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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q/A

Amendment No. 1



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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 June 30, 2006

OR



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

For the transition period  to

Commission File Number 000-50640



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SUMTOTAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 42-1607228                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

1808 North Shoreline Boulevard

Mountain View, California 94043

(Address of principal executive offices,
including zip code)

(650) 934-9500

(Registrants telephone number, including area code)



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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 file. See definition of
accelerated filer in Rule 12b-2 of the Exchange Act.

 ̈Large accelerated filer    x  Accelerated filer ̈Non-accelerated filer

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

The number of shares outstanding of the issuers
Common Stock, par value $0.001, including shares held in escrow, as of July 31, 2006 was approximately 25,552,690 shares.



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SUMTOTAL SYSTEMS, INC.

FORM 10Q

For the Quarter Ended June 30, 2006

TABLE OF CONTENTS



|                               |  |                         |  |     
|------------------------------ |  | ----------------------- |  | ----
|                               |  |                         |  | Page
|PART I  FINANCIAL INFORMATION |  |                        
|                               |  |                        
|Item 4.                        |  | Controls and Procedures |  | 3   
|                               | 
|PART II 
OTHER INFORMATION    |  |                        
|                               |  |                        
|Item 1A.                       |  | Risk Factors            |  | 7   
|                               |  |                        
|Item 6.                        |  | Exhibits                |  | 17  
|                               | 
|SIGNATURES                     |  | 18                     



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Explanatory Note

The Company is hereby amending its Form 10-Q for the quarter ended June 30, 2006 to revise the disclosure regarding Controls and Procedures in Part I, Item 4 and a related risk factor in Part II, Item 1A.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of June 30, 2006. Our disclosure controls and procedures are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported accurately and on a timely basis, 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 disclosures.

Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of June 30, 2006 because the three material
weaknesses described below and in our Form 10-K for the period ended December 31, 2005 were not fully remediated as of June 30, 2006.

To address the three material weaknesses described below, we performed additional analyses and other post-closing substantive management review procedures to ensure our consolidated financial statements were prepared in accordance with
generally accepted accounting principles. These included detailed reviews by the Corporate Controller and/or the Chief Financial Officer of (i) all significant revenue transactions, (ii) aged receivables to determine collectibility,
(iii) invoices received after the end of the period to ensure that accruals were appropriate, and (iv) analyses and/or reconciliations of all material balance sheet and statement of operations accounts. Accordingly, management, including
our Chief Executive Officer and Chief Financial Officer, believe the condensed consolidated financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the
periods presented.

(b) Managements Report on Internal Control Over Financial Reporting

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005. Managements assessment
identified the following material weaknesses in the Companys internal control over financial reporting as of December 31, 2005:



| | 1. | Inadequate reviews of account reconciliations, analyses and journal entries as well as spreadsheet controls.We had inadequate review procedures over account reconciliations,
account and transaction analyses, journal entries as well as certain spreadsheets.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These were originally discovered by
management during its documentation, testing and evaluation of internal controls over financial reporting as of December 31, 2004. This initial review occurred during the period May 2004 through July 2005. Management further determined that the
material weakness still existed as of December 31, 2005 during its documentation, testing and evaluation of internal controls over financial reporting that occurred during the period from August 2005 through March 2006.

Individually the control deficiencies did not rise to the level of a material control weakness but in aggregate these deficiencies resulted in a more than
remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Specifically, control deficiencies were noted in the following areas:



| |  |  | Review of journal entries, supporting documentation, calculations and assumptions used to prepare the financial statements and account analyses. The summary sheet of the work papers
supporting our annual goodwill and intangible asset impairment analysis contained an error that was not noted during the review and approval process. Additionally, the final bad debt reserve analysis was not updated to reflect changes made to the
related final accounts receivable reconciliation.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Security protection, input data accuracy and logic review over certain spreadsheets used in period-end accounting, analysis and reporting. There was a lack of password protection,
version control, and review of the underlying formulas and data logic review for the spreadsheets related to our restructuring reserve analysis, pro-forma stock based compensation analysis, and certain vendor specific objective evidence analyses.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Review of stock option information and assumptions input into third party software and reconciliations to ensure data integrity. There was no evidence of documented review for one
stock option grant made during the year. Additionally, there was inadequate evidence of review of the interest rate, volatility and options life assumptions input into our third party software system.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review of period-end accruals and reconciliations in the procurement cycle. There were unexplained reconciling differences in one of the underlying account reconciliations.
Additionally, there was inadequate documentation of the review and approval of miscellaneous expense reimbursements.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | Inadequate controls over revenue.
| | -- | ---------------------------------

These were
originally discovered by management during its documentation, testing and evaluation of internal controls over financial reporting as of December 31, 2004. This initial review occurred during the period May 2004 through July 2005. Management
further determined that the material weakness still existed as of December 31, 2005 during its documentation, testing and evaluation of internal controls over financial reporting that occurred during the period from August 2005 through March
2006.

Certain key controls and review procedures over accounting for revenue were not functioning effectively. Specifically,



| |  |  | Documentation of certain revenue recognition decisions was lacking. Formal evidence of timely review and approval of certain revenue recognition decisions was inconsistent and
inadequate.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review procedures over the application of revenue recognition policies for software license and service arrangements were inadequate. There were errors in our documentation of the
application of revenue recognition policies to certain software and service arrangements. Additionally, there were errors in the reconciliations of certain deferred revenue accounts which were not noted during the review and approval process.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review procedures over the accounting for service projects, such as the review of documentation supporting project milestone delivery or professional service hours rendered were
inadequate. There was insufficient evidence of project set-up review and approval for certain service arrangements. Additionally, there was inadequate review and approval of third party time and expense for a certain service arrangement.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review procedures relating to royalty customer listings, fixed price contracts and the application of cash receipts were inadequate. There was inadequate evidence of timely review
and approval of the set-up of certain customer royalty and fixed price arrangements. Additionally, there was inadequate evidence of timely review and approval of our posting of cash receipts.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Review procedures relating to shipping documentation for the accuracy of revenue cut-off were inadequate. There was inadequate evidence of timely review and approval and shipping
documentation related to certain revenue transactions that occurred during the cut-off period in the third quarter of 2005. Although this was corrected as of December 31, 2005 there was inadequate data available for testing to conclude that the
deficiency had been corrected as of year-end.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Inadequate controls over integration of business acquired.
| | -- | ----------------------------------------------------------

We had inadequate review procedures and controls surrounding the fourth quarter acquisition and integration of Pathlore. These were discovered by the Companys independent registered public accounting firm during its audit of the
financial statements and internal control over financial reporting for the fiscal year ended December 31, 2005.



| |  |  | Certain differences in accounting policies were not initially correctly and completely harmonized prior to year-end, resulting in adjustments as of December 31, 2005. These
differences were conforming the calculation of the bad debt reserve at Pathlore to the same methodology as SumTotal, adjusting the calculation of maintenance and hosting revenue recognized to a daily proration for partial months and correctly
netting down billed amounts which were not contractually committed reducing receivables and deferred revenue by the same amount
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Certain of the acquisition-related adjusting journal entries were not reviewed by the appropriate level of management. The work papers calculating the allocation of purchase price
to underlying assets were reviewed and approved. However, the journal entries reflecting this work were not approved.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These
deficiencies resulted in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected.

