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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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(Mark One)

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

For the fiscal year ended December 31, 2005

OR



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

Commission file number: 000-27163

LOGO



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Kana Software, Inc.

(Exact Name of Registrant as Specified in its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0435679                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|181 Constitution Drive Menlo Park, California                  |  | 94025                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          

(650) 614-8300

(Registrants Telephone Number, Including Area Code)

Securities registered pursuant to
Section 12(b) of the Act:

None

Securities registered pursuant to section 12(g) of the Act:

Common Stock, $0.001 par value per
share

(Title of class)



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Indicate by check mark if the Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities
Act.    Yes ̈No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes ̈No  x

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 ̈No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

Large accelerated
filer ̈Accelerated filer ̈Non-accelerated filer  x

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

As of June 30, 2005, the last business day of the Registrants most recently completed second fiscal quarter, the aggregate market value of the
voting stock held by non-affiliates of the Registrant was approximately $49,395,302 based upon the closing sales price of the Registrants Common Stock as reported on the NASDAQ National Market of $1.60.

At May 31, 2006 the Registrant had outstanding approximately 34,517,637 shares of Common Stock, $0.001 par value per share.



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KANA Software, Inc.

Form 10-K

For the Fiscal Year Ended December 31, 2005

TABLE OF CONTENTS



|          |  |                                                                                                                  |  |     
|--------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|          |  |                                                                                                                  |  | Page
|PART I.   |  |                                                                                                                  |  |     
|Item 1.   |  | Business                                                                                                         |  | 1   
|Item 1A.  |  | Risk Factors                                                                                                     |  | 8   
|Item 1B.  |  | Unresolved Staff Comments                                                                                        |  | 22  
|Item 2.   |  | Properties                                                                                                       |  | 22  
|Item 3.   |  | Legal Proceedings                                                                                                |  | 22  
|Item 4.   |  | Submission of Matters to a Vote of Security Holders                                                              |  | 23  
|          |  |                                                                                                                 
|PART II.  |  |                                                                                                                  |  |     
|Item 5.   |  | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 24  
|Item 6.   |  | Selected Financial Data                                                                                          |  | 25  
|Item 7.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 27  
|Item 7A.  |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 42  
|Item 8.   |  | Financial Statements and Supplementary Data                                                                      |  | 43  
|Item 9.   |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             |  | 71  
|Item 9A.  |  | Controls and Procedures                                                                                          |  | 71  
|Item 9B.  |  | Other Information                                                                                                |  | 73  
|          |  |                                                                                                                 
|PART III. |  |                                                                                                                  |  |     
|          |  |                                                                                                                 
|Item 10.  |  | Directors and Executive Officers of the Registrant                                                               |  | 74  
|Item 11.  |  | Executive Compensation                                                                                           |  | 76  
|Item 12.  |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                   |  | 83  
|Item 13.  |  | Certain Relationships and Related Transactions                                                                   |  | 87  
|Item 14.  |  | Principal Accountant Fees and Services                                                                           |  | 88  
|          |  |                                                                                                                 
|PART IV.  |  |                                                                                                                  |  |     
|          |  |                                                                                                                 
|Item 15.  |  | Exhibits and Financial Statement Schedules                                                                       |  | 90  
|          |  |                                                                                                                 
|          |  | Signatures                                                                                                       |  | 97  
|          |  |                                                                                                                 
|          |  | Exhibit Index                                                                                                    |  | 99  



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PART I

In addition to historical information, this report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections
about our business and industry, and our beliefs and assumptions. Words such as anticipate, believe, estimate, expects, intend, plan, will and variations of these
words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict
and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described in Item 1A Risk Factors and
elsewhere in this report. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or false. We undertake no obligation to revise or publicly release the results of any revision to these
forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

ITEM 1. BUSINESS.

Overview

KANA Software, Inc. (the Company or KANA) is a world leader in multi-channel customer service. Our software applications enable organizations to improve the quality and efficiency of
interactions with customers and partners across multiple communication points. KANAs integrated solutions allow companies to deliver consistent, managed service across all channels, including email, chat, call centers and Web self-service, so
customers have the freedom to choose the service they want, how and when they want it. Our target market is the Global 2000 with a focus on large enterprises with high volumes of customer interactions, such as banks, telecommunications companies,
high-tech manufacturers, healthcare organizations and government agencies.

We are headquartered in Menlo Park, California, with offices in
Japan, Hong Kong, Korea and throughout the United States and Europe.

We were incorporated in July 1996 in California and reincorporated in
Delaware in September 1999. We had no significant operations until 1997. References in this Annual Report on Form 10-K to we, our and us collectively refer to KANA, our predecessor and our subsidiaries and its
predecessors. Our principal executive offices are located at 181 Constitution Drive, Menlo Park, California 94025 and our telephone number is (650) 614-8300. Our Internet website is located at http://www.kana.com. We make available free of
charge on our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934, as soon as
reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). All such filings are also available at the Securities and Exchange Commission Public Reference Room
at 100F Street, NE, Washington, DC 20549. Information regarding the Public Reference Room may be obtained by calling the SEC at 1-(800)-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements and
other information regarding issuers that file electronically with the SEC which can be found at http://www.sec.gov.

Our Strategy

Deliver world-class products that focus on improving customer satisfaction, increasing corporate revenue and reducing the cost to provide service.
Independent studies have shown that a significant percentage of an enterprises cost of providing service to its customers resides in resolving individual customer questions and problems, or cases. These cases must be received, routed, tracked
and resolved by customer service agents. While many enterprises possess technology capable of routing and tracking cases, the actual resolution of customer issues is largely unautomated, and therefore is the most costly phase. Our product portfolio
addresses this largely underserved customer service resolution market. Our knowledge-powered customer service solutions focus on automating the service resolution process across multiple channels. The majority of our license revenues are for
applications that are used by our customers agents (Assisted Service), or directly by their customers (Web Self-Service), empowering them with knowledge and information to resolve their issues.



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Partner with the worlds leading system integrators. Our strategy is to focus our efforts on
the sale of software and maintenance and to enter into strategic relationships with leading systems integrators in order to provide our customers with a wide range of implementation, systems integration and consulting services. Our professional
services organization augments the systems integrator partners with subject matter expertise on our applications. Our customers can benefit from the integrators deep KANA product expertise, as well as their outstanding industry knowledge and
proven integration success. In addition, these integrators employ larger sales forces than we do, and we generally coordinate our sales efforts with them.

Deliver industry-specific applications. Some industries, such as banking, telecommunications and healthcare, have exceptionally high volumes of customer interactions, and providing consistent and accurate
feedback to customers of companies in these industries has become increasingly difficult as the products and offerings of such companies have become increasingly complicated. We continue to expand our portfolio of industry-specific applications to
address the unique needs of our customers through a series of industry starter kits.

Products

KANA provides a comprehensive suite of customer service software. Around the world, KANAs multi-channel customer service solutions are helping
Global 2000 companies provide more intelligent, effective interactions with customers, leading to loyal and lasting customer relationships while reducing costs in the contact center.

KANAs suite of multi-channel solutions is built on open standards for a high degree of adaptability and flexibility. KANA solutions provide the
critical link between contact centers and marketing departments, allowing organizations to have effective, efficient interactions with customers at all points of contact (including web, telephone and e-mail) and throughout the enterprise. KANA
employs robust reporting tools across its entire product family to allow companies to continually analyze and improve their customer and partner relationships. These features enable Global 2000 companies and other enterprises to reduce the cost of
information access for their employees, customers and partners while creating profitable customer relationships.

Our customers can deploy
KANAs multi-channel solutions as a complete suite or as separate applications. Our solutions include the following products:



| |  |  | KANA IQ - Bringing together a self-service application for customers along with an assisted-service solution for contact center agents, KANA IQ is a sophisticated knowledge
base that enables customers and agents alike to quickly and accurately locate the information they need.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KANA Response - KANA Response is a high-performance email management system that enables agent-assisted service with fast, high-volume, intelligent, automated e-mail, Web and
instant messaging request management.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KANA ResponseIQ - KANA ResponseIQ is a tightly-integrated combination of KANA IQ and KANA Response that enables companies to better manage e-mail responses to customer
inquiries by accessing a common knowledge base that routes requests through appropriate communications channels. ResponseIQ either automatically responds to customers requests with answers to their questions or, when an automatic answer is
unavailable or the customer indicates that the automatic answer is not sufficient, forwards requests to the most qualified agents based on the rules set by the organization.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KANA Contact Center - KANA Contact Center is a multi-channel customer service application for contact centers that provides request management, solution publishing,
self-service capabilities, and extranet workflow.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our applications are designed to easily integrate with other enterprise
software and legacy systems. They can be installed on systems running either Unix or Microsoft Windows NT operating systems, and provide



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customers with capabilities for personalization, customer profile management, inquiry management, universal business
rules, knowledge management, and extranet workflow. They can be linked with customers legacy systems allowing customers to design their systems to preserve previous investments. Our service orientated architecture uses data modeling to make
data located in external systems available in our application without requiring the data to be moved or replicated. KANAs applications are built on a single web-architected platform, which we refer to as KANAs Enterprise Application
Framework. This service-orientated framework provides KANA customers with full access to our applications using a standard web browser and without requiring them to install additional software on their individual computers.

Alliances

We enter into strategic relationships with
leading systems integrators that have developed significant expertise with our web-architected applications and are able to provide customers with a wide range of consulting, implementation and systems integration services. Our systems integrator
partners are involved in most customer engagements and, in 2001, we significantly reduced the size of our professional services team and narrowed the scope of our professional services program in part to ensure that we did not compete with these key
partners for professional services engagements. In addition, many of these systems integrators act as resellers for our products, and we rely on them for assistance in driving our sales efforts. We believe that support for our products by these
systems integrators is increasingly important in influencing new customers decisions to license our products. Our systems integrators include Accenture, BearingPoint, HCL Technologies, and International Business Machines (IBM)
Business Consulting Services. These integrators have been integral to KANAs success in selling its products to large-organizations such as Advanced Micro Devices, Blue Cross and Blue Shield of Minnesota, Dell Computer Corp., eBay, Highmark,
O2, Sony Electronics, Inc., Sprint, Wachovia, Yahoo! and others.

Services and Support

Customer Support. Our customer support group uses KANAs own applications to provide multi-channel global support for our customers and
partners, including phone and e-mail support and self-service solutions via our KANA Customer and KANA Partner customer support portals.

Professional Services. Our worldwide consulting and education services group provides business and technical expertise to support our alliance partners and customers. Our consulting services group works closely with systems
integrators during implementations to lend technical experience and functional product expertise and to assist the integrators in providing our customers with high-quality, successful, enterprise-wide implementations. Education services provides a
full set of training programs and materials for our customers and partners, including a comprehensive set of courses for end users, business consultants and developers, which are available through instructor-led, web-based and on-site classes.

Each of our service groups provide up-to-date information to our customers and partners through quarterly newsletters, as well as real
time updates to our customer and partner facing knowledge base.

Sales

Our sales strategy is to focus on Global 2000 companies through a combination of strategic alliances and our direct sales force. We maintain direct sales personnel across the United States and internationally
throughout Europe, Asia-Pacific and Canada.



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Customers

Our customers range from Global 2000 companies to growing companies pursuing an e-business strategy. The following is a list of customers that we believe are representative of our overall customer base:



|                                 |  |                           
|-------------------------------- |  | --------------------------
|Financial Services               |  | Communications            
|Ameritrade                       |  | AT&T                      
|Axa                              |  | BellCanada                
|Bank of America                  |  | BellSouth                 
|Bank One                         |  | Cingular Wireless         
|Bank Leumi                       |  | Comcast                   
|Capital One                      |  | Eircom                    
|Citizens Bank                    |  | Hutchison 3G              
|Citigroup                        |  | O2                        
|Create Services (Lloyds TSB)     |  | SBC                       
|E*Trade                          |  | Sprint                    
|Hana Bank                        |  | Telstra                   
|JP Morgan Chase                  |  | Verizon Communications    
|Kookmin Bank                     |  | Verizon Wireless          
|Sumitomo Mitsui Card Company     |  |                           
|TD Waterhouse                    |  |                           
|Wachovia                         |  |                           
|Washington Mutual                |  |                           
|                                 | 
|Health Care                      |  | Government/Education      
|Allergan                         |  | Open University           
|Anthem                           |  | State of California       
|Blue Cross Blue Shield Minnesota |  | State of Ohio             
|Cigna                            |  | UK Inland Revenue         
|Highmark                         |  |                           
|Kaiser Permanente                |  |                           
|                                 | 
|High Technology                  |  | Transportation/Hospitality
|BEA Systems                      |  | America West Airlines     
|Dell Computer Corp.              |  | Best Western International
|Earthlink                        |  | British Airways           
|eBay                             |  | Delta Airlines            
|CAP GEMINI                       |  | Disney                    
|Hewlett-Packard                  |  | Jet Blue Airways          
|IBM                              |  | KLM                       
|Malam Information Technologies   |  | Northwest Airlines        
|NEC                              |  | Priceline.com             
|Palm                             |  | Travelocity               
|Siemens                          |  |                           
|Texas Instruments                |  |                           
|Yahoo!                           |  |                           
|                                 | 
|Manufacturing/Consumer Goods     |  | Retail                    
|ADC                              |  | 1-800 Flowers             
|Canon                            |  | Avon.com                  
|Creative Labs                    |  | Barnes & Noble.com        
|Daimler-Chrysler                 |  | eBay                      
|Nissan                           |  | Home Depot                
|Polycom                          |  | Staples.com               
|Sony Electronics, Inc.           |  | Target                    
|Taylor Made                      |  | The Gap                   
|Xerox                            |  | Williams-Sonoma           



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One customer, IBM, accounted for 11% of our total revenues in both 2004 and 2005. No customer accounted
for 10% or more of our total revenues in 2003. A substantial portion of our license and service revenues in any given quarter has been, and we expect will continue to be, generated from a limited number of customers. Our chief operating decision
maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, we
consider ourselves to be in a single industry segment: specifically the licensing and support of its software applications. Revenue classification is based upon customer location. See Note 12 to the Consolidated Financial Statements in Item 8
for geographic information on revenue for the years ended December 31, 2005, 2004, and 2003 and our long-lived assets (Property and Equipment, net, and Other Assets), at December 31, 2005 and 2004.

Research and Development

We believe that strong
product development capabilities are essential to our strategy of enhancing our core technology, developing additional applications incorporating that technology and maintaining the competitiveness of our product and service offerings. We have
invested significant time and resources in creating a structured process for undertaking all product development. In the first quarter of 2003, we began implementing an outsourcing strategy, which involves subcontracting a significant portion of our
software programming, quality assurance and technical documentation activities to HCL, Accenture, IBM and BearingPoint with staffing in India and China. A substantial amount of outsourcing resources was devoted to developing a new version of our
solutions on a J2EE architecture, which was released in December 2004. We began to significantly reduce the scope of our outsourced development activities in early 2005 to better align our costs with our revenues.

Our success significantly depends on our ability to enhance our existing customer service solutions and to develop new services, functionality and
technology that address the increasingly sophisticated and varied needs of our existing and prospective customers. The challenges of developing new products and enhancements require us to commit a substantial investment of resources, and we might
not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead existing and potential customers to choose a competitors products.

Our research and development expenses were $13.2 million, $19.5 million, and $21.4 million in 2005, 2004, and 2003 respectively.

Competition

The market for our products and services
is intensely competitive, evolving and subject to rapid technological change. We currently face competition for our products from software designed by our customers in-house development teams and by third parties. We expect that these
competing software applications will continue to be a major source of competition for the foreseeable future. Our primary competitors for customer relationship management software platforms are larger, more established companies such as Oracle which
recently acquired Siebel Systems. We also face competition from Chordiant Software, ATG, Amdocs, Knova, Talisma, eGain, RightNow, Instranet and Pegasystems with respect to several specific applications we offer. We may face increased competition
upon introduction of new products or upgrades from competitors, especially knowledge-powered products.

We believe that the principal
competitive factors affecting our industry include having a significant base of customers recommending our products, the breadth and depth of a given solution, product cost, product quality and performance, customer service, product scalability and
reliability, product features, ability to implement solutions, and perception of financial position. We believe that our products currently compete favorably with respect to many of these factors, and, in particular, that our web-based architecture
provides us with a competitive advantage because it allows for greater product scalability and rapid implementation. However, we may not be able to maintain our



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competitive position against current and potential competitors, especially those with greater financial, marketing,
service, support, technical and other resources, and who may, for example, be able to add features or functionality to their competing products more quickly or decide to sell their products to their existing customer bases for other products.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources,
significantly greater name recognition and a larger installed base of customers than we have. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our
industry. We may lose potential customers to competitors for various reasons, including the possible introduction by competitors of new software hosting technologies, which could be more scalable, easier to implement and cheaper than the current
technologies, and the ability or willingness of competitors to offer lower prices and other incentives that we cannot match. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.
We also expect that competition will increase as a result of industry consolidations.

Intellectual Property

We rely upon a combination of patent, copyright, trade secret and trademark laws, and contractual restrictions, such as confidentiality agreements and
licenses, to establish and protect our proprietary rights. We currently have six issued U.S. patents, four of which expire in 2018 and two of which expire in 2020, and a number of U.S. patent applications pending. Our pending applications, if
allowed, in conjunction with our issued patents, would cover a significant portion of the technology underlying our products and services. We have also filed international patent applications corresponding to some of our U.S. applications. In
addition, we have several trademarks that are registered or pending registration in the U.S. or abroad. Although we rely on patent, copyright, trade secret and trademark law to protect our technology, we believe that factors such as the
technological and creative skills of our personnel, new product development, frequent product enhancements and reliable product maintenance are more essential to establishing and maintaining a technology leadership position.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology or
to develop products with the same functionality as our products. Policing unauthorized use of our products is difficult. Also, the laws of other countries in which we market our products may offer little or no effective protection of our proprietary
technology. Furthermore, our competitors could independently develop technologies equivalent to ours, and our intellectual property rights may not be broad enough for us to prevent such competitors from selling products incorporating those
technologies. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business.

Substantial litigation regarding intellectual property rights exists in our industry. We expect that software in our industry may be
increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. Some of our competitors in the market for customer communications software may have
filed or may intend to file patent applications covering aspects of their technology that they may claim our technology infringes. Such competitors could make a claim of infringement against us with respect to our products and technology. Third
parties may currently have, or may eventually be issued, patents upon which our current or future products or technology infringe. Any of these third parties might make a claim of infringement against us. See Item 1A Risk
FactorsWe may become involved in litigation over proprietary rights, which could be costly and time consuming.

Backlog

As of December 31, 2005 and 2004 we had $17.9 million and $21.1 million, respectively, in backlog, which relates to firm orders,
with $516,000 and $2.2 million, respectively, not expected to be recognized within one year due to the timing of obligations in the underlying agreement. The substantial majority of these firm orders relates to annual support contracts, and was
invoiced and recorded as deferred revenue as of December 31, 2005 and 2004.



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Employees

As of December 31, 2005, we had 125 full-time employees, compared to 181 full-time employees as of December 31, 2004. As of May 31, 2006, we had 130 permanent full-time employees. Of the May 31, 2006 employees, 30 were
in our services and support group, 47 were in sales and marketing, 25 were in research and development, and 28 were in finance, legal, Information Technology (IT) and administration.



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ITEM 1A. RISK FACTORS.

We operate in a dynamic and rapidly changing business environment that involves
substantial risks and uncertainty, including but not limited to the specific risks identified below. The risks described below are not the only ones facing our company. Additional risks not presently known to us, or that we currently deem
immaterial, may become important factors that impair our business operations. Any of these risks could cause, or contribute to causing, our actual results to differ materially from expectations. Prospective and existing investors are strongly urged
to carefully consider the various cautionary statements and risks set forth in this report and our other public filings.

Risks Related to Our
Business and Industry

The relatively large size of many of our expected license transactions could contribute to our failure to meet expected
sales in any given quarter and could materially harm our operating results.

Our quarterly revenues are especially subject to
fluctuation because they depend on the completion of relatively large orders for our products and related services. The average size of our license transactions is generally large relative to our total revenue in any quarter, particularly as we have
focused on larger enterprise customers, on licensing our more comprehensive integrated products, and have involved system integrators in our sales process. If sales expected from a specific customer in a particular quarter are not realized in that
quarter, we are unlikely to be able to generate revenue from alternate sources in time to compensate for the shortfall. This dependence on large orders makes our net revenue and operating results more likely to vary from quarter to quarter, and more
difficult to predict, because the loss of any particular large order is significant. In recent periods, we have experienced increases in the length of a typical sales cycle. This trend may add to the uncertainty of our future operating results and
reduce our ability to anticipate our future revenues. Moreover, to the extent that significant sales occur earlier than anticipated, revenues for subsequent quarters may be lower than expected. As a result, our operating results could suffer if any
large orders are delayed or canceled in any future period. In part as a result of this aspect of our business, our quarterly revenues and operating results may fluctuate in future periods and we may fail to meet the expectations of investors and
public market analysts, which could cause the price of our common stock to decline. We expect the concentration of revenues among fewer customers to continue in the future.

