**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

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**FORM 10-Q**

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**(Mark One)**

**x****                          QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

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

**OR**

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

**For the transition period from             to             **

**CommissionFile No. 000-30901**

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**SUPPORTSOFT, INC.**(Exact Name of Registrant as Specified in Its Charter)
| **Delaware**                                                    | **94-3282005**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) | (I.R.S. Employer  Identification No.) |

**575BroadwayRedwood City, CA 94063**(Address of Principal Executive Offices)****(Zip Code)

Registrant’sTelephone Number, Including Area Code: **(650) 556-9440**

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Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90days.    Yes  x    No  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):
| Large accelerated  filer  o | Accelerated  filer  x | Non-accelerated  filer  o |
|---------------------------------------|---------------------------------|-------------------------------------|

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act.):    Yes  o    No  x

On October 27, 2006, 44,442,358 shares of theRegistrant’s Common Stock, $0.0001 par value, were outstanding.

 

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**SUPPORTSOFT,INC.**

**FORM 10-Q**

**QUARTERLYPERIOD ENDED SEPTEMBER 30, 2006**

**INDEX**
|                                | ** **                                                                                                        | **Page** |
|--------------------------------|-------------------------------------------------------------------------------------------------------------------|----------|
| Part  I: Financial Information |                                                                                                              |     |
| Item 1:                   | Financial Statements  (Unaudited)                                                                                 |     | 3 |
|                           | Condensed  Consolidated Balance Sheets at September 30, 2006 and December 31, 2005                                |     | 3 |
|                           | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2006 and 2005 |     | 4 |
|                           | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2006 and 2005            |     | 5 |
|                           | Notes to Condensed Consolidated Financial Statements                                                              |     | 6 |
| Item 2:                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |     | 15 |
| Item 3:                   | Quantitative  and Qualitative Disclosures About Market Risk                                                       |     | 21 |
| Item 4:                   | Controls and Procedures                                                                                           |     | 22 |
| Part  II: Other Information    |                                                                                                              | 22       |
| Item 1:                   | Legal Proceedings                                                                                                 |     | 22 |
| Item 1A:                  | Risk  Factors                                                                                                     |     | 23 |
| Item 4:                   | Submission  of Matters to a Vote of Security Holders                                                              |     | 31 |
| Item 5:                   | Other Information                                                                                                 |     | 31 |
| Item 6:                   | Exhibits                                                                                                          |     | 32 |
| Signature                      |                                                                                                              | 33       |
| Exhibit Index             |                                                                                                              | 34       |

 

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**PART I. FINANCIAL INFORMATION**

**ITEM 1: FINANCIAL STATEMENTS**

**SUPPORTSOFT, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(In thousands)**
|                                                      | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                      |       |                         |       |                        |       |
| Cash and cash  equivalents                           |       | $                            | 18,495     |                        | $          | 23,342 |   |
| Marketable securities                                |       | 103,989                      |       | 97,321                      |       |
| Accounts receivable,  net                            |       | 7,038                        |       | 17,437                      |       |
| Prepaids and other  current assets                   |       | 2,644                        |       | 2,451                       |       |
| Total current assets                                 |       | 132,166                      |       | 140,551                     |       |
| Property and equipment,  net                         |       | 928                          |       | 1,211                       |       |
| Goodwill                                             |       | 9,792                        |       | 9,792                       |       |
| Intangible assets, net                               |       | 3,177                        |       | 3,994                       |       |
| Other assets                                         |       | 441                          |       | 701                         |       |
|                                                 |       |                         |       |                        |       |
| **Total assets**                                     |       | $                            | 146,504    |                        | $          | 156,249 |   |
|                                                 |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**       | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                 |       |                         |       |                        |       |
| Accounts payable                                     |       | $                            | 210        |                        | $          | 1,030 |   |
| Accrued compensation                                 |       | 1,680                        |       | 2,669                       |       |
| Other accrued  liabilities                           |       | 3,382                        |       | 2,985                       |       |
| Deferred revenue, less  long-term portion            |       | 10,291                       |       | 14,060                      |       |
| Total current  liabilities                           |       | 15,563                       |       | 20,744                      |       |
| Deferred  revenue—long-term portion             |       | 299                          |       | 969                         |       |
| Other long-term  liabilities                         |       | 173                          |       | 142                         |       |
| Contingencies                                        |       |                         |       |                        |       |
| Stockholders’ equity:                           |       |                         |       |                        |       |
| Common stock                                         |       | 4                            |       | 4                           |       |
| Additional paid-in  capital                          |       | 200,250                      |       | 195,990                     |       |
| Accumulated other  comprehensive loss                |       | (675                         | )          | (645                        | )          |
| Accumulated deficit                                  |       | (69,110                      | )          | (60,955                     | )          |
| Total stockholders’  equity                     |       | 130,469                      |       | 134,394                     |       |
| **Total liabilities and  stockholders’ equity** |       | $                            | 146,504    |                        | $          | 156,249 |   |

See accompanying notes.

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**SUPPORTSOFT, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)(Unaudited)**
|                                                                                                                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:                                                                                                                                         |       |                                                 |       |                                                |       |   |   |   |   |
| License fees                                                                                                                                     |       | $                                                    | 4,479      |                                                | $          | 5,404 |   | $ | 10,013 |   | $ | 23,751 |   |
| Services                                                                                                                                         |       | 7,379                                                |       | 7,582                                               |       | 20,846 |   | 22,369 |   |
| Total revenue                                                                                                                                    |       | 11,858                                               |       | 12,986                                              |       | 30,859 |   | 46,120 |   |
| Costs and expenses:                                                                                                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of license fees                                                                                                                             |       | 119                                                  |       | 123                                                 |       | 333 |   | 440 |   |
| Cost of services  (including stock-based compensation of $87 and $210 for the three and nine  months ended September 30, 2006)              |       | 3,955                                                |       | 3,530                                               |       | 10,442 |   | 10,640 |   |
| Amortization of intangible  assets                                                                                                               |       | 272                                                  |       | 272                                                 |       | 816 |   | 816 |   |
| Research and  development (including stock-based compensation of $83 and $301 for the three  and nine months ended September 30, 2006)      |       | 2,267                                                |       | 2,700                                               |       | 7,125 |   | 8,535 |   |
| Sales and marketing  (including stock-based compensation of $219 and $592 for the three and nine  months ended September 30, 2006)          |       | 6,013                                                |       | 5,304                                               |       | 16,993 |   | 18,369 |   |
| General and  administrative (including stock-based compensation of $415 and $1,224 for the  three and nine months ended September 30, 2006) |       | 2,689                                                |       | 2,110                                               |       | 7,677 |   | 6,437 |   |
| Total costs and  expenses                                                                                                                        |       | 15,315                                               |       | 14,039                                              |       | 43,386 |   | 45,237 |   |
| Income (loss) from  operations                                                                                                                   |       | (3,457                                               | )          | (1,053                                              | )          | (12,527 | ) | 883 |   |
| Interest income and  other, net                                                                                                                  |       | 1,842                                                |       | 909                                                 |       | 4,705 |   | 2,523 |   |
| Income (loss) before  income taxes                                                                                                               |       | (1,615                                               | )          | (144                                                | )          | (7,822 | ) | 3,406 |   |
| (Provision) benefit for  income taxes                                                                                                            |       | (72                                                  | )          | 59                                                  |       | (333 | ) | (126 | ) |
| Net income (loss)                                                                                                                                |       | $                                                    | (1,687     | )                                                   | $          | (85 | ) | $ | (8,155 | ) | $ | 3,280 |   |
| Basic net income (loss)  per share                                                                                                               |       | $                                                    | (0.04      | )                                                   | $          | (0.00 | ) | $ | (0.19 | ) | $ | 0.08 |   |
| Shares used in  computing basic net income (loss) per share                                                                                      |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 42,914 |   |
| Diluted net income  (loss) per share                                                                                                             |       | $                                                    | (0.04      | )                                                   | $          | (0.00 | ) | $ | (0.19 | ) | $ | 0.07 |   |
| Shares used in computing diluted net income (loss) per share                                                                                     |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 44,629 |   |

See accompanying notes.

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**SUPPORTSOFT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)(Unaudited)**
|                                                                                                      | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Operating Activities:                                                                                |       |                                                |       |   |   |
| Net income (loss)                                                                                    |       | $                                                   | (8,155     | ) | $ | 3,280 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                                                       |       | 761                                                 |       | 845 |   |
| Amortization of  intangible assets                                                                   |       | 817                                                 |       | 817 |   |
| Stock-based  compensation                                                                            |       | 2,327                                               |       | — |   |
| Other                                                                                                |       | 57                                                  |       | 154 |   |
| Changes in assets and  liabilities:                                                                  |       |                                                |       |   |   |
| Accounts receivable,  net                                                                            |       | 10,399                                              |       | (3,296 | ) |
| Prepaids and other  current assets                                                                   |       | (193                                                | )          | 791 |   |
| Other long-term assets                                                                               |       | 260                                                 |       | (340 | ) |
| Accounts payable                                                                                     |       | (820                                                | )          | 484 |   |
| Accrued compensation                                                                                 |       | (988                                                | )          | (979 | ) |
| Other accrued  liabilities                                                                           |       | 396                                                 |       | (68 | ) |
| Other long-term  liabilities                                                                         |       | 31                                                  |       | — |   |
| Deferred revenue                                                                                     |       | (4,439                                              | )          | (5,178 | ) |
| Net cash provided by  (used in) operating activities                                                 |       | 453                                                 |       | (3,490 | ) |
|                                                                                                 |       |                                                |       |   |   |
| Investing Activities:                                                                                |       |                                                |       |   |   |
| Purchases of property  and equipment                                                                 |       | (478                                                | )          | (939 | ) |
| Purchases of marketable  securities                                                                  |       | (52,946                                             | )          | (71,757 | ) |
| Sales and maturities of  marketable securities                                                       |       | 46,191                                              |       | 77,746 |   |
| Net cash provided by (used  in) investing activities                                                 |       | (7,233                                              | )          | 5,050 |   |
|                                                                                                 |       |                                                |       |   |   |
| Financing Activities:                                                                                |       |                                                |       |   |   |
| Proceeds from issuances  of common stock                                                             |       | 1,933                                               |       | 2,036 |   |
| Repurchase of common  stock                                                                          |       | —                                              |       | (922 | ) |
| Net cash provided by  financing activities                                                           |       | 1,933                                               |       | 1,114 |   |
| Net increase (decrease)  in cash and cash equivalents                                                |       | (4,847                                              | )          | 2,674 |   |
| Cash and cash  equivalents at beginning of period                                                    |       | 23,342                                              |       | 16,509 |   |
| Cash and cash  equivalents at end of period                                                          |       | $                                                   | 18,495     |   | $ | 19,183 |   |
|                                                                                                 |       |                                                |       |   |   |
| Supplemental schedule  of cash flow information:                                                     |       |                                                |       |   |   |
| Income taxes paid                                                                                    |       | $                                                   | 253        |   | $ | 114 |   |

See accompanying notes.

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**SUPPORTSOFT,INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(1) Significant Accounting Policies**

**Basis of Presentation**

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of SupportSoft, Inc. (the “Company”or “SupportSoft”) and its wholly-owned subsidiaries. All intercompany balancesand transactions have been eliminated. The balance sheet as of September 30,2006 and the statements of operations for the three and nine months ended September 30,2006 and 2005 and cash flows for the nine months ended September 30, 2006and 2005 are unaudited. In the opinion of management, these unaudited interimcondensed consolidated financial statements reflect all adjustments (consistingof normal recurring adjustments) that are necessary for a fair presentation ofthe results for and as of the periods shown. The results of operations for suchperiods are not necessarily indicative of the results expected for the fullfiscal year or for any future period. The condensed consolidated financialstatement information as of December 31, 2005 is derived from auditedfinancial statements as of that date. These unaudited interim condensedconsolidated financial statements should be read with the consolidatedfinancial statements and related notes included in the Company’s Annual Reporton Form 10-K, filed with the Securities and Exchange Commission onMarch 16, 2006.

**Use of Estimates and Reclassifications**

The preparation of interim condensed consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the amounts reported in the consolidated financialstatements and the accompanying notes. Actual results could differ materiallyfrom these estimates. In addition, certain amounts that were previouslyreported have been reclassified to conform to the current period presentation.

**Revenue Recognition**

We recognize revenue inaccordance with the American Institute of Certified Public Accountants’ (AICPA)Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended bySOP 98-4 and SOP 98-9. License revenue is recognized when all of the followingcriteria are met:

·                  Persuasiveevidence of an arrangement exists;

·                  Deliveryhas occurred;

·                  Collectionis considered probable; and

·                  Thefees are fixed or determinable.

SupportSoft considers all arrangements with paymentterms longer than 90 days not to be fixed or determinable. If the fee isdetermined not to be fixed or determinable, revenue is recognized as paymentsbecome due from the customer.

License revenue is comprised of fees for perpetualand term licenses of our software. Perpetual license revenue is recognizedusing the residual method described in SOP 98-9 for arrangements in whichlicenses are sold with multiple elements. We allocate revenue on these licensesbased upon the fair value of each undelivered element (for example, undeliveredmaintenance and support, consulting, and training). The determination of fairvalue is based upon vendor specific objective evidence (VSOE). VSOE formaintenance and support is determined based upon separate renewals ofmaintenance and support from customers. VSOE for training and consulting isbased upon separate sales of these services to customers. Assuming all otherrevenue recognition criteria are met, the difference between the totalarrangement fee and the amount deferred for each undelivered element isrecognized as license revenue. Our perpetual arrangements may includecontractual obligations such as rights to unspecified future products whichrequire license revenue to be taken ratably over the contract period.

Term licenses are sold with maintenance for whichSupportSoft does not have VSOE to determine fair value. As a result, licenserevenue for term licenses is recognized ratably over the duration of theagreement. License fees for term licenses include the right to support and maintenancefor the duration of the term license. We do not allocate maintenance revenuefrom term licenses to services revenue, as we do not believe there is anallocation methodology that provides a meaningful and supportable allocationbetween license and maintenance revenue. Consulting revenue associated with theterm licenses is recognized ratably over the period associated with the initialpayment, generally one year.