In making our assessment, management used the criteria set forth by COSO in Internal ControlIntegrated Framework. Because of the material weaknesses described above, management concluded that, as of
December 31, 2005, our internal control over financial reporting was not effective based on those criteria.



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(c) Changes in Internal Control Over Financial Reporting

During 2005 and the first half of 2006 we designed and implemented numerous initiatives to improve the internal control structure of the Company. The
parties responsible for designing and implementing the initiatives referenced below are the Chief Executive Officer, Chief Financial Officer, Corporate Controller, and Audit Committee of our Board of Directors. Commencing in March 2005, we began the
process of designing and creating the initiatives described below to remediate the material weaknesses identified in our Form 10-K for the years ended December 31, 2004 and 2005. The Chief Financial Officer was responsible for assigning actions
to appropriate personnel within the accounting and information technology functions.

The following initiatives were created and implemented in fiscal year
2005 to address the material control weaknesses identified as of December 31, 2004 and to generally improve the Companys internal controls over financial reporting.

With respect to Company level controls, the Company fully remediated, by December 31, 2005, the material control weakness identified in our Form 10-K for the year ended December 31, 2004 by creating and
implementing the following initiatives:



| |  |  | strengthened its internal controls over financial reporting throughout its management structure. This included adding additional members to its Disclosure Committee, increasing the
time spent by the executive staff in reviewing and discussing the Companys periodic filings and convening more frequent Audit Committee meetings. These changes were initiated to provide for a more robust review and analysis of the
Companys periodic filings;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | hired additional finance and accounting personnel with expertise in U.S. generally accepted accounting principles, including two senior financial positions  one in Europe and
one in the U.S., upgrading and adding staff to the accounting function at the manager and accountant level and engaging three experienced consultants to provide additional technical expertise as needed;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | strengthened its risk assessment controls, including mechanisms for anticipating and identifying financial reporting risks and for reacting to changes in the operating environment
that could have a material effect on financial reporting . A large part of the additional time spent by executive management and the Audit Committee was focused on risk assessment and, in particular, in reviewing the risk factors disclosed in the
Companys periodic filings;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | communicated the importance of internal controls and employee duties and responsibilities. The Company held internal training sessions with employees and discussed internal controls
at Company-wide employee meetings; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | implemented procedures surrounding its access controls and segregation of duties between key IT functions. This included segregating the roles of system administrators and users,
restricting access to individual modules within the accounting function, segregating duties between network and application administrators, restricting access, implementing peer reviews, and requiring additional approvals for changes to applications
and related databases.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

With respect to segregation of duties, the Company fully remediated, by December 31, 2005, the material control
weakness identified in our Form 10-K for the year ended December 31, 2004 by creating and implementing procedures and controls surrounding segregation of duties within its purchasing, disbursement and payroll processes and accounting system.
This included the development of a segregation of duties matrix, reassignment of certain duties where the analysis indicated that there was not adequate segregation of duties, and restriction of access to certain accounting modules. In addition, the
Company performed an analysis of customer and vendor accounts to ensure their existence and validity.

With respect to financial statement preparation and
review procedures, the Company believes that it has remediated, by December 31, 2005, the material control weakness identified in our Form 10-K for the year ended December 31, 2004 by creating and implementing strengthened procedures
surrounding the level of supporting documentation, review and supervision within the accounting and finance departments, and preparation and review of footnote disclosures. All reviews are fully documented and dated, and believed to be effective.
However, deficiencies related to our reviews of account reconciliations, analyses and journal entries as well as spreadsheet controls remained as of December 31, 2005. Individually, the control deficiencies did not rise to the level of a
material control weakness but in aggregate, these deficiencies resulted in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.



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With respect to purchases, payroll and disbursements, the Company fully remediated, by December 31, 2005, the
material control weakness identified in our Form 10-K for the year ended December 31, 2004 by creating and implementing the following initiatives:



| |  |  | strengthened controls and approvals surrounding wire transfers and transfers between investment accounts and the payment of invoices. This included adding a requirement for a second
approver on all wire transfers and more rigorous enforcement of the authority levels for approving invoices;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | enhanced policies surrounding purchase orders. In particular, the Company enforced the Company policy that requires initiation of a purchase order before vendors are engaged to
provide goods and services and further clarified which types of expenses could be paid without a purchase order;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | improved the review process of employee expense reports to ensure that exceptions to the policy were appropriately reviewed and approved; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | improved the procedures surrounding the review and approval of commission payments to provide a more detailed review of the calculations as well as to ensure the reviews of
commission payments were properly documented.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

With respect to accounting for investments, the Company fully remediated, by December 31,
2005, the material control weakness identified in our Form 10-K for the year ended December 31, 2004 by creating and implementing strengthened policies and procedures regarding the review of investments managed by a third party. In particular,
the Company ensured that there was a review of compliance with the Companys investment policy and a review to ensure the correct classification of the investments on the balance sheet.

During the quarter ended March 31, 2006, the Company:



| |  |  | Appointed a Worldwide Director of Revenue to oversee the revenue recognition process, procedures and review of these transactions. The Worldwide Director was appointed by the
Companys CFO and reports to the Companys Corporate Controller.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continued to hire additional qualified personnel to strengthen the accounting and finance organizations. We hired a payroll accountant and a general accountant, both of whom report
to and are supervised by the Companys accounting manager. We also hired a revenue recognition supervisor reporting directly to our Worldwide Director, and a manager of credit and collections reporting to our Corporate Controller.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Improved training for staff to ensure that account reconciliations and analyses are complete and accurate. We conducted accounting department training regarding the required format
and content of the documentation for our account reconciliations and supporting analysis. This training was reviewed and approved by our CFO and conducted by our Corporate Controller.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the quarter ended June 30, 2006, the Company:



| |  |  | Continued to hire additional qualified personnel to strengthen the accounting and finance organizations. We hired an accounts payable accountant and an accounting supervisor, both
of whom report to and are supervised by our accounting manager. We also hired an additional credit and collections specialist, who reports to our manager of credit and collections, and additional staff in the revenue accounting team.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continued to improve training for staff to ensure that roles and responsibilities are clearly defined and understood and that policies and procedures are being followed. This
training was provided to all accounting and finance personnel and was performed by our Corporate Controller with the assistance of the internal audit function. This training was reviewed and approved by the Chief Financial Officer.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Completed the integration of Pathlore. All transactions are now processed through the same systems and controls as other parts of the business This integration was supervised and
monitored by the Corporate Controller.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Initiated an upgrade and enhancement of our automated accounting and reporting systems that included improved internal controls, in particular with respect to segregation of duties.
This upgrade was reviewed and approved by our IT Steering Committee and under the direction of our Director of Finance.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Established an internal audit function reporting directly to the Audit Committee.
| | - |  | ---------------------------------------------------------------------------------



| |  |  | Reviewed and enhanced our accounting and reporting policies and procedures. This was performed under the review and direction of our Chief Financial Officer and supervised by our
Corporate Controller.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Enhanced our ongoing formal internal control monitoring and testing program. This was performed via the establishment of an internal audit function under the direction and approval
of the Companys Audit Committee. The Director of Internal Audit meets approximately twice each month with the Chief Executive Officer and Chief Financial Officer to discuss and report on the status of the Companys internal controls and
meets approximately once per quarter with the Audit Committee.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These initiatives are part of our overall program that is
intended to remediate all material control weaknesses by December 31, 2006. Management believes that it has developed and implemented the requisite initiatives to fully remediate all previously identified material control weaknesses, but the
material control weaknesses identified in our Form 10-K for fiscal year 2005 related to (a) inadequate reviews of account reconciliations, analyses and journal entries as well as spreadsheet controls; (b) inadequate controls over revenue;
and (c) inadequate controls over integration, remain subject to testing. Management has and will continue to test and evaluate these controls throughout the remainder of the year in order to enable management to make a conclusion, as of
December 31, 2006, as to whether the initiatives were effective in fully remediating these remaining material control weaknesses.

