| Cash and cash  equivalents at beginning of period                    |       | 18,944                                              |       | 40,874 |   |
| Cash and cash  equivalents at end of period                          |       | $                                                   | 39,594     |   | $ | 38,114 |   |

 

See accompanying notes to condensedconsolidated financial statements.

5

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**RightNowTechnologies, Inc.**

**Notesto Condensed Consolidated Financial Statements**

(Unaudited)

**(1)**                     Business Description and Basis of Presentation

***BusinessDescription***

RightNow Technologies, Inc.(the “Company” or “RightNow”) provides customer experience management softwaresolutions for companies of all sizes.  The Company’s on demand software is designed to go beyond traditionalcustomer relationship management (“CRM”) solutions to support a business’external customer-facing channels as well as sales, marketing and customerservice operations.  Founded in 1995, RightNow is headquartered inBozeman, Montana, with additional offices in Boston, Massachusetts; Chicago,Illinois; Dallas, Texas; San Mateo, California; Princeton, New Jersey;Rochester, New York; London, England; Sydney, Australia; Munich, Germany; andTokyo, Japan.  The Company operates inone segment, which is the customer experience management market.

***Basisof Presentation***

The accompanying interim condensed consolidatedfinancial statements are unaudited. These financial statements and notes should be read in conjunction withthe audited consolidated financial statements and related notes, together withmanagement’s discussion and analysis of financial condition and results ofoperations, contained in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005.

The accompanying interim condensed consolidatedfinancial statements have been prepared in accordance with United Statesgenerally accepted accounting principles. In the opinion of management, the interim consolidated financialstatements and notes have been prepared on the same basis as the auditedconsolidated financial statements in the Annual Report on Form 10-K and includeall adjustments necessary for the fair presentation of the Company’s financialposition at September 30, 2006, and results of operations and cash flows forthe nine month periods ended September 30, 2005 and 2006.  The interim period results are notnecessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformitywith United States generally accepted accounting principles requires managementto make estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses, and disclosures of contingent assets andliabilities.  Management evaluates theseestimates and assumptions on an on-going basis. Significant estimates and assumptions made by management include theidentification and fair value of individual elements in multiple-element salesarrangements, whether the fees charged for our products and services are fixedand determinable, valuation allowances for trade receivables and deferredincome tax assets, and assumptions used in estimating the fair value of stockoptions granted for stock-based compensation.

6

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***(2) Certain Risks andConcentrations***

The Company’s revenue is derived from the license,hosting and support of its software products and provision of relatedprofessional services.  The markets in whichthe Company competes are highly competitive and rapidly changing.  Significant technological changes, changes incustomer requirements, or the emergence of competitive products with newcapabilities or technologies could adversely affect the Company’s operatingresults.  The Company has historicallyderived a majority of its revenue from customer service softwaresolutions.  These products are expectedto continue to account for a significant portion of revenue for the foreseeablefuture.  As a result of this revenueconcentration, the Company’s business could be harmed by a decline in demandfor, or in the prices of, these products or as a result of, among otherfactors, any change in pricing model, a maturation in the markets for theseproducts, increased price competition or a failure by the Company to keep upwith technological change.

The Company’s customers are worldwide withapproximately 70% to 80% of revenue in the United States.  A third-party reseller representedapproximately 12% of revenue in the three months ended September 30, 2006, andrepresented approximately 13% of accounts receivable at September 30,2006.  One individual customerrepresented approximately 14% or revenue for the three months ended September30, 2005.  No individual customeraccounted for more than 10% of the Company’s revenue in the nine months endedSeptember 30, 2005 or 2006.

As of December 31, 2005 and September 30, 2006, assetslocated outside the United States were 11% and 9%, respectively, of totalassets.   The loss from operationsoutside of the United States totaled $5.3 million and $6.7 million for the ninemonths ended September 30, 2005 and 2006, respectively.  Revenue by geographical region follows (inthousands):
|               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **    | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|          |       |                                                 |       |                                                |       |   |   |   |   |
| United States |       | $                                                    | 17,291     |                                                | $          | 23,847 |   | $ | 47,699 |   | $ | 61,287 |   |
| Europe        |       | 3,752                                                |       | 4,732                                               |       | 9,876 |   | 15,081 |   |
| Asia Pacific  |       | 2,111                                                |       | 1,509                                               |       | 4,999 |   | 5,259 |   |
|          |       | $                                                    | 23,154     |                                                | $          | 30,088 |   | $ | 62,574 |   | $ | 81,627 |   |

 

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**(3) Net Income (Loss) Per Share**

***A reconciliation of the denominator used in the calculation of basicand diluted net income (loss) per share is as follows (in thousands):***
|                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  common shares outstanding for basic net income per share |       | 30,802                                               |       | 32,316                                              |       | 30,287 |   | 32,144 |   |
| Effect of  dilutive securities:                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Employee stock options                                                     |       | 2,840                                                |       | —                                              |       | 3,214 |   | — |   |
| Warrants                                                                   |       | 25                                                   |       | —                                              |       | 40 |   | — |   |
| Weighted average shares  outstanding for dilutive net income per share     |       | 33,667                                               |       | 32,316                                              |       | 33,541 |   | 32,144 |   |

 

***The following common stock equivalents were excluded fromthe computation of diluted earnings per share because their impact wasanti-dilutive (in thousands):***
|                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **             | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                   |       |                                                 |       |                                                |       |   |   |   |   |
| Employee stock options |       | 537                                                  |       | 4,156                                               |       | 550 |   | 4,156 |   |

 

**(4)Comprehensive Income (Loss)**

***Comprehensive income (loss) for the comparative periods was as follows(in thousands):***
|                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income  (loss)                               |       | $                                                    | 2,343      |                                                | $          | (519 | ) | $ | 4,703 |   | $ | (2,714 | ) |
| Other  comprehensive income (loss):              |       |                                                 |       |                                                |       |   |   |   |   |
| Foreign currency translation adjustment          |       | 39                                                   |       | 13                                                  |       | 226 |   | 87 |   |
| Unrealized gain (loss) on short-term investments |       | (27                                                  | )          | 49                                                  |       | (54 | ) | 64 |   |
| Comprehensive income  (loss)                     |       | $                                                    | 2,355      |                                                | $          | (457 | ) | $ | 4,875 |   | $ | (2,563 | ) |

 

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**(5)           Stock-Based Compensation**

***The Company’s 1998 Long-Term Incentive and Stock Option Plan, asamended, and the 2004 Equity Incentive Plan (the “equity plans”) provide forstock options to be granted to employees, consultants, independent contractors,officers and directors.  The equity planshave been approved by stockholders. Except for automatic grants to directors, options are granted at thediscretion of the Company’s board of directors, at an exercise price and termdetermined by the board.  However, exerciseprices are not less than the fair market value at the date of grant, and theterm of the options is not greater than ten years.  Options generally vest over a period of fouryears in eight equal increments.  TheCompany also has an employee stock purchase plan (“ESPP”) that allows employeesto purchase shares of common stock at a discount to the fair market value atthe date of purchase.  Purchase periodsunder the ESPP are consecutive six-month periods ending on the last day in Juneand December each year.  Shares issued tosatisfy stock option exercises and ESPP are newly issued.  At September 30, 2006, the Company hadapproximately 3.8 million shares available for future issuance under the equityplans and ESPP.***

On January 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting StandardsNo. 123(R), *Share Based Payment*, (“SFAS 123R”), forits stock-based compensation plans. Under SFAS 123R, stock-based compensation costs are recognized based onthe estimated fair value at the grant date for all stock-based awards.  The Company estimates grant date fair valuesusing the Black-Scholes-Merton option pricing model, which requires assumptionsof the life of the award and the stock price volatility over the term of theaward.  The Company records compensationcost of stock-based awards using the straight line method, which is recordedinto earnings over the vesting period of the award.

The Company previouslyaccounted for its stock-based compensation plans under the intrinsic valuerecognition and measurement provisions of Accounting Principles Board OpinionNo. 25 (“APB 25”), *Accounting for StockIssued to Employees*, and related interpretations, and adopted thedisclosure-only provisions of Statement of Financial Accounting Standards No.123 (“SFAS 123”), *Accounting for Stock-Based Compensation*,as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”),*Accounting for Stock-Based Compensation –Transition and Disclosures*. Under APB 25, no compensation expense was recorded in earnings for theCompany’s stock-based awards.  The proforma effects on net income and earnings per share for stock-based awards wereinstead disclosed in the footnotes to the consolidated financial statements inaccordance with SFAS 123.

The Company has electedto use the modified prospective transition method as permitted under SFAS 123Rand therefore has not restated its financial results for prior periods.  Under this transition method, compensationcost recorded in the three and nine month periods ended September 30, 2006includes the cost for all stock-based awards granted prior to, but not yetvested as of December 31, 2005, based on the grant-date fair value estimated inaccordance with the original provisions of SFAS 123.  Compensation expense for all stock-basedawards granted after December 31, 2005 was based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R.

Compensation expenserecognized in the statement of operations for the three and nine month periodsended September 30, 2006 is based on awards ultimately expected to vest andreflects an estimate of awards that will be forfeited.  SFAS 123R requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates.

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The following tableillustrates the stock-based compensation expense resulting from stock-basedawards included in the condensed consolidated statement of operations (amountsin thousands):

|                                                        | ** ** | **Three Months  Ended  Sep 30, 2006** | ** ** | **Nine Months  Ended  Sep 30, 2006** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Stock-based  compensation expense:                     |       |                                                 |       |                                                |       |
| Cost of software, hosting and support                  |       | $                                                    | 52         |                                                | $          | 145 |   |
| Cost of professional services                          |       | 124                                                  |       | 358                                                 |       |
| Sales and marketing                                    |       | 529                                                  |       | 1,430                                               |       |
| Research and development                               |       | 230                                                  |       | 622                                                 |       |
| General and administrative                             |       | 179                                                  |       | 1,020                                               |       |
| Stock-based compensation expense before income taxes   |       | 1,114                                                |       | 3,575                                               |       |
| Income tax provision (benefit)                         |       | —                                               |       | —                                              |       |
| Stock-based  compensation expense, net of income taxes |       | $                                                    | 1,114      |                                                | $          | 3,575 |   |

 

No stock-based compensation expense was capitalizedduring the three or nine months ended September 30, 2006.

The following table presents the impact of ouradoption of SFAS 123R on selected line items from our condensed consolidatedfinancial statements for the three and nine months ended September 30, 2006(amounts in thousands, except per-share amounts):
|                                                  | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                       | ** ** | **As reported  under SFAS  123R**                    | ** ** | **If reported  under  APB 25**                      | ** ** | **As reported  under SFAS  123R** | ** ** | **If reported  under  APB 25** | ** ** |
| Condensed  consolidated statement of operations: |       |                                                           |       |                                                          |       |   |   |   |   |
| Income (loss) from operations                    |       | $                                                              | (1,156     | )                                                             | $          | (42 | ) | $ | (4,541 | ) | $ | (966 | ) |
| Income (loss) before income taxes                |       | (416                                                           | )          | 698                                                           |       | (2,361 | ) | 1,214 |   |
| Net income (loss)                                |       | (519                                                           | )          | 595                                                           |       | (2,714 | ) | 861 |   |
|                                             |       |                                                           |       |                                                          |       |   |   |   |   |
| Net income (loss) per share:                     |       |                                                           |       |                                                          |       |   |   |   |   |
| Basic                                            |       | $                                                              | (0.02      | )                                                             | $          | 0.02 |   | $ | (0.08 | ) | $ | 0.03 |   |
| Diluted                                          |       | (0.02                                                          | )          | 0.02                                                          |       | (0.08 | ) | 0.03 |   |
|                                             |       |                                                           |       |                                                          |       |   |   |   |   |
| Condensed  consolidated statement of cash flows: |       |                                                           |       |                                                          |       |   |   |   |   |
| Cash provided by operating activities            |       | $                                                              | 9,836      |                                                          | $          | 9,836 |   | $ | 22,752 |   | $ | 22,752 |   |
| Cash provided by  financing activities           |       | 354                                                            |       | 354                                                           |       | 1,339 |   | 1,339 |   |

 

Unrecognized compensation expense of outstanding stockoptions at September 30, 2006 was approximately $11 million, which is expectedto be recognized over a weighted-average period of 2.7 years.