We also recognize license revenue from arrangementswith resellers. Revenue is recognized upon persuasive evidence that theproducts have been sold to an end user; and all other revenue recognitioncriteria are met.

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In connection with licensing arrangements wemay also provide hosting services, for which SupportSoft does not haveVSOE.  If hosting services are sold withperpetual licenses, license revenue is recognized ratably over the term of theinitial hosting contract.  Hostingservices revenue is also recognized ratably over the duration of the initialhosting contract.  Consulting servicessold in conjunction with arrangements that include licenses and hostingservices are recognized ratably over the duration of the initial hosting term.  Fees for hosting services and consulting servicesare recognized as services revenue in the Company’s consolidated statements ofoperations.

Services revenue is primarily comprised of revenuefrom professional services, such as maintenance and support, consulting andtraining. Arrangements that include services are evaluated to determine whetherthose services are essential to the functionality of other elements of the arrangement.Revenue from non-essential consulting and training services associated withperpetual licenses is generally recognized as the services are performed ormilestones are accepted by customers. When non-essential services are bundledin a term licensing arrangement, revenue from the services is recognizedratably over the period associated with the initial payment, generally oneyear. Maintenance and support revenue is recognized over the term of themaintenance and support period which is generally one year. In the eventservices are considered essential to the functionality of other elements of thearrangement, revenue under the arrangement is recognized using contractaccounting pursuant to SOP 81-1, Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts.

**Cash, CashEquivalents and Marketable Securities**

SupportSoft considers all liquid instruments with anoriginal maturity at the date of purchase of ninety days or less to be cashequivalents. At September 30, 2006, cash equivalents and marketablesecurities consisted primarily of money market funds, commercial paper, federalagency securities, corporate bonds and market auction securities. Ourmarketable securities are classified as available-for-sale as of the respectivebalance sheet dates, and are reported at fair value with unrealized gains andlosses included in accumulated other comprehensive income within stockholders’equity on the consolidated balance sheet. Realized gains and losses anddeclines in value judged to be other-than-temporary on available-for-salesecurities are included in other income (expense), net in the consolidatedstatement of operations.

The amortized cost of debt securities is adjustedfor amortization of premiums and accretion of discounts to maturity, both ofwhich are included in interest income. SupportSoft recorded net unrealizedlosses on available-for-sale securities of $29,000 and $117,000 at September 30,2006 and December 31, 2005, respectively.

We monitor our investments for impairment on aquarterly basis and determine whether a decline in fair value isother-than-temporary by considering factors such as current economic and marketconditions, the credit rating of the security’s issuer, the length of time aninvestment’s fair value has been below our carrying value, and our ability andintent to hold investments to maturity. If an investment’s decline in fairvalue is deemed to be other-than-temporary, we would reduce its carrying valueto its estimated fair value, as determined based on quoted market prices orliquidation values.

The following is a summary of cash, cash equivalentsand available-for-sale securities at September 30, 2006 (in thousands):
| ** **                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|---------------------------|------------|---------------------|------------|-------------------------------|------------|---------------------|------------|
| Cash                      |       | $                   | 4,808      |                          | $          | —              |       | $ | 4,808 |   |
| Money market funds        |       | 542                 |       | —                        |       | 542                 |       |
| Commercial paper          |       | 19,605              |       | (16                           | )          | 19,589              |       |
| Federal agency securities |       | 1,000               |       | (2                            | )          | 998                 |       |
| Corporate bonds           |       | 28,683              |       | (11                           | )          | 28,672              |       |
| Market auction securities |       | 67,875              |       | —                        |       | 67,875              |       |
|                      |       | $                   | 122,513    |                          | $          | (29                 | )          | $ | 122,484 |   |
|                      |       |                |       |                          |       |                |       |
| Classified as:            |       |                |       |                          |       |                |       |
| Cash and cash equivalents |       | $                   | 18,508     |                          | $          | (13                 | )          | $ | 18,495 |   |
| Marketable securities     |       | 104,005             |       | (16                           | )          | 103,989             |       |
|                      |       | $                   | 122,513    |                          | $          | (29                 | )          | $ | 122,484 |   |

 

**Concentrations of Credit Risk**

Financial instruments that potentially subjectSupportSoft to concentrations of credit risk consist principally of cashequivalents, marketable securities and trade accounts receivable. Ourinvestment portfolio is diversified and consists of investment gradesecurities. Our investment policy limits the amount of credit risk exposure toany one issuer and in any 

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single country except the United States. The creditrisk in our trade accounts receivable is mitigated by our credit evaluationprocess, reasonably short collection terms and sales primarily to largeorganizations in diversified industries.

For the three months ended September 30, 2006,one customer accounted for 21% of our total revenue. For the nine months endedSeptember 30, 2006, no customer accounted for 10% of our total revenue. For thethree months ended September 30, 2005, one customer accounted for 19% ofour total revenue. For the nine months ended September 30, 2005, twocustomers each accounted for 11% of our total revenue.

**TradeAccounts Receivable**

Trade accounts receivable are recorded at theinvoiced amount. We perform evaluations of our customers’ financial conditionand generally do not require collateral. We make judgments as to our ability tocollect outstanding receivables and provide allowances for the portion ofreceivables when collection becomes doubtful. Provisions are made based upon aspecific review of all significant outstanding invoices. For those invoices notspecifically provided for, provisions are recorded at differing rates, basedupon the age of the receivable. In determining these percentages, we analyzeour historical collection experience and current payment trends. If thehistorical data we use to calculate the allowance for doubtful accounts doesnot reflect the future ability to collect outstanding receivables, additionalprovisions for doubtful accounts may be needed and the future results ofoperations could be materially affected. At September 30, 2006 andDecember 31, 2005, the Company had reserves for credit losses of $276,000and $296,000, respectively. At September 30, 2006, two different customerseach accounted for 10% or more of total accounts receivable. These customersaccounted for 12% and 10% individually of our total accounts receivable, net.At December 31, 2005, two customers each accounted for 10% or more of ourtotal accounts receivable, net. These two customers each accounted for 20% ofour total accounts receivable, net.

**Stock-BasedCompensation**

*Adoptionof SFAS 123R*

On January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment,” (“SFAS 123R”) which requires the measurement and recognition ofcompensation expense for all share-based payment awards, including employeestock options and employee stock purchases, made to employees and directorsbased on estimated fair values. Prior to January 1, 2006, the Companyaccounted for share-based payments to employees using the intrinsic valuemethod under APB Opinion No. 25, as permitted by SFAS 123, and, as such,generally recognized no compensation cost for employee stock options oremployees stock purchases in its financial statements.

SupportSoft elected the modified prospectivetransition method for adopting SFAS 123R which required the application of theaccounting standard as of January 1, 2006, the first day of the Company’s2006 fiscal year. Under this transition method, compensation cost recognized inthe three and nine months ended September 30, 2006 includes the applicableamounts of: (a) compensation cost for all stock-based payments grantedprior to, but not yet vested as of, December 31, 2005 based on thegrant-date fair value estimated in accordance with the original provisions ofSFAS 123 and previously presented in the pro-forma footnote disclosures, and(b) compensation cost of all share-based payments granted subsequent toJanuary 1, 2006 based on the grant-date fair value estimated in accordancewith the new provisions of SFAS 123R. Prior periods have not been restated toreflect the impact of SFAS 123R.

*StockOption Plans*

During fiscal 1998, SupportSoft adopted the 1998Stock Option Plan (the “Plan”). Under this Plan, up to 9,424,434 shares ofSupportSoft’s common stock may be granted as options or sold to eligibleparticipants. Under the Plan, options to purchase common stock may be granted atno less than 85% of the fair value on the date of the grant (110% of fair valuein certain instances), as determined by the Board of Directors. Options underthe Plan can be immediately exercisable at the Board of Directors’ discretion;however, shares issued are subject to SupportSoft’s right to repurchase suchshares at the original issuance price, which lapses in a series of installmentsmeasured from the vesting commencement date of the option.

In February 2000, the Board of Directors approvedSupportSoft’s 2000 Omnibus Equity Incentive Plan (the “2000 Incentive Plan”). Atotal of 4,000,000 shares of common stock were initially reserved for issuanceto eligible participants under the 2000 Incentive Plan. On January 1 ofeach year, the number of shares reserved automatically increases by the lesserof 2,000,000 shares, 5% of outstanding shares, or an amount determined by theboard of directors. On January 1, 2006, the shares reserved under the 2000Incentive Plan were automatically increased by 2,000,000 shares. Under both ofSupportSoft’s option plans, options generally vest over a 48-month period fromthe date of grant and have a maximum term of 10 years. In the fourth quarter of2005, SupportSoft began issuing only non-statutory options with a contractualterm of 7 years.

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As of September 30, 2006 we had approximately 3.4 millionshares of common stock reserved for future issuance under both of these plans.

*EmployeeStock Purchase Plan*

In February 2000, the Board of Directors approvedSupportSoft’s 2000 Employee Stock Purchase Plan (the “2000 Purchase Plan”). Atotal of 2,000,000 shares of common stock were initially reserved for issuanceunder the 2000 Purchase Plan. On January 1 of each year, the number ofshares reserved automatically increases by the lesser of 2,000,000 shares, 3%of the outstanding shares, or an amount determined by the Board of Directors.For 2006, the Board of Directors elected to have zero shares added to the 2000Purchase Plan. The 2000 Purchase Plan permits eligible employees to acquireshares of SupportSoft’s common stock through periodic payroll deductions of upto 15% of total compensation. Purchases occur on the last day of each Januaryand July following the end of each six-month purchase period. The price atwhich the common stock may be purchased is 85% of the lesser of the fair marketvalue of SupportSoft’s common stock at the beginning of the applicable offeringperiod or the end of the applicable purchase period. Beginning August 1,2006, the offering period for all new participants in the 2000 Purchase Planwill be six months. Prior to August 1, 2006, all participants wereenrolled in offering periods which could last up to 24 months and contained upto four separate purchase periods.

As of September 30, 2006, we had approximately 1.9 millionshares of common stock reserved for future issuance under this plan.

**DeterminingFair Value**

*Valuation and Attribution Method*: SupportSoft estimates the fair value ofstock options granted generally using the Black-Scholes option pricing model.Stock options vest on a graded schedule, however the Company recognizes theexpense on a straight-line basis over the requisite service period of theentire award, net of estimated forfeitures and subject to the minimum expenserequirements of SFAS 123R. These limitations require that on any date thecompensation cost recognized is at least equal to the portion of the grant-datefair value of the award that is vested at that date.

*Risk-free Interest Rate*: The Company bases its risk-free interestrate upon the yield currently available on US Treasury zero coupon issues forthe expected term of the employee stock options.

*Expected Term*: The Company’s expected term represents theperiod that the Company’s stock options are expected to be outstanding and isdetermined based on historical experience of similar stock options consideringthe contractual terms of the stock options, vesting schedules and expectationsof future employee behavior.

*Expected Volatility*: The Company’s expected volatility representsthe amount by which the stock price is expected to fluctuate throughout theperiod that the stock option is outstanding. The Company bases its expectedvolatility on a weighted average calculation combining both historical andimplied volatilities as it believes that this combination is morerepresentative of future stock price trends than historical volatility alone.The implied volatility factor included in this computation is based upon tradedoptions on the Company’s stock.

*Estimated Forfeitures*: SFAS 123R requires that the stock optionexpense recognized be based on awards that are ultimately expected to vest, andtherefore a forfeiture rate should be applied at the time of grant and revised,if necessary, in subsequent periods when actual forfeitures differ from thoseestimates. Prior to January 1, 2006 the Company accounted for forfeituresonly as they occurred. Commencing in 2006, the Company has estimated itsforfeitures based on historical experience.

*Expected Dividend*: The Company uses a dividend yield of zero,as it has never paid cash dividends and currently does not expect to paydividends in the future.

9

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The fair value of the Company’s stock optionsgranted to employees during the three and nine months ended September 30,2006 and 2005 was estimated using the following assumptions:
| ** **                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006 **(1) | ** ** | **2005 **(1) | ** ** |
| **Stock Option Plan:**                   |       |                                                 |       |                                                |       |   |   |   |   |
| Risk-free interest rate                  |       | 4.7                                                  | %          | 4.1                                                 | %          | 4.5 | % | 3.9 | % |
|                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Expected term                            |       | 3.9 years                                       |       | 4.0 years                                      |       | 3.9 years |   | 4.0 years |   |
| Volatility                               |       | 54.6                                                 | %          | 73.3                                                | %          | 50.6 | % | 77.9 | % |
| Estimated forfeitures                    |       | 8                                                    | %          | 0                                                   | %          | 8 | % | 0 | % |
| Expected dividend                        |       | 0                                                    | %          | 0                                                   | %          | 0 | % | 0 | % |
| Weighted average fair value              |       | $                                                    | 1.81       |                                                | $          | 3.11 |   | $ | 1.92 |   | $ | 3.19 |   |
| **Employee Stock Purchase Plan (ESPP):** |       |                                                 |       |                                                |       |   |   |   |   |
| Risk-free interest rate                  |       | 4.7                                                  | %          | 3.8                                                 | %          | 4.7 | % | 3.4 | % |
| Expected term                            |       | 0.5 to 2.0 years                      |       | 0.5 to 2.0 years                     |       | 0.5 to 2.0 years |   | 0.5 to 2.0 years |   |
| Volatility                               |       | 54.1                                                 | %          | 71.0                                                | %          | 54.1 | % | 75.6 | % |
| Estimated forfeitures                    |       | 8                                                    | %          | 0                                                   | %          | 8 | % | 0 | % |
| Expected dividend                        |       | 0                                                    | %          | 0                                                   | %          | 0 | % | 0 | % |
| Weighted average  fair value             |       | $                                                    | 1.66       |                                                | $          | 2.52 |   | $ | 1.66 |   | $ | 2.77 |   |

 

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(1)                      The assumptions for the nine month periodrepresent weighted averages.