We may not be able to forecast our revenues accurately because our products have a long and variable sales cycle and we rely on systems integrator partners for sales.

The long sales cycle for our products may cause license revenue and operating results to vary significantly from period to period. To date, the sales
cycle for most of our product sales has taken anywhere from 6 to 18 months. We believe that many existing and potential customers have reassessed and reduced their planned technology and software investments and are deferring purchasing decisions,
requiring additional evaluations and levels of internal approval for software investment and lengthening their purchase cycles. Our sales cycle typically requires pre-purchase evaluation by a significant number of individuals in our customers
organizations. Along with third parties that often jointly market our software with us, we invest significant amounts of time and resources educating and providing information to prospective customers regarding the use and benefits of our products.
Many of our customers evaluate our software slowly and deliberately, depending on the specific technical capabilities of the customer, the size of the deployment, the complexity of the customers network environment, and the quantity of
hardware and the degree of hardware configuration necessary to deploy our products. The continuing stagnancy of information technology spending in our markets has led to a significant increase in the time required for this process.

Furthermore, we increasingly rely on systems integrators to identify, influence and manage large transactions with customers, and we expect this trend to
continue as our industry consolidates. Selling our products in conjunction with our systems integrators who incorporate our products into their offerings can involve a particularly long and unpredictable sales cycle, as it typically takes more time
for the prospective customer to evaluate proposals from multiple vendors. In addition, when systems integrators propose the use of our products to their customers, it is typically part of a larger project, which can require more levels of customer
approvals. We have little or no control over the sales cycle of an integrator-led transaction or our customers budgetary constraints and internal decision-making and acceptance processes.



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As a result of increasingly long sales cycles, we have faced increased difficulty in predicting our
operating results for any given period, and have experienced significant unanticipated fluctuations in our revenues from period to period. Any failure to achieve anticipated revenues for a period could cause our stock price to decline.

Our business relies heavily on customer service solutions, and these solutions may not gain market acceptance.

We have made customer service solutions our main focus and, in recent periods, have allocated a significant portion of our research and development and
marketing resources to the development and promotion of such products. If these products are not accepted by potential customers, our business would be materially adversely affected. For our current business model to succeed, we believe that we will
need to convince new and existing customers of the merits of purchasing our customer service solutions over traditional customer relationship management, or CRM, solutions and competitors customer service solutions. Many of these customers
have previously invested substantial resources in adopting and implementing their existing CRM products, whether such products are ours or are those of our competitors. We may be unable to convince customers and potential customers that it is worth
them purchasing substantial new software packages to provide them with our specific customer service capabilities. If our strategy of offering customer service solutions fails, we may not be able to sell sufficient quantities of our product
offerings to generate significant license revenues, and our business could be harmed.

Our expenses are generally fixed and we will not be able to
reduce these expenses quickly if we fail to meet our revenue expectations.

Most of our expenses, such as employee compensation and
outsourcing of technical support and certain development functions, are relatively fixed in the short term. Other expenses like leases are fixed and are more long term. Moreover, our forecast is based, in part, upon our expectations regarding future
revenue levels. As a result, in any particular quarter our total revenue can be below expectation and we could not proportionately reduce operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate
negative effect on our expected operating results for that quarter.

If we fail to generate sufficient revenues to support our business and require
additional financing, failure to obtain such financing would affect our ability to maintain our operations and to grow our business, and the terms of any financing we obtain may impair the rights of our existing stockholders.

In the future, we may be required to seek additional financing to fund our operations or growth, and such financing may not be available to us, or may
impair the rights of our existing stockholders. Furthermore, any failure to raise sufficient capital in a timely fashion could prevent us from growing or pursuing our strategies or cause us to limit our operations and cause potential customers to
question our financial viability. We had cash and cash equivalents of $6.2 million at December 31, 2005. It is likely that our cash position could decrease over the next few quarters and some customers will be increasingly concerned about
our cash situation and our ongoing ability to update and maintain our products. This could significantly harm our sales efforts.

On
November 30, 2005, the Company established a new banking relationship with Bridge Bank N.A. (Bridge). In addition, on November 30, 2005, the Company entered into a Business Financing Agreement and Intellectual Property Security Agreement
with Bridge under which the Company has access to a Loan facility of $7.0 million (Loan). This Loan is made up of two parts, (i) a Formula Revolving Line of Credit of up to $5.0 million and (ii) a Non-Formula Revolving Line of Credit of
up to $6.0 million, of which $2.0 million is available for a borrowing base for stand-by letters of credits, settlement limits on foreign exchange contracts (FX) or cash management products. The combined total borrowing under the two parts cannot
exceed $7.0 million. The Formula Revolving Line of Credit is collateralized by all of our assets and expires November 29, 2006 at which time the entire balance under the line of credit will be due. Interest for the Formula Revolving Line of Credit
accrues at Bridges Prime Lending Rate plus 2% while interest for the Non-Formula Revolving Line of Credit will accrue at Bridges Prime Lending Rate plus 0.50%. On December 29, 2005, the Company entered into a Business Financing
Agreement, which provided for additional advances up to $1.5 million based on an advance rate of 80% of eligible receivables. The overall Loan Facility was increased to $7.5 million. As of December 31, 2005, the Company had $7.4 million drawn
against the Loan. On March 30, 2006, the Company modified the Business Financing Agreement with Bridge Bank to increase the additional advances for accounts receivable to $2.0 million and the overall Loan Facility to $8.0 million. Factors such as
the commercial success of



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our existing products and services, the timing and success of any new products and services, the progress of our research
and development efforts, our results of operations, the status of competitive products and services, and the timing and success of potential strategic alliances or potential opportunities to acquire or sell technologies or assets may require us to
seek additional funding sooner than we expect. In the event that we require additional cash, we may not be able to secure additional financing on terms that are acceptable to us, especially in the current uncertain market climate, and we may not be
successful in implementing or negotiating other arrangements to improve our cash position. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and
the securities we issue might have rights, preferences, and privileges senior to those of our current stockholders. If adequate funds were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current
operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.

If we fail to grow our customer base or generate repeat business, our operating results could be harmed.

Our business model generally depends on the sale of our products to new customers as well as on expanded use of our products within our customers
organizations. If we fail to grow our customer base or generate repeat and expanded business from our current and future customers, our business and operating results will be seriously harmed. In some cases, our customers initially make a limited
purchase of our products and services for pilot programs. These customers may not purchase additional licenses to expand their use of our products. If these customers do not successfully develop and deploy initial applications based on our products,
they may choose not to purchase deployment licenses or additional development licenses. In addition, as we introduce new versions of our products, new product lines or new product features, our current customers might not require the additional
functionality we offer and might not ultimately license these products. Furthermore, because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously
sold; any downturn in our software license revenue would negatively affect our future services revenue. Also, if customers elect not to renew their maintenance agreements, our services revenue could decline significantly. If customers are unable to
pay for their current products or are unwilling to purchase additional products, our revenues would decline. Additionally, a substantial percentage of our sales come from repeat customers. If a significant existing customer or a group of existing
customers decide not to repeat business with us, our revenues would decline and our business would be harmed.

We face substantial competition
and may not be able to compete effectively.

The market for our products and services is intensely competitive, evolving, and
subject to rapid technological change. From time to time, our competitors reduce the prices of their products and services (substantially in certain cases) in order to obtain new customers. Competitive pressures could make it difficult for us to
acquire and retain customers and could require us to reduce the price of our products.

Our customers requirements and the technology
available to satisfy those requirements are continually changing. Therefore, we must be able to respond to these changes in order to remain competitive. If our international development partners do not adequately perform the software programming,
quality assurance and technical documentation activities we outsourced, we may not be able to respond to such changes as quickly or effectively. Changes in our products may also make it more difficult for our sales force to sell effectively. In
addition, changes in customers demand for the specific products, product features, and services of other companies may result in our products becoming uncompetitive. We expect the intensity of competition to increase in the future.
Increased competition may result in price reductions, reduced gross margin and loss of market share. We may not be able to compete successfully against current and future competitors, and competitive pressures may seriously harm our business.

Our competitors vary in size and in the scope and breadth of products and services offered. We currently face competition with our
products from systems designed in-house and by our competitors. We expect that these systems will continue to be a major source of competition for the foreseeable future. Our primary competitors for eCRM platforms are larger, more established
companies such as Oracle, which recently acquired Siebel Systems. The rate that competitors are consolidating is increasing. We also face competition from Chordiant Software, ATG, Amdocs, Knova, Talisma, eGain, RightNow, Instranet, and Pegasystems
with respect to specific applications we



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offer. We may face increased competition upon introduction of new products or upgrades from competitors, or if we expand
our product line through acquisition of complementary businesses or otherwise. As we have combined and enhanced our product lines to offer a more comprehensive software solution, we are increasingly competing with large, established providers of
customer management and communication solutions as well as other competitors. Our combined product line may not be sufficient to successfully compete with the product offerings available from these companies, which could slow our growth and harm our
business.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing and other
resources, significantly greater name recognition and a larger installed base of customers than we have. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge
of our industry. We may lose potential customers to competitors for various reasons, including the ability or willingness of competitors to offer lower prices and other incentives that we cannot match. It is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of recent industry consolidations, as well as anticipated future consolidations.

We have a history of losses and may not be able to generate sufficient revenue to achieve and maintain profitability.

Since we began operations in 1997, our revenues have not been sufficient to support our operations, and we have incurred substantial operating losses in
every quarter. As of December 31, 2005, our accumulated deficit was approximately $4.3 billion, which includes approximately $2.7 billion related to goodwill impairment charges. Our stockholders deficit at December 31, 2005, was $9.8
million. We continue to commit a substantial investment of resources to sales, product marketing, and developing new products and enhancements, and we will need to increase our revenue to achieve profitability and positive cash flows. Our
expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding improvements in general economic conditions and customer purchasing and payment
patterns, many of which are beyond our control. Our history of losses has previously caused some of our potential customers to question our viability, which has in turn hampered our ability to sell some of our products. Additionally, our revenue has
been affected by the uncertain economic conditions in recent years, both generally and in our market. As a result of these conditions, we have experienced and expect to continue to experience difficulties in attracting new customers, which means
that we may continue to experience losses, even if sales of our products and services grow.

We rely on marketing, technology, and distribution
relationships for the sale, installation and support of our products that may generally be terminated at any time, and if our current and future relationships are not successful, our growth might be limited.

We rely on marketing and technology relationships with a variety of companies, including systems integrators and consulting firms that, among other
things, generate leads for the sale of our products and provide our customers with implementation and ongoing support. If we cannot maintain successful marketing and technology relationships or if we fail to enter into additional such relationships,
we could have difficulty expanding the sales of our products and our growth might be limited.

A significant percentage of our revenues
depend on leads generated by systems integrators, or SIs, and their recommendations of our products. If SIs do not successfully market our products, our operating results will be materially harmed. In addition, many of our direct sales
are to customers that will be relying on SIs to implement our products, and if SIs are not familiar with our technology or able to successfully implement our products, our operating results will be materially harmed. We expect to continue increasing
our leverage of SIs as indirect sales channels and, if this strategy is successful, our dependence on the efforts of these third parties for revenue growth and customer service will increase. Our reliance on third parties for these functions has
reduced our control over such activities and reduced our ability to perform such functions internally. If we come to rely primarily on a single SI that subsequently terminates its relationship with us, becomes insolvent or is acquired by another
company with which we have no relationship, or decides not to provide implementation services related to our products, we may not be able to internally generate sufficient revenue or increase the revenues generated by our other SI relationships to
offset the resulting lost revenues. Furthermore, SIs typically suggest our solution in combination with other products and services, some of which may compete with our solution. SIs are not required to promote any fixed



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quantities of our products, are not bound to promote our products exclusively, and may act as indirect sales channels for
our competitors. If these companies choose not to promote our products or if they develop, market, or recommend software applications that compete with our products, our business will be harmed.

In addition to relying on SIs to recommend our products, we also rely on SIs and other third-party resellers to install and support our products. If the
companies providing these services fail to implement our products successfully for our customers, the customer may be unable to complete implementation on the schedule that it had anticipated and we may have increased customer dissatisfaction or
difficulty making future sales as a result. We might not be able to maintain our relationships with SIs and other indirect sales channel partners and enter into additional relationships that will provide timely and cost-effective customer support
and service. If we cannot maintain successful relationships with our indirect sales channel partners, we might have difficulty expanding the sales of our products and our growth could be limited. In addition, if such third parties do not provide the
support our customers need, we may be required to hire subcontractors to provide these professional services. Increased use of subcontractors would harm our margins because it costs us more to hire subcontractors to perform these services than it
would to provide the services ourselves.

Reductions in our workforce may adversely affect our ability to release products and product updates in a
timely manner.

We have substantially reduced our headcount over the last two years from a total of 211 as of December 31, 2003
to 181 as of December 31, 2004 to 125 as of December 31, 2005. The majority of this reduction was the result of our decision to shift a significant portion of our software programming, quality assurance, and technical documentation
activities to international development partners in early 2003. We reduced the size of our research and development department from 88 employees as of December 31, 2003 to 34 employees as of December 31, 2004, and to 30 employees as of
December 31, 2005. In addition, we reduced the level of our expenditures on outsourced development in 2005 (the Company announced plans to further reduce headcount in certain locations and concentrate R&D efforts in our Headquarters in
Menlo Park, California). The reductions in our research and development headcount and the reductions in our outsourced development capacity may limit our ability to release products within expected timeframes. For example, many of the employees who
were terminated in headcount reductions possessed specific knowledge or expertise that may prove to have been important to our operation. As a result of these staff reductions, our ability to respond to unexpected challenges may be impaired and we
may be unable to take advantage of new opportunities. Personnel reductions may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us to incur significant expense. Our termination
of two outsourcing arrangements in early 2005 may further reduce our ability to respond to development challenges and to introduce new products in expected timeframes.

We may be unable to hire and retain the skilled personnel necessary to develop and grow our business.

Concern over our long-term financial strength may create concern among existing employees about job security, which could lead to increased turnover and reduce our ability to meet the needs of our current and future customers. Because our
stock price declined drastically in recent years, and has not experienced any sustained recovery from the decline, stock-based compensation, including options to purchase our common stock, may have diminished effectiveness as employee hiring and
retention devices. If we are unable to retain qualified personnel, we could face disruptions to operations, loss of key information, expertise or know-how and unanticipated additional recruitment and training costs. If employee turnover increases,
our ability to provide customer service and execute our strategy would be negatively affected.

For example, our ability to increase
revenues in the future depends considerably upon our success in training and retaining effective direct sales personnel and the success of our direct sales force. We might not be successful in these efforts. Our products and services require
sophisticated sales efforts. We have experienced significant turnover in our sales force including domestic senior sales management, and may experience further turnover in future periods. It generally takes a new salesperson nine or more months to
become productive, and they may not be able to generate new sales. Our business will be harmed if we fail to retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more
slowly than anticipated.



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If we fail to respond to changing customer preferences in our market, demand for our products and our ability to
enhance our revenues will suffer.

If we do not continue to improve our products and develop new products that keep pace with
competitive product introductions and technological developments, satisfy diverse and rapidly evolving customer requirements, and achieve market acceptance, we might be unable to attract new customers. Our industry is characterized by rapid and
substantial developments in the technologies and products that enjoy widespread acceptance among prospective and existing customers. The development of proprietary technology and necessary service enhancements entails significant technical and
business risks and requires substantial expenditures and lead-time. In addition, if our international development partners fail to provide the development support we need, our products and product documentation could fall behind those produced by
our competitors, causing us to lose customers and sales. We might not be successful in marketing and supporting our products or developing and marketing other product enhancements and new products that respond to technological advances and market
changes, on a timely or cost-effective basis. In addition, even if these products are developed and released, they might not achieve market acceptance. We have experienced delays in releasing new products and product enhancements in the past and
could experience similar delays in the future. These delays or problems in the installation or implementation of our new releases could cause us to lose customers.

Our failure to manage multiple technologies and technological change could reduce demand for our products.

Rapidly
changing technology and operating systems, changes in customer requirements, and evolving industry standards might impede market acceptance of our products. Our products are designed based upon currently prevailing technology to work on a variety of
hardware and software platforms used by our customers. However, our software may not operate correctly on evolving versions of hardware and software platforms, programming languages, database environments and other systems that our customers use. If
new technologies emerge that are incompatible with our products, or if competing products emerge that are based on new technologies or new industry standards and that perform better or cost less than our products, our key products could become
obsolete and our existing and potential customers could seek alternatives to our products. We must constantly modify and improve our products to keep pace with changes made to these platforms and to database systems and other back-office
applications and Internet-related applications. Furthermore, software adapters are necessary to integrate our products with other systems and data sources used by our customers. We must develop and update these adapters to reflect changes to these
systems and data sources in order to maintain the functionality provided by our products. As a result, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems,
databases, customer relationship management software, web servers and other enterprise and Internet-based applications could delay our product development, increase our product development expense or cause customers to delay evaluation, purchase and
deployment of our analytics products. Furthermore, if our international development partners fail to respond adequately when adaptation of our products is required, our ability to respond would be hampered even if such uncertainties were eliminated.
If we fail to modify or improve our products in response to evolving industry standards, our products could rapidly become obsolete.

Failure to
develop new products or enhancements to existing products on a timely basis would hurt our sales and damage our reputation.

The
challenges of developing new products and enhancements require us to commit a substantial investment of resources to development, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which
could be exploited by our competitors and lead potential customers to choose alternative products. To be competitive, we must develop and introduce on a timely basis new products and product enhancements for companies with significant e-business
customer interactions needs. Our ability to deliver competitive products may be negatively affected by the diversion of resources to development of our suite of products, and responding to changes in competitive products and in the demands of our
customers. If we experience product delays in the future, we may face:



| |  |  | customer dissatisfaction;
| | - |  | -------------------------



| |  |  | cancellation of orders and license agreements;
| | - |  | ----------------------------------------------



| |  |  | negative publicity;
| | - |  | -------------------



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| |  |  | loss of revenues; and
| | - |  | ---------------------



| |  |  | slower market acceptance
| | - |  | ------------------------

Furthermore, delays in bringing
new products or enhancements to market can result, for example, from potential difficulties with managing outsourced research and development, including overseeing such activities occurring in India and China or from loss of institutional knowledge
through reductions in force, or the existence of defects in new products or their enhancements.

Failure to license necessary third party software
incorporated in our products could cause delays or reductions in our sales.

We license third party software that we incorporate
into our products. These licenses may not continue to be available on commercially reasonable terms or at all. Some of this technology would be difficult to replace. The loss of any of these licenses could result in delays or reductions of our
applications until we identify, license and integrate or develop equivalent software. If we are required to enter into license agreements with third parties for replacement technology, we could face higher royalty payments and our products may lose
certain attributes or features. In the future, we might need to license other software to enhance our products and meet evolving customer needs. If we are unable to do this, we could experience reduced demand for our products.

Our independent registered public accounting firm has identified material weaknesses in our internal controls that, if not remediated, could affect our ability to
prepare timely and accurate financial reports, which could cause investors to lose confidence in our reported financial information and have a negative effect on the trading price of our stock.

In the course of the audit of our consolidated financial statements for the year ended December 31, 2004, our independent registered public
accounting firm identified and reported material weaknesses in our internal control over financial reporting. A material weakness is a reportable condition in which our internal controls do not reduce to a low level the risk that undetected
misstatements caused by error or fraud may occur in amounts that are material to our audited consolidated financial statements. In addition, our Chief Executive Officer and Chief Financial Officer performed an evaluation of our disclosure controls
and procedures and found that they were not effective. First, we had weaknesses in our general accounting processes related to insufficient documentation and analyses to support our consolidated financial statements, failure to properly evaluate
estimates of royalties due, and insufficient staffing in the accounting and reporting function, which is exacerbated by changes in management and accounting personnel and insufficient training of our accounting department. Second, there was no
independent review of journal entries, and insufficient documentation or support for journal entries and consolidation entries. In a number of cases, these required adjustments to our consolidated financial statements for the year ended
December 31, 2004.

Finally, during the first quarter of 2005, our Audit Committee completed an examination of certain of our internal
controls relating to travel and entertainment expenses and determined that we had made erroneous expense reimbursements to our Chief Executive Officer and certain other executive officers, primarily as a result of inconsistent travel and
entertainment policies, inadequate review of expense reimbursement requests and carelessness.

