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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended December 31, 2005



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from  to



Commission File No. 0-30260



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eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0466366                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



345 E. Middlefield,
Mountain View, CA

(Address of principal executive offices)

94043

(Zip Code)



(650) 230-7500

(Registrants telephone number, including area code)



N/A

(Former name, former address
and former fiscal year, if changed since last report)



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



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



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated filer ̈ |  | Non-accelerated filer  x



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



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.



|                              |  |                                 
|----------------------------- |  | --------------------------------
|Class                         |  | Outstanding at December 31, 2005
|Common Stock $0.001 par value |  | 15,301,548                      



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##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



TABLE
OF CONTENTS



|         |  |                                                                                                               |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                               |  | Page
|         |  |                                                                                                              
|PART I.  |  | FINANCIAL INFORMATION                                                                                         |  | 1   
|         |  |                                                                                                              
|Item 1.  |  | Financial Statements (unaudited)                                                                              |  | 1   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Balance Sheets at June 30, 2005 and December 31, 2005                                  |  | 1   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2005 and 2004 |  | 2   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2005 and 2004           |  | 3   
|         |  |                                                                                                              
|         |  | Notes to Condensed Consolidated Financial Statements                                                          |  | 4   
|         |  |                                                                                                              
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 12  
|         |  |                                                                                                              
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                    |  | 23  
|         |  |                                                                                                              
|Item 4.  |  | Controls and Procedures                                                                                       |  | 23  
|         |  |                                                                                                              
|PART II. |  | OTHER INFORMATION                                                                                             |  | 24  
|         |  |                                                                                                              
|Item 1.  |  | Legal Proceedings                                                                                             |  | 24  
|         |  |                                                                                                              
|Item 1A. |  | Risk Factors                                                                                                  |  | 24  
|         |  |                                                                                                              
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                   |  | 33  
|         |  |                                                                                                              
|Item 3.  |  | Defaults upon Senior Securities                                                                               |  | 34  
|         |  |                                                                                                              
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                           |  | 34  
|         |  |                                                                                                              
|Item 5.  |  | Other Information                                                                                             |  | 34  
|         |  |                                                                                                              
|Item 6.  |  | Exhibits                                                                                                      |  | 34  
|         |  |                                                                                                              
|         |  | Signatures                                                                                                    |  | 35  



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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS



(in thousands)



|                                       |  |                  |          |   |              |   |          |  
|-------------------------------------- |  | ---------------- | -------- | - | ------------ | - | -------- | -
|                                       |  | December 31,2005 |          |   | June 30,2005 |  
|                                       |  | (unaudited)      |          |   |              |  
|ASSETS                                 |  |                  |          |  
|                                       |  |                 
|Current assets:                        |  |                  |          |   |              |   |          |  
|Cash and cash equivalents              |  | $                | 4,856    |   |              | $ | 4,498    |  
|Restricted cash                        |  |                  | 12       |   |              |   | 12       |  
|Accounts receivable, net               |  |                  | 5,031    |   |              |   | 4,590    |  
|Prepaid and other current assets       |  |                  | 1,014    |   |              |   | 1,125    |  
|                                       |  |                  |          |   |              |   |          |  
|Total current assets                   |  |                  | 10,913   |   |              |   | 10,225   |  
|                                       |  |                 
|Property and equipment, net            |  |                  | 823      |   |              |   | 741      |  
|Goodwill                               |  |                  | 4,880    |   |              |   | 4,880    |  
|Other assets                           |  |                  | 55       |   |              |   | 58       |  
|                                       |  |                  |          |   |              |   |          |  
|                                       |  | $                | 16,671   |   |              | $ | 15,904   |  
|                                       |  |                  |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY   |  |                  |          |   |              |   |          |  
|                                       |  |                 
|Current liabilities:                   |  |                  |          |   |              |   |          |  
|Accounts payable                       |  | $                | 1,033    |   |              | $ | 1,109    |  
|Accrued compensation                   |  |                  | 1,364    |   |              |   | 1,386    |  
|Accrued liabilities                    |  |                  | 1,276    |   |              |   | 1,190    |  
|Deferred revenue                       |  |                  | 4,327    |   |              |   | 4,144    |  
|Accrued restructuring                  |  |                  |         |   |              |   | 17       |  
|Current portion of bank borrowings     |  |                  | 1,650    |   |              |   | 1,585    |  
|                                       |  |                  |          |   |              |   |          |  
|Total current liabilities              |  |                  | 9,650    |   |              |   | 9,431    |  
|                                       |  |                 
|Related party notes payable            |  |                  | 8,096    |   |              |   | 7,579    |  
|Bank borrowing, net of current portion |  |                  | 86       |   |              |   | 69       |  
|Other long term liabilities            |  |                  | 223      |   |              |   | 229      |  
|                                       |  |                  |          |   |              |   |          |  
|Total liabilities                      |  |                  | 18,055   |   |              |   | 17,308   |  
|                                       |  |                 
|Commitments                            |  |                  |          |   |              |   |          |  
|                                       |  |                 
|Stockholders deficit:                 |  |                  |          |   |              |   |          |  
|Common stock                           |  |                  | 15       |   |              |   | 15       |  
|Additional paid-in capital             |  |                  | 315,617  |   |              |   | 315,467  |  
|Notes receivable from stockholders     |  |                  | (73      | ) |              |   | (72      | )
|                                       |  |                 
|Accumulated other comprehensive loss   |  |                  | (533     | ) |              |   | (456     | )
|Accumulated deficit                    |  |                  | (316,410 | ) |              |   | (316,358 | )
|                                       |  |                  |          |   |              |   |          |  
|Total shareholders deficit            |  |                  | (1,384   | ) |              |   | (1,404   | )
|                                       |  |                  |          |   |              |   |          |  
|                                       |  | $                | 16,671   |   |              | $ | 15,904   |  
|                                       |  |                  |          |   |              |   |          |  



See accompanying
notes



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eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ----------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                         |  | Three Months Ended December 31, |        |   | Six Months Ended December 31, |  
|                                                                                         |  | 2005                            |        |   | 2004                          |   |        | 2005 |  |   | 2004   |  
|Revenue:                                                                                 |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|License                                                                                  |  | $                               | 2,013  |   |                               | $ | 1,384  |      |  | $ | 3,390  |   |  | $ | 2,657  |  
|Support and Services                                                                     |  |                                 | 3,996  |   |                               |   | 3,803  |      |  |   | 7,842  |   |  |   | 7,251  |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                                            |  |                                 | 6,009  |   |                               |   | 5,187  |      |  |   | 11,232 |   |  |   | 9,908  |  
|Cost of license                                                                          |  |                                 | 133    |   |                               |   | 76     |      |  |   | 186    |   |  |   | 249    |  
|Cost of support and services                                                             |  |                                 | 1,578  |   |                               |   | 1,512  |      |  |   | 3,302  |   |  |   | 2,967  |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                                                             |  |                                 | 4,298  |   |                               |   | 3,599  |      |  |   | 7,744  |   |  |   | 6,692  |  
|                                                                                         |  |                                 |        |  
|Operating costs and expenses:                                                            |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Research and development                                                                 |  |                                 | 704    |   |                               |   | 524    |      |  |   | 1,417  |   |  |   | 1,062  |  
|Sales and marketing                                                                      |  |                                 | 2,258  |   |                               |   | 2,206  |      |  |   | 4,385  |   |  |   | 4,307  |  
|General and administrative                                                               |  |                                 | 739    |   |                               |   | 848    |      |  |   | 1,368  |   |  |   | 1,598  |  
|Restructuring and other                                                                  |  |                                 |       |   |                               |   | (958   | )    |  |   |       |   |  |   | (958   | )
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total operating costs and expenses                                                       |  |                                 | 3,701  |   |                               |   | 2,620  |      |  |   | 7,170  |   |  |   | 6,009  |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Income from operations                                                                   |  |                                 | 597    |   |                               |   | 979    |      |  |   | 574    |   |  |   | 683    |  
|Non-operating income (expense)                                                           |  |                                 | (352   | ) |                               |   | (247   | )    |  |   | (626   | ) |  |   | (523   | )
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Net income / (loss)                                                                      |  |                                 | 245    |   |                               |   | 732    |      |  |   | (52    | ) |  |   | 160    |  
|                                                                                         |  |                                 |        |  
|Dividends on convertible preferred stock                                                 |  |                                 |       |   |                               |   | (1,781 | )    |  |   |       |   |  |   | (3,732 | )
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Net income / (loss) applicable to common stockholders                                    |  | $                               | 245    |   |                               | $ | (1,049 | )    |  | $ | (52    | ) |  | $ | (3,572 | )
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Per Share information:                                                                   |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|                                                                                         |  |                                 |        |  
|Basic and diluted net income / (loss) per common share                                   |  | $                               | 0.02   |   |                               | $ | (0.22  | )    |  | $ | (0.00  | ) |  | $ | (0.84  | )
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Weighted average shares used in computing basic and diluted net loss per common share    |  |                                 | 15,302 |   |                               |   | 4,831  |      |  |   | 15,302 |   |  |   | 4,264  |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Below is a summary of stock-based compensation included in the costs and expenses above: |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Cost of support and services                                                             |  | $                               | 8      |   |                               | $ |       |      |  | $ | 20     |   |  | $ |       |  
|Research and development                                                                 |  |                                 | 15     |   |                               |   |       |      |  |   | 30     |   |  |   |       |  
|Sales and marketing                                                                      |  |                                 | 20     |   |                               |   |       |      |  |   | 37     |   |  |   |       |  
|General and administrative                                                               |  |                                 | 32     |   |                               |   |       |      |  |   | 64     |   |  |   |       |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  
|Total stock-based compensation expense                                                   |  | $                               | 75     |   |                               | $ |       |      |  | $ | 151    |   |  | $ |       |  
|                                                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |        |  



See accompanying
notes



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eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                                   |  |                               |        |   |      |   |         |  
|-------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---- | - | ------- | -
|                                                                                                   |  | Six Months Ended December 31, |       
|                                                                                                   |  | 2005                          |        |   | 2004 |  
|Cash flows from operating activities:                                                              |  |                               |        |   |      |   |         |  
|Net income / (loss)                                                                                |  | $                             | (52    | ) |      | $ | 160     |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                               |        |   |      |   |         |  
|Depreciation                                                                                       |  |                               | 167    |   |      |   | 183     |  
|Stock-Based Compensation                                                                           |  |                               | 151    |   |      |   |        |  
|Provision for doubtful accounts and sales returns                                                  |  |                               | 13     |   |      |   | 22      |  
|Accrued interest and amortization of discount on related party notes                               |  |                               | 517    |   |      |   | 468     |  
|Changes in operating assets and liabilities:                                                       |  |                               |        |   |      |   |         |  
|Accounts receivable                                                                                |  |                               | (553   | ) |      |   | (330    | )
|Prepaid and other current assets                                                                   |  |                               | 89     |   |      |   | 132     |  
|Other assets                                                                                       |  |                               | 3      |   |      |   | 130     |  
|Accounts payable                                                                                   |  |                               | (63    | ) |      |   | (80     | )
|Accrued compensation                                                                               |  |                               |       |   |      |   | 196     |  
|Accrued liabilities                                                                                |  |                               | 129    |   |      |   | (17     | )
|Accrued restructuring                                                                              |  |                               | (17    | ) |      |   | (1,024  | )
|Deferred revenue                                                                                   |  |                               | 290    |   |      |   | 641     |  
|Other long term liabilities                                                                        |  |                               | (6     | ) |      |   | (12     | )
|                                                                                                   |  |                               |        |   |      |   |         |  
|Net cash provided by operating activities                                                          |  |                               | 668    |   |      |   | 469     |  
|                                                                                                   |  |                              
|Cash flows from investing activities:                                                              |  |                               |        |   |      |   |         |  
|Purchases of property and equipment                                                                |  |                               | (268   | ) |      |   | (239    | )
|                                                                                                   |  |                               |        |   |      |   |         |  
|Net cash used in investing activities                                                              |  |                               | (268   | ) |      |   | (239    | )
|                                                                                                   |  |                              
|Cash flows from financing activities:                                                              |  |                               |        |   |      |   |         |  
|Payments on borrowings                                                                             |  |                               | (3,050 | ) |      |   | (1,121  | )
|Payments on capital lease obligations                                                              |  |                               |       |   |      |   | (8      | )
|Proceeds from borrowings                                                                           |  |                               | 3,130  |   |      |   | 1,365   |  
|Net proceeds from issuance of common stock                                                         |  |                               | 1      |   |      |   |        |  
|                                                                                                   |  |                               |        |   |      |   |         |  
|Net cash provided by financing activities                                                          |  |                               | 81     |   |      |   | 236     |  
|                                                                                                   |  |                              
|Effect of exchange rate differences on cash                                                        |  |                               | (123   | ) |      |   | (113    | )
|                                                                                                   |  |                               |        |   |      |   |         |  
|Net increase in cash and cash equivalents                                                          |  |                               | 481    |   |      |   | 353     |  
|Cash and cash equivalents at beginning of period                                                   |  |                               | 4,498  |   |      |   | 5,181   |  
|                                                                                                   |  |                               |        |   |      |   |         |  
|Cash and cash equivalents at end of period                                                         |  | $                             | 4,856  |   |      | $ | 5,534   |  
|                                                                                                   |  |                               |        |   |      |   |         |  
|Supplemental cash flow disclosures:                                                                |  |                               |        |   |      |   |         |  
|Cash paid for interest                                                                             |  | $                             | 27     |   |      | $ | 86      |  
|Cash paid for taxes                                                                                |  |                               | 49     |   |      |   | 132     |  
|                                                                                                   |  |                              
|Non cash item:                                                                                     |  |                               |        |   |      |   |         |  
|Conversion of preferred stock to common stock                                                      |  | $                             |       |   |      | $ | 112,486 |  



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eGAIN COMMUNICATIONS CORPORATION



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Organization, Nature of Business and Basis of Presentation



We are a leading provider of customer service and contact center software, used by global enterprises and fast-growing businesses. Trusted by prominent enterprises and growing mid-sized companies worldwide,
eGains award winning software has been helping organizations achieve and sustain customer service excellence for more than a decade.



We have prepared the condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission and
included the accounts of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.



Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted pursuant to such rules and regulations. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of our financial position, results of operations and cash flows for the periods presented. These financial statements and notes should be read in conjunction with our audited consolidated financial statements and notes thereto for
the fiscal year ended June 30, 2005, included in our Annual Report on Form 10-K. The condensed consolidated balance sheet at June 30, 2005 has been derived from audited financial statements as of that date but does not include all the
information and footnotes required by generally accepted accounting principles for complete financial statements. The results of our operations for the interim periods presented are not necessarily indicative of results that may be expected for any
other interim period or for the full fiscal year ending June 30, 2006.



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



Note 2.
Software Revenue Recognition



We derive revenues from two
sources: license fees and support and services. Support and services includes hosting, software maintenance and support, and professional services. Maintenance and support consists of technical support and software upgrades and enhancements.
Professional services primarily consist of consulting and implementation services and training. Significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may
result in the amount and timing of our revenue for any period if different conditions were to prevail.



We apply the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9
Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions to all transactions involving the licensing of software products. In the event of a multiple element arrangement, we evaluate the
transaction as if each element represents a separate unit of accounting taking into account all factors following the guidelines set forth in Emerging Issues Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables, (EITF 00-21). For fixed fee arrangements the services revenues are recognized in accordance with the provisions of SOP 81-1, Accounting for Performance of Construction Type and Certain Production Type
Contracts, when reliable estimates are available for the costs and efforts necessary to complete the implementation services. When such estimates are not available, the completed contract method is utilized.



