**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**Form 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Quarterly Period Ended September 30, 2005**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition periodfrom                        to                        **

**CommissionFile Number 0-30881**

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**CLICK COMMERCE, INC.**

(Exact name of registrant as specified in its charter)

| **Delaware**                     | ** ** | **36-4088644**          |
|----------------------------------|------------|-------------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer        |
| incorporation or  organization)  |       | Identification  Number) |

 

**233 North Michigan Avenue,22 FloorChicago, Illinois 60601**

(Address of principalexecutive offices)

**(312) 482-9006**

(Registrant’s telephonenumber, including area code)

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

**Securities registeredpursuant to Section 12(g) of the Act:**

**CommonStock, par value $0.001 per share**

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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 90 days. Yes x  No o

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes o  No x

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

Asof November 14, 2005, there were 11,229,866 shares of the registrant’scommon shares outstanding.

 

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**CLICK COMMERCE, INC.**

**INDEX**

|                | ** ** | ** **                                                                                                                                                                  | ** ** | **Page No.** |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| PART I.   |       | FINANCIAL  INFORMATION                                                                                                                                                      |       |              |   |
| Item 1.        |       | Financial  Statements                                                                                                                                                       |       | 3                 |   |
|           |       | Condensed  Consolidated Balance Sheets as of September 30, 2005 (unaudited) and  December 31, 2004                                                                |       | 3                 |   |
|           |       | Condensed  Consolidated Statements of Income and Comprehensive Income for the three and  nine months ended September 30, 2005 and September 30, 2004  (unaudited) |       | 4                 |   |
|           |       | Condensed  Consolidated Statements of Cash Flows for the nine months ended  September 30, 2005 and 2004 (unaudited)                                                    |       | 5                 |   |
|           |       | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                                                           |       | 7                 |   |
| Item  2.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                 |       | 17                |   |
| Item 3.        |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                                                                 |       | 25                |   |
| Item 4.        |       | Controls and Procedures                                                                                                                                                     |       | 25                |   |
| PART II.  |       | OTHER  INFORMATION                                                                                                                                                          |       | 26                |   |
| Item 6.        |       | Exhibits                                                                                                                                                                    |       | 26                |   |
| SIGNATURES     |       | 27                                                                                                                                                                          |       |
| CERTIFICATIONS |       |                                                                                                                                                                        |       |

 

2

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**PART I.   FINANCIAL INFORMATION**

**Item1.   Financial Statements**

**CLICK COMMERCE, INC.CONDENSED CONSOLIDATEDBALANCE SHEETS(Dollars in thousands, except per share data)**

| ** **                                                                                                                                                                                                                                                                                          | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                          | ** ** | **(unaudited)**                  | ** ** | ** **                      | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Current assets:                                                                                                                                                                                                                                                                                     |       |                             |       |                            |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                          |       |                             | $          | 11,135                          |       |   |   | $ | 13,382 |   |   |
| Trade accounts  receivable, less allowance for doubtful accounts of $574 and $514,  respectively                                                                                                                                                                                               |       |                             | 16,453     |                            |       |   | 7,264 |   |   |
| Revenues earned on  contracts in progress in excess of billings                                                                                                                                                                                                                                     |       |                             | 839        |                            |       |   | 276 |   |   |
| Prepaids and other  current assets                                                                                                                                                                                                                                                                  |       |                             | 2,670      |                            |       |   | 389 |   |   |
| Total current assets                                                                                                                                                                                                                                                                                |       |                             | 31,097     |                            |       |   | 21,311 |   |   |
| Property and equipment,  net                                                                                                                                                                                                                                                                        |       |                             | 2,949      |                            |       |   | 870 |   |   |
| Intangible assets, net                                                                                                                                                                                                                                                                              |       |                             | 20,198     |                            |       |   | 2,944 |   |   |
| Goodwill                                                                                                                                                                                                                                                                                            |       |                             | 35,615     |                            |       |   | 6,874 |   |   |
| Other assets                                                                                                                                                                                                                                                                                        |       |                             | 1,184      |                            |       |   | 738 |   |   |
| Total assets                                                                                                                                                                                                                                                                                        |       |                             | $          | 91,043                          |       |   |   | $ | 32,737 |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                                      |       |                             |       |                            |       |   |   |   |   |
| Current liabilities:                                                                                                                                                                                                                                                                                |       |                             |       |                            |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                                                                    |       |                             | $          | 1,039                           |       |   |   | $ | 573 |   |   |
| Billings in excess of  revenues earned on contracts in progress                                                                                                                                                                                                                                     |       |                             | 15         |                            |       |   | 68 |   |   |
| Deferred revenue                                                                                                                                                                                                                                                                                    |       |                             | 10,971     |                            |       |   | 5,174 |   |   |
| Accrued compensation                                                                                                                                                                                                                                                                                |       |                             | 2,499      |                            |       |   | 1,585 |   |   |
| Accrued expenses and  other current liabilities                                                                                                                                                                                                                                                     |       |                             | 5,642      |                            |       |   | 2,177 |   |   |
| Short-term notes payable                                                                                                                                                                                                                                                                            |       |                             | 1,070      |                            |       |   | — |   |   |
| Total current  liabilities                                                                                                                                                                                                                                                                          |       |                             | 21,236     |                            |       |   | 9,577 |   |   |
| Long-term debt                                                                                                                                                                                                                                                                                      |       |                             | 6,360      |                            |       |   | — |   |   |
| Other liabilities                                                                                                                                                                                                                                                                                   |       |                             | 20         |                            |       |   | 6 |   |   |
| Total liabilities                                                                                                                                                                                                                                                                                   |       |                             | 27,616     |                            |       |   | 9,583 |   |   |
| Shareholders’ equity:                                                                                                                                                                                                                                                                          |       |                             |       |                            |       |   |   |   |   |
| Preferred stock, $0.001  par value, 5,000,000 shares authorized, no shares issued and outstanding                                                                                                                                                                                                   |       |                             | —     |                            |       |   | — |   |   |
| Common stock, $0.001 par  value, 75,000,000 shares authorized; 11,442,271 and 9,742,401 shares issued  as of September 30, 2005 and December 31, 2004, respectively;  11,413,207 and 9,713,337 shares outstanding as of September 30, 2005 and  December 31, 2004, respectively |       |                             | 11         |                            |       |   | 10 |   |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                          |       |                             | 100,039    |                            |       |   | 69,386 |   |   |
| Accumulated other  comprehensive income                                                                                                                                                                                                                                                             |       |                             | 140        |                            |       |   | 153 |   |   |
| Treasury stock, at  cost—29,064 shares                                                                                                                                                                                                                                                         |       |                             | (117       | )                               |       |   | (117 | ) |   |
| Accumulated deficit                                                                                                                                                                                                                                                                                 |       |                             | (36,646    | )                               |       |   | (46,278 | ) |   |
| Total shareholders’  equity                                                                                                                                                                                                                                                                    |       |                             | 63,427     |                            |       |   | 23,154 |   |   |
| Total liabilities and shareholders’ equity                                                                                                                                                                                                                                                     |       |                             | $          | 91,043                          |       |   |   | $ | 32,737 |   |   |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**CLICKCOMMERCE, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME ANDCOMPREHENSIVE INCOME**

**(Dollars inthousands, except per share data)(Unaudited)**

| ** **                                               | ** ** | **Three months ended September 30,**                                                             | ** ** | **Nine months ended September 30,**                                                        | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **         2005         ** | ** ** | **         2004        ** | ** ** | **         2005         ** | ** ** | **        2004        ** | ** ** |
| Revenues                                                 |       |                                                                                                                 |       |                                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Product license                                          |       |                                                                                                                 | $          | 2,107                                                                                                          |       |   | $ | 1,221 |   |   | $ | 5,911 |   |   |   | $ | 3,081 |   |   |
| Service:                                                 |       |                                                                                                                 |       |                                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Maintenance and hosting                                  |       |                                                                                                                 | 7,587      |                                                                                                           |       | 2,682 |   |   | 17,130 |   |   |   | 6,397 |   |   |
| Consulting and  implementation services             |       |                                                                                                                 | 4,574      |                                                                                                           |       | 2,419 |   |   | 11,920 |   |   |   | 7,537 |   |   |
| Subscription                                             |       |                                                                                                                 | 1,937      |                                                                                                           |       | 714 |   |   | 5,518 |   |   |   | 1,501 |   |   |
| Total service                                            |       |                                                                                                                 | 14,098     |                                                                                                           |       | 5,815 |   |   | 34,568 |   |   |   | 15,435 |   |   |
| Total revenues                                           |       |                                                                                                                 | 16,205     |                                                                                                           |       | 7,036 |   |   | 40,479 |   |   |   | 18,516 |   |   |
| Cost of revenues:                                        |       |                                                                                                                 |       |                                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Product license                                          |       |                                                                                                                 | 613        |                                                                                                           |       | 97 |   |   | 1,155 |   |   |   | 240 |   |   |
| Service                                                  |       |                                                                                                                 | 5,334      |                                                                                                           |       | 2,526 |   |   | 14,150 |   |   |   | 7,208 |   |   |
| Total cost of revenues                                   |       |                                                                                                                 | 5,947      |                                                                                                           |       | 2,623 |   |   | 15,305 |   |   |   | 7,448 |   |   |
| Gross profit                                             |       |                                                                                                                 | 10,258     |                                                                                                           |       | 4,413 |   |   | 25,174 |   |   |   | 11,068 |   |   |
| Operating expenses:                                      |       |                                                                                                                 |       |                                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                                      |       |                                                                                                                 | 2,058      |                                                                                                           |       | 1,084 |   |   | 4,806 |   |   |   | 2,362 |   |   |
| Research and development                                 |       |                                                                                                                 | 1,822      |                                                                                                           |       | 1,007 |   |   | 4,697 |   |   |   | 2,072 |   |   |
| General and  administrative                              |       |                                                                                                                 | 1,596      |                                                                                                           |       | 856 |   |   | 3,884 |   |   |   | 2,971 |   |   |
| Amortization of  stock-based compensation           |       |                                                                                                                 | —     |                                                                                                           |       | — |   |   | — |   |   |   | 21 |   |   |
| Amortization of  intangible assets                       |       |                                                                                                                 | 810        |                                                                                                           |       | 200 |   |   | 2,035 |   |   |   | 431 |   |   |
| Total operating expenses                                 |       |                                                                                                                 | 6,286      |                                                                                                           |       | 3,147 |   |   | 15,422 |   |   |   | 7,857 |   |   |
| Operating income                                         |       |                                                                                                                 | 3,972      |                                                                                                           |       | 1,266 |   |   | 9,752 |   |   |   | 3,330 |   |   |
| Other income (expense),  net                             |       |                                                                                                                 | (185       | )                                                                                                              |       | 104 |   |   | (123 | ) |   |   | 68 |   |   |
| Income before income  taxes                              |       |                                                                                                                 | 3,787      |                                                                                                           |       | 1,370 |   |   | 9,629 |   |   |   | 3,398 |   |   |
| Income tax expense                                       |       |                                                                                                                 | —     |                                                                                                           |       | — |   |   | — |   |   |   | — |   |   |
| Net income                                               |       |                                                                                                                 | $          | 3,787                                                                                                          |       |   | $ | 1,370 |   |   | $ | 9,629 |   |   |   | $ | 3,398 |   |   |
| Basic net income per  common share                       |       |                                                                                                                 | $          | 0.33                                                                                                           |       |   | $ | 0.14 |   |   | $ | 0.86 |   |   |   | $ | 0.38 |   |   |
| Diluted net income per  common share                     |       |                                                                                                                 | $          | 0.31                                                                                                           |       |   | $ | 0.14 |   |   | $ | 0.81 |   |   |   | $ | 0.36 |   |   |
| Weighted average common  shares outstanding—basic   |       |                                                                                                                 | 11,405,022 |                                                                                                           |       | 9,719,083 |   |   | 11,164,770 |   |   |   | 8,991,067 |   |   |
| Weighted average common  shares outstanding—diluted |       |                                                                                                                 | 12,138,648 |                                                                                                           |       | 10,074,352 |   |   | 11,891,690 |   |   |   | 9,403,505 |   |   |
| Comprehensive income:                                    |       |                                                                                                                 |       |                                                                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                               |       |                                                                                                                 | $          | 3,787                                                                                                          |       |   | $ | 1,370 |   |   | $ | 9,629 |   |   |   | $ | 3,398 |   |   |
| Unrealized loss on  marketable  securities               |       |                                                                                                                 | —     |                                                                                                           |       | — |   |   | — |   |   |   | (5 | ) |   |
| Foreign currency  translation  adjustment                |       |                                                                                                                 | (21        | )                                                                                                              |       | 6 |   |   | (13 | ) |   |   | 21 |   |   |
| Comprehensive income                                     |       |                                                                                                                 | $          | 3,766                                                                                                          |       |   | $ | 1,376 |   |   | $ | 9,616 |   |   |   | $ | 3,414 |   |   |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**CLICK COMMERCE, INC.CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(Dollars in thousands)(Unaudited)**