Our management has determined that these
deficiencies constitute material weaknesses as of December 31, 2004 that continued to exist during 2005. As a result, we are unable to conclude that our disclosure controls and procedures were effective as of December 31, 2005. (See
Item 9A. Controls and Procedures in Part II: Financial Information). We believe that these deficiencies did not have a material impact on our consolidated financial statements included in this report due to the fact that we performed
substantial analysis on and for the December 31, 2005 and prior periods balances, including performing historical account reconciliations, having account balance analysis reviewed by senior management and reconstructing certain account
balances. However, these deficiencies increase the risk that a transaction will not be accounted for consistently and in accordance with established policy or accounting principles generally accepted in the United States, and they increase the risk
of error.

Management, with the oversight of the Audit Committee of the Board of Directors, has begun to address these control deficiencies
and is committed to effective remediation of all these deficiencies as expeditiously as possible. For instance, our new Chief Financial Officer joined the Company in mid October 2004. Some new



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processes and controls have already been approved and are being implemented. The Company plans to develop and implement
further improvements and additional controls. In addition, management believes that it has remediated the material weakness relating to travel and entertainment expense reimbursement during the first quarter of 2005. The Companys other
weaknesses will not be considered remediated until new internal controls are developed and implemented throughout the Company, are operational for a period of time and are tested, and management concludes that these controls are operating
effectively.

Our remediation measures may not be successful in correcting the material weakness reported by our independent registered
public accounting firms. In addition, we cannot assure you that additional material weaknesses or significant deficiencies in our internal controls will not be discovered in the future. In addition, controls may become inadequate because of changes
in conditions, and the degree of compliance with the policies or procedures may deteriorate. Any failure to remediate the material weaknesses described above or to implement and maintain effective internal controls could harm our operating results,
cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Deficiencies in our internal controls could also cause investors to lose confidence in our reported financial information, which
could have a negative effect on the trading price of our stock.

We face additional risks and costs as a result of the delayed filing of our
Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30, and September 30, 2005, and March 31, 2006, and our Annual Report on Form 10-K for the years ended December 31, 2004 and 2005.

As a result of missing an established deadline with the NASDAQ Listing Qualifications Panel for filing our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005, we have experienced additional risks and costs. The March 31, 2005 10-Q was filed on October 11, 2005, past the NASDAQ Listing Qualification Panels established deadline of October 7, 2005;
thus, the NASDAQ Listing Qualifications Panel delisted the Companys common stock effective as of the beginning of trading on October 17, 2005. Since our common stock was delisted from The NASDAQ Stock Market, the ability of our
stockholders to sell our common stock has been severely limited, causing our stock price to continue to decline.

As a result of our
delayed filings, we will be ineligible to register our securities on Form S-3 for sale by us or resale by others until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for one year. Instead, the Company may be
required to use Form S-1 to raise capital or complete acquisitions, which would increase transaction costs and adversely affect our ability to raise capital or complete acquisitions of other companies during this period.

Our common stock was recently delisted from The NASDAQ National Market.

Our common stock was delisted from The NASDAQ National Market effective at the opening of business on October 17, 2005 and our common stock is currently trading on the Pink Sheets. This delisting will
likely reduce the liquidity of our securities, could cause investors not to trade in our securities and result in a lower stock price and could have an adverse effect on the Company. Additionally, we may become subject to the SEC rules that affect
penny stocks, which are stocks below $5.00 per share that are not quoted on a NASDAQ Market. These SEC rules would make it more difficult for brokers to find buyers for our securities and could lower the net sales prices that our
stockholders are able to obtain. If our price of common stock remains low, we may not be able to raise equity capital. While we intend to seek to have our common stock quoted on the Over the Counter (OTC) Bulletin Board, there can be no
assurances as to when, or whether, they will become quoted on the OTC Bulletin Board.

Our stock price has been highly volatile and has experienced a
significant decline, and may continue to be volatile and decline.

The trading price of our common stock has fluctuated widely in the
past and we expect that it will continue to do so in the future, as a result of a number of factors, many of which are outside our control, such as:



| |  |  | variations in our actual and anticipated operating results;
| | - |  | -----------------------------------------------------------



| |  |  | changes in our earnings estimates by analysts;
| | - |  | ----------------------------------------------



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| |  |  | the volatility inherent in stock prices within the emerging sector within which we conduct business; and
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | the volume of trading in our common stock, including sales of substantial amounts of common stock issued upon the exercise of outstanding options and warrants.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

In addition, stock markets in general, and particularly The NASDAQ National Market and the Pink Sheets, have
experienced extreme price and volume fluctuations that have affected the market prices of many technology and computer software companies, particularly Internet-related companies. Such fluctuations have often been unrelated or disproportionate to
the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a particular companys securities,
securities class action litigation has often been brought against that company. Securities class action litigation could result in substantial costs and a diversion of our managements attention and resources.

Since becoming a publicly traded security listed on The NASDAQ National Market in September 1999, our common stock has reached a sales price high of
$1,698.10 per share and a sales price low of $0.65 per share. On October 17, 2005, our common stock was delisted from The NASDAQ National Market due to the failure to file our Quarterly Report on Form 10-Q for the quarter ended March 31,
2005. Since October 17, 2005, our common stock has been traded on the Pink Sheets. The last reported sale price of our shares on May 31, 2006 was $1.90 per share.

We have experienced transitions in our management team, our board of directors and our independent registered public accounting firm in the past and may continue to do so in the future.

We have experienced a number of transitions with respect to our board of directors, executive officers, and our independent registered public accounting
firm in recent quarters, including the following:



| |  |  | In June 2006, Deloitte & Touche LLP, our independent registered public accounting firm resigned.
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | In June 2006, Brian Kelly resigned from his position as President, Connectify.
| | - |  | ------------------------------------------------------------------------------



| |  |  | In February 2006, we appointed Burr, Pilger & Mayer LLP as our new independent registered public accounting firm.
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | In February 2006, Alan Hubbard resigned from his position as Executive Vice President of Products and Technology.
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | In January 2006, Deloitte & Touche LLP notified us that they would resign as our independent registered public accounting firm upon completion of their review of our
unaudited financial statements for the quarter and six months ended June 30, 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In December 2005, William Clifford was elected to our board of directors.
| | - |  | -------------------------------------------------------------------------



| |  |  | In November 2005, Chuck Bay retired from the Board of Directors.
| | - |  | ----------------------------------------------------------------



| |  |  | In October 2005, John F. Nemelka was elected to our board of directors.
| | - |  | -----------------------------------------------------------------------



| |  |  | In September 2005, Tim Angst resigned from his position as Executive Vice President of Worldwide Operations.
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | In August 2005, Michael S. Fields accepted the position of Chief Executive Officer while retaining his role as chairman of the board.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In August 2005, Mr. Bay resigned his position as Chief Executive Officer.
| | - |  | -------------------------------------------------------------------------



| |  |  | In July 2005, Mr. Bay began a leave of absence from his position as Chief Executive Officer, and Mr. Fields was appointed acting president and chairman of the board.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2005, Michael J. Shannahan and Mr. Fields were elected to our board of directors.
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | In April 2005, two of our independent outside directors, Mark Bertelson and Thomas Galvin, resigned from our Board of Directors and Board committees.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In November 2004, Stephanie Vinella was elected to our board of directors.
| | - |  | --------------------------------------------------------------------------



| |  |  | In October 2004, Thomas Doyle resigned from his position as Chief Operating Officer and President.
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | In July 2004, PricewaterhouseCoopers LLP, our independent accountants, resigned as our independent registered public accounting firm. In September 2004, we appointed
Deloitte & Touche LLP as our new independent registered public accounting firm.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2004, John Huyett resigned from his position as Chief Financial Officer, and in October 2004, John Thompson was appointed Executive Vice President and Chief Financial
Officer.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Such past and future transitions may continue to result in disruptions in our operations and require
additional costs.

Our pending patents may never be issued and, even if issued, may provide little protection.

Our success and ability to compete depend to a significant degree upon the protection of our software and other proprietary technology rights. We
currently have six issued U.S. patents, four of which expire in 2018 and two of which expire in 2020, and multiple U.S. patent applications pending relating to our software. None of our technology is patented outside of the United States. It is
possible that:



| |  |  | our pending patent applications may not result in the issuance of patents;
| | - |  | --------------------------------------------------------------------------



| |  |  | any issued patents may not be broad enough to protect our proprietary rights;
| | - |  | -----------------------------------------------------------------------------



| |  |  | any issued patents could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions
claimed in those patents;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | current and future competitors may independently develop similar technology, duplicate our products or design around any of our patents; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | effective patent protection may not be available in every country in which we do business.
| | - |  | ------------------------------------------------------------------------------------------

We rely upon trademarks, copyrights and trade secrets to protect our proprietary rights, which may not be sufficient to protect our intellectual property.

In addition to patents, we rely on a combination of laws, such as copyright, trademark and trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses, to establish and protect our proprietary rights. However, despite the precautions that we have taken:



| |  |  | laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | current federal laws that prohibit software copying provide only limited protection from software pirates, and effective trademark, copyright and trade secret protection
may be unavailable or limited in foreign countries;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Also, the laws of some other countries in which we market our products may offer little or no effective protection of our
proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our
business.

We may become involved in litigation over proprietary rights, which could be costly and time consuming.

The software and Internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent
litigation based on allegations of infringement or other violations of intellectual property rights. As the number of entrants into our market increases, the possibility of an intellectual property claim against us grows. Our technologies may not be
able to withstand any third-party claims or rights against their use. Some of our competitors in the market for customer communications software may have filed or may intend to file patent applications covering aspects of their technology that they
may claim our technology infringes. Such competitors could make a claim of infringement against us with respect to our products and technology. Third parties may currently have, or may eventually be issued, patents upon which our current or future
products or technology infringe. Any of these third parties might make a claim of infringement against us. For example, from time to time, companies have asked us to evaluate the need for a license of patents they hold, and we cannot assure you that
patent infringement claims will not be filed against us in the future. Other companies may also have pending patent applications (which are typically confidential for the first eighteen months following filing) that cover technologies we incorporate
in our products.



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In addition, many of our software license agreements require us to indemnify our customers from any claim
or finding of intellectual property infringement. We periodically receive notices from customers regarding patent license inquiries they have received which may or may not implicate our indemnity obligations. Any litigation, brought by others, or us
could result in the expenditure of significant financial resources and the diversion of managements time and efforts. In addition, litigation in which we are accused of infringement might cause product shipment delays, require us to develop
alternative technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a claim of infringement was made against us and we could not develop non-infringing technology or
license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.

We may face liability
claims that could result in unexpected costs and damages to our reputation.

Our licenses with customers generally contain
provisions designed to limit our exposure to potential product liability claims, such as disclaimers of warranties and limitations on liability for special, consequential, and incidental damages. In addition, our license agreements generally limit
the amounts recoverable for damages to the amounts paid by the licensee to us for the product or service giving rise to the damages. However, some domestic and international jurisdictions may not enforce these contractual limitations on liability.
We may be subject to claims based on errors in our software or mistakes in performing our services including claims relating to damages to our customers internal systems. A product liability claim could divert the attention of management and
key personnel, could be expensive to defend, and could result in adverse settlements and judgments.

We may face higher costs and lost sales if our
software contains errors.

We face the possibility of higher costs as a result of the complexity of our products and the potential
for undetected errors. Due to the mission critical nature of many of our products and services, errors could be particularly problematic. In the past, we have discovered software errors in some of our products after their introduction. We have only
a few beta customers that test new features and functionality of our software before we make these features and functionalities generally available to our customers. If we are not able to detect and correct errors in our products or
releases before commencing commercial shipments, we could face:



| |  |  | loss of or delay in revenues expected from the new product and an immediate and significant loss of market share;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | loss of existing customers that upgrade to the new product and of new customers;
| | - |  | --------------------------------------------------------------------------------



| |  |  | failure to achieve market acceptance;
| | - |  | -------------------------------------



| |  |  | diversion of development resources;
| | - |  | -----------------------------------



| |  |  | injury to our reputation;
| | - |  | -------------------------



| |  |  | increased service and warranty costs;
| | - |  | -------------------------------------



| |  |  | legal actions by customers; and
| | - |  | -------------------------------



| |  |  | increased insurance costs.
| | - |  | --------------------------

Our security could be breached, which
could damage our reputation and deter customers from using our services.

We must protect our computer systems and network from
physical break-ins, security breaches and other disruptive problems caused by the Internet or other users. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network, which
could adversely affect our ability to retain or attract customers, damage our reputation and subject us to litigation. We have been in the past, and could be in the future, subject to denial of service, vandalism and other attacks on our systems by
Internet hackers. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage in certain circumstances may
be insufficient to cover losses that may result from such events.

Our international operations expose us to additional risks.

A substantial proportion of our revenues are generated from sales outside North America, exposing us to additional financial and operational risks. Sales
outside North America represented 30% of our total revenues for



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the year ended December 31, 2005, compared to 35% of our total revenues for the year ended December 31, 2004.
We have established offices in the United Kingdom, Japan, the Netherlands, Hong Kong and South Korea. Sales outside North America could increase as a percentage of total revenues as we attempt to expand our international operations. In addition to
the additional costs and uncertainties of being subject to international laws and regulations, international operations require significant management attention and financial resources, as well as additional support personnel. To the extent our
international operations grow, we will also need to, among other things, expand our international sales channel management and support organizations and develop relationships with international service providers and additional distributors and
system integrators. In addition, international operations can lead to greater difficulty with collecting accounts receivable, longer sales cycles and collection periods, greater seasonal fluctuations in business activity and increases in our tax
rates. Any growth in our international operations would compound these difficulties. Furthermore, products must be localized, or customized to meet the needs of local users, before they can be sold in particular foreign countries. Developing
localized versions of our products for foreign markets is difficult and can take longer than expected.

International laws and regulations may expose
us to potential costs and litigation.

Our international operations increase our exposure to international laws and regulations. If
we cannot comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potential litigation. For example, the governments of foreign countries might attempt to
regulate our products and services or levy sales or other taxes relating to our activities. In addition, foreign countries may impose tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers, any of which could
make it more difficult for us to conduct our business. The European Union has enacted its own privacy regulations that may result in limits on the collection and use of certain user information, which, if applied to the sale of our products and
services, could negatively impact our results of operations.

We may suffer foreign exchange rate losses.

Our international revenues and expenses are denominated in local currency. Therefore, a weakening of other currencies compared to the U.S. dollar could
make our products less competitive in foreign markets and could negatively affect our operating results and cash flows. We have not yet experienced, but may in the future experience, significant foreign currency transaction losses, especially
because we generally do not engage in currency hedging. To the extent the international component of our revenues grows, our results of operations will become more sensitive to foreign exchange rate fluctuations.

If we acquire companies, products, or technologies, we may face risks associated with those acquisitions.

We acquired Hipbone, Inc. in early 2004, and if we are presented with appropriate opportunities, we may make other investments in complementary companies,
products, or technologies. We may not realize the anticipated benefits of any acquisition or investment. For example, since inception, the Company has recorded $2.7 billion of impairment charges for the cost of goodwill obtained from acquisitions.
If we acquire another company, we will likely face risks, uncertainties and disruptions associated with the integration process, including, among other things, difficulties in the integration of the operations, technologies and services of the
acquired company, the diversion of our managements attention from other business concerns and the potential loss of key employees of the acquired businesses. If we fail to successfully integrate other companies that we may acquire, our
business could be harmed. Also, acquisitions can expose us to liabilities and risks facing the company we acquire, including lawsuits or claims against the company that are unknown at the time of the acquisition. Furthermore, we may have to incur
debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our existing stockholders. In addition, our operating results may suffer because of acquisition-related costs or
amortization expenses or charges relating to acquired goodwill and other intangible assets.

The role of acquisitions in our future growth may be
limited, which could harm our business and strategy.

Because the recent trading prices of our common stock have been significantly
lower than in the past, the role of acquisitions in our growth may be substantially limited. In the past, acquisitions have been an important part of our growth strategy. To gain access to key technologies, new products and broader customer bases,
we have acquired companies in exchange for shares of our common stock. If we are unable to acquire companies in exchange for our common stock, we may not have access to new customers, needed technological advances, new products, and/or enhancements
to existing products. This would substantially impair our ability to respond to market opportunities.



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Compliance with new regulations governing public company corporate governance and reporting will result in
additional costs.

Our continuing preparation for and implementation of various corporate governance reforms and enhanced disclosure
laws and regulations adopted in recent years requires us to incur significant additional accounting and legal costs. We, like other public companies, are preparing for new accounting disclosures required by laws and regulations adopted in connection
with the Sarbanes-Oxley Act of 2002. In particular, we will be preparing to provide, if required, beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2007, an Annual Report on our internal control over
financial reporting and auditors attestation with respect to our report required by Section 404 of the Sarbanes-Oxley Act. Any unanticipated difficulties in preparing for and implementing these and other corporate governance and reporting
reforms could result in material delays in compliance or significantly increase our costs. Also, there can be no assurance that we will be able to fully comply with these new laws and regulations. Any failure to timely prepare for and implement the
reforms required by these new laws and regulations could significantly harm our business, operating results, and financial condition.

Changes in the
accounting treatment of stock options could adversely affect our results of operations.

In December 2004, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS 123R) Share-Based Payment, to require companies to expense employee stock options for financial reporting purposes. This standard
became effective for the Company for our quarterly and annual periods beginning on January 1, 2006. Such stock option expensing requires us to value our employee stock option grants pursuant to an option valuation formula and amortize that
value against our earnings over the vesting period in effect for those options. Through December 31, 2005, we have accounted for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and have adopted the disclosure-only alternative of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. When we expense employee stock options in the future, this
change in accounting treatment could materially and adversely affect our reported results of operations as the stock-based compensation expense would be charged directly against our reported earnings. For pro forma disclosure illustrating the effect
such a change on our recent results of operations, see Note 1 to the Consolidated Financial Statements in Item 8. The adoption of SFAS 123R could adversely affect our ability to comply with the financial covenants of our credit facility with
our bank.

We have adopted anti-takeover defenses that could delay or prevent an acquisition of the Company.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock. Without any further vote or action on the part of the
stockholders, the board has the authority to determine the price, rights, preferences, privileges, and restrictions of the preferred stock. This preferred stock, if issued, might have preference over and harm the rights of the holders of common
stock. Although the ability to issue this preferred stock provides us with flexibility in connection with possible acquisitions and other corporate purposes, it can also be used to make it more difficult for a third party to acquire a majority of
our outstanding voting stock. We currently have no plans to issue preferred stock.

Our certificate of incorporation, bylaws and equity
compensation plans include provisions that may deter an unsolicited offer to purchase us. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer, or proxy contest.
Furthermore, our board of directors is divided into three classes, only one of which is elected each year. In addition, directors are only removable by the affirmative vote of at least 662/3% of all classes of voting stock. These factors may further delay or prevent a change of control of us.



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Risks Related to Our Industry

Future regulation of the Internet may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.

State, federal and foreign regulators could adopt laws and regulations that impose additional burdens on companies that conduct business online. These
laws and regulations could discourage communication by e-mail or other web-based communications, particularly targeted e-mail of the type facilitated by our products, which could reduce demand for our products and services.

The growth and development of the market for online services may prompt calls for more stringent consumer protection laws or laws that may inhibit the
use of Internet-based communications or the information contained in these communications. The adoption of any additional laws or regulations may decrease the expansion of the Internet. A decline in the growth of the Internet, particularly as it
relates to online communication, could decrease demand for our products and services and increase our costs of doing business, or otherwise harm our business. Any new legislation or regulations, application of laws and regulations from jurisdictions
whose laws do not currently apply to our business, or application of existing laws and regulations to the Internet and other online services could increase our costs and harm our growth.

The imposition of sales and other taxes on products sold by our customers over the Internet could have a negative effect on online commerce and the demand for our products and services.

The imposition of new sales or other taxes could limit the growth of Internet commerce generally and, as a result, the demand for our products and
services. Federal legislation that limits the imposition of state and local taxes on Internet-related sales will expire on November 1, 2007. Congress may choose to modify this legislation or to allow it to expire, in which case state and local
governments would be free to impose taxes on electronically purchased goods. We believe that most companies that sell products over the Internet do not currently collect sales or other taxes on shipments of their products into states or foreign
countries where they are not physically present. However, one or more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction companies that engage in e-commerce within their jurisdiction. A
successful assertion by one or more states or foreign countries that companies that engage in e-commerce within their jurisdiction should collect sales or other taxes on the sale of their products over the Internet, even though not physically in the
state or country, could indirectly reduce demand for our products.

Privacy concerns relating to the Internet are increasing, which could result in
legislation that negatively affects our business in reduced sales of our products.