PART IIOTHER INFORMATION

Item 1A. Risk Factors

Factors That May Affect Future Results of Operations

Set forth below and elsewhere in this and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ
materially from the results contemplated by the forward-looking statements contained in this report. All forward-looking statements included in this report are based on information available to us on the date hereof. We assume no obligation to
update any forward-looking statement.

We have a history of losses, we expect future losses on a Generally Accepted Accounting Principles
(GAAP) basis, and we may not achieve GAAP profitability on a consistent basis.

We expect to continue to derive
substantially all of our revenue from the licensing of our new business performance and learning technology software family of products, the SumTotal 7.x Series, as well as our legacy products, Aspen Learning Management Server and Aspen Learning
Content Management Server, Docent Learning Management Server and Docent Learning Content Management System, and Pathlore products (Legacy Products) and related services, including without limitation, maintenance, services and hosting. We
do not expect revenues from these product offerings to be sufficient to achieve and maintain U.S. GAAP profitability on a consistent basis. With the exception of the Pathlore mainframe products which we acquired in the fall of 2005, we began to
transition our Legacy Products to our SumTotal 7.x Series and services related to these offerings at the end of the fourth quarter of 2004 and beginning the first quarter of 2005. If we fail to continue to generate adequate revenues from the
SumTotal Systems Suite and related services, we will continue to incur losses. In addition, in the future, we expect to continue to incur additional non-cash expenses relating to the amortization of deferred compensation and purchased intangible
assets that will contribute to our net losses. Further, starting with the first quarter of fiscal 2006, we have been required to record as an expense charges related to all current outstanding and future grants of stock options in our reported
results from operations in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R),Share-Based Payments, which was issued by the FASB in December 2004. This has had the impact of increasing
our reported expenses and our U.S. GAAP losses. As a result of all of the foregoing, we expect to incur additional U.S. GAAP basis expenses related to stock-based compensation awards for the foreseeable future and these future expenses will
adversely impact our ability to achieve profitability on a U.S. GAAP basis. Continued losses or failure to meet or exceed our forecasts or industry analysts projections could cause the price of our common stock to decline.

Our operating results are uncertain and may fluctuate significantly from quarter to quarter or year to year, which could negatively affect the value of your
investment.

We have experienced substantial fluctuations in operating results on a quarterly and annual basis and expect these
fluctuations will continue in the future. Our operating results may be affected by a number of other factors, including: (1) the size and timing of product orders and the timing and execution of professional services engagements for SumTotal
7.x Series and the Legacy Products; (2) the mix of revenue from products and services; (3) the ability to meet client project milestones; (4) market acceptance of our products and services, especially SumTotal 7.x Series and
related services; (5) failure to complete fixed-price professional services engagements within budget, on time and to clients satisfaction; (6) ongoing costs and efforts in connection with compliance with Section 404 of the
Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Section 404); (7) the timing of revenue and expense recognition; (8) the overall movement toward industry consolidation among both our competitors and our customers;
(9) recognition of impairment of existing assets; and (10) how well we execute on our strategy and operating plans.



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Our future revenue is difficult to predict, and we may not be able to adjust spending in response to
revenue shortfalls. Our limited operating history with our current business performance and learning management solutions, and the rapidly evolving nature of the business performance and learning management market make prediction of future revenue
and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and are basically fixed in the short-term. Other expenses, as a result of changes in the law or otherwise, such as expenses related to litigation or
compliance with Sarbanes-Oxley Section 404, may also increase and cause us to fall short of our forecasts. If we are unable to predict future revenue accurately, including, in particular, the timing of future revenue, we may be unable to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall, and may therefore fall short of our forecasts. Failure to meet our forecasts or industry analysts expectations would likely cause a decline in the price of our
common stock.

Risk of Impairment of Goodwill and Intangible Assets

Goodwill represents the excess of costs over the net fair value of net assets acquired in a business combination. Goodwill is not amortized, but is instead tested for impairment at least annually in accordance with
the provisions of SFAS No. 142,Goodwill and Other Intangible Assets. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values using straight-line and
accelerated methods designed to match the amortization to the benefits received where applicable. They are reviewed for impairment in accordance with SFAS No. 144,Accounting for Impairment or Disposal of Long-Lived Assets.
Recoverability of goodwill is measured by a comparison of the carrying amount of a reporting unit, which is a component representing a segment or one level below a segment, to the estimated undiscounted future cash flows expected to be generated by
the reporting unit. If the carrying amount of a reporting unit, after any adjustments required for other long-lived assets, exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the
unit exceeds its fair value.

Purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows
expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of
the asset group.

Any significant adverse changes to the key assumptions about acquired businesses and their prospects or an adverse change
in market conditions could result in a change to the estimation of fair value that could result in an impairment charge. Given the significance of the intangible asset balances as a percent of our total asset balance, an adverse change to the
estimated fair value of intangible assets could result in an impairment charge that would be material to our reported results from operation and related financial statements.

Sales cycles are lengthy, requiring considerable additional investment with no assurance of generating revenue from our efforts.

The period between our initial contact with a potential customer and a customers purchase of our products and services often extends over several fiscal quarters or a fiscal year. To sell our products and
services successfully, we generally must educate our potential customers regarding the use and benefits of our products and services, which typically requires significant time, capital and other resources. The delay or failure to complete sales in a
particular quarter could reduce our revenue in that quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized. If the sales cycle unexpectedly lengthens in general or for one or more large orders, it would
negatively affect the timing of our revenue, and our revenue growth would be harmed. Many of our potential customers are large enterprises that generally take longer than smaller organizations to make significant business decisions, and the
formation and execution of even a relatively small

number of large contracts with these enterprise customers may have a significant impact on our
revenues. In addition, we must allocate and expend resources prior to completing a sales transaction, with no guarantee that a particular sales transaction will be consummated, resulting in a failure to generate any revenue from these activities if
the particular sales transaction is not consummated and potentially affecting our stock price as well.



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Our operating results may be affected by successful warranty claims, refund requests, litigation claims for breach of
contract or other claims related to product defects.

Although we generally attempt to contractually limit our liability for damages
arising from defects and other mistakes in rendering professional services, these contractual protections are not always obtained and may not be enforced or otherwise may not protect us from liability for claims such as warranty claims, refund
claims, or litigation claims. If such a claim is successful, our insurance may not be sufficient to cover these claims. Any of these consequences could have a material adverse impact on our financial condition, results of operations, our reputation,
or the market value of our common stock.