When licenses are sold together with system implementation and consulting
services, license fees are recognized upon shipment, provided that (i) payment of the license fees is not dependent upon the performance of the consulting and implementation services, (ii) the services are available from other vendors,
(iii) the services



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qualify for separate accounting as we have sufficient experience in providing such services and we have vendor specific
objective evidence pricing, and (iv) the services are not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and the service revenues are recognized under the
percentage of completion method. This has not been necessary in the last three years.



We use signed software license and services agreements and order forms as evidence of an arrangement for sales of software, hosting, maintenance and support. We use signed engagement letters to evidence an arrangement
for professional services.



License Revenue



We recognize license revenue when persuasive evidence of an arrangement
exists, the product has been delivered, no significant obligations remain, the fee is fixed or determinable, and collection of the resulting receivable is probable. In software arrangements that include rights to multiple software products and/or
services, we use the residual method under which revenue is allocated to the undelivered elements based on vendor specific objective evidence of the fair value of such undelivered elements. The residual amount of revenue is allocated to the
delivered elements and recognized as revenue assuming all other criteria for revenue recognition have been met. Such undelivered elements in these arrangements typically consist of software maintenance and support, implementation and consulting
services and in some cases hosting services.



Software is
delivered to customers electronically or on a CD-ROM, and license files are delivered electronically. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. We have standard payment terms
included in our contracts. We assess collectibility based on a number of factors, including the customers past payment history and its current creditworthiness. If we determine that collection of a fee is not reasonably assured, we defer the
revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the
acceptance period.



We periodically sell to resellers. Revenue
from sales to resellers is recognized either upon delivery to the reseller or on a sell-through basis depending on the facts and circumstances of the transaction, such as our understanding of the resellers plans to sell the software, if there
are any return provisions, price protection or other allowances, the resellers financial status and our past experience with the particular reseller. Historically sales to resellers have not included any return provisions, price protections or
other allowances.



Professional Services Revenue



Included in support services revenues are revenues derived from system
implementation consulting and training. The majority of our consulting and implementation services and accompanying agreements qualify for separate accounting. For hosting implementation services that do not qualify for separate accounting, we
recognize the services revenue ratably over the remaining term of the hosting agreement. We use vendor specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of
any separate prices stated within the contract for each element. Our consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. Substantially all of our contracts are on a time-and-materials
basis. For time-and-materials contracts, we recognize revenue as services are performed. For a fixed-fee contract, we recognize revenue based upon the costs and efforts to complete the services in accordance with the percentage of completion method.



Training revenue is recognized when training is provided.



Hosting Services Revenue



Included in support services revenues are revenues derived from our hosted
service offerings. We recognize hosting services revenue ratably over the period of the applicable agreement as services are provided. Hosting agreements are typically for a period of one or two years and automatically renew unless either party
cancels the agreement. The majority of the hosting services customers purchase a combination of our hosting service and professional services. In some cases the customer may also acquire a license for the software.



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We evaluate whether each of the elements in these arrangements represents a separate unit of accounting,
as defined by EITF 00-21, using all applicable facts and circumstances, including whether (i) we sell or could readily sell the element unaccompanied by the other elements, (ii) the element has stand-alone value to the customer,
(iii) there is objective reliable evidence of the fair value of the undelivered item, and (iv) there is a general right of return.



We allocate the arrangement consideration to the separate units of accounting based on their relative fair values, as determined by the price of the
undelivered items when sold separately. Assuming all other criteria are met (i.e., evidence of an arrangement exists, collectibility is probable, and fees are fixed or determinable), revenue is recognized as follows:



| |  |  | Hosting services are recognized ratably over the term of the initial hosting contract;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | Professional services are recognized as described above under Professional Services Revenue; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | License revenue is recognized as described above under License Revenue.
| | - |  | -------------------------------------------------------------------------



If evidence of fair value cannot be established for the undelivered elements of an agreement, the entire amount of revenue
from the arrangement is recognized ratably over the period that these elements are delivered. For implementation services that we determine do not have stand-alone value to the customer, we recognize the services revenue ratably over the remaining
term of the hosting agreement.



Maintenance and Support Revenue



Included in support services revenues are revenues
derived from maintenance and support. Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Maintenance and support is renewable by the customer on an annual basis. Rates for
maintenance and support, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement with the customer.



Note 3. Stock-Based Compensation



We adopted Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004), Share-Based Payment, (SFAS 123R) effective July 1, 2005. SFAS 123R requires the recognition of the fair value of stock compensation in net income. We recognize the stock compensation
expense over the requisite service period of the individual grantees, which generally equals the vesting period. All of our stock compensation is accounted for as an equity instrument. Prior to July 1, 2005, we followed Accounting Principles
Board (APB) Opinion 25, Accounting for Stock Issued to Employees, (APB 25) and related interpretations in accounting for our stock compensation.



We have elected the modified prospective transition method for adopting SFAS 123R. Under this method, the provisions of SFAS
123R apply to all awards granted or modified after the date of adoption. We had no unearned stock compensation liability recorded on our balance sheet as of June 30, 2005. In addition, the unrecognized expense of awards not yet vested at the
date of adoption shall be recognized in net income in the periods after the date of adoption using the same valuation method (i.e. Black-Scholes) and assumptions determined under the original provisions of SFAS 123, Accounting for
Stock-Based Compensation, as disclosed in our previous filings. As a result of our adoption of SFAS 123R, we recognized $75,000 and $151,000 in stock compensation expense on our unaudited condensed consolidated statement of operations for
the three and six months ended December 31, 2005. The total compensation cost of options granted but not yet vested as of July 1, 2005 was $345,000. The table below summarizes the effect of adoption of SFAS 123R.



|                                                              |  |                                     |     |   |                                   |   |       |  
|------------------------------------------------------------- |  | ----------------------------------- | --- | - | --------------------------------- | - | ----- | -
|                                                              |  | Three months endedDecember 31, 2005 |     |   | Six months endedDecember 31, 2005 |  
|Non-cash stock-based compensation expense                     |  | $                                   | (75 | ) |                                   | $ | (151  | )
|Income tax benefit                                            |  |                                     |    |   |                                   |   |      |  
|                                                              |  |                                     |     |   |                                   |   |       |  
|Net income effect of adoption                                 |  | $                                   | (75 | ) |                                   | $ | (151  | )
|Net effect earnings per share (basic and diluted) of adoption |  | $                                   |    |   |                                   | $ | (0.01 | )



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We utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation
granted after the adoption of SFAS 123R. The weighted-average fair values of the options granted under our stock option plans for the period was $0.58 using the following assumptions:



|                                |  |                                    
|------------------------------- |  | -----------------------------------
|                                |  | Three months endedDecember 31, 2005
|Dividend yield                  |  |                                   
|Expected volatility             |  | 0.92                               
|Average risk-free interest rate |  | 4.37                               
|Expected life (in years)        |  | 6.25                               



The dividend yield of
zero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. We determined the appropriate measure of expected volatility by reviewing historic volatility in the share price of our common
stock. The risk-free interest rate is derived from the average U.S. Treasury Strips rate with maturities approximating the expected lives of the awards during the period, which approximate the rate in effect at the time of grant.



In developing our estimate of expected life, we determined that our
historical share option exercise experience does not provide a reasonable basis upon which to estimate expected life. In addition, estimating life based on the expected terms of options granted by other, similar companies with similarly structured
awards was considered but data was not readily available to arrive at reliable estimates. We therefore used the technique commonly referred to as the SEC Shortcut Approach. In SAB 107 the SEC staff described a temporary shortcut
approach to developing the estimate of the expected life of a plain vanilla employee stock option. Under this approach, the expected life would be presumed to be the mid-point between the vesting date and the end of the contractual
term. The shortcut approach is not permitted for options granted, modified or settled after December 31, 2007.



Based on our historical experience of option pre-vesting cancellations, we have assumed an annualized 14% forfeiture rate for our options. Under the
true-up provisions of SFAS 123R, we will record additional expense if the actual forfeiture rate is lower than we estimated, and will record a recovery of prior expense if the actual forfeiture is higher than we estimated.



SFAS 123R requires us to present pro forma information for the comparative
period prior to the adoption as if we had accounted for all our employee stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net income and earnings per share if we had applied the fair
value recognition provisions of SFAS 123 to stock-based employee compensation to the prior-year period (dollars in thousands, except per-share data).



|                                                               |  |                                      |   |  |                                   |  
|-------------------------------------------------------------- |  | ------------------------------------ | - |  | --------------------------------- | -
|                                                               |  | Three months ended December 31, 2004 |   |  | Six months endedDecember 31, 2004 |  
|Net loss as reported                                           |  | (1,049                               | ) |  | (3,572                            | )
|Add: employee stock compensation included in reported net loss |  |                                     |   |  |                                  |  
|Less: employee stock compensation under SFAS No. 123           |  | (57                                  | ) |  | (115                              | )
|Pro forma net loss                                             |  | (1,106                               | ) |  | (3,687                            | )
|                                                               |  |                                     
|Net loss per basic and diluted share as reported               |  | (0.22                                | ) |  | (0.84                             | )
|Pro forma net loss per basic and diluted share                 |  | (0.23                                | ) |  | (0.86                             | )



During the three
months ended December 31, 2004, there were approximately 2,000 options granted.



We account for stock-based compensation under SFAS 123R for the period after its adoption, and in accordance with APB 25, using the intrinsic value method (pro forma disclosure) for the period prior to the adoption of
SFAS 123R. Total compensation cost of all options granted but not yet vested as of December 31, 2005 was $234,000, which is expected to be recognized over the weighted average period of 3.22 years. Effective July 1, 2005, we adopted FAS
123(R), Share-Based Payments, and used the modified prospective method to value our share-based payments. Accordingly, for the three and six months ended December 31, 2005, stock-based compensation was accounted under FAS 123(R)
while for the three and six months ended December 31, 2004, stock-based compensation was accounted under APB 25, Accounting for Stock Issued to Employees.



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Note 4. Net Loss Per Common Share



Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding.



The following table sets forth the calculation of basic and
diluted net loss per common share (in thousands, except per share data):



|                                                                                      |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ---- | ----------------------------- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                      |  | Three Months Ended December 31, |        |      | Six Months Ended December 31, |       
|                                                                                      |  | 2005                            |        | 2004 |                               |        | 2005 |  |   | 2004   |  
|Net income / (loss) applicable to common stockholders                                 |  | $                               | 245    |      | $                             | (1,049 | )    |  | $ | (52    | ) |  | $ | (3,572 | )
|                                                                                      |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  
|Basic and diluted:                                                                    |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares outstanding                                                   |  |                                 | 15,302 |      |                               | 4,831  |      |  |   | 15,302 |   |  |   | 4,264  |  
|Less weighted-average shares subject to repurchase                                    |  |                                 | 0      |      |                               | 0      |      |  |   | 0      |   |  |   | 0      |  
|                                                                                      |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                                 | 15,302 |      |                               | 4,831  |      |  |   | 15,302 |   |  |   | 4,264  |  
|                                                                                      |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net income / (loss) per common share                                |  | $                               | 0.02   |      | $                             | (0.22  | )    |  | $ | (0.00  | ) |  | $ | (0.84  | )
|                                                                                      |  |                                 |        |      |                               |        |      |  |   |        |   |  |   |        |  



Outstanding options
and warrants to purchase 2,326,554 and 918,685 shares of common stock at December 31, 2005 and 2004, respectively, were not included in the computation of diluted net loss per common share for the periods presented as a result of their
anti-dilutive effect. Such securities could have a dilutive effect in future periods.



Note 5. Comprehensive Income / (Loss)



We
report comprehensive income / (loss) and the components in accordance with Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). Under SFAS 130, comprehensive income includes all changes in
equity during a period except those resulting from investments by or distributions to owners. The comprehensive income was $194,000 for the quarter ended December 31, 2005 and the comprehensive income was $675,000 for the quarter ended
December 31, 2004. Comprehensive loss was $129,000 for the six months ended December 31, 2005 and comprehensive income was $47,000 for the six months ended December 31, 2004. Accumulated other comprehensive loss presented
in the accompanying consolidated balance sheets at December 31, 2005 and June 30, 2005 consists solely of accumulated foreign currency translation adjustments.



|                                    |  |                                 |     |   |                               |   |     |      |  |   |      |   |  |   |      |  
|----------------------------------- |  | ------------------------------- | --- | - | ----------------------------- | - | --- | ---- |  | - | ---- | - |  | - | ---- | -
|(in thousand)                       |  | Three Months Ended December 31, |     |   | Six Months Ended December 31, |  
|                                    |  | 2005                            |     |   | 2004                          |   |     | 2005 |  |   | 2004 |  
|Net income / (loss)                 |  | $                               | 245 |   |                               | $ | 732 |      |  | $ | (52  | ) |  | $ | 160  |  
|Less : foreign exchange translation |  |                                 | (51 | ) |                               |   | (57 | )    |  |   | (77  | ) |  |   | (113 | )
|                                    |  |                                 |     |   |                               |   |     |      |  |   |      |   |  |   |      |  
|Comprehensive income / (loss)       |  | $                               | 194 |   |                               | $ | 675 |      |  | $ | (129 | ) |  | $ | 47   |  
|                                    |  |                                 |     |   |                               |   |     |      |  |   |      |   |  |   |      |  



Note 6. Segment Information



We operate in one segment, the development, license,
implementation and support of our customer service infrastructure software solutions. Operating segments are identified as components of an enterprise for which



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##### Table of Contents

discrete financial information is available and regularly reviewed by the companys chief operating decision-maker
to make decisions about resources to be allocated to the segment and assess its performance. Our chief operating decision-makers, as defined under SFAS No. 131, are the members of our executive management team. Our chief operating
decision-maker reviews financial information presented on a consolidated basis, accompanied by separate information about operating results by geographic region for purposes of making operating decisions and assessing financial performance.