| ** **                                                                                   | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                                    |       |                                                |       |   |   |
| Net income                                                                                   |       | $                                                   | 9,629      |   | $ | 3,398 |   |
| Adjustments to reconcile net  income to net cash provided by (used in) operating activities: |       |                                                |       |   |   |
| Amortization of  stock-based compensation                                                    |       | —                                              |       | 21 |   |
| Depreciation                                                                                 |       | 866                                                 |       | 345 |   |
| Amortization of  Intangibles                                                                 |       | 2,814                                               |       | 431 |   |
| Provision for  doubtful accounts                                                             |       | 60                                                  |       | 180 |   |
| Loss on disposal  of assets                                                                  |       | 160                                                 |       | — |   |
| Changes in operating  assets and liabilities, net of effect of acquisitions:                 |       |                                                |       |   |   |
| Trade accounts  receivable                                                                   |       | (2,221                                              | )          | (1,330 | ) |
| Prepaids and other  current assets                                                           |       | (592                                                | )          | 89 |   |
| Accounts payable                                                                             |       | (2,379                                              | )          | (74 | ) |
| Billings in excess  of revenues earned on contracts in progress                              |       | (53                                                 | )          | — |   |
| Deferred revenue                                                                             |       | (4,266                                              | )          | (1,354 | ) |
| Accrued  compensation                                                                        |       | (3,663                                              | )          | 266 |   |
| Accrued expenses  and other current liabilities                                              |       | (1,725                                              | )          | (330 | ) |
| Other, net                                                                                   |       | 131                                                 |       | 68 |   |
| Net cash (used in)  provided by operating activities                                         |       | (1,239                                              | )          | 1,710 |   |
| **Cash flows from investing activities:**                                                    |       |                                                |       |   |   |
| Purchases of  property and equipment                                                         |       | (604                                                | )          | (206 | ) |
| Deal costs,  Webridge acquisition                                                            |       | —                                              |       | (186 | ) |
| Acquisition  bTrade, net of cash acquired and deal costs                                     |       | —                                              |       | (1,619 | ) |
| Acquisition of  Optum, net of cash acquired and deal costs(a)                                |       | (1,065                                              | )          | — |   |
| Acquisition of  ChannelWave, net of deal costs(a)                                            |       | (1,053                                              | )          | — |   |
| Acquisition of  Xelus, net of cash acquired and deal costs(a)                                |       | 794                                                 |       | — |   |
| Change in  long-term investments, net                                                        |       | (200                                                | )          | (70 | ) |
| Net cash used in  investing activities                                                       |       | (2,128                                              | )          | (2,081 | ) |
| **Cash flows from financing activities:**                                                    |       |                                                |       |   |   |
| Proceeds from  exercise of stock options                                                     |       | 251                                                 |       | 96 |   |
| Proceeds from  long-term debt                                                                |       | 6,291                                               |       | — |   |
| Payments on  long-term and short-term debt                                                   |       | (5,419                                              | )          | — |   |
| Payments under  capital lease obligations                                                    |       | (3                                                  | )          | (69 | ) |
| Net cash provided  by (used in) financing activities                                         |       | 1,120                                               |       | 27 |   |
| Effect of foreign  exchange rates on cash and cash equivalents                               |       | —                                              |       | 1 |   |
| Net increase  (decrease) in cash and cash equivalents                                        |       | (2,247                                              | )          | (343 | ) |
| Cash and cash  equivalents at beginning of period                                            |       | 13,382                                              |       | 11,863 |   |
| Cash and cash  equivalents at end of period                                                  |       | $                                                   | 11,135     |   | $ | 11,520 |   |
| **Supplemental disclosures:**                                                                |       |                                                |       |   |   |
| Interest paid                                                                                |       | $                                                   | 89         |   | $ | 13 |   |
| Income taxes paid                                                                            |       | $                                                   | 100        |   | $ | — |   |
| Common stock  issued for acquisition activities                                              |       | $                                                   | 30,404     |   | $ | 6,897 |   |

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(a)    Assetsand liabilities were recorded as follows in connection with the cash payments(cash acquired) for the ChannelWave, Inc., Optum, Inc., and Xelus, Inc.acquisitions

The accompanying notes are an integral part of these condensed consolidated financial statements.

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**CLICK COMMERCE, INC.CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Continued)(Dollars in thousands)(Unaudited)**

| ** **                                   | ** ** | **Channel Wave, Inc.** | ** ** | **Optum, Inc.** | ** ** | **Xelus, Inc.** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|----------------------|------------|----------------------|------------|
| Intangible assets  acquired                  |       |                             | 3,272      |                 |       |                 | 13,726     |   |   |   | 3,036 |   |   |
| Goodwill                                     |       |                             | 2,919      |                 |       |                 | 23,992     |   |   |   | 1,830 |   |   |
| Other assets  aquired                        |       |                             | 471        |                 |       |                 | 6,927      |   |   |   | 4,803 |   |   |
| Total assets  acquired                       |       |                             | 6,662      |                 |       |                 | 44,645     |   |   |   | 9,669 |   |   |
| Less: Liabilities acquired                   |       |                             | 1,404      |                 |       |                 | 17,500     |   |   |   | 10,463 |   |   |
| Net assets acquired exclusive of cash        |       |                             | 5,258      |                 |       |                 | 27,145     |   |   |   | (869 | ) |   |
| Less:Value of  shares issued for acquisition |       |                             | 4,280      |                 |       |                 | 26,124     |   |   |   | — |   |   |
| Plus: Acquisition  costs paid                |       |                             | 75         |                 |       |                 | 44         |   |   |   | 75 |   |   |
| Total cash paid  (acquired)                  |       |                             | 1,053      |                 |       |                 | 1,065      |   |   |   | (794 | ) |   |

 

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**CLICK COMMERCE, INC.NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1. BASIS OF PRESENTATION**

The unaudited condensedconsolidated financial statements include the accounts of Click Commerce, Inc.and its wholly owned subsidiaries (the “Company”) and reflect all adjustments(which are normal and recurring in nature) that, in the opinion of management,are necessary for a fair presentation of the interim periods presented. Theresults of operations for the three and nine months ended September 30,2005 include the results of operations of ChannelWave, Inc. (see note 4)from February 3, 2005 through the end of the period, the results ofoperations of Optum, Inc. (see note 4) from February 8, 2005 throughthe end of the period, and the results of Xelus, Inc. (see note 4) from May 28,2005 through the end of the period. The results of operations for the interimperiods presented are not necessarily indicative of the results to be expectedfor any subsequent quarter or for the entire fiscal year ending December 31,2005. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted in accordance with the Securities and Exchange Commission’s rules andregulations. The unaudited condensed consolidated financial statements andnotes included herein should be read in conjunction with the Company’s auditedconsolidated financial statements and notes included in the Company’s AnnualReport on Form 10-K and other documents that have been filed withthe Securities and Exchange Commission.

**2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**Revenue Recognition**

Substantially all of the Company’s revenues are derivedfrom four primary sources: (i) licensing software, (ii) providingtechnical support and product updates, otherwise known as maintenance, (iii) applicationhosting, and (iv) providing professional services, including consulting,implementation and training services. The Company’s software is generally soldthrough a perpetual license or a limited term license (a subscription). TheCompany typically licenses its software in multiple-element arrangements inwhich the customer purchases a combination of: (i) software products, (ii) amaintenance arrangement, which is generally priced as a percentage of thesoftware license fees and provides for technical support and updates over aperiod of generally one year, (iii) hosting services, and/or (iv) aprofessional services arrangement.

The Company recognizes revenue using the residualmethod pursuant to the requirements of Statement of Position No. 97-2“Software Revenue Recognition” (“SOP 97-2”), as amended by Statementof Position No. 98-9, “Software Revenue Recognition with Respect toCertain Arrangements.” Under the residual method, revenue is recognized in amultiple-element arrangement when company-specific objective evidence of fairvalue exists for all of the undelivered elements in the arrangement, but doesnot exist for one or more of the delivered elements in the arrangement. TheCompany allocates revenue to each element in a multiple-element arrangementbased on its respective fair value, with the fair value determined by the pricecharged when that element is sold separately. The Company defers revenue forthe fair value of its undelivered elements (e.g. professional services andmaintenance) and recognizes revenue for the remainder of the arrangement feeattributable to the delivered elements (i.e. software product) when thecriteria in SOP 97-2 have been met. If evidence of fair value of theundelivered elements of the arrangement does not exist, all revenue from thearrangement is deferred until such time evidence of fair value does exist, oruntil all elements of the arrangement are delivered.