Any future acquisitions we make, or attempt to make, could disrupt our business and harm our financial
condition if we are not able to close an announced transaction or successfully integrate the acquired business in a timely manner.

We
have made and may continue to make acquisitions of business and technologies to enhance our business. Acquisitions involve numerous risks, including problems combining the purchased operations and key employees, technologies or products,
unanticipated costs, diversion of managements attention from our core business, adverse effects on existing business relationships with suppliers and customers, risks associated with entering markets in which we have no or limited prior
experience and potential loss of key employees. The integration of businesses that we have acquired or that we may acquire in the future into our business has been and will continue to be a complex, time consuming and expensive process. Failure to
operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices could adversely impact the success of any business combination as evidenced in previous
combination and acquisition transactions. For example, although we completed the combination of Docent and Click2learn in March 2004, the difficulty in integrating financial controls and procedures contributed to our failure to timely file our
Annual Report on Form 10-K with the SEC for fiscal 2004. We are in the process of integrating Pathlores financial controls into ours, and we may experience problems with this integration. Moreover, the integration of the products, product
roadmap, and operations from the combination of Docent, Click2learn and Pathlore is a continuing activity and will be for the foreseeable future.

Our operating results may suffer because of acquisition-related expenses, amortization of intangible assets and impairment of acquired goodwill or intangible assets. Furthermore, we may have to incur debt or issue equity securities to pay
for any future acquisitions, or to provide for additional working capital requirements, the issuance of which could be dilutive to our existing shareholders. If we are unable to successfully address any of these risks, our business, financial
condition or operating results could be harmed.

There can be no assurance that we will be able to timely close other acquisitions, or
other business combinations we may make in the future on favorable terms or on a timely basis, or that we will be able to successfully integrate Pathlore or any other businesses, products, technologies or personnel that we might acquire and failure
to do so may negatively affect our financial results, customer, employee and investor confidence, and ultimately our stock price.

Our credit facility
requires compliance with certain restrictive covenants, and if we breach the covenants, we will be in default and the lender could demand repayment and foreclose on the loan.

The credit facility we established in conjunction with our acquisition of Pathlore requires compliance with certain restrictive covenants. If we cannot
achieve the financial results necessary to maintain compliance with these covenants, we could be declared in default and be required to sell or liquidate our assets to repay outstanding debt of approximately $15.3 million. These covenants include,
but are not limited to, earnings before interest, taxes, depreciation and amortization (EBITDA) levels, leverage ratios, and restrictions related to capital expenditures, indebtedness, distributions, investments, and change of control.
There is no test of the financial covenants if the company maintains a minimum balance of at least $15.0 million between qualified cash accounts (accounts pledged to the lender) and excess availability under the revolver. As of June 30, 2006,
we had $21.6 million comprising $16.6 million in qualified cash accounts and $5.0 million in excess availability under the revolver and therefore no test of the covenants was required. In the event that our qualified cash balance falls below the
$15.0 million threshold and it cannot achieve the financial results necessary to maintain compliance with these covenants, we could be declared in default and be required to sell or liquidate its assets to repay outstanding debt of approximately
$15.3 million.

If we breach any of these covenants, the lender could demand repayment of the outstanding debt and could foreclose upon all or
substantially all of our assets and the assets of our subsidiaries. These covenants may adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities that may be in our
interest. As a result of our credit facility, we may have more debt than some of our competitors, which could place us at a competitive disadvantage and make us more susceptible to downturns in our business in the event our income is not sufficient
to cover our debt service requirements. Even if we are able to repay the debt, under the terms of the credit facility, there are penalties for making pre-payments that would otherwise save us substantial future interest payments. The forced
premature repayment of the loan could leave us without: (1) the ability to control which assets are sold to satisfy the loan; and (2) sufficient assets to continue as a going concern. Each of these risks may cause concern among our
customers or investors and therefore cause a decrease in our revenues or stock price.



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Our business may not generate the cash needed to finance our operations or growth, and for that and other reasons we
may need additional financing in the future, which we may be unable to obtain, or if we do, whether under the universal shelf registration we filed or otherwise, it may result in dilution to our current stockholder base.

Our recent acquisition of Pathlore decreased our cash position. If our business does not generate the cash needed to finance our operations or growth,
including potential business acquisitions or investments, we may need to obtain additional financing or take steps to restrict our operations in order to conserve existing cash. In addition, poor financial results or unanticipated expenses could
give rise to additional financing requirements. Therefore, we have filed a universal shelf registration statement on Form S-3 for an aggregate maximum offering of $75 million. We may be unable to obtain financing on terms favorable to us, or at all.
If we are able to raise additional funds, if necessary, the issuance of additional shares may result in investor dilution. Further, it may be more difficult to obtain additional financing because of our credit facility, whether under the Form S-3 or
otherwise. If we need to obtain financing and adequate funds are not available or are not available on acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability
to enhance our products, fund expansion, respond to competitive pressures or take advantage of business opportunities, thereby resulting in a decrease in our revenues and stock price.

If we fail to mitigate our risk in foreign exchange fluctuations with the hedging contracts that we enter into, our statement of operations may be negatively impacted, which could in turn result in loss of investor
confidence.

Given the international nature of our business, we have assets and liabilities denominated in foreign currencies, and are
therefore subject to losses due to fluctuations in foreign exchange rates. We have entered into, and will likely in the future enter into, forward foreign exchange hedging contracts in an attempt to mitigate such foreign exchange currency
risk. If we fail to estimate such exposures accurately, then this could negatively affect our statement of operations, may cause a loss in investor confidence, and therefore a decrease in our stock price.

Our products contain defects, and, if we cannot fix any material defects in a timely fashion, we may need to halt further sales or shipments of our products, delay
introduction of new products, and/or account for warranty claims.

Our product offerings, both current and future, are complex and often
contain defects, including software and process errors, incorrect code, faulty error handling, incomplete use cases, known and unknown, despite internal and third party testing. New product offerings contain new features and functionality, which
result in a greater likelihood of defects, and frequently, defects are undetected until the period immediately following introduction and initial shipment of new products or enhancements to existing products. For example, although we attempted to
discover and resolve all defects in our new product line that we believed would be considered serious by our customers before shipment to them, SumTotal 7.x Series is not error-free and some customers have notified us that they consider some of the
defects in the SumTotal 7.x Series to be serious.

In addition, our products include third party software, and any defects in third party
software that we incorporate in our products will compromise our products. It may be difficult for us to correct any errors in third party software because the software is not within our control. Accordingly, our revenue could decrease and our costs
could increase in the event of any errors in this technology. Furthermore, we may become subject to legal claims related to defects in our products, including defects in licensed technology, based on product liability, infringement of intellectual
property or other legal theories. The defects, some of which were unknown to us, some which may yet to be discovered, and others of which may manifest themselves in future releases of our products, could cause performance problems and result in
material adverse financial consequences to our customers and us, including without limitation, delay in recognizing, declining or lost revenues and delay in customer acceptance.