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The following table illustrates the effect on reportednet income and net income per share for the three and nine months endedSeptember 30, 2005 as if the Company had applied the fair value recognitionprovisions of SFAS 123 to stock-based awards (in thousands, except per-sharedata):
|                                        | ** ** | **Three Months  Ended  Sep 30, 2005** | ** ** | **Nine Months  Ended  Sep 30, 2005** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                   |       |                                                 |       |                                                |       |
| Net income as  reported                |       | $                                                    | 2,343      |                                                | $          | 4,703 |   |
| Less stock-based  compensation expense |       | (544                                                 | )          | (2,528                                              | )          |
| Pro forma net  income                  |       | $                                                    | 1,799      |                                                | $          | 2,175 |   |
|                                   |       |                                                 |       |                                                |       |
| Net income per  share:                 |       |                                                 |       |                                                |       |
| Basic:                                 |       |                                                 |       |                                                |       |
| As reported                            |       | $                                                    | 0.08       |                                                | $          | 0.16 |   |
| Pro forma                              |       | 0.06                                                 |       | 0.07                                                |       |
| Diluted:                               |       |                                                 |       |                                                |       |
| As reported                            |       | $                                                    | 0.07       |                                                | $          | 0.14 |   |
| Diluted                                |       | 0.05                                                 |       | 0.07                                                |       |

 

The estimatedweighted-average fair value per share of stock options granted in the threemonths endedSeptember 30, 2005 and 2006 was $6.93 and $7.86, respectively, and for the ninemonths ended September 30, 2005 and 2006 was $7.02 and $8.43,respectively.  The estimated fair valueof shares purchased under the ESPP for the six months ended June 30, 2005 was$5.79.  For the purchase periods endingJune 30, 2006 and December 31, 2005, terms of the plan were deemednoncompensatory under SFAS 123R. Assumptions used to obtain the estimated fairvalues were:  
|                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Employee stock  options         |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average risk free rate |       | 4.2                                                  | %          | 4.9                                                 | %          | 3.9 | % | 4.8 | % |
| Weighted average expected term  |       | 5.0 yrs                                              |       | 4.4 yrs                                             |       | 5.0 yrs |   | 4.4 yrs |   |
| Weighted average volatility     |       | 70                                                   | %          | 55                                                  | %          | 74 | % | 57 | % |
| Dividend yield                  |       | 0                                                    | %          | 0                                                   | %          | 0 | % | 0 | % |
|                            |       |                                                 |       |                                                |       |   |   |   |   |
| Employee Stock  Purchase Plan   |       |                                                 |       |                                                |       |   |   |   |   |
| Risk free rate                  |       | —                                               |       | —                                              |       | 2.9 | % | — |   |
| Expected term                   |       | —                                               |       | —                                              |       | 0.5 yrs |   | — |   |
| Volatility                      |       | —                                               |       | —                                              |       | 74 | % | — |   |
| Dividend yield                  |       | —                                               |       | —                                              |       | 0 | % | — |   |

 

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

*Risk Free Rate:* The risk-free rate is determined by reference to theU.S. Treasury yield curve in effect at or near the time of grant for theexpected term of the award.

*Expected Term*: The expected term represents the period that theCompany’s stock-based awards are expected to be outstanding and is estimatedbased on historical experience of similar awards, giving consideration to thecontractual term of the awards, vesting schedules and expectations of employeeexercise behavior.

*Volatility*: The Company’s estimate of expected volatility isbased on a combination of the Company’s historical volatility and peer-companyvolatilities.  The Company has a limitedhistory of volatility, as well as limited traded options from which to deriveimplied volatility.  The

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Companybelieves the combination of its historical and peer-company volatilities ismore representative of future stock price trends than its historical volatilityalone.

*Dividend Yield:* The dividend yield assumption is based on the Company’shistory and expectation of dividend payouts.

Activity under the Company’s stock option plans forthe nine months ended September 30, 2006 was as follows (option shares inthousands):
| ** **                                        | ** ** | **Shares  available  for grant** | ** ** | **Shares  underlying  outstanding  options** | ** ** | **Weighted  average  exercise  price per  share** | ** ** | **Aggregate  intrinsic  value (in  thousands)** | ** ** | **Weighted  average  remaining  contractual  life (in years)** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Balance at  December 31, 2005                     |       | 3,007                                 |       | 3,898                                        |       | $                                                      | 6.41       |                                                 |       |                                                                     |       |   |
| Annual reserve addition (1)                       |       | 1,000                                 |       | —                                       |       | —                                                 |       |                                                 |       |                                                                     |       |
| Granted                                           |       | (934                                  | )          | 934                                          |       | 16.81                                                  |       |                                                 |       |                                                                     |       |
| Exercised                                         |       | —                                |       | (508                                         | )          | 2.47                                                   |       |                                                 |       |                                                                     |       |
| Forfeited, expired, exchanged or canceled (2)     |       | 135                                   |       | (168                                         | )          | 11.69                                                  |       |                                                 |       |                                                                     |       |
| Balance at  September 30, 2006                    |       | 3,208                                 |       | 4,156                                        |       | $                                                      | 9.02       |                                                 | $          | 28,914                                                                   |       | 7.5 |   |
|                                              |       |                                  |       |                                         |       |                                                   |       |                                                 |       |                                                                     |       |
| Vested or  expected to vest at September 30, 2006 |       |                                  |       | 3,865                                        |       | $                                                      | 8.66       |                                                 | $          | 28,160                                                                   |       | 7.2 |   |
|                                              |       |                                  |       |                                         |       |                                                   |       |                                                 |       |                                                                     |       |
| Exercisable at  September 30, 2006                |       |                                  |       | 2,010                                        |       | $                                                      | 5.57       |                                                 | $          | 20,411                                                                   |       | 6.2 |   |

 

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(1)          The 2004 Equity IncentivePlan provides for an automatic, annual increase on the first of each year in anamount equal to the lesser of: a) 1,000,000 shares; b) 4% of the number ofoutstanding common shares on the last day of the previous fiscal year; or c)such lesser amount as determined by the board of directors.  The annual automatic increase has beenapproved by shareholders through December 31, 2014.

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

The total intrinsic value of options exercised duringthe nine months ended September 30, 2005 and 2006 was $27.2 million and $6.9million, respectively.

From time to time the Company may grant stock optionsto consultants.  The Company accounts forconsultant stock options in accordance with SFAS 123 and Emerging Issues TaskForce Consensus Issue No. 96-18 (“EITF 96-18”), *Accounting for Equity Instruments that are Issued to Other ThanEmployees for Acquiring, or in Conjunction With Selling, Goods or Services*.  Compensation expense for the grant of stockoptions to consultants is determined based on the estimated fair value of thestock options at the measurement date as defined in EITF 96-18 and isrecognized over the vesting period. There were no stock options granted to non-employees for the nine monthsended September 30, 2005 or 2006.

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***(6)           Warranties and Indemnification***

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

The Company’sarrangements generally include certain provisions for indemnifying customersagainst liabilities if its products or services infringe a third-party’sintellectual property rights.  To date,the Company has not incurred any material costs as a result of suchindemnifications and has not accrued any liabilities related to suchobligations in the accompanying consolidated financial statements.

The Company hasentered into service level agreements with a small number of its customerswarranting certain levels of uptime reliability and permitting those customersto receive credits or terminate their license agreements in the event that theCompany fails to meet those levels.  Todate, the Company has not provided any material credits, or cancelled anyagreements related to these service level agreements.

The Company hasalso agreed to indemnify its directors and executive officers for costsassociated with any fees, expenses, judgments, fines and settlement amountsincurred by any of these persons in any action or proceeding to which any ofthose persons is, or is threatened to be, made a party by reason of the person’sservice as a director or officer, including any action by the Company, arisingout of that person’s services as the Company’s director or officer or thatperson’s services provided to any other company or enterprise at the Company’srequest.

***Litigation***

From time to time, the Company is involved in legalproceedings arising in the normal course of business.  The Company believes that the resolution ofthese matters will not have a material effect on the Company’s consolidatedfinancial position, results of operations or liquidity.

**(7)           Acquisition**

On May 22, 2006, theCompany acquired the outstanding common and preferred stock of Salesnet, Inc. (“Salesnet”),a provider of on demand sales force automation solutions, for $8.7 million innet cash paid at closing.  Theacquisition is expected to accelerate the product development of the Company’ssales force automation product set, and increase the Company’s domain expertisein sales automation.  The acquisition isbeing accounted for under the purchase method of accounting and, accordingly,the results of Salesnet are included in the condensed consolidated financialstatements since the acquisition date.

The Company has allocatedthe purchase price to the Salesnet assets acquired and liabilities assumed atestimated fair values, after considering a number of factors, including the useof an independent appraisal.  Thepurchase price and purchase price allocation are as follows (amounts inthousands):
| Cash consideration        |   | $   | 9,015  |   |
|---------------------------|--------|-----|--------|--------|
| Direct  acquisition costs |   | 182 |   |
| Total purchase price      |   | $   | 9,197  |   |

 

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| Purchase price allocation:                |   |   |   |
|-------------------------------------------|--------|--------|--------|
| Cash and cash  equivalents                |   | $      | 466    |   |
| Accounts  receivable                      |   | 407    |   |
| Property and  equipment                   |   | 264    |   |
| Other assets                              |   | 208    |   |
| Intangible  assets                        |   | 8,452  |   |
| Accounts payable  and accrued liabilities |   | (322   | )      |
| Deferred revenue                          |   | (252   | )      |
| Capitalized  lease obligations            |   | (26    | )      |
| Total purchase price                      |   | $      | 9,197  |   |

 

The components of the intangible assets listed inthe above table as of the acquisition date are as follows (amounts inthousands):
| Goodwill                   |   | $     | 4,322  |   |
|----------------------------|--------|-------|--------|--------|
| Customer  relationships    |   | 3,250 |   |
| Technology                 |   | 740   |   |
| Trade name and  trademarks |   | 140   |   |
| Intangible assets          |   | $     | 8,452  |   |

 

The excess of thepurchase price over the estimated fair value of the net assets acquired of $4.3million has been recorded as goodwill, which is deemed to have an indefiniteuseful life and, accordingly, will not be amortized, but will be subject toperiodic impairment testing in future periods. The customer relationships and technology intangible assets will be amortizedover a period of four years using the straight-line method.  The trade name and trademarks will beamortized over a period of three years using the straight-line method

**Item 2. ****                ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

***CautionaryStatement***

*The followingdiscussion and analysis of our financial condition and results of operationsshould be read in conjunction with the financial statements and related notesin this report.  This discussion containsforward-looking statements that involve risks and uncertainties.  These forward-looking statements are based onour current expectations, estimates and projections about our industry,management’s beliefs, and certain assumptions made by us, all of which are subjectto change.  Forward-looking statementscan often be identified by words such as “anticipates,” “expects,” “intends,” “plans,”“predicts,” “believes,” “seeks,” “ estimates,” “may,” “will,” “should,” “would,”“could,” “potential,” “continue,” “ongoing,” similar expressions, andvariations or negatives of these words and include, but are not limited to,statements regarding projected results of operations and management’s futurestrategic plans. Our actual results could differ significantly from those projectedin the forward-looking statements as a result of factors, including thosediscussed under “Risk Factors” and elsewhere in this report.  We assume no obligation to update theforward-looking statements or such risk factors.*

***Overview***

We are a leading provider of customerexperience management software solutions for companies of all sizes.   Our on demand software is designed to gobeyond traditional customer relationship management (“CRM”) solutions tosupport a business’s external customer-facing channels as well as sales,marketing and customer service operations.