7

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License revenue from contracts in which the Company’sservices are not considered essential to the functionality of the software arerecognized upon delivery, assuming the above criteria for revenue recognitionare met under SOP 97-2. Services are not considered essential if thesoftware is ready for use by the customer upon receipt and, therefore,implementation services do not involve significant customization to, ormodification or development of, the underlying software code.

Revenue from contracts in which the Company’s servicesare essential to the functionality of the other elements of the contract isrecognized using the percentage-of-completion method under contract accountingas services are performed as the Company delivers, customizes and installs thesoftware. The percentage completed is measured by the percentage of labor hoursincurred to date in relation to estimated total labor hours required to fulfillthe contract. In contracts with revenue recognized under thepercentage-of-completion method, revenues are presented as product licenserevenue to the extent that the underlying contracts are for software licensesbased on equal application of discounts across all elements of the largerarrangement. When percentage-of-completion accounting is used, the Companyrecords cash receipts from customers and billed amounts due from customers inexcess of recognized revenue as billings in excess of revenues earned oncontracts in progress. The timing and amount of cash receipts from customerscan vary significantly depending on specific contract terms and can, therefore,have a significant impact on the amount of billings in excess of revenuesearned on contracts in progress at the end of any given period.

The Company provides hosting services to customersthat have licensed the Company’s software under a limited-term software license(a subscription). Revenue from software subscriptions have been accounted forin accordance with the guidance provided by Staff Accounting Bulletin (“SAB”) No. 104,“*Revenue Recognition.”* The feesrelated to multiple-element arrangements are allocated to the individualelements in accordance with Emerging Issues Task Force (“EITF”) 00-21 “*Revenue Arrangements with Multiple Deliverables,”*based upon verifiable, objective evidence of the fair values of each accountingunit. The Company’s subscription arrangements with customers generally includeseveral elements, including (1) a limited-term software license (asubscription), (2) strategic consulting services, (3) set-up andsoftware subscription services, and (4) hosting services. The Companyrequires customers in these limited term arrangements to use its hostingservices, which in accordance with EITF 00-3, “*Application of AICPA Statement of Position 97-2to Arrangements That Include the Right to Use Software Stored on Another Entity’sHardware,”* results in all arrangement revenue being deferred andrecognized ratably over the term of the limited-term license agreement. If thearrangement includes consulting services, these services are presented asconsulting and implementation service revenues and are deferred and recognizedratably over the term of the arrangement, which is normally 12-24 months.Under SAB No. 104, costs associated with set-up and implementation of thesubscriptions may be expensed as incurred or deferred and recognized over theterm of the related arrangement. The Company has elected to defer such costs.The software subscription service typically begins upon customer acceptance.

The Company also provides hosting services tocustomers that have licensed the Company’s software on a perpetual basis. Insuch cases and in accordance with EITF 00-3, the hosting revenue isconsidered a separate contractual element of the arrangement and is recognizedaccording to SOP 97-2. Fair value of the hosting services istypically based on the stated renewal rate of the hosting services, which isdeemed substantive by management.

The Company determines the fair value of the maintenanceportion of the arrangement based on the stated renewal rate for additionalmaintenance terms based on renewal rates charged separately to other companies.The Company’s customers typically prepay maintenance for the first year inconnection with new software licenses and the related revenue is deferred andrecognized ratably over the term of the initial maintenance contract.Maintenance is renewable by the customer on an annual basis thereafter. Ratesfor maintenance, including subsequent renewal rates, are typically establishedbased upon a 

8

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specified percentage ofnet license fees as set forth in the arrangement and are deemed to besubstantive by management.

Professional service revenues primarily consists ofimplementation services related to the installation of the Company’s softwareproducts and training revenues. The fair value of the professional servicesportion of the arrangement is based on the daily rates the Company charges forthese services when sold independently from a software license.

In accordance with EITF No. 01-14,the Company classifies the reimbursement of out-of-pocket expenses from itscustomers as consulting and implementation revenue in the statement of income.

**Cash,Cash Equivalents and Short-Term Investments**

The Company considers allhighly liquid investments with original maturity dates of three months or lessto be cash equivalents. Cash equivalents are carried at cost, whichapproximates fair market value.

**Long-term Investments**

The Company has investedin a long-term investment fund. Under terms of the investment, the Company hasa total commitment of $2.0 million of which $1.1 million has been contributedto date for a pro rata ownership interest of less than 2%.

**Stock-Based Compensation**

The Company accounts for its stock options inaccordance with the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 123,*“Accounting for Stock-BasedCompensation,”* which permits entities to recognize as expense overthe vesting period the fair value of all stock-based awards on the date ofgrant. Alternatively, SFAS No. 123 also allows entities to continue toapply the provisions of Accounting Principles Board Opinion No. 25,*“Accounting for Stock Issued to Employees”*(“APB 25”) and related interpretations. The Company continues to apply theprovisions of APB 25 and provides the pro forma disclosures required by SFAS No. 123,as amended by SFAS No. 148,*“Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123.”* As such, compensation expense would berecorded only if the fair value of the underlying stock exceeded the exerciseprice on the grant date.

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TheCompany has applied APB No. 25 and related interpretations in accountingfor the Employee Stock Option Plan and the Directors’ Stock Option Plan.Accordingly, no compensation expense has been recognized on stock options forwhich the exercise price equaled the fair value at the date of grant. Had theCompany determined compensation expense based on the method required by SFAS No. 123,the Company’s net income and net income per common share for the three and ninemonths ended September 30, 2005 and 2004 would approximate the pro formaamounts below.

| ** **                                                                                                                     | ** ** | **Three months ended  September 30,**               | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2005**                                                           | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| Net income, as  reported                                                                                                       |       | $                                                                  | 3,787      |                                                | $          | 1,370 |   | $ | 9,629 |   | $ | 3,398 |   |
| Stock-based employee compensation expense included  in the determination of net income as reported, net of related tax effects |       | —                                                             |       |                                                |       | — |   | 21 |   |
| Total fair value method employee stock-based  compensation expense, net of related tax effects                                 |       | (1,573                                                             | )          | (354                                                | )          | (4,074 | ) | (885 | ) |
| Pro forma net income                                                                                                           |       | $                                                                  | 2,214      |                                                | $          | 1,016 |   | $ | 5,555 |   | $ | 2,534 |   |
| Basic income per share:                                                                                                        |       |                                                               |       |                                                |       |   |   |   |   |
| As reported                                                                                                                    |       | $                                                                  | 0.33       |                                                | $          | 0.14 |   | $ | 0.86 |   | $ | 0.38 |   |
| Pro forma                                                                                                                      |       | $                                                                  | 0.19       |                                                | $          | 0.10 |   | $ | 0.50 |   | $ | 0.28 |   |
| Diluted income per  share:                                                                                                     |       |                                                               |       |                                                |       |   |   |   |   |
| As reported                                                                                                                    |       | $                                                                  | 0.31       |                                                | $          | 0.14 |   | $ | 0.81 |   | $ | 0.36 |   |
| Pro forma                                                                                                                      |       | $                                                                  | 0.18       |                                                | $          | 0.10 |   | $ | 0.47 |   | $ | 0.27 |   |

 

The fair value of each stock option granted isestimated on the date of grant using the Black-Scholes option-pricing model,with the following weighted average assumptions for the three months and ninemonths ended September 30, 2005, respectively: expected life of4 years; expected volatility of between 78% and 91%; risk-free interestrate of 4%, and 0% dividend yield.

Priorto its IPO, the Company granted certain stock options at exercise prices lessthan their deemed fair value. Such deferred compensation was amortized on astraight-line basis over the vesting period of each individual award, resultingin $21,000 of stock-based compensation expense for the nine months ended September 30,2004. The deferred compensation was fully amortized at September 30, 2004.The following table contains the amortization expense attributable to eachnoted expense caption, as applicable on the Condensed Consolidated Statementsof Operations.

| ** **                                                  | ** ** | **Three months ended  September 30,**                 | ** ** | **Nine months ended  September 30,**                  | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** | **     2005     ** | ** ** | **     2004     ** | ** ** |
| ** **                                                  | ** ** | **(in thousands)**                                              | ** ** |
| Stock-based employee  compensation expense attributable to: |       |                                                                 |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenues                                            |       |                                                                 | —     |                                                                 |       |   | — |   |   |   | — |   |   |   | 13 |   |   |
| Sales and marketing                                         |       |                                                                 | —     |                                                                 |       |   | — |   |   |   | — |   |   |   | 8 |   |   |
| Total                                                       |       |                                                                 | $          | —                                                               |       |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 21 |   |   |
|                                                             |            |                                                                      |            |                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the fourth quarter of2004, the FASB issued Statement No. 123 (revised 2004), or SFAS No. 123R,“Share-Based Payment,” which replaces Statement No. 123 “*Accounting for Stock-Based Compensation*,”and supersedes APB Opinion No. 25, “*Accountingfor Stock Issued to Employees*.” SFAS No. 123R eliminates theintrinsic value method of accounting option that was provided in the originalStatement No. 123. Under Statement No. 123R, pro forma disclosurewill no longer be allowed after a phase-in period. In the first quarter of2005, the Securities and Exchange Commission (SEC) issued Staff 

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AccountingBulletin No. 107 which provided further clarification on theimplementation of SFAS No. 123R. The Company is currently evaluatingthe requirements of SFAS 123R, and as such are presently accounting foremployee stock option grants in a footnote disclosure, as permitted by SFAS No. 123.The Company’s adoption of SFAS 123R will have an impact on our results ofoperations effective January 1, 2005 (the mandated date of adoption).

**3. NET INCOME PER SHARE**

Netincome per share was computed as follows:

| ** **                                            | ** ** | **Three months endedSeptember 30,**                    | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                                              | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(in thouasnds, except per share amounts)** | ** ** |
| **Basic income per share:**                           |       |                                                                  |       |                                                |       |   |   |   |   |
| Net income                                            |       | $                                                                     | 3,787      |                                                | $          | 1,370 |   | $ | 9,629 |   | $ | 3,398 |   |
| Weighted average common shares outstanding            |       | 11,405                                                                |       | 9,719                                               |       | 11,164 |   | 8,991 |   |
| Per share amount                                      |       | $                                                                     | 0.33       |                                                | $          | 0.14 |   | $ | 0.86 |   | $ | 0.38 |   |
| **Diluted  income (loss) per share:**                 | ** ** | ** **                                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                            |       | $                                                                     | 3,787      |                                                | $          | 1,370 |   | $ | 9,629 |   | $ | 3,398 |   |
| Weighted average common shares outstanding            |       | 11,405                                                                |       | 9,719                                               |       | 11,164 |   | 8,991 |   |
| Add: Effect of dilutive securities—stock options |       | 734                                                                   |       | 355                                                 |       | 728 |   | 413 |   |
| Diluted weighted average shares outstanding           |       | 12,139                                                                |       | 10,074                                              |       | 11,892 |   | 9,404 |   |
| Per share amount                                      |       | $                                                                     | 0.31       |                                                | $          | 0.14 |   | $ | 0.81 |   | $ | 0.36 |   |

 

For the three months endedSeptember 30, 2005 and 2004, 68,435 and 351,351 shares, respectively,attributable to outstanding stock options were excluded from the calculation ofdiluted earnings per share because their effect was antidilutive. For the ninemonths ended September 30, 2005 and 2004, 74,882 and 245,237 shares,respectively, attributable to outstanding stock options were excluded from thecalculation of diluted earnings per share because their effect wasantidilutive.