If we fail to successfully manage our product transition to, or fail to successfully deploy upgrades to our SumTotal 7.x Series on a timely basis, our business and financial results will be harmed.

We introduced SumTotal 7.0 in December 2004, SumTotal 7.1 in April 2005, SumTotal 7.2 in April 2006, and plan to
launch subsequent product releases over the next year. We face numerous risks relating to product transitions, including customers delaying their purchasing decision until they have confidence in our new product and until we have proven we can
successfully install and implement SumTotal 7.x Series. Due to the product transition, we may be unable to accurately forecast revenue from product sales and related services, the number and severity of defects and increased support requirements due
to the complexity of the new product. In order to successfully market and sell the product, we must ensure broad-based cooperation from and coordination between multiple departments, including engineering and marketing, and from multiple geographic
regions, including Bellevue, Washington, Mountain View, California, and Hyderabad, India. If we fail to successfully manage the transition to this new product offering, our business and financial results may be adversely affected, which may cause a
decline in the price of our common stock.



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Our lack of product diversification, and our reliance on the SumTotal Systems Suite, means that any decline in price
or demand for our products and services would seriously harm our business.

We expect SumTotal Systems Suite and, in particular, our new
product, SumTotal 7.x Series and successor products and related services to continue to account for a significant majority of our revenue for the foreseeable future. Consequently, a decline in the price of, or demand for, the SumTotal Systems
Suite and successor products or services, or their failure to achieve broad market acceptance, would seriously harm our business and would likely result in the decline of our common stock.

Our intellectual property is subject to, and may be subject to, legal challenges or unauthorized use or claims of infringement, any of which could diminish the value
of our products and services or deter customers from purchasing our products.

Our success depends in large part on our proprietary
technology. We rely on a combination of copyrights, trade secret and trademark laws, contractual restrictions, restrictions on disclosure and other methods to protect our proprietary technology. These legal protections afford only limited protection
for our technology. We do not rely on patents to protect our intellectual property either in the United States or in foreign jurisdictions. Furthermore, effective protection of intellectual property rights is unavailable or limited in certain
foreign countries. It may also be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization and it may be possible for third parties to independently develop substantially
equivalent intellectual property. We cannot assure you that the protection of our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products and services or design around any
patents or other intellectual property rights we hold. Consequently the value of our products and services to our customers could diminish substantially.

From time-to-time, we are involved in legal proceedings or threats of legal proceedings. Litigation is expensive to defend and even the threat of legal proceedings diverts management attention from operating our
business and causes increases in our expense levels. In addition, from time-to-time, we have received, and may in the future receive, threatening letters and notice of claims of infringement of other parties proprietary rights. Such claims
could result in costly litigation and could divert management and technical resources. They could also delay product shipment or require us to develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not
be available on reasonable terms, or at all. In the event of an adverse judgment against us (including a judgment or settlement which may impose adverse conditions on us), we may be required to cease shipping, to pay damages, to license technology
on terms that may not be favorable to us or to alter our technology, website or software products, any of which may adversely affect our operating results and cause us to meet our forecasts or industry analysts forecasts, thereby causing a
possible decline in the price of our common stock.

Our products include third party technology, the loss of which could materially harm our business.

We use some licensed third party technology components in our products. Future licenses to this technology may not be available to us
on commercially reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or could force us to discontinue offering portions of our
business performance and learning management solutions until equivalent technology, if available, is identified, licensed and integrated.

Security and
privacy breaches could subject us to litigation and liability.

We host certain of our customers business performance and learning
management software implementations and provide access to that software using the Internet. Computer viruses could be introduced into our systems or those of our customers, which could disrupt the operation of our hosting systems or make them
inaccessible to users and we depend on third parties to provide key components of our networks and systems and Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer
equipment to enable customers to access and use hosted software implementations.

We could become subject to litigation and liability if
third parties penetrate security for our hosting systems or otherwise misappropriate our users confidential information, or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new
discoveries in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or
cause interruptions in our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service



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interruptions or to alleviate problems caused by breaches or service interruptions. Each of our key third party networks
and systems component providers, Internet service providers and telecommunications companies partners has experienced significant outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our
systems, which could cause our customers to believe we were at fault and withhold payments due to us, decreased revenue and a decline in the price of our stock.

Our disaster recovery plan does not include redundant back-up computer systems, and a disaster could severely damage our operations.

Our disaster recovery plan does not include redundant back-up computer systems at an alternate site. A disaster could severely harm our business because our computer systems could be interrupted for an indeterminate length of time. Our
operations depend on our ability to maintain and protect the computer systems needed for our day-to-day operations. A number of these computer systems are located in Mountain View, California on or near known earthquake fault zones and flood plains.
Although these systems are designed to be fault tolerant, they are vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and other events. Any damage to our facility could lead to interruptions in the services
we provide to our customers and loss of customer information, and could impair our ability to operate our business, leading customers to withhold payments due to us and decreased revenue. The business interruption insurance we maintain may not be
adequate to cover our losses resulting from disasters or other business interruptions, which would result in increased expenses and a possible decline in our stock price as well.

Terrorism and U.S. military actions may adversely affect our business.

In light of recent terrorist
activity, political and military instability, and existing and possible U.S. military actions, significant instability and uncertainty in the world may continue to have a material adverse effect on world financial markets, including financial
markets in the U.S. In addition, such adverse political effects may have an adverse impact on economic conditions in the U.S. Unfavorable economic conditions in the U.S. may have an adverse effect on our business operations including, but not
limited to, our ability to expand the market for our products, obtain financing as needed, enter into strategic relationships and effectively compete in the business performance and learning management markets. Such consequences may lead to a
decrease in demand for our products and services and as a result our stock price may suffer.

We may not be able to adapt to rapidly changing technology
and evolving industry standards and if, as a result, our products become obsolete or there is a delay in meeting our customer needs, we would lose market share.

The business performance and learning management software market is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry
standards. The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our products and services obsolete. Our success depends on our ability to adapt to a rapidly changing
landscape and to offer new products and services to address our customers changing demands. We may experience difficulties that delay or prevent the successful design, development, introduction or marketing of our products and services. To the
extent we in fact experience such delays, we may experience difficulty in attracting new customers and may lose existing customers.

Market acceptance
of new platforms and operating environments may require us to undergo the expense of developing and maintaining compatible product lines.

Although our software products can be licensed for use with a variety of popular industry standard relational database management system platforms, specific operating systems, or other combinations of licensed software, there may be
currently existing or future platforms or user interfaces that achieve popularity in the marketplace which may not be architecturally compatible with our software product design. Developing and maintaining consistent software product performance
characteristics across all of these combinations could place a significant strain on our resources and software product release schedules, which could adversely affect revenue and results of operations. To maintain software performance across
accepted platforms and operating environments, to achieve market acceptance of those that we support, or to adapt to popular new ones, our expenses may increase and our sales and revenues may be adversely affected.

The business performance and learning managed software market is highly competitive, and we may be unable to compete successfully.

The market for our products and services is intensely competitive, dynamic and subject to rapid technology change. While we believe there is a trend
toward market consolidation, the business performance and learning management software market is still highly fragmented and competitive, with no single company accounting for a dominant share of the market.