Information relating to our geographic areas is as follows (in
thousands):



|                         |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|------------------------ |  | ------------------------------- | ----- | - | ----------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ----- | -
|                         |  | Three months ended December 31, |       |   | Six months ended December 31, |  
|                         |  | 2005                            |       |   | 2004                          |   |       | 2005 |  |   | 2004   |  
|Total Revenue:           |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|North America            |  | $                               | 3,069 |   |                               | $ | 2,752 |      |  | $ | 5,664  |   |  | $ | 5,062 |  
|Europe                   |  |                                 | 2,704 |   |                               |   | 2,304 |      |  |   | 5,200  |   |  |   | 4,614 |  
|Asia Pacific             |  |                                 | 236   |   |                               |   | 131   |      |  |   | 368    |   |  |   | 232   |  
|                         |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|                         |  | $                               | 6,009 |   |                               | $ | 5,187 |      |  | $ | 11,232 |   |  | $ | 9,908 |  
|                         |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|Operating Income (Loss): |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|North America            |  | $                               | 74    |   |                               | $ | 1,089 |      |  | $ | (70    | ) |  | $ | 864   |  
|Europe                   |  |                                 | 784   |   |                               |   | 362   |      |  |   | 1,278  |   |  |   | 794   |  
|Asia Pacific*            |  |                                 | (261  | ) |                               |   | (472  | )    |  |   | (634   | ) |  |   | (975  | )
|                         |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  
|                         |  | $                               | 597   |   |                               | $ | 979   |      |  | $ | 574    |   |  | $ | 683   |  
|                         |  |                                 |       |   |                               |   |       |      |  |   |        |   |  |   |       |  

---

|* | Include costs associated with corporate support
|- | -----------------------------------------------



In addition, identifiable tangible assets corresponding to our geographic areas are as follows (in thousands):



|              |  |              |        |      |   |       
|------------- |  | ------------ | ------ | ---- | - | ------
|              |  | December 31,
|              |  | 2005         |        | 2004
|North America |  | $            | 5,834  |      | $ | 5,530 
|Europe        |  |              | 5,265  |      |   | 3,669 
|Asia Pacific  |  |              | 692    |      |   | 807   
|              |  |              |        |      |   |       
|              |  | $            | 11,791 |      | $ | 10,006
|              |  |              |        |      |   |       



The
following table provides the revenue for the three and six months ended December 31, 2005 and 2004 (in thousands):



|                         |  |                                 |       |                               |   |       |  |      |        |  |   |      
|------------------------ |  | ------------------------------- | ----- | ----------------------------- | - | ----- |  | ---- | ------ |  | - | -----
|                         |  | Three months ended December 31, |       | Six months ended December 31,
|                         |  | 2005                            |       | 2004                          |   | 2005  |  | 2004
|Revenue:                 |  |                                 |       |                               |   |       |  |      |        |  |   |      
|License                  |  | $                               | 2,013 |                               | $ | 1,384 |  | $    | 3,390  |  | $ | 2,657
|Hosting services         |  |                                 | 850   |                               |   | 879   |  |      | 1,687  |  |   | 1,806
|Maint & Support services |  |                                 | 2,094 |                               |   | 2,099 |  |      | 4,154  |  |   | 3,943
|Professional services    |  |                                 | 1,052 |                               |   | 825   |  |      | 2,001  |  |   | 1,502
|                         |  |                                 |       |                               |   |       |  |      |        |  |   |      
|                         |  | $                               | 6,009 |                               | $ | 5,187 |  | $    | 11,232 |  | $ | 9,908
|                         |  |                                 |       |                               |   |       |  |      |        |  |   |      



During the three
months ended December 31, 2005, there was one customer that accounted for 19% of total revenue and there were no customers that accounted for more than 10% of total revenue in the comparable year-ago quarter. For the six months ended
December 31, 2005 and 2004, there were no customers that accounted for more than 10% of total revenue.



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Note 7. Related Party Notes Payable



During fiscal year 2003, we entered into a note and warrant purchase agreement with Ashutosh Roy, our Chief Executive
Officer, pursuant to which Mr. Roy made loans to us evidenced by one or more subordinated secured promissory notes and received warrants to purchase shares of our common stock in connection with each of such loans. The five year subordinated
secured promissory note bears interest at an effective annual rate of 12% due and payable upon the term of such note. We have the option to prepay each note at any time subject to the prepayment penalties set forth in such note. On December 31,
2002, Mr. Roy loaned to us $2.0 million under the agreement and received warrants that allow him to purchase up to 236,742 shares at an exercise price equal to $2.11 per share On October, 31, 2003, we entered into an amendment to the 2002 note
and warrant purchase agreement with Mr. Roy, pursuant to which he loaned to us an additional $2.0 million and received additional warrants to purchase up to 128,766 shares at $3.88 per share. The principal and interest due on the loans as of
December 31, 2005 was $5.2 million. As of December 31, 2005, warrants to purchase 365,509 shares of common stock were vested and outstanding.



On March 31, 2004, we entered into a note and warrant purchase agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners
L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P. (the lenders) pursuant to which the lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common
stock in connection with such loans. The secured promissory notes have a term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time
subject to the prepayment penalties set forth in such notes. The warrants allow the lenders to purchase up to 312,500 shares at an exercise price of $2.00. The principal and interest due on the loans as of December 31, 2005 was $2.9 million. As
of December 31, 2005, warrants to purchase 312,500 shares of common stock were vested and outstanding.



Note 8. Bank Borrowings



On October 29, 2004, we entered into a new loan and security agreement (the Credit Facility) with Silicon Valley Bank (SVB) which replaced the existing accounts receivable purchase agreement. The Credit Facility
provided for the advance of up to the lesser of $1.5 million or 80% of certain qualified receivables. The Credit Facility bears interest at a rate of prime plus 2.5% per annum, provided that if we maintain an adjusted quick ratio of greater
than 2 : 1, then the rate shall be reduced to a rate of prime plus 1.75%. In addition, the Credit Facility carries a $750 per month collateral monitoring fee. We are in compliance with the financial covenants under this agreement that require us to
meet certain rolling three-month operating losses during the term of the Credit Facility. On December 28, 2004, we entered into an amendment to the Credit Facility that revised the terms to allow for the advance of up to the lesser of $1.5
million or the sum of 80% of certain qualified receivables and 50% of our unrestricted cash on deposit with SVB less the total outstanding obligations to SVB and any outstanding letters of credit. As of December 31, 2005, the interest rate was
9.75%, and the outstanding balance under the Credit Facility was $1.5 million. On March 29, 2005, we entered into a further amendment to the Credit Facility that revised the terms to allow for the advance of up to an additional $750,000 to be
used to finance equipment purchases (the Equipment Line). Interest accrues from the date of each advance, under the Equipment Line, at a rate of prime plus 3% per annum. Each advance under the Equipment Line must be repaid in 24
equal monthly payments of principal and interest, commencing on the first day of the first month following the date the advance is made, and continuing on the first day of each succeeding month. As of December 31, 2005, the interest rate was
10.25% and the outstanding balance under the Equipment Line was approximately $236,000.



Note 9. Restructuring



Background



Beginning in fiscal 2001 and continuing through the first quarter of fiscal
2004, economic conditions in North America and many of the other countries in which we operate either deteriorated or stabilized at depressed levels. This continuing weak economic environment, and in particular spending in technology, has had an
adverse impact on sales of enterprise software. As a result, we saw a decline in our revenues from fiscal 2001 to fiscal 2004. In response to this decline, we initiated a series of steps to streamline operations and better align operating costs and
expenses with revenue trends. Specifically, we took the following actions:



| |  | We reduced the discretionary portion of our operating costs through various cost control initiatives, including: (i) reducing marketing expenditures; (ii) movement of
certain key business functions from North America to India; (iii) temporary reduction in salaries (fiscal 2002) in North America and Europe; (iv) eliminating the majority of bonuses or realigning bonuses more closely with achievement of
financial objectives; (v) reducing depreciation, primarily through reduced capital expenditures; and (vi) reducing other discretionary expenditures, such as costs related to outside consultants, travel and recruiting.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | Based on our continued evaluation of economic conditions and a continued decline in our revenues we initiated a further restructuring of our operations in fiscal 2002. The Plan
consisted primarily of the consolidation of excess facilities, the abandonment of certain assets in connection with the consolidation of excess facilities and further reductions in our workforce.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Based on our continued evaluation of economic conditions and a continued decline in our revenues we initiated a further restructuring of our operations in the first fiscal quarter
of 2004. The Plan consisted of further reductions in our workforce in Europe.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Based upon our evaluation of the performance of our Japan operations we initiated a restructuring plan in January 2005 to close the Japan office.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



As part of separate settlement agreements with the two landlords, in the
event we made a distribution of cash, stock or other consideration to holders of our Series A Preferred with respect to the shares of Series A Preferred, each of the two landlords would receive a payment equal to the lesser of (i) $1.0 million
or (ii) the amount payable to a holder of shares of Series A Preferred with an aggregate stated value of $1.0 million. Based upon the final distribution to the preferred stock holders we reduced the outstanding liability we had accrued for
these two settlements by approximately $958,000. In February 2005, a total payment of $242,000 was made for the finalized settlements and the over accrual of $46,000 was reversed.



During the three and six months ended December 31, 2005, we recorded no restructuring expense and the restructuring
accrual was paid in full.



Note 10. Commitments



We generally warrant that the program portion of our software will perform
substantially in accordance with certain specifications for a period up to 180 days. Our liability for a breach of this warranty is either a return of the license fee or providing a fix, patch, work-around or replacement of the software.



We also provide standard warranties against and indemnification for the
potential infringement of third party intellectual property rights to our customers relating to the use of our products, as well as indemnification agreements with certain officers and employees under which we may be required to indemnify such
persons for liabilities arising out of their duties to us. The terms of such obligations vary. Generally, the maximum obligation is the amount permitted by law.



Historically, costs related to these warranties have not been significant, however we cannot guarantee that a warranty reserve will not become
necessary in the future.



Note 11. New Accounting Pronouncements



In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections. This new standard replaces APB Opinion No. 20, Accounting Changes in Interim Financial Statements, and SFAS No. 3, Reporting Accounting Changes in Interim Financial
Statements, and represents another step in the FASBs goal to converge its standards with those issued by the International Accounting Standards Board (IASB). Among other changes, SFAS 154 requires retrospective application to
prior periods financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS 154 also provides that (1) a change in method of depreciating or amortizing a long-lived non-financial asset be accounted
for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a restatement. The new standard is effective
for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005. Early adoption of this standard is permitted for accounting changes and correction of errors made in fiscal years beginning after
June 1, 2005. We do not expect the adoption of SFAS 154 to have a material effect on our consolidated financial statements.



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Note 12. Subsequent Event



On January 27, 2006 we entered into an extension of our Credit Facility with Silicon Valley Bank. The amendment
extended the termination date to July 28, 2006 and the advance level under the Equipment Line was reduced to $124,000. All other terms and conditions remained the same as outlined in Note 8. Bank Borrowings.



Note 13. Litigation



Beginning on October 25, 2001, a number of securities class action
complaints were filed against us, and certain of our then officers and directors and underwriters connected with our initial public offering of common stock in the U.S. District Court for the Southern District of New York (consolidated into In re
Initial Public Offering Sec. Litig.). The complaints alleged generally that the prospectus under which such securities were sold contained false and misleading statements with respect to discounts and excess commissions received by the
underwriters as well as allegations of laddering whereby underwriters required their customers to purchase additional shares in the aftermarket in exchange for an allocation of IPO shares. The complaints sought an unspecified amount in
damages on behalf of persons who purchased the common stock between September 23, 1999 and December 6, 2000. Similar complaints were filed against 55 underwriters and more than 300 other companies and other individuals. The over 1,000
complaints were consolidated into a single action. We reached an agreement with the plaintiffs to resolve the cases as to our liability and that of our officers and directors. The settlement involved no monetary payment or other consideration by us
or our officers and directors and no admission of liability. On August 31, 2005, the court issued an order preliminarily approving the settlement and setting a public hearing on its fairness for April 24, 2006 (the postponement from
January 2006 to April 2006 was because of difficulties in mailing the required notice to class members). On October 27, 2005, the court issued an order making some minor changes to the form of notice to be sent to class members.



On February 12, 2004, we filed suit against Insight
Enterprises, Inc., the acquirer of Comark, Inc., a value-added reseller of our software, claiming inter alia breach of contract and failure to pay in connection with a sale of our software to one customer in the Superior Court of the State of
California, Santa Clara County. The lawsuit seeks in excess of $600,000 in damages.



With the exception of these matters, we are not a party to any other material pending legal proceedings, nor is our property the subject of any material pending legal proceeding, except routine legal proceedings
arising in the ordinary course of our business and incidental to our business, none of which are expected to have a material adverse impact, as taken individually or in the aggregate, upon our business, financial position or results of operations.
However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert managements attention and impact other resources.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



This report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that involve risks and uncertainties.
These statements may be identified by the use of the words such as anticipates, believes, continue, could, would, estimates, forecasts, expects,
intends, may, might, plans, potential, predicts, should, or will and similar expressions or the negative of those terms. The forward-looking statements
include, but are not limited to, risks stemming from strategic and operational choices in recent quarters, failure to improve our sales results and grow revenue, failure to compete successfully in the markets in which we do business, our history of
net losses and our ability to sustain profitability, our limited operating history, the adequacy of our capital resources and need for additional financing, continued lengthy and delayed sales cycles, the development of our strategic relationships
and third party distribution channels, broad economic and political instability around the world affecting the market for our goods and services, the continued need for customer service and contact center software solutions and the continued
acceptance of our Web-native architecture, our ability to respond to rapid technological change and competitive challenges, the effects of cost reductions on our workforce and ability to service customers, risks from our substantial international
operations, adverse results in pending litigation, legal and regulatory uncertainties and other risks related to protection of our intellectual property assets and the operational integrity and maintenance of our systems. Our actual results
could



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differ materially from those discussed in statements relating to our future plans, product releases, objectives,
expectations and intentions, and other assumptions underlying or relating to any of these statements. Factors that could contribute to such differences include those discussed in Factors That May Affect Future Results and elsewhere in
this document. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or understanding to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.



Overview



We build, sell, and deploy customer interaction hub software solutions for enterprises and mid-sized businesses. Our solutions help businesses transform
their call centers to multi-channel customer interaction hubs to deliver differentiated service while maintaining costs. The customer interaction hub market presents a growing opportunity worldwide as the total number of customer interactions is
growing geometrically as consumer choice increases and products become more complex. Consumers are demanding consistent, high-quality service from businesses across all channelsweb, phone, email, print, and in-person. In response, businesses
are looking to invest in effective front-end and efficient back-end customer interaction processes within a customer interaction hub. In a customer interaction hub, interactions across all channels - web, email, phone, print, or in-personare
handled with the same service delivery infrastructurewith common queues for work allocation, best-practice business processes, unified knowledge bases, and aggregated customer history.



We are a focused leader in the customer interaction hub space with proven
customer successes and sustained product leadership. Our success is defined by the business value our customers derive from our solutions. eGain Service 7, our software suite, available through licensed or hosted models, includes integrated,
best-in-class applications for customer email management, live web collaboration, virtual agent customer service, knowledge management, and web self-service. These robust applications are built on the eGain Service Management Platform (eGain
SMP), a scalable framework that includes end-to-end service process management, multi-channel, multi-site contact center management, a flexible integration approach, and certified out-of-the-box integrations with leading call center and
business systems.



Recent Developments



The 2005 Stock Incentive Plan (the 2005 Plan) was adopted by the
Board of Directors in March 2005. The 2005 Plan allows for the issuance of options to purchase up to 460,000 shares of our Common Stock.The 2005 Plan was approved by our stockholders on December 8, 2005. The primary purpose of the 2005
Plan is to promote the long-term success of eGain and the creation of stockholder value by (a) encouraging our employees to focus on critical long-range objectives, (b) encouraging the attraction and retention of employees with exceptional
qualifications and (c) linking the interests of our employees directly to our stockholders interests through increased stock ownership.



Critical Accounting Policies and Estimates



Managements Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates
and judgments, including those related to revenue recognition, valuation allowances and accrued liabilities, long-lived assets and stock-based compensation. Management bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.



Stock-Based Compensation



We adopted Statement
of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, effective July 1, 2005. SFAS 123R is a new and very complex accounting standard, the application of which requires
significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates to value equity-based compensation. SFAS 123R
also requires that the benefit of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after the effective date. This tax difference for unexercised options must also be recorded as a deferred tax item and recorded in additional paid in capital. We cannot estimate what those
amounts will be in the future (because they depend on, among other things when employees exercise stock options). Refer to Note 3  Stock-Based Compensation in our notes to our unaudited condensed consolidated financial statements included
elsewhere in this quarterly report on Form 10-Q for more discussion.



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Revenue Recognition



We derive revenues from two sources: license fees, and support and services. Support and services includes hosting, software maintenance and support, and
professional services. Maintenance and support consists of technical support and software upgrades and enhancements. Professional services primarily consist of consulting and implementation services and training. Significant management judgments and
estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if different conditions were to prevail.



We apply the provisions of Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended by SOP 98-9 Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions to all transactions involving the licensing of software products. In the
event of a multiple element arrangement, we evaluate the transaction as if each element represents a separate unit of accounting taking into account all factors following the guidelines set forth in Emerging Issues Task Force Issue No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables, (EITF 00-21). For fixed fee arrangements the services revenues are recognized in accordance with the provisions of SOP 81-1, Accounting for
Performance of Construction Type and Certain Production Type Contracts, when reliable estimates are available for the costs and efforts necessary to complete the implementation services. When such estimates are not available, the completed
contract method is utilized.