**4. BUSINESS COMBINATIONS**

On April 21, 2004, the Company entered into anAsset Purchase Agreement (the “Purchase Agreement”) with Webridge, Inc.(“Webridge”), a privately held Delaware corporation based in Beaverton, Oregon.Pursuant to the Purchase Agreement, dated as of March 17, 2004 and amendedMarch 30, 2004, Click-Webridge, Inc., a wholly owned subsidiary ofthe Company, purchased substantially all of the operating assets of Webridge.Click-Webridge, Inc. acquired the operating assets of Webridge based on avaluation of Webridge as a going-concern, for consideration consisting of615,303 shares of Click Commerce, Inc. common stock, valued at $5.766per share, including shares issued for working capital adjustments.

On July 1, 2004, The Company entered into anAgreement and Plan of Merger dated as of June 17, 2004 to acquirebTrade, Inc. (“bTrade”), a privately held Texas corporation based inIrving, Texas. Pursuant to this Agreement and Plan of Merger, bTrade became awholly owned indirect subsidiary of the Company. The Company acquired bTrade,based on a valuation of bTrade as a going-concern, for consideration consistingof approximately 669,367 shares (adjusted for working capital settlements),valued at $4.795 per share, of Company common stock, $0.2 million of cash, andthe repayment of approximately $1.3 million of existing bTrade indebtedness.

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On February 2, 2005, the Company entered into anAsset Purchase Agreement (the “Purchase Agreement”) with ChannelWave, Inc.(“ChannelWave”). Pursuant to the Purchase Agreement, the Company acquiredcertain assets from ChannelWave, including substantially all assets relating toChannelWave’s Partner Relationship Management System and Service InformationSystem businesses, for consideration comprised of $1.0 million of cash and225,807 shares valued at $18.954 per share of the Company’s common stock (ofwhich 29,033 shares are being held by the Company in escrow for certainpotential additional liabilities of ChannelWave pursuant to the PurchaseAgreement). On October 19, 2005, the Company completed a repurchase of181,024 shares pursuant to Share Repurchase Agreements (the “Share RepurchaseAgreements”) with Commerce 5, Inc. (formerly known as ChannelWave, Inc.)and a former executive officer of Commerce 5, Inc., respectively dated October 18,2005. Pursuant to the terms of the Share Repurchase Agreements, the Companyrepurchased shares of its common stock for a purchase price of $15.50 pershare, or $2,805,872.00 in the aggregate. The remaining 44,783 shares of theCompany’s common stock are expected to be registered for resale on aRegistration Statement on Form S-3.

On February 7, 2005, the Company entered into anAgreement and Plan of Merger (the “Merger Agreement”) with Optum, Inc. (“Optum”)and its stockholders, pursuant to which the Company acquired Optum. Inconsideration for the merger, the Company paid $325,467 in cash, issued1,405,780 shares valued at $18.583 per share of the Company’s common stockto the stockholders of Optum (of which $65,093 in cash and 281,156 sharesof the Company’s common stock are being held by an escrow agent for certainpotential additional liabilities of Optum pursuant to the Merger Agreement),assumed approximately $4.3 million of Optum indebtedness, and incurredvarious transaction-related expenses. The shares of the Company’s common stockare expected to be registered for resale on a Registration Statement on Form S-3.

On May 27, 2005, the Company entered into anAgreement and Plan of Merger (the “Merger Agreement”) with Xelus, Inc. (“Xelus”)and its stockholders, pursuant to which the Company acquired Xelus. Inconsideration for the merger, the Company paid $1 in cash, assumedapproximately $2.2 million of Xelus indebtedness, settled a long-termlease liability for $543,000 and incurred various transaction-relatedexpenses. No shares of Company stock were issued in connection with the Xelusacquisition.

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The following tablesummarizes the estimated fair values of the assets acquired and the liabilitiesassumed on the effective dates of the ChannelWave, Optum and Xelusacquisitions. The Company incurred approximately $75,000, $250,000 and $125,000of direct expenses related to the closing of the ChannelWave, Optum and Xelusacquisitions, respectively. Due to the timing of the acquisitions, the finalallocations of the purchase prices are subject to change as the Company completesthe valuation of the acquired assets and assumed liabilities.

| ** **                                      | ** ** | **ChannelWave**                | ** ** | **Optum**                      | ** ** | **Xelus**                  | ** ** |
|-------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **February 2, 2005** | ** ** | **February 7, 2005** | ** ** | **May 27, 2005** | ** ** |
| ** **                                      | ** ** | **(in thousands)**        | ** ** |
| Assets:                                         |       |                           |       |                           |       |                       |       |   |   |   |   |   |   |
| Cash and cash  equivalents                      |       |                           | $          | —                         |       |                       |       | $ | 817 |   |   |   | $ | 844 |   |   |
| Trade accounts receivable, net                  |       |                           | 421        |                           |       |                       | 3,769      |   |   |   | 2,935 |   |   |
| Other current assets                            |       |                           | —     |                           |       |                       | 1,094      |   |   |   | 1,061 |   |   |
| Total current assets                            |       |                           | 421        |                           |       |                       | 5,680      |   |   |   | 4,840 |   |   |
| Property and equipment                          |       |                           | 50         |                           |       |                       | 1,644      |   |   |   | 807 |   |   |
| Intangible assets, including in-process R&D |       |                           | 3,272      |                           |       |                       | 13,726     |   |   |   | 3,036 |   |   |
| Goodwill                                        |       |                           | 2,919      |                           |       |                       | 23,992     |   |   |   | 1,830 |   |   |
| Other assets                                    |       |                           | —     |                           |       |                       | 421        |   |   |   | — |   |   |
| Total assets                                    |       |                           | $          | 6,662                          |       |                       |       | $ | 45,463 |   |   |   | $ | 10,513 |   |   |
| Liabilities:                                    |       |                           |       |                           |       |                       |       |   |   |   |   |   |   |
| Accounts payable                                |       |                           | $          | —                         |       |                       |       | $ | 1,705 |   |   |   | $ | 1,141 |   |   |
| Accrued liabilities                             |       |                           | 75         |                           |       |                       | 4,363      |   |   |   | 678 |   |   |
| Accrued compensation                            |       |                           | —     |                           |       |                       | 3,411      |   |   |   | 1,132 |   |   |
| Deferred revenue                                |       |                           | 1,329      |                           |       |                       | 3,571      |   |   |   | 5,239 |   |   |
| Short-term lease obligation                     |       |                           | —     |                           |       |                       | 165        |   |   |   | — |   |   |
| Short-term debt obligation                      |       |                           | —     |                           |       |                       | 1,761      |   |   |   | 2,204 |   |   |
| Long-term debt obligation                       |       |                           | —     |                           |       |                       | 2,524      |   |   |   | 69 |   |   |
| Total liabilities                               |       |                           | 1,404      |                           |       |                       | 17,500     |   |   |   | 10,463 |   |   |
| Stockholders’  equity:                     |       |                           |       |                           |       |                       |       |   |   |   |   |   |   |
| Net assets  acquired                            |       |                           | $          | 5,258                          |       |                       |       | $ | 27,963 |   |   |   | $ | 50 |   |   |

 

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Thefollowing table sets forth the allocation, to date, of intangible assets tocustomer relationships, developed technology, trade names and order backlog, aswell as the in-process R&D charge recorded from the acquisition of bTrade.These intangible assets, as well as the goodwill recorded by the Company, willbe evaluated, as required, to determine that the fair values of such assets donot exceed their recorded values. If an impairment exists, the carrying valuesof such assets will be reduced to their fair value.

| ** **                                               | ** ** | **Customer  Relationships(1)** | ** ** | **Developed  Technology(2)** | ** ** | **Trade  Names(3)** | ** ** | **Order  Backlog(4)** | ** ** | **In process  R&D(5)** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|---------------------|------------|-----------------------|------------|---------------------------------|------------|-----------|------------|
| Xelus(6)                                                 |       |                           | 2,684      |                         |       |                | 283        |                  |       |                            | —     |      |       |   | 69 |   |   |   | — |   |   | 3,036 |   |
| Optum(6)                                                 |       |                           | 9,850      |                         |       |                | 3,573      |                  |       |                            | —     |      |       |   | 303 |   |   |   | — |   |   | 13,726 |   |
| ChannelWave(6)                                           |       |                           | 2,758      |                         |       |                | 514        |                  |       |                            | —     |      |       |   | — |   |   |   | — |   |   | 3,272 |   |
| bTrade                                                   |       |                           | 1,195      |                         |       |                | 274        |                  |       |                            | —     |      |       |   | 143 |   |   |   | 6 |   |   | 1,618 |   |
| Webridge                                                 |       |                           | 560        |                         |       |                | 910        |                  |       |                            | 150        |      |       |   | — |   |   |   | — |   |   | 1,620 |   |
| Allegis                                                  |       |                           | 466        |                         |       |                | —     |                  |       |                            | —     |      |       |   | — |   |   |   | — |   |   | 466 |   |
| Gross intangible  assets and in-process R&D          |       |                           | 17,513     |                         |       |                | 5,554      |                  |       |                            | 150        |      |       |   | 515 |   |   |   | 6 |   |   | 23,738 |   |
| Accumulated  amortization to date                        |       |                           | (2,146     | )                            |       |                | (953       | )                     |       |                            | (71        | )         |       |   | (364 | ) |   |   | (6 | ) |   | (3,540 | ) |
| Balance at  September 30, 2005                 |       |                           | $          | 15,367                       |       |                |       | $                     | 4,601      |                            |       |      | $          | 79 |   |   |   | $ | 151 |   |   |   | $ | — |   |   | $ | 20,198 |   |
| Amortization  expense                                    |       |                           |       |                         |       |                |       |                  |       |                            |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Nine months ended  September 30, 2005               |       |                           | 1,718      |                         |       |                | 779        |                  |       |                            | 37         |      |       |   | 280 |   |   |   |   |   |   | 2,814 |   |
| Nine months ended  September 30, 2004               |       |                           | 249        |                         |       |                | 119        |                  |       |                            | 22         |      |       |   | 35 |   |   |   | 6 |   |   | 431 |   |
| Estimated  amortization expense for the 12 months ended: |       |                           |       |                         |       |                |       |                  |       |                            |       |      |       |   |   |   |   |   |   |   |   |   |   |
| December 31,  2005                                  |       |                           | 2,345      |                         |       |                | 1,035      |                  |       |                            | 50         |      |       |   | 385 |   |   |   |   |   |   | 3,815 |   |
| December 31,  2006                                  |       |                           | 2,536      |                         |       |                | 1,194      |                  |       |                            | 50         |      |       |   | 46 |   |   |   |   |   |   | 3,826 |   |
| December 31,  2007                                  |       |                           | 2,536      |                         |       |                | 1,194      |                  |       |                            | 16         |      |       |   |   |   |   |   |   |   |   | 3,746 |   |
| December 31,  2008                                  |       |                           | 2,536      |                         |       |                | 910        |                  |       |                            |       |      |       |   |   |   |   |   |   |   |   | 3,446 |   |
| December 31, 2009                                   |       |                           | 2,416      |                         |       |                | 844        |                  |       |                            |       |      |       |   |   |   |   |   |   |   |   | 3,260 |   |
|                                                          |            |                                |            |                              |            |                     |            |                       |            |                                 |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Customer relationshipsare amortized over 7 years for Optum and Xelus, 6 years for ChannelWave,5 years for bTrade and Webridge, and 3 years for Allegis.