*TaxEffects of Share-Based Payments*

On November 10, 2005, the Financial AccountingStandards Board (FASB) issued FASB Staff Position No. SFAS-123R-3 “TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards”which provides for an alternative transition method to calculate the taxeffects of stock-based compensation expense pursuant to SFAS 123R. Thealternative transition method includes a simplified approach to establish thebeginning balance of the additional paid-in-capital pool related to the taxeffects of employee stock-based compensation, and to determine the subsequent impacton the additional paid-in-capital pool and cash flows for the tax effects ofemployee stock-based compensation awards that are outstanding upon the adoptionof SFAS 123R. As of September 30, 2006, the Company was still evaluatingwhich transition method to adopt.

*StockCompensation Expense*

The Company recorded the following stock-basedcompensation expense for the three and nine months ended September 30,2006 (in thousands):
|                                                                        | ** ** | **Three months ended  September 30, 2006** | ** ** | **Nine months ended  September 30, 2006** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Stock option compensation expense recognized in:                       |       |                                                           |       |                                                          |       |
| Cost of services                                                       |       | $                                                              | 62         |                                                          | $          | 147 |   |
| Research and development                                               |       | 65                                                             |       | 210                                                           |       |
| Sales and marketing                                                    |       | 196                                                            |       | 490                                                           |       |
| General and administrative                                             |       | 400                                                            |       | 1,172                                                         |       |
|                                                                   |       | 723                                                            |       | 2,019                                                         |       |
|                                                                   |       |                                                           |       |                                                          |       |
| ESPP compensation expense recognized in:                               |       |                                                           |       |                                                          |       |
| Cost of services                                                       |       | 25                                                             |       | 63                                                            |       |
| Research and development                                               |       | 18                                                             |       | 91                                                            |       |
| Sales and marketing                                                    |       | 23                                                             |       | 102                                                           |       |
| General and administrative                                             |       | 15                                                             |       | 52                                                            |       |
|                                                                   |       | 81                                                             |       | 308                                                           |       |
|                                                                   |       |                                                           |       |                                                          |       |
| Stock-based  compensation expense included in total costs and expenses |       | $                                                              | 804        |                                                          | $          | 2,327 |   |

 

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For the three and nine months ended September 30,2006, the Company recorded $804,000 and $2.3 million respectively instock-based compensation expense. There was no stock-based compensation expenserecognized for the three and nine months ended September 30, 2005.

For the nine months ended September 30, 2006,there was $238,000, of the total stock-based compensation expense related tothe acceleration of the stock options awarded to the Company’s former chiefexecutive officer in connection with a transition agreement datedMarch 12, 2006. Pursuant to the terms of this agreement, provided theformer CEO remained an employee of the Company, on the date the Board ofDirectors appointed a new CEO, all then outstanding and unvested options wouldbe immediately vested. A new CEO was appointed on April 6, 2006 andvesting of 115,625 shares was accelerated. This acceleration represents amodification of the original terms of the awards. The cost of this modificationwas determined to be $238,000, all of which has been recognized at the end ofthe second quarter of 2006. There was no stock-based compensation expenserelated to this recognized in the third quarter of 2006.

As a result of adopting SFAS 123R, the Company’sloss before income taxes and net loss for the three months ended September 30,2006 was $804,000 higher than if it had continued to account for share-basedcompensation under APB 25. Basic and diluted loss per share for the threemonths ended September 30, 2006 would have both been $0.02 lower if theCompany had not adopted SFAS 123R.

Similarly, the Company’s loss before income taxesand net loss for the nine months ended September 30, 2006 was $2.3  million higher than if it had continued toaccount for share-based compensation under APB 25. Basic and diluted loss pershare for the nine months ended September 30, 2006 would have both been$0.06 lower if the Company had not adopted SFAS 123R.

Net cash proceeds from the exercise of stock optionswere $382,000 and $1.4 million for the three and nine months ended September 30,2006 respectively. No income tax benefit was realized from stock optionexercises during the three and nine months ended September 30, 2006.

The table below reflects the net loss and loss pershare for the three and nine months ended September 30, 2006 compared withthe pro-forma information for the three and nine months ended September 30,2005 (in thousands):
| ** **                                                                          | ** ** | **For the three months ended  September 30,** | ** ** | **For the nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2006**                                                               | ** ** | **2005 **(2)                                                     | ** ** | **2006** | ** ** | **2005 **(2) | ** ** |
| Net income (loss) – as reported for the prior period                           |       | N/A                                                                    | (1)        | $                                                                     | (85        | ) | N/A | (1) | $ | 3,280 |   |
| Stock-based compensation expense relating to:                                       |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Stock options                                                                       |       | (723                                                                   | )          | (2,005                                                                | )          | (2,019 | ) | (6,060 | ) |
| ESPP stock purchases                                                                |       | (81                                                                    | )          | (56                                                                   | )          | (308 | ) | (369 | ) |
| Net loss, including the effect of stock-based  compensation expense                 |       | $                                                                      | (1,687     | )                                                                     | $          | (2,146 | ) | $ | (8,155 | ) | $ | (3,149 | ) |
| Basic net income per share – as reported for the  prior period                 |       | N/A                                                                    | (1)        | $                                                                     | 0.00       |   | N/A | (1) | $ | 0.08 |   |
| Basic net loss per  share – including the effect of stock-based compensation   |       | $                                                                      | (0.04      | )                                                                     | $          | (0.05 | ) | $ | (0.19 | ) | $ | (0.07 | ) |
| Diluted net income per share – as reported for the  prior period               |       | N/A                                                                    | (1)        | $                                                                     | 0.00       |   | N/A | (1) | $ | 0.07 |   |
| Diluted net loss per share – including the effect of  stock-based compensation |       | $                                                                      | (0.04      | )                                                                     | $          | (0.05 | ) | $ | (0.19 | ) | $ | (0.07 | ) |

 

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(1)       Net income and net income per share prior toJanuary 1, 2006 did not include stock-based compensation expense for stockoptions and employee stock purchases under SFAS 123 because the Company had notadopted the recognition provisions of SFAS 123.

(2)       Stock-based compensation expense, net income (loss)and net income (loss) per share prior to January 1, 2006 is calculatedbased on the pro-forma application of SFAS 123.

Prior to the adoption of SFAS 123R, our Board ofDirectors approved the acceleration of vesting of certain unvested andout-of-money stock options with exercise prices equal to or greater than $5.00per share previously awarded to employees, including executive officers, underour equity compensation plans. The acceleration of vesting was effective forstock options outstanding as of December 21, 2005. Options to purchaseapproximately 3.0 million shares of common stock or 32% of our then outstandingunvested stock options were subject to this acceleration. The weighted averageprice of the options that were accelerated was $7.02. The options acceleratedexcluded options previously granted to Board of Directors, employees who hadterminations pending and foreign employees who opted out of the accelerationfor tax reasons. For all officers and vice-presidents (non-officers) theacceleration was accompanied by restrictions imposed on any shares that may inthe future be purchased through the exercise of accelerated stock options.Those restrictions prevent the sale of any such shares prior to the date suchshares would have originally vested had the optionee been employed on such date(whether or not the optionee is actually an employee at that time). The purposeof the acceleration was to enable us to avoid recognizing compensation expenseassociated with these options in our Consolidated Statements of Operations uponthe adoption of SFAS 123R on January 1, 2006. The acceleration of thevesting of these stock options resulted in an approximate total savings of$12.0 million of future compensation expense that would have impacted expensesthrough the third quarter of 2009.

*StockOption Activity*

The following table represents stock option activityfor the nine months ended September 30, 2006:

11

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| ** **                                          | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value  (in ‘000’s)** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| Outstanding  options at the beginning of the period |       | 10,124,138                 |       | $                                          | 6.304      |                                                |       |                                                            |       |   |
| Granted                                             |       | 4,115,200                  |       | 4.082                                      |       |                                                |       |                                                            |       |
| Exercised                                           |       | (469,544                   | )          | 4.160                                      |       |                                                |       |                                                            |       |
| Forfeited                                           |       | (1,880,638                 | )          | 7.603                                      |       |                                                |       |                                                            |       |
|                                                |       |                       |       |                                       |       |                                                |       |                                                            |       |
| Outstanding  options at the end of the period       |       | 11,889,156                 |       | $                                          | 5.590      |                                                | 6.60       |                                                            | $          | 4,445,558 |   |
|                                                |       |                       |       |                                       |       |                                                |       |                                                            |       |
| Options vested  and expected to vest                |       | 11,810,111                 |       | $                                          | 5.600      |                                                | 6.60       |                                                            | $          | 4,422,866 |   |
|                                                |       |                       |       |                                       |       |                                                |       |                                                            |       |
| Outstanding exercisable  at the end of the period   |       | 7,787,283                  |       | $                                          | 6.330      |                                                | 6.60       |                                                            | $          | 3,359,070 |   |

The aggregate intrinsic value in the table aboverepresents the total pre-tax intrinsic value that would have been received bythe option holders had they all exercised their options on September 30,2006. This amount will change based on the fair market value of the Company’sstock. During the three and nine months ended September 30, 2006, theaggregate intrinsic value of options exercised under the Company’s stockoptions plans was $147,000 and $538,000, respectively. Total fair value ofoptions vested during the three and nine months ended September 30, 2006was $733,000 and $2.1 million, respectively.

At September 30, 2006, there was $8.7 millionof unrecognized compensation cost related to existing options outstanding as ofSeptember 30, 2006 which is expected to be recognized over a weighted averageperiod of 3.4 years.

**Net Income(Loss) Per Share**

Basic and diluted net income (loss) per share arepresented in accordance with Statement of Financial Accounting StandardsNo. 128, “Earnings per Share” (“SFAS 128”), for all periods presented. Inaccordance with SFAS 128, basic and diluted net loss per share have beencomputed using the weighted-average number of common shares outstanding duringthe period.

The following table sets forth the computation ofbasic and diluted net income (loss) per share (in thousands, except per sharedata):
| ** **                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss)                                     |       | $                                                    | (1,687     | )                                                   | $          | (85 | ) | $ | (8,155 | ) | $ | 3,280 |   |
| Basic:                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average  shares of common stock outstanding   |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 42,914 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Shares used in  computing basic net income per share   |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 42,914 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic net income  (loss) per share                     |       | $                                                    | (0.04      | )                                                   | $          | (0.00 | ) | $ | (0.19 | ) | $ | 0.08 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted:                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average  shares of common stock outstanding   |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 42,914 |   |
| Add: Common  equivalent shares outstanding             |       | —                                               |       | —                                              |       | — |   | 1,715 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Shares used in  computing diluted net income per share |       | 44,152                                               |       | 43,001                                              |       | 44,000 |   | 44,629 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted net income  (loss) per share:                  |       | $                                                    | (0.04      | )                                                   | $          | (0.00 | ) | $ | (0.19 | ) | $ | 0.07 |   |

**Warranties and Indemnifications**

SupportSoft generally provides a warranty for itssoftware products and services to its customers and accounts for its warrantiesunder the FASB’s Statement of Financial Accounting Standards No. 5, “Accountingfor Contingencies” (“SFAS 5”). Our standard warranty period is 90 days,but warranty periods can sometimes be longer and vary from customer tocustomer. In the event there is a failure of the product in breach of suchwarranties, SupportSoft generally is obligated to correct the product orservice to conform to the warranty provision or, if SupportSoft is unable to doso, the customer is entitled to seek a refund of the purchase price of theproduct or service. SupportSoft did not provide for a warranty accrual as of September 30,2006 or December 31, 2005. To date, SupportSoft’s product warranty expensehas not been significant.

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SupportSoft generally agrees to indemnify itscustomers against legal claims that SupportSoft’s software products infringecertain third-party intellectual property rights and accounts for itsindemnification obligations under SFAS 5. To date, SupportSoft has not beenrequired to make any payment resulting from infringement claims assertedagainst our customers and has not recorded any related accruals.

**RecentAccounting Pronouncements**

In June 2006, the Financial AccountingStandards Board (FASB) issued Interpretation No. 48 (FIN 48), “Accounting forUncertainty in Income Taxes.” This Interpretation clarifies the accounting foruncertainty in income taxes recognized in a company’s financial statements inaccordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribesa  recognition and measurement thresholdand measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN 48 is effective for fiscal years beginning after December 15, 2006. TheCompany is currently evaluating the effects that FIN 48 may have on itsaccounting for income tax practices.

**(2)Comprehensive Income (Loss)**

Statement of Financial Accounting StandardsNo. 130, “Reporting Comprehensive Income” (“SFAS 130”) establishesstandards for reporting and displaying comprehensive net income and itscomponents in stockholders’ equity. However, it has no impact on our net incomeor loss as presented in our financial statements. SFAS 130 requires foreigncurrency translation adjustments and changes in the fair value ofavailable-for-sale securities to be included in comprehensive income or loss.

The following are thecomponents of comprehensive income (loss) (in thousands):
|                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income  (loss)                                           |       | $                                                    | (1,687     | )                                                   | $          | (85 | ) | $ | (8,155 | ) | $ | 3,280 |   |
| Net unrealized  gain (loss) on available-for-sale securities |       | 72                                                   |       | 38                                                  |       | 87 |   | 134 |   |
| Foreign currency  translation gain (loss)                    |       | 46                                                   |       | 132                                                 |       | (118 | ) | (311 | ) |
| Comprehensive income  (loss)                                 |       | $                                                    | (1,569     | )                                                   | $          | 85 |   | $ | (8,186 | ) | $ | 3,103 |   |

The components of accumulated other comprehensiveincome (loss) relate entirely to translation adjustment gains and losses andunrealized gains and losses on available-for-sale securities and are $(646,000)and $(29,000) at September 30, 2006, respectively.

**(3) IncomeTaxes**

We recorded income tax provisions of $72,000 and $333,000for the three and nine months ended September 30, 2006, respectively.These provisions primarily reflect foreign income taxes and foreign withholdingtaxes. For the three months ended September 30, 2005, we recorded a benefitfor income taxes of approximately $59,000. The income tax benefit reflects a reductionof projected annual income in the third quarter of 2005.  For the nine months ended September 30, 2005,we recorded a provision of $126,000 which primarily reflects foreign taxes.