Businesses using our products capture
information regarding their customers when those customers contact them on-line with customer service inquiries. Privacy concerns could cause visitors to resist providing the personal data necessary to allow our customers to use our software
products most effectively. More importantly, even the perception of privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our products. In addition, legislative or regulatory requirements may heighten these concerns if
businesses must notify Web site users that the data captured after visiting certain Web sites may be used by marketing entities to unilaterally direct product promotion and advertising to that user. If consumer privacy concerns are not adequately
resolved, our business could be harmed. Government regulation that limits our customers use of this information could reduce the demand for our products. A number of jurisdictions have adopted, or are considering adopting, laws that restrict
the use of customer information from Internet applications. The European Union has required that its member states adopt legislation that imposes restrictions on the collection and use of personal data, and that limits the transfer of personally
identifiable data to countries that do not impose equivalent restrictions. In the United States, the Childrens Online Privacy Protection Act was enacted in October 1998. This legislation directs the Federal Trade Commission to regulate the
collection of data from children on commercial websites. In addition, the Federal Trade Commission has investigated the privacy practices of businesses that collect information on the Internet. These and other privacy-related initiatives could
reduce demand for some of the Internet applications with which our products operate, and could restrict the use of these products in some e-commerce applications. This could, in turn, reduce demand for these products.



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ITEM 1B. UNRESOLVED STAFF COMMENTS.

Not applicable.

ITEM 2. PROPERTIES.

Our corporate headquarters are located in Menlo Park, California, where we lease
approximately 45,000 square feet under a lease that expires in April 2007. In addition, we lease offices in several cities throughout the United States and internationally in the Netherlands, Japan, Korea, and Hong Kong. We believe the facilities we
are now using are adequate and suitable for our business requirements.

We have a total of approximately 39,460 square feet of excess space
available for sublease or renegotiation. The excess space is located in Menlo Park, California, and Princeton, New Jersey. Remaining lease commitment terms on these leases vary from one to five years. We are seeking to sublease or renegotiate the
obligations associated with the excess space.

ITEM 3. LEGAL PROCEEDINGS.

The underwriters for our initial public offering, Goldman Sachs & Co.,
Lehman Bros, Hambrecht & Quist LLC and Wit Soundview Capital Corp, KANA and certain current and former officers of KANA were named as defendants in federal securities class action lawsuits filed in the United States District Court for the
Southern District of New York. The cases allege violations of various securities laws by more than 300 issuers of stock, including KANA, and the underwriters for such issuers, on behalf of a class of plaintiffs who, in the case of KANA, purchased
KANAs stock between September 21, 1999 and December 6, 2000 in connection with our initial public offering. Specifically, the complaints allege that the underwriter defendants engaged in a scheme concerning sales of KANAs and
other issuers securities in the initial public offering and in the aftermarket. In July 2003, we decided to join in a settlement negotiated by representatives of a coalition of issuers named as defendants in this action and their insurers.
Although we believe that the plaintiffs claims have no merit, we have decided to accept the settlement proposal to avoid the cost and distraction of continued litigation. Because the settlement will be funded entirely by KANAs insurers,
we do not believe that the settlement will have any effect on our consolidated financial condition, results of operation or cash flows. The proposed settlement agreement is subject to final approval by the court. Should the court fail to approve the
settlement agreement, we believe we have meritorious defenses to these claims and will defend the action vigorously.

Other third parties
have from time to time claimed, and others may claim in the future that we have infringed their past, current or future intellectual property rights. We have in the past been forced to litigate such claims. These claims, whether meritorious or not,
could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business or could require us to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm our
business.

The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative
impact on our consolidated results of operations, consolidated balance sheet and cash flows, due to defense costs, diversion of management resources and other factors.



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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The 2005 Annual Meeting of Stockholders was
held on November 17, 2005 at Fenwick & West LLP, located at Silicon Valley Center, 801 California Street, Mountain View, California. Four proposals were voted on at the meeting. The results of each proposal are as follows.

Proposal No. 1 to elect two (2) Class III directors to serve for a three-year term expiring at the 2008 Annual Meeting of Stockholders or
until a successor is duly elected and qualified, or until his earlier resignation, death or removal was approved by the stockholders. The nominees received the following votes:



|                  |  |            |  |         
|----------------- |  | ---------- |  | --------
|Nominee           |  | For        |  | Withheld
|Michael S. Fields |  | 25,590,566 |  | 797,913 
|                  |  |           
|John F. Nemelka   |  | 25,567,666 |  | 820,813 

Incumbent Class II directors Jerry Batt, Michael J. Shannahan and William T. Clifford are
currently serving for a term expiring at the 2007 Annual Meeting of Stockholders. Incumbent Class I directors Dr. Dixie L. Mills and Stephanie Vinella are currently serving for a term expiring at the 2006 Annual Meeting of Stockholders.

Proposal No. 2 to approve an amendment to the KANA 1999 Stock Incentive Plan to increase the size of automatic stock option grants to
our non-employee directors and to update the KANA 1999 Stock Incentive Plan to reflect all prior split adjustments and evergreen was approved by the stockholders. This proposal received the following votes:



|        |  |          
|------- |  | ---------
|        |  | Votes    
|For     |  | 9,220,575
|        | 
|Against |  | 1,901,113
|        | 
|Abstain |  | 53,343   

Proposal No. 3 to to approve an amendment to our Certificate of Incorporation to decrease the
number of authorized shares of common stock from 1,000,000,000 to 250,000,000 was approved by the stockholders. This proposal received the following votes:



|        |  |           
|------- |  | ----------
|        |  | Votes     
|For     |  | 26,200,643
|        | 
|Against |  | 172,306   
|        | 
|Abstain |  | 15,530    

Proposal No. 4 to ratify the appointment of Deloitte & Touche LLP as our independent
registered public accounting firm for the fiscal year ending December 31, 2005 was approved by the stockholders. This proposal received the following votes:



|        |  |           
|------- |  | ----------
|        |  | Votes     
|For     |  | 25,653,915
|        | 
|Against |  | 693,920   
|        | 
|Abstain |  | 40,645    



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PART II

ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Our common stock currently trades on the Pink Sheets under the symbol KANA.PK. Prior to October 17, 2005, our common stock was listed on The NASDAQ National Market. Our common stock traded
on the Pink Sheets as of the beginning of trading on October 17, 2005. The table below sets forth the high and low sales prices for our common stock as reported on The NASDAQ National Market and the high and low bid information for
our common stock as reported on the Pink Sheets, as applicable, for the periods indicated:



|               |  |      |      |   |     |   |      |   
|-------------- |  | ---- | ---- | - | --- | - | ---- | --
|               |  | High |      |   | Low |  
|Fiscal 2004    |  |      |      |   |     |   |      |   
|First Quarter  |  | $    | 5.70 |   |     | $ | 3.32 |   
|Second Quarter |  |      | 4.64 |   |     |   | 2.31 |   
|Third Quarter  |  |      | 2.47 |   |     |   | 1.27 |   
|Fourth Quarter |  |      | 2.19 |   |     |   | 1.44 |   
|Fiscal 2005    |  |      |      |   |     |   |      |   
|First Quarter  |  |      | 2.03 |   |     |   | 1.50 |   
|Second Quarter |  |      | 1.90 |   |     |   | 1.25 |   
|Third Quarter  |  |      | 1.69 |   |     |   | 1.44 |   
|Fourth Quarter |  |      | 1.80 | * |     |   | 1.08 | **

---

|* | This high bid information is reported on the Pink Sheets.
|- | -----------------------------------------------------------

|** | This low bid information is reported on the Pink Sheets.
|-- | ----------------------------------------------------------

Holders of Record

There were approximately 1,193 stockholders of record of our common stock as of May 31, 2006. The
actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not
include stockholders whose shares may be held in trust by other entities.

Dividend Policy

We have not paid any cash dividends on our capital stock. We currently intend to retain any earnings to fund the development and growth of our business
and, therefore, do not anticipate paying any cash dividends in the foreseeable future. In addition, our existing credit facilities prohibit the payment of cash or stock dividends on our capital stock without the lenders prior written consent.

Unregistered Sales of Equity Securities

In June 2005, the Company completed a private placement of unregistered securities for the issuance of 1,631,541 shares of common stock and warrants to purchase 815,769 shares of common stock for gross proceeds of approximately $2.4
million. In September 2005, the Company completed a private placement of unregistered securities for the issuance of 2,626,912 shares of common stock and warrants to purchase 945,687 shares of common stock for gross proceeds of approximately $4.0
million. In October 2005, the Company issued an additional 425,358 shares of common stock and warrants to purchase 153,130 shares of common stock for no proceeds. In May 2006, the Company issued an additional 593,854 shares of common stock for no
proceeds in exchange for extending the registration deadline of the shares of common stock of the warrants issued to investors from January 27, 2006 to September 30, 2006.

Securities Authorized for Issuance Under Equity Compensation Plans

Information regarding the
securities authorized for issuance under our equity compensation plans can be found under Item 12 of Part III of this Annual Report.



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ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in
conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations, the consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K, and other
information we have filed with the Securities and Exchange Commission.

The consolidated statements of operations data for the years ended
December 31, 2005, 2004, 2003, 2002, and 2001, and the consolidated balance sheet data at December 31, 2005, 2004, 2003, 2002, and 2001 are derived from our audited consolidated financial statements. The diluted net loss per share
computation excludes shares of common stock issuable upon exercise or conversion of other securities, including outstanding warrants and options to purchase common stock and common stock subject to repurchase rights, because their effect would be
antidilutive. See Note 1 of the Notes to the Consolidated Financial Statements included in Item 8 of Part II of this report for a detailed explanation of the determination of the shares used to compute basic and diluted net loss per
share. Historical results are not necessarily indicative of results to be expected for any future period.



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|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|--------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | -------- | - |  | - | --------- | -
|                                                                                                          |  | Year Ended December 31,                  |        
|                                                                                                          |  | 2005                                     |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |         
|                                                                                                          |  | (in thousands, except per share amounts) |        
|Consolidated Statements of Operations Data:                                                               |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Revenues:                                                                                                 |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|License fees                                                                                              |  | $                                        | 8,094   |   |      | $ | 14,169  |      |  | $ | 26,228  |   |  | $    | 41,530   |   |  | $ | 37,963    |  
|Services                                                                                                  |  |                                          | 35,034  |   |      |   | 34,731  |      |  |   | 34,778  |   |  |      | 37,560   |   |  |   | 52,632    |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Total revenues                                                                                            |  |                                          | 43,128  |   |      |   | 48,900  |      |  |   | 61,006  |   |  |      | 79,090   |   |  |   | 90,595    |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Costs and Expenses:                                                                                       |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Cost of license fees                                                                                      |  |                                          | 2,995   |   |      |   | 2,449   |      |  |   | 3,125   |   |  |      | 3,402    |   |  |   | 2,536     |  
|Cost of services                                                                                          |  |                                          | 8,744   |   |      |   | 9,488   |      |  |   | 9,702   |   |  |      | 29,250   |   |  |   | 51,799    |  
|Amortization of goodwill                                                                                  |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   | 122,860   |  
|Amortization of acquired intangible assets                                                                |  |                                          | 133     |   |      |   | 119     |      |  |   | 1,453   |   |  |      | 4,800    |   |  |   | 4,800     |  
|Sales and marketing                                                                                       |  |                                          | 17,673  |   |      |   | 25,099  |      |  |   | 29,189  |   |  |      | 37,423   |   |  |   | 69,635    |  
|Research and development                                                                                  |  |                                          | 13,230  |   |      |   | 19,497  |      |  |   | 21,437  |   |  |      | 25,933   |   |  |   | 35,558    |  
|General and administrative                                                                                |  |                                          | 11,379  |   |      |   | 8,137   |      |  |   | 9,073   |   |  |      | 13,053   |   |  |   | 21,215    |  
|Stock-based compensation (1)                                                                              |  |                                          | 38      |   |      |   | 1,231   |      |  |   | 5,870   |   |  |      | 16,620   |   |  |   | 15,880    |  
|Merger and transition related costs                                                                       |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   | 13,443    |  
|Impairment of internal-use software                                                                       |  |                                          | 6,326   |   |      |   | 1,062   |      |  |   |        |   |  |      |         |   |  |   |          |  
|Restructuring costs                                                                                       |  |                                          | 468     |   |      |   | 3,400   |      |  |   | 1,704   |   |  |      | (5,086   | ) |  |   | 89,047    |  
|Goodwill impairment                                                                                       |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      | 55,000   |   |  |   | 603,446   |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Total costs and expenses                                                                                  |  |                                          | 60,986  |   |      |   | 70,482  |      |  |   | 81,553  |   |  |      | 180,395  |   |  |   | 1,030,219 |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Loss from operations                                                                                      |  |                                          | (17,858 | ) |      |   | (21,582 | )    |  |   | (20,547 | ) |  |      | (101,305 | ) |  |   | (939,624  | )
|Impairment of investment                                                                                  |  |                                          |        |   |      |   |        |      |  |   | (500    | ) |  |      |         |   |  |   | (1,000    | )
|Interest and other income (expense), net                                                                  |  |                                          | 88      |   |      |   | 128     |      |  |   | 186     |   |  |      | 913      |   |  |   | 1,521     |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Loss from continuing operations before income taxes                                                       |  |                                          | (17,770 | ) |      |   | (21,454 | )    |  |   | (20,861 | ) |  |      | (100,392 | ) |  |   | (939,103  | )
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Income tax expense                                                                                        |  |                                          | (196    | ) |      |   | (314    | )    |  |   | (318    | ) |  |      |         |   |  |   |          |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Loss from continuing operations                                                                           |  |                                          | (17,966 | ) |      |   | (21,768 | )    |  |   | (21,179 | ) |  |      | (100,392 | ) |  |   | (939,103  | )
|Discontinued operation:                                                                                   |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Loss from operations of discontinued operation                                                            |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   | (125      | )
|Gain (loss) on disposal, including provision of $1.1 million for operating losses during phase-out period |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      | 381      |   |  |   | (3,667    | )
|Cumulative effect of accounting change related to the elimination of negative goodwill                    |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      | 3,901    |   |  |   |          |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Net loss                                                                                                  |  | $                                        | (17,966 | ) |      | $ | (21,768 | )    |  | $ | (21,179 | ) |  | $    | (96,110  | ) |  | $ | (942,895  | )
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Basic and diluted net loss per share:                                                                     |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Loss from continuing operations                                                                           |  | $                                        | (0.58   | ) |      | $ | (0.75   | )    |  | $ | (0.88   | ) |  | $    | (4.48    | ) |  | $ | (68.33    | )
|Income (loss) from discontinued operation                                                                 |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      | 0.02     |   |  |   | (0.28     | )
|Gain on elimination of negative goodwill                                                                  |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      | 0.17     |   |  |   |          |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Net loss                                                                                                  |  | $                                        | (0.58   | ) |      | $ | (0.75   | )    |  | $ | (0.88   | ) |  | $    | (4.29    | ) |  | $ | (68.61    | )
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Shares used in computing basic and diluted net loss per share                                             |  |                                          | 30,814  |   |      |   | 28,950  |      |  |   | 24,031  |   |  |      | 22,403   |   |  |   | 13,743    |  
|                                                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|                                                                                                          | 
|                                                                                                          |  | December 31,                             |        
|                                                                                                          |  | 2005                                     |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |         
|                                                                                                          |  | (in thousands)                           |        
|Consolidated Balance Sheet Data:                                                                          |  |                                          |         |   |      |   |         |      |  |   |         |   |  |      |          |   |  |   |           |  
|Cash and cash equivalents                                                                                 |  | $                                        | 6,216   |   |      | $ | 13,772  |      |  | $ | 16,282  |   |  | $    | 19,112   |   |  | $ | 25,476    |  
|Marketable securities                                                                                     |  |                                          |        |   |      |   | 6,361   |      |  |   | 16,674  |   |  |      | 13,386   |   |  |   | 14,654    |  
|Working capital (deficit)                                                                                 |  |                                          | (18,439 | ) |      |   | (9,657  | )    |  |   | 4,168   |   |  |      | (4,533   | ) |  |   | (13,697   | )
|Total assets                                                                                              |  |                                          | 35,706  |   |      |   | 50,361  |      |  |   | 69,878  |   |  |      | 80,550   |   |  |   | 160,672   |  
|Total long-term debt                                                                                      |  |                                          |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   | 108       |  
|Total stockholders equity (deficit)                                                                      |  | $                                        | (9,794  | ) |      | $ | 3,164   |      |  | $ | 21,532  |   |  | $    | 21,952   |   |  | $ | 66,839    |  



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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In
addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The forward-looking statements are
not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions. Words such as anticipate, believe, estimate,
expects, intend, plan, will and variations of these words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to
risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and
uncertainties include, but are not limited to, those described in Item 1A Risk Factors and elsewhere in this report. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or
false. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking
statements.

Overview

KANA is a
world leader in multi-channel customer service. Our software applications enable organizations to improve the quality and efficiency of interactions with customers and partners across multiple communication points. KANAs integrated
solutions allow companies to deliver consistent, managed service across all channels, including email, chat, call centers and Web self-service, so customers have the freedom to choose the service they want, how and when they want it. As a result,
our target market is comprised of large enterprises with high volumes of customer interactions, such as banks, telecommunications companies, high-tech manufacturers, healthcare organizations, and government agencies.

Our revenue is primarily derived from the sale of our software and related maintenance and support of the software. To a lesser extent, we derive
revenues from consulting and training. Our products are generally installed by our customers using a systems integrator, such as IBM, Accenture, BearingPoint or HCL Technologies. To a large degree, we rely on our relationship with IBM to recommend
and install our software. This provides leverage in the selling phase, and also allows us to realize higher gross margins by selling primarily software licenses and support, which typically have higher margins than consulting and implementation
services. In the past, KANA supplied specialists (subject matter experts) to work with IBM and other systems integrators. While KANA continues this practice, KANA has recently seen an increase in providing consulting and implementation services
directly. These services may be provided to our existing customers who would like KANA to review their implementations or to new customers who are not quite large enough to gain the interest of a large system integrator to provide services to the
KANA customer. However, in the case of most of the initial installations of our premise based applications that are generally installed by our customers using a system integrator, these services generally increase the cost of the project
substantially, subjecting their purchase to more levels of required approval and scrutiny of projected cost savings in their customer service and marketing departments. Consequently, we face difficulty predicting the quarter in which sales to
expected customers will occur, if at all, which contributes to the uncertainty of our future operating results. To the extent that significant sales occur earlier or later than anticipated, revenues for subsequent quarters may be lower or higher,
respectively, than expected.

In the first quarter of 2005, we reduced our cost structure through the reduction of outsourced product
development, a reduction in amortization related to the discontinuance of certain internal-use software, reduced headcount, and other cost reduction programs. In late 2005, we made a decision to back shore virtually all product development, i.e. we
are in the process of bringing core technology development to the United States. We will also be back shoring our Technical Support. We anticipate that these adjustments and others will reduce our total cost of licenses, cost of services, sales,
marketing, research and development, and general and administrative expenses into the first quarter of 2006. After that time, we will strive to match our spending with the anticipated revenue but, given the unpredictability of our license revenue,
we are unable to predict when KANA will be profitable, if at all.



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Since 1997 we have incurred substantial costs to develop our products and to recruit, train and
compensate personnel for our engineering, sales, marketing, client services, and administration departments. As a result, we have incurred substantial losses since inception. On December 31, 2005, the Company had ending cash, cash equivalents,
and short term investments of $6.2 million and borrowings outstanding under our line of credit of $7.4 million expiring in November 2006. As of December 31, 2005, the Company had an accumulated deficit of $4.3 billion and a negative working
capital of $18.4 million. Losses from operations were $17.9 million and $21.6 million for 2005 and 2004, respectively. Net cash used for operating activities was $16.3 million and $13.1 million in 2005 and 2004, respectively. These conditions, among
others, raise substantial doubt about the Companys ability to continue as a going concern. The condensed consolidated financial statements do not reflect any adjustments that might be required as a result of this uncertainty.

We continue to take steps to lower the expenses related to cost of revenues, sales and marketing, research and development, and general and
administrative areas of the Company. KANA successfully closed two private sales of KANA common stock, approximately $2.4 million on June 30, 2005 and approximately $4.0 million on September 29, 2005. Management believes that based on its
current plans, its existing funds will be sufficient to meet the Companys working capital and capital expenditure requirements through December 31, 2006. However, if we experience lower than anticipated demand for our products, we will
need to further reduce costs, issue equity securities or borrow money to meet our cash requirements. Any such equity issuances could be dilutive to our stockholders, and any financing transactions may be on unfavorable terms.

As of December 31, 2005, we had 125 full-time employees, which represents a decrease from 181 employees at December 31, 2004 and a decrease
from 211 employees at December 31, 2003. As of May 31, 2006, we had 130 permanent full-time employees.