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We released our initialversion of RightNow Service in 1997. This product addressed the new customer service needs resulting from theincreasing use of the Internet as a customer service channel.  Since then, we have significantly enhancedproduct features and functionality to address customer service needs acrossmultiple communication channels, including web, interactive voice, e-mail,chat, telephone and proactive outbound e-mail communications. We have alsoadded several products that are complementary to our RightNow Service solution,including RightNow Marketing and RightNow Sales, which automate aspects ofmarketing campaigns and sales operations. In May 2005, we purchased the assets of Convergent Voice, and addedvoice enabled-CRM capabilities to our product portfolio.  In May 2006, we purchased Salesnet, Inc., aprovider of salesforce automation services. To date, approximately 80% to 90% of our revenue has been generated bythe RightNow Service suite.

During the nine months ended September30, 2006, we signed 250 new customers and added approximately 200 customersthrough our acquisition of Salesnet, Inc., to bring our customer base toapproximately 1,800. Our products served more than 765 million customerinteractions, or unique sessions hosted by our solutions.  Our solutions, whether sold pursuant to termor perpetual licenses, are available either on a hosted basis, where they aredeployed in our co-location facilities and accessed on demand by our clients,or on a non-hosted basis, where our clients deploy them in their ownfacilities.  Approximately 89% of ourclients have elected the hosted option as of September 30, 2006.  We distribute our solutions primarily throughdirect sales efforts and to a lesser extent through indirect channels.

***Sources of Revenue***

Our revenue is comprised of fees for termand perpetual licenses of our software, fees for hosting and support related toour licenses, and fees for professional services. Our term license agreementsare generally two years in length, but can range from six months to five years,and include our software and related upgrades, and hosting and support servicesover the term of the agreement. The majority of our revenue in each of our lastthree years and the nine months ended September 30, 2006 was derived fromtwo-year term license agreements, which are paid in full at the beginning ofthe license period.  We also offer termagreements that may be paid on a monthly or quarterly basis, which contain aminimum commitment period and include our software and related upgrades,hosting and support.  Perpetual licensesare typically sold with annual maintenance contracts that include upgrades,hosting and support.

Our software license agreements generallyinclude capacity-based fees, which are measured primarily by web pages served,user seats, outgoing email transactions, or minutes used, and certain fixedfees.  A number of our agreements providefor additional fees for usage above established levels, which are billed andrecognized into revenue when earned.

Hosting and support agreements providemaintenance and management of our software at a third party facility, technicalsupport for our software products, and unspecified product upgrades on a whenand if available basis.

Beginning in January 2007, we intend toreplace our term license arrangements with subscription service arrangements (“subscriptions”),to better align our terms of sale with industry standard and increase marketpenetration.  We believe that revenuerecognition for subscriptions will not be materially different from our currentterm license arrangements.  We alsointend to continue to sell perpetual licenses in the same manner as our currentpractice.

Professional services revenue iscomprised of revenue from consulting, education and development services, andreimbursement of related travel costs. Consulting and education services include implementation and bestpractices consulting.  Developmentservices include customizations and integrations for a client’s specificbusiness application.

Professional services are sold withinitial license agreements and periodically over the client engagement. Theaverage deployment time for our clients is approximately 50 days.  Our typical education courses are billed on aper person, per class basis.

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Depending on the size and complexity ofthe client project, our consulting or development services contracts are eitherfixed price/fixed scope or, less frequently, billed on a time and materialsbasis. We have determined that the professional services element of oursoftware arrangements is not essential to the functionality of thesoftware.  We have also determined thatour professional services: a) are available from other vendors; b) do notinvolve a significant degree of risk or unique acceptance criteria; and c)qualify for separate accounting as we have sufficient experience in providingsuch services.

***Cost of Revenueand Operating Expenses***

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

Our hosting costs areaffected by the percentage of clients who license our products on a hostedbasis and the number of times our clients and their customers use oursolutions, which we refer to as customer interactions. As a result of economiesof scale in our hosting infrastructure and declines in computer hardware andtelecommunications costs, we were able to reduce hosting costs as a percentageof total revenue in 2003, 2004 and 2005. In 2006, we have added a European hosting center which was in service inthe quarter ended September 30, 2006.

As our client base andsolutions usage grows, we intend to continue to invest additional resources inour hosting services, technical support and professional services.

*Salesand Marketing Expenses. *Sales andmarketing expenses consist primarily of salaries and related expenses foremployees in sales and marketing, including commissions and bonuses,advertising, marketing events, corporate communications, product managementexpenses, travel costs and allocated overhead. Beginning January 1, 2006, salesand marketing expenses also include stock-based compensation expense. Weexpense our sales commissions when earned, which is typically at the time therelated sale is invoiced to the client, and we recognize the majority of ourrevenue from our agreements ratably over the terms of the licenses.Accordingly, we generally experience a delay between increasing sales andmarketing expenses and the recognition of corresponding revenue. We expectsignificant additional increases in sales and marketing expenses in absolutedollars as we continue to hire additional sales and marketing personnel andincrease the level of marketing activities.

Beginning in January2007, we expect to replace our term license sales arrangements withsubscription service arrangements (“subscriptions”).  We expect to adopt a policy of recognizingcontract acquisition costs, such as sales commissions, in proportion to therevenue recognized under the subscription agreements instead of recognizing theentire contract acquisition expense when earned.  The ratable recognition of contractacquisition expenses for subscription agreements is expected to decrease salesand marketing expenses as a percentage of revenue beginning in 2007.

*Researchand Development Expenses. *Research anddevelopment expenses consist primarily of salary and related expenses fordevelopment personnel and costs related to the development of new products,enhancement of existing products, translation fees, quality assurance, testingand allocated overhead. Beginning January 1, 2006, research and developmentexpenses also include stock-based compensation expense. To date, we have notcapitalized any software development costs because the timing of the commercialreleases of our products has substantially coincided with the attainment of

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technologicalfeasibility. As a result, research and development costs have been expensed asincurred. We intend to continue to expand and enhance our product offerings. Toaccomplish this, we plan to hire additional personnel and, from time to time, contractwith third parties. We expect that research and development expenses willincrease in absolute dollars as we seek to expand our technology and productofferings.

*Generaland Administrative Expenses*. General and administrative expenses consist primarily of salary andrelated expenses for management, finance and accounting, legal, informationsystems and human resources personnel, professional fees, other corporateexpenses and allocated overhead. Beginning January 1, 2006, general andadministrative expenses also include stock-based compensation expense. Weanticipate that we will incur additional employee salaries and relatedexpenses, professional service fees and insurance costs related to the growthof our business and operations.

***CriticalAccounting Policies and Estimates***

Ourfinancial statements and accompanying notes are prepared in accordance withaccounting principles generally accepted in the United States.  Preparing financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues and expenses. These assumptions are affected by management’s application of accountingpolicies.  Our critical accountingpolicies include: revenue recognition; valuation of receivables and deferredtax assets; and accounting for equity-based compensation.

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

***Revenue Recognition***

Weaccount for our sales arrangements in accordance with the American Institute ofCertified Public Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, and SOP 98-9, Modification ofSOP 97-2, *Software Revenue Recognition With Respect toCertain Transactions*.  Theapplication of these rules requires judgment, including the identification ofindividual elements in multiple element arrangements, whether there isobjective and reliable evidence of fair value up to and including vendorspecific objective evidence (“VSOE”) of fair value for some or allelements.  Customers may receive certainelements upon delivery or over time.  Forexample, under our sales arrangements customers typically receive the softwarelicense up front, and receive hosting and support services continuously overthe length of the agreement.  Under ourterm arrangements, revenues for the software, hosting and support elements arerecognized ratably over the length of the agreement.  Under a perpetual license arrangement, VSOEof the hosting and support elements is based on the price charged at renewalwhen sold separately, and therefore the license element is recognizedimmediately into revenue upon delivery using the residual method, and thehosting and support elements are recognized ratably over the contractual term.

Weacquired Salesnet, Inc. in May, 2006 and we account for its sales arrangementsunder Emerging Issues Task Force Issue No. 00-21, *RevenueArrangements with Multiple Deliverables*.  Under these arrangements, fees charged foraccess to the software, hosting services, and support services are recognizedratably over the length of the agreement, and fees charged for professionalservices are recognized when delivered. We believe the fees for professional services qualify for separateaccounting because: a) the services have value to the customer on a stand-alonebasis; b) objective and reliable evidence of fair value exists for theseservices; c) performance of the services is considered probable and does notinvolve unique customer acceptance criteria.

Changesto the elements in our sales arrangements, or our ability to establish VSOE orfair value for those elements, may result in a material change to the amount ofrevenue recorded in a given period.

Ourstandard payment terms are net 30, although payment within 90 days isconsidered normal.  We provide extendedpayment terms in certain circumstances. In such cases, judgment is required in determining whether our fee isfixed and determinable and the appropriate timing of revenue recognition.

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Changes to ourpractice of providing extended payment terms or providing concessions followinga sale, may result in a material change to the amount of revenue recorded in agiven period.

***Allowance fordoubtful accounts***

Weregularly assess the collectibility of outstanding customer invoices and, in sodoing, we maintain an allowance for estimated losses resulting from thenon-collection of customer receivables. In estimating this allowance, we consider factors such as: historicalcollection experience; a customer’s current creditworthiness; customerconcentration; age of the receivable balance; and general economic conditionsthat may affect a customer’s ability to pay. Actual customer collections could differ from our estimates and exceedour related loss allowance.

***Income Taxes***

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

Wehave established a valuation allowance equal to our net deferred tax assets dueto uncertainties regarding the realization of our net operating losscarryforwards, tax credits, and deductible timing differences.  The uncertainty of realizing these benefitsis based primarily on our lack of taxable earnings.

***Equity-BasedCompensation***

Wehave adopted the provisions of Statement of Financial Accounting Standards No.123(R), *Share Based Payment*, (“SFAS 123R”)beginning January 1, 2006 utilizing the modified prospective method.  This statement requires the cost ofshare-based payment arrangements to be recorded in the statement ofoperations.  Prior to 2006, the estimatedcost of share-based payment arrangements was disclosed in a footnote to thefinancial statements.  Share-basedcompensation amounts are affected by our stock price as well as our assumptionsregarding the expected volatility of our stock, our employee stock optionexercise behaviors, and the related income tax effects.  Our assumptions are based primarily on ourhistorical information, some of which was developed when we were a privatecompany.

***Recently Issued Accounting Standards***

InFebruary 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“SFAS”) No. 155, *Accounting for Certain Hybrid Instruments*, which amends SFAS133, *Accounting for Derivative Instruments and HedgingActivities*, and SFAS 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishment of Debt*.  The new standard allows an entity toremeasure at fair value a hybrid financial instrument that contains an embeddedderivative that otherwise would require bifurcation from the host, if theholder irrevocably elects to account for the whole instrument on a fair valuebasis.  Subsequent changes in the fairvalue of the instrument would be recognized in earnings.  SFAS 155 is effective for all financialinstruments acquired or issued after the beginning of an entity’s first fiscalyear that begins after September 15, 2006. We do not believe the adoption of SFAS 155 will have a material effecton our financial statements.

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SFAS156, *Accounting for Servicing of Financial Asset*,amends SFAS 140 to address the recognition and measurement of separatelyrecognized servicing assets and liabilities and to simplify efforts to obtainhedge-like (offset) accounting.  SFAS 156is effective as of the beginning of the first fiscal year that begins afterSeptember 15, 2006, with earlier adoption permitted as of the beginning of anentity’s fiscal year, provided the entity has not yet issued interim financialstatements for that fiscal year.  We donot believe adoption of SFAS 156 will have a material effect on our financialstatements.

SFAS157, *Fair Value Measurements*, defines fairvalue, establishes a framework for measuring fair value in GAAP, and enhancesdisclosures about fair value measurements. This statement applies when other accounting pronouncements require fairvalue measurements; it does not require new fair value measurements.  SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those years.  Wedo not believe adoption of SFAS 157 will have a material effect on ourfinancial statements.

SFAS158, *Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans – an amendment of FASB Statements No. 87, 88,,106 and 132(R)*, requires an employer to recognize in its statementof financial position the overfunded our underfunded status of a definedbenefit postretirement plan measured as the difference between the fair valueof plan assets and the benefit obligation. Employers must also recognize as a component of other comprehensiveincome, net of tax, the actuarial gains and losses and the prior service costsand credits that arise during the period. SFAS 158 is effective for public entities for fiscal years ending afterDecember 15, 2006.  We do not believe theadoption of SFAS 158 will have a material effect on our financial statements.