As of September 30, 2006, our deferred taxassets are fully offset by a valuation allowance. The Financial AccountingStandards Board’s Statement of Financial Accounting Standards No. 109 “Accountingfor Income Taxes,” provides for the recognition of deferred tax assets if realizationof such assets is more likely than not. Based upon the weight of availableevidence, which includes SupportSoft’s historical operating performance,reported cumulative net losses since inception and difficulty in accuratelyforecasting our future results, the Company provided a full valuation allowanceagainst its net deferred tax assets. We reassess the need for our valuationallowance on a quarterly basis. If it is later determined that a portion of thevaluation allowance should be reversed it will be a benefit to the income taxprovision.

**(4)Contingencies**

*LegalMatters*

Except as noted below, there are no material changesin the status of our legal proceedings from those described in our AnnualReport on Form 10-K for the year ended December 31, 2005, as updated in ourQuarterly Reports on Form 10-Q for the quarters ended March 31, 2006 and June30, 2006.

*In re SupportSoft, Inc. SecuritiesLitigation* is aconsolidated complaint filed in the United Stated District Court of theNorthern District of California against the Company, our former CEO and formerCFO. The complaint generally alleges 

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violations of certain federal securities law andseeks unspecified damages. On May 31, 2006, this action was certified toproceed as a class action on behalf of all persons and entities who purchasedor otherwise acquired the securities of the Company from January 29, 2004 toOctober 1, 2004 and who were allegedly damaged thereby.

*White v. Base et al.*is a derivative shareholder complaint filedin the Superior Court of the State of California for the County of San Mateo.This complaint was filed on behalf of the Company as a nominal defendantagainst certain of our directors and former directors and alleges that thedirector defendants harmed the Company by making or permitting the Company tomake false and misleading statements between January 20, 2004 and October 1,2004. On September 25, 2006, the court denied Defendants’ demurrer to theplaintiffs’ First Amended Complaint.  Defendants’ answer is due on November 6, 2006.

We are also subject to other routine legalproceedings, as well as demands, claims and threatened litigation, that arisein the normal course of our business. The ultimate outcome of any litigation isuncertain, and either unfavorable or favorable outcomes could have a materialnegative impact. Regardless of outcome, litigation can have an adverse impacton SupportSoft because of defense costs, diversion of management resources andother factors.

*Taxes*

We are required to make periodic filings in thestates where we are deemed to have a presence for tax purposes. We haveundergone state audits in the past and have paid assessments arising from theseaudits. To date, such amounts have not been material. We evaluate estimatedlosses that could arise from similar assessments in accordance with Statementof Financial Accounting Standard No. 5, “Accounting for Contingencies.” Weconsider such factors as the degree of probability of an unfavorable outcomeand the ability to make a reasonable estimate of the amount of loss.

**(5)Restructuring Obligations and Other Charges**

In the fourth quarter of 2005, SupportSoft’smanagement performed a review of its business operations and realigned itsresources and go-to-market strategies to help maximize future revenueopportunities. As a result of this business review, the Company implemented arestructuring plan that included the termination of 27 employees and closure ofvarious offices worldwide. All of the employees included in the restructuringwere terminated as of December 31, 2005. As a result of the restructuringplan, the Company recorded a restructuring charge of $645,000 for severancecosts and lease termination-related costs during the fourth quarter of 2005.

In the third quarter of 2006, in connection with abusiness review conducted by SupportSoft’s new Chief Executive Officer, theCompany reduced its workforce by 25 employees, or approximately 10% of itsworkforce at that time. As a result, the Company recorded a restructuringcharge of $756,000 in the third quarter of 2006. The restructuring charge wascomprised entirely of severance costs and other personnel-related terminationcosts. Restructuring expenses included in the Consolidated Statements ofOperations for the three and nine months ended September 30, 2006 were $184,000for cost of services, $40,000 for research and development, $338,000 for salesand marketing and $194,000 for general and administrative. Cash payments of$468,000 were made against those obligations during the third quarter of 2006.

The obligations at September 30, 2006 aresummarized in the following table (in thousands):
| ** **                                          | ** ** | **Severance **(1) | ** ** | **Facilities **(2) | ** ** | **Total** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-------------------------|------------|-----------|------------|
| Restructuring  costs                                |       | $                      | 456        |                    | $          | 189       |       | $ | 645 |   |
| Cash payments                                       |       | (346                   | )          | (34                     | )          | (380      | )          |
|                                                |       |                   |       |                    |       |      |       |
| Restructuring  obligations, December 31, 2005  |       | $                      | 110        |                    | $          | 155       |       | $ | 265 |   |
| Cash payments                                       |       | (110                   | )          | (102                    | )          | (212      | )          |
|                                                |       |                   |       |                    |       |      |       |
| Restructuring  obligations, March 31, 2006     |       | $                      | —     |                    | $          | 53        |       | $ | 53 |   |
| Cash payments                                       |       | —                 |       | (53                     | )          | (53       | )          |
|                                                |       |                   |       |                    |       |      |       |
| Restructuring  obligations, June 30, 2006      |       | $                      | —     |                    | $          | —    |       | $ | — |   |
| Restructuring  costs                                |       | 756                    |       | —                  |       | —    |       |
| Cash payments                                       |       | (468                   | )          | —                  |       | —    |       |
| Restructuring  obligations, September 30, 2006 |       | $                      | 288        |                    | $          | —    |       | $ | — |   |

 

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(1)       Severance costs include those expensesrelated to severance pay and related employee benefit obligations.

(2)       Facilities costs include obligations undernon-cancelable leases for facilities that we will no longer occupy, as well aspenalties associated with early terminations of leases and disposal of fixedassets. The related leases are short term in nature expiring in less than one year.No sublease income has been included.

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**ITEM 2: MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations should be read together with theunaudited condensed consolidated financial statements and related notesappearing in Item 1 of this report on Form 10-Q and the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements and related notes included in SupportSoft’sAnnual Report on Form 10-K for the year ended December 31, 2005.

**This report on Form 10-Q containsforward-looking statements. These statements relate to our future plans,objectives, expectations, intentions and financial performance, as well asstatements regarding our plans to introduce consumer technology supportservices****.**** ****Forward-looking statements are subject to risks and uncertainties thatcould cause actual results to differ materially from those discussed in theseforward-looking statements. These risks and uncertainties include, but are notlimited to, our ability to achieve broad adoption and acceptance of ourofferings, the potential for a decrease in revenue caused by our reliance on afew large transactions in any period, long sales cycles, the ability of oursoftware to operate with hardware and software platforms that are used by ourcustomers now or in the future, our ability to compete successfully in thesupport automation software market and in the consumer technology supportmarket, our limited experience in servicing consumers directly, our ability tomeet consumer expectations, our dependence on channel partners for customeracquisition, our ability to manage rapid headcount growth, our ability toaddress market opportunities in light of the recent restructuring andleadership transitions, diversion of management attention to litigation mattersor strategic matters, our ability to accurately predict performance, our abilityto retain key employees, our ability to obtain sufficient patent protection,and the uncertain economic conditions in the United States and in internationalmarkets. ****Additional risks anduncertainties include those listed under Item 1A, “Risk Factors.”SupportSoft expressly disclaims any obligation or undertaking to releasepublicly any updates or revisions to any forward-looking statements containedin this report to conform these statements to actual results or changes in ourexpectations or in events, conditions or circumstances on which any suchstatement is based. You should not place undue reliance on theseforward-looking statements, which apply only as of the date hereof.**

**Overview**

We have historically developed, marketed anddistributed software designed to facilitate the identification, diagnosis andresolution of technology-related problems. Our software solutions have beenutilized by:

·      Digitalservice providers, to provide automated installation, verification and supportof the broadband services they provide to their subscribers; and

·      Corporateenterprises, either directly or as part of an outsourced solution from managedservice providers, to automate the management of computing endpoints and to provideservice and support automation to customers, partners and employees.

Our revenue to date has consisted of softwarelicense fees and fees for maintenance, consulting, hosting and trainingservices. We have licensed our software to customers predominately on aperpetual basis in which we recognize the license revenue upfront, assuming allcriteria for revenue recognition under the applicable accounting rules havebeen met. Maintenance fees relating to perpetual software licenses result inratable revenue over the length of the maintenance term, which is generally oneyear. Consulting and training revenues are generally recognized as the servicesare performed or in accordance with predefined project milestones.

Our total revenue for the three and nine monthsended September 30, 2006 was approximately $11.9 million and $30.9 million. Ourtotal revenue increased in the third quarter of 2006 by $1.1 million, orapproximately 10%, over the second quarter of 2006 driven primarily by anincrease in license revenue.  Licenserevenue in the third quarter of 2006 increased $1.0 million, or approximately29%, over the prior quarter.  Servicesrevenue increased $98,000, or approximately 1%, in the third quarter of 2006 overthe prior quarter. Despite the sequential quarterly increases in license andservices revenue in 2006, our total revenue for the three and nine months endedSeptember 30, 2006 represents decreases of 9% and 33% from the comparableperiods in 2005.

In April 2006, we named Joshua Pickus as President andChief Executive Officer of SupportSoft. In July 2006, following an evaluationof the Company’s business operations and market opportunities we announced aplan to (1) strengthen our current business through more effectivedeployment and management of resources, and (2) extend our business byproviding consumer technology support services. In addition to continuing to offer our software to corporate customers,we plan to offer technology support services to consumers through call-centerbased experts using our own technology.

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We believe the market for consumer technologysupport services is large and rapidly growing. We also believe we are wellpositioned to participate in this market because of our support automationtechnology, our expertise in addressing technology support problems and ourcustomer relationships. We plan to reach consumers through channel partners,such as hardware manufacturers, independent software vendors, serviceproviders, portals and other channel partners who will refer consumers to usand receive a referral fee or revenue share from us. We also plan to acquirecustomers directly through our support.com website where consumers wouldconnect to our expert center and pay us a fee for resolving their technologyproblems.

Although we intend to leverage many of our existingresources, we anticipate making significant additional investments in supportof our new technology support service offering, including investments inestablishment of our technology support call center and additionalpersonnel. We expect that these additional investments will precede any materialrevenue from our new business initiative. As a result, we currently expect toincur losses for the foreseeable future in our business. See the risk factorrelating to our new consumer technology services initiative under Item 1A, “RiskFactors.”   To partially offset the costof these new investments, we reduced our workforce by 25 employees, or approximately10% of our workforce at that time  duringthe third quarter of 2006.  We incurredapproximately $756,000 in severance and other personnel-related terminationcosts in connection with this restructuring.

Our diluted earnings (loss) per share for the threeand nine months ended September 30, 2006 was $(0.04) and $(0.19) comparedto $0.00 and $0.07 for the three and nine months ended September 30, 2005,including the impact of stock compensation expense in 2006.

We intend the following discussion of our financialcondition and results of operations that follows to provide information thatwill assist in understanding our financial statements, the changes in certainkey items in those financial statements from year to year, and the primaryfactors that accounted for those changes, as well as how certain accountingprinciples, policies and estimates affect our financial statements.

**CriticalAccounting Policies and Estimates**

In preparing our consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates, we make assumptions, judgments and estimates that can have asignificant impact on our net revenue, operating results, as well as on thevalue of certain assets and liabilities on our consolidated balance sheet. Webase our assumptions, judgments and estimates on historical experience andvarious other factors that we believe to be reasonable under the circumstances.Actual results could differ materially from these estimates under differentassumptions or conditions. On a regular basis we evaluate our assumptions,judgments and estimates and make changes accordingly. We believe that theassumptions, judgments and estimates involved in the accounting for revenuerecognition, allowance for doubtful accounts, accounting for income taxes,business combinations and stock-based compensation have the greatest potentialimpact on our consolidated financial statements, so we consider these to be ourcritical accounting policies. We discuss below the critical accountingestimates associated with these policies. For further information on thecritical accounting policies, see Note 1 of our Notes to Consolidated FinancialStatements.

*RevenueRecognition*

We recognize revenue in accordance with generallyaccepted accounting principles that have been prescribed for the softwareindustry. Revenue recognition requirements in the software industry are verycomplex and are subject to change. Our revenue recognition policy is one of ourcritical accounting policies because revenue is a key component of our resultsof operations and is based on complex rules which require us to make judgments.In applying our revenue recognition policy we must determine which portions ofour revenue are recognized currently and which portions must be deferred. Inorder to determine current and deferred revenue, we make judgments with regardto the expected amount of future services and the appropriate fair value forthose services. We also make judgments as to whether future services areessential to the functionality of other elements of the software arrangement.

We do not record revenue on sales transactions whenthe collection of cash is in doubt at the time of sale. Rather, revenue isrecognized from these transactions as cash is collected. The determination ofcollectibility requires significant judgment.

*Allowancefor Doubtful Accounts*

We make judgments as to our ability to collectoutstanding receivables and provide allowances for the portion of receivableswhen collection becomes doubtful. Provisions are made based upon a specificreview of all significant outstanding invoices. For those invoices notspecifically provided for, provisions are recorded at differing rates, basedupon the age of the receivable. In determining these percentages, we analyzeour historical collection experience and current payment trends. If thehistorical data we use to calculate the allowance for doubtful accounts doesnot reflect the future ability to collect 

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outstanding receivables, additional provisions fordoubtful accounts may be needed and the future results of operations could bematerially affected.

*Accountingfor Income Taxes*

We are required to estimate our income taxes in eachof the tax jurisdictions in which we operate. This process involves management’sestimation of our actual current tax exposures together with an assessment oftemporary differences determined based on the difference between the financialstatement and tax basis of certain items. These differences result in netdeferred tax assets and liabilities, which are included within the consolidatedbalance sheet. We must then assess the likelihood that the deferred tax assetswill be recovered from future taxable income and to the extent we believe thatrecovery is not likely, we must establish a valuation allowance. To the extentwe establish a valuation allowance or adjust this allowance in a period, wemust include a tax expense or benefit within the tax provision in the statementof operations.