Critical Accounting Policies and
Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these consolidated financial statements requires us to make estimates and
assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the
circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. In some cases, changes in the accounting estimates are reasonably likely to occur from period to
period. Accordingly, actual results could differ materially from our estimates.

We believe the following discussion addresses the
Companys most critical accounting policies, which are those that are most important to the portrayal of the Companys financial condition and results of operations and require managements most difficult, subjective and complex
judgments. In addition, please refer to Note 1 of the Notes to the Consolidated Financial Statements for a further description of our accounting policies.

Revenue Recognition.

The Company recognizes revenues in accordance with the American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended.

Revenue
from software license agreements is recognized when the basic criteria of software revenue recognition have been met (i.e. persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and
collection is probable). The Company uses the residual method described in AICPA SOP 98-9, Modification of SOP 97-2 With Respect to Certain Transactions (SOP 98-9) to recognize revenue when a license agreement includes one or more
elements to be delivered at a future date and vendor-specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as license revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.



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When licenses are sold together with consulting services, license fees are recognized upon delivery,
provided that (1) the basic criteria of software revenue recognition have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the consulting services do not provide
significant customization of the software products and are not essential to the functionality of the software that was delivered. The Company does not provide significant customization of its software products.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable and, the Company generally does not recognize
revenue on these arrangements until the customer payments become due and all other revenue recognition criteria have been met.

Probability
of collection is based upon assessment of the customers financial condition through review of their current financial statements or publicly-available credit reports. For sales to existing customers, prior payment history is also considered in
assessing probability of collection. The Company is required to exercise significant judgment in deciding whether collectibility is reasonably assured, and such judgments may materially affect the timing of our revenues and our results of
operations.

Services revenues include revenues for consulting services, customer support and training. Consulting services revenues and
the related cost of services are generally recognized on a time and materials basis. KANAs consulting arrangements do not include significant customization of the software. Customer support agreements provide technical support and the right to
unspecified future upgrades on an if-and-when available basis. Customer support revenues are recognized ratably over the term of the support period (generally one year). Training services revenues are recognized as the related training services are
delivered. The unrecognized portion of amounts billed in advance of delivery for services is recorded as deferred revenues.

Vendor-specific objective evidence for consulting and training services are based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management,
if it is probable that the price, once established, will not change before market introduction. Vendor-specific objective evidence for maintenance services is generally based on the price charged when an element is sold separately or the stated
contractual renewal rates.

Reserve for Loss Contract

During the second quarter of 2002, we received a scheduled payment of $4.0 million that we reported as deferred revenue, which was associated with an agreement to settle a loss contract. The $4.0 million is recognized
as revenue as we fulfill our support and training obligations. As of December 31, 2005, we had recognized $3.8 million of the $4.0 million as revenue, and $175,000 remained in deferred revenue that relates to support to be recognized ratably through
the first quarter of 2006. $880,000 of the $4.0 million was related to training and was recognized in the third quarter of 2005 when the training credits expired.

Accounting for Internal-Use Software

Internal-use software costs, including fees paid to third
parties to implement the software, are capitalized beginning when we have determined various factors are present, including among others, that technology exists to achieve the performance requirements, we have made a decision as to whether we will
purchase the software or develop it internally, and we have authorized funding for the project. Capitalization of software costs ceases when the software implementation is substantially complete and is ready for its intended use, and the capitalized
costs are amortized over the softwares estimated useful life (generally five years) using the straight-line method. As of December 31, 2005, we had $561,000 of capitalized costs for internal use software, net of $411,000 accumulated
amortization.

When events or circumstances indicate the carrying value of internal use software might not be recoverable, we assess the
recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is recognized to the extent that
the carrying value exceeds the projected discounted future operating cash flows and is recognized as a write down of the asset. In addition, if it is no longer probable that computer software being developed will be placed in service, the asset will
be adjusted to the lower of its carrying value or fair value, if any, less direct selling costs. Any such adjustment would result in an expense in the period recorded, which could have a material adverse effect on our consolidated statement of
operations. In the fourth quarter ended December 31, 2004, the Companys Information Technology department reviewed its operations and technology requirements, and decided to discontinue its use of certain internal use software, which resulted
in a non-cash impairment charge of $1.1 million. Additionally, during the quarter ended March 31, 2005 we decided to discontinue the use of certain other internal-use software, which resulted in an additional $6.3 million impairment expense.



Restructuring

During 2001, we recorded significant liabilities in connection with our restructuring program. These reserves included estimates pertaining to contractual
obligations related to excess leased facilities in Menlo Park, California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining lease commitments terminate over various dates beginning in April 2007 through January 2011. We are seeking
to sublease or renegotiate the obligations associated with the excess space. We had $7.6 million in accrued restructuring costs as of December 31, 2005, which was our estimate, as of that date, of the exit costs of these excess facilities. We
have worked with real estate brokers in each of the markets where the properties are located to help us estimate the amount of the accrual. This process involves significant judgments regarding these markets. If we determine that any of these real
estate markets has deteriorated further, additional adjustments to this accrual may be required, which would result in additional restructuring expenses in the period in which such determination is made. Likewise, if any of these real estate markets
strengthen, and we are able to sublease the properties earlier or at more favorable rates than projected, or if we are otherwise able to negotiate early termination of obligations on favorable terms, adjustments to the accrual may be required that
would increase income in the period in which such determination is made. As of December 31, 2005, our estimate of accrued restructuring cost included an assumption that we would receive $2.0 million in sublease payments that are not yet subject
to any contractual arrangement and for which, in most cases, a potential sublessee has not been identified. We have assumed that the majority of these sublease payments will begin in 2007 and continue through the end of the related leases.

In December 2005, the Company consolidated its research and development operations into one location in Menlo Park, California to optimize
the Companys research and development processes and decrease overall operating expenses. As a result, the Company terminated the employment of 15 employees based in New Hampshire. As a result of this consolidation, the Company incurred a
restructuring charge of $282,000 related to employee termination costs. Additionally, we recorded a $186,000 restructuring charge during 2005 related to a change in evaluation of the real estate conditions in the United Kingdom, a change in the
sublease estimates in the United States and the consolidation of our research and development operations in Menlo Park, California.



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Goodwill and Intangible Assets

We regularly evaluate all potential indicators of impairment of goodwill and intangible assets, but at a minimum, test goodwill and intangible assets for
impairment on an annual basis. Our judgments regarding the existence of impairment indicators are based on market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that goodwill and
other intangible assets associated with our acquired businesses are impaired.

The remaining amount of goodwill as of December 31,
2005 is $8.6 million. We continue to assess whether any potential indicators of impairment of goodwill have occurred and have determined that no such indicators have arisen since June 30, 2005, the date of our annual goodwill impairment test. Any
further impairment loss could have a material adverse impact on our financial condition and results of operations.

Income Taxes

We estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial
statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as net operating loss carryforwards, and stock-based compensation, for
tax and accounting purposes. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is
not more likely than not, we establish a valuation allowance. We concluded that a full valuation allowance was required for all periods presented. While we have considered future taxable income in assessing the need for the valuation allowance, in
the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would be made, increasing our income in the period in which such
determination was made.

Pursuant to the Internal Revenue Code, the amounts of and benefits from net operating loss carryforwards may be
impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize include, but are not limited to, a cumulative change of more than 50% ownership of the company, as defined, over a
three year period. The portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets.

Contingencies and Litigation

We are subject to lawsuits and other claims and proceedings. We assess the likelihood
of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of loss contingency required, if any, for these matters are made after careful analysis of each individual matter. The required
loss contingencies may change in the future as the facts and circumstances of each matter changes.

Stock Based Compensation

Through December 31, 2005, we have accounted for our stock-based compensation arrangements with employees using the intrinsic-value
method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Deferred stock-based compensation is recorded on the date of grant when the deemed fair value of the underlying
common stock exceeds the exercise price for stock options or the purchase price for the shares of common stock. However, we have adopted the disclosure requirements of SFAS No. 148, Accounting for Stock-Based Compensation, Transition and
Disclosure, and disclose in our consolidated financial statement footnotes what the net loss and net loss per share would have been adjusted to if we accounted for options using the fair-value method under SFAS No. 123, Accounting for
Stock-Based Compensation.

The preparation of the financial statement footnotes requires us to estimate the fair value of stock options
granted to employees. While fair value may be readily determinable for awards of stock, market quotes are not available for long-term, nontransferable stock options because these instruments are not traded. We currently use the Black-Scholes
valuation model to estimate the fair value of employee stock options. However, the Black-Scholes valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable.
Option valuation models require the input of highly subjective assumptions, including but not limited to stock price volatility. Because our stock options have characteristics significantly different from those of traded options and changes to the
subjective input assumptions can materially affect the fair value estimate, in managements opinion, existing models do not provide a reliable single measure of the fair value of our employee stock options. We are currently evaluating our
option valuation methodologies and assumptions in light of evolving accounting standards related to employee stock options. See Recent Accounting Pronouncements below.



Effect of Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004) (SFAS 123R), Share Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). SFAS 123R requires compensation costs relating to share-based payment transactions be recognized in financial statements. The pro forma disclosure previously permitted under SFAS 123 will no longer
be an acceptable alternative to recognition of expenses in the financial statements. SFAS 123R became effective for the Company on January 1, 2006. Through December 31, 2005, the Company has reported compensation costs related to share-based
payments under APB 25, as allowed by SFAS 123, and provides disclosure in the notes to financial statements as required by SFAS 123. We are currently evaluating the requirements of SFAS 123R and we expect that the adoption
of SFAS 123R will have a material impact on our consolidated results of operations and net loss per share. However, the impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future. It is likely that we will adopt the modified prospective application method and the Black Scholes valuation model to determine the fair value of our stock as provided by the provisions of SFAS 123R.



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In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107. In
accordance with this Bulletin, effective January 1, 2006 we will no longer present stock-based compensation separately on our statements of operations. Instead we will present stock-based compensation in the same lines as cash compensation paid
to the same individuals.

In November 2005, the FASB issued FASB Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. FSP Nos. FAS 115-1 and FAS 124-1 amend SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities,SFAS No. 124, Accounting for
Certain Investments Held by Not-for-Profit Organizations,as well as APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. This guidance nullifies certain requirements of EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. FSP Nos. FAS 115-1 and FAS 124-1 include guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements
for investments that are deemed to be temporarily impaired. FSP Nos. FAS 115-1 and FAS 124-1 also require an other-than-temporary impaired debt securities to be written down to its impaired value, which becomes the new cost basis. FSP Nos. FAS 115-1
and FAS 124-1 are effective for fiscal years beginning after December 15, 2005. We do not believe that adoption of FSP Nos. FAS 115-1 and FAS 124-1 on January 1, 2006 will have a material effect on our financial position, cash flows
or results of operations.

Results of Operations

The following table sets forth selected data for the periods presented. Percentages are expressed as a percentage of total revenues.



|                                           |  |                          |   |  |      |   |  |      |  
|------------------------------------------ |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                                           |  | Years Ended December 31, |  
|                                           |  | 2005                     |   |  | 2004 |   |  | 2003 |  
|Revenues:                                  |  |                          |   |  |      |   |  |      |  
|License fees                               |  | 19                       | % |  | 29   | % |  | 43   | %
|Services                                   |  | 81                       |   |  | 71   |   |  | 57   |  
|                                           |  |                          |   |  |      |   |  |      |  
|Total revenues                             |  | 100                      |   |  | 100  |   |  | 100  |  
|                                           |  |                          |   |  |      |   |  |      |  
|Costs and Expenses:                        |  |                          |   |  |      |   |  |      |  
|Cost of license fees                       |  | 7                        |   |  | 5    |   |  | 5    |  
|Cost of services                           |  | 20                       |   |  | 19   |   |  | 16   |  
|Amortization of acquired intangible assets |  |                         |   |  |     |   |  | 8    |  
|Sales and marketing                        |  | 41                       |   |  | 51   |   |  | 48   |  
|Research and development                   |  | 31                       |   |  | 40   |   |  | 35   |  
|General and administrative                 |  | 26                       |   |  | 17   |   |  | 15   |  
|Stock-based compensation                   |  |                         |   |  | 3    |   |  | 10   |  
|Impairment of internal-use software        |  | 15                       |   |  | 2    |   |  |     |  
|Restructuring costs                        |  | 1                        |   |  | 7    |   |  | 3    |  
|                                           |  |                          |   |  |      |   |  |      |  
|Total costs and expenses                   |  | 141                      | % |  | 144  | % |  | 139  | %
|                                           |  |                          |   |  |      |   |  |      |  



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Comparison of the Years Ended December 31, 2005 and 2004

Revenues

Total revenues
decreased by 12% to $43.1 million for the year ended December 31, 2005 from $48.9 million for the year ended December 31, 2004, primarily as a result of fewer license transactions in 2005 than in 2004. We believe the decrease in 2005 was
due to many factors including competitive pressures, greater-than-anticipated delays in completing expected license transactions through systems integrators, and a slow recovery in the information technology spending environment.

License revenues include licensing fees only, and exclude associated maintenance and consulting revenue. The majority of our licenses to customers are
perpetual and associated revenues are recognized upon shipment provided that all revenue recognition criteria are met as discussed in Revenue Recognition under Critical Accounting Policies above. License revenues decreased by
43% to $8.1 million for 2005 from $14.2 million for 2004. This decrease in license revenue was primarily due to a decrease in the average selling price of license transactions due to competitive pricing pressures, as well as a decrease in the number
of license transactions closed during the year. We expect our average selling price to continue to fluctuate in future quarters given the relatively low number of new transactions that comprise the majority of our license revenue recognized per
quarter. The market for our products is unpredictable and intensely competitive, and the economic environment over the last few years has had an effect on corporate purchasing, which has adversely affected sales of our products.

Our service revenues consist of support revenues and professional services fees. Support revenues relate to providing customer support, product
maintenance and updates to our customers (including when-and-if-available upgrades). Professional services revenues relate to providing consulting, training and, to a lesser extent, implementation services to our customers. Service revenues remained
flat at $35.0 million for the year ended December 31, 2005 compared to $34.7 million for 2004. The consistency in service revenue amount was in line with expectations since the relatively small percentage of support renewal cancellations is
typically more than offset by new maintenance contracts associated with new license transactions. Support revenues are the largest component of service revenues, and in 2005, were relatively consistent with our 2004 support revenues, at $29.8
million in 2005 versus $31.0 million in 2004. The drop in sales of new licenses in 2005 affected service revenues less than license revenues because the majority of our maintenance revenues relate to ongoing maintenance contracts with existing
customers. We expect that service revenues in 2006 will be fairly consistent with those from 2005 in absolute dollars.

Revenues from
international sales were $13.1 million, or 30% of total revenues, in the year ended December 31, 2005 and $17.2 million, or 35% of total revenues, in the year ended December 31, 2004. Our international revenues were derived from sales in
Europe and Asia Pacific.

Costs and Expenses

Total cost of revenues decreased by 2% to $11.9 million for the year ended December 31, 2005 from $12.0 million for the year ended December 31, 2004.

License Fees. Cost of license fees consists of third party software royalties, costs of product packaging, documentation, and production and
delivery costs for shipments to customers. Cost of license fees as a percentage of license revenue for 2005 was 37% compared to 17% in 2004. The increase was due to royalty costs associated with a relatively higher proportion of non-revenue-related
shipments, such as upgrades and updates during 2005, as well as a decrease in license fees.

Services. Cost of services consists
primarily of salaries and related expenses for our customer support, consulting, and training services organization, and allocation of facility costs and system costs incurred in providing customer support. Cost of services decreased to 25% of
service revenues, or $8.7 million, for 2005 compared to 27% of service revenues, or $9.5 million, for 2004. Both totals exclude amortization of stock-based compensation of $2,000 and $346,000 for periods ended December 31, 2005 and 2004,
respectively. The consistency in service margins in 2005 compared to 2004 was due to consistency in our strategy and professional service staffing levels throughout 2005 and 2004.



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Amortization of Acquired Intangible Assets.The amortization of acquired intangible
assets recorded in 2005 and 2004 related to $400,000 of intangible assets recorded in connection with the acquisition of Hipbone, Inc. in February 2004. Amortization totaled $133,000 and $119,000 for the years ended December 31, 2005 and 2004,
respectively.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related costs for
sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials. Sales and marketing expenses decreased by 30% to $17.7 million for the year ended December 31, 2005 from
$25.1 million for the year ended December 31, 2004. This decrease was partly attributable to reductions in sales and marketing personnel during 2005, from 70 positions at December 31, 2004 to 41 positions at December 31, 2005 and a
reduction in information technology support.

Research and Development. Research and development expenses consist primarily of
compensation and related costs for research and development employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses decreased by 32% to $13.2 million for the year ended
December 31, 2005 from $19.5 million for the year ended December 31, 2004. This decrease was partly attributable to a reduction in research and development personnel during 2005 by 12%, from 34 at December 31, 2004 to 30 at
December 31, 2005 and a reduction in information technology support. The decrease can also be attributed to lower outsourcing expenses paid to our development partners with staffing in India and China.

General and Administrative. General and administrative expenses consist primarily of compensation and related costs for finance, legal, human
resources, corporate governance, and bad debt expense. Information technology and facilities costs are allocated among all operating departments. General and administrative expenses increased by 40% to $11.4 million for the year ended
December 31, 2005 from $8.1 million for the year ended December 31, 2004. This increase was primarily attributable to an increase in professional services and other general and administrative expenses for the year ended December 31,
2005, partially offset by a reduction of general and administrative personnel during 2005 by 16%, from 25 at December 31, 2004 to 21 at December 31, 2005.

Stock-Based Compensation. We amortize employee-related deferred stock-based compensation on an accelerated basis by charges to operations over the vesting period of the options,
consistent with the method described in FASB Interpretations No. 28. Amortization of stock-based compensation was $38,000 and $1.2 million for the years ended December 31, 2005 and 2004, respectively. In 2005 and 2004, there were no
options granted with an exercise price below the fair value of the option shares on the grant date.

As of December 31,
2005, no unearned deferred stock-based compensation remained to be amortized. The amortization of stock-based compensation for 2005 and 2004, by operating expense, is detailed as follows (in thousands):



|                           |  |                         |    |      |   |      
|-------------------------- |  | ----------------------- | -- | ---- | - | -----
|                           |  | Year Ended December 31,
|                           |  | 2005                    |    | 2004
|Cost of service            |  | $                       | 2  |      | $ | 346  
|Sales and marketing        |  |                         | 9  |      |   | 646  
|Research and development   |  |                         | 2  |      |   | 82   
|General and administrative |  |                         | 25 |      |   | 157  
|                           |  |                         |    |      |   |      
|Total                      |  | $                       | 38 |      | $ | 1,231
|                           |  |                         |    |      |   |      

Impairment of Internal Use Software. In the fourth quarter ended December 31, 2004,
the Companys IT department reviewed its operations and technology requirements, and decided to discontinue its use of certain internal use software. As a result, a material charge for impairment was required under SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. The capitalized cost of this internal-use software included capitalized fees paid to third parties to implement the software. The total non-cash impairment charge related to this
software was $1.1 million in the fourth quarter of 2004.



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In the first quarter ended March 31, 2005, the Company reviewed all continuing operating expenses
across the entire Company, including our technology requirements. One result of this review was a decision to discontinue the use of certain internal use software. The total non-cash impairment charge related to this software was $6.3 million in the
first quarter of 2005.

Restructuring Costs.During the preparation of the Companys consolidated financial statements for the
three months ended March 31, 2005, the Company discovered that errors had been made in the fourth quarter 2004 revaluation of the restructuring accrual calculation for unoccupied leased facilities. The Company increased the first quarter 2005
restructuring accrual by $938,000 to adjust for these errors. The Company believes that these errors are not material to the financial statements for 2004 or 2005.

In the second quarter of 2005, the assumptions as to when certain U.S. facilities would be subleased were revised, which increased the reserve by $1.0 million. This increase was offset by an additional $1.6 million in
sublease income from the actual sublet of the Marlow U.K. facility.

In the third quarter of 2005, the Company made adjustments to the
restructuring accrual of $189,000 to correct for certain calculation errors made in the fourth quarter of 2004. The Company believes that these errors are not material to the Companys financial statements for 2004 or 2005.

In the fourth quarter of 2005, the Company recorded a restructuring charge of $271,000 for the termination of certain employees net of adjustments to
restructured facilities.

During the year ended December 31, 2004, the Company recorded $3.4 million in restructuring costs related to
a change in evaluation of real estate market conditions in the United Kingdom, and changes in sublease estimates based on offers from potential subtenants in the United States.