When licenses are sold together
with system implementation and consulting services, license fees are recognized upon shipment, provided that (i) payment of the license fees is not dependent upon the performance of the consulting and implementation services, (ii) the
services are available from other vendors (iii) the services qualify for separate accounting as we have sufficient experience in providing such services and we have vendor specific objective evidence of pricing, and (iv) the services are
not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and the service revenues are recognized under the percentage of completion method. This has not been
necessary in the last three years.



We use signed software
license and services agreements and order forms as evidence of an arrangement for sales of software, hosting, maintenance and support. We use signed engagement letters to evidence an arrangement for professional services.



License Revenue



We recognize license revenue when persuasive evidence of an arrangement exists, the product has been delivered, no
significant obligations remain, the fee is fixed or determinable, and collection of the resulting receivable is probable. In software arrangements that include rights to multiple software products and/or services, we use the residual method under
which revenue is allocated to the undelivered elements based on vendor specific objective evidence of the fair value of such undelivered elements. The residual amount of revenue is allocated to the delivered elements and recognized as revenue
assuming all other criteria for revenue recognition have been met. Such undelivered elements in these arrangements typically consist of software maintenance and support, implementation and consulting services and in some cases hosting services.



Software is delivered to customers electronically or on a
CD-ROM, and license files are delivered electronically. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. We have standard payment terms included in our contracts. We assess collectibility
based on a number of factors, including the customers past payment history and its current creditworthiness. If we determine that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection
becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period.



We periodically sell to resellers. Revenue from sales to resellers is
recognized either upon delivery to the reseller or on a sell-through basis depending on the facts and circumstances of the transaction, such as our understanding of the resellers plans to sell the software, if there are any return provisions,
price protection or other allowances, the resellers financial status and our past experience with the particular reseller. Historically sales to resellers have not included any return provisions, price protections or other allowances.



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Professional Services Revenue



Included in support services revenues are revenues derived from system implementation consulting and training. The majority
of our consulting and implementation services and accompanying agreements qualify for separate accounting. For hosting implementation services that do not qualify for separate accounting, we recognize the services revenue ratably over the remaining
term of the hosting agreement. We use vendor specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each
element. Our consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. Substantially all of our contracts are on a time-and-materials basis. For time-and-materials contracts, we recognize
revenue as services are performed. For a fixed-fee contract, we recognize revenue based upon the costs and efforts to complete the services in accordance with the percentage of completion method.



Training revenue is recognized when training is provided.



Hosting Services Revenue



Included in support services revenues are revenues derived from our hosted
service offerings. We recognize hosting services revenue ratably over the period of the applicable agreement as services are provided. Hosting agreements are typically for a period of one or two years and automatically renew unless either party
cancels the agreement. The majority of the hosting services customers purchase a combination of our hosting service and professional services. In some cases the customer may also acquire a license for the software.



We evaluate whether each of the elements in these arrangements represents a
separate unit of accounting, as defined by EITF 00-21, using all applicable facts and circumstances, including whether (i) we sell or could readily sell the element unaccompanied by the other elements, (ii) the element has stand-alone
value to the customer, (iii) there is objective reliable evidence of the fair value of the undelivered item, and (iv) there is a general right of return.



We allocate the arrangement consideration to the separate units of accounting based on their relative fair values, as
determined by the price of the undelivered items when sold separately. Assuming all other criteria are met (i.e., evidence of an arrangement exists, collectibility is probable, and fees are fixed or determinable), revenue is recognized as follows:



| |  |  | Hosting services are recognized ratably over the term of the initial hosting contract;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | Professional services are recognized as described above under Professional Services Revenue; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | License revenue is recognized as described above under License Revenue.
| | - |  | -------------------------------------------------------------------------



If evidence of fair value cannot be established for the undelivered elements of an agreement, the entire amount of revenue
from the arrangement is recognized ratably over the period that these elements are delivered. For implementation services that we determine do not have stand-alone value to the customer, we recognize the services revenue ratably over the remaining
term of the hosting agreement.



Maintenance and Support Revenue



Included in support services revenues are revenues
derived from maintenance and support. Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Maintenance and support is renewable by the customer on an annual basis. Rates for
maintenance and support, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.



Valuation of Goodwill



We review goodwill annually for impairment (or more frequently if impairment indicators arise). We performed an annual goodwill impairment review at
June 30 every year and we found no impairment. Additionally, we did not identify any indicators which made us believe goodwill was potentially impaired during the quarter ended December 31, 2005.



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Allowance for Doubtful Accounts



We maintain an allowance for doubtful accounts to reserve for potential
uncollectible trade receivables. We review our trade receivables by aging category to identify specific customers with known disputes or collectability issues. We exercise judgment when determining the adequacy of these reserves as we evaluate
historical bad debt trends, general economic conditions in the U.S. and internationally, and changes in customer financial conditions. If we made different judgments or utilized different estimates, material differences may result in additional
reserves for trade receivables, which would be reflected by charges in general and administrative expenses for any period presented.



Results of Operations



The following table sets forth the results of operations for the periods presented expressed as a percentage of total revenue:



|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   
|---------------------------------- |  | ------------------------- | - |  | ----------------------- | -- |  | ---- | - |  | ---- | --
|                                   |  | Three Months December 31, |   |  | Six Months December 31, |   
|                                   |  | 2005                      |   |  | 2004                    |    |  | 2005 |   |  | 2004 |   
|Revenue:                           |  |                           |   |  |                         |    |  |      |   |  |      |   
|License                            |  | 33                        | % |  | 27                      | %  |  | 30   | % |  | 27   | % 
|Support and Services               |  | 67                        | % |  | 73                      | %  |  | 70   | % |  | 73   | % 
|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   
|Total revenue                      |  | 100                       | % |  | 100                     | %  |  | 100  | % |  | 100  | % 
|Cost of license                    |  | 2                         | % |  | 2                       | %  |  | 2    | % |  | 3    | % 
|Cost of support and services       |  | 26                        | % |  | 29                      | %  |  | 29   | % |  | 30   | % 
|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   
|Gross profit                       |  | 72                        | % |  | 69                      | %  |  | 69   | % |  | 67   | % 
|                                   |  |                           |   | 
|Operating costs and expenses:      |  |                           |   |  |                         |    |  |      |   |  |      |   
|Research and development           |  | 12                        | % |  | 10                      | %  |  | 13   | % |  | 11   | % 
|Sales and marketing                |  | 38                        | % |  | 43                      | %  |  | 39   | % |  | 43   | % 
|General and administrative         |  | 12                        | % |  | 16                      | %  |  | 12   | % |  | 16   | % 
|Restructuring and other            |  | 0                         | % |  | (19                     | )% |  | 0    | % |  | (10  | )%
|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   
|Total operating costs and expenses |  | 62                        | % |  | 50                      | %  |  | 64   | % |  | 60   | % 
|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   
|Income from operations             |  | 10                        | % |  | 19                      | %  |  | 5    | % |  | 7    | % 
|                                   |  |                           |   |  |                         |    |  |      |   |  |      |   



Revenues



Total revenue increased 16% to $6.0 million in the quarter ended
December 31, 2005 from $5.2 million in the quarter ended December 31, 2004. Total revenue for the six months ended December 31, 2005 increased 13% to $11.2 million, compared to $9.9 million in the same period last year. The increase
was primarily due to the increase in license and professional services revenue. During the three months ended December 31, 2005, there was one customer that accounted for 19% of total revenue, no one customer accounted for more than 10% of
total revenue in the comparable year-ago quarter. For the six months ended December 31, 2005 and 2004, there were no customers that accounted for more than 10% of total revenue.



Based upon current sales activities we anticipate total revenue to increase over the next fiscal year. We are seeing
increased interest from medium to larger-sized companies in our customer interaction solutions. There is however general unpredictability of the length of our current sales cycles and seasonal buying patterns. In addition, sales to these larger
companies are generally more complex and time consuming, with new customers often choosing to make smaller initial purchases to be followed up with additional purchases if product meets with their business requirements. Also, because we offer a
hybrid delivery model the mix of new hosting and license business in a quarter could also have an impact on our revenue in a particular quarter. For license transactions the license revenue amount is generally recognized in the quarter delivery and
acceptance of our software takes place whereas, for hosting transactions, hosting revenue is recognized ratably over the term of the hosting contract, which is typically one to two years. As a result, our total revenue may increase or decrease in
future quarters as a result of the timing and mix of license transactions.



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License



|                            |  |                          |       |   |                        |   |       |        |  |   |     |  |      |   |  |      |       |   |        |   |       |   |  |   |     |  |    |  
|--------------------------- |  | ------------------------ | ----- | - | ---------------------- | - | ----- | ------ |  | - | --- |  | ---- | - |  | ---- | ----- | - | ------ | - | ----- | - |  | - | --- |  | -- | -
|(in thousands)              |  | Three Months December 31 |       |   | Six months December 31 |  
|                            |  | 2005                     |       |   | 2004                   |   |       | Change |  | % |     |  | 2005 |   |  | 2004 |       |   | Change |   | %     |  
|Revenue:                    |  |                          |       |   |                        |   |       |        |  |   |     |  |      |   |  |      |       |   |        |   |       |   |  |   |     |  |    |  
|License                     |  | $                        | 2,013 |   |                        | $ | 1,384 |        |  | $ | 629 |  | 45   | % |  | $    | 3,390 |   |        | $ | 2,657 |   |  | $ | 733 |  | 28 | %
|Percentage of total revenue |  |                          | 33    | % |                        |   | 27    | %      |  |   |     |  |      |   |  |      | 30    | % |        |   | 27    | % |  |   |     |  |    |  



License revenue
increased 45% to $2.0 million in the quarter ended December 31, 2005 from $1.4 million in the quarter ended December 31, 2004. License revenue for the six months ended December 31, 2005 increased 28% to $3.4 million, compared to $2.7
million in the same period last year. The increase was primarily due to one license transaction in the quarter that accounted for approximately 16% of total revenue for the quarter. This transaction was a follow on sale to an existing customer
purchasing additional licenses for previously purchased products. License revenue represented 33% and 27% of total revenue for the quarters ended December 31, 2005 and 2004, respectively. License revenue represented 30% and 27% of total revenue
for the six months ended December 31, 2005 and 2004, respectively. Given the general unpredictability of the length of current sales cycles, license revenue may increase or decrease in future quarters as a result of the timing of license
transactions being completed, but we anticipate license revenues to increase over the future quarters.



Support and Services



|                            |  |                           |       |   |                         |   |       |        |  |   |     |   |  |      |    |  |      |       |   |        |   |       |   |  |   |      |   |  |    |   
|--------------------------- |  | ------------------------- | ----- | - | ----------------------- | - | ----- | ------ |  | - | --- | - |  | ---- | -- |  | ---- | ----- | - | ------ | - | ----- | - |  | - | ---- | - |  | -- | --
|(in thousands)              |  | Three Months December 31, |       |   | Six Months December 31, |  
|                            |  | 2005                      |       |   | 2004                    |   |       | Change |  |   | %   |   |  | 2005 |    |  | 2004 |       |   | Change |   |       | % | 
|Revenue:                    |  |                           |       |   |                         |   |       |        |  |   |     |   |  |      |    |  |      |       |   |        |   |       |   |  |   |      |   |  |    |   
|Hosting services            |  | $                         | 850   |   |                         | $ | 879   |        |  | $ | (29 | ) |  | (3   | )% |  | $    | 1,687 |   |        | $ | 1,806 |   |  | $ | (119 | ) |  | (7 | )%
|Maint. and support services |  | $                         | 2,094 |   |                         | $ | 2,099 |        |  | $ | (5  | ) |  | 0    | %  |  | $    | 4,154 |   |        | $ | 3,942 |   |  | $ | 212  |   |  | 5  | % 
|Professional services       |  | $                         | 1,052 |   |                         | $ | 825   |        |  | $ | 227 |   |  | 27   | %  |  | $    | 2,001 |   |        | $ | 1,502 |   |  | $ | 499  |   |  | 33 | % 
|                            |  |                           |       |   |                         |   |       |        |  |   |     |   |  |      |    |  |      |       |   |        |   |       |   |  |   |      |   |  |    |   
|Total support and services  |  | $                         | 3,996 |   |                         | $ | 3,803 |        |  | $ | 193 |   |  | 5    | %  |  | $    | 7,842 |   |        | $ | 7,250 |   |  | $ | 592  |   |  | 8  | % 
|Percentage of total revenue |  |                           | 67    | % |                         |   | 73    | %      |  |   |     |   |  |      |    |  |      | 70    | % |        |   | 73    | % |  |   |      |   |  |    |   



Support and services
includes hosting, software maintenance and support and professional services. Maintenance and support consists of technical support and software upgrades and enhancements. Professional services primarily consist of consulting and implementation
services and training. Support and services revenue increased 5% to $4.0 million in the quarter ended December 31, 2005 from $3.8 million in the quarter ended December 31, 2004. Support and services for the six months ended
December 31, 2005 increased 8% to $7.8 million, compared to $7.3 million in the same period last year. The increase was primarily due to the increase in professional services and maintenance and support revenue. Support and services revenue
represented 67% and 73% of total revenue for the quarters ended December 31, 2005 and 2004, respectively. Support and services revenue represented 70% and 73% of total revenue for the six months ended December 31, 2005 and 2004,
respectively



Hosting revenue decreased 3% to $850,000 in the
quarter ended December 31, 2005 from $879,000 in the quarter ended December 31 but increased 2% from $837,000 for the quarter ended September 30, 2005. Hosting services for the six months ended December 31, 2005 decreased 7% to
$1.7 million, compared to $1.8 million in the same period last year. The decrease was due in part to a small number of hosted customers who also own the licenses for the products taking the management of these products in-house. We expect hosting
revenue to increase in future periods based upon current renewal rates for existing hosted customers and the new hosting agreements entered into in recent quarters that we expect to start generating hosting revenue in future quarters.



Maintenance and support revenue was $2.1 million in the quarter ended
December 31, 2005 unchanged from the quarter ended December 31, 2004. Maintenance and support revenue for the six months ended December 31, 2005 increased 5% to $4.2 million, compared to $3.9 million in the same period last year. The
increase was primarily due to the increase in license revenue. We expect maintenance and support revenue to increase in future periods based upon current renewal rates and the increase in license revenue in recent quarters.



Professional services revenue increased 27% to $1.1 million in the quarter
ended December 31, 2005 from $825,000 in the quarter ended December 31, 2004. Professional services revenue for the six months ended December 31, 2005 increased 33% to $2.0 million, compared to $1.5 million in the same period last
year. The increase was primarily due to the increase in the size of professional services engagements with larger companies deploying our customer interation solutions within their organizations. Based upon our current sales pipeline we expect
professional services revenue to increase slightly in future periods.