Our competitors vary in size, scope and the breadth of products and services offered. We face competition from: (1) other developers of business
performance and learning technology systems; (2) providers of other business performance



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and learning technology solutions; (3) vendors of other enterprise software applications that are beginning to offer
learning delivery and management functionality; (4) large professional consulting firms and in-house information technology departments; and (5) developers of web authoring tools. Additionally, companies may choose to develop their own
business performance and learning management software internally rather than acquiring it from third parties.

There are relatively low
barriers to entry in the business performance and learning technology market, and we expect the intensity of competition to increase in the future. Increased competition may result in price reductions, reduced gross margins or loss of market share,
any of which could seriously harm our business and financial results.

In addition, some of our existing and potential competitors have
longer operating histories and significantly greater financial, technical, marketing and other resources and therefore may be able to respond more quickly to new or changing opportunities, technologies, standards and customer requirements to compete
more aggressively on pricing, or to sustain prolonged periods of negative cash flows and unfavorable market conditions. We may not be able to compete successfully against our current and future competitors, and competitive pressures that we
encounter may seriously harm our business.

The business performance and learning management software market may not grow to a sufficient size or at a
sufficient rate to sustain our business.

Corporate training and education historically have been conducted primarily through classroom
instruction. Although technology-based training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market. Accordingly, our success will depend on the extent to which
companies implement business performance and learning management software solutions for the design, development, delivery and management of their corporate learning needs.

Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit
or compete with their existing investments. Even if companies implement business performance and learning management software solutions, they may still choose to develop such solutions internally. If the use of business performance and learning
management software does not become widespread, or if companies choose to develop such software internally rather than acquiring it from third parties, then our business performance and learning management software may not be commercially
successful.

Our stock price has been and may continue to be volatile.

The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price is subject to continued fluctuations in response to a number of factors, including: (1) actual or
anticipated variations in quarterly operating results; (2) changes in financial estimates or recommendations by securities analysts; (3) compliance with Sarbanes-Oxley and, in particular, Sarbanes-Oxley Section 404, including the cost
of identifying and remedying significant deficiencies and material weaknesses in our internal controls; (4) conditions or trends in business performance and learning management markets; (5) announcements by us or our competitors of
significant customer wins, technological innovations, new products or services, significant acquisitions, strategic partnerships, joint ventures or capital commitments; (6) failure to accurately forecast our sales, especially since we rely on
the sales of a small number of relatively large orders; (7) the seasonal fluctuations of our customers buying decisions; (8) additions or departures of key personnel, including the recent departure of our President, and;
(9) general market conditions.

Fluctuations in the price and trading volume of our common stock may prevent stockholders from
reselling their shares above the price at which they purchased their shares.

In addition, companies that have experienced volatility in
the market price of their stock have been subject to securities class action litigation, and we may be the target of this type of litigation in the future. Securities litigation, like other litigation against us could result in substantial costs,
negative publicity and divert our managements attention, which could seriously harm our business and stock price.

Our recent stock performance
may impair the carrying value of our goodwill and intangible assets.

Our common stock has declined from $8.00 per share on the first
trading day following March 18, 2004 when the acquisition of Docent was completed, to $5.45 per share at the close of market on July 31, 2006. The carrying value of our goodwill and intangible assets on June 30, 2006 was $62.3 million
and $21.2 million, respectively. A further sustained decline in our stock price could help trigger an impairment analysis, which then might result in an impairment based not only on stock price but other factors.



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We have experienced and may continue to experience turnover of senior management and key personnel, which could harm
our business or operations and competition for other personnel is competitive and getting more competitive.

Our success depends to a
significant degree on the performance of the senior management team and other key employees. While our Section 16 officers were granted two-year retention agreements in October 2005, around the time our former chief executive officer resigned,
there is no guarantee that such officers, as well as other employees, will remain employed with us. The loss of any of these individuals could harm our business. We do not have employment agreements other than offer letters with our executives or
with any other key employee, and we do not maintain key person life insurance for any officer or key employee.

Our success also depends on
our ability to attract, integrate, motivate and retain highly skilled technical, sales and marketing and professional services personnel. Competition for qualified personnel in the software industry, particularly engineering and other technical
personnel, is intense and is increasing, and there can be no assurance that we will be able to attract and retain highly skilled employees in sufficient numbers to sustain our current business or to support future growth.

A substantial amount of our engineering activities are based in Hyderabad, India and are subject to contingencies and delays that arent typically experienced
with stateside engineering efforts.

We rely significantly on our engineering operations in Hyderabad, India to enable us to complete
customer implementation projects and new releases of our products on time and within established budgets.

Our efforts in Hyderabad and
elsewhere abroad are subject to a number of risks inherent in international operations, including: (1) difficulties and costs of recruiting and retaining qualified engineers and other personnel in our foreign offices; (2) different
learning styles and cultures; (3) intense and increasing competition from other technology companies with regard to hiring and retaining qualified personnel; (4) increasing growth and development of the technology market in India
generally, and in Hyderabad specifically, increasing competition and costs of hiring and retaining qualified personnel; (5) numerous and potentially conflicting regulatory requirements; (6) export controls; (7) import tariffs and
other barriers to trade, changes in laws or governmental policies; (8) reduced protection of intellectual property rights; (9) regional political and economic instability; (10) challenges with reliability in our infrastructure, given
that India does not have the same scale and reliability of overall infrastructure relative to stateside; and (11) fluctuations in currency exchange rates which could adversely impact our reported other income and expense.

If our India or other overseas operations fail, for any reason, to provide adequate and timely product enhancements, updates and fixes to us or customer
implementations, our ability to fix defects in our SumTotal 7.x Series, our ability to develop new versions of our SumTotal 7.x Series, and our ability to respond to customer or competitive demands would be harmed and we would lose sales
opportunities and customers.

In addition, our engineering efforts are based primarily out of two offices: Bellevue, Washington and
Hyderabad, India. If the two offices fail to work together successfully, we may experience delays in fixing defects in SumTotal 7.x Series, customer implementations, or in developing and releasing future versions of our product.

We rely on independent partners and third parties to help conduct our international operations and provide engineering services, including product development and
customer implementation and sales and marketing efforts.

We rely on independent partners such as distributors, alliance partners,
value-added resellers, and system integrators to help conduct our international operations and sales and marketing efforts in many foreign countries. We also use independent third parties to provide engineering services. Moreover, we expect to
increasingly rely on these independent partners for the product development, customer implementation, distribution and sale of our branded products globally. Our success in international markets consequently will depend to a large degree on the
success of these independent partners, with whom we have a limited working experience and over whom we have little control. If they are unwilling or unable to dedicate sufficient resources to our relationships, our international operations will
suffer so our future success will depend in part on our ability to attract, train and motivate new distributors, resellers, alliance partners and systems integrators and expand our relationships with current independent partners. We may not be
successful in expanding our distributor and reseller relationships, and our sales would suffer as a result. Further, we will be required to invest significant additional resources in order to expand these relationships, and the cost of this
investment may exceed the revenues generated from this investment.