The following table summarizes our restructuring activity for the years ended December 31, 2005 and 2004 (in thousands):



|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|----------------------------------- |  | --------- | ---- | - | ---------- | - | ------ | ----- |  | - | ------ | -
|                                    |  | Severance |      |   | Facilities |   |        | Total | 
|Restructuring reserve at 12/31/2003 |  | $         | 184  |   |            | $ | 10,010 |       |  | $ | 10,194 |  
|Restructuring charge                |  |           |     |   |            |   | 3,400  |       |  |   | 3,400  |  
|Payments made                       |  |           | (184 | ) |            |   | (2,757 | )     |  |   | (2,941 | )
|Sublease payments received          |  |           |     |   |            |   | 141    |       |  |   | 141    |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at 12/31/2004 |  |           |     |   |            |   | 10,794 |       |  |   | 10,794 |  
|Restructuring charge                |  |           | 282  |   |            |   | 186    |       |  |   | 468    |  
|Payments made                       |  |           |     |   |            |   | (4,204 | )     |  |   | (4,204 | )
|Sublease payments received          |  |           |     |   |            |   | 494    |       |  |   | 494    |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at 12/31/2005 |  | $         | 282  |   |            | $ | 7,270  |       |  | $ | 7,552  |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  

The remainder of the restructuring payments will be paid relatively evenly from 2006 through 2011.

Goodwill Impairment.During June 2005, we performed our annual test for goodwill impairment as required by SFAS No. 142. Based
on our evaluation, we concluded that goodwill was not impaired as the fair value of the Company exceeded its carrying value, including goodwill. There have been no events or circumstances from June 30, 2005 to December 31, 2005 that have
affected our June 30, 2005 conclusion regarding the recoverability of goodwill. The remaining amount of goodwill at December 31, 2005 is $8.6 million. Any further impairment loss could have a material adverse impact on our financial
condition and results of operations.



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Interest and Other Income (Expense), net

Interest and other income (expense), net consists primarily of interest income, interest expense and changes in fair value of warrant liabilities.
Interest income consists primarily of interest earned on cash and cash equivalents and marketable securities and was approximately $265,000 and $294,000 for the years ended December 31, 2005 and 2004, respectively. The decrease in interest
income related to lower cash and cash equivalents and marketable securities balances in 2005 than in 2004. Interest expense relates primarily to our line of credit and was approximately $513,000 and $180,000 for the years ended December 31,
2005 and 2004, respectively. Interest and other income (expense), net also consists of changes in the fair value of warrant liabilities of approximately $331,000 and zero for the years ended December 31, 2005 and 2004, respectively.

Provision for Income Taxes

We have incurred operating losses on a consolidated basis for all periods from inception through December 31, 2005. Accordingly, we have recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future
realization of the tax benefit is not currently more likely than not. In 2005 and 2004, certain of our foreign subsidiaries were profitable, based upon application of our intercompany transfer pricing agreements, which resulted in us reporting
income tax expense totaling approximately $196,000 and $314,000 for the years ended December 31, 2005 and 2004, respectively, in those foreign jurisdictions.

As of December 31, 2005 the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $444.6 million and $345.6 million, respectively. The federal and state net operating
loss carryforwards, if not offset against future taxable income, will expire by 2025. The Company also had foreign net operating loss carryforwards of approximately $20.0 million. The foreign losses expire at various dates and some can be carried
forward indefinitely. Pursuant to the Internal Revenue Code, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses
that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. As such, the portion of the net operating loss and tax credit carryforwards subject
to potential expiration has not been included in deferred tax assets. In addition, it is possible additional limitations may exist.

Comparison of
the Years Ended December 31, 2004 and 2003

Revenues

Total revenues decreased by 20% to $48.9 million for the year ended December 31, 2004 from $61.0 million for the year ended December 31, 2003,
primarily as a result of fewer license transactions in 2004 than in 2003. We believe the decrease in 2004 was due to many factors including competitive pressures, greater-than-anticipated delays in completing expected license transactions through
systems integrators, and a slow recovery in the information technology spending environment.

License revenues include licensing fees only,
and exclude associated maintenance and consulting revenue. The majority of our licenses to customers are perpetual and associated revenues are recognized upon shipment provided that all revenue recognition criteria are met. License revenues
decreased by 46% to $14.2 million for the year ended December 31, 2004 from $26.2 million for 2003. This decrease in license revenue was primarily due to a decrease in the average selling price of license transactions due to competitive pricing
pressures, as well as a decrease in the number of license transactions closed during the year.

Our service revenues consist of support
revenues and professional services fees. Support revenues relate to providing customer support, product maintenance and updates to our customers (including when-and-if-available upgrades). Professional services revenues relate to providing
consulting, training and, to a lesser extent, implementation services to our customers. Service revenues remained flat at $34.7 million for the year ended December 31, 2004 compared to $34.8 million for 2003. The consistency in service revenue
amount was in line with expectations since the relatively small percentage of support renewal cancellations is typically more than offset by new maintenance contracts associated with new license transactions. In addition, we maintained a relatively



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constant professional services headcount in 2004 compared with 2003. Support revenues are the largest component of
service revenues, and, in 2004, were relatively consistent with our 2003 support revenues, at $31.0 million in 2004 versus $30.6 million in 2003. The drop in sales of new licenses in 2004 affected service revenues less than license revenues because
the majority of our maintenance revenues relate to ongoing maintenance contracts with existing customers.

Revenues from international
sales were $17.2 million, or 35% of total revenues, in the year ended December 31, 2004 and $17.2 million, or 28% of total revenues, in the year ended December 31, 2003. Our international revenues were derived from sales in Europe, Canada
and Asia Pacific.

Costs and Expenses

Total cost of revenues decreased by 16% to $12.0 million for the year ended December 31, 2004 from $14.3 million for the year ended December 31, 2003.

License Fees. Cost of license fees consists of third party software royalties, costs of product packaging, documentation, and production and
delivery costs for shipments to customers. Cost of license fees as a percentage of license revenue for 2004 was 17% compared to 12% in 2003. The increase was due to royalty costs associated with a relatively higher proportion of non-revenue-related
shipments, such as upgrades and updates during 2004.

Services. Cost of services revenue consists primarily of salaries and related
expenses for our customer support, consulting, and training services organization, and allocation of facility costs and system costs incurred in providing customer support. Cost of services revenue decreased to 27% of services revenue, or $9.5
million, for 2004 compared to 28%, or $9.7 million, for the prior year. Both totals exclude amortization of stock-based compensation of $346,000 and $430,000 for periods ending December 31, 2004 and 2003, respectively. The consistency in
service margins in 2004 compared to 2003 was due to consistency in our strategy and professional service staffing levels throughout 2004 and 2003.

Amortization of Acquired Intangible Assets.The amortization of acquired intangible assets recorded in 2004 and 2003 related to $14.8 million of intangible assets recorded in connection with the purchase of Silknet
Software, Inc. in April 2000 and Hipbone, Inc. in February 2004. The amortization of the assets related to Silknet concluded in April 2003. Amortization totaled $119,000 and $1.5 million for the years ended December 31, 2004 and 2003,
respectively.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related costs for
sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials. Sales and marketing expenses decreased by 14% to $25.1 million for the year ended December 31, 2004 from
$29.2 million for the year ended December 31, 2003. This decrease was partly attributable to reductions in sales and marketing personnel during 2004, from 77 positions as of December 31, 2003 to 70 positions as of December 31, 2004
and a reduction in information technology support. In addition, commission expense in 2004 was $600,000 lower than in 2003 due to decreases in license revenues in 2004 as discussed above.

Research and Development. Research and development expenses consist primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses decreased by 9% to $19.5 million for the year ended December 31, 2004 from $21.4 million for the year ended
December 31, 2003. This decrease was partly attributable to a reduction in research and development personnel during 2004 by 15%, from 40 as of December 31, 2003 to 34 at December 31, 2004 and a reduction in information technology
support. The decrease can also be attributed to lower outsourcing expenses paid to our development partners with staffing in India and China.

General and Administrative. General and administrative expenses consist primarily of compensation and related costs for finance, legal, human resources, corporate governance, and bad debt expense. Information technology and
facilities costs are allocated among all operating departments. General and administrative expenses decreased by 11% to $8.1 million for the year ended December 31, 2004 from $9.1 million for the year ended December 31, 2003. This decrease
was primarily attributable to a reduction in information technology support, professional services, bad debt expense and other general and administrative expenses for the year ended December 31, 2004.



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Stock-Based Compensation. We amortize employee-related deferred stock-based compensation on an
accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in FASB Interpretations No. 28. The amortization of deferred stock-based compensation related to fully vested warrants to
third parties are amortized on a straight-line basis. Amortization of stock-based compensation was $1.2 million and $5.9 million for the years ended December 31, 2004 and 2003, respectively. In 2004 and 2003, there were no options granted with
an exercise price below the fair value of the option shares on the grant date.

As of December 31, 2004, a total of approximately
$58,000 of unearned deferred stock-based compensation remained to be amortized. The amortization of stock-based compensation for 2004 and 2003, by operating expense, is detailed as follows (in thousands):



|                           |  |                         |       |      |   |      
|-------------------------- |  | ----------------------- | ----- | ---- | - | -----
|                           |  | Year Ended December 31,
|                           |  | 2004                    |       | 2003
|Cost of service            |  | $                       | 346   |      | $ | 430  
|Sales and marketing        |  |                         | 646   |      |   | 2,300
|Research and development   |  |                         | 82    |      |   | 2,149
|General and administrative |  |                         | 157   |      |   | 991  
|                           |  |                         |       |      |   |      
|Total                      |  | $                       | 1,231 |      | $ | 5,870
|                           |  |                         |       |      |   |      

Impairment of Internal Use Software. In the fourth quarter ended December 31, 2004,
the Companys IT department reviewed its operations and technology requirements, and decided to discontinue its use of certain internal use software. As a result, a material charge for impairment was required under SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.The capitalized cost of this internal-use software included capitalized fees paid to third parties to implement the software. The total non-cash impairment charge related to this
software was $1.1 million in the fourth quarter.

Restructuring Costs. During the year ended December 31, 2004, the Company
recorded $3.4 million in restructuring costs related to a change in evaluation of real estate market conditions in the United Kingdom, and changes in sublease estimates based on offers from potential subtenants in the United States. For the year
ended December 31, 2003, the Company recorded approximately $1.7 million in restructuring related to a change in real estate market conditions relating to excess leased facilities, and discussions with our respective landlords.

The following table summarizes our restructuring activity for the years ended December 31, 2004 and 2003 (in thousands):



|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|----------------------------------- |  | --------- | ---- | - | ---------- | - | ------ | ----- |  | - | ------ | -
|                                    |  | Severance |      |   | Facilities |   |        | Total | 
|Restructuring reserve at 12/31/2002 |  | $         | 217  |   |            | $ | 10,731 |       |  | $ | 10,948 |  
|                                    |  |           |     
|Restructuring charge                |  |           |     |   |            |   | 1,704  |       |  |   | 1,704  |  
|Payments made                       |  |           | (33  | ) |            |   | (2,773 | )     |  |   | (2,806 | )
|Sublease payments received          |  |           |     |   |            |   | 348    |       |  |   | 348    |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at 12/31/2003 |  |           | 184  |   |            |   | 10,010 |       |  |   | 10,194 |  
|                                    |  |           |     
|Restructuring charge                |  |           |     |   |            |   | 3,400  |       |  |   | 3,400  |  
|Payments made                       |  |           | (184 | ) |            |   | (2,757 | )     |  |   | (2,941 | )
|Sublease payments received          |  |           |     |   |            |   | 141    |       |  |   | 141    |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at 12/31/2004 |  | $         |     |   |            | $ | 10,794 |       |  | $ | 10,794 |  
|                                    |  |           |      |   |            |   |        |       |  |   |        |  



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The remainder of the restructuring payments will be paid relatively evenly from 2005 through 2011.

Goodwill Impairment.During June 2004 we performed our annual test for goodwill impairment as required by SFAS No. 142. Based
on our evaluation, we concluded that goodwill was not impaired as the fair value of the Company exceeded its carrying value, including goodwill. There have been no events or circumstances from June 30, 2004 to December 31, 2004 that have
affected our June 30, 2004 conclusion regarding the recoverability of goodwill. The remaining amount of goodwill at December 31, 2004 was $8.6 million. Any further impairment loss could have a material adverse impact on our financial
condition and results of operations.

Interest and Other Income (Expense), net

Interest and other income (expense), net consists of interest income, interest expense and other income (expense). Interest income consisted primarily of
interest earned on cash and short-term investments and was approximately $294,000 and $315,000 for the years ended December 31, 2004 and 2003. The decrease in other income (expense), net related to lower amounts of interest income earned due to
lower average cash balances in 2004 than in 2003. Interest expense consisted primarily of interest expense related to our line of credit and was approximately $180,000 and $174,000 for the years ended December 31, 2004 and 2003.

Provision for Income Taxes

We incurred operating losses on a consolidated basis for all periods from inception through December 31, 2004. Accordingly, we recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future
realization of the tax benefit is not currently more likely than not. In 2004 and 2003, certain of our foreign subsidiaries were profitable, based upon application of our intercompany transfer pricing agreements, which resulted in us reporting
income tax expense totaling approximately $314,000 and $318,000, respectively, in those foreign jurisdictions.

As of December 31,
2004, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $425.0 million and $358.1 million, respectively. The Company also had foreign net operating loss carryforwards of approximately $20.0
million. The federal net operating loss carryforwards, if not offset against future taxable income, will expire from 2011 through 2024. Pursuant to the Internal Revenue Code, the amounts and benefits from net operating loss carryforwards may be
impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over
a three year period. As such, the portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets. In addition, it is possible additional limitations may exist.

Quarterly Results of Operations

The following
tables set forth a summary of our unaudited quarterly operating results for each of the eight quarters in the period ended December 31, 2005. The information has been derived from our unaudited consolidated financial statements that, in
managements opinion, have been prepared on a basis consistent with the audited consolidated financial statements contained elsewhere in this Annual Report and include all adjustments, consisting only of normal recurring adjustments, necessary
for a fair presentation of this information when read in conjunction with our audited consolidated financial statements and notes thereto. The operating results for any quarter are not necessarily indicative of results to be expected for any future
period.



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|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|------------------------------------------------------------- |  | ------------- | ------ | - | ------------ | - | ------ | ------------- |  | - | ------------ | - |  | ------------ | ------ | - | ------------ | - | ------- | ------------- |  | - | ------------ | - |  | - | ------ | - |  | - | ------ | -
|                                                              |  | Quarter Ended |       
|                                                              |  | Mar. 31,2004  |        |   | June 30,2004 |   |        | Sept. 30,2004 |  |   | Dec. 31,2004 |   |  | Mar. 31,2005 |        |   | June 30,2005 |   |         | Sept. 30,2005 |  |   | Dec. 31,2005 |  
|Consolidated Statements of Operations Data:                   |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Revenues:                                                     |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|License fees                                                  |  | $             | 4,583  |   |              | $ | 1,049  |               |  | $ | 3,827        |   |  | $            | 4,710  |   |              | $ | 1,541   |               |  | $ | 2,364        |   |  | $ | 1,600  |   |  | $ | 2,589  |  
|Services                                                      |  |               | 8,672  |   |              |   | 8,563  |               |  |   | 8,583        |   |  |              | 8,913  |   |              |   | 8,530   |               |  |   | 8,318        |   |  |   | 9,353  |   |  |   | 8,833  |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Total revenues                                                |  |               | 13,255 |   |              |   | 9,612  |               |  |   | 12,410       |   |  |              | 13,623 |   |              |   | 10,071  |               |  |   | 10,682       |   |  |   | 10,953 |   |  |   | 11,422 |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Costs and Expenses:                                           |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Cost of license fees                                          |  |               | 786    |   |              |   | 219    |               |  |   | 170          |   |  |              | 1,274  |   |              |   | 814     |               |  |   | 835          |   |  |   | 597    |   |  |   | 749    |  
|Cost of services                                              |  |               | 2,557  |   |              |   | 2,324  |               |  |   | 2,239        |   |  |              | 2,368  |   |              |   | 2,619   |               |  |   | 1,754        |   |  |   | 2,219  |   |  |   | 2,152  |  
|Amortization of acquired intangible assets                    |  |               | 19     |   |              |   | 33     |               |  |   | 33           |   |  |              | 34     |   |              |   | 33      |               |  |   | 33           |   |  |   | 34     |   |  |   | 33     |  
|Sales and marketing                                           |  |               | 6,453  |   |              |   | 5,897  |               |  |   | 6,523        |   |  |              | 6,226  |   |              |   | 5,340   |               |  |   | 4,286        |   |  |   | 4,309  |   |  |   | 3,738  |  
|Research and development                                      |  |               | 4,984  |   |              |   | 5,078  |               |  |   | 4,844        |   |  |              | 4,591  |   |              |   | 4,308   |               |  |   | 3,348        |   |  |   | 2,908  |   |  |   | 2,666  |  
|General and administrative                                    |  |               | 2,016  |   |              |   | 2,181  |               |  |   | 1,588        |   |  |              | 2,352  |   |              |   | 3,362   |               |  |   | 2,754        |   |  |   | 2,245  |   |  |   | 3,018  |  
|Stock-based compensation                                      |  |               | 543    |   |              |   | 361    |               |  |   | 308          |   |  |              | 19     |   |              |   | 27      |               |  |   | 9            |   |  |   | 2      |   |  |   |       |  
|Impairment of internal-use software                           |  |               |       |   |              |   |       |               |  |   |             |   |  |              | 1,062  |   |              |   | 6,326   |               |  |   |             |   |  |   |       |   |  |   |       |  
|Restructuring costs                                           |  |               |       |   |              |   |       |               |  |   |             |   |  |              | 3,400  |   |              |   | 938     |               |  |   | (552         | ) |  |   | (189   | ) |  |   | 271    |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Total costs and expenses                                      |  |               | 17,358 |   |              |   | 16,093 |               |  |   | 15,705       |   |  |              | 21,326 |   |              |   | 23,767  |               |  |   | 12,467       |   |  |   | 12,125 |   |  |   | 12,628 |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Loss from operations                                          |  |               | (4,103 | ) |              |   | (6,481 | )             |  |   | (3,295       | ) |  |              | (7,703 | ) |              |   | (13,696 | )             |  |   | (1,785       | ) |  |   | (1,172 | ) |  |   | (1,205 | )
|Interest and other income (expense), net                      |  |               | 83     |   |              |   | 75     |               |  |   | (4           | ) |  |              | (26    | ) |              |   | (42     | )             |  |   | (45          | ) |  |   | (74    | ) |  |   | 249    |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Loss before income taxes                                      |  |               | (4,020 | ) |              |   | (6,406 | )             |  |   | (3,299       | ) |  |              | (7,729 | ) |              |   | (13,738 | )             |  |   | (1,830       | ) |  |   | (1,246 | ) |  |   | (957   | )
|Income tax expense                                            |  |               | (66    | ) |              |   | (66    | )             |  |   | (78          | ) |  |              | (104   | ) |              |   | (62     | )             |  |   | (54          | ) |  |   | (18    | ) |  |   | (62    | )
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Net loss                                                      |  | $             | (4,086 | ) |              | $ | (6,472 | )             |  | $ | (3,377       | ) |  | $            | (7,833 | ) |              | $ | (13,800 | )             |  | $ | (1,884       | ) |  | $ | (1,264 | ) |  | $ | (1,018 | )
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share                          |  | $             | (0.14  | ) |              | $ | (0.22  | )             |  | $ | (0.12        | ) |  | $            | (0.27  | ) |              | $ | (0.47   | )             |  | $ | (0.06        | ) |  | $ | (0.04  | ) |  | $ | (0.03  | )
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Shares used in computing basic and diluted net loss per share |  |               | 28,640 |   |              |   | 28,939 |               |  |   | 29,031       |   |  |              | 29,180 |   |              |   | 29,254  |               |  |   | 29,278       |   |  |   | 30,929 |   |  |   | 33,785 |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|As a Percentage of Total Revenues:                            |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Revenues:                                                     |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|License fees                                                  |  |               | 35     | % |              |   | 11     | %             |  |   | 31           | % |  |              | 35     | % |              |   | 15      | %             |  |   | 22           | % |  |   | 15     | % |  |   | 23     | %
|Services                                                      |  |               | 65     |   |              |   | 89     |               |  |   | 69           |   |  |              | 65     |   |              |   | 85      |               |  |   | 78           |   |  |   | 85     |   |  |   | 77     |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Total revenues                                                |  |               | 100    |   |              |   | 100    |               |  |   | 100          |   |  |              | 100    |   |              |   | 100     |               |  |   | 100          |   |  |   | 100    |   |  |   | 100    |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Costs and Expenses:                                           |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Cost of license fees                                          |  |               | 6      |   |              |   | 2      |               |  |   | 1            |   |  |              | 9      |   |              |   | 8       |               |  |   | 8            |   |  |   | 6      |   |  |   | 7      |  
|Cost of services                                              |  |               | 19     |   |              |   | 24     |               |  |   | 18           |   |  |              | 18     |   |              |   | 26      |               |  |   | 17           |   |  |   | 20     |   |  |   | 19     |  
|Amortization of acquired intangible assets                    |  |               | 0      |   |              |   | 0      |               |  |   | 0            |   |  |              | 0      |   |              |   | 0       |               |  |   | 0            |   |  |   | 0      |   |  |   | 0      |  
|Sales and marketing                                           |  |               | 49     |   |              |   | 61     |               |  |   | 53           |   |  |              | 46     |   |              |   | 53      |               |  |   | 40           |   |  |   | 39     |   |  |   | 33     |  
|Research and development                                      |  |               | 38     |   |              |   | 53     |               |  |   | 39           |   |  |              | 34     |   |              |   | 43      |               |  |   | 31           |   |  |   | 27     |   |  |   | 23     |  
|General and administrative                                    |  |               | 15     |   |              |   | 23     |               |  |   | 13           |   |  |              | 17     |   |              |   | 34      |               |  |   | 26           |   |  |   | 21     |   |  |   | 26     |  
|Stock-based compensation                                      |  |               | 4      |   |              |   | 4      |               |  |   | 3            |   |  |              | 0      |   |              |   | 0       |               |  |   | 0            |   |  |   | 0      |   |  |   | 0      |  
|Impairment of internal-use software                           |  |               | 0      |   |              |   | 0      |               |  |   | 0            |   |  |              | 8      |   |              |   | 63      |               |  |   | 0            |   |  |   | 0      |   |  |   | 0      |  
|Restructuring costs                                           |  |               | 0      |   |              |   | 0      |               |  |   | 0            |   |  |              | 25     |   |              |   | 9       |               |  |   | (5           | ) |  |   | (2     | ) |  |   | 2      |  
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  
|Total costs and expenses                                      |  |               | 131    | % |              |   | 167    | %             |  |   | 127          | % |  |              | 157    | % |              |   | 236     | %             |  |   | 117          | % |  |   | 111    | % |  |   | 111    | %
|                                                              |  |               |        |   |              |   |        |               |  |   |              |   |  |              |        |   |              |   |         |               |  |   |              |   |  |   |        |   |  |   |        |  

The amount and timing of our operating expenses generally will vary from quarter to quarter
depending on our level of actual and anticipated business activities. Our revenues and operating results are difficult to forecast and will fluctuate, and we believe that period-to-period comparisons of our operating results will not necessarily be
meaningful. As a result, you should not rely upon them as an indication of future performance.