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##### Table of Contents

Cost of Revenues



|                            |  |                           |       |   |                         |   |       |        |  |   |     |  |      |   |  |      |       |   |        |   |       |   |  |   |     |  |   |  
|--------------------------- |  | ------------------------- | ----- | - | ----------------------- | - | ----- | ------ |  | - | --- |  | ---- | - |  | ---- | ----- | - | ------ | - | ----- | - |  | - | --- |  | - | -
|(in thousands)              |  | Three Months December 31, |       |   | Six Months December 31, |  
|                            |  | 2005                      |       |   | 2004                    |   |       | Change |  | % |     |  | 2005 |   |  | 2004 |       |   | Change |   | %     |  
|Cost of Revenues            |  | $                         | 1,711 |   |                         | $ | 1,588 |        |  | $ | 123 |  | 8    | % |  | $    | 3,488 |   |        | $ | 3,216 |   |  | $ | 272 |  | 8 | %
|Percentage of total revenue |  |                           | 28    | % |                         |   | 31    | %      |  |   |     |  |      |   |  |      | 31    | % |        |   | 32    | % |  |   |     |  |   |  



Total cost of revenue
increased 8% to $1.7 million in the quarter ended December 31, 2005 from $1.6 million in the quarter ended December 31, 2004. Total cost of revenue for the six months ended December 31, 2005 increased 8% to $3.5 million, compared to
$3.2 million in the same period last year. The increase was primarily due to the increased personnel costs associated with the increase in professional services revenues. Total cost of revenue represented 28% and 31% of total revenues in the quarter
ended December 31, 2005 and 2004. The reduction in the cost if revenue as a percentage of total revenue for the quarter ended December 31, 2005 was primarily due to the increase of license revenue as a percentage of total revenue when compared
to the quarter ended December 31, 2004. Total cost of revenue represented 31% and 32% of total revenues for the six months ended December 31, 2005 and 2004.



In order to better understand the changes within our cost of revenues and resulting gross margins, we have provided the
following discussion of the individual components of our cost of revenues.



Cost of License



|                              |  |                           |     |   |                         |   |    |        |  |   |    |  |      |   |  |      |     |   |        |   |     |   |  |     |   |  |     |   
|----------------------------- |  | ------------------------- | --- | - | ----------------------- | - | -- | ------ |  | - | -- |  | ---- | - |  | ---- | --- | - | ------ | - | --- | - |  | --- | - |  | --- | --
|(in thousands)                |  | Three Months December 31, |     |   | Six Months December 31, |  
|                              |  | 2005                      |     |   | 2004                    |   |    | Change |  | % |    |  | 2005 |   |  | 2004 |     |   | Change |   |     | % | 
|Cost of License               |  | $                         | 133 |   |                         | $ | 76 |        |  | $ | 57 |  | 75   | % |  | $    | 186 |   |        | $ | 249 |   |  | (63 | ) |  | (25 | )%
|Percentage of license revenue |  |                           | 2   | % |                         |   | 1  | %      |  |   |    |  |      |   |  |      | 2   | % |        |   | 3   | % |  |     |   |  |     |   
|Gross Margin                  |  |                           | 93  | % |                         |   | 95 | %      |  |   |    |  |      |   |  |      | 95  | % |        |   | 91  | % |  |     |   |  |     |   



Cost of license
primarily includes third-party software royalties and delivery costs for shipments to customers. Total cost of license increased 75% to $133,000 in the quarter ended December 31, 2005 from $76,000 in the quarter ended December 31, 2004.
The increase was primarily due to the increase in third-party royalty costs associated with the increase in license revenue. Total cost of license for the six months ended December 31, 2005 decreased 63% to $186,000, compared to $249,000 in the
same period last year. Total cost of license increased as a percentage of total license revenues to 2% (a gross margin of 93%) in the quarter ended December 31, 2005 from 1% (a gross margin of 95%) in the quarter ended December 31, 2004.
The decrease in cost of license for the six months ended December 31, 2005 when compared to the six months ended December 31, 2004 was primarily due to the expiration and renegotiation of certain royalty agreements that resulted in a reduction in
the amortization of prepaid royalties. In addition, as part of our ongoing product development strategy, eGain Service 7 has less third-party software built into it than prior product releases and therefore lower corresponding costs for third-party
software royalty costs. Total cost of license decreased as a percentage of total license revenues to 2% (a gross margin of 95%) for the six months ended December 31, 2005 from 3% (a gross margin of 91%) for the six months ended
December 31, 2004. We anticipate cost of license as a percentage of revenue to remain relatively constant in future periods, but to increase or decrease in absolute dollars based upon the increase or decrease in our license revenue in future
periods.



Cost of Support and Services



|                                      |  |                           |       |   |                         |   |       |        |  |   |    |  |      |   |  |      |       |   |        |   |       |   |  |     |  |    |  
|------------------------------------- |  | ------------------------- | ----- | - | ----------------------- | - | ----- | ------ |  | - | -- |  | ---- | - |  | ---- | ----- | - | ------ | - | ----- | - |  | --- |  | -- | -
|(in thousands)                        |  | Three Months December 31, |       |   | Six Months December 31, |  
|                                      |  | 2005                      |       |   | 2004                    |   |       | Change |  | % |    |  | 2005 |   |  | 2004 |       |   | Change |   | %     |  
|Cost of support and service           |  | $                         | 1,578 |   |                         | $ | 1,512 |        |  | $ | 66 |  | 4    | % |  | $    | 3,302 |   |        | $ | 2,967 |   |  | 335 |  | 11 | %
|Percentage of supp. and serv. revenue |  |                           | 26    | % |                         |   | 29    | %      |  |   |    |  |      |   |  |      | 29    | % |        |   | 30    | % |  |     |  |    |  
|Gross Margin                          |  |                           | 61    | % |                         |   | 60    | %      |  |   |    |  |      |   |  |      | 58    | % |        |   | 59    | % |  |     |  |    |  



Cost of support and
services includes personnel costs for our hosting services, consulting services and customer support. It also includes depreciation of capital equipment used in our hosted network, cost of support for the third-party software and lease costs paid to
remote co-location centers. Total cost of support and services increased 4% to $1.6 million in the quarter ended December 31, 2005 from $1.5 million in the quarter ended December 31, 2004. Total cost of support and services for the six
months ended December 31, 2005 increased 11% to $3.3 million, from $3.0 million in the same period last year. Total cost of support and services as a percentage of total support and services revenues was 26% (a gross margin of 61%) in the
quarter ended December 31, 2005 compared to 29% (a gross margin of 60%) in the quarter ended December 31, 2004. Total cost of support and services as a percentage of total support and services revenues was 29% (a gross margin of 58%) for
the six months ended December 31, 2005 compared to 30% (a gross margin of 59%) in the same period last year. The increase was primarily due to increased personnel costs associated with delivering the increased professional
services engagements. Based upon current revenue expectations, we anticipate cost of support and services to increase in absolute dollars in future periods but for the gross margins to remain relatively constant in future periods.



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##### Table of Contents

Research and Development



|                            |  |                           |     |   |                         |   |     |        |  |   |     |  |      |   |  |      |       |   |        |   |       |   |  |   |     |  |    |  
|--------------------------- |  | ------------------------- | --- | - | ----------------------- | - | --- | ------ |  | - | --- |  | ---- | - |  | ---- | ----- | - | ------ | - | ----- | - |  | - | --- |  | -- | -
|(in thousands)              |  | Three Months December 31, |     |   | Six Months December 31, |  
|                            |  | 2005                      |     |   | 2004                    |   |     | Change |  | % |     |  | 2005 |   |  | 2004 |       |   | Change |   | %     |  
|Research and Development    |  | $                         | 704 |   |                         | $ | 524 |        |  | $ | 180 |  | 34   | % |  | $    | 1,417 |   |        | $ | 1,062 |   |  | $ | 355 |  | 33 | %
|Percentage of total revenue |  |                           | 12  | % |                         |   | 10  | %      |  |   |     |  |      |   |  |      | 13    | % |        |   | 11    | % |  |   |     |  |    |  



Research and
development expenses primarily consist of compensation and benefits for our engineering, product management and quality assurance personnel and, to a lesser extent, occupancy costs and related overhead. Our product development focus in fiscal year
2005 and continuing in fiscal year 2006 is in bringing additional products onto the core Service Management Platform (eGain SMP). Leveraging our open Java J2EE architecture, we have also expanded our reach with support for additional operating
systems and data base platforms. Research and development costs increased 34% to $704,000 in the quarter ended December 31, 2005 from $524,000 in the quarter ended December 31, 2004. Total research and development costs for the six months
ended December 31, 2005 increased 33% to $1.4 million, from $1.1 million in the same period last year. The increase is primarily due to increased personnel costs. Total research and development expenses as a percentage of total revenues was 12%
in the quarter ended December 31, 2005 compared to 10% in the quarter ended December 31, 2004. Total research and development expenses as a percentage of total revenues was 13% for the six months ended December 31, 2005 compared to
11% in the same period last year. Based upon current revenue expectations and increased personnel costs, we anticipate a slight increase in research and development expense in future periods.



Sales and Marketing



|                            |  |                           |       |   |                         |   |       |        |  |   |     |   |  |      |    |  |      |       |   |        |   |       |   |  |   |     |   |  |    |   
|--------------------------- |  | ------------------------- | ----- | - | ----------------------- | - | ----- | ------ |  | - | --- | - |  | ---- | -- |  | ---- | ----- | - | ------ | - | ----- | - |  | - | --- | - |  | -- | --
|(in thousands)              |  | Three Months December 31, |       |   | Six Months December 31, |  
|                            |  | 2005                      |       |   | 2004                    |   |       | Change |  |   | %   |   |  | 2005 |    |  | 2004 |       |   | Change |   |       | % | 
|Sales                       |  | $                         | 1,833 |   |                         | $ | 1,719 |        |  | $ | 114 |   |  | 7    | %  |  | $    | 3,520 |   |        | $ | 3,376 |   |  | $ | 144 |   |  | 4  | % 
|Marketing                   |  | $                         | 425   |   |                         | $ | 487   |        |  | $ | (62 | ) |  | (13  | %) |  | $    | 865   |   |        | $ | 931   |   |  | $ | (66 | ) |  | (7 | %)
|Total Sales and Marketing   |  | $                         | 2,258 |   |                         | $ | 2,206 |        |  | $ | 52  |   |  | 2    | %  |  | $    | 4,385 |   |        | $ | 4,307 |   |  | $ | 78  |   |  | 2  | % 
|Percentage of total revenue |  |                           | 38    | % |                         |   | 43    | %      |  |   |     |   |  |      |    |  |      | 39    | % |        |   | 43    | % |  |   |     |   |  |    |   



Sales and marketing
expenses primarily consist of compensation and benefits for our sales, marketing and business development personnel, lead generation activities, advertising, trade show and other promotional costs and, to a lesser extent, occupancy costs and related
overhead. Sales and marketing expense was $2.2 million in the quarter ended December 31, 2005 unchanged from the quarter ended December 31, 2004. Total Sales and marketing expense for the six months ended December 31, 2005 was $4.4
million compared to $4.3 million from the same period last year. Total sales and marketing expenses as a percentage of total revenues was 38% in the quarter ended December 31, 2005 compared to 43% in the quarter ended December 31, 2004.
Total sales and marketing expenses as a percentage of total revenues was 39% for the six months ended December 31, 2005 compared to 43% in the same period last year.



Total sales expenses increased 7% to $1.8 million in the quarter ended December 31, 2005 from $1.7 million in the
quarter ended December 31, 2004. Total sales expenses for the six months ended December 31, 2005 increased 4% to $3.5 million, from $3.4 million in the same period last year. The increase was primarily due to increased sales commissions
associated with the increased total revenue.



Total marketing
expenses decreased 13% to $425,000 in the quarter ended December 31, 2005 from $487,000 in the quarter ended December 31, 2004. Total marketing expenses for the six months ended December 31, 2005 decreased 7% to $865,000, from
$931,000 in the same period last year. The decrease was primarily due to the timing of the annual customer summit and the costs associated with this event. In fiscal 2005 we held this event in the second fiscal quarter, whereas for this fiscal year
the event was held in the first fiscal quarter.



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##### Table of Contents

We expect sales and marketing expenses to increase in future periods as we plan to increase the size of
our sales team and expand our marketing activities in an effort to increase revenues.



General and Administrative



|                            |  |                           |     |   |                         |   |     |        |  |   |      |   |  |      |    |  |      |       |   |        |   |       |   |  |   |      |   |  |     |   
|--------------------------- |  | ------------------------- | --- | - | ----------------------- | - | --- | ------ |  | - | ---- | - |  | ---- | -- |  | ---- | ----- | - | ------ | - | ----- | - |  | - | ---- | - |  | --- | --
|(in thousands)              |  | Three Months December 31, |     |   | Six Months December 31, |  
|                            |  | 2005                      |     |   | 2004                    |   |     | Change |  |   | %    |   |  | 2005 |    |  | 2004 |       |   | Change |   |       | % | 
|General and Administrative  |  | $                         | 739 |   |                         | $ | 848 |        |  | $ | (109 | ) |  | (13  | )% |  | $    | 1,368 |   |        | $ | 1,598 |   |  | $ | (230 | ) |  | (14 | )%
|Percentage of total revenue |  |                           | 12  | % |                         |   | 16  | %      |  |   |      |   |  |      |    |  |      | 12    | % |        |   | 16    | % |  |   |      |   |  |     |   



General and
administrative expenses primarily consist of compensation and benefits for our finance, human resources, administrative and legal services personnel, fees for outside professional services, provision for doubtful accounts and, to a lesser extent,
occupancy costs and related overhead. General and administrative expense decreased 13% to $739,000 in the quarter ended December 31, 2005 from $848,000 in the quarter ended December 31, 2004. Total general and administrative expenses for
the six months ended December 31, 2005 decreased 14% to $1.4 million, from $1.6 million in the same period last year. Total general and administrative expenses as a percentage of total revenues was 12% for both the three and six months ended
December 31, 2005 compared to 16% for both the three and six months ended December 31, 2004. The decrease was primarily due to reduced bad debt expense, reduced insurance premiums and reduced personnel costs. Based upon current revenue
expectations, we do not anticipate a significant increase or decrease in general and administrative expenses in future periods.



Stock-Based Compensation



|                               |  |                           |    |                         |      |    |        |    |   |    |      |   |     |      |  |        |  |    |  |   
|------------------------------ |  | ------------------------- | -- | ----------------------- | ---- | -- | ------ | -- | - | -- | ---- | - | --- | ---- |  | ------ |  | -- |  | --
|(in thousands)                 |  | Three Months December 31, |    | Six Months December 31,
|                               |  | 2005                      |    |                         | 2004 |    | Change |    | % |    | 2005 |   |     | 2004 |  | Change |  | % 
|Cost of support and services   |  | $                         | 8  |                         |      |   |        | NM |   | NM |      | $ | 20  |      |  |       |  | NM |  | NM
|Research and development       |  |                           | 15 |                         |      |   |        | NM |   | NM |      |   | 30  |      |  |       |  | NM |  | NM
|Sales and marketing            |  |                           | 20 |                         |      |   |        | NM |   | NM |      |   | 37  |      |  |       |  | NM |  | NM
|General and administrative     |  |                           | 32 |                         |      |   |        | NM |   | NM |      |   | 64  |      |  |       |  | NM |  | NM
|                               |  |                           |    |                         |      |    |        |    |   |    |      |   |     |      |  |        |  |    |  |   
|Total Stock-Based Compensation |  | $                         | 75 |                         |      |   |        | NM |   | NM |      | $ | 151 |      |  |       |  | NM |  | NM
|Percentage of total revenue    |  |                           | 1  | %                       |      | NM |        | NM |   | NM |      |   | 2   | %    |  | NM     |  | NM |  | NM



Stock compensation
expenses include the amortization of the fair value of share-based payments made to employees, Board of Directors and consultants, primarily in the form of stock options as we adopted the provision of SFAS 123R on July 1, 2005 (see Note 3
 Stock-Based Compensation). The fair value of stock options granted is recognized as an expense as the underlying stock options vest.