(2)          Developed technology isamortized over 5 years for bTrade, ChannelWave and Optum and 4 years forWebridge and 3 years for Xelus and is reflected in the cost of product licenserevenue on the consolidated statement of income and comprehensive income(loss).

(3)          Trade names areamortized over 3 years.

(4)          Order backlogs areamortized over 1 year for bTrade, Optum and Xelus.

(5)          In-process R&D ischarged immediately to amortization of intangible assets on the statement ofincome and comprehensive income.

(6)          Pending final valuationby independent firm.

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The following unauditedpro forma financial information for the three and nine months ended September 30,2005 and 2004 presents the consolidated operations of the Company as if all ofthe acquisitions had been made on January 1, 2004, after giving effect tocertain adjustments for the pro forma acquisition as of the assumed January 1,2004 acquisition date. Under the provisions of SFAS No. 142, goodwillacquired in transactions completed after September 30, 2001 is notamortized. As all of the Company’s acquisitions occurred subsequent to thatdate, these pro forma results do not reflect any goodwill amortization expense.The Unaudited pro forma financial information is provided for informationalpurposes only. It should not be construed to be indicative of the Company’sconsolidated results of operations had the acquisitions been consummated onthese earlier dates and do not project the Company’s results of operations forany future period:

| ** **                           | ** ** | **Three months ended  September 30,**               | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                                           | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(in thousands, except per share data)** | ** ** |
| Revenues                             |       | N/A                                                                |       | $                                                   | 18,430     |   | $ | 46,811 |   | $ | 55,869 |   |
| Net income (loss)                    |       |                                                               |       | (2,063                                              | )          | 8,231 |   | (5,129 | ) |
| Basic net income  (loss) per share   |       | N/A                                                                |       | $                                                   | (0.40      | ) | $ | 0.63 |   | $ | (0.40 | ) |
| Diluted net income  (loss) per share |       | N/A                                                                |       | N/A                                                 |       | $ | 0.60 |   | N/A |   |

 

**5. RESTRUCTURING**

In the second quarter of 2003, the Company implementeda restructuring plan following the acquisition of Allegis. As part of thisplan, certain redundant costs were eliminated including rents for excess officespace in Chicago and Boston.

As of September 30,2005, the Company’s restructuring accrual covered remaining lease commitmentson excess office space in Boston. Due to the length of this lease agreement,payments against the restructuring accrual will be made through the quarterending December 31, 2005. The following table contains the significantcomponents of the restructuring charge and current year-to-date activityrelating to those components.

| ** **                | ** ** | **Accrual at  December 31,  2004** | ** ** | **2005 YTD  cash  payments** | ** ** | **Balance at  September 30,  2005** | ** ** |
|---------------------------|------------|----------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|------------|
| Facilities  related costs |       |                                         | $          | 79                                |       |                                          |       | $ | (63 | ) |   |   | $ | 16 |   |   |
|                           |            |                                              |            |                                   |            |                                               |            |  |  |  |  |  |  |  |  |  |

 

**6.FINANCING ARRANGEMENTS**

On March 31, 2005,the Company entered into a $10.0 million revolving line of credit agreementmaturing on April 1, 2008. The borrowing under the line of credit carriesan interest rate based on the LIBOR average rate with a weighted averageinterest rate of 5.4% in the quarter ended September 30, 2005. The unusedportion is subject to a fee of 0.3%. As of September 30, 2005, the Companyhad borrowed $6.4 million to pay off the debt and certain liabilities assumedin the Optum and Xelus acquisitions. Of the remaining $3.6 million, up to $2.0million may be used for the Company’s letters of credit. As of September 30,2005, the Company has $0.6 million outstanding under various letters of credit.The line of credit contains terms that, among other provisions, require theCompany to maintain certain minimum net worth and other financial ratios andspecific limits or restrictions on additional indebtedness, liens andcontinuity of business. Provisions under this line of credit are not consideredrestrictive to normal operations. The Company was in violation of certain debtprovisions at September 30, 2005, but received a wavier from the lendinginstitution.

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**7. COMMITMENTS AND CONTINGENCIES**

In November 2002, the FASB issued FIN 45, “*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*.”Under the Company’s standard software license agreements, the Company agrees toindemnify, defend and hold harmless its licensees’ use of Company software fromand against certain losses, damages and costs arising from claims alleging thelicensees’ use of Company software infringes on the intellectual propertyrights of a third party. The indemnification is contingent upon (a) thecustomer providing the Company with prompt written notice of such claims; (b) thecustomer providing reasonable cooperation to the Company in the defense andsettlement of such claim, at the Company’s expense; and (c) the Companyhaving sole authority to defend or settle the claim. Historically, the Companyhas not been required to pay material amounts in connection with claimsasserted under these provisions, and accordingly, the Company has not recordeda liability relating to such provisions.

In the fourth quarter of 2004, the Company received aletter from the tax authorities in the Netherlands that proposed taxdeficiencies, penalties and interest based on audits of the years 2000, 2001and 2002 in the amount of €2.3 million,or approximately $2.8 million. The asserted tax deficiencies relate tocertain wage tax amounts, including amounts related to vested employee stockoptions that the tax inspector believes should have been withheld by theCompany on behalf of several employees. The Company believes that it hasmeritorious legal defenses to a significant portion of these allegeddeficiencies. The Company recorded an accrual of $650,000 in the fourth quarterof the year ended December 31, 2004 for its assessment of the mostprobable outcome of this matter. This reserve is recorded in accrued expensesand other current liabilities on the September 30, 2005 and December 31,2004 condensed consolidated balance sheets.

Inaddition to the Company’s revolving credit facility, the Company also assumedthree short-term notes in connection with its acquisition of Xelus. The tablebelow outlines the payment time frames for these notes. The table also outlinesthe Company’s lease commitments over the next five years. The Company isobligated as lessee under certain noncancelable operating leases for equipment,cars and office space, and is also obligated to pay insurance, maintenance andother executory costs associated with the leases.

| ** ** | ** ** | **Operating  Leases** | ** ** | **Short-term  Notes payable** | ** ** | **Long-term  Debt** | ** ** |
|------------|------------|-----------------------|------------|------------------------------------|------------|---------------------|------------|
| 2005       |       |                  | 1,035      |                               |       |                | 193        |   |   |   | — |   |   |
| 2006       |       |                  | 1,932      |                               |       |                | 877        |   |   |   | — |   |   |
| 2007       |       |                  | 1,378      |                               |       |                | —     |   |   |   | — |   |   |
| 2008       |       |                  | 1,408      |                               |       |                | —     |   |   |   | 6,360 |   |   |
| 2009       |       |                  | 1,043      |                               |       |                | —     |   |   |   | — |   |   |
| Thereafter |       |                  | 616        |                               |       |                | —     |   |   |   | — |   |   |

 

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

The following discussionshould be read in conjunction with the Company’s consolidated condensedfinancial statements and notes elsewhere in this quarterly report.

**Overview**

Click Commerce, Inc. (the “Company”) providessoftware designed to help companies streamline their trading partnerinteractions and automate compliance-related activities. We believe thatcompanies using our software, companies can optimize business processes,improve financial performance, lower costs for partners and customers, increasebrand loyalty, improve customer service and reduce risk. The Company’scollaborative commerce and supply chain solutions are designed to enablecompanies to streamline their trading partner interactions to drive businessvalue and competitive advantage. The Company’s compliance automation solutionsare designed to enable institutions to automate their regulatory complianceprocesses and manage research project approvals. Each of the company’s productlines applies similar underlying technology to effect secure Internetcommunications as a replacement for handwritten forms, telephone and faxcommunications and other electronic data systems. The Company commenced operationson August 20, 1996.

Effective March 24, 2003, the Company completedits acquisition of all of the capital stock of Allegis Corporation (“Allegis”),a privately-held California corporation engaged in licensing partnerrelationship management software and providing professional implementationservices, hosting and maintenance services related to its software. Results ofAllegis’ operations have been included in the Company’s consolidated financialstatements since March 24, 2003. Under the terms and conditions of theAgreement and Plan of Merger, Allegis became a wholly owned subsidiary of theCompany, and the holders of Allegis’ preferred stock received cashconsideration in an aggregate amount of approximately $10,200. The Companyfunded the acquisition using available cash on hand.

Effective April 21, 2004, the Company enteredinto an Asset Purchase Agreement (the “Purchase Agreement”) with Webridge, Inc.(“Webridge”), a privately held Delaware corporation based in Beaverton, Oregon.Pursuant to the Purchase Agreement, dated as of March 17, 2004 and amendedMarch 30, 2004, Click-Webridge, Inc., a wholly owned subsidiary ofthe Company, purchased substantially all of the operating assets of Webridge.Click-Webridge, Inc. acquired the operating assets of Webridge based on avaluation of Webridge as a going-concern, for consideration consisting of615,303 shares of Click Commerce, Inc. common stock, valued at $5.766per share, including shares issued for working capital adjustments. The Companyincurred $0.2 million of transaction costs.