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LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2005, we had $6.2 million in cash and cash equivalents and marketable securities, compared to $20.1 million as of December 31, 2004. As of December 31, 2005, we had negative working
capital of $18.4 million. $14.5 million of our current liabilities consists of current deferred revenue (primarily reflecting payments for future maintenance services under our software licenses).

History and recent trends. We have had negative cash flows from operations in each year since inception. To date, we have funded our operations
primarily through issuances of common stock and, to a lesser extent, cash acquired in acquisitions. Cash used in operations increased from $12.7 million in 2003, to $13.1 million in 2004 to $16.3 million in 2005. The increase of cash used in
operations primarily relates to a 12% decrease in revenues during the same period offset partially by a reduction in payments of operating expenses. Our cost reductions have been realized through our restructuring plan commencing in 2001, as well as
various cost controls and operational efficiencies realized since 2001. In 2005, 2004, and 2003, we had net workforce reductions of approximately 56, 30, and 154 employees, respectively.

Primary driver of cash flow. Our ability to generate cash in the future depends upon our success in generating sufficient sales, especially new
license sales. We expect our maintenance renewals in 2006 will be fairly consistent with 2005. Since our new license transactions are relatively small in volume and are difficult to predict, we may not be able to generate new license transactions as
anticipated in any particular future period. From time to time, changes in working capital will affect our cash flows. However, we do not expect this to materially impact our future cash flows over time, since we expect relative stability, or slight
growth, in our assets and liabilities.

Operating cash flow. Our use of $16.3 million of cash for operating activities for the year
ended December 31, 2005, included $18.0 million net loss, a $331,000 reduction in the fair value of the warrant liability and $437,000 change in the provision for doubtful accounts partially offset by non-cash charges of $2.3 million in
depreciation, $38,000 in amortization of stock-based compensation, $133,000 in amortization of acquired intangible assets, $468,000 of restructuring costs, and a $6.3 million in impairment of internal-use software. Other working capital changes
totaled a negative $6.9 million, resulting primarily from a $1.5 million increase in accounts receivable, $3.1 million reduction in accrued restructuring, and $2.9 million reduction in deferred revenue, partially offset by $547,000 decrease in
prepaid expenses and other assets, and $129,000 increase in accounts payable and accrued liabilities. Our operating activities used $13.1 million and $12.7 million of cash and cash equivalents for the years ended December 31, 2004 and 2003,
respectively. These expenditures were primarily attributable to net losses experienced during these periods, offset in part by non-cash charges related to impairment of goodwill and amortization of intangibles and stock-based compensation.

Investing cash flow. Our investing activities provided $5.0 million of cash for the year ended December 31, 2005, and
consisted primarily of net transfers of short-term investments to cash totaling $6.4 million, partially offset by purchases of property and equipment of $465,000 and an increase in restricted cash of $932,000. Our investing activities provided $9.4
million of cash for the year ended December 31, 2004, and consisted primarily of net transfers of short-term investments to cash totaling $10.4 million, partially offset by purchases of property and equipment of $895,000 and cash paid for
acquisitions of $421,000. Our investing activities used $4.5 million of cash for the year ended December 31, 2003, and consisted primarily of net transfers of short-term investments to cash totaling $3.3 million and purchases of property and
equipment of $1.2 million.

Financing cash flow. In June 2005, the Company completed a private placement of unregistered securities
for the issuance of 1,631,541 shares of our common stock and warrants to purchase 815,769 shares of common stock for gross proceeds of $2.4 million. In September 2005, the Company completed a private placement of unregistered securities for the
issuance of 2,626,912 shares of common stock and warrants to purchase 945,687 shares of common stock for gross proceeds of $4.0 million. Financing activities provided $4.4 million in cash for the year ended December 31, 2005, due to the net
proceeds from these issuances of common stock and warrants, as well as net proceeds from loan activities of $4.0 million partially offset by the increase in restricted cash of $5.9 million required by our loan agreement. Our financing activities
provided $824,000 in cash for the year ended December 31, 2004, due to net proceeds from issuances of common stock. Our financing activities provided $14.2 million in cash for the year ended December 31, 2003, due to net proceeds from
issuances of common stock, particularly the public offering in November 2003, which raised $13.1 million in net proceeds.



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Existence and timing of contractual obligations. On November 30, 2005, the Company established a
new banking relationship with Bridge Bank N.A. (Bridge). In addition, on November 30, 2005, the Company entered into a Business Financing Agreement and Intellectual Property Security Agreement with Bridge under which the Company has
access to a Loan facility of $7.0 million (Loan). This Loan is made up of two parts, (i) a Formula Revolving Line of Credit of up to $5.0 million and (ii) a Non-Formula Revolving Line of Credit of up to $6.0 million, of which $2.0
million is available for a borrowing base for stand-by letters of credits, settlement limits on foreign exchange contracts (FX) or cash management products. The combined total borrowing under the two parts cannot exceed $7.0 million. The Formula
Revolving Line of Credit is collateralized by all of our assets and expires November 29, 2006 at which time the entire balance under the line of credit will be due. Interest for the Formula Revolving Line of Credit accrues at Bridges Prime
Lending Rate plus 2% while interest for the Non-Formula Revolving Line of Credit will accrue at Bridges Prime Lending Rate plus 0.50%. On December 29, 2005, the Company entered into a Business Financing Agreement, which provided for additional
advances up to $1.5 million based on an advance rate of 80% of eligible receivables. The overall Loan Facility was increased to $7.5 million. As of December 31, 2005, the Company had $7.4 million drawn against the Loan. On March 30, 2006, the
Company modified the Business Financing Agreement with Bridge Bank to increase the additional advances for accounts receivable to $2.0 million and the overall Loan Facility to $8.0 million.

Our future payments due under debt and lease obligations and other contractual commitments as of December 31, 2005 are as follows (in thousands):



|                                              |  |                        |        |                 |   |            |  |            |       |                  |   |       |  |   |   
|--------------------------------------------- |  | ---------------------- | ------ | --------------- | - | ---------- |  | ---------- | ----- | ---------------- | - | ----- |  | - | --
|                                              |  | Payments Due By Period
|                                              |  | Total                  |        | Less than1 year |   | 1 - 3years |  | 3 - 5years |       | More than5 years
|Contractual obligations:                      |  |                        |        |                 |   |            |  |            |       |                  |   |       |  |   |   
|Line of credit                                |  | $                      | 7,400  |                 | $ | 7,400      |  | $          |      |                  | $ |      |  | $ |  
|Non-cancelable operating lease obligation (1) |  |                        | 17,858 |                 |   | 5,309      |  |            | 7,407 |                  |   | 5,089 |  |   | 53
|Less: Sublease income (2)                     |  |                        | 7,870  |                 |   | 1,446      |  |            | 3,452 |                  |   | 2,953 |  |   | 19
|Other contractual obligations (3)             |  |                        | 4,940  |                 |   | 4,066      |  |            | 874   |                  |   |      |  |   |  
|                                              |  |                        |        |                 |   |            |  |            |       |                  |   |       |  |   |   
|Total                                         |  | $                      | 22,328 |                 | $ | 15,329     |  | $          | 4,829 |                  | $ | 2,136 |  | $ | 34
|                                              |  |                        |        |                 |   |            |  |            |       |                  |   |       |  |   |   

---

|(1) | Includes leases for properties included in the restructuring liability.
|--- | -----------------------------------------------------------------------



|(2) | Includes only subleases that are under contract as of December 31, 2005, and excludes future estimated sublease income for agreements not yet signed.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Represents minimum payments to four vendors for future royalty fees, minimum payments to one vendor for software services, minimum payments to one outsourcing company and minimum
payments for severance obligations.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating leases. In accordance with GAAP, none of our operating lease
obligations are reflected on our consolidated balance sheet. The vast majority of our operating leases relates to facilities and do not involve a transfer of ownership at the end of the lease.

Outlook. Based on our current 2006 revenue expectations, we expect our cash and cash equivalents will be sufficient to meet our working capital
and capital expenditure needs through December 31, 2006. If we do not experience anticipated demand for our products, we will need to further reduce costs, or issue equity securities or borrow money to meet our cash requirements. If we raise
additional funds through the issuance of equity or convertible securities, the percentage ownership of our stockholders would be reduced and the securities we issue might have rights, preferences and privileges senior to those of our current
stockholders. In addition, rising interest rates may impede the Companys ability to borrow additional funds as well as maintain its current debt arrangements. If adequate funds were not available on acceptable terms, our ability to achieve or
sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly
limited. Our expectations as to our future cash flows and our future cash balances are subject to a number of assumptions, including assumptions regarding anticipated increases in our revenue, improvements in general economic conditions and customer
purchasing and payment patterns, many of which are beyond our control.



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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We develop products in the United
States and sell these products in North America, Europe, Asia, and Australia. In the year ended December 31, 2005 and 2004, revenues from customers outside of the United States approximated 30% and 35%, respectively, of total revenues.
Generally, our sales are made in the local currency of our customers. As a result, our financial results and cash flows could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.
We rarely use derivative instruments to hedge against foreign exchange risk. As such, we are exposed to market risk from fluctuations in foreign currency exchange rates, principally from the exchange rate between the US dollar and the Euro and the
British pound. We manage exposure to variability in foreign currency exchange rates primarily due to the fact that liabilities and assets, as well as revenues and expenses, are denominated in the local currency. However, different durations in our
funding obligations and assets may expose us to the risk of foreign exchange rate fluctuations. We have not entered into any derivative instrument transactions to manage this risk. Based on our overall foreign currency rate exposure at
December 31, 2005, we do not believe that a hypothetical 10% change in foreign currency rates would materially adversely affect our financial position or results of operations.

We do not consider our cash equivalents or short-term investments to be subject to interest rate risk due to their short maturities.



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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

KANA Software, Inc.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Contents



|                                                          |  |      
|--------------------------------------------------------- |  | -----
|                                                          |  | Page 
|Reports of Independent Registered Public Accounting Firms |  | 44-46
|Financial Statements                                      |  |      
|Consolidated Balance Sheets                               |  | 47   
|Consolidated Statements of Operations                     |  | 48   
|Consolidated Statements of Stockholders Equity (Deficit) |  | 49   
|Consolidated Statements of Cash Flows                     |  | 50   
|Notes to the Consolidated Financial Statements            |  | 51   



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Kana Software, Inc. and subsidiaries:

We have audited the
accompanying consolidated balance sheet of Kana Software, Inc. and its subsidiaries (the Company) as of December 31, 2005 and the related consolidated statements of operations, stockholders equity (deficit), and cash flows for
the year then ended. Our audit also included the financial statement schedule listed in Item 15(a)(2) as of and for the year ended December 31, 2005. The consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our
audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kana Software, Inc. and its subsidiaries as of December 31, 2005 and the
results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule as of and for the
year ended December 31, 2005, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects, the information set forth therein.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1
to the consolidated financial statements, the Companys recurring losses from operations, net capital deficiency, negative cash flow from operations and accumulated deficit raise substantial doubt about its ability to continue as a going
concern. Managements plans as to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Burr, Pilger & Mayer LLP



Palo Alto, California

June 15, 2006



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Kana Software, Inc. and subsidiaries:

We have audited the
accompanying consolidated balance sheet of Kana Software, Inc. and subsidiaries (collectively the Company) as of December 31, 2004, and the related consolidated statements of operations and comprehensive loss, stockholders equity,
and cash flows for the year then ended. Our audit also included the consolidated financial statement schedule for the year ended December 31, 2004 listed in Item 15(a)(2). These financial statements and the financial statement schedule are the
responsibility of the Companys management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the
Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such 2004 consolidated financial statements present fairly, in all material respects, the financial position of the Company as of
December 31, 2004, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the 2004 consolidated financial
statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ Deloitte & Touche LLP

San Jose, California

August 26, 2005



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

KANA Software, Inc.:

In our opinion, the accompanying
consolidated statements of operations and comprehensive loss, of stockholders equity and of cash flows for the year ended December 31, 2003 present fairly, in all material respects, the results of operations and cash flows of KANA
Software, Inc. and its subsidiaries for the year ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the
index appearing under Item 15 (a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement
schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit of these statements in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

San Jose, California

March 17, 2004



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KANA SOFTWARE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                       |  |              |            |   |      |   |            |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                                                                                                       |  | December 31, |           
|                                                                                                                       |  | 2005         |            |   | 2004 |  
|ASSETS                                                                                                                 |  |              |            |   |      |   |            |  
|Current assets:                                                                                                        |  |              |            |   |      |   |            |  
|Cash and cash equivalents                                                                                              |  | $            | 6,216      |   |      | $ | 13,772     |  
|Marketable securities                                                                                                  |  |              |           |   |      |   | 6,361      |  
|Restricted cash                                                                                                        |  |              | 5,900      |   |      |   |           |  
|Accounts receivable, net of allowance of $149 and $586                                                                 |  |              | 6,095      |   |      |   | 4,497      |  
|Prepaid expenses and other current assets                                                                              |  |              | 2,859      |   |      |   | 3,308      |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total current assets                                                                                                   |  |              | 21,070     |   |      |   | 27,938     |  
|Restricted cash, long-term                                                                                             |  |              | 1,063      |   |      |   | 131        |  
|Property and equipment, net                                                                                            |  |              | 1,846      |   |      |   | 10,124     |  
|Goodwill                                                                                                               |  |              | 8,623      |   |      |   | 8,623      |  
|Acquired intangible assets, net                                                                                        |  |              | 148        |   |      |   | 281        |  
|Other assets                                                                                                           |  |              | 2,956      |   |      |   | 3,264      |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total assets                                                                                                           |  | $            | 35,706     |   |      | $ | 50,361     |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                                                         |  |              |            |   |      |   |            |  
|Current liabilities:                                                                                                   |  |              |            |   |      |   |            |  
|Line of credit                                                                                                         |  | $            | 7,400      |   |      | $ | 3,427      |  
|Accounts payable                                                                                                       |  |              | 5,057      |   |      |   | 4,308      |  
|Accrued liabilities                                                                                                    |  |              | 8,706      |   |      |   | 9,462      |  
|Accrued restructuring                                                                                                  |  |              | 2,727      |   |      |   | 2,768      |  
|Deferred revenue                                                                                                       |  |              | 14,529     |   |      |   | 17,630     |  
|Warrant liability                                                                                                      |  |              | 1,090      |   |      |   |           |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total current liabilities                                                                                              |  |              | 39,509     |   |      |   | 37,595     |  
|Deferred revenue, long-term                                                                                            |  |              | 506        |   |      |   | 889        |  
|Accrued restructuring, long-term                                                                                       |  |              | 4,825      |   |      |   | 8,026      |  
|Other long-term liabilities                                                                                            |  |              | 660        |   |      |   | 687        |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total liabilities                                                                                                      |  |              | 45,500     |   |      |   | 47,197     |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Commitments and contingencies (Note 6)                                                                                 |  |              |            |   |      |   |            |  
|                                                                                                                       |  |             
|Stockholders equity (deficit):                                                                                        |  |              |            |   |      |   |            |  
|Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding                       |  |              |           |   |      |   |           |  
|Common stock, $0.001 par value; 250,000,000 shares authorized; 33,923,783 and 29,245,402 shares issued and outstanding |  |              | 34         |   |      |   | 29         |  
|Additional paid-in capital                                                                                             |  |              | 4,293,063  |   |      |   | 4,288,176  |  
|Deferred stock-based compensation                                                                                      |  |              |           |   |      |   | (58        | )
|Accumulated other comprehensive income                                                                                 |  |              | 517        |   |      |   | 459        |  
|Accumulated deficit                                                                                                    |  |              | (4,303,408 | ) |      |   | (4,285,442 | )
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total stockholders equity (deficit)                                                                                   |  |              | (9,794     | ) |      |   | 3,164      |  
|                                                                                                                       |  |              |            |   |      |   |            |  
|Total liabilities and stockholders equity (deficit)                                                                   |  | $            | 35,706     |   |      | $ | 50,361     |  
|                                                                                                                       |  |              |            |   |      |   |            |  

See accompanying notes to consolidated financial statements.



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KANA SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)



|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                 |  | Year Ended December 31, |        
|                                                                                 |  | 2005                    |         |   | 2004 |   |         | 2003 | 
|Revenues:                                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|License fees                                                                     |  | $                       | 8,094   |   |      | $ | 14,169  |      |  | $ | 26,228  |  
|Services                                                                         |  |                         | 35,034  |   |      |   | 34,731  |      |  |   | 34,778  |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Total revenues                                                                   |  |                         | 43,128  |   |      |   | 48,900  |      |  |   | 61,006  |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Costs and Expenses:                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Cost of license fees                                                             |  |                         | 2,995   |   |      |   | 2,449   |      |  |   | 3,125   |  
|Cost of services                                                                 |  |                         | 8,744   |   |      |   | 9,488   |      |  |   | 9,702   |  
|Amortization of acquired intangible assets                                       |  |                         | 133     |   |      |   | 119     |      |  |   | 1,453   |  
|Sales and marketing                                                              |  |                         | 17,673  |   |      |   | 25,099  |      |  |   | 29,189  |  
|Research and development                                                         |  |                         | 13,230  |   |      |   | 19,497  |      |  |   | 21,437  |  
|General and administrative                                                       |  |                         | 11,379  |   |      |   | 8,137   |      |  |   | 9,073   |  
|Stock-based compensation (1)                                                     |  |                         | 38      |   |      |   | 1,231   |      |  |   | 5,870   |  
|Impairment of internal-use software                                              |  |                         | 6,326   |   |      |   | 1,062   |      |  |   |        |  
|Restructuring costs                                                              |  |                         | 468     |   |      |   | 3,400   |      |  |   | 1,704   |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Total costs and expenses                                                         |  |                         | 60,986  |   |      |   | 70,482  |      |  |   | 81,553  |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss from operations                                                             |  |                         | (17,858 | ) |      |   | (21,582 | )    |  |   | (20,547 | )
|Impairment of investment                                                         |  |                         |        |   |      |   |        |      |  |   | (500    | )
|Interest and other income (expense), net                                         |  |                         | 88      |   |      |   | 128     |      |  |   | 186     |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss before income taxes                                                         |  |                         | (17,770 | ) |      |   | (21,454 | )    |  |   | (20,861 | )
|Income tax expense                                                               |  |                         | (196    | ) |      |   | (314    | )    |  |   | (318    | )
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                         |  | $                       | (17,966 | ) |      | $ | (21,768 | )    |  | $ | (21,179 | )
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share                                             |  | $                       | (0.58   | ) |      | $ | (0.75   | )    |  | $ | (0.88   | )
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Shares used in computing basic and diluted net loss per share                    |  |                         | 30,814  |   |      |   | 28,950  |      |  |   | 24,031  |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|_________  (1)    Stock-based compensation is allocated as follows (see Note 1): | 
|                                                                                 |  | Year Ended December 31, |        
|                                                                                 |  | 2005                    |         |   | 2004 |   |         | 2003 | 
|Cost of services                                                                 |  | $                       | 2       |   |      | $ | 346     |      |  | $ | 430     |  
|Sales and marketing                                                              |  |                         | 9       |   |      |   | 646     |      |  |   | 2,300   |  
|Research and development                                                         |  |                         | 2       |   |      |   | 82      |      |  |   | 2,149   |  
|General and administrative                                                       |  |                         | 25      |   |      |   | 157     |      |  |   | 991     |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                                 |  | $                       | 38      |   |      | $ | 1,231   |      |  | $ | 5,870   |  
|                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  

See accompanying notes to consolidated financial statements.