The operations of these partners are based outside the U.S. and are
therefore subject to risks distinct from those that face U.S.-based operations, including: (1) the burden of complying with a variety of foreign laws; (2) language barriers; (3) longer payment cycles and greater difficulty in
collecting accounts receivable; (4) reduced protection of intellectual property rights; (5) fluctuating exchange rates; (6) price controls and other restrictions on foreign currency; (7) military action or political upheaval in
the host countries which could force these partners to terminate the services they are providing to us or to close their operations entirely; and (8) social unrest or disturbances.



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Our internal control over financial reporting and disclosure controls and procedures are not effective and may not be
adequate to prevent or detect misstatements or errors, which could cause us to have to restate our financial statements and cause our stock price to decline or subject us to costly litigation.

For the fiscal years ended December 31, 2004 and 2005, management has concluded that our internal controls over financial reporting and disclosure
controls have been ineffective due to material weaknesses in our internal control over financial reporting. While we continue to take steps to remediate material weaknesses and test the adequacy of our initiatives to remediate these material
weaknesses, we cannot assure you that our efforts will be successful or that additional material weaknesses will not be found. If we are not successful in remediating these material weaknesses or if other material weaknesses are found, we cannot
assure you that our financial statements will be error free. If errors are found in the financial statements that we file with the Securities and Exchange Commission, we may be required to restate those financial statements which could result in a
loss of investor confidence in us, cause our stock price to decline and subject us to costly litigation.

A control system, no matter how
well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Our management does not expect that our internal controls and procedures will prevent all errors and all fraud
because, in addition to resource constraints, there are inherent limitations of all control systems, including the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control or procedure. The design of any system of controls and procedures is also
based in part on 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. Because of the inherent limitations in a
control system, misstatements due to error or fraud may occur and not be detected. In such event, we may not, for instance, be able to recognize revenue we expected to recognize; we may not be able to meet our forecasts or industry analysts
projections; or we may be the subject of litigation, each of which would likely harm our financial results and may result in a decline in the price of our common stock.

Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are burdensome and uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could
decline.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to report on, and our independent
registered public accounting firm to attest to, the effectiveness of our internal controls over financial reporting, at least annually. The rules governing the standards that must be met for management to assess our internal controls over financial
reporting are new, complex and subject to proposed changes. Currently, the rules require significant documentation, testing and possible remediation of our internal controls over financial reporting. The process of reviewing, documenting
and testing our internal controls over financial reporting will likely continue to result in increased expenses and the devotion of significant management and other internal resources. As we did in connection with our report on internal
controls in 2004, we may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting during fiscal 2006. During this process, if we are
unable to effectively remediate our material weaknesses, or if our management identifies one or more material weaknesses in our internal control over financial reporting, we will be unable to assert such internal control is effective, and the price
of our stock may suffer.

We were not able to comply with the requirements of Section 404 for fiscal 2004 on a timely basis and had to
delay filing our Annual Report on Form 10-K until August 1, 2005. We had numerous material weaknesses, and developed and implemented extensive remediation plans. Although we have reduced the number of material weaknesses in 2005
compared to 2004, we still have some material weaknesses, and there is no assurance that our remediation plans will effectively address the material weaknesses, or that such changes in our control procedures will not create other material
weaknesses. If our management is unable to assert that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to attest that our management report is fairly stated or they
are unable to express an opinion on the effectiveness of our internal controls) we may not be able to timely file, or file at all, our periodic financial reports, and thus we will be subject to delisting. Even if we are able to file such
reports, investor confidence in the accuracy and completeness of our financial reports may be lost, leading to an adverse effect on the price of our stock.

If we are unable to effectively remediate any additional material weaknesses identified by us or our independent registered public accounting firm, we will be unable to assert such internal control is
effective. If internal controls and procedures are determined to be inadequate and ineffective, this may result in a loss of shareholder confidence and adversely impact our stock price.



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Recently enacted and proposed changes in securities laws and regulations have increased and are likely to continue to
increase our expenses.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the
provisions of the Sarbanes-Oxley Act of 2002, have increased, and will continue to increase our expenses as we devote resources to respond to the new requirements. The Sarbanes-Oxley Act mandates, among other things, that companies adopt new
corporate governance measures, and it imposes comprehensive reporting and disclosure requirements; sets stricter independence and financial expertise standards for audit committee members; and imposes increased civil and criminal penalties for
companies, their chief executive officers, chief financial officers and directors for securities law violations. In addition, the NASDAQ Global Market, on which our common stock is listed, has also adopted comprehensive rules and regulations
relating to corporate governance. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of
operations and divert managements attention from business operations. While we are endeavoring to reduce the costs of compliance, compliance is costly due to the necessity of hiring additional personnel and external consultants and our
independent registered public accounting firm. For example, we incurred over $4.0 million dollars in fiscal 2005 on compliance costs related to the Sarbanes-Oxley Act which directly increased our general and administrative operating expenses and
contributed to our loss from operations in fiscal 2005. We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced
coverage or incur substantially higher costs to maintain coverage. Further, our directors and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have
difficultly attracting and retaining qualified directors and executive officers, which could adversely affect our business.

Changes in accounting
regulations and related interpretations and policies, particularly those related to revenue recognition and share based payments, could cause us to defer recognition of revenue or recognize lower revenue or to report lower earnings per share.

While we believe that we are in compliance with SOP No. 97-2,Software Revenue Recognition, as amended, the AICPA continues
to issue implementation guidelines for these standards and the accounting profession continues to discuss a wide range of potential interpretations. Additional implementation guidelines, and changes in interpretations of such guidelines, could lead
to unanticipated changes in our current revenue accounting practices that could cause us to defer the recognition of revenue to future periods or to recognize lower revenue.

The FASB issued SFAS No. 123(R),Share-Based Payment, which requires us to recognize as an expense stock-based compensation to employees
based on their fair values, and eliminates the ability to account for stock-based compensation using the intrinsic value method in accordance with APB No. 25,Accounting for Stock Issued to Employees. As a result, when we record an
expense for our stock-based compensation plans using the fair value method beginning in fiscal 2006, we may have significant compensation charges. For example, in the first fiscal half of 2006, we recorded total stock-based compensation under SFAS
No. 123(R) of $2.0 million.

We may become subject to government regulation and legal uncertainties that could result in liability or increase the
cost of doing business, thereby adversely affecting our financial results.

We are not currently subject to direct regulation by any
domestic or foreign governmental agency, other than regulations applicable to businesses generally, such as export control laws. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations
may become applicable to us or may be adopted in the future with respect to the Internet covering issues such as taxation, user privacy, content, right to access personal data, copyrights, distribution and characteristics and quality of services.

The applicability of existing laws governing issues such as taxation, property ownership, copyrights, and other intellectual property
issues, encryption, libel, export or import matters and personal privacy to the Internet is uncertain. The vast majority of these laws were adopted prior to the broad commercial use of the Internet and related technologies. As a result, they do not
contemplate or address the unique issues of the Internet and related technologies. Changes to these laws, including some recently proposed changes, could create uncertainty in the Internet marketplace. Such uncertainty could reduce demand for our
services or increase the cost of doing business due to increased costs of litigation or increased service delivery costs.

In addition, we
could be liable for the misuse of personal information. The Federal Trade Commission, the European Union and certain state and local authorities have been investigating certain Internet companies regarding their use of personal information. We could
incur additional expenses if new regulations regarding the use of personal information are introduced or if these authorities choose to investigate our privacy practices.