Effective July 1, 2004, the Company entered intoan Agreement and Plan of Merger dated as of June 17, 2004 to acquire allof the capital stock of bTrade, Inc. (“bTrade”), a privately-held Texascorporation based in Irving, Texas. Pursuant to this Agreement and Plan ofMerger, bTrade became a wholly owned indirect subsidiary of the Company. TheCompany acquired bTrade, based on a valuation of bTrade as a going-concern, forconsideration consisting of approximately 669,367 shares (adjusted for workingcapital settlements), valued at $4.795 per share, of Company common stock, $0.2million of cash, and the assumption of and repayment of approximately $1.3million of existing bTrade indebtedness. The Company incurred $0.2 million oftransaction costs.

Effective February 2, 2005, the Company enteredinto an Asset Purchase Agreement (the “Purchase Agreement”) with ChannelWave, Inc.(“ChannelWave”), pursuant to which the Company acquired certain assets fromChannelWave, including substantially all assets relating to ChannelWave’sPartner Relationship Management System and Service Information Systembusinesses, for consideration comprising $1.0 million of cash and 225,807shares valued at $18.954 per share of the Company’s common stock (of which29,033 shares are being held by the Company in escrow for certain potentialadditional liabilities of ChannelWave pursuant to the Purchase Agreement). On October 19,2005, the Company 

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completed a repurchase of181,024 shares pursuant to Share Repurchase Agreements (the “Share RepurchaseAgreements”) with Commerce 5, Inc. (formerly known as ChannelWave, Inc.)and a former executive officer of Commerce 5, Inc., respectively dated October 18,2005. Pursuant to the terms of the Share Repurchase Agreements, the Companyrepurchased shares of its common stock for a purchase price of $15.50 pershare, or $2,805,872.00 in the aggregate. The remaining 44,783 shares of theCompany’s common stock are expected to be registered for resale on aRegistration Statement on Form S-3.

Effective February 7,2005, the Company entered into an Agreement and Plan of Merger (the “MergerAgreement”) with Optum, Inc. (“Optum”) and its stockholders, pursuant towhich the Company acquired Optum. In consideration for the merger, the Companypaid $325,467 in cash, and issued 1,405,780 shares valued at $18.583 pershare of the Company’s common stock to the stockholders of Optum (of which$65,093 in cash and 281,156 shares of the Company’s common stock are beingheld by an escrow agent for certain potential additional liabilities of Optumpursuant to the Merger Agreement), assumed approximately $4.3 million ofOptum indebtedness. The shares of the Company’s common stock are expected to beregistered for resale on a Registration Statement on Form S-3.

Effective May 27,2005, the Company entered into an Agreement and Plan of Merger (the “MergerAgreement”) with Xelus, Inc. (“Xelus”) and its stockholders, pursuant towhich the Company acquired Xelus. In consideration for the merger, the Companypaid $1 in cash to shareholders, assumed approximately $2.2 million ofXelus indebtedness, settled a long-term lease liability for $543,000 andincurred various transaction-related expenses. No shares of Company stock wereissued in connection with the Xelus acquisition.

The Company focused itsefforts in 2004 and the first nine months of 2005 on maintaining and improvingprofitability as well as broadening its product offerings through acquisitions.In 2004 and through the first nine months of 2005, the Company reportedincreasing net income. Management plans to continue investing in new andimproved product offerings and in increasing the exposure of the Company’sproducts and services through its targeted marketing programs. Managementfurther believes that each investment must be prudently made and justified bythe expected return on such investment.

The Company offers severallicensing and service options for its software products. Customers can eitherpurchase a perpetual software license or enter into a limited-term softwarelicense, also called a subscription contract. Customers may also choose to usethe Company’s hosting services for their perpetual software license or installthe software on servers within their own internal environment. Subscriptionlicenses are only available to customers who also use our hosting services.

Perpetual license revenuesand professional services are typically recognized as the software or serviceis delivered, assuming all other revenue recognition criteria are met and donot provide a contractual, predictable future revenue stream. The recurringrevenue opportunities come from subscriptions or maintenance and hostingservices. While the Company may have better visibility of future revenue fromsubscription licenses, customers make the final decision on the form of theirsoftware license. The Company encourages all of its customers to use itshosting services.

The Company depends onseveral factors to increase revenue and maintain profitability: adding newcustomers, maintaining its current base of subscriptions, increasing hostingand maintenance revenues, and improving the gross margin on professionalservices. Adding new customers is the primary responsibility of the salesdepartment. Maintaining the other revenue streams is the responsibility of theCompany’s professional services and hosting departments. The Company hasdeveloped compensation structures for these departments that it believesprovides appropriate incentives for achievement of their respective goals.

The Company’s revenue isprincipally derived from sales of perpetual licenses or subscriptions to itssoftware, and the related services surrounding those products. The ClickCommerce software suite comprises a collaborative portal platform; variousapplications that provide the basis for controlling 

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workflow,reporting, opportunity management, product information management, sales ordermanagement, and after sales service management; supply chain management,warehouse management; network logistics management and parts optimization. TheCompany also recognizes revenue from services, including business consulting,implementation, maintenance, training and managed hosting services.

Cost of product licenserevenues includes production and shipping expenses, which are expensed asincurred, amortization of developed technology (acquired in the Webridge,bTrade, ChannelWave and Optum acquisitions), and the costs of licensing thirdparty software incorporated into or required by the Company’s products. These thirdparty license costs are expensed as the products are delivered under perpetuallicenses and subscriptions or over the maintenance period to the extent thatthe third party license costs relate to those product offerings. Cost ofservice revenues include salaries and related expenses for professionalservices and technical support personnel who provide consulting andimplementation services, maintenance and hosting services, as well as anallocation of data processing and direct overhead costs which are expensed asincurred.

Operating expenses areclassified into five general categories: sales and marketing, research anddevelopment, general and administrative, amortization of stock-basedcompensation and amortization of intangible assets. Sales and marketingexpenses consist primarily of salaries and other related costs for sales andmarketing personnel, sales commissions, travel, public relations and marketingmaterials. Research and development expenses consist primarily of personnelcosts to support product development. General and administrative expensesconsist primarily of salaries and other related costs for executive management,finance and administrative employees, legal and accounting services, andcorporate liability insurance. Amortization of stock-based compensationrepresents the amortization over the related service period of the differencebetween the exercise price of options granted and the deemed fair market valueof the underlying common stock on the date of grant. Amortization of intangibleassets represents amortization expense for certain intangible assets withfinite useful lives, which were recorded in connection with the acquisitions ofAllegis Corporation during the first quarter of 2003, Webridge on April 21,2004, bTrade on July 1, 2004, ChannelWave, on February 2, 2005,Optum, on February 7, 2005 and Xelus on May 27, 2005. The intangibleassets are identified, valued and classified into separate categories. Thecategories are customer relationships, developed technologies, order backlog,trade names and in-process research and development. The amortization ofdeveloped technologies is recorded in the cost of product license line item onthe consolidated statement of income and comprehensive income.

The Company believes thatperiod-to-period comparisons of operating results should not be relied upon aspredictive of future performance. The Company’s prospects must be considered inlight of the risks, expenses and difficulties encountered by similarly sizedsoftware and technology companies, particularly companies in new, rapidlyevolving markets. The Company may not be successful in addressing such risksand difficulties.

**CriticalAccounting Policies**

The Company’s consolidatedfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America. As such, the Company makescertain estimates, judgments and assumptions that it believes are reasonablebased upon the information available. These estimates and assumptions affect thereported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the periodspresented. The Company’s critical accounting policies include revenuerecognition and any resulting deferral of revenues and related costs, theestimation of credit losses on accounts receivable, the application of purchaseaccounting and the valuation of deferred tax assets. There has been no changeto these policies. For a discussion of these critical accounting policies, see “CriticalAccounting Policies and Estimates” in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004, filed with the Securities andExchange Commission.

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**Results of Operations**

Thefollowing table sets forth selected unaudited financial data for the periodsindicated in dollars and as a percentage of total revenue.

| ** **                                 | ** ** | **Three Months Ended September 30,** | ** **   | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|--------------|---------------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                                 | ** **   | **2004**                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(in 000’s)**                                 | ** **   | **% of  Revenue**                                  | ** ** | **(in 000’s)** | ** ** | **% of  Revenue** | ** ** | **(in 000’s)** | ** ** | **% of  Revenue** | ** ** | **(in 000’s)** | ** ** | **% of  Revenue** | ** ** |
| Revenues                                   |       |                                                     |         |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product license                            |       |                                                     | $ 2,107 |                                                    |       |   | 13.0 | % |   |   | $ 1,221 |   |   |   | 17.4 | % |   |   | $ 5,911 |   |   |   | 14.6 | % |   |   | $ 3,081 |   |   |   | 16.6 | % |   |
| Service                                    |       |                                                     |         |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Maintenance and hosting                    |       |                                                     | 7,587        |                                                    |       |   | 46.8 | % |   |   | 2,682 |   |   |   | 38.1 | % |   |   | 17,130 |   |   |   | 42.3 | % |   |   | 6,397 |   |   |   | 34.5 | % |   |
| Consulting and implementation service |       |                                                     | 4,574        |                                                    |       |   | 28.2 | % |   |   | 2,419 |   |   |   | 34.4 | % |   |   | 11,920 |   |   |   | 29.4 | % |   |   | 7,537 |   |   |   | 40.7 | % |   |
| Subscription                               |       |                                                     | 1,937        |                                                    |       |   | 12.0 | % |   |   | 714 |   |   |   | 10.1 | % |   |   | 5,518 |   |   |   | 13.6 | % |   |   | 1,501 |   |   |   | 8.1 | % |   |
| Total Service                              |       |                                                     | 14,098       |                                                    |       |   | 87.0 | % |   |   | 5,101 |   |   |   | 82.6 | % |   |   | 34,568 |   |   |   | 85.4 | % |   |   | 15,435 |   |   |   | 83.4 | % |   |
| Total                                      |       |                                                     | 16,205       |                                                    |       |   | 100.0 | % |   |   | 7,036 |   |   |   | 100.0 | % |   |   | 40,479 |   |   |   | 100.0 | % |   |   | 18,516 |   |   |   | 100.0 | % |   |
| Cost of Revenues                           |       |                                                     |         |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product license                            |       |                                                     | 613          |                                                    |       |   | 3.8 | % |   |   | 97 |   |   |   | 1.4 | % |   |   | 1,155 |   |   |   | 2.8 | % |   |   | 240 |   |   |   | 1.3 | % |   |
| Consulting and implementation service |       |                                                     | 5,334        |                                                    |       |   | 32.9 | % |   |   | 2, 526 |   |   |   | 35.9 | % |   |   | 14,150 |   |   |   | 35.0 | % |   |   | 7,208 |   |   |   | 38.9 | % |   |
| Total cost of revenues                     |       |                                                     | 5,947        |                                                    |       |   | 36.7 | % |   |   | 2,623 |   |   |   | 37.3 | % |   |   | 15,305 |   |   |   | 37.8 | % |   |   | 7,448 |   |   |   | 40.2 | % |   |
| Gross profit                               |       |                                                     | 10,258       |                                                    |       |   | 63.3 | % |   |   | 4,413 |   |   |   | 62.7 | % |   |   | 25,174 |   |   |   | 62.2 | % |   |   | 11,068 |   |   |   | 59.8 | % |   |
| Operating  Expenses:                       |       |                                                     |         |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Sales and marketing                        |       |                                                     | 2,058        |                                                    |       |   | 12.7 | % |   |   | 1,084 |   |   |   | 15.4 | % |   |   | 4,806 |   |   |   | 11.9 | % |   |   | 2,362 |   |   |   | 12.8 | % |   |
| Research and development                   |       |                                                     | 1,822        |                                                    |       |   | 11.2 | % |   |   | 1,007 |   |   |   | 14.3 | % |   |   | 4,697 |   |   |   | 11.6 | % |   |   | 2,072 |   |   |   | 11.2 | % |   |
| General and administrative                 |       |                                                     | 1,596        |                                                    |       |   | 9.8 | % |   |   | 856 |   |   |   | 12.2 | % |   |   | 3,884 |   |   |   | 9.6 | % |   |   | 2,971 |   |   |   | 16.0 | % |   |
| Amortization of stock-based compensation   |       |                                                     | —       |                                                    |       |   | 0.0 | % |   |   | — |   |   |   | 0.0 | % |   |   | — |   |   |   | 0.0 | % |   |   | 21 |   |   |   | 0.1 | % |   |
| Amortization of intangibles assets    |       |                                                     | 810          |                                                    |       |   | 5.0 | % |   |   | 200 |   |   |   | 2.8 | % |   |   | 2,035 |   |   |   | 5.0 | % |   |   | 312 |   |   |   | 1.7 | % |   |
| Total operating expenses                   |       |                                                     | 6,286        |                                                    |       |   | 38.8 | % |   |   | 3,147 |   |   |   | 44.7 | % |   |   | 15,422 |   |   |   | 38.1 | % |   |   | 7,738 |   |   |   | 41.8 | % |   |
| Operating income                           |       |                                                     | $ 3,972 |                                                    |       |   | 24.5 | % |   |   | $ 1,266 |   |   |   | 18.0 | % |   |   | $ 9,752 |   |   |   | 24.1 | % |   |   | $ 3,330 |   |   |   | 18.0 | % |   |