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KANA SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)

(In thousands, except share data)



|                                                                                    |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|----------------------------------------------------------------------------------- |  | ------------ | - |  | ------------------------- | ---- | - | ------------------------------------ | - | --------- | ----------------------------------------------- |  | - | ------------------- | - |  | ------------------------------------ | ---- | - |  | - | ---------- | - |  | - | ------- | -
|                                                                                    |  | Common Stock |   |  | AdditionalPaid-In Capital |      |   | Deferred Stock- Based Compen- sation |   |           | Accumulated Other Compre- hensive Income (Loss) |  |   | Accumulated Deficit |   |  | Total Stockholders Equity (Deficit) |     
|                                                                                    |  | Shares       |   |  | Amount                    |      |   |                                      |   |           |                                                
|Balances at December 31, 2002                                                       |  | 22,939,872   |   |  | $                         | 195  |   |                                      | $ | 4,273,029 |                                                 |  | $ | (8,602              | ) |  | $                                    | (175 | ) |  | $ | (4,242,495 | ) |  | $ | 21,952  |  
|Issuance of common stock upon exercise of stock options, net of share cancellations |  | 406,035      |   |  |                           | 1    |   |                                      |   | 705       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 706     |  
|Issuance of common stock for Employee Stock Purchase Plan                           |  | 293,020      |   |  |                           |     |   |                                      |   | 411       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 411     |  
|Shares sold in public offering, net                                                 |  | 4,692,000    |   |  |                           | 5    |   |                                      |   | 13,095    |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 13,100  |  
|Amortization of deferred stock-based compensation                                   |  |             |   |  |                           |     |   |                                      |   | (1,191    | )                                               |  |   | 7,061               |   |  |                                      |     |   |  |   |           |   |  |   | 5,870   |  
|Exercise of warrants                                                                |  | 105,356      |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   |        |  
|Issuance of warrants                                                                |  |             |   |  |                           |     |   |                                      |   | 459       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 459     |  
|Comprehensive income (loss):                                                        |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Foreign currency translation adjustment                                             |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      | 213  |   |  |   |           |   |  |   | 213     |  
|Net loss                                                                            |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   | (21,179    | ) |  |   | (21,179 | )
|Total comprehensive income (loss)                                                   |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | (20,966 | )
|                                                                                    |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Balances at December 31, 2003                                                       |  | 28,436,283   |   |  |                           | 201  |   |                                      |   | 4,286,508 |                                                 |  |   | (1,541              | ) |  |                                      | 38   |   |  |   | (4,263,674 | ) |  |   | 21,532  |  
|Issuance of common stock upon exercise of stock options                             |  | 132,635      |   |  |                           |     |   |                                      |   | 276       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 276     |  
|Issuance of common stock for Employee Stock Purchase Plan                           |  | 413,984      |   |  |                           |     |   |                                      |   | 548       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 548     |  
|Reclassification                                                                    |  |             |   |  |                           | (172 | ) |                                      |   | 172       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   |        |  
|Amortization of deferred stock-based compensation                                   |  |             |   |  |                           |     |   |                                      |   | (254      | )                                               |  |   | 1,483               |   |  |                                      |     |   |  |   |           |   |  |   | 1,229   |  
|Acquisition of Hipbone                                                              |  | 262,500      |   |  |                           |     |   |                                      |   | 926       |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 926     |  
|Comprehensive income (loss):                                                        |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Foreign currency translation adjustment                                             |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      | 421  |   |  |   |            |   |  |   | 421     |  
|Net loss                                                                            |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   | (21,768    | ) |  |   | (21,768 | )
|Total comprehensive income (loss)                                                   |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | (21,347 | )
|                                                                                    |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Balances at December 31, 2004                                                       |  | 29,245,402   |   |  |                           | 29   |   |                                      |   | 4,288,176 |                                                 |  |   | (58                 | ) |  |                                      | 459  |   |  |   | (4,285,442 | ) |  |   | 3,164   |  
|Issuance of common stock upon exercise of stock options                             |  | 14,480       |   |  |                           |     |   |                                      |   | 22        |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 22      |  
|Adjustment                                                                          |  | (19,910      | ) |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   |        |  
|Amortization of deferred stock-based compensation                                   |  |             |   |  |                           |     |   |                                      |   | (20       | )                                               |  |   | 58                  |   |  |                                      |     |   |  |   |           |   |  |   | 38      |  
|Issuance of common stock, net of fees                                               |  | 4,683,811    |   |  |                           | 5    |   |                                      |   | 4,885     |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | 4,890   |  
|Comprehensive income (loss):                                                        |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Foreign currency translation adjustment                                             |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      | 58   |   |  |   |           |   |  |   | 58      |  
|Net loss                                                                            |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   | (17,966    | ) |  |   | (17,966 | )
|Total comprehensive income (loss)                                                   |  |             |   |  |                           |     |   |                                      |   |          |                                                 |  |   |                    |   |  |                                      |     |   |  |   |           |   |  |   | (17,908 | )
|                                                                                    |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  
|Balances at December 31, 2005                                                       |  | 33,923,783   |   |  | $                         | 34   |   |                                      | $ | 4,293,063 |                                                 |  | $ |                    |   |  | $                                    | 517  |   |  | $ | (4,303,408 | ) |  | $ | (9,794  | )
|                                                                                    |  |              |   |  |                           |      |   |                                      |   |           |                                                 |  |   |                     |   |  |                                      |      |   |  |   |            |   |  |   |         |  

See accompanying notes to consolidated financial statements.



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KANA SOFTWARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|---------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                             |  | For the Year Ended December 31, |        
|                                                                             |  | 2005                            |         |   | 2004 |   |         | 2003 | 
|Cash flows from operating activities:                                        |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                     |  | $                               | (17,966 | ) |      | $ | (21,768 | )    |  | $ | (21,179 | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                                 |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                |  |                                 | 2,326   |   |      |   | 5,471   |      |  |   | 8,088   |  
|Loss on the disposal of property and equipment                               |  |                                 | 69      |   |      |   | 44      |      |  |   |        |  
|Amortization of acquired intangible assets                                   |  |                                 | 133     |   |      |   | 119     |      |  |   | 1,453   |  
|Stock-based compensation                                                     |  |                                 | 38      |   |      |   | 1,231   |      |  |   | 5,870   |  
|Impairment of internal-use software                                          |  |                                 | 6,326   |   |      |   | 1,062   |      |  |   |        |  
|Provision for doubtful accounts                                              |  |                                 | (437    | ) |      |   | (601    | )    |  |   | (3,628  | )
|Restructuring costs                                                          |  |                                 | 468     |   |      |   | 3,336   |      |  |   | 1,704   |  
|Impairment of investment                                                     |  |                                 |        |   |      |   |        |      |  |   | 500     |  
|Other non-cash charges                                                       |  |                                 |        |   |      |   |        |      |  |   | 459     |  
|Change in fair value of warrant liability                                    |  |                                 | (331    | ) |      |   |        |      |  |   |        |  
|Changes in operating assets and liabilities, net of effects of acquisitions: |  |                                 |         |   |      |   |         |      |  |   |         |  
|Accounts receivable                                                          |  |                                 | (1,521  | ) |      |   | 4,075   |      |  |   | 5,989   |  
|Prepaid expenses and other assets                                            |  |                                 | 547     |   |      |   | (810    | )    |  |   | (29     | )
|Accounts payable and accrued liabilities                                     |  |                                 | 129     |   |      |   | 1,753   |      |  |   | (4,873  | )
|Accrued restructuring                                                        |  |                                 | (3,130  | ) |      |   | (3,389  | )    |  |   | (2,458  | )
|Deferred revenue                                                             |  |                                 | (2,914  | ) |      |   | (3,596  | )    |  |   | (4,583  | )
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                        |  |                                 | (16,263 | ) |      |   | (13,073 | )    |  |   | (12,687 | )
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                        |  |                                 |         |   |      |   |         |      |  |   |         |  
|Purchases of marketable securities                                           |  |                                 | (10,351 | ) |      |   | (12,515 | )    |  |   | (19,791 | )
|Maturities and sales of marketable securities                                |  |                                 | 16,740  |   |      |   | 22,901  |      |  |   | 16,503  |  
|Purchases of property and equipment                                          |  |                                 | (465    | ) |      |   | (895    | )    |  |   | (1,230  | )
|Proceeds from the sale of property and equipment                             |  |                                 |        |   |      |   | 22      |      |  |   |        |  
|Acquisition, net of cash acquired                                            |  |                                 |        |   |      |   | (421    | )    |  |   |        |  
|Restricted cash                                                              |  |                                 | (932    | ) |      |   | 330     |      |  |   | (13     | )
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                          |  |                                 | 4,992   |   |      |   | 9,422   |      |  |   | (4,531  | )
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Cash flows from financing activities:                                        |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net borrowings under line of credit                                          |  |                                 | 3,973   |   |      |   |        |      |  |   |        |  
|Payments on notes payable                                                    |  |                                 |        |   |      |   |        |      |  |   | (42     | )
|Restricted cash                                                              |  |                                 | (5,900  | ) |      |   |        |      |  |   |        |  
|Net proceeds from issuances of common stock and warrants                     |  |                                 | 6,333   |   |      |   | 824     |      |  |   | 14,217  |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                    |  |                                 | 4,406   |   |      |   | 824     |      |  |   | 14,175  |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Effect of exchange rate changes on cash and cash equivalents                 |  |                                 | (691    | ) |      |   | 317     |      |  |   | 213     |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                         |  |                                 | (7,556  | ) |      |   | (2,510  | )    |  |   | (2,830  | )
|Cash and cash equivalents at beginning of year                               |  |                                 | 13,772  |   |      |   | 16,282  |      |  |   | 19,112  |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                     |  | $                               | 6,216   |   |      | $ | 13,772  |      |  | $ | 16,282  |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Supplemental disclosure of cash flow information:                            |  |                                 |         |   |      |   |         |      |  |   |         |  
|Cash paid during the year for interest                                       |  | $                               | 302     |   |      | $ | 69      |      |  | $ | 173     |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Cash paid during the year for income taxes                                   |  | $                               | 431     |   |      | $ | 426     |      |  | $ | 289     |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Noncash activities:                                                          |  |                                 |         |   |      |   |         |      |  |   |         |  
|Issuance of warrants to a customer                                           |  | $                               |        |   |      | $ |        |      |  | $ | 459     |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Impairment of investment                                                     |  | $                               |        |   |      | $ |        |      |  | $ | 500     |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  
|Issuance of common stock in connection with the acquisition of Hipbone       |  | $                               |        |   |      | $ | 926     |      |  | $ |        |  
|                                                                             |  |                                 |         |   |      |   |         |      |  |   |         |  

See accompanying notes to consolidated financial statements.



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KANA SOFTWARE, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Kana Software, Inc. and Summary of Significant Accounting Policies

Nature of Operations

Kana Software, Inc. and its subsidiaries (the Company or KANA) were
incorporated in July 1996 in California and reincorporated in Delaware in September 1999. KANA develops, markets and supports customer communications software products. The Company sells its products primarily in the United States and Europe, and to
a lesser extent, in Asia, through its direct sales force and third party integrators.

Basis of Presentation

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. As of December 31, 2005, the Company had an accumulated deficit of $4.3 billion and has experienced recurring losses. We continue to take steps to lower the expenses related to cost of revenues,
sales and marketing, research and development, and general and administrative areas of the Company.

Since 1997 we have incurred
substantial costs to develop our products and to recruit, train and compensate personnel for our engineering, sales, marketing, client services, and administration departments. As a result, we have incurred substantial losses since inception. On
December 31, 2005, the Company had cash and cash equivalents of $6.2 million, restricted cash of $5.9 million and borrowings outstanding under a line of credit of $7.4 million due in November 2006. As of December 31, 2005, the Company had an
accumulated deficit of $4.3 billion, negative working capital of $18.4 million and a stockholders deficit of $9.8 million. Losses from operations were $17.9 million and $21.6 million for 2005 and 2004, respectively. Net cash used for operating
activities was $16.3 million and $13.1 million in 2005 and 2004, respectively. These conditions, among others, raise substantial doubt about the Companys ability to continue as a going concern. The consolidated financial statements do not
reflect any adjustments that might be required as a result of this uncertainty.

In February 2005, we announced we were taking actions to
reduce these expenses substantially. For example, employee headcount decreased from 181 on December 31, 2004 to 125 on December 31, 2005. We also were able to substantially reduce our headcount in outsourced engineering after completing
the development of a new product announced in December 2004. We are continuing to find ways to lower costs without materially changing our support for our customers. In addition, the Company was successful in closing two private sales of KANA common
stock, approximately $2.4 million on June 30, 2005 and approximately $4.0 million on September 29, 2005. Management believes that based on its current plans, its existing funds will be sufficient to meet the Companys working capital
and capital expenditure requirements through December 31, 2006. However, if we experience lower than anticipated demand for our products, we will need to further reduce costs, issue equity securities or borrow money to meet our cash
requirements. Any such equity issuances could be dilutive to our stockholders, and any financing transactions may be on unfavorable terms.

Reclassifications

Certain reclassifications have been made to the 2004 financial statements to conform to the
current year presentation, none of which had an effect on total assets, total stockholders equity (deficit), or net loss.

The
Company revised the presentation of the common stock and additional paid-in capital balances on the consolidated balance sheet as of December 31, 2004 and the consolidated statement of shareholders equity (deficit) for the year ended
December 31, 2004. At December 31, 2004, the Company had 29.2 million shares of common stock outstanding with $0.001 par value. Previously reported common stock as a component of stockholders equity (deficit) was $201,000 at
December 31, 2004. The Company reclassified $172,000 from common stock to additional paid-in capital to reflect the calculated par value of outstanding common stock of $29,000 as of December 31, 2004. This reclassification had no impact on
total stockholders equity (deficit), net loss, net loss per share, or cash flows.

Additionally, the Company reclassified $493,000
previously included in accounts payable to accrued liabilities in the consolidated balance sheet for the year ended December 31, 2004, to be comparable with the 2005 presentation.

Principles of Consolidation

The consolidated financial statements include the accounts of
KANA and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.



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Use of Estimates

The preparation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and the accompanying notes. On an ongoing basis, the Company evaluates estimates, including those related to revenue recognition, provision for doubtful accounts, fair value of acquired intangible assets and
goodwill, useful lives of property and equipment, income taxes, restructuring costs, and contingencies and litigation, among others. The Company bases estimates on historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from those
estimates under different assumptions or conditions.

Revenue Recognition

The Company recognizes revenues in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position
(SOP) 97-2, Software Revenue Recognition, as amended.

Revenue from software license agreements is recognized when the
basic criteria of software revenue recognition have been met (i.e. persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collection is probable). The Company uses the residual
method described in AICPA SOP 98-9, Modification of SOP 97-2 With Respect to Certain Transactions (SOP 98-9) to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and
vendor-specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as license
revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

When licenses are sold together with consulting services, license fees are recognized upon delivery, provided that (1) the basic criteria of
software revenue recognition have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the consulting services do not provide significant customization of the software products
and are not essential to the functionality of the software that was delivered. The Company does not provide significant customization of its software products.

Revenue arrangements with extended payment terms are generally considered not to be fixed or determinable and, the Company generally does not recognize revenue on these arrangements until the customer payments become
due and all other revenue recognition criteria have been met.

Probability of collection is based upon assessment of the customers
financial condition through review of their current financial statements or publicly-available credit reports. For sales to existing customers, prior payment history is also considered in assessing probability of collection. The Company is required
to exercise significant judgment in deciding whether collectibility is reasonably assured, and such judgments may materially affect the timing of our revenue recognition and our results of operations.

Services revenues include revenues for consulting services, customer support and training. Consulting services revenues and the related cost of services
are generally recognized on a time and materials basis. KANAs consulting arrangements do not include significant customization of the software. Customer support agreements provide technical support and the right to unspecified future upgrades
on an if-and-when available basis. Customer support revenues are recognized ratably over the term of the support period (generally one year). Training services revenues are recognized as the related training services are delivered. The unrecognized
portion of amounts billed in advance of delivery for services is recorded as deferred revenue.

Vendor-specific objective evidence for
consulting and training services are based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once
established, will not change before market introduction. Vendor-specific objective evidence for customer support is generally based on the price charged when an element is sold separately or the stated contractual renewal rates.



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Cost of license revenue primarily includes license fees paid to third party software vendors and
fulfillment costs. Cost of services revenue consists primarily of personnel related costs incurred in providing consulting services, customer support and training to customers.

Accounts Receivable and the Allowance for Doubtful Accounts

Accounts receivable are stated at
cost, net of allowances for doubtful accounts. The Company makes judgments as to its ability to collect outstanding receivables and records allowances when collection becomes doubtful. Allowance charges are recorded as general and administrative
expenses. These estimates are based on assessing the credit worthiness of our customers based on multiple sources of information and analysis of such factors as our historical collection experience and industry and geographic concentrations of
credit risk.

The accounts receivable aging is reviewed on a regular basis, and write-offs are recorded on a case by case basis net of any
amounts that may be collected.

Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments with an original maturity date of three months or less at the date of purchase to be cash equivalents.
The Company has classified its marketable securities as available for sale. These items are carried at fair value, based on the quoted market prices, with unrealized gains and losses reported as a separate component of accumulated other
comprehensive income (loss) in stockholders equity (deficit). All marketable securities mature in less than one year. To date, unrealized and realized gains or losses have not been material. The cost of securities sold is based on the specific
identification method.

Fair Value of Financial Instruments

The carrying values of the Companys financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their relatively
short maturities or payment terms. Based on borrowing rates currently available to the Company for lines of credit with similar terms, the carrying value of the Companys line of credit obligation approximates fair value.

Certain Risks and Concentrations

Financial
instruments subjecting the Company to concentrations of credit risk consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. Cash, cash equivalents and marketable securities are deposited with financial
institutions that management believes are creditworthy.

The Companys customers are primarily concentrated in the United States and
Europe. To reduce credit risk, the Company performs ongoing credit evaluations on its customers financial condition, and generally requires no collateral to support its accounts receivable. The Company establishes an allowance for doubtful
accounts based upon factors surrounding the credit risk of customers, historical trends and other information and, to date, such losses have been within managements expectations. As of December 31, 2005, four customers individually
represented more than 10% of total accounts receivable, totaling 51% in aggregate of accounts receivable. As of December 31, 2004, one customer represented more than 10% of total accounts receivable.

During the years ended December 31, 2005 and 2004, one customer represented 11% of total revenues. During the year ended December 31, 2003, no
customer represented more than 10% of total revenues.

Restricted Cash

The Company maintained $7.0 million and $0.1 million in both current and long-term restricted cash as of December 31, 2005 and 2004, respectively,
primarily as collateral for the line of credit facility with Bridge Bank and for the Companys leased facilities. Restricted cash of $5.9 million serves as collateral for the line of credit facility with Bridge Bank and was classified as a
current asset on the consolidated balance sheet at December 31, 2005 and $1.1 million serves as collateral for leased facilities and was classified as long term on the consolidated balance sheet at December 31, 2005.



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Impairment of Long-Lived Assets

The Company periodically assesses potential impairment of its long-lived assets with estimable useful lives which include property and equipment and
acquired intangible assets, in accordance with the provisions of Statement of Financial