We use the modified prospective method to value our share-based payments under SFAS 123R. Accordingly, for the three and six months ended
December 31, 2005, we accounted for stock compensation under SFAS 123R while for the three and six months ended December 31, 2004, we accounted for stock compensation under APB 25. Under APB 25, we were generally required to record
compensation expense only if there were positive differences between the market value of our common stock and the exercise price of the options granted to employees as of the date of the grant. Under SFAS 123R, however, we record compensation
expense for all share-based payments made to employees based on the fair value at the date of the grant. Therefore, stock compensation for the three and six months ended December 31, 2005 is not comparable to the prior-year period.



Based upon recent and anticipated option grants, we do not expect our
stock compensation expense to increase significantly in the three months ended March 31, 2006.



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Restructuring



There was no restructuring expense in the quarter ended December 31, 2005, compared to a restructuring benefit of $958,000 in the comparable year-ago quarter. The
year-ago quarter restructuring benefit related to the accrual adjustment for the two outstanding lease settlements that had a final payment tied to the payment made to Series A Preferred holders.



Income From Operations



|                          |  |                           |     |   |                         |   |     |        |  |   |      |   |  |      |    |  |      |     |   |        |   |     |   |  |   |      |   |  |     |   
|------------------------- |  | ------------------------- | --- | - | ----------------------- | - | --- | ------ |  | - | ---- | - |  | ---- | -- |  | ---- | --- | - | ------ | - | --- | - |  | - | ---- | - |  | --- | --
|(in thousands)            |  | Three Months December 31, |     |   | Six Months December 31, |  
|                          |  | 2005                      |     |   | 2004                    |   |     | Change |  |   | %    |   |  | 2005 |    |  | 2004 |     |   | Change |   |     | % | 
|Operating Income / (Loss) |  | $                         | 597 |   |                         | $ | 979 |        |  | $ | (382 | ) |  | (39  | )% |  | $    | 574 |   |        | $ | 683 |   |  | $ | (109 | ) |  | (16 | )%
|Operating Margin          |  |                           | 10  | % |                         |   | 19  | %      |  |   |      |   |  |      |    |  |      | 5   | % |        |   | 7   | % |  |   |      |   |  |     |   



Income from operations
decreased 39% to $597,000 in the quarter ended December 31, 2005 from $979,000 in the quarter ended December 31, 2004. Total income for the six months ended December 31, 2005 decreased 16% to $574,000, from $683,000 in the same period
last year. The operating margin was 10% in the quarter ended December 31, 2005 period compared to 19% in the quarter ended December 31, 2004. For the six months ended December 31, 2005, the operating margin was 5% compared to 7% for
the six months ended December 31, 2005. Income from operations included a restructuring benefit of $958,000 that was recorded in quarter ended December 31, 2004. This restructuring benefit positively impacted the operating margins for the
three and six months ended December 31, 2004 by 19% and 7% respectively.



Interest Expense and Other Income / (Expenses)



Interest expense increased 10% to $259,000 in the quarter ended December 31, 2005 from $236,000 in the quarter ended December 31, 2004. For the six months ended December 31, 2005, interest expense increased 10% to $514,000
from $467,000 in the same period last year. The increase was primarily due to the increase in interest on borrowings from related party notes payable.



Other expense was $93,000 in the quarter ended December 31, 2005 compared to $11,000 in the quarter ended December 31, 2004. For the six months
ended December 31, 2005, other expense increased to $112,000 from $56,000 in the same period last year. The increase was primarily due to state franchise tax and foreign tax expenses.



Liquidity and Capital Resources



As of December 31, 2005, cash and cash equivalents totaled $4.9
million, an increase of $358,000 from June 30, 2005. The increase was primarily due to the net cash provided by operating activities offset in part by net cash used in investing activities. We believe that existing capital resources will enable
us to maintain current and planned operations for at least the next 12 months. From time to time, however, we may consider opportunities for raising additional capital and/or exchanging all or a portion of our existing debt for equity. We can make
no assurances that such opportunities will be available to us on economic terms we consider favorable if at all.



On October 29, 2004, we entered into a loan and security agreement (the Credit Facility) with Silicon Valley Bank (SVB) which
replaced the existing accounts receivable purchase agreement. The Credit Facility provided for the advance of up to the lesser of $1.5 million or 80% of certain qualified receivables. The Credit Facility bears interest at a rate of prime plus
2.5% per annum, provided that if we maintain an adjusted quick ratio of greater than 2 : 1, then the rate shall be reduced to a rate of prime plus 1.75%. In addition, the Credit Facility carries a $750 per month collateral monitoring fee. We
are in compliance with the financial covenants under this agreement that require us to meet certain rolling three-month operating losses during the term of the Credit Facility. On December 28, 2004, we entered into an amendment to the Credit
Facility that revised the terms to allow for the advance of up to the lesser of $1.5 million or the sum of 80% of certain qualified receivables and 50% of our unrestricted cash on deposit with SVB less the total outstanding obligations to SVB and
any outstanding letters of credit. As of December 31, 2005, the interest rate was 9.75%, and the outstanding balance under the Credit Facility was $1.5 million. On March 29, 2005, we entered into a further amendment to the Credit Facility
that revised the terms to allow for the advance of up to an additional $750,000 to be used to finance equipment purchases (the Equipment



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##### Table of Contents

Line). Interest accrues from the date of each advance, under the Equipment Line, at a rate of prime plus
3% per annum. Each advance under the Equipment Line must be repaid in 24 equal monthly payments of principal and interest, commencing on the first day of the first month following the date the advance is made, and continuing on the first day of
each succeeding month. As of December 31, 2005, the interest rate was 10.25% and the outstanding balance under the Equipment Line was approximately $236,000 (see Note 12  Subsequent Events). On January 27, 2006 we entered into an
extension of our Credit Facility with Silicon Valley Bank. The amendment extended the termination date to July 28, 2006 and the advance level under the Equipment Line was reduced to $124,000. All other terms and conditions remained the same as
outlined in Note 8. Bank Borrowings.



On March 31, 2004,
we entered into a note and warrant purchase agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P. (the lenders) pursuant to which the
lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common stock in connection with such loans. The secured promissory notes have a term of five years and bear interest at an
effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time subject to the prepayment penalties set forth in such notes. The warrants allow the lenders to purchase up to 312,500
shares at an exercise price of $2.00. The principal and interest due on the loans as of December 31, 2005 was $2.9 million. As of December 31, 2005, warrants to purchase 312,500 shares of common stock were vested and outstanding.



On December 24, 2002, we entered into a note and warrant
purchase agreement with Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy made loans to us evidenced by subordinated secured promissory notes and received warrants to purchase shares of our common stock in connection with
each of such loans. The five-year subordinated secured promissory note bears interest at an effective annual rate of 12% due and payable upon the term of such note. We have the option to prepay each note at any time subject to the prepayment
penalties set forth in such note. On December 31, 2002, Mr. Roy loaned to us $2.0 million under the agreement and received warrants that allow him to purchase up to 236,742 shares at an exercise price equal to $2.11 per share. On October,
31, 2003, we entered into an amendment to the 2002 note and warrant purchase agreement with Mr. Roy, pursuant to which he loaned to us an additional $2.0 million and received additional warrants to purchase up to 128,766 shares at $3.88 per
share. The principal and interest due on the loans as of December 31, 2005 was $5.2 million. As of December 31, 2005, warrants to purchase 365,509 shares of common stock were vested and outstanding.



On August 8, 2000, we raised and received net proceeds of $82.6 million
through the issuance of shares of convertible preferred stock and warrants to purchase approximately 383,000 shares of common stock in a private placement. The convertible preferred stock liquidation value accreted at a rate of 6.75% per annum.
All preferred shares and accreted dividends totaling $112.5 million converted to common stock on December 23, 2004. The cumulative accretion through December 23, 2004 totaled $29.9 million.



Cash Flows



Net cash provided by operating activities was $668,000 for the six months ended December 31, 2005 and consisted primarily of
net loss offset by non-cash expenses related to depreciation, stock-based compensation and accrued interest, partially offset by the net change in operating assets and liabilities. The net change in operating assets and liabilities primarily
consisted of an increase in accounts receivable partially offset by an increase in deferred revenue and accrued liabilities. Days sales outstanding for the quarter ended December 31, 2005 was 75 days compared to 69 days for the quarter ended
September 30, 2005 and 55 days for the quarter ended December 31, 2004. 75 days is at the higher end of our targeted range of 65 to 75 days for days sales outstanding and we are focusing our collection efforts to decrease this number by the end of
the third fiscal quarter of 2006. Net cash provided by operating activities was $469,000 for the six months ended December 31, 2004 and consisted primarily of net income offset by non-cash expenses related to depreciation and accrued interest,
partially offset by the net change in operating assets and liabilities. The net change in operating assets and liabilities primarily consisted of a decrease in restructuring accrual and an increase in accounts receivable partially offset by an
increase in deferred revenue, a decrease in prepaid and other assets and an increase in accrued compensation.



Continuing to operate a cash-positive business depends on our ability to achieve positive earnings and maintain or increase the level of our software
license revenues, and continuing to effectively manage working capital including collecting outstanding receivables within our standard payment terms. In addition, our ability to generate future cash flows from operations could be negatively
impacted by a decrease in demand for our products, which are subject to rapid technological change, or a reduction of capital expenditures by our customers as a result of a downturn in the global economy, among other factors.



Net cash used in investing activities was $268,000 for the six months ended
December 31, 2005 compared to $239,000 for the six months ended December 31, 2004. Cash used in investing activities were primarily due to the purchases of equipment.



Net cash provided by financing activities was $81,000 for the six months ended December 31, 2005 compared to $236,000
for the six months ended December 31, 2004. Cash provided from financing activities was primarily due to the proceeds from the bank borrowings and the issuance of common stock, partially offset by the payments on bank borrowings.



Commitments



The following table summarizes eGains contractual obligations, excluding interest payments, as of December 31,
2005 and the effect such obligations are expected to have on its liquidity and cash flow in future periods (in thousands):



|                           |  |                     |       |      |   |      |  |      |       |      |   |            |  |       |     |  |   |     |  |   |       
|-------------------------- |  | ------------------- | ----- | ---- | - | ---- |  | ---- | ----- | ---- | - | ---------- |  | ----- | --- |  | - | --- |  | - | ------
|                           |  | Year Ended June 30, |       |      |   |     
|                           |  | 2006                |       | 2007 |   | 2008 |  | 2009 |       | 2010 |   | Thereafter |  | Total
|Operating leases           |  | $                   | 268   |      | $ | 566  |  | $    | 566   |      | $ | 549        |  | $     | 171 |  | $ | 171 |  | $ | 2,291 
|Bank borrowings            |  |                     | 1,575 |      |   | 135  |  |      | 25    |      |   |           |  |       |    |  |   |    |  |   | 1,735 
|Related Party Note Payable |  |                     |      |      |   |     |  |      | 2,810 |      |   | 5,611      |  |       |    |  |   |    |  |   | 8,421 
|                           |  |                     |       |      |   |      |  |      |       |      |   |            |  |       |     |  |   |     |  |   |       
|Total                      |  | $                   | 1,843 |      | $ | 701  |  | $    | 3,401 |      | $ | 6,160      |  | $     | 171 |  | $ | 171 |  | $ | 12,447
|                           |  |                     |       |      |   |      |  |      |       |      |   |            |  |       |     |  |   |     |  |   |       



The bank borrowings
obligation due in fiscal 2006 is for our Credit Facility with Silicon Valley Bank. On January 27, 2006 we entered into an amendment to the Credit Facility that extended the termination date to July 28, 2006 . See Note 12. Subsequent Events.



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##### Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk



We develop products in the United States and India and sell these products internationally. Generally, sales are made in local currency. As a result, our
financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. To date, the effect of changes in foreign currency exchange rates on revenues and operating expenses
has not been material. We do not currently use derivative instruments to hedge against foreign exchange risk.



Item 4. Controls and Procedures



(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange
Act), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the
objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible
disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions.



Based
on their evaluation as of December 31, 2005, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material
information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.



(b) Changes in internal controls. There were no significant
changes in our internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material
weaknesses.



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##### Table of Contents

PART II. OTHER INFORMATION



Item 1. Legal Proceedings



Beginning on October 25, 2001, a number of securities class action complaints were filed against us, and certain of our then officers and directors and underwriters connected with our initial public offering of common stock in the U.S.
District Court for the Southern District of New York (consolidated into In re Initial Public Offering Sec. Litig.). The complaints alleged generally that the prospectus under which such securities were sold contained false and misleading
statements with respect to discounts and excess commissions received by the underwriters as well as allegations of laddering whereby underwriters required their customers to purchase additional shares in the aftermarket in exchange for
an allocation of IPO shares. The complaints sought an unspecified amount in damages on behalf of persons who purchased the common stock between September 23, 1999 and December 6, 2000. Similar complaints were filed against 55 underwriters
and more than 300 other companies and other individuals. The over 1,000 complaints were consolidated into a single action. We reached an agreement with the plaintiffs to resolve the cases as to our liability and that of our officers and directors.
The settlement involved no monetary payment or other consideration by us or our officers and directors and no admission of liability. On August 31, 2005, the court issued an order preliminarily approving the settlement and setting a public
hearing on its fairness for April 24, 2006 (the postponement from January 2006 to April 2006 was because of difficulties in mailing the required notice to class members). On October 27, 2005, the court issued an order making some
minor changes to the form of notice to be sent to class members.



On February 12, 2004, we filed suit against Insight Enterprises, Inc., the acquirer of Comark, Inc., a value-added reseller of our software, claiming inter alia breach of contract and failure to pay in connection with a sale of
our software to one customer in the Superior Court of the State of California, Santa Clara County. The lawsuit seeks in excess of $600,000 in damages.



With the exception of these matters, we are not a party to any other material pending legal proceedings, nor is our property the subject of any material
pending legal proceeding, except routine legal proceedings arising in the ordinary course of our business and incidental to our business, none of which are expected to have a material adverse impact, as taken individually or in the aggregate, upon
our business, financial position or results of operations. However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert managements attention and impact other resources.



Item 1A. Risk Factors



We have a history
of losses and may not be able to continue to be profitable in the future



We earned a net profit of $245,000 for the quarter ended December 31, 2005 but for the six months ended December 31, 2005 we incurred a net loss of $52,000. As of December 31, 2005, we had an
accumulated deficit of approximately $316.4 million. We do not know if we will continue to be profitable in the foreseeable future. However, we must continue to spend resources on maintaining and strengthening our business, and this may, in the near
term, have a continued negative effect on our operating results and our financial condition. If we incur net losses in future periods, we may not be able to retain employees, or fund investments in capital equipment, sales and marketing programs,
and research and development to successfully compete against our competitors. We also expect to continue to spend financial and other resources on developing and introducing product and service offerings. Accordingly, if our revenue declines despite
such investments, our business and operating results could suffer. This may also, in turn, cause the price of our common stock to demonstrate volatility and/or continue to decline.



If we fail to expand and improve our sales and marketing activities, we may be unable to grow our business, negatively impacting our
operating results and financial condition



Expansion and
growth of our business is dependent on our ability to develop a productive international sales force. Moreover, many of our competitors have sizeable sales-forces and greater resources to devote to sales and marketing, which results in their
enhanced ability to develop and maintain customer relationships. Thus, failure to develop our sales force and/or failure of our sales and marketing investments to translate into increased sales volume and enhanced customer relationships may hamper
our efforts to achieve profitability. This may impede our efforts to ameliorate operations in other areas of the company and may result in further decline of our common stock price.



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Due to the complexity of our eService platform and related products and services, we must utilize highly
trained sales personnel to educate prospective customers regarding the use and benefits of our products and services as well as provide effective customer support. Because, in the past, we have experienced turnover in our sales force and have fewer
resources than many of our competitors, our sales and marketing organization may not be able to successfully compete with those of our competitors.