*BusinessCombinations*

When we acquire businesses, we allocate the purchaseprice to the fair value of tangible assets and liabilities acquired andidentifiable intangible assets. Any residual purchase price is recorded asgoodwill. We engage independent third-party appraisal firms to assist indetermining the fair values of assets acquired and liabilities assumed. Such avaluation requires management to make significant estimates, especially withrespect to intangible assets. These estimates are based on historicalexperience and information obtained from the management of the acquiredcompanies. These estimates can include, but are not limited to, the cash flowsthan an asset is expected to generate in the future, the appropriate weightedaverage cost of capital, and the cost savings expected to be derived fromacquiring an asset. These estimates are inherently uncertain and unpredictable.In addition, unanticipated events and circumstances may occur which may affectthe accuracy or validity of such estimates.

At September 30, 2006, goodwill was $9.8 million,and net identifiable intangible assets were $3.2 million. We assess theimpairment of goodwill annually or more often if events or changes incircumstances indicate that the carrying value may not be recoverable. Weassess the impairment of goodwill at the entity level because we have only onereporting unit. We determine the fair value of the Company by analyzing salesprices of comparable software companies as a multiple of revenue. We supplementthis evaluation using the Company’s market capitalization. An impairment losswould be recognized if the fair value of the Company is less than the carryingvalue of the Company’s net assets on the date of the evaluation. We assess theimpairment of identifiable intangible assets whenever events or changes incircumstances indicate that its carrying amount may not be recoverable. Animpairment loss would be recognized when the sum of the undiscounted future netcash flows expected to result from the use of the asset and its eventualdisposition is less than its carrying amount. Such impairment loss would bemeasured as the difference between the carrying amount of the asset and itsfair value. The estimate of cash flow is based upon, among other things,certain assumptions about expected future operating performance and anappropriate discount rate determined by our management. Our estimates ofdiscounted cash flows may differ from actual cash flows due to, among otherthings, economic conditions, changes to the business model or changes inoperating performance. If we made different estimates, material differences mayresult in write-downs of net long-lived and intangible assets, which would bereflected by charges to our operating results for any period presented. AtSeptember 30, 2006, management concluded its annual evaluation forimpairment of goodwill and no impairment was recognized. We test for impairmentduring the third quarter of each year, or earlier if indicators of impairmentexist.

*Stock-basedcompensation*

We account for stock-basedcompensation in accordance with the provisions of SFAS 123R. We adopted SFAS123R using the modified prospective transition method which requires theapplication of the accounting standard starting from January 1, 2006.Under the fair value recognition provisions of SFAS 123R, stock-basedcompensation cost is estimated at the grant date based on the fair value of theaward and is recognized as expense ratably over the requisite service period ofthe award. We estimate the fair value of stock-based awards on the grant dategenerally using the Black-Scholes-Merton option-pricing model. Determining theappropriate fair value model and calculating the fair value of stock-basedawards requires judgment, including estimating stock price volatility,forfeiture rates and expected life. If any of these assumptions used inthe option-pricing models change significantly, stock-based compensation maydiffer materially in the future from that recorded in the accompanyingfinancial statements.

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**RESULTS OF OPERATIONS**

The following table sets forth the results ofoperations for the three and nine months ended September 30, 2006 and 2005expressed as a percentage of total revenue.
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenue:                           |       |                                                 |       |                                                |       |   |   |   |   |
| License fees                       |       | 38                                                   | %          | 42                                                  | %          | 32 | % | 51 | % |
| Services                           |       | 62                                                   |       | 58                                                  |       | 68 |   | 49 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net revenue                        |       | 100                                                  |       | 100                                                 |       | 100 |   | 100 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Costs and  expenses:               |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of license  fees              |       | 1                                                    |       | 1                                                   |       | 1 |   | 1 |   |
| Cost of services                   |       | 33                                                   |       | 27                                                  |       | 34 |   | 23 |   |
| Amortization of  intangible assets |       | 2                                                    |       | 2                                                   |       | 2 |   | 2 |   |
| Research and  development          |       | 19                                                   |       | 21                                                  |       | 23 |   | 18 |   |
| Sales and  marketing               |       | 51                                                   |       | 41                                                  |       | 55 |   | 40 |   |
| General and  administrative        |       | 23                                                   |       | 16                                                  |       | 25 |   | 14 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Total costs and  expenses          |       | 129                                                  |       | 108                                                 |       | 140 |   | 98 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  from operations     |       | (29                                                  | )          | (8                                                  | )          | (40 | ) | 2 |   |
| Interest and  other income, net    |       | 16                                                   |       | 7                                                   |       | 15 |   | 5 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss)  before income taxes |       | (13                                                  | )          | (1                                                  | )          | (25 | ) | 7 |   |
| Income tax  provision              |       | (1                                                   | )          | 0                                                   |       | (1 | ) | 0 |   |
|                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net income  (loss)                 |       | (14                                                  | )%         | (1                                                  | )%         | (26 | )% | 7 | % |

 

**Three and Nine Months Ended September 30, 2006**

***Revenue***

*License fees*. Although license fees increasedsequentially from the second quarter of 2006, license fees decreased to $4.5million for the three months ended September 30, 2006 from $5.4 millionfor the three months ended September 30, 2005 and to $10.0 million for thenine months ended September 30, 2006 from $23.8 million for the ninemonths ended September 30, 2005. The decrease reflected consummation offewer large license transactions in addition to a lower number of total licensetransactions.

Most of our customer contracts are for perpetuallicenses, which, provided the criteria for revenue recognition are met,generally result in the immediate recognition of license revenue. Although undercertain contracts we have sold hosting services with our licenses or we havesold term licenses, both of which result in ratable license revenue, ratablelicense revenue is currently an immaterial percentage of our totalrevenue.  As a result, failure to enter intosignificant new perpetual licenses in any particular period, as we experiencedin the first three quarters of 2006, could cause our license revenue to declinesubstantially. We are seeking to introduce transaction structures that involveratable revenue recognition and we currently expect that any revenues from ourplanned consumer technology support services initiative would consist of revenuesharing payments or service fees from a large number of transactions ratherthan large upfront software license fees upon which we have depended in thepast.

*Services revenue*. Although services revenue increasedsequentially from the second quarter of 2006, services revenue decreased to $7.4million for the three months ended September 30, 2006 from $7.6 million forthe three months ended September 30, 2005 and to $20.8 million for the ninemonths ended September 30, 2006 from $22.4 million for the nine monthsended September 30, 2005. Services revenue decreased primarily due tolower consulting revenue of $518,000 and $2.5 million for the three and ninemonth periods in 2006 as compared with the same periods in 2005 primarily as aresult of one service provider customer in North America ordering lessconsulting services than previous quarters. These decreases in consultingrevenues were partially offset by increases in maintenance revenue of $348,000and $1.2 million in the three and nine month periods in 2006 as compared withthe same periods in 2005 arising from maintenance contracts related to newlicense transactions.

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Revenue from customers outside the United Statesaccounted for approximately 19% and 22% of our total revenue for the three and ninemonth periods ended September 30, 2006, compared with 21% and 23% for thethree and nine month periods ended September 30, 2005.

***Cost of license fees***

Cost of license fees consists primarily of costsrelated to third-party royalty fees under license arrangements for technologyembedded in or resold with our products. Cost of license fees decreased to $119,000in the three months ended September 30, 2006 from $123,000 in the threemonths ended September 30, 2005. Cost of license fees for the nine monthsended September 30, 2006 decreased to $333,000 from $440,000 for the sameperiod in 2005. These decreases primarily resulted from the sale of lessthird-party software in the three and nine months ended September 30, 2006compared with the same periods in the prior year.

***Cost of services***

Cost of services consists primarily of compensationcosts, travel costs, related overhead expenses for professional servicespersonnel, payments made to third parties for subcontracted consulting servicesand outsourced hosting fees. Cost of services increased to $4.0 million for thethree months ended September 30, 2006 from $3.5 million for the threemonths ended September 30, 2005. This increase was primarily due torestructuring charges of $184,000 relating to our reduction in workforce andincreases in compensation related costs, third party consulting fees and outsourcedhosting fees. Cost of services for the nine months ended September 30,2006 decreased to $10.4 million from $10.6 million for the same period in 2005.This decrease was primarily due to decreases in the use of third partyconsultants.

Included in the cost of services for the three and ninemonths ended September 30, 2006 was $87,000 and $210,000 of stock-basedcompensation expense. There were no comparable expenses in the same periodslast year, because we adopted the provisions of SFAS 123R effectiveJanuary 1, 2006.

***Operating Expenses***

*Research and development.* Research and development costs are expensedas incurred. Research and development expense consists primarily ofcompensation costs, consulting expenses and related overhead costs for researchand development personnel. Research and development expense decreased to $2.3million for the three months ended September 30, 2006 from $2.7 millionfor the three months ended September 30, 2005. Research and developmentexpense decreased to $7.1 million for the nine months ended September 30,2006 from $8.5 million for the same period in 2005. These decreases wereprimarily due to decreases in salary and related expenses as a result of lowerheadcount and decreases in third-party consulting costs. Included in researchand development expense for the three and nine months ended September 30,2006 was $83,000 and $301,000 of stock-based compensation expense. There wereno comparable expenses in the same periods last year, because we adopted theprovisions of SFAS123R effective January 1, 2006.

*Sales and marketing.* Sales and marketing expense consistsprimarily of compensation costs, including salaries, sales commissions andrelated overhead costs for sales and marketing personnel and promotionalexpenses, including public relations, advertising and trade shows. Sales andmarketing expense increased to $6.0 million for the three months ended September 30,2006 from $5.3 million for the three months ended September 30, 2005. Theincrease was primarily due to a restructuring charge of $338,000 relating toour reduction in workforce, increases in recruiting expenses and commissionexpenses offset by a decrease in salaries and related costs due to lowerheadcount. Sales and marketing expense decreased to $17.0 million for the ninemonths ended September 30, 2006 from $18.4 million for the same period in2005. The decrease was primarily due to lower variable compensation expenses, includinglower sales commissions resulting from fewer license sales, a decrease insalary and related expenses as a result of lower headcount, and fewer eventsand tradeshows. Included in sales and marketing expenses for the three and ninemonths ended September 30, 2006 was $219,000 and $592,000 of stock-basedcompensation expense. There were no comparable expenses in the same periodslast year, because we adopted the provisions of SFAS123R effectiveJanuary 1, 2006.

*General and administrative.* General and administrative expense consistsprimarily of compensation costs and related overhead costs for administrativepersonnel and professional fees for legal, accounting and other professionalservices. General and administrative expense increased to $2.7 million for thethree months ended September 30, 2006 from $2.1 million for the threemonths ended September 30, 2005. General and administrative expenseincreased to $7.7 million for the nine months ended September 30, 2006from $6.4 million for the same period in 2005. This increase was primarily dueto a restructuring charge of $194,000 relating to our reduction in workforce, increasesin salary expense due to executive transitions and third-party consulting fees.Also included in general and administrative expenses for the three and ninemonths ended September 30, 2006 is $415,000 and $1.2 million ofstock-based compensation expense. There were no 

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comparable expenses in the same periods last year,because we adopted the provisions of SFAS123R effective January 1, 2006.

*Stock-based compensation*. On January 1, 2006, we adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment,” (SFAS 123R) which requires the measurement and recognition ofcompensation expense for all share-based payment awards made to employees anddirectors including employee stock options and employee stock purchases basedon estimated fair values. Prior to January 1, 2006, we accounted forshare-based payments to employees using the intrinsic value method under APBOpinion No. 25, as permitted by SFAS 123, and, as such, generallyrecognized no compensation cost for employee stock options or employee stockpurchases in our financial statements.

We elected the modified prospective transitionmethod for adopting SFAS 123R which requires the application of the accountingstandard as of January 1, 2006, the first day of our 2006 fiscal year.Under this transition method, compensation cost recognized in the three and ninemonths ended September 30, 2006, includes the proportionate amounts of:(a) compensation cost for all stock-based payments granted prior to, butnot yet vested as of, December 31, 2005 based on the grant-date fair valueestimated in accordance with the original provisions of SFAS 123 and previouslypresented in the pro-forma footnote disclosures, and (b) compensation costof all stock-based payments granted subsequent to January 1, 2006 based onthe grant-date fair value estimated in accordance with the new provisions ofSFAS 123R. Prior periods have not been re-stated to reflect the impact of SFAS123R.

For the three and nine months ended September 30,2006, we recorded $804,000 and $2.3 million respectively in stock-basedcompensation expense. At September 30, 2006, there was $8.7 million ofunrecognized compensation expense related to existing options outstanding as ofSeptember 30, 2006 which is expected to be recognized over a weightedaverage period of 3.4 years.

Prior to the adoption of SFAS 123R, our Board ofDirectors approved the acceleration of vesting of certain unvested andout-of-money stock options with exercise prices equal to or greater than $5.00per share previously awarded to employees, including our executive officers,under our equity compensation plans. The acceleration of vesting was effectivefor stock options outstanding as of December 21, 2005. Options to purchaseapproximately 3.0 million shares of common stock or 32% of our then outstandingunvested stock options were subject to this acceleration. The weighted averageprice of the options that were accelerated was $7.02. The acceleration of thevesting of these stock options resulted in an approximate total savings of$12.0 million of future compensation expense that would have impacted expensesthrough the third quarter of 2009. The options accelerated excluded optionspreviously granted to members of the Board of Directors, employees who had terminationspending and foreign employees who opted out of the acceleration for taxreasons. For all officers and vice-presidents (non-officers) the accelerationwas accompanied by restrictions imposed on any shares that may in the future bepurchased through the exercise of accelerated stock options. Those restrictionsprevent the sale of any such shares prior to the date such shares would haveoriginally vested had the optionee been employed on such date (whether or notthe optionee is actually an employee at that time). The purpose of theacceleration was to enable us to avoid recognizing compensation expenseassociated with these options in our Consolidated Statements of Operations uponthe adoption of SFAS 123R on January 1, 2006.

*Interest income and other, net.* Interest income and other, net increased to$1.8 million for the three months ended September 30, 2006 from $909,000for the three months ended September 30, 2005. Interest income and other,net increased to $4.7 million for the nine months ended September 30, 2006from $2.5 million for the same period in 2005. These increases were primarilydue to an increase in interest income due to higher interest rates earned onour marketable securities. The increase for the three months ended September30, 2006 over the same period in 2005 is also due to a one-time payment of$295,000 that we received in the third quarter of 2006 in settlement of acontractual dispute.