 

**Comparisonof the three months ended September 30, 2005 to the three months ended September 30,2004**

*Revenue*

Total revenue increased$9.2 million, or 130%, to $16.2 million for the three months ended September 30,2005 from $7.0 million for the three months ended September 30, 2004.Product license revenue consists of revenue from separate product-onlyagreements and from multiple element agreements accounted for under thepercentage-of-completion method using hours of input in relation to theestimate of total hours to complete the engagements. Product license revenueincreased by $0.9 million, or 73%, to $2.1 million, primarily as aresult of sales relating to software license sales resulting from the Optum andXelus acquisitions. Optum and Xelus’ license sales accounted for 55% of licenserevenue.

Maintenance and hostingrevenues increased by $4.9 million or 183% to $7.6 million for thethree months ended September 30, 2005. The increase is primarilyattributable to the maintenance and hosting revenue associated with Optum,which made up 61% of the Company’s maintenance and hosting revenue for thethree months ended September 30, 2005. Consulting and implementationservice revenues are largely comprised of fees related to time and materialsprojects, other service agreements, training and needs analyses, as well asservice elements contained in multiple element agreements accounted for underthe percentage-of-completion method using hours of input to estimate percentagecomplete. Consulting 

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andimplementation service revenues increased by $2.2 million, or 89%, to $4.6 million,over the prior year quarter arising from the consulting and implementationservice revenues related to the Optum and Xelus acquisitions which accountedfor 59% of total consulting and implementation services revenue. Consulting andimplementation service revenues increases are generally related to new licensetransactions or as follow-on service contracts. Service revenues are generatedin situations when a customer purchases a license from the Company and uses theCompany’s service staff to install and integrate the licensed software.Subscription revenue increased by $1.2 million, or 171%, to $1.9 million.This increase is a result of the ChannelWave and Optum acquisitions. Optumaccounted for 55% of total subscription revenue

*Cost of Revenue*

Total cost of revenueincreased by $3.3 million, or 127% to $5.9 million for the threemonths ended September 30, 2005. The cost of service revenue increased by$2.8 million, or 111%, to $5.3 million. The cost of service revenueincrease is a result of an increase in employee compensation directly relatedto additional headcount added in conjunction with the acquisitions of Xelus,Webridge, bTrade, ChannelWave and Optum. Cost of product revenue increased by$0.5 million, or 532%, to $0.6 million. $0.3 million of thisincrease was due to the amortization of developed technology. The amortizationof developed technology results from the allocation of purchase price todeveloped technologies in the acquisitions of Xelus, bTrade, Optum andWebridge. Gross profit margins were 63.3% for the three months ended September 30,2005, compared to 62.7% for the three months ended September 30, 2004. Thegross margin percentage remained flat due to the Company’s ability to improvebillable utilization rates for the professional service staff which offset asmaller percentage higher margin product and subscription sales. Product andsubscription revenue totaled 25% of total revenues for the three months ended September 30,2005 versus 27.5% for the three months ended September 30, 2004.

*Operating Expenses*

*Sales and Marketing**  *Sales and marketing expensesincreased by approximately $1.0 million, or 90%, to $2.1 million forthe three months ended September 30, 2005 from $1.1 million for thethree months ended September 30, 2004. The increase in sales and marketingexpense was directly attributable to the acquisition of Xelus, and Optum, whichincreased the Company’s sales force headcount by approximately 250%. Inaddition, marketing increased its headcount by 100%, this headcount increasealso contributed to higher sales and marketing costs.

*Research and Development**  *Research and development expensesincreased by approximately $.8 million, or 80%, to $1.8 million forthe three months ended September 30, 2005, compared to $1.0 millionfor the comparable prior year three-month period. This increase was almostentirely attributable to an increase in employee compensation, and third partyoff shore consultanting costs. The Xelus and Optum acquisitions resulted in anincrease in the Company’s research and development expenses by $0.8 millionor nearly 50.0% of the total expenses. To date, all software development costshave been expensed as incurred.

*General and Administrative**  *General and administrative expensesincreased by approximately $0.7 million, or 86%, to $1.6 million forthe three months ended September 30, 2005 from $0.9 million for thethree months ended September 30, 2004. The increase is attributable to thecosts associated with the Company’s Sarbanes Oxley Act compliance initiative,an increase in executive compensation, and the use of third party consultantsfor tax and tax related services. The acquisitions had no significant impact ongeneral and administrative expenses as the Company promptly eliminatedsubstantially all such expenses of the acquired companies.

*Amortization of IntangibleAssets**  *Theincrease in amortization of intangibles relates to the intangible assetsacquired in the acquisitions of Xelus, ChannelWave and Optum. These intangibleassets have useful 

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lives that rangefrom one to seven years and accounted for the $0.6 million increase inamortization expense for the quarter ended September 30, 2005.

**Comparisonof the nine months ended September 30, 2005 to the nine months ended September 30,2004**

*Revenue*

Total revenue increased$22.0 million, or 119%, to $40.5 million for the nine months ended September 30,2005 from $18.5 million for the nine months ended September 30, 2004.Product license revenue consists of revenue from separate product-onlyagreements and from multiple element agreements accounted for under thepercentage-of-completion method using hours of input in relation to theestimate of total hours to complete the engagements. Product license revenueincreased by $2.8 million, or 92%, to $5.9 million, as a result ofthe acquisitions of Xelus, Webridge, bTrade, ChannelWave and Optum. Theseacquisitions accounted for 80% of license revenue. Maintenance and hostingrevenues increased by $10.7 million or 168% to $17.1 million for thenine months ended September 30, 2005. The increase is primarilyattributable to the acquisitions of Xelus, bTrade and Optum, which made up 60%of the Company’s maintenance and hosting revenue for the nine months ended September 30,2005. Consulting and implementation service revenues are largely comprised offees related to time and materials projects, other service agreements,maintenance, hosting, training and needs analyses, as well as multiple elementagreements accounted for under the percentage-of-completion method using hoursof input in relation to the estimate of total hours to complete theengagements. Consulting and implementation service revenues increased by $4.4 million,or 58%, to $11.9 million, over the comparable prior year nine month periodarising from the Webridge, Xelus, bTrade and Optum consulting andimplementation service revenues. Webridge, Xelus, bTrade and Optum made up 73%of consulting and implementation service revenues for the nine months ended September 30,2005. Consulting and implementation service revenues increases are generallyrelated to new license transactions or as follow-on service contracts. Servicerevenues are generated in situations when a customer purchases a license fromthe Company and uses the Company’s service staff to install and integrate thelicensed software. Subscription revenue increased by $4.0 million or 268%,to $5.5 million for the nine months ended September 30, 2005 from$1.5 million for the nine months ended September 30, 2004. Thisincrease is a direct result of the bTrade, and Optum acquisitions, whichaccounted for $3.8 million of the total increase.

*Cost of Revenue*

Total cost of revenueincreased by $7.9 million, or 105% to $15.3 million for the ninemonths ended September 30, 2005. This cost of revenue increase is a resultof an increase in employee compensation directly related to the acquisitions ofXelus, Webridge, bTrade, ChannelWave and Optum. Cost of product revenueincreased by $0.9 million, or 381%, to $1.1 million, due to theamortization of developed technology. The amortization of developed technologyresults from the allocation of purchase price to developed technologies in theacquisitions of Xelus, bTrade, Optum and Webridge. Gross profit marginsincreased to 62% for the nine months ended September 30, 2005, compared to60% for the nine months ended September 30, 2004. The gross marginpercentage increase is due to an improvement in the utilization rate ofprofessional service staff and the increase in higher margin subscription andlicense revenue. The increase in the gross margin percentage was partiallyoffset by a decrease in license revenue as a percentage of total revenue.Product revenue represented 15% of total revenues for the nine months ended September 30,2005 versus 17% for the nine months ended September 30, 2004.

*Operating Expenses*

*Sales and Marketing**  *Sales and marketing expensesincreased by approximately $2.4 million, or 103%, to $4.8 million forthe nine months ended September 30, 2005 from $2.4 million for thenine months ended September 30, 2004. The increase in sales and marketingexpense was directly attributable to the 

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acquisitions ofbTrade, Optum and Xelus, which increased the Company’s sales force headcount byapproximately 296%.