We must compete successfully in our market segment



The market for customer service and contact center software is intensely competitive. Other than product development and existing customer relationships,
there are no substantial barriers to entry in this market, and established or new entities may enter this market in the near future. While home-grown software developed by enterprises represents indirect competition, we also compete directly with
packaged application software vendors in the customer service arena, including Art Technology Group, Inc., Avaya, Inc., Genesys Telecommunications (a wholly-owned subsidiary of Alcatel), Kana Software, Inc., RightNow Technologies, Inc., Knova
Software, Inc., and Talisma Corp. In addition, we face actual or potential competition from larger software companies such as Microsoft Corporation, Oracle Corporation, SAP, Inc. and similar companies who may attempt to sell customer service
software to their installed base.



We believe competition will
continue to be fierce and increase as current competitors enhance the sophistication of their offerings and as new participants enter the market. Many of our current and potential competitors have longer operating histories, larger customer bases,
broader brand recognition, and significantly greater financial, marketing and other resources. More established and better-financed, these companies may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies,
and make more attractive offers to businesses to induce them to use their products or services.



Further, any delays in the roll out or general market acceptance of our applications would likely harm our competitive position by allowing our
competitors additional time to improve their product and service offerings, and also provide time for new competitors to develop applications and solicit prospective customers within our target markets. Increased competition could result in pricing
pressures, reduced operating margins and loss of market share.



Our lengthy
sales cycles and the difficulty in predicting timing of sales or delays may impair our operating results



The long sales cycle for our products may cause license revenue and operating results to vary significantly from period to period. The sales cycle for our
products can be six months or more and varies substantially from customer to customer. Because we sell complex and deeply integrated solutions, it can take many months of customer education to secure sales. While our potential customers are
evaluating our products before, if ever, executing definitive agreements, we may incur substantial expenses and spend significant management effort in connection with the potential customer. Our multi-product offering and the increasingly complex
needs of our customers contribute to a longer and unpredictable sales cycle. Consequently, we often face difficulty predicting the quarter in which expected sales will actually occur. This contributes to the uncertainty and fluctuations in our
future operating results. In particular, since the economic slowdown that began in 2000, corporate spending levels have decreased and the decision-making and approval process has become more complicated. This has caused our average sales cycle to
further increase and, in some cases, has prevented deals from closing that we believed were likely to close. Consequently, we may miss our revenue forecasts and may incur expenses that are not offset by corresponding revenue.



Our failure to expand strategic and third-party distribution channels would impede our
revenue growth



To grow our revenue base, we need to
increase the number of our distribution partners, including software vendors and resellers. Our existing or future distribution partners may choose to devote greater resources to marketing and supporting the products of our competitors that could
also harm our financial condition or results of operations. Our failure to expand third-party distribution channels would impede our future revenue growth. Similarly, to increase our revenue and implementation capabilities, we must continue to
develop and expand relationships with systems integrators. We sometimes rely on systems integrators to recommend our products to their customers and to install and support our products for their customers. We likewise depend on broad market
acceptance by these systems integrators of our product and service offerings. Our agreements generally do not



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prohibit competitive offerings and systems integrators may develop, market or recommend software applications that
compete with our products. Moreover, if these firms fail to implement our products successfully for their customers, we may not have the resources to implement our products on the schedule required by their customers. To the extent we devote
resources to these relationships and the partnerships do not proceed as anticipated or provide revenue or other results as anticipated our business may be harmed. Once partnerships are forged, there can be no guarantee that such relationships will
be renewed in the future or available on acceptable terms. If we lose strategic third party relationships, fail to renew or develop new relationships, or fail to fully exploit revenue opportunities within such relationships, our results of
operations and future growth may suffer.



Due to our limited operating
history and the emerging market for our products and services, revenue and operating expenses are unpredictable and may fluctuate, which may harm our operating results and financial condition



Due to the emerging nature of the multichannel contact center market and
other similar factors, our revenue and operating results may fluctuate from quarter to quarter. Our revenues in certain past quarters fell and could continue to fall short of expectations if we experience delays or cancellations of even a small
number of orders. It is possible that our operating results in some quarters will be below the expectations of financial analysts or investors. In this event, the market price of our common stock is also likely to decline.



A number of factors are likely to cause fluctuations in our operating
results, including, but not limited to, the following:



| |  |  | demand for our software and budget and spending decisions by information technology departments of our customers;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | seasonal trends in technology purchases;
| | - |  | ----------------------------------------



| |  |  | our ability to attract and retain customers;
| | - |  | --------------------------------------------



| |  |  | litigation relating to our intellectual proprietary rights.
| | - |  | -----------------------------------------------------------



In addition, we base our expense levels in part on expectations regarding future revenue levels. In the short term, expenses, such as employee
compensation and rent, are relatively fixed. If revenue for a particular quarter is below expectations, we may be unable to reduce our operating expenses proportionately for that quarter. Accordingly, such a revenue shortfall would have a
disproportionate effect on expected operating results for that quarter. Moreover, we believe that any further significant reductions in expenses would be difficult to achieve given current operating levels. For this reason, period-to-period
comparisons of our operating results may also not be a good indication of our future performance.



We may need additional capital, and raising such additional capital may be difficult or impossible and will likely significantly dilute existing stockholders



We believe that existing capital resources will enable us to maintain
current and planned operations for the next 12 months. However, our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular, that revenues maintain at the levels
achieved in fiscal year 2005 and that customers continue to pay on a timely basis, and we may need to secure additional financing due to unforeseen or unanticipated market conditions. Such financing may be difficult to obtain on terms acceptable to
us and will almost certainly dilute existing stockholder value.



Uncertainty
about the impact of SFAS 123R could adversely affect us



Effective in the first quarter of fiscal year 2006, we adopted SFAS 123R, which significantly changes the way in which we account for equity-based compensation. SFAS 123R is relatively new and to date has not yet been adopted by many
companies. As a result, it may be difficult for analysts and others reviewing our financial statements to compare our financial statements to our prior period statements and to those of other companies that have not adopted SFAS 123R. Our stock
price could be adversely affected if, as a result of adoption SFAS 123R, our financial performance compares unfavorably to other similarly situated companies.



SFAS 123R is a new and very complex accounting standard the application of which requires significant judgment and the use of estimates, particularly
surrounding stock price volatility, option forfeiture rates and expected option lives, to build a model for valuing equity-based compensation. There is a risk that, as we and others gain experience with SFAS 123R or as a result of subsequent
accounting guidelines, we could determine that the assumptions or model we used requires modification. Any such modification could result in different charges in future periods and, potentially, could require us to correct the charges taken in prior
periods.



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Finally, in connection with the adoption of SFAS 123R, we are reviewing our overall equity compensation
strategy, and may issue fewer stock options to our employees than we have in the past. These changes in approaches to employee compensation could adversely affect our ability to attract and retain the highly qualified personnel we need to succeed.



Our common stock has been delisted and thus the price and liquidity of our
common stock has been affected and our ability to obtain future equity financing may be further impaired



In February 2004, we were delisted from the Nasdaq SmallCap Market due to noncompliance with Marketplace Rule 4310(c)(2)(B), which requires companies
listed to have a minimum of $2,500,000 in stockholders equity or $35,000,000 market value of listed securities or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently
completed fiscal years.



Our common stock now trades in the
over-the-counter market on the OTC Bulletin Board owned by the Nasdaq Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq National Market or the Nasdaq SmallCap Market. The OTC Bulletin
Board is generally considered less efficient than the Nasdaq SmallCap Market. Consequently, selling our common stock is likely more difficult because of diminished liquidity in smaller quantities of shares likely being bought and sold, transactions
could be delayed, and securities analysts and news media coverage of us may be further reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of common stock.



Our listing on the OTC Bulletin Board, or further declines in our stock
price, may greatly impair our ability to raise additional necessary capital through equity or debt financing, and significantly increase the dilution to our current stockholders caused by any issuance of equity in financing or other transactions.
The price at which we would issue shares in such transactions is generally based on the market price of our common stock and a decline in the stock price could result in our need to issue a greater number of shares to raise a given amount of
funding.



In addition, as our common stock is not listed on a
principal national exchange, we are subject to Rule 15g-9 under the Securities and Exchange Act of 1934, as amended. That rule imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than
established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchasers written consent to the
transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common stock in the secondary market. Moreover, investors may be less
interested in purchasing low-priced securities because the brokerage commissions, as a percentage of the total transaction value, tend to be higher for such securities, and some investment funds will not invest in low-priced securities (other than
those which focus on small-capitalization companies or low-priced securities).



We depend on broad market acceptance of our applications and of our business model



We depend on the widespread acceptance and use of our applications as an effective solution for businesses seeking to manage high volumes of customer
interactions across multiple channels, including web, phone, email, print and in-person. While we believe the potential to be very large, we cannot accurately estimate the size or growth rate of the potential market for such product and service
offerings generally, and we do not know whether our products and services in particular will achieve broad market acceptance. The market for eService software is relatively new and rapidly evolving, and concerns over the security and reliability of
online transactions, the privacy of users and quality of service or other issues may inhibit the growth of the Internet and commercial online services. If the market for our applications fails to grow or grows more slowly than we currently
anticipate, our business will be seriously harmed.



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Furthermore, our business model is premised on business assumptions that are still evolving.
Historically, customer service has been conducted primarily in person or over the telephone. Our business model assumes that both customers and companies will increasingly elect to communicate via multiple channels, as well as demanding integration
of the online channels into the traditional telephone-based call center. Our business model also assumes that many companies recognize the benefits of a hosted delivery model and will seek to have their eService applications hosted by us. If any of
these assumptions is incorrect, our business will be seriously harmed and our stock price will decline.



We may experience a further decrease in market demand due to the slowed economy, which has also been further stymied by the concerns of terrorism, war, and social and political instability in the regions in which
we do business



Spending on technology solutions by
corporations and government enterprises has been markedly slow to rebound. In addition, the terrorist attacks in the United States and Europe and turmoil and war in the Middle East, Asia and elsewhere has increased the uncertainty in the United
States, the European Union and Asian economies and may further add to the prolonged decline in the United States business environment. The war on terrorism, along with the effects of a terrorist attack and other similar events, the war in Iraq,
military activities in Afghanistan, and hostilities between India and Pakistan, could contribute further to the slowdown of the already slumping market demand for goods and services, including digital communications software and services. If the
economy continues to decline as a result of the recent economic, political and social turmoil, or if there are further terrorist attacks in the United States and Europe, or as a result of the war in the Middle East and Asia, particularly India, we
may experience further decreases in the demand for our products and services, which may harm our operating results.



We may not be able to respond to the rapid technological change of the customer service and contact center industry



The eService industry is characterized by rapid technological change,
changes in customer requirements and preferences, and the emergence of new industry standards and practices that could render our existing services, proprietary technology and systems obsolete. We must continually develop or introduce and improve
the performance, features and reliability of our products and services, particularly in response to competitive offerings. Our success depends, in part, on our ability to enhance our existing services and to develop new services, functionality and
technology that address the increasingly sophisticated and varied needs of prospective customers. If we do not properly identify the feature preferences of prospective customers, or if we fail to deliver product features that meet the standards of
these customers, our ability to market our service and compete successfully and to increase revenues could be impaired. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and
requires substantial expenditures and lead-time. We may not be able to keep pace with the latest technological developments. We may also be unable to use new technologies effectively or adapt services to customer requirements or emerging industry
standards or regulatory or legal requirements. More generally, if we cannot adapt or respond in a cost-effective and timely manner to changing industry standards, market conditions or customer requirements, our business and operating results will
suffer.



Our international operations involve various risks



We derived 48% of our revenues from international sales for the quarter
ended December 31, 2005 compared to 47% for the quarter ended December 31, 2004. Including those discussed above, our international sales operations are subject to a number of specific risks, such as:



| |  |  | foreign currency fluctuations and imposition of exchange controls;
| | - |  | ------------------------------------------------------------------



| |  |  | expenses associated with complying with differing technology standards and language translation issues;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | difficulty and costs in staffing and managing our international operations;
| | - |  | ---------------------------------------------------------------------------



| |  |  | difficulties in collecting accounts receivable and longer collection periods;
| | - |  | -----------------------------------------------------------------------------



| |  |  | various trade restrictions and tax consequences; and
| | - |  | ----------------------------------------------------



| |  |  | reduced intellectual property protections in some countries.
| | - |  | ------------------------------------------------------------



More than 50% of our workforce is employed through eGain India, and located in India. Of these employees more than 50% are allocated to research and
development. Although the movement of certain operations internationally was principally motivated by cost cutting, the continued management of these remote operations will



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require significant management attention and financial resources that could adversely affect our operating performance.
In addition, with the significant increase in the numbers of foreign businesses that have established operations in India, the competition to attract and retain employees there has increased significantly. As a result of the increased competition
for skilled workers, we experienced increased compensation costs and expect these costs to increase in the future. Our reliance on our workforce in India makes us particularly susceptible to disruptions in the business environment in that region. In
particular, sophisticated telecommunications links, high speed data communications with other eGain offices and customers, and overall consistency and stability of our business infrastructure are vital to our day to day operations, and any
impairment of such infrastructure will cause our financial condition and results to suffer. The maintenance of stable political relations between the United States, European Union and India are also of great importance to our operations.



Any of these risks could have a significant impact on our product
development, customer support or professional services. To the extent the benefit of maintaining these operations abroad does not exceed the expense of establishing and maintaining such activities, our operating results and financial condition will
suffer.



Difficulties in implementing our products could harm our revenues
and margins



We generally recognize revenue from a
customer sale when persuasive evidence of an arrangement exists, the product has been delivered, the arrangement does not involve significant customization of the software, the license fee is fixed or determinable and collection of the fee is
probable. If an arrangement requires significant customization or implementation services from us, recognition of the associated license and service revenue could be delayed. The timing of the commencement and completion of the these services is
subject to factors that may be beyond our control, as this process requires access to the customers facilities and coordination with the customers personnel after delivery of the software. In addition, customers could delay product
implementations. Implementation typically involves working with sophisticated software, computing and communications systems. If we experience difficulties with implementation or do not meet project milestones in a timely manner, we could be
obligated to devote more customer support, engineering and other resources to a particular project. Some customers may also require us to develop customized features or capabilities. If new or existing customers have difficulty deploying our
products or require significant amounts of our professional services, support, or customized features, revenue recognition could be further delayed or canceled and our costs could increase, causing increased variability in our operating results.



Our reserves may be insufficient to cover receivables we are unable to
collect



We assume a certain level of credit risk with our
customers in order to do business. Conditions affecting any of our customers could cause them to become unable or unwilling to pay us in a timely manner, or at all, for products or services we have already provided them. In the past, we have
experienced collection delays from certain customers, and we cannot predict whether we will continue to experience similar or more severe delays in the future. Although we have established reserves to cover losses due to delays or inability to pay,
there can be no assurance that such reserves will be sufficient to cover our losses. If losses due to delays or inability to pay are greater than our reserves, it could harm our business, operating results and financial condition.



Litigation and infringement claims could be costly to defend and distract our management
team



We may be involved in legal proceedings and claims
from time to time in the ordinary course of our business, including claims of alleged infringement of the intellectual property or proprietary rights of third parties, employment claims and other commercial contract disputes. Third parties may also
infringe or misappropriate our copyrights, trademarks and other proprietary rights for which we may be required to file suit to protect or mediate our rights. In the past we have had lawsuits brought or threatened against us in a variety of contexts
including but not limited to claims related to issues associated with our initial public offering of common stock, breach of contract and litigation associated with the termination of employees.



From time to time, parties have also asserted or threatened infringement
claims, and may continue to do so. Because the contents of patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products. In particular,
intellectual property litigation is expensive and time-consuming and could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on
acceptable terms, if at all, in the event of a successful claim of infringement. Our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.