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Anti-takeover provisions could make the sale of the company more difficult.

Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board
of directors. For example, no potential acquirer would be able to call a special meeting of stockholders to remove our board of directors. A potential acquirer would also not be able to act by written consent without a meeting. In addition, our
board of directors has staggered terms that make it difficult to remove all directors at once. The acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquirer would not be able to
cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on our board of directors than if cumulative voting were permitted.

Subject to its fiduciary duties, our board of directors may in the future adopt a stockholder rights plan. If the board adopts a stockholder rights plan,
it may discourage a merger or tender offer involving our securities that is not approved by our board of directors by increasing the cost of effecting any such transaction and, accordingly, could have an adverse impact on stockholders who may want
to vote in favor of such merger or participate in such tender offer.

In addition, Section 203 of the Delaware General Corporation Law
limits business combination transactions with 15% stockholders that have not been approved by the issuers board of directors. These provisions and other similar provisions make it more difficult or impossible for a third party to acquire us
without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders.

Item 6. Exhibits



|      |  |                                                                                                                                                                                                                                                                                                                                                    
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a)   |  | Exhibits                                                                                                                                                                                                                                                                                                                                           
|      | 
|2.1   |  | Amended and Restated Agreement and Plan of Merger by and among SumTotal Systems, Inc., Pathlore Software Corporation, Galaxy Acquisition Corporation, James Collis, as Stockholder Representative,
and U.S. Bank National Association, as Escrow Agent dated September 19, 2005 (incorporated by reference to Form 8-K filed on September 23, 2005)
|      | 
|3.1   |  | Amended and Restated Articles of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19,
2004)                                                                                                                                                                    
|      | 
|3.2   |  | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on March 19, 2004)                                                                                                                                                                                                                                                        
|      | 
|4.1   |  | Registration Rights Agreement dated as of November 15, 2001 by and between Click2learn and various investors (incorporated by reference to Click2learns Current Report on Form 8-K
dated November 15, 2001)                                                                                                                                       
|      | 
|4.2   |  | Form of Warrant to Purchase Common Stock dated as of November 20, 2001 from Click2learn to various investors (incorporated by reference to Click2learns Current Report on Form 8-K
dated November 15, 2001)                                                                                                                                       
|      | 
|4.3   |  | Registration Rights Agreement dated as of June 20, 2003 by and between Click2learn and various investors (incorporated by reference to Click2learns Current Report on Form 8-K dated
June 20, 2003)                                                                                                                                               
|      | 
|4.4   |  | Form of Warrant to Purchase Common Stock dated as June 20, 2003 from Click2learn to various investors (incorporated by reference to Click2learns Current Report on Form 8-K dated
June 20, 2003)                                                                                                                                                  
|      | 
|4.5   |  | Registration Rights Agreement between SumTotal, Inc. and certain stockholders of Pathlore Software Corporation dated August 3, 2005 (incorporated by reference to Exhibit 4.5 to Form 10-K
filed March 28, 2006)                                                                                                                                   
|      | 
|10.16 |  | *Amended and Restated Equity Incentive Plan, dated June 9, 2006 (incorporated by reference to Exhibit 10.16 to Form 10-Q filed August 9, 2006)                                                                                                                                                                                                     
|      | 
|10.17 |  | *Section 16 Officers Compensation (incorporated by reference to Form 8-K filed on June 12, 2006)                                                                                                                                                                                                                                                  
|      | 
|31.1  |  | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a- 14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                 
|      | 
|31.2  |  | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a- 14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                 
|      | 
|32.1  |  | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**                                                                                                                                                                   

---

|* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Previously filed.
|-- | -----------------



17



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##### Table of Contents

SIGNATURES

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



|                   |  |  |  |                                              
|------------------ |  |  |  | ---------------------------------------------
|                   |  |  |  | SUMTOTAL SYSTEMS, INC.                       
|                   |  | 
|September 15, 2006 |  |  |  | /s/ NEIL J. LAIRD                            
|Date               |  |  |  | Neil J. Laird                                
|                   |  |  |  | Chief Financial Officer                      
|                   |  |  |  | (Duly Authorized Officer and                 
|                   |  |  |  | Chief Financial and Chief Accounting Officer)



18



---

##### Table of Contents

EXHIBIT INDEX



|           |  |                                                                                                                                                                                                                                                                                                                                                    
|---------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Description                                                                                                                                                                                                                                                                                                                                        
|           | 
|2.1        |  | Amended and Restated Agreement and Plan of Merger by and among SumTotal Systems, Inc., Pathlore Software Corporation, Galaxy Acquisition Corporation, James Collis, as Stockholder Representative,
and U.S. Bank National Association, as Escrow Agent dated September 19, 2005 (incorporated by reference to Form 8-K filed on September 23, 2005)
|           | 
|3.1        |  | Amended and Restated Articles of Incorporation, filed with the Secretary of State of Delaware on March 18, 2004 (incorporated by reference to Form 8-K filed on March 19,
2004)                                                                                                                                                                    
|           | 
|3.2        |  | Amended and Restated Bylaws (incorporated by reference to Form 8-K filed on March 19, 2004)                                                                                                                                                                                                                                                        
|           | 
|4.1        |  | Registration Rights Agreement dated as of November 15, 2001 by and between Click2learn and various investors (incorporated by reference to Click2learns Current Report on Form 8-K
dated November 15, 2001)                                                                                                                                       
|           | 
|4.2        |  | Form of Warrant to Purchase Common Stock dated as of November 20, 2001 from Click2learn to various investors (incorporated by reference to Click2learns Current Report on Form 8-K
dated November 15, 2001)                                                                                                                                       
|           | 
|4.3        |  | Registration Rights Agreement dated as of June 20, 2003 by and between Click2learn and various investors (incorporated by reference to Click2learns Current Report on Form 8-K dated
June 20, 2003)                                                                                                                                               
|           | 
|4.4        |  | Form of Warrant to Purchase Common Stock dated as June 20, 2003 from Click2learn to various investors (incorporated by reference to Click2learns Current Report on Form 8-K dated
June 20, 2003)                                                                                                                                                  
|           | 
|4.5        |  | Registration Rights Agreement between SumTotal, Inc. and certain stockholders of Pathlore Software Corporation dated August 3, 2005 (incorporated by reference to Exhibit 4.5 to Form 10-K
filed March 28, 2006)                                                                                                                                   
|           | 
|10.16      |  | *Amended and Restated Equity Incentive Plan, dated June 9, 2006 (incorporated by reference to Exhibit 10.16 to Form 10-Q filed August 9, 2006)                                                                                                                                                                                                     
|           | 
|10.17      |  | *Section 16 Officers Compensation (incorporated by reference to Form 8-K filed on June 12, 2006)                                                                                                                                                                                                                                                  
|           | 
|31.1       |  | Certifications of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a- 14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                 
|           | 
|31.2       |  | Certifications of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a- 14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                 
|           | 
|32.1       |  | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**                                                                                                                                                                   

---

|* | Each exhibit marked with a (*) is a compensatory contract, plan or other arrangement in which one or more directors and/or executive officers are eligible to participate.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Previously filed.
|-- | -----------------