InJuly 2006, the Financial Accounting Standard Board issued FASB Interpretation48, *Accounting for Income Tax Uncertainties*(“FIN 48”).  FIN 48 defines the thresholdfor recognizing the benefits of tax return positions in the financialstatements as “more-likely-than-not” to be sustained by the taxingauthority.  The recently issuedliterature also provides guidance on the derecognition, measurement andclassification of income tax uncertainties, along with any related interest andpenalties.  FIN 48 also includes guidanceconcerning accounting for income tax uncertainties in interim periods and increasesthe level of disclosures associated with any recorded income taxuncertainties.  FIN 48 is effective forfiscal years beginning after December 15, 2006. The differences between the amounts recognized in the statements offinancial position prior to the adoption of FIN 48 and the amounts reportedafter adoption will be accounted for as a cumulative-effect adjustment recordedto the beginning balance of retained earnings. The Company is currently assessing the potential impact of FIN 48 on itsconsolidated financial position and results of operations.

TheSecurities and Exchange Commission recently issued Staff Accounting BulletinNo. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*,which addresses how uncorrected errors in previous years should be consideredwhen quantifying errors in current-year financial statements.  The bulletin requires registrants to considerthe effect of all carry over and reversing effects of prior-year misstatementswhen quantifying errors in current-year financial statements, and allowsregistrants to record the effects of adopting the guidance as acumulative-effect adjustment to retained earnings.  Such an adjustment must be reported as of thebeginning of the first fiscal year ending after November 15, 2006.  The bulletin does not change the SEC staff’sprevious guidance on evaluating the materiality of errors.  The Company believes the adoption of theguidance will not have a material effect on its financial condition.

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***Results ofOperations***

The following table sets forth certainconsolidated statement of operations data expressed as a percentage of totalrevenue for the periods indicated:  
|                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenue:                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Software,  hosting and support            |       | 78                                                   | %          | 79                                                  | %          | 78 | % | 78 | % |
| Professional  services                    |       | 22                                                   |       | 21                                                  |       | 22 |   | 22 |   |
| Total  revenue                            |       | 100                                                  |       | 100                                                 |       | 100 |   | 100 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenue:                          |       |                                                 |       |                                                |       |   |   |   |   |
| Software,  hosting and support            |       | 10                                                   |       | 12                                                  |       | 10 |   | 12 |   |
| Professional  services                    |       | 13                                                   |       | 17                                                  |       | 14 |   | 17 |   |
| Total  cost of revenue                    |       | 23                                                   |       | 29                                                  |       | 24 |   | 29 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Gross profit                              |       | 77                                                   |       | 71                                                  |       | 76 |   | 71 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Operating expenses:                       |       |                                                 |       |                                                |       |   |   |   |   |
| Sales  and marketing                      |       | 48                                                   |       | 55                                                  |       | 51 |   | 55 |   |
| Research  and development                 |       | 13                                                   |       | 12                                                  |       | 12 |   | 13 |   |
| General  and administrative               |       | 7                                                    |       | 8                                                   |       | 7 |   | 9 |   |
| Total  operating expenses                 |       | 68                                                   |       | 75                                                  |       | 70 |   | 77 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss) from  operations            |       | 9                                                    |       | (4                                                  | )          | 6 |   | (6 | ) |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Interest and other  income (expense), net |       | 2                                                    |       | 2                                                   |       | 2 |   | 3 |   |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss) before  income taxes        |       | 11                                                   |       | (2                                                  | )          | 8 |   | (3 | ) |
| Provision for income  taxes               |       | (1                                                   | )          | —                                              |       | (1 | ) | — |   |
| Net income (loss)                         |       | 10                                                   | %          | (2                                                  | )%         | 7 | % | (3 | )% |

 

The following table sets forth our ondemand customer interactions and percent of clients hosting and our revenue bytype and geography expressed as a percentage of total revenue for each of theperiods indicated:
|                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Customer interactions (in millions)            |       | 188                                                  |       | 261                                                 |       | 530 |   | 765 |   |
| Percentage of clients hosting                  |       | 87                                                   | %          | 89                                                  | %          | 87 | % | 89 | % |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue by type:                               |       |                                                 |       |                                                |       |   |   |   |   |
| Recurring (term licenses, hosting and support) |       | 51                                                   | %          | 56                                                  | %          | 53 | % | 56 | % |
| Perpetual licenses                             |       | 27                                                   |       | 23                                                  |       | 25 |   | 22 |   |
| Professional services                          |       | 22                                                   |       | 21                                                  |       | 22 |   | 22 |   |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue by geography:                          |       |                                                 |       |                                                |       |   |   |   |   |
| United States                                  |       | 75                                                   | %          | 79                                                  | %          | 76 |   | 76 | % |
| Europe                                         |       | 16                                                   |       | 16                                                  |       | 16 |   | 18 |   |
| Asia Pacific                                   |       | 9                                                    |       | 5                                                   |       | 8 |   | 6 |   |

 

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***Overview of Current Period and Outlook***

Revenue for the quarter ended September30, 2006 of $30.1 million was 30% more than the third quarter of 2005, andrepresented our 35th consecutive quarter of top-line growth.  Revenue growth has been driven by newcustomer acquisitions, the release of new products – including new productsobtained through business acquisitions - and customer purchases of additionalcapacity.  We signed 83 new customersduring the quarter ended September 30, 2006 and, when combined with thecustomers acquired through the Salesnet acquisition in May 2006, our totalcustomer base is approximately 1,800. Deferred revenues of $102.6 million at September 30, 2006 are 61% morethan one year earlier.  Beginning January1, 2006 we adopted the provisions of the new accounting standard forstock-based compensation and recorded $1.1 million and $3.6 million ofstock-based compensation expenses in the three month and nine month periodsended September 30, 2006, respectively.

Cash provided by operating activities was$9.8 million and $22.8 million in the three and nine month periods endedSeptember 30, 2006, respectively.

As of September 30, 2006, we had anaccumulated deficit of $36 million.  Thisdeficit resulted primarily from costs incurred in the development, sales andmarketing of our products and for general and administrative purposes.  We intend to continue to invest in our sales andmarketing activities, product development and business infrastructure.  During periods of investment and growth,because the majority of expenses are presently recorded as incurred and themajority of revenue is deferred, we anticipate that any growth in revenue willbe largely offset by an increase in cost of revenue and operating expenses.

Beginning in 2007, we expect to changeour customer contracts from term license arrangements to subscription servicesarrangements (“subscriptions”).  Thischange in the manner in which we sell our products is anticipated to betteralign our terms of sale with industry standard, and assist us in increasing ourmarket penetration.  We believe thatrevenue recognition under subscriptions will not be materially different thanthat under our current term license arrangements.  As part of this change in the manner in whichwe sell our products, we expect to initially adopt an accounting policy torecognize customer contract acquisition costs, such as sales commissions, in proportionto the subscription revenue recognized as opposed to recognizing asincurred.  As such, beginning in 2007 weexpect sales and marketing expenses to decrease as a percentage of revenue.

***Three Months andNine Months Ended September 30, 2005 and 2006***

***Revenue***
| ** **                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Amounts in thousands)** | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
|                                 |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Software, hosting and  support       |       | $                                                        | 18,005     |                                                    | $          | 23,754 |   | 32 | % | $ | 48,743 |   | $ | 63,700 |   | 31 | % |
| Professional services                |       | 5,149                                                    |       | 6,334                                                   |       | 23 |   | 13,831 |   | 17,927 |   | 30 |   |
| Total revenue                        |       | $                                                        | 23,154     |                                                    | $          | 30,088 |   | 30 | % | $ | 62,574 |   | $ | 81,627 |   | 30 | % |

 

*Software, hosting and support*

For the quarter ended September 30, 2006,software, hosting and support revenue increased $5.7 million, or 32%, over thethird quarter of 2005.  Recurringsoftware, hosting and support revenue in the 2006 quarter increased $5.0million, or 43%, while perpetual software license revenue increased $0.7million, when compared to the third quarter of 2005.  The growth in recurring software, hosting andsupport revenue resulted primarily from a 29% increase in average number ofcustomers combined with a 2% increase in average revenue per client.  We added 83 new clients during the quarterended September 30, 2006 primarily due to focus on new client acquisition, andadded approximately 200 customers in May 2006 through our acquisition ofSalesnet, Inc.  Average revenue perclient has grown from additional usage 

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capacityand upgrades and enhancements purchased by clients.    For the nine months ended September 30,2006, software, hosting and support revenue increased 31% over the comparable2005 period.

Beginning January 1, 2006, averagesoftware, hosting and support revenue per client includes the value of certaintools that had been categorized as professional services revenue in priorperiods.  This change in revenuecategorization follows the transfer of ongoing development and supportresponsibility for these tools from the professional services organization tothe software, hosting and support organization effective January 1, 2006.

Perpetual license fee revenue decreasedto 23% of total revenue in the quarter ended September 30, 2006 from 27% oftotal revenue in the quarter ended September 30, 2005, and decreased to 22% oftotal revenue in the nine months ended September 30, 2006 from 25% in the ninemonths ended September 30, 2005.  The mixof perpetual license revenue affects our overall profitability in any givenperiod since it is recorded into revenue in full upon delivery instead of beingratably recognized into revenue, as is the case with term licenses.  Perpetual license revenue has ranged between18% and 29% of total revenue over the past eight quarters.  We believe there are many factors that causeour perpetual license revenue to fluctuate as a percentage of total revenue,including client planning horizons, and client purchasing preferences andpatterns. However, we have seen an overall downward trend in the amount ofperpetual license revenue in recent periods and we expect perpetual licenserevenue will continue to decline as a percentage of revenue in future periods.

*Professional services*

For the quarter ended September 30, 2006, professionalservices revenue increased $1.2 million, or 23%, over the third quarter of2005.  Average professional servicesrevenue per client decreased slightly in the third quarter of 2006 compared tothe third quarter of 2005, while average number of clients increased 29%.  Average professional services revenue perclient in 2006 has been reduced because of a change in classification ofcertain tools from professional services revenue to software, hosting andsupport revenue.  These tools, consistingof connectors to other general-use software applications and customizationtools, had been created by our professional services organization and includedin professional services revenue in 2005. Effective January 1, 2006, we transferred the ongoing development andsupport responsibilities for these tools to our product group, and accordingly,the associated revenue is classified as software, hosting and support revenuebeginning in 2006.   Professionalservices revenue for the nine months ended September 30, 2006 has increased 30%over the comparable 2005 period due to a 6% increase in average revenue perclient and a 23% increase in average number of clients.

The mix of professional services revenueto total revenue will also affect our operating results from period-to-period,due to the lower gross profit earned on professional services revenue ascompared to software, hosting and support revenue.  We expect professional services revenue torange between 20% and 25% of total revenue in future periods.

***Cost of Revenue***
| ** **                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Amounts in thousands)** | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
|                                 |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Software, hosting and  support       |       | $                                                        | 2,253      |                                                    | $          | 3,667 |   | 63 | % | $ | 6,593 |   | $ | 9,597 |   | 46 | % |
| Professional services                |       | 3,026                                                    |       | 4,969                                                   |       | 64 |   | 8,601 |   | 14,014 |   | 63 |   |
|                                 |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Total cost of revenue                |       | $                                                        | 5,279      |                                                    | $          | 8,636 |   | 64 | % | $ | 15,194 |   | $ | 23,611 |   | 55 | % |

 

*Software, hosting and support*

For the quarter ended September 30, 2006,cost of software, hosting and support revenue increased $1.4 million, or 63%,over the comparable 2005 quarter due to staff additions, capacity additions toour hosting centers, and growth in the volume of customer interactionsserved.  Staff additions in our software,hosting and support organization increased salaries and related employee costsby $422,000 in the third 

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quarterof 2006 over the third quarter of 2005. Stock-based compensation expense included in the cost of software,hosting and support was $52,000 and zero in the third quarter of 2006 and 2005,respectively.  Average employee count inour hosting and support organization was 74 in the third quarter of 2006compared to 60 in the third quarter of 2005. Capital additions related to our new European hosting center, as well asnormal hosting capacity additions, increased depreciation expense by $378,000in the third quarter of 2006 over the third quarter of 2005.  This additional capacity, combined with 39%higher volume of customer interactions, increased third-party hosting fees,telecommunications expenses, and maintenance expenses by $448,000 in the thirdquarter of 2006 over the third quarter of 2005. As a percent of the associated revenue, cost of software, hosting andsupport increased to 15% in the three and nine months ended September 30, 2006from 13% in the three and nine months ended September 30, 2005.