*Provision for income taxes.* The income tax provision increased to $72,000for the three months ended September 30, 2006 from a $59,000 tax benefitfor the three months ended September 30, 2005. The income tax provisionincreased to $333,000 for the nine months ended September 30, 2006 from $126,000for the same period in 2005. This increase was primarily due to foreignwithholding taxes related to international customer payments.

Each quarter, we evaluate the realizability of ourdeferred tax assets. At September 30, 2006, we had recorded a fullvaluation allowance against our deferred tax assets based on the realizationcriteria outlined in the applicable accounting literature. Amongst otherimportant factors, we have considered and will continue to consider our historyof earnings and our ability to generate pre-tax income in the future. Givingappropriate consideration to all the relevant factors and assuming we performas we expect in the future, we believe the release of a portion of ourvaluation allowance will be appropriate at some point in the future. This wouldresult in an income tax benefit within the statement of operations in theperiod of adjustment.

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**LIQUIDITY AND CAPITAL RESOURCES**

Since our incorporation in December 1997, we havefinanced our operations primarily through our initial public offering,follow-on public offering, cash flows from operations and, to a lesser extent,from the private placement of our preferred and common stock, bank borrowingsand capital equipment lease financing. In November 2003, we completed ourfollow-on public offering from which we received net proceeds of approximately$77.7 million. There are many variables that impact our financial planincluding the levels of revenue, costs and expenses, and new capitalinvestments. Actual cash usage could differ from these projections.

***Operating Activities***

Net cash provided by (used in) operating activitieswas $453,000 and $(3.5) million for the nine months ended September 30,2006 and 2005, respectively. Net cash provided by operating activities for the ninemonths ended September 30, 2006 was primarily due to cash collectionsduring the period, which contributed to a reduction in accounts receivable of$10.4 million. The reduction in accounts receivable was offset by a net loss of$8.2 million, adjusted for amounts which did not require the use of cash of $4.0million. These non-cash items primarily include depreciation, amortization andstock-based compensation expense. Net cash used in operating activities for thenine months ended September 30, 2005 was primarily the result of net incomeof $3.3 million offset by an increase in accounts receivable, net of $3.3million and a decrease in deferred revenue of $5.2 million.

***Investing Activities***

Net cash provided by (used in) in investingactivities was $(7.2) million and $5.1 million for the nine months ended September 30,2006 and 2005, respectively. Net cash used in investing activities for the ninemonths ended September 30, 2006, was due to the purchases of property andequipment of $(478,000) and by the net purchases in marketable securities of $(6.8)million. Net cash provided by investing activities for the nine months ended September 30,2005, was due primarily to the sale and maturity of $77.7 million of short terminvestments, offset by purchases of $71.8 million in short term investments andthe purchase of property and equipment of $1.0 million.

***Financing Activities***

Net cash generated by financing activities was $1.9million for the nine months ended September 30, 2006 and $1.1 million forthe nine months ended September 30, 2005. Net cash provided by financingactivities was attributable to net proceeds from the purchase of common stockunder the employee stock purchase plan and the exercise of employee stockoptions. In the second quarter of 2005, our board of directors authorized therepurchase of up to 2,000,000 outstanding shares of our common stock. To date,we have repurchased 192,598 shares of outstanding common stock at a cost of$922,294 or an average cost of $4.76 per share, excluding commissions. Nopurchases have been made since the second quarter of 2005.

***Working Capital and Capital Expenditure Requirements***

At September 30, 2006, we had stockholders’equity of $130.5 million and working capital of $116.6 million. Included as areduction to working capital is deferred revenue of $10.3 million, which willnot require dollar-for-dollar of cash to settle, but will be recognized asrevenue in the future. We believe that our existing cash balances will besufficient to meet our working capital requirements and stock repurchase program,as well as our planned capital expenditures for at least the next 12 months.

A sustained period of losses, such as the loss weincurred in the first three quarters of 2006, would likely result in anincreased net usage of cash to fund our operating activities. Also, if werequire additional capital resources to grow our business internally or toacquire complementary technologies and businesses at any time in the future, wemay seek to sell additional equity or debt securities. The sale of additionalequity or debt securities could result in more dilution to our stockholders.Financing arrangements may not be available to us, or may not be available inamounts or on terms acceptable to us.

**ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

We have operations in the United States and othercountries and market and sell our products in North America, South America,Asia and Europe. As a result, our financial results could be affected byfactors such as changes in foreign currency exchange rates or weak economicconditions in foreign markets. As most sales are currently made in U.S.dollars, a strengthening of the dollar could make our products less competitivein foreign markets.

As of September 30, 2006, we held $18.5 millionin cash and cash equivalents consisting of highly liquid investments havingoriginal maturity dates of no more than 90 days. Declines of interest ratesover time would reduce our interest income from our highly liquid marketablesecurities. Based upon our balance of cash and cash equivalents, a decrease ininterest rates of 

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100 basis points would cause a correspondingdecrease in our annual interest income of approximately $185,000. Due to thenature of our highly liquid cash equivalents, a change in interest rates wouldlikely not materially change the fair market value of our cash and cashequivalents.

As of September 30, 2006, we held $104.0million in marketable securities, which consisted primarily of corporate bonds,government debt securities maturing in less than eighteen months and marketauction securities resetting in less than forty-five days. The weighted averageinterest rate of our portfolio was approximately 5.16% at September 30,2006. A decline in interest rates over time would reduce our interest incomefrom our marketable securities. A decrease in interest rates of 100 basispoints would cause a corresponding decrease in our annual interest income ofapproximately $1.0 million. Due to the nature of our highly liquid cashequivalents, a change in interest rates would likely not materially change thefair market value of our marketable securities.

**ITEM 4: CONTROLS AND PROCEDURES**

**Evaluationof disclosure controls and procedures.**

We maintain “disclosure controls and procedures,” assuch term is defined in Rule 13a-15(e) under the Securities Exchange Act of1934 (the “Exchange Act”), that are designed to ensure that informationrequired to be disclosed by us in reports that we file or submit under theExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in Securities and Exchange Commission rules and forms, andthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating our disclosure controls and procedures, managementrecognized that disclosure controls and procedures, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the disclosure controls and procedures are met. Ourdisclosure controls and procedures have been designed to meet, and managementbelieves they meet, reasonable assurance standards. Additionally, in designingdisclosure controls and procedures, our management necessarily was required toapply its judgment in evaluating the cost-benefit relationship of possibledisclosure controls and procedures. The design of any disclosure controls andprocedures also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions.

Our Chief Executive Officer and our Chief FinancialOfficer, after evaluating the effectiveness of our “disclosure controls andprocedures” as of the end of the period covered by this quarterly report, haveconcluded that our disclosure controls and procedures are effective based ontheir evaluation of these controls and procedures required byparagraph (b) of Exchange Act Rules 13a-15 or 15d-15.

**Changes ininternal control over financial reporting.**

There were no changes in our internal control overfinancial reporting during the quarter ended September 30, 2006 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**PART II: OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS.**

Except as noted below, there are no material changesin the status of our legal proceedings from those described in our AnnualReport on Form 10-K for the year ended December 31, 2005, as updated in ourQuarterly Reports on Form 10-Q for the quarters ended March 31, 2006 and June30, 2006.

*In re SupportSoft, Inc. SecuritiesLitigation* is aconsolidated complaint filed in the United Stated District Court of theNorthern District of California against the Company, our former CEO and formerCFO. The complaint generally alleges violations of certain federal securitieslaw and seeks unspecified damages. On May 31, 2006, this action was certifiedto proceed as a class action on behalf of all persons and entities whopurchased or otherwise acquired the securities of the Company from January 29,2004 to October 1, 2004 and who were allegedly damaged thereby.

*White v. Basu et al.*is a derivative shareholder complaint filedin the Superior Court of the State of California for the County of San Mateo.This complaint was filed on behalf of the Company as a nominal defendantagainst certain of our directors and former directors and alleges that thedirector defendants harmed the Company by making or permitting the Company tomake false and misleading statements between January 20, 2004 and October 1,2004. On September 30, 2006, the court denied Defendants’ demurrer to theplaintiffs’ First Amended Complaint. Defendants’answer was filed November 6, 2006.

We are also subject to other routine legalproceedings, as well as demands, claims and threatened litigation, that arisein the normal course of our business. The ultimate outcome of any litigation isuncertain, and either unfavorable or favorable 

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outcomes could have a material negative impact.Regardless of outcome, litigation can have an adverse impact on SupportSoftbecause of defense costs, diversion of management resources and other factors.

**ITEM 1A. RISK FACTORS**

Investing in our securities involves a high degreeof risk. In addition to the other information contained in this report, youshould consider the following risk factors before investing in our securities.

**Ourquarterly results may fluctuate, which may cause our stock price to decline.**

Our quarterly revenue and operating results have inthe past and may in the future fluctuate from quarter to quarter. As a result,we believe that quarter-to-quarter and year-to-year comparisons of our revenueand operating results are not necessarily meaningful, and that thesecomparisons may not be accurate indicators of future performance.

Several factors that havecontributed or may in the future contribute to fluctuations in our operatingresults include:

·                  demand for our software;

·                  size and timing of customer orders and ourability to receive payment and recognize revenue in a given quarter;

·                  our reliance on a small number of customers fora substantial portion of our revenue;

·                  the price and mix of products and services weor our competitors offer;

·                  our ability to attract and retain customers;

·                  the amount and timing of operating costs andcapital expenditures relating to expansion of our business, infrastructure andmarketing activities;

·                  the exercise of judgment by our management inmaking accounting decisions in accordance with our accounting policies, such aswhen to recognize certain tax assets and the impairment of goodwill or identifiableintangible assets; and

·                  general economic conditions and their effecton our operations.

In prior years, we licensed a significant portion ofour software on a term basis in which revenue was recognized ratably over thelength of the agreement with the customer. In recent periods, however, wetypically licensed our software on a perpetual basis in which we recognize thelicense revenue upfront, assuming all criteria for revenue recognition havebeen met. As we shifted to a perpetual licensing model, we have becomedependent on a few customer contracts with upfront license revenue for asubstantial portion of our revenue in any one quarter. In addition, asignificant portion of our total revenue each quarter comes from a number oforders received in the last month of a quarter. In previous quarters, we failedto close expected perpetual licenses with upfront revenue. If we continue tofail to close orders expected to be completed by the end of a quarter,particularly if these orders are for perpetual licenses with upfront revenue,or if there is any cancellation of or delay in the closing of orders,particularly any large customer orders, our quarterly results would suffer.

**Because a small number of customershave historically accounted for and may in future periods account forsubstantial portions of our revenue, our revenue could decline because ofdelays or losses of specific customer orders.**

A small number of customers have historicallyaccounted for, and may in future periods account for, substantial portions ofour revenue. For the quarter ended September 30, 2006, one customeraccounted for 21% of our total revenue. Our consumer technology supportservices initiative, if successful, would reduce our dependence on largetransactions, from a small number of customers. However, in the near term weare likely to continue to derive a significant portion of our revenue fromlarge transactions. Therefore our revenue could decline because of the loss ordelay of a single customer order. Additionally, we may not obtain newcustomers. The failure to obtain significant new customers, particularlycustomers that purchase perpetual licenses with upfront payments, the loss ordelay of significant customer orders and the failure of existing customers topay ongoing fees when due would harm our operating results.

**Our recently announced consumertechnology services initiative will increase operating expenses without anyassurance of yielding increased revenue.**

In April of 2006, we named Joshua Pickus asPresident and Chief Executive Officer of SupportSoft. Mr. Pickus conductedan evaluation of our business operations and market opportunities whichconcluded in July 2006. Following this evaluation, we announced a plan to (1) strengthenour current business through more effective deployment and management ofresources, and (2) extend our business by providing consumer technology supportservices in an effort to achieve sustained long term revenue growth. Inaddition to continuing to offer our software to technology service providersand enterprises, we plan to 

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offer technology support services to consumersthrough call-center based experts using our technology. Although we believethis new business initiative is complementary to our core business, there canbe no assurance that we will be able to offer these new services in a cost-effectiveor timely manner. We have limited experience in servicing consumers directly andin management call centers, including outsourced call centers, and we expect tospend significant cash and incur increased operating expenses to restructureSupportSoft to align with this new initiative, to obtain the human capitalnecessary to support this initiative, and to promote our brand directly toconsumers. There can be no assurance that these investments will yieldincreased revenue to offset the expenses. Furthermore, this new businessinitiative, if not favorably received by consumers, could damage the reputationof our core business as well as strain our management, financial andoperational resources necessary to maintain our core business. The lack of marketacceptance of such efforts or our inability to generate satisfactory revenuefrom such expanded services to offset their cost could have a material adverseeffect on our business, prospects, financial condition and results ofoperations.

 **We were not profitable for the first three quarters of2006 and are likely to continue to sustain a loss.**

Although we have been profitable on an annual basissince 2003, we were not profitable for the first three quarters of 2006. Ourexpenditures could continue to exceed our revenue in future periods, thuspreventing us from achieving or maintaining profitability on a quarterly orannual basis. To achieve and maintain profitability, we will need to generateand sustain substantially higher revenue while maintaining reasonable cost andexpense levels. If we fail to achieve profitability, the market price of ourcommon stock will likely decline. We may not achieve profitability if ourrevenue does not increase or if revenue increases more slowly than we expect.In addition, our operating expenses are largely fixed in any given quarter andany shortfall in anticipated revenue in any quarter could harm our results forsuch period. Finally, a sustained period of losses would also likely result inan increased net usage of cash to fund our operating activities.

Although we intend to leverage many of our existingresources, we anticipate making significant additional investments in supportof our consumer technology support services initiative including investments inestablishment of our expert call center and additional personnel. Weexpect that theses additional investments will precede any revenue from our newbusiness initiative. As a result, we currently expect to incur losses in ourbusiness for the foreseeable future. See risk factor relating to our newbusiness initiative under Item 1A, “Risk Factors.”