*Research and Development**  *Research and development expensesincreased by approximately $2.6 million, or 127%, to $4.7 million forthe nine months ended September 30, 2005, compared to $2.1 millionfor the comparable prior year nine-month period. This increase was almostentirely attributable to an increase in employee compensation and third partyoff-shore consulting costs. The Xelus and Optum acquisitions resulted in anincrease in the Company’s research and development expenses by $2.2 millionor 47% of the total expenses. To date, all software development costs have beenexpensed as incurred.

*General and Administrative**  *General and administrative expensesincreased by approximately $0.9 million, or 31%, to $3.9 million forthe nine months ended September 30, 2005 from $3.0 million for thenine months ended September 30, 2004. The increase is attributable to specialprojects such as the Sarbanes Oxley compliance initiative, third party taxservices and other special projects related to the finance and human resourcesdepartments. There was also a 5% increase in employee compensation expense. Theacquisitions had no significant impact on general and administrative expensesas the Company promptly eliminated substantially all such expenses of theacquired companies.

*Amortization of IntangibleAssets**  *Theincrease in amortization of intangibles relates to the intangible assetsacquired in the acquisitions of Xelus, Webridge, bTrade, ChannelWave and Optum.These intangible assets have useful lives that range from one to seven yearsand accounted for the $2.0 million increase in amortization expense forthe nine months ended September 30, 2005.

**Liquidityand Capital Resources**

At September 30,2005, the Company had $11.1 million of cash and cash equivalents. Net cashused by operating activities was $1.2 million for the nine months ended September 30,2005. Sources of cash from operations include $9.6 million of net income,$0.9 million of depreciation and $2.8 million of amortization ofintangible assets, a $0.2 million loss on disposal of assets. Cash sourceswere offset by uses of cash relating to several operating and asset captions asdescribed below. There was a $4.3 million decrease in deferred revenuethat reflects the calendar year renewal cycles of many of its maintenancecustomers. Accrued compensation resulted in a $3.7 million use of cash dueto decreases in compensation accruals, resulting from payouts of severances andbonuses of the acquired companies coupled with the payout of $1.7 millionin fiscal year 2004 bonuses to the existing Click employees (employees who werewith the Company at December 31, 2005) in February 2005. Another $2.2 millionin cash was used as accounts receivables increased from December 31, 2004(net of $6.4 million of receivables acquired). In addition, there was a cashuse of $2.4 million relating to a decrease of accounts payable, net of$2.8 million of accounts payable acquired with the Xelus and Optummergers.

The Company used $2.1 millionin cash for investing activities in the first nine months ended September 30,2005. Of the $2.1 million, a net $1.3 million was used for theacquisitions of ChannelWave, Optum and Xelus. An additional amount $0.6 millionwas used to purchase fixed assets relating to the relocation of the Chicagoheadquarters. The Company also used $0.2 million of cash related to year-to-datefunding of its commitments to a long-term investment fund.

Net cash provided byfinancing activities was $1.1 million. The Company drew $6.3 millionagainst its revolving credit facility with a bank to pay off $5.4 millionof debt ($2.9 million of short-term debt and $2.5 million oflong-term debt) assumed in the acquisition of Optum and Xelus. The Company alsogenerated a source of cash of $0.3 million from stock options that wereexercised in the first three quarters of 2005.

On March 31, 2005,the Company entered into a $10.0 million revolving line of creditagreement maturing on April 1, 2008. The borrowing under the line ofcredit carries an interest rate based on the LIBOR average rate with a weightedaverage interest rate of 5.4% for the quarter ended September 30, 

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2005.The unused portion is subject to a fee of 0.3%. On September 30, 2005, theCompany had $6.3 million outstanding under the revolving line of creditcomprised of which, $4.5 million was used to pay off debt and certainliabilities assumed in the Optum acquisition and $1.4 million that wasused to the purchase of a secured note and settlement of an office leaserelated to the Xelus acquisition. Of the remaining $3.7 million availableunder the line of credit, up to $2.0 million may be used for the Company’sletters of credit. The line of credit contains terms that, among otherprovisions, require maintaining certain minimum net worth and other financialratios and specific limits or restrictions on additional indebtedness, liensand continuity of business. Provisions under this line of credit are notconsidered restrictive to normal operations. As of September 30, 2005, theCompany had outstanding letters of credit of $0.6 million.

Subsequent to the thirdquarter, on October 19, 2005, the Company completed the repurchase ofshares pursuant to Share Repurchase Agreements (the “Share RepurchaseAgreements”) with Commerce 5, Inc. (formerly known as ChannelWave, Inc.)and a former executive officer of Commerce 5, Inc., respectively dated October 18,2005. The repurchased shares were issued on February 2, 2005, as part ofthe consideration for the Company’s acquisition of certain business assets fromCommerce 5, Inc. Under the acquisition agreement, the Company had agreedto register such shares for sale, but the related registration statement hasnot yet become effective due to delays in the completion of the 2004 audit ofthe financial statements of Optum, Inc., which the Company also acquiredin February 2005. Pursuant to the terms of the Share RepurchaseAgreements, the Company repurchased 181,024 shares of the Company’s commonstock for a purchase price of $15.50 per share, or $2,805,872.00 in theaggregate. The Company financed the repurchase of such shares through the useof a portion of its available cash and cash equivalents.

The Company continues toevaluate strategic alternatives, including opportunities to strategically growthe business, enter into strategic relationships, make acquisitions or enterinto business combinations. The Company can provide no assurance that any suchstrategic alternatives will come to fruition and may elect to terminate suchevaluations at any time.

The Company believes thatits cash resources are sufficient for the long-term operation of its existingbusiness and, therefore, has no current plans to raise additional equityfinancing during the next twelve months related to its existing businesses. TheCompany may, however, require additional cash to fund investments incomplementary businesses or technologies. The Company’s cash needs could alsobe affected by changes in business or market conditions. If the Company findsit necessary to obtain additional equity or debt financing, there can be noassurance that the Company will be able to raise it on acceptable terms or atall.

**Safe Harbor Statement under the Private SecuritiesLitigation Reform Act of 1995 within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended:**

Statements in this Form 10-Qthat are not historical facts and refer to the Company’s future prospects are “forward-lookingstatements” under the Private Securities Litigation Reform Act of 1995. Theseforward-looking statements are generally identified by words such as “expect,” “anticipate,”“intend,” “believe,” “hope,” “assume,” “estimate” and other similar words andexpressions. The statements are subject to risks and uncertainties and actualresults may differ materially from those indicated by these forward-lookingstatements as a result of various factors, including but not limited to theextent of customer acceptance and utilization of the Company’s channelmanagement solutions, the impact of competitive products and services, theCompany’s ability to develop new and enhanced versions of its products andservices, the effect of economic and business conditions, the volume and timingof customer contracts and related approval processes, capital and intellectualproperty spending of the Company’s target customers, changes in technology,deployment delays or errors associated with the Company’s products, the abilityof the Company to integrate acquired businesses or products and the Company’sability to protect its intellectual property rights. For a discussion of theseand other risk factors that could 

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affectthe Company’s business, see “Risk Factors” in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004, which is on file with the Securitiesand Exchange Commission.

**Item3.**                        Qualitativeand Quantitative Disclosures About Market Risk

The following discussesthe Company’s exposure to market risk related to changes in foreign currencyexchange rates and interest rates. This discussion contains forward-lookingstatements that are subject to risks and uncertainties. Actual results couldvary materially as a result of a number of factors including those set forth inPart I of the Company’s Annual Report on Form 10-K under “RiskFactors.”

*Foreign Currency Exchange Rate Risk*

To date, substantially allof the Company’s recognized revenues have been denominated in U.S. dollars andprimarily from customers in the United States and the exposure to foreigncurrency exchange rate changes has been immaterial. The Company expects,however, that future product license and professional service revenues may alsobe derived from international markets and may be denominated in the currency ofthe applicable market. As a result, operating results may become subject tosignificant fluctuations based upon changes in the exchange rates of certaincurrencies in relation to the U.S. dollar. Furthermore, to the extent theCompany engages in international sales denominated in U.S. dollars, an increasein the value of the U.S. dollar relative to foreign currencies could make theCompany’s products less competitive in international markets. Although theCompany will continue to monitor its exposure to currency fluctuations, and,when appropriate, may use financial hedging techniques in the future tominimize the effect of these fluctuations, there is no assurance that exchangerate fluctuations will not adversely affect financial results in the future.

*Interest Rate Risk*

As of September 30,2005, the Company had cash and cash equivalents of $11.1 million and debtof $7.4 million. Rising interest rates will increase interest income fromshort-term investments and interest expense on the Company’s debt. Based uponthe balance of cash and cash equivalents at September 30, 2005, a changein interest rates of 0.5% would cause a corresponding change in annual interestincome of less than $0.1 million. Based on the Company’s long-term debt atSeptember 30, 2005, at change in interest rates of 1.0% would cause acorresponding change in interest expense of less than $0.1 million.

**Item4.**                        Controlsand Procedures

The Company carried out anevaluation, under the supervision and with the participation of management,including the Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the disclosure controls andprocedures pursuant to Rule 13a-15 under the Exchange Act of 1934 asof the end of the third quarter of 2005. Based on that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective as of such date to ensurethat information required to be disclosed in the reports that it files orsubmits under the Securities Exchange Act of 1934 (i) is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms and (ii) isaccumulated and communicated to the Company’s management, including the ChiefExecutive Officer and the Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure.

There was no change ininternal control over financial reporting that occurred during the thirdquarter of 2005 that has materially affected or is reasonably likely tomaterially affect the Company’s internal control over financial reporting.

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**PART II.   OTHER INFORMATION.**

Items 1, 2, 3, 4 and 5 areinapplicable and have been omitted from this report.

**Item 6.**                        Exhibits.

Thefollowing exhibits are included herein:

| Exhibit  Number | ** **                                                                                              | **Description** |
|-----------------|---------------------------------------------------------------------------------------------------------|-----------------|
| 31.1            | Certification of Michael  W. Ferro, Jr. pursuant to section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2            | Certification of Michael  W. Nelson pursuant to section 302 of the Sarbanes-Oxley Act of 2002.          |
| 32.1            | Certification of Michael  W. Ferro, Jr. pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2            | Certification of Michael W. Nelson pursuant to  section 906 of the Sarbanes-Oxley Act of 2002.          |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities and Exchange Act of 1934, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

|                               | Click Commerce, Inc. |
|-------------------------------|---------------------------|
|                          | By:                       | /s/  MICHAEL W. NELSON |
| * *                      | * *                  | Michael W. Nelson*Chief Financial Officer and Treasurer  (Principal Financial and Accounting Officer)* |
| Date: November 14,  2005 | * *                  |   |

 

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