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Where appropriate, we intend to vigorously defend all claims. However, any actual or threatened claims,
even if not meritorious or material, could result in the expenditure of significant financial and managerial resources. The continued defense of these claims and other types of lawsuits could divert managements attention away from running our
business. Negative developments in lawsuits could cause our stock price to decline as well. In addition, required amounts to be paid in settlement of any claims, and the legal fees and other costs associated with such settlement cannot be estimated
and could, individually or in the aggregate, materially harm our financial condition.



We rely on trademark, copyright, trade secret laws, contractual restrictions and patent rights to protect our intellectual property and proprietary rights and if these rights are impaired our ability to generate revenue will be harmed



We regard our patents, copyrights, service marks,
trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers and partners to
protect our proprietary rights. We have numerous registered trademarks as well as common law trademark rights in the United States and internationally. In addition, we own several patents in the area of case-based reasoning. We will seek additional
trademark and patent protection in the future. We do not know if our trademark and patent applications will be granted, or whether they will provide the protection eGain desires, or whether they will subsequently be challenged or invalidated. It is
difficult to monitor unauthorized use of technology, particularly in foreign countries, where the laws may not protect our proprietary rights as fully as in the United States. Furthermore, our competitors may independently develop technology similar
to our technology.



Despite our efforts to protect our
proprietary rights through confidentiality and license agreements, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. These precautions may not prevent misappropriation or infringement of our
intellectual property. In addition, we routinely require employees, customers, and potential business partners to enter into confidentiality and nondisclosure agreements before we will disclose any sensitive aspects of our products, technology, or
business plans. In addition, we require employees to agree to surrender any proprietary information, inventions or other intellectual property they generate or come to possess while employed by us. In addition, some of our license agreements with
certain customers and partners require us to place the source code for our products into escrow. These agreements typically provide that some party will have a limited, non-exclusive right to access and use this code as authorized by the license
agreement if there is a bankruptcy proceeding instituted by or against us, or if we materially breach a contractual commitment to provide support and maintenance to the party.



Unknown software defects could disrupt our products and services and problems arising from our vendors products or services could
disrupt operations, which could harm our business and reputation



Our product and service offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects or errors in translation or integration, particularly when first introduced or
when new versions are released or localized for international markets. We may not discover software defects that affect our new or current services or enhancements until after they are deployed. It is possible that, despite testing by us, defects
may occur in the software and we can give no assurance that our products and services will not experience such defects in the future. Furthermore, our customers generally use our products together with products from other companies. As a result,
when problems occur in the integration or network, it may be difficult to identify the source of the problem. Even when our products do not cause these problems, these problems may cause us to incur significant warranty and repair costs, divert the
attention of our engineering personnel from product development efforts and cause significant customer relations problems. These defects or problems could result in damage to our reputation, lost sales, product liability claims, delays in or loss of
market acceptance of our products, product returns and unexpected expenses, and diversion of resources to remedy errors.



We may need to license third-party technologies and may be unable to do so



To the extent we need to license third-party technologies, we may be unable to do so on commercially reasonable terms or at
all. In addition, we may fail to successfully integrate any licensed technology into our products or services. Third-party licenses may expose us to increased risks, including risks associated with the



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integration of new technology, the diversion of resources from the development of our own proprietary technology, and our
inability to generate revenue from new technology sufficient to offset associated acquisition and maintenance costs. Our inability to obtain and successfully integrate any of these licenses could delay product and service development until
equivalent technology can be identified, licensed and integrated. This in turn would harm our business and operating results.



Our stock price has demonstrated volatility and overall declines since being listed on the public market and continued market conditions may cause further declines or
fluctuations



The price at which our common stock trades
has been and will likely continue to be highly volatile and show wide fluctuations and substantial declines due to factors such as the following:



| |  |  | the thinly traded nature of our stock on the OTC Bulletin Board;
| | - |  | ----------------------------------------------------------------



| |  |  | concerns related to liquidity of our stock, financial condition or cash balances;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | actual or anticipated fluctuations in our operating results, our ability to meet announced or anticipated profitability goals and changes in or failure to meet securities
analysts expectations;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | announcements of technological innovations and/or the introduction of new services by us or our competitors;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | developments with respect to intellectual property rights and litigation, regulatory scrutiny and new legislation;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | conditions and trends in the Internet and other technology industries; and
| | - |  | --------------------------------------------------------------------------



| |  |  | general market and economic conditions.
| | - |  | ---------------------------------------



Furthermore, the stock market has in the past experienced significant price and volume fluctuations that have affected the market prices for the common
stock of technology companies, particularly Internet companies, regardless of the specific operating performance of the affected company. These broad market fluctuations may cause the market price of our common stock to increase and decline.



In addition, in past periods of volatility in the market price
of a particular companys securities, securities class action litigation has been brought against that company following such declines. To the extent our stock price precipitously drops in the future, we may become involved in this type of
litigation. Litigation of this kind, or involving intellectual property rights, is often expensive and diverts managements attention and resources, which could continue to harm our business and operating results.



Ability to hire and retain key personnel



Our success will also depend in large part on the skills, experience and
performance of our senior management, engineering, sales, marketing and other key personnel. The loss of the services of any of our senior management or other key personnel, including our Chief Executive Officer and co-founder, Ashutosh Roy, could
harm our business.



Increased levels of attrition in the Indian
workforce on which we deeply rely for research and development and where we have moved significant resources in recent years would have significant effects on the company and its results of operations.



Unplanned system interruptions and capacity constraints and failure to effect efficient
transmission of data of customer communications and data over the Internet could harm our business and reputation



Our customers have in the past experienced some interruptions with the eGain-hosted operations. We believe that these interruptions will continue to occur
from time to time. These interruptions could be due to hardware and operating system failures. As a result, our business will suffer if we experience frequent or long system interruptions that result in the unavailability or reduced performance of
our hosted operations or reduce our ability to provide remote management services. We expect to experience occasional temporary capacity constraints due to sharply increased traffic or other Internet wide disruptions, which may cause unanticipated
system disruptions, slower response times, impaired quality, and degradation in levels of customer service. If this were to continue to happen, our business and reputation could be seriously harmed.



The growth in the use of the Internet has caused interruptions and delays in
accessing the Internet and transmitting data over the Internet. Interruptions also occur due to systems burdens brought on by unsolicited bulk email or Spam, malicious service attacks and hacking into operating systems, viruses, worms
and Trojan horses, the proliferation of which may be beyond our control and may seriously impact ours and our customers businesses.



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Because we provide Internet-based eService software, interruptions or delays in Internet transmissions
will harm our customers ability to receive and respond to online interactions. Therefore, our market depends on ongoing improvements being made to the entire Internet infrastructure to alleviate overloading and congestion.



Our success largely depends on the efficient and uninterrupted operation of
our computer and communications hardware and network systems. Most of our computer and communications systems are located in Mountain View, California. Due to our locations, our systems and operations are vulnerable to damage or interruption from
fire, earthquake, power loss, telecommunications failure and similar events.



We have entered into service agreements with some of our customers that require minimum performance standards, including standards regarding the availability and response time of our remote management services. If we
fail to meet these standards, our customers could terminate their relationships with us, and we could be subject to contractual refunds and service credits to customers. Any unplanned interruption of services may harm our ability to attract and
retain customers.



We may be liable for activities of customers or others
using our hosted operations



As a provider of customer
service and contact center software for the Internet, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the actions of our customers, and their customers, or others using
our solutions or communicating through our networks. This liability could result from the nature and content of the communications transmitted by customers through the hosted operations. We do not and cannot screen all of the communications
generated by our customers, and we could be exposed to liability with respect to this content. Furthermore, some foreign governments, including Germany and China, have enforced laws and regulations related to content distributed over the Internet
that are more strict than those currently in place in the United States. In some instances criminal liability may arise in connection with the content of Internet transmissions.



Although we carry general liability and umbrella liability insurance, our insurance may not cover claims of these types or
may not be adequate to indemnify us for all liability that may be imposed. There is a risk that a single claim or multiple claims, if successfully asserted against us, could exceed the total of our coverage limits. There also is a risk that a single
claim or multiple claims asserted against us may not qualify for coverage under our insurance policies as a result of coverage exclusions that are contained within these policies. Should either of these risks occur, capital contributed by our
stockholders might need to be used to settle claims. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of our insurance coverage could harm our reputation and business and operating results, or
could result in the imposition of criminal penalties.



If our system
security is breached, our business and reputation could suffer and we may face liability associated with disclosure of sensitive customer information



A fundamental requirement for online communications and transactions is the secure transmission of confidential information over public networks. Third
parties may attempt to breach our security or that of our customers. We may be liable to our customers for any breach in our security and any breach could harm our business and reputation. Although we have implemented network security measures, our
servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays, or loss of data. We may be required to expend significant capital and other resources to license
encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach. Since our applications frequently manage sensitive and personally identifiable customer information, and we may
also be subject to claims associated with invasion of privacy or inappropriate disclosure, use or loss of this information and fraud and identity theft crimes associated with such use or loss. Any imposition of liability, particularly liability that
is not covered by insurance or is in excess of insurance coverage, could harm our reputation and our business and operating results.



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The regulatory environment for and certain legal uncertainties in the operation of our business and our
customers business could impair our growth or decrease demand for our services or increase our cost of doing business



Few laws currently apply directly to activity on the Internet and related services for businesses operating commercial online service. However new laws
are frequently proposed and other laws made applicable to Internet communications every year both in the U.S. and internationally. In particular, in the operation of our business we face risks associated with privacy, confidentiality of user data
and communications, consumer protection and pricing, taxation, content, copyright, trade secrets, trademarks, antitrust, defamation and other legal issues. In particular, legal concerns with respect to communication of confidential data have
affected our financial services and health care customers due to newly enacted federal legislation. The growth of the industry and the proliferation of ecommerce services may prompt further legislative attention to our industry and thus invite more
regulatory control of our business. Further, the growth and development of the market for commercial online transactions may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies engaged in
ecommerce. Moreover, the applicability to the Internet of existing laws in various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve.



In addition, the applicability of laws and regulations directly applicable
to the businesses of our customers, particularly customers in the fields of financial services, will continue to affect us. The security of information about our customers end-users continues to be an area where a variety of laws and
regulations with respect to privacy and confidentiality are enacted. As our customers implement the protections and prohibitions with respect to the transmission of end-user data, our customers will look to us to assist them in remaining in
compliance with this evolving area of regulation. In particular the Gramm-Leach-Bliley Act contains restrictions with respect to the use and protection of financial services records for end-users whose information may pass through our system.



The imposition of more stringent protections and/or new
regulations and the application of existing laws to our business could burden our company and those with which we do business. Further, the adoption of additional laws and regulations could limit the growth of our business and that of our business
partners and customers. Any decreased generalized demand for our services, or the loss, decrease in, business by a key partner or customer due to regulation or the expense of compliance with any regulation, could either increase the costs associated
with our business or affect revenue, either of which could harm our financial condition or operating results.



Finally, we face increased regulatory scrutiny and potential criminal liability for our executives associated with various accounting and corporate
governance rules promulgated under the Sarbanes-Oxley Act of 2002. We have reviewed and will continue to monitor all of our accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including
those related to relationships with our independent accountants, enhanced financial disclosures, internal controls, board and board committee practices, corporate responsibility and loan practices, and intend to fully comply with such laws.
Nevertheless, such increased scrutiny and penalties involve risks to both eGain and our executive officers and directors in monitoring and insuring compliance. A failure to properly navigate the legal disclosure environment and implement and enforce
appropriate policies and procedures, if needed, could harm our business and prospects.



We may engage in future acquisitions or investments that could dilute our existing stockholders, cause us to incur significant expenses or harm our business



We may review acquisition or investment prospects that might complement our current business or enhance our technological capabilities.
Integrating any newly acquired businesses or their technologies or products may be expensive and time-consuming. To finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings. Additional funds
may not be available on terms that are favorable to us, if at all, and, in the case of equity financings, may result in dilution to our existing stockholders. We may not be able to operate acquired businesses profitably. If we are unable to
integrate newly acquired entities or technologies effectively, our operating results could suffer. Future acquisitions by us could also result in large and immediate write-offs, incurrence of debt and contingent liabilities, or amortization of
expenses related to goodwill and other intangibles, any of which could harm our operating results.



Material Changes in Risk Factors from our Annual Report on Form 10-K for our Fiscal Year Ended June 30, 2005



Since the filing of our Annual Report on Form 10-K for our fiscal year ended June 30, 2005, we have deleted certain risk factors relating to the effect of our cost
reduction initiatives and restructurings on our employees. Although employee turnover and poor moral could reduce our efficiency and our ability to meet the needs of our customers, we do not believe that the effects of our restructurings continue to
negatively impact our current employees moral. The last of these restructuring occurred more than 2 years ago and we believe our current employees generally have less concerns about planned work force reductions relating to declines in our
operating levels.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



None.



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Item 3. Defaults upon Senior Securities



None.



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



On December 8, 2005 eGains annual meeting of stockholders was held and the following matters were voted on:



1. The following individuals were elected to the board of directors to serve
until the 2006 annual meeting of stockholders and thereafter until their successors are elected and qualified:



|                            |  |                              |  |                                       
|--------------------------- |  | ---------------------------- |  | --------------------------------------
|Nominees                    |  | Total Vote for each Director |  | Total Vote Withheld from each Director
|Mr. Ashutosh Roy            |  | 10,321,346                   |  | 12,749                                
|Mr. Gunjan Sinha            |  | 10,244,983                   |  | 89,112                                
|Mr. Mark A. Wolfson         |  | 10,292,254                   |  | 41,841                                
|Mr. David G. Brown          |  | 10,300,401                   |  | 33,694                                
|Mr. Phiroz P. Darukhanavala |  | 10,236,108                   |  | 97,987                                



2. The proposal to
approve and adopt the eGain Communications Corporation 2005 Stock Incentive Plan:



|          |  |         |  |         |  |          
|--------- |  | ------- |  | ------- |  | ---------
|For       |  | Against |  | Abstain |  | Non Votes
|8,191,679 |  | 67,594  |  | 2,859   |  | 2,071,963



3. The vote to ratify
the appointment of BDO Seidman, LLP as eGains independent auditors was as follows:



|           |  |         |  |         |  |          
|---------- |  | ------- |  | ------- |  | ---------
|For        |  | Against |  | Abstain |  | Non Votes
|10,325,168 |  | 7,958   |  | 969     |  | 0        



Item 5. Other Information



None.



Item 6. Exhibits



|             |  |                                                                                                                                                                  
|------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits No. |  | Description of Exhibits                                                                                                                                          
|31.1         |  | Rule 13a-15(e)/15d-15(e) Certification of Chief Executive Officer.                                                                                               
|             | 
|31.2         |  | Rule 13a-15(e)/15d-15(e) Certification of Chief Financial Officer.                                                                                               
|             | 
|32.1         |  | Certification pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of Ashutosh Roy, Chief Executive Officer.*
|             | 
|32.2         |  | Certification pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of Eric Smit, Chief Financial Officer.*   

---

|* | The material contained in this exhibit is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the
company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after date hereof and irrespective of any general incorporation language contained in such filing.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the
requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                         |  |                                  |  |                                                                                                              
|------------------------ |  | -------------------------------- |  | -------------------------------------------------------------------------------------------------------------
|Dated: February 14, 2006 |  | eGAIN COMMUNICATIONS CORPORATION
|                         |  |                                 
|                         |  | By                               |  | /s/ Eric N. Smit                                                                                             
|                         |  |                                  |  | Eric N. Smit Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)



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