**Our inability to meet futurefinancial performance targets that we announce or that are published byresearch analysts could cause the price of our common stock to decline.**

From time to time, we provide guidance related toour future financial performance. In addition, financial analysts publish theirown expectations of our future financial performance. Because our quarterlyrevenue and our operating results fluctuate, future financial performance isdifficult to predict. In the past, we have failed to meet our guidance. Futurenegative adjustments of our guidance or the failure to meet our guidance orthose expectations of research analysts could likely cause the market price ofour common stock to decline.

Management’s ability to accurately predictperformance is affected in large part by a significant portion of our totalrevenue being dependant upon the closing of new large customer orders. Inaddition, our guidance is based in part upon the expectation of new productsales and services offerings with which we have a limited history and as aresult it is difficult to evaluate our future revenue from these products. Inthe event we fail to close orders expected or forecasted to be completed, ourresults will not meet our guidance or the expectations of securities analystsor investors, which would likely cause the market price of our common stock todecline.

**Our sales cycle is lengthy and ifrevenue forecasted for a particular quarter is not realized in that quarter,significant expenses incurred may not be offset by corresponding revenue.**

Our sales cycle for our software typically rangesfrom three to nine months or more and may vary substantially from customer tocustomer. The purchase of our products and services generally involves asignificant commitment of capital and other resources by a customer. Thiscommitment often requires significant technical review, assessment ofcompetitive products and approval at a number of management levels within acustomer’s organization. In addition, in the wake of Sarbanes-Oxley, companieshave enhanced their approval processes making sales more difficult orprotracted. While our customers are evaluating our products and services, wemay incur substantial sales and marketing expenses and spend significantmanagement effort to complete these sales. Any delay in completing sales in aparticular quarter or the failure to complete a sale after expending resourcesduring the sales cycle could cause our operating results to suffer.

**Our productinnovations may not achieve the market penetration necessary for us to expandour market share.**

If we fail to develop enhanced versions of oursoftware in a timely manner or to provide products and services that achieverapid and broad market acceptance, we may not maintain or expand our marketshare. We may fail to identify new product and service opportunities for ourcurrent market or new markets that we enter into in the future. In addition,our existing products may become obsolete if we fail to introduce new productsor product enhancements that meet new customer 

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demands, support new standards or integrate with newor upgraded versions of packaged applications. We have limited control overfactors that affect market acceptance of our product and services, including:

·                  the willingness of companies to transition toautomated solutions; and

·                  acceptance of competitors’ solutions or othersimilar technologies.

**We may engage in investments oracquisitions or other strategic matters that could divert management attentionand prove difficult to integrate with our business and technology.**

We may engage in acquisitions of other companies,products or technologies or in other strategic initiatives. If we fail to integratesuccessfully any future acquisitions, or the technologies associated with suchacquisitions, the revenue and operating results of the combined company coulddecline. The process of integrating businesses, technologies, services orproducts may result in unforeseen operating difficulties and expenditures.Acquisitions involve a number of other potential risks to our business,including the following:

·                  potential adverse effects on our operatingresults, including unanticipated costs and liabilities, unforeseen accountingcharges or fluctuations resulting from failure to accurately forecast thefinancial impact of an acquisition;

·                  failure to integrate products or technologieswith our existing products, technologies and business model;

·                  failure to integrate management informationsystems, personnel, research and development and marketing, sales and supportoperations;

·                  potential loss of key employees;

·                  diversion of management’s attention fromother business concerns and disruption of our ongoing business;

·                  difficulty in maintaining controls andprocedures;

·                  potential loss of customers;

·                  uncertainty on the part of our existingcustomers about our ability to operate on a combined basis;

·                  failure to realize the potential financial orstrategic benefits of the acquisition; and

·                  failure to successfully further develop thecombined technology, resulting in the impairment of amounts recorded asgoodwill or other intangible assets.

**Our failure to establish and expandthird-party alliances would harm our ability to sell our software and provideour services.**

We have alliances with third parties that areimportant to our business. Our existing relationships include those withsoftware and hardware vendors, and relationships with companies who provideoutsourced support and service capabilities to enterprise customers. If theserelationships fail, we may have to devote substantially more resources to thesales and marketing of our products and services than we would otherwise, andour efforts may not be as effective. For example, companies that provideoutsourced support and services often have extensive relationships with ourexisting and potential customers and significant input in the purchasedecisions of these customers. In addition, we may establish relationships withthird party resellers and other sales partners as we expand into geographicregions such as Europe and Asia. Our failure to maintain existingrelationships, or to establish new relationships with key third parties, couldsignificantly harm our ability to sell our products and services. In addition,our competitors may have strong alliances with other companies, includinghardware providers, which could impact our ability to obtain greater marketshare, participate in deals where hardware and software are sold together, orrequire us to reduce the price of products and services, which could harm ourbusiness, financial condition and operating results.

Additionally, our consumer technology supportservices initiative will require us to establish relationships with thirdparties who will refer customers to us as well as with third parties to whichwe intend to outsource much of our call center services. Failure to establishor maintain these relationships on acceptable terms or at all could materiallyand adversely affect the success of this initiative.

**If the growth of demand for digitalservices by subscribers of digital services providers does not continue or ifdemand by digital service providers for our software does not continue, ourability to increase our revenue could suffer.**

Our ability to increase our revenue will depend inpart on increased demand for digital services. If this demand does not grow asrapidly or to the extent we anticipate, our business could suffer. The growthof digital services is uncertain and will depend in particular upon theavailability, at a reasonable price, of such digital services, the building ofinfrastructure to support such services, the availability of competitiveproducts, and the reliability of such services.

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Even if the demand and deployment of digitalservices grows, we may not be able to grow our revenue because our products fornew digital services are relatively new and unproven and have not generatedsignificant revenue to date.

**We are seeking to increase ourinternational revenues and if our revenue from this effort does not exceed theexpense of establishing and maintaining international operations, our businesscould suffer.**

We are seeking to increase our internationalrevenues.  For the year endedDecember 31, 2004 international revenue was 11% of total revenue and forthe year ended December 31, 2005 international revenue was 21% of totalrevenue. For the nine months ended September 30, 2006, international revenuewas 22% of total revenue. We have limited experience in internationaloperations and may not be able to compete effectively in international marketsor effectively manage our operations in various countries. If we do notgenerate enough revenue from international operations to offset the expense ofthese operations, our business and our ability to increase revenue and enhanceour operating results could suffer. Risks we face in conducting businessinternationally include:

·                  costs of staffing and managing internationaloperations;

·                  smaller customers with less ability to payUnited States rates for the software;

·                  difficulty in reaching geographicallydispersed customers;

·                  differing technology standards and legalconsiderations;

·                  longer sales cycles;

·                  dependence on local vendors and consultants;

·                  difficulties in staffing and managinginternational operations, including the difficulty in managing a geographicallydispersed workforce in compliance with diverse local laws and customs anddifficulty in motivating and retaining qualified individuals;

·                  potential adverse tax consequences;

·                  changes in currency exchange rates andcontrols;

·                  difficulties in maintaining effectiveinternal control over financial reporting as a result of ageographically-dispersed workforce and customers;

·                  longer collection cycles for accountsreceivable; and

·                  the effects of external events such asterrorist acts and any related conflicts or similar events worldwide.

**If we do not expand ourprofessional services organization, especially internationally, our customersmay become dissatisfied and our operating results could suffer. Also, as weexpand our professional services organization, it may not operate in aprofitable manner.**

Clients that license our software typically engageour professional services organization to assist with installation andimplementation of our software and related consulting services. Revenue fromprofessional services represented a substantial portion of our total revenuefor the three and nine months ended September 30, 2006. We plan to furtherincrease the number of services personnel, especially internationally, to meetcustomer needs. We may not be able to recruit the services personnel we need orretain our current services personnel because competition for qualifiedservices personnel is intense. New services personnel will require training andeducation and take time to reach full productivity.

In addition, we cannot be certain that ourprofessional services business will operate in a profitable manner. We havegenerally billed our customers for professional services on a time and materialbasis using an agreed upon daily rate. However, increasingly customers haverequested various contract structures, including milestone based contracts andcontracts for a fixed total fee. If unanticipated factors in a project areencountered and the contract structure prevents us from billing additionalamounts, the profitably of our professional services business would suffer.Furthermore, an estimated loss on a contract is generally required to berecorded in the period in which a loss becomes evident. Recording a loss on aservices contract could have a material adverse effect on our operating resultsfor the period in which the loss was recorded.

 **The loss of key personnel and the integration of newmanagement may affect our ability to achieve our business goals.**

Our success depends on the skills, experience andperformance of our senior management, engineering, sales, marketing and otherkey personnel. The loss of the services of any of our senior management orother key personnel could harm our business and our ability to achieve ourbusiness goals. To date in 2006, Radha R. Basu, our former President and ChiefExecutive Officer, John Van Siclen, our former Senior Vice President ofWorldwide Field Operations, and Brian Beattie, our former Chief FinancialOfficer, resigned. We have also recently implemented reductions in ourworkforce. Reductions in our workforce as well as changes in senior managementcould make it difficult to motivate and retain remaining key employees orattract new employees, and provide distractions affecting our ability to manageour business.

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Since April 2006, we have appointed a new CEO,Senior Vice President of Sales, Senior Vice President of Global Services andChief Marketing Officer. The efforts in integrating new management may divertattention from other business concerns and disrupt our ongoing business,especially in the short term. Our success will depend to a significant extenton the ability of these executives to function effectively in their new rolesand our ability to retain the services of these new executives.  If  these executives do not function effectivelyor if we lose the services of one or more of our executives or key employees,our business could be harmed.

**Our exposure to the credit risks ofour customers and resellers may make it difficult to collect receivables andcould adversely affect our operating results and financial condition.**

Industry and economic conditions have weakened thefinancial position of some of our customers in the cable and telecommunicationsindustries, which are industries from which we derive a substantial portion ofour total revenue, and these businesses have traditionally been highlyleveraged businesses. To sell to some of these customers, we may be required totake risks of uncollectible accounts. We may be exposed to similar risksrelating to third party resellers and other sales partners, as we intend toincreasingly utilize such parties as we expand into new geographic regions.Additionally, as we have expanded our business internationally we haveexperienced longer payment terms and collection cycles from customers outsidethe United States. While we monitor these situations carefully and attempt totake appropriate measures to protect ourselves, it is possible that we may haveto write down or write off doubtful accounts. Such write-downs or write-offswould negatively affect our operating results for the period in which theyoccur, and, if large, could have a material adverse effect on our operatingresults and financial condition.

**Our products depend on and workwith products containing complex software, and if our products fail to performproperly due to errors in the software, we may need to devote resources to correctthe errors or compensate for losses from these errors and our reputation couldbe harmed.**

Our products depend on complex software, bothinternally developed and licensed from third parties. Also, our customers mayuse our products with other companies’ products which also contain complexsoftware. Complex software often contains errors and may not perform properly.These errors could result in:

·                  delays in product shipments;

·                  unexpected expenses and diversion ofresources to identify the source of errors or to correct errors, whether or notthe error is later determined to be related to our software;

·                  damage to our reputation;

·                  lost sales;

·                  contractual penalties, demands, claims andlitigation and related defense costs; and

·                  warranty claims.

If our products fail to perform properly due toerrors, bugs or similar problems in the software, we could be required todevote valuable resources to correct the errors or compensate for losses fromthese errors. Furthermore, if our products are found to contain errors or bugs,whether resulting from internally developed or third-party licensed software,our reputation with our customer base could be harmed and our business couldsuffer.

Additionally we will be using our own products todiagnose and resolve consumer technology problems in our new businessinitiative. If our products fail to perform well in this environment, our newbusiness initiative could suffer and may not be successful.

**Ourreported results of operations will continue to be materially and adverselyaffected by our adoption of SFAS 123R.**

Statement of Financial Accounting StandardsNo. 123 (revised 2004),*Share-BasedPayment* (SFAS 123R), became effective in our first quarter of2006, and has resulted in our recognition of substantial compensation expenserelating to our employee stock options and employee stock purchase plans.Historically, we generally have not recognized in our statement of operationsany compensation expense related to stock option grants we issue under ourstock option plans or the discounts we provide under our employee stockpurchase plans. Under the new rules, we are required to measure thecompensation expense related to employee stock awards on a fair value basis,which leads to substantial additional compensation expense and a materialadverse effect on our reported results of operations.

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**If we are unable to maintaineffective disclosure controls and procedures, including our internal controlover financial reporting, our ability to report our financial results on a timelyand accurate basis may be adversely affected.**

We have evaluated our “disclosure controls andprocedures” as such term is defined in Rule 13a-15(e) under the SecuritiesExchange Act of 1934, as well as our internal control over financial reportingas required by Section 404 of the Sarbanes-Oxley Act of 2002. Ourindependent registered public accounting firm has performed a similarevaluation of our internal control over financial reporting. Effective controlsare necessary for us to provide reliable financial reports and effectivelyprevent fraud. If we cannot provide reliable financial reports or preventfraud, our operating results could be harmed. As of December 31, 2005, weconcluded that our internal control over financial reporting were effective. However,in 2004 we had material weaknesses in our internal controls and we cannot becertain that we will continue to have adequate controls over our financialprocesses and reporting in the future. If weaknesses are identified, ourability to report our financial results on a timely and accurate basis may beadversely affected. In addition, if we cannot maintain effective internalcontrol over financial reporting and disclosure controls and procedures,investors may lose confidence in our reported financial information, whichcould have a negative effect on the trading price of our common stock.

**If our existing customers do notrenew maintenance services or purchase additional products, our operatingresults could suffer.**

Historically, we have derived, and expect tocontinue to derive, a significant portion of our total revenue from existingcustomers who purchase additional products or renew maintenance services. Ourcustomers may not renew maintenance services or purchase additional productsand may not expand their use of our products. In addition, as we introduce newproducts, our current customers may not require or desire the functionality ofour new products and may not ultimately purchase these products. If ourcustomers do not renew maintenance services or do not purchase additionalproducts, our revenue levels and operating results could suffer.