*Professional services*

For the quarter ended September 30, 2006,professional services costs increased $1.9 million, or 64%, over the comparable2005 quarter.  The growth in absolutedollars in the third quarter of 2006 resulted primarily from staff additions,which increased salaries and related expenses by $1.2 million and increasedtravel and living expenses by $144,000 in the third quarter of 2006 over thethird quarter of 2005.  Growth in thenumber of large consulting engagements increased contract services by $313,000in the third quarter of 2006 over the third quarter of 2005.   Stock-based compensation expense in the costof professional services was $124,000 in the third quarter of 2006 as comparedto zero in the third quarter of 2005. Average employee count in our professional services group was 131 in thethird quarter of 2006 compared to 89 in the third quarter of 2005.  As a percent of the associated revenue,professional services costs were 78% and 76% in the three and nine months endedSeptember 30, 2006, respectively, as compared to 59% and 62% in the three andnine months ended September 30, 2005, respectively, due to the increased numberof large consulting engagements, the 2006 reclassification noted above in thediscussion under professional services revenue, and the addition of stock-basedcompensation charges beginning in 2006. We expect the cost of professional services to range between 75% and 80%of the associated revenue in the future.

***Operating Expenses***
| ** **                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Amounts in thousands)** | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **Percent  Change** | ** ** | **2005** | ** ** | **2006** | ** ** | **Percent  Change** | ** ** |
|                                 |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Sales and marketing                  |       | $                                                        | 11,248     |                                                    | $          | 16,535 |   | 47 | % | $ | 31,262 |   | $ | 45,113 |   | 44 | % |
| Research and development             |       | 2,937                                                    |       | 3,740                                                   |       | 27 |   | 7,524 |   | 10,346 |   | 38 |   |
| General and  administrative          |       | 1,627                                                    |       | 2,333                                                   |       | 43 |   | 4,623 |   | 7,098 |   | 54 |   |
|                                 |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Total operating expenses             |       | $                                                        | 15,812     |                                                    | $          | 22,608 |   | 43 | % | $ | 43,409 |   | $ | 62,557 |   | 44 | % |

 

*Sales and Marketing Expenses*

For the quarter ended September 30, 2006,sales and marketing expense increased $5.3 million, or 47%, over the comparable2005 quarter due to the addition of sales representatives, increasedadvertising expenditures, and increased sales incentive costs.  Average employee count in our sales andmarketing organization increased to 261 in the third quarter of 2006 from 197in the third quarter of 2005.  Employeegrowth added $1.8 million in salaries and related expenses, and added $416,000in travel and living expenses.  Stock-basedcompensation expense in our sales and marketing organization was $529,000 inthe quarter ended September 30, 2006 as compared to zero in the quarter endedSeptember 30, 2005.  Advertising costsincreased $911,000 in the September 2006 quarter over the September 2005quarter due to increased expenditures on visibility and awarenessprograms.  Sales incentive increased $1.3million in the quarter ended September 30, 2006 over the quarter endedSeptember 30, 2005 due to growth in the value of new customer contractsinvoiced.  As a percent of total revenue,sales and marketing expenses increased to 55% in the three and nine months ended September 30, 2006, respectively,from 48% and 51% in the three and nine months ended September 30, 2005,respectively.

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*Research and Development Expenses*

For the quarter ended September 30, 2006,research and development expenses increased $803,000, or 27%, over thecomparable 2005 quarter due to higher salaries and related costs of $658,000,and stock-based compensation expense of $230,000.  Average employee count in our research anddevelopment organization grew to 134 employees in the third quarter of 2006from 106 employees in the third quarter of 2005.  Research and development expenses haveremained approximately constant at 12% to 13% of revenue for the three and ninemonths ended September 30, 2005 and 2006.

*General and Administrative Expenses*

For the quarter ended September 30, 2006,general and administrative expenses increased $706,000, or 43%, over the thirdquarter of 2005 primarily due to staff additions.  Average employee count in our general andadministrative organization was 62 in the third quarter of 2006 as compared to42 in the third quarter of 2005, which increased salaries and related expensesby $390,000.  The 2006 quarter alsoincludes $179,000 of stock-based compensation as compared to zero in the prioryear.  General and administrativeexpenses have ranged between 7% and 9% of revenue for the three and nine monthsended September 30, 2005 and 2006.

*Stock-based Compensation*

We adopted the provisions of Statement ofFinancial Accounting Standards No. 123(R), *Share Based Payment*,using the modified prospective method, on January 1, 2006.  Under the modified prospective method, priorperiods have not been restated to conform to the current period accountingtreatment.  Adoption of this accountingstandard required the recognition of $1.1 million and $3.6 million ofstock-based compensation expense in the three month and nine month periodsended September 30, 2006, respectively. Amounts recorded to each cost and expense category have been noted inthe above discussion.  At September 30,2006, we had approximately $11 million of deferred stock-based compensationexpense that is expected to be recorded into earnings over a weighted-averageperiod of 2.7 years.  Total stock-basedcompensation expense for the year ended December 31, 2006 is anticipated to beapproximately $4.9 million.  Thisestimate is based on assumptions regarding our stock price, the number andtiming of stock awards granted and forfeited, our stock price volatility, andemployee exercise behaviors.  Actualstock-based compensation expense could differ materially from our estimates.

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

|                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Amounts in thousands)** | ** ** | **2005**                                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                      |       | $                                                    | 437        |                                                | $          | 776 |   | $ | 1,082 |   | $ | 2,170 |   |
| Interest expense                     |       | (3                                                   | )          | (3                                                  | )          | (3 | ) | (8 | ) |
| Other income  (expense)              |       | 6                                                    |       | (33                                                 | )          | (16 | ) | 18 |   |
| Total other income  (expense)        |       | $                                                    | 440        |                                                | $          | 740 |   | $ | 1,063 |   | $ | 2,180 |   |

 

Interest income increased 178% and 200%in the three and nine months ended September 30, 2006 over the comparable 2005periods due to growth in the average yield-to-maturity in our investmentportfolio, as well as growth in our cash and short-term investmentbalances.  Investment yields have risenalong with the periodic increases in the federal funds rate.  Our investment portfolio consists primarilyof short-term, investment-grade government and corporate debt instruments.  Interest expense in the 2006 periods resultedfrom certain capitalized lease obligations. Other income (expense) consists of gains or losses on equipmentdisposals and realized foreign currency exchange gains or losses.

***Provision for Income Taxes***

The provision for income taxes in thethree month and nine month periods ended September 30, 2006 is based on ourexpectations for the full year results, and consists primarily of federalalternative minimum taxes.  Our incometax provision is dependent on many factors, including actual tax deductions 

24

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forstock-based compensation as compared to book deductions, the level of businessconducted in state and foreign tax jurisdictions, management’s expectations ofthe realization of deferred tax assets and the associated valuation allowance,and other factors.

At September 30, 2006, we had $35 millionof net deferred income tax assets that have been reserved in full by avaluation allowance.  In the future, ifavailable evidence indicates that it is more likely than not that we will beable to utilize some or all of our deferred tax assets, we will record anincome tax benefit, a credit to additional paid-in capital, or a credit togoodwill or other intangible assets of Salesnet, in the amount of the assetrecognized.  At that time, we expect thatour effective tax rate would increase to more closely approximate the U.S.federal statutory rate.

***Liquidity and CapitalResources***

Information regarding deferred revenueand cash provided by operating activities follows (in thousands):
| ** **                            | ** ** | **Quarter Ended** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| **(Amounts in thousands)**  | ** ** | **Sep 30,  2005** | ** ** | **Dec 31,  2005** | ** ** | **Mar 31,  2006** | ** ** | **Jun 30,   2006** | ** ** | **Sep 30,   2006** | ** ** |
|                                  |       |                   |       |   |   |   |   |   |   |   |   |
| Deferred revenue                      |       | $                      | 63,752     |   | $ | 67,923 |   | $ | 80,906 |   | $ | 87,234 |   | $ | 102,620 |   |
| Cash provided by operating activities |       | 5,248                  |       | 3,844 |   | 6,052 |   | 6,864 |   | 9,836 |   |
|                                       |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We have historically funded ouroperations with cash from operations, equity financings and debtborrowings.  In August 2004 we completedour initial public offering of 6.4 million shares of common stock and receivednet proceeds of approximately $40 million. Since that time we have utilized approximately $10 million of the netoffering proceeds for business acquisitions. Remaining proceeds are invested in short-term, investment-grade,interest-bearing securities.

At September 30, 2006, cash and cashequivalents, and short-term investments, totaled $75 million.   In addition to our cash and short-terminvestments, other sources of liquidity at September 30, 2006 included a $3.0million bank line of credit facility, under which there have been no borrowingsto date.

Operating activities provided $9.8million of cash during the three months ended September 30, 2006, as comparedto $5.2 million of cash from operations in the corresponding period of theprior year.  The majority of our cashfrom operations in the third quarter of 2006 was from growth in deferredrevenue, net of growth in accounts receivable. We typically bill customers on net 30-day terms at the beginning of thelicense period, which is reflected in accounts receivable and deferredrevenue.  In periods of increasing sales,we would expect growth in accounts receivable and deferred revenue which,historically, has provided funding for operations.  Any change in our billing practice resultingin delayed payment terms could have a material adverse effect on cash providedfrom operations and growth in deferred revenue.

The allowance for uncollectible accountsreceivable represented 7% and 5% of current accounts and term receivables atSeptember 30, 2006 and December 31, 2005, respectively.  We regularly assess the adequacy of theallowance for uncollectible accounts. Actual customer collections could differ from our estimates and exceedthe related loss allowance.

We expect to pay approximately $500,000in cash income taxes in 2006, consisting of U.S. federal alternative minimumtaxes and foreign tax withholdings.

Investing activities used $2.6 million incash during the three months ended September 30, 2006, which consisted of $1.0million in capital additions and $1.6 million for the net purchase ofshort-term investments.  In May 2006, wespent approximately $8.7 million for the acquisition of Salesnet, Inc.  Capital expenditures consist primarily ofcapacity additions to our hosting operations and are expected to beapproximately $8.0 to $8.5 million for the full year 2006.

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Financing activities provided $1.3million in the nine months ended September 30, 2006 from employee purchases ofCompany stock under employee benefit plans.

We believe our existing cash andshort-term investments, together with funds generated from operations, shouldbe sufficient to fund operating and investment requirements for the next twelvemonths.   Our future capital requirementswill depend on many factors, including our rate of revenue growth and expansionof our sales and marketing activities, the possible acquisition ofcomplementary products or businesses, the timing and extent of spendingrequired for research and development efforts, and the continuing marketacceptance of our products.  To theextent that available funds are insufficient to fund our future activities, wemay need to raise additional funds through public or private equity or debtfinancings.  Additional equity or debtfinancing may not be available on terms favorable to us or at all.

***Off-Balance Sheet Arrangements***

As of September 30, 2006, we did not haveany significant off-balance-sheet arrangements, as defined in Item303(a)(4)(ii) of Regulation S-K promulgated by the SEC.

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***ContractualObligations and Commitments***

As part of the acquisition of Salesnet,Inc., during the quarter ended June 30, 2006, we incurred contractualobligations pertaining to operating and capital leases of approximately$175,000 per year through the year 2010. During the quarter ended September 30, 2006, we entered into a five yearoperating lease for a hosting center in the United Kingdom, with annualpayments of approximately $300,000. During the quarter ended September 30,2006, we signed agreements to reserve meeting and hotel rooms for the Company’s2007 and 2008 North American User’s Conference. The agreements contain cancellation penalties that are based on asliding scale leading up to the conference dates.  The maximum penalty is $1.5 million shouldcancellation occur.

There have been no other significantchanges to our contractual obligations since December 31, 2005.

**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

***Foreign CurrencyExchange Risk***

Our results of operations and cash flowsare subject to fluctuations due to changes in foreign currency exchange rates,particularly changes in the Euro, British pound, Australian dollar, andJapanese yen, because our contracts are frequently denominated in localcurrency.  To date, we have not enteredinto any hedge transactions since exchange rate fluctuations have had littleimpact on our operating results and cash flows. In the future, we may utilizeforeign currency forward and option contracts to manage currency exposures.

***Interest RateSensitivity***

Interest income and expense are sensitiveto changes in the general level of U.S. interest rates.  Net proceeds of our initial public offeringof common stock are invested in short-term, interest-bearing securities, whichare subject to credit and interest rate risk.  Our investment portfolio is investment-grade and diversified amongissuers and types to reduce credit risk. The average maturity of our investment portfolio is less than 90 daysand we expect to hold the investments until maturity.  If market interest rates were to increase by100 basis points from the level at September 30, 2006, the fair value of ourinvestment portfolio would decline by approximately $140,000.

**Item 4.  Controls and Procedures**

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

Our management, with the participation ofour Chief Executive Officer and Chief Financial Officer, has evaluated theeffectiveness of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of theend of the period covered by this report. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, as of the end ofthe period covered by this report, our disclosure controls and procedures wereeffective in ensuring that information required to be disclosed by us in thereports that we file or submit under the Securities Exchange Act of 1934 is (i)recorded, processed, summarized and reported, within the time periods specifiedin the rules and forms of the Securities and Exchange Commission and (ii)accumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.

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

During the most recent completed fiscalquarter covered by this report, there has been no change in our internalcontrol over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)under the Securities Exchange Act of 1934) that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

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**Part II.  Other Information**

***Item 1.  Legal Proceedings***

From time to time, we are involved inlegal proceedings in the ordinary course of business.  We believe that the resolution of thesematters will not have a material effect on the Company’s consolidated financialposition, results of operations or liquidity.

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

A restated description ofthe risk factors associated with our business is set forth below.  This description includes any and all changes(whether or not material) to, and supercedes, the description of the riskfactors associated with our business previously disclosed in Part 1, Item 1A ofour Annual Report on Form 10-K for the year ended December 31, 2005.

*Before deciding to purchase, hold orsell our common stock, you should carefully consider the risks described below,in addition to the other cautionary statements and risks described elsewhereand the other information contained in this report and in our other filingswith the Securities and Exchange Commission, including our reports on Forms10-K, 10-Q and 8-K. The risks and uncertainties described below are not theonly ones we face. Additional risks and uncertainties not presently known to usor that we currently deem immaterial may also affect our business. If any of theseknown or unknown risks or uncertainties actually occurs with material adverseeffects on RightNow, our business, financial condition and results ofoperations could be seriously harmed. In that event, the market price for ourcommon stock could decline and you may lose all or part of your investment.*

***We may not be ableto achieve, sustain or increase profitability in the future.***

Prior to 2004, we incurred significant operatinglosses of approximately $4.1 million in 2003, $2.7 million in 2002and $15.3 million in 2001. We have incurred an operating loss of $2.7million in the first nine months of 2006. As of September 30, 2006, we had an accumulated deficit of approximately$36 million. We expect to continue to incur significant sales and marketing, researchand development and general and administrative expenses as we expand ouroperations and, as a result, we will need to generate significant revenue toachieve profitability. Even if we achieve profitability, we may not be able toincrease profitability on a quarterly or annual basis in the future, which maycause the price of our stock to decline.

***Our quarterlyresults of operations may fluctuate in the future.***

Our quarterly revenue and results of operations mayfluctuate as a result of a variety of factors, many of which are outside of ourcontrol. If our quarterly revenue or results of operations fall below theexpectations of investors or securities analysts, the price of our common stockcould decline substantially. Fluctuations in our results of operations may bedue to a number of factors, including, but not limited to, those listed belowand identified throughout this “Risk Factors” section:

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

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

·                  ourpresent policy of expensing sales commissions when earned, which is typicallyat the time of invoice, while the majority of our revenue is recognized ratablyover future periods;

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

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

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

·                  changesin our pricing policies or those of our competitors;

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

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

·                  thepurchasing and budgeting cycles of our clients; and

·                  generaleconomic, industry and market conditions.

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

Due to the foregoing factors, and the other risksdiscussed in this report, you should not rely on quarter-to-quarter comparisonsof our results of operations as an indication of our future performance.

***If our efforts to enhance existing solutions, introduce newsolutions or expand the applications for our products and solutions to broaderCRM markets do not succeed, our ability to grow our business will be adverselyaffected.***

Approximately 80% to 90% of our revenue is derived from RightNowService, a suite of solutions used to optimize customer service operations. Ifwe are unable to successfully develop and sell new and enhanced versions ofRightNow Service, or introduce new products and solutions for the customerservice market, our financial performance will suffer. Although to date themajority of business has been focused on providing solutions for customerservice operations, we have introduced sales, marketing, and voice-enabledapplications to expand our solution offerings. Our efforts to expand beyond thecustomer service market may not be successful because certain of ourcompetitors have far greater experience and brand recognition in the broadersegments of the CRM market. In addition, our efforts to expand our on demandsoftware solutions beyond the customer service market may divert managementresources from our existing operations and require us to commit significantfinancial resources to a market where we are less proven, which may harm ourbusiness, financial condition and results of operations.

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

The market for customer relationship management solutions ishighly competitive and fragmented, and is subject to rapidly changingtechnology, shifting client requirements, frequent introductions of newproducts and services, and increased marketing activities of other industryparticipants.  Competition hasintensified with our most recent product releases.  Increased competition could result in pricingpressure, reduced sales, lower margins or the failure of our solutions toachieve or maintain broad market acceptance. If we are unable to competeeffectively, it will be difficult for us to add and retain clients, and ourbusiness, financial condition and results of operations will be seriouslyharmed.

We face competition from:

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

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·                  CRMsystems that are developed and maintained internally by businesses;

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

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

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

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

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

In addition, many of our current and potential competitorshave established or may establish business, financial or strategicrelationships among themselves or with existing or potential clients, alliancepartners or other third parties, or may combine and consolidate to become moreformidable competitors with better resources. For example, in January 2006, Oracle Corporation completed itsacquisition of Siebel Systems, Inc.  Wealso expect that new competitors, such as enterprise software vendors andonline service providers that have traditionally focused on enterprise resourceplanning or back office applications, will continue to enter the on-demand CRMmarket with competing products as the on demand CRM market develops andmatures. For example, Microsoft recently announced its intention to offeron-demand CRM applications to the small business market.  It is possible that these new competitorscould rapidly acquire significant market share.

***The market for our ondemand application services is at an early stage of development, and if it doesnot develop or develops more slowly than we expect, our business will beharmed.***

The market for on demand application services is at an earlystage of development, and it is uncertain whether these application serviceswill achieve and sustain high levels of demand and market acceptance. Oursuccess will depend to a substantial extent on the willingness of companies toincrease their use of on demand application services in general and for ondemand customer relationship management applications in particular. Thewillingness of companies to increase their use of any on demand applicationservices is in part dependent on the actual and perceived reliability of hostedsolutions.  In addition, many companieshave invested substantial personnel and financial resources to integratetraditional enterprise software into their businesses, and therefore may bereluctant or unwilling to migrate to on demand application services. While wehave supported and continue to support traditional on site deployment of oursoftware applications, widespread market acceptance of our on demand softwaresolutions is critical to the success of our business. Other factors that mayaffect the market acceptance of our solutions include:

·                  ondemand security capabilities and reliability;

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

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

·                  thelevel of customization we offer;

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

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

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

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

If businesses do not perceive the benefits of on demandsolutions in general, or our on demand solutions in particular, then the marketfor these solutions may not develop further, or it may develop more 

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slowlythan we expect, either of which would adversely affect our business, financialcondition and results of operations.

***Failure to effectivelydevelop and expand our sales and marketing capabilities could harm our abilityto increase our client base and achieve broader market acceptance of oursolutions.***

Increasing our client base and achieving broader marketacceptance of our solutions will depend to a significant extent on our abilityto expand our sales and marketing operations. We plan to continue to expand ourdirect sales force and engage additional third-party channel partners, bothdomestically and internationally. This expansion will require us to investsignificant financial and other resources. Our business will be seriouslyharmed if our efforts do not generate a corresponding significant increase inrevenue. We may not achieve anticipated revenue growth from expanding ourdirect sales force if we are unable to hire and develop talented direct salespersonnel, if our new direct sales personnel are unable to achieve desiredproductivity levels in a reasonable period of time, or if we are unable toretain our existing direct sales personnel. We also may not achieve anticipatedrevenue growth from our third-party channel partners if we are unable toattract and retain additional motivated channel partners, if any existing or futurechannel partners fail to successfully market, resell, implement or support oursolutions for their customers, or if they represent multiple providers anddevote greater resources to market, resell, implement and support competingproducts and services.

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

The majority of our solutions are sold pursuant to termlicense agreements that are subject to renewal every two years or less and ourclients have no obligation to renew their licenses. Because our clients mayelect not to renew, we may not be able to consistently and accurately predictfuture renewal rates. Our clients’ renewal rates may decline or fluctuate as aresult of a number of factors, including their level of satisfaction with oursolutions, their ability to continue their operations or invest in customerservice, their acceptance of our intended change from a term license agreementto a subscription service agreement beginning in 2007, or the availability andpricing of competing products. If large numbers of existing clients do notrenew their licenses, or renew their licenses on terms less favorable to us,and if we cannot replace or supplement those non-renewals with new licensesgenerating the same or greater level of revenue, our business, financialcondition and results of operations will be adversely affected.

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

We have substantially expanded our overall business,headcount and operations in recent periods. We have increased our total numberof full-time employees to 654 at September 30, 2006 from 530 at December 31,2005. To achieve our business objectives, we will need to continue to expandour business at a rapid pace. This expansion has placed, and is expected tocontinue to place, a significant strain on our managerial, administrative, operational,financial and other resources. We anticipate that this expansion will requiresubstantial management effort and significant additional investment in ourinfrastructure. If we are unable to successfully manage our growth, ourbusiness, financial condition and results of operations will be adverselyaffected.

Part of the challenge that we expect to face in the course ofour expansion is to maintain the high level of customer service to which ourclients have become accustomed. To date, we have focused on providingpersonalized account management and customer service on a frequent basis toensure our clients are effectively leveraging the capabilities of our solution.We believe that much of our success to date has been the result of high clientsatisfaction, attributable in part to this focus on client service. To theextent our client base grows, we will need to expand our account management,client service and other personnel, and third-party channel partners, in orderto enable us to continue to maintain high levels of client service and 

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satisfaction.If we are not able to continue to provide high levels of client service, ourreputation, as well as our business, financial condition and results ofoperations, could be harmed.

***If there are interruptionsor delays in our hosting services through third-party error, our own error orthe occurrence of unforeseeable events, delivery of our solutions could becomeimpaired, which could harm our relationships with clients and subject us toliability.***

As of September 30, 2006, approximately 89% of ourclients were using our hosting services for deployment of our softwareapplications. We generally provide our hosting services for our non-voiceapplications through computer hardware that we own and that is currentlylocated in third-party web hosting co-location facilities maintained andoperated in California, Massachusetts, New Jersey and London, England. In theUnited Kingdom, our voice applications are hosted by a third party who alsoowns and operates the hardware on which our applications reside.  We do not maintain long-term supply contractswith any of our hosting providers, and providers do not guarantee that ourclients’ access to hosted solutions will be uninterrupted, error-free orsecure. Our operations depend on our providers’ ability to protect their andour systems in their facilities against damage or interruption from naturaldisasters, power or telecommunications failures, criminal acts and similarevents. Our back-up computer hardware and systems have not been tested underactual disaster conditions and may not have sufficient capacity to recover alldata and services in the event of an outage occurring simultaneously at allhosting facilities. In the event that our hosting facility arrangements wereterminated, or there was a lapse of service or accidental or willful damage tosuch facilities, we could experience lengthy interruptions in our hostingservice as well as delays and/or additional expense in arranging new facilitiesand services. Any or all of these events could cause our clients to lose accessto their important data. In addition, the failure by our third-party hostingfacilities to meet our capacity requirements could result in interruptions inour service or impede our ability to scale our operations.

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

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

Our hosting systems and our software store and transmitproprietary information and critical data belonging to our clients and theircustomers. Any accidental or willful security breaches or other unauthorizedaccess could expose us to a risk of information loss, litigation and otherpossible liabilities. If security measures are breached because of third-partyaction, employee error, malfeasance or otherwise, or if design flaws in oursoftware are exposed and exploited, and, as a result, a third party obtainsunauthorized access to any of our clients’ data, our relationships with clientsand our reputation will be damaged, our business may suffer and we could incursignificant liability. Because techniques used to obtain unauthorized access orto sabotage systems change frequently and generally are not recognized untillaunched against a target, we and our third-party hosting co-locationfacilities may be unable to anticipate these techniques or to implementadequate preventative measures.

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

International sales comprised 21% and 25% of our revenue forthe quarters ended September 30, 2006 and 2005, respectively. We intend tocontinue to pursue and expand our international business activities. 

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Adversepolitical and economic conditions could make it difficult for us to increaseour international sales or to operate abroad. International operations aresubject to many inherent risks, including:

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

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

·                  fluctuationsin currency exchange rates;

·                  longercollection periods and difficulties in collecting receivables from foreignentities;

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

·                  reducedprotection for our intellectual property in some countries;

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

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

We believe that international sales will continue torepresent a significant portion of our revenue for the foreseeable future, andthat continued growth will require further expansion of our internationaloperations. A substantial percentage of our international sales are denominatedin the local currency. As a result, an increase in the relative value of thedollar could make our products more expensive and potentially less pricecompetitive in international markets. We typically do not engage in anytransactions as a hedge against risks of loss due to foreign currencyfluctuations. Any of these factors may adversely affect our futureinternational sales and, consequently, affect our business, financial conditionand results of operations.

***If we fail to respondeffectively to rapidly changing technology and evolving industry standards,particularly in the on demand CRM industry, our solutions may become lesscompetitive or obsolete.***

The CRM industry is characterized by rapid technologicaladvances, changes in client requirements, frequent new product and serviceintroductions and enhancements, changes in protocols and evolving industrystandards. Our hosted business model and the on demand CRM market arerelatively new and may evolve even more rapidly than the rest of the CRMmarket. Competing products and services based on new technologies or newindustry standards may perform better or cost less than our solutions and couldrender our solutions less competitive or obsolete. In addition, because oursolutions are designed to operate on a variety of network hardware and softwareplatforms using a standard Internet web browser, we will need to continuouslymodify and enhance our solutions to keep pace with changes in Internet-relatedhardware, software, communication, browser and database technologies and tointegrate with our clients’ systems as they change and evolve. Furthermore,uncertainties about the timing and nature of new network platforms ortechnologies, or modifications to existing platforms or technologies, couldincrease our research and development expenses. If we are unable tosuccessfully develop and market new and enhanced solutions that respond in atimely manner to changing technology and evolving industry standards, and if weare unable to satisfy the diverse and evolving technology needs of our clients,our business, financial condition and results of operations will suffer.

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

Our success and future growth depends to a significant degreeupon the skills, experience, performance and continued service of our seniormanagement, engineering, sales, marketing, service, support and other keypersonnel. Specifically, we believe that our future success is highly dependenton Greg Gianforte, our founder, Chairman and Chief Executive Officer. Inaddition, we do not have employment agreements with any of our senior managementor key personnel that require them to remain our employees and, therefore, theycould terminate their employment with us at any time without penalty. If welose the services of Mr. Gianforte or any of our other key personnel, ourbusiness will be severely disrupted and we may be unable to operateeffectively. We do not maintain “key person” life insurance policies on any ofour key employees except Mr. Gianforte. This life insurance policy wouldnot be 

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sufficientto compensate us for the loss of his services. Our future success also dependsin large part upon our ability to attract, train, integrate, motivate andretain highly skilled employees, particularly sales, marketing and professionalservices personnel, software engineers, product trainers, and senior personnel.Competition for these personnel is intense, especially for engineers with highlevels of expertise in designing and developing software and for senior salesexecutives.

***If our solutions fail toperform properly or if they contain technical defects, our reputation will beharmed, our market share would decline and we could be subject to productliability claims.***

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

Product liability claims could require us to spendsignificant time and money in litigation or to pay significant settlements ordamages. Although we maintain general liability insurance, including coveragefor errors and omissions, this coverage may not be sufficient to coverliabilities resulting from such product liability claims. Also, our insurer maydisclaim coverage. Our liability insurance also may not continue to be availableto us on reasonable terms, in sufficient amounts, or at all. Any productliability claims successfully brought against us would cause our business tosuffer.

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

Our success depends to a significant degree upon theprotection of our software and other proprietary technology rights. We rely ontrade secret, copyright and trademark laws, patents and confidentialityagreements with employees and third parties, all of which offer only limitedprotection. The steps we have taken to protect our intellectual property maynot prevent misappropriation of our proprietary rights or the reverse engineeringof our solutions. We may not be able to obtain any further patents ortrademarks, and our pending applications may not result in the issuance ofpatents or trademarks. Any of our issued patents may not be broad enough toprotect our proprietary rights or could be successfully challenged by one ormore third parties, which could result in our loss of the right to preventothers from exploiting the inventions claimed in those patents. Furthermore,legal standards relating to the validity, enforceability and scope ofprotection of intellectual property rights in other countries are uncertain andmay afford little or no effective protection of our proprietary technology.Consequently, we may be unable to prevent our proprietary technology from beingexploited abroad, which could diminish international sales or require costlyefforts to protect our technology. Policing the unauthorized use of ourproducts, trademarks and other proprietary rights is expensive, difficult and,in some cases, impossible. Litigation may be necessary in the future to enforceor defend our intellectual property rights, to protect our trade secrets or todetermine the validity and scope of the proprietary rights of others. Suchlitigation could result in substantial costs and diversion of managementresources, either of which could harm our business. Accordingly, despite ourefforts, we may not be able to prevent third parties from infringing upon ormisappropriating our intellectual property.

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***Our product developmentefforts may be constrained by the intellectual property of others, and we maybecome subject to claims of intellectual property infringement, which could becostly and time-consuming.***

 

The software and Internet industries are characterized by theexistence of a large number of patents, trademarks and copyrights, and byfrequent litigation based upon allegations of infringement or other violationsof intellectual property rights. As we seek to extend our CRM product andservice offerings, we may be constrained by the intellectual property rights ofothers. We have in the past been named as a defendant in a lawsuit allegingintellectual property infringement, and we may again in the future have todefend against intellectual property lawsuits. We may not prevail in any futureintellectual property infringement litigation given the complex technicalissues and inherent uncertainties in litigation. Any claims, regardless oftheir merit, could be time-consuming and distracting to management, result incostly litigation or settlement, cause product development delays, or requireus to enter into royalty or licensing agreements. If any of our productsviolate third-party proprietary rights, we may be required to re-engineer ourproducts or seek to obtain licenses from third parties, which may not beavailable on reasonable terms or at all. Because our license agreementstypically require us to indemnify our clients from any claim or finding ofintellectual property infringement, any such litigation or successfulinfringement claims could adversely affect our business, financial conditionand results of operations. Any efforts to re-engineer our products, obtainlicenses from third parties on favorable terms or license a substitutetechnology may not be successful and, in any case, may substantially increaseour costs and harm our business, financial condition and results of operations.Further, our software products contain open source software components that arelicensed to us under various public domain licenses. While we believe we havecomplied with our obligations under the various applicable licenses for opensource software that we use, there is little or no legal precedent governingthe interpretation of many of the terms of certain of these licenses andtherefore the potential impact of such terms on our business is somewhatunknown. Use of open source standards also may make us more vulnerable tocompetition because the public availability of open source software could makeit easier for new market entrants and existing competitors to introduce similarcompeting products quickly and cheaply.

***Future acquisitions coulddisrupt our business and harm our financial condition and results ofoperations.***

In order to expand our addressable market, we may decide toacquire additional businesses, products and technologies. In May 2006, weacquired Salesnet, Inc., our second acquisition since becoming a publiccompany.   Acquisitions could requiresignificant capital infusions and could involve many risks, including, but notlimited to, the following:

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

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

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

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

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

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

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

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

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***Changes to financialaccounting standards may affect our results of operations and financialcondition.***

Generally accepted accounting principles and accompanyingaccounting pronouncements, implementation guidelines and interpretations formany aspects of our business, such as software revenue recognition andaccounting for stock-based compensation, are complex and involve subjectivejudgments by management.  Changes togenerally accepted accounting principles, their interpretation, or changes inour products or business could significantly change our reported earnings andfinancial condition and could add significant volatility to thosemeasures.  For example, since ourinception in 1997, we have used stock options as a fundamental component of ouremployee compensation programs.  Newaccounting requirements that began January 1, 2006 make the use of stock-basedcompensation much more expensive and introduce additional volatility in ourresults of operations.  See Note 5 to theCondensed Consolidated Financial Statements and *Management’sDiscussion and Analysis of Financial Condition and Results of Operations –Critical Accounting Policies* in this report for additionalinformation on recently enacted changes to generally accepted accountingprinciples.

***Volatility in the price of our common stock mayadversely affect our ability to predict the fair value of our stock awards andthe resulting stock-based compensation expense.***

The fair value of stock awards under SFAS 123R is estimatedusing several factors, including the underlying price of the stock option,which is not known until the date of grant, and Company assumptions of expectedstock price volatility, the expected term of the award, and other factors.  These factors can cause significantvariations in the estimated fair value of the awards, and therefore causesignificant fluctuations in our operating results.  For example, our stock price has rangedbetween $11.84 and $20.00 per share in the first nine months of 2006.  Using the same assumptions for expected term,volatility, and risk-free rate, the fair value of an option granted at the lowend of the price range would have been $6.26 per share, and would have been$10.57 per share if granted at the high end of the range.  The volatility in the market value of ourstock could cause us to incur significantly higher or lower stock-basedcompensation expense in future periods. The trading price of our common stock depends in part on our ability toaccurately forecast our results, and if we were to miss our forecasts, we maylose credibility with investors and research analysts, which in turn couldcause the price of our common stock to decline.

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

We have historically used stock options as a key component ofour employee compensation because we believe it aligns employees’ interestswith our stockholders’ interest, encourages employee retention, and provides acompetitive component of our overall compensation program.  Due to the required adoption of SFAS 123R,and the recording of stock option expense on our operating statements, we maydetermine that it is in our best interest to reduce the number or size of ourstock-based awards, or change the type of awards granted.  In doing so, we may not be able to attract,retain and motivate our employees.

***We may not be able tosecure additional financing on favorable terms, or at all, to meet our futurecapital needs.***

We may require additional capital to respond to businesschallenges, including the need to develop new solutions or enhance our existingsolutions, enhance our operating infrastructure, fund expansion, respond tocompetitive pressures and acquire complementary businesses, products andtechnologies. Absent sufficient cash flow from operations, we may need toengage in equity or debt financings to secure additional funds to meet ouroperating and capital needs. In addition, even though we may not needadditional funds, we may still elect to sell additional equity or debtsecurities or obtain credit facilities for other reasons. We may not be able tosecure additional debt or equity financing on favorable terms, or at all, atthe time when we need such funding. If we raise additional funds throughfurther issuances of equity or convertible debt securities, our existingstockholders could suffer significant dilution in their percentage 

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ownershipof our company, and any new equity securities we issue could have rights,preferences and privileges senior to those of holders of our common stock. Anydebt financing secured by us in the future could involve restrictive covenantsrelating to our capital raising activities and other financial and operationalmatters, which may make it more difficult for us to obtain additional capital,to pay dividends and to pursue business opportunities, including potentialacquisitions. In addition, if we decide to raise funds through debt orconvertible debt financings, we may be unable to meet our interest or principalpayments.

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

The future success of our products and our hosted businessdepends upon the continued and widespread adoption of the Internet as a primarymedium for commerce, communication and business applications. Our businessgrowth would be impeded if the performance or perception of the Internet, orcompanies providing hosted solutions, was harmed by security problems such as “viruses,”“worms” and other malicious programs, reliability issues arising from outagesand damage to Internet infrastructure, delays in development or adoption of newstandards and protocols to handle increased demands of Internet activity,increased costs, decreased accessibility and quality of service, or increasedgovernment regulation and taxation of Internet activity.

Federal, state or foreign government bodies or agencies havein the past adopted, and may in the future adopt, laws or regulations affectingdata privacy, the solicitation, collection, processing or use of personal orconsumer information, the use of the Internet as a commercial medium and theuse of e-mail for marketing or other consumer communications. In addition,government agencies or private organizations may begin to impose taxes, fees orother charges for accessing the Internet or for sending commercial e-mail.These laws or charges could limit the growth of Internet-related commerce orcommunications generally, result in a decline in the use of the Internet andthe viability of Internet- based services such as ours and reduce the demandfor our products, particularly our RightNow Marketing solution.

The Internet has experienced, and is expected to continue toexperience, significant user and traffic growth, which has, at times, causeduser frustration with slow access and download times. If Internet activitygrows faster than Internet infrastructure or if the Internet infrastructure isotherwise unable to support the demands placed on it, or if hosting capacitybecomes scarce, our business growth may be adversely affected.

***Privacy concerns and lawsor other domestic or foreign regulations may adversely affect our business orreduce sales of our solutions.***

Businesses using our solutions collect personal informationregarding their customers when those customers contact them with customerservice inquiries. A valuable component of our solutions is their ability toallow our clients to use and analyze their customers’ information to increasesales, marketing and up-sell or cross-sell opportunities. Federal, state andforeign government bodies and agencies, however, have adopted and areconsidering adopting laws and regulations regarding the collection, use anddisclosure of personal information obtained from consumers. The costs ofcompliance with, and other burdens imposed by, such laws and regulations thatare applicable to the businesses of our clients may limit the use and adoptionof this component of our solutions and reduce overall demand for our solutions.Furthermore, even where a client desires to make full use of these features inour solutions, privacy concerns may cause our clients’ customers to resistproviding the personal data necessary to allow our clients to use our solutionsmost effectively. Even the perception of privacy concerns, whether or notvalid, may inhibit market acceptance of our products.

The European Union has also adopted a directive that requiresmember states to impose restrictions on the collection and use of personal datathat are far more stringent, and impose more significant burdens on subjectbusinesses, than current privacy standards in the United States. All of thesedomestic and international legislative and regulatory initiatives may adverselyaffect our clients’ ability to 

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collectand/or use demographic and personal information from their customers, whichcould reduce demand for our solutions.

In addition to government activity, privacy advocacy groupsand the technology and direct marketing industries are considering various new,additional or different self-regulatory standards that may place additionalburdens on us. If the gathering of profiling information were to be curtailedin this manner, customer service CRM solutions would be less effective, whichwould reduce demand for our solutions and harm our business.

***Non-solicitation concerns,laws or regulations may adversely affect our clients’ ability to performoutbound marketing and other e-mail communications, which could reduce sales ofour solutions.***

In January 2004, the federal Controlling the Assault ofNon-Solicited Pornography and Marketing Act of 2003, or CAN-SPAM Act, becameeffective. The CAN-SPAM Act regulates the transmission and content ofcommercial e-mails and, among other things, obligates the sender of suche-mails to provide recipients with the ability to opt-out of receiving futuree-mails from the sender, and establishes penalties for the transmission ofe-mail messages which are intended to deceive the recipient as to source orcontent. Many state legislatures also have adopted laws that impact thedelivery of commercial e-mail, and laws that regulate commercial e-mailpractices have been enacted in many of the international jurisdictions in whichwe do business, including Europe, Australia, and Canada. In addition, Internetservice providers and licensors of software products have introduced a varietyof systems and products to filter out certain types of commercial e-mail,without any common protocol to determine whether the recipient desired toreceive the e-mail being blocked. As a result, it is difficult for us todetermine in advance whether or not e-mails generated by our clients using oursolutions will be permitted by spam filters to reach the intended recipients.

Our RightNow Marketing solution specifically serves themarket for mass distribution marketing and other e-mail communications. Theincreasing regulation of e-mail delivery, both domestically andinternationally, and the spam filtering practices of Internet service providersand e-mail users generally, will place significant additional burdens on ourclients who have outbound communication programs, and may cause those clientsto substantially change their outbound communications programs or abandon themaltogether.  These factors may lead to areduction in sales of our RightNow Marketing solution, may make it necessary toredesign our RightNow Marketing solution to make it easier for our clients toconform to the requirements of such laws and standards, which would increaseour expenses, or may make it necessary for us to redefine the market for anduse of our RightNow Marketing solution, which could reduce our revenue.

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

Our clients consist of large and small companies in nearlyall industry sectors and geographies. Potential new clients or existing clientscould defer purchases of our products because of unfavorable macroeconomicconditions, such as rising interest rates, fluctuations in currency exchangerates, industry or national economic downturns, industry purchasing patterns,and other factors.   Our ability to growrevenues may be adversely affected by unfavorable economic conditions.

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***The significant control over stockholdervoting matters and our office leases that may be exercised by our founder andChief Executive Officer will limit your ability to influence corporate actionsand may require us to find alternative office space to lease or buy in thefuture.***

AtSeptember 30, 2006, Greg Gianforte, our founder and Chief Executive Officer,and his spouse, Susan Gianforte, together beneficially owned approximately 31%of our currently outstanding common stock and, together with our other officersand directors, beneficially owned approximately 48% of our currentlyoutstanding common stock. In addition, none of the shares of common stock heldby Mr. Gianforte and Mrs. Gianforte are subject to vesting restrictions. As a result,Mr. Gianforte and Mrs. Gianforte, acting alone or together with some of ourother officers and directors, will be able to control all matters requiringstockholder approval, including the election of directors, management changesand approval of significant corporate transactions. This concentration ofownership may have the effect of delaying, preventing or deterring a change incontrol of RightNow, could deprive our stockholders of an opportunity toreceive a premium for their common stock as part of a sale of RightNow andmight reduce the market price of our common stock.

Inaddition, Mr. Gianforte beneficially owns, directly or indirectly, a 50%membership interest in Genesis Partners, LLC, our landlord from whom we leaseour principal offices in Bozeman, Montana. Consequently, Mr. Gianforte hassignificant control over any decisions by Genesis Partners regarding renewal,modification or termination of our Bozeman, Montana leases. In the event thatour current leases with Genesis Partners were terminated or otherwise could notbe renewed, or came up for renewal on commercially unreasonable terms, we wouldbe required to find alternative office space to lease or buy.

***Anti-takeover provisions in our charterdocuments and Delaware law could discourage, delay or prevent a change incontrol of our company and may affect the trading price of our common stock.***

Provisionsof our certificate of incorporation and bylaws and Delaware law may discourage,delay or prevent a merger or acquisition that a stockholder may considerfavorable and may limit the market price of our common stock. These provisionsinclude the following:

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

·                  authorizingthe board to issue preferred stock;

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

·                  limitingthe persons who may call special meetings of stockholders;

·                  prohibitingcertain transactions under certain circumstances with interested stockholders;

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

·                  prohibitingstockholder action by written consent.

It ispossible that the provisions contained in our certificate of incorporation andbylaws, the existence of super voting rights held by insiders and the abilityof our board of directors to issue preferred stock without stockholder actionmay have the effect of delaying, deferring or preventing a change in control ofour company without further action by the stockholders, may discourage bids forour common stock at a premium over the market price of our common stock and mayadversely affect the market price of our common stock and the voting and otherrights of the holders of our common stock.

***Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds***

**(a)****                                 Salesof Unregistered Securities**

None.

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**(b)           Use of Proceeds from Sales ofRegistered Securities**

OnAugust 5, 2004, the Securities and Exchange Commission declared effective ourRegistration Statement on From S-1 (Reg. File No. 333-115331) under theSecurities Act of 1933, as amended, in connection with the initial publicoffering of our common stock, par value $.0001 per share.  Of the 7,245,000 shares registered under theregistration statement for an aggregate offering price of $50,715,000, we sold6,416,961 shares, including shares sold upon exercise of the underwriters’over-allotment option, for an aggregate offering price of $44,918,727, and321,945 shares, including shares sold upon exercise of the underwriters’over-allotment option, were sold by a selling stockholder for an aggregateoffering price of $2,253,615.  Afterdeducting $3.3 million in underwriting discounts and commissions and $1.8million in other offering costs, we received net proceeds from the offering ofapproximately $40 million.  None of theexpenses and none of our net proceeds from the offering were paid directly or indirectlyto any director, officer, general partner of RightNow or their associates,persons owning 10% or more of any class of equity securities of RightNow, or anaffiliate of RightNow.

In May2005, we spent $1 million of the offering proceeds for the acquisition of theassets of Convergent Voice.  In May 2006,we spent approximately $8.7 million of the offering proceeds to acquireSalesnet, Inc.  We currently intend touse the remaining proceeds for general corporate purposes as described in theprospectus for the offering.  Pendingthese uses, the net proceeds from the offering are invested in short-term,interest-bearing, investment-grade securities.

**(c)           Not applicable.**

***Item 3.  Defaults Upon Senior Securities.***

None.

***Item 4.  Submission of Matters to a Vote of SecurityHolders.***

None.

***Item 5.  Other Information.***

None.

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**Item 6.  Exhibits**

***Exhibits***

Theexhibits listed below are part of this Form 10-Q, unless otherwise indicated.
| Exhibit 3.1†  | Amended and  Restated Certificate of Incorporation of the Registrant.                                                                                                                                   |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 3.2*       | Amended and  Restated Bylaws of the Registrant.                                                                                                                                                         |
| Exhibit  10.9**(1) | Form of  Executive Officer Offer Letter and schedule of omitted material details  thereto.                                                                                                              |
| Exhibit 31.1       | Certification of  Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15(d)-14(a),  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                |
| Exhibit 31.2       | Certification of  Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or  15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                               |
| Exhibit 32.1       | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 (furnished herewith). |

 

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| † | Incorporated by  reference to Exhibit 4.2 to the Company’s registration statement on Form S-8  (File No. 333-118515) filed with the Securities and Exchange Commission on  August 24, 2004.                                                                                                                                                                                                                                                                                                                                     |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *      | Incorporated by  reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File  No. 000-31321) filed with the Securities and Exchange Commission on January  25, 2006.                                                                                                                                                                                                                                                                                                                                             |
| **     | Incorporated by  reference to the exhibit of the same number from the Company’s registration  statement on Form S-1 (File No. 333-115331) initially filed with the  Securities and Exchange Commission on May 10, 2004, as amended, and to  Exhibit 10.19 to the Company’s Current Report on Form 8-K filed with the  Securities and Exchange Commission on April 18, 2006, and to Exhibit 10.22 to  the Company’s Current Report on Form 8-K filed with the Securities and  Exchange Commission on October 10, 2006. |
| (1)    | Denotes  management contract or compensatory plan or arrangement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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**SIGNATURE**

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the Registranthas duly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

Dated:  November 9, 2006

**RightNowTechnologies, Inc.**

(Registrant)
| By:    | /s/ Susan J.  Carstensen                     |   |
|--------|----------------------------------------------|--------|
|   | Susan J. Carstensen                          |
|   | Chief Financial Officer, Vice President,     |
|   | Treasurer and Assistant Secretary            |
|   | (Principal Financial and Accounting Officer) |

 

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