**Our software may not operate withthe hardware and software platforms that are used by our customers now or inthe future, and as a result our business and operating results may suffer.**

We currently serve a customer base with a widevariety of constantly changing hardware, software and networking platforms. Ifwe fail to release versions of our software that are compatible with operatingsystems, software applications or hardware devices used by our customers, ourbusiness and operating results would suffer. Our future success also dependson:

·                  the continuing ability of our products tointer-operate with multiple platforms and packaged applications used by ourcustomer base; and

·                  our management of software being developed bythird parties for our customers or for use with our products.

**We rely on third-party technologiesand our inability to use or integrate third-party technologies could delayproduct or service development.**

We intend to continue to license technologies fromthird parties, including applications used in our research and developmentactivities and technologies such as third-party search engine technology, whichare integrated into our products and services. Our inability to obtain orintegrate any of these technologies with our own products could delay productand service development until equivalent technology can be identified, licensedand integrated. These technologies may not continue to be available to us oncommercially reasonable terms or at all. We may fail to successfully integrateany licensed technology into our products or services, which would harm ourbusiness and operating results. Third-party licenses also expose us to increasedrisks that include:

·                  risks of product malfunction after newtechnology is integrated;

·                  the diversion of resources from thedevelopment of our own proprietary technology; and

·                  our inability to generate revenue from newtechnology sufficient to offset associated acquisition and maintenance costs.

**We must compete successfully in themarket for software and services that resolve technical problems or we willlose market share and our business will suffer.**

We compete in markets that are highly competitive,subject to rapid change and significantly affected by new product introductionsand other market activities of industry participants. We compete with a numberof companies in the market for automated delivery of support and serviceautomation and other vendors who may offer products or services with featuresthat compete with specific elements of our software products and services. Inaddition, our customers and potential customers have developed or may developinternally similar software systems. We expect that internally developedapplications will continue to be a principal source of competition in theforeseeable future.

The markets for our products are still rapidlyevolving, and we may not be able to compete successfully against current andpotential competitors. Our ability to expand our business will depend on ourability to maintain our technological advantage, introduce timely enhancedproducts to meet the growing support needs, deliver on-going value to ourcustomers and scale our business. Our potential competitors may have longeroperating histories, significantly greater financial, technical and other 

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resources, stronger strategic alliances or greatername recognition than we do. Competition in our markets could reduce our marketshare or require us to reduce the price of products and services, which couldharm our business, financial condition and operating results.

As we enter the market for consumer technologysupport services, we expect to compete against a set of competitors differentthan the competitors against whom we have historically competed, includingelectronics retailers offering on-site technology support services, companiesoffering online technology support services and companies offering localtechnology support services. Certain of these anticipated competitors havelonger operating histories, significantly greater financial, technical andother resources, stronger strategic alliances or greater name recognition thanwe do.

**Our system security is important toour customers and we may need to spend significant resources to protect againstor correct problems caused by security breaches.**

A fundamental requirement for online communications,transactions and support is the secure transmission of confidentialinformation. Third parties may attempt to breach our security or that of ourcustomers. We may be liable to our customers for any breach in security and anybreach could harm our business and reputation. Also, computers are vulnerableto computer viruses, physical or electronic break-ins and similar disruptions,which could lead to interruptions, delays or loss of data. We may be requiredto expend significant capital and other resources to further protect againstsecurity breaches or to correct problems caused by any breach.

**Failure to resolve pendingsecurities claims and other lawsuits may lead to continued costs and expensesand divert management’s attention from our business, which could cause ourrevenue and our stock price to decline.**

In the past, securities class action litigation hasoften been brought against public companies, including our company, afterperiods of volatility in the market price of securities. The market price ofour common stock has been subject to significant fluctuations and may continueto fluctuate or decline. In addition, the anti-takeover provisions we haveadopted in the past, such as prohibiting stockholder action by written consent,or may adopt in the future may be perceived negatively by the market causing adecline in our stock price or litigation against us. Securities class actionlawsuits were filed against us in November 2001 and again in December 2004. Inaddition, a derivative shareholder lawsuit was filed against us in December2005. Should these lawsuits linger for a long period of time, whetherultimately resolved in our favor or not, or further lawsuits be filed againstus, coverage limits of our insurance or our ability to pay such amounts may notbe adequate to cover the fees and expenses and any ultimate resolutionassociated with such litigation. The size of these payments, if any,individually or in the aggregate, could seriously impair our cash reserves andfinancial condition. The continued defense of these lawsuits also could resultin continued diversion of our management’s time and attention away frombusiness operations, which could cause our financial results to decline. Afailure to resolve definitively current or future material litigation in whichwe are involved or in which we may become involved in the future, regardless ofthe merits of the respective cases, could also cast doubt as to our prospectsin the eyes of customers, potential customers and investors, which could causeour revenue and stock price to decline.

**Privacy concerns and laws or otherdomestic or foreign regulations may reduce the effectiveness of our solution orharm our reputation and cause us to lose customers.**

Our software contains features which allow ourcustomers to control, monitor or collect information from computers running thesoftware. Federal, state and foreign government bodies and agencies, however,have adopted or are considering adopting laws and regulations regarding thecollection, use and disclosure of personal information obtained from consumersand individuals. The costs of compliance with, and other burdens imposed by,such laws and regulations that are applicable to the businesses of ourcustomers may limit the use and adoption of our solutions and reduce overalldemand for it. Furthermore, privacy concerns may cause our customers’ customersto resist providing the data necessary to allow our customers to use oursolutions effectively. Even the perception of privacy concerns, whether or notvalid, may inhibit adoption of our solutions. In addition, we may face claimsabout invasion of privacy or inappropriate disclosure, use or loss of thisinformation. Any imposition of liability could harm our reputation, cause us tolose customers and cause our operating results to suffer.

**Any system failure that causes aninterruption in our customers’ ability to use our products or services or adecrease in their performance could harm our relationships with our customersand result in reduced revenue.**

Our software is vulnerable to damage or interruptionfrom computer viruses, human error, natural disasters, electricity gridfailures and intentional acts of vandalism and similar events. These problemscould interrupt our customers’ ability to use our products or services, whichcould harm our reputation and cause us to lose customers and revenue.

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**We may not obtain sufficient patentprotection, which could harm our competitive position, increase our expensesand harm our business.**

Our success and ability to compete depend to asignificant degree upon the protection of our software and other proprietary technology.It is possible that:

·                  our pending patent applications may not beissued;

·                  competitors may independently develop similartechnologies or design around any of our patents;

·                  patents issued to us may not be broad enoughto protect our proprietary rights; and

·                  our issued patents could be successfullychallenged.

**We rely upon patents, trademarks,copyrights and trade secrets to protect our proprietary rights and if theserights are not sufficiently protected, it could harm our ability to compete andto generate revenue.**

We rely on a combination of laws, such as patents,copyright, trademark and trade secret laws, and contractual restrictions, suchas confidentiality agreements and licenses, to establish and protect ourproprietary rights. Our ability to compete and grow our business could sufferif these rights are not adequately protected. Our proprietary rights may not beadequately protected because:

·                  laws and contractual restrictions may notadequately prevent misappropriation of our technologies or deter others fromdeveloping similar technologies; and

·                  policing unauthorized use of our products andtrademarks is difficult, expensive and time-consuming, and we may be unable todetermine the existence or extent of this unauthorized use.

Also, the laws of other countries in which we marketour products may offer little or no protection of our proprietary technologies.Reverse engineering, unauthorized copying or other misappropriation of ourproprietary technologies could enable third parties to benefit from ourtechnologies without paying us for them, which would harm our competitiveposition and market share.

**We may face intellectual propertyinfringement claims that could be costly to defend and result in our loss ofsignificant rights.**

Other parties may assert intellectual propertyinfringement claims against us or our customers and our products may infringethe intellectual property rights of third parties. For example, our productsmay infringe issued patents that may relate to our products. In addition, as isincreasingly common in the software industry, we may be confronted with theaggressive enforcement of patents by companies whose primary business activityis to acquire patents for the purpose of offensively asserting them againstother companies.  Intellectual propertylitigation is expensive and time-consuming and could divert management’sattention from our business. If there is a successful claim of infringement, wemay be required to develop non-infringing technology or enter into royalty orlicense agreements which may not be available on acceptable terms, if at all.Our failure to develop non-infringing technologies or license the proprietaryrights on a timely basis would harm our business.

**We have recorded long-lived assets,and our results of operations would be adversely affected if their valuebecomes impaired.**

Goodwill and identifiable intangible assets wererecorded as a result of our acquisition of substantially all of the assets ofCore Networks Incorporated on September 2, 2004. We assess the impairmentof goodwill annually or more often if events or changes in circumstancesindicate that the carrying value may not be recoverable. We assess theimpairment of acquired product rights and other identifiable intangible assetswhenever events or changes in circumstances indicate that its carrying amountmay not be recoverable. An impairment loss would be recognized when the sum ofthe discounted future net cash flows expected to result from the use of theasset and its eventual disposition is less than its carrying amount. Suchimpairment loss would be measured as the difference between the carrying amountof the asset and its fair value. Material differences may result in write-downsof net long-lived and intangible assets, which would cause our operatingresults to suffer.

**If securities analysts stoppublishing research or reports about us or our business or if they downgradeour stock, the price of our stock could decline.**

The trading market for our common stock relies inpart on the research and reports that industry or financial analysts publishabout us or our business. We do not control these analysts. If one or more ofthe analysts who currently cover us downgrade our stock, our stock price wouldlikely decline rapidly. Furthermore, if one or more of these analysts ceasecoverage of us, we could lose visibility in the market, which in turn couldcause our stock price to decline.

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**Risks Related To Our Industry**

**We may experience a decrease inmarket demand due to uncertain economic conditions in the United States and ininternational markets, which has been further exacerbated by the concerns ofterrorism, war and social and political instability.**

The United States and some international economieshave in the past, experienced periods of slow economic growth. In addition, theterrorists attacks in the United States and turmoil in the Middle East haveincreased the uncertainty in the United States economy and may furtherexacerbate the decline in economic conditions, both domestically andinternationally. Terrorist acts and similar events, or war in general, couldcontribute further to a slowdown of the market demand for goods and services,including software solutions. If the economy declines as a result of economic,political and social turmoil, or if there are further terrorist attacks in theUnited States or elsewhere, we may experience decreases in the demand for ourproducts and services, which may harm our operating results.

**We may be required to change ourbusiness practices if there are changes in accounting regulations and relatedinterpretations and policies.**

Accounting standards groups and regulators areactively re-examining various accounting policies, guidelines andinterpretations related to revenue recognition, expensing stock options, incometaxes, investments in equity securities, facilities consolidation, accountingfor acquisitions, allowance for doubtful accounts and other financial reportingmatters. These standards groups and regulators could promulgate interpretationsand guidance that could result in material and potentially adverse changes toour business practices and accounting policies.

**New rulesand regulations for public companies have increased and may continue toincrease our administrative costs.**

The Sarbanes-Oxley Act of 2002, as well as new rulessubsequently implemented by the Securities and Exchange Commission and theNasdaq Global Market, have required changes in corporate governance practicesof public companies.

These rules and regulations are increasing our legaland financial compliance costs, and making some activities more time-consumingand costly. These rules and regulations make it more difficult and moreexpensive for us to obtain director and officer liability insurance, and we maybe required to accept reduced coverage or incur substantially higher costs toobtain coverage. These new rules and regulations could also make it moredifficult for us to attract and retain qualified members of our board ofdirectors, particularly to serve on our audit committee, and qualifiedexecutive officers.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

None.

**ITEM 5. OTHER INFORMATION.**

None.

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**ITEM 6. EXHIBITS**
|        | Exhibits. –                                                              |
|--------|-------------------------------------------------------------------------------|
|   |                                                                          |
|   | 31.1 Chief Executive Officer Section 302  Certification                       |
|   |                                                                          |
|   | 31.2 Chief Financial Officer Section 302  Certification                       |
|   |                                                                          |
|   | 32.1 Statement of the Chief Executive Officer under  18 U.S.C. § 1350(1) |
|   |                                                                          |
|   | 32.2 Statement of the Chief Financial Officer under  18 U.S.C. § 1350(1) |

 

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| (1) | The certifications filed as Exhibits 32.1 and 32.2  are not deemed “filed” for purposes of Section 18 of the Securities  Exchange Act of 1934 and are not to be incorporated by reference into any  filing of the Company under the Securities Exchange Act of 1933 or the  Securities Exchange Act of 1934, whether made before or after the date hereof  irrespective of any general incorporation by reference language contained in  any such filing, except to the extent that the registrant specifically  incorporates it by reference. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

32

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**SIGNATURE**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
| November 8, 2006 |              |
|------------------|-------------------|
|             |              |
|             | SUPPORTSOFT, INC. |
|             |              |
|             | By:               | /s/ KEN OWYANG |
|             | ** **        | **Ken  Owyang** |
|             | ** **        | **Chief  Financial Officer and** |
|             | ** **        | **Senior  Vice President of Finance and** |
|             | ** **        | **Administration** |
|             | ** **        | **(Principal  Financial Officer, Chief Accounting** |
|             | ** **        | **Officer  and Duly Authorized Signatory)** |

 

33

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**EXHIBIT INDEXTO SUPPORTSOFT, INC.**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THE QUARTER ENDED SEPTEMBER 30, 2006**
| 31.1 |   | Chief Executive Officer Section 302 Certification                        |
|------|--------|--------------------------------------------------------------------------|
| 31.2 |   | Chief Financial Officer Section 302 Certification                        |
| 32.1 |   | Statement of the Chief Executive Officer under 18  U.S.C. § 1350(1) |
| 32.2 |   | Statement of the Chief Financial Officer under 18  U.S.C. § 1350(1) |

 

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| (1) | The certifications filed as Exhibits 32.1 and 32.2  are not deemed “filed” for purposes of Section 18 of the Securities  Exchange Act of 1934 and are not to be incorporated by reference into any  filing of the Company under the Securities Exchange Act of 1933 or the  Securities Exchange Act of 1934, whether made before or after the date hereof  irrespective of any general incorporation by reference language contained in  any such filing, except to the extent that the registrant specifically  incorporates it by reference. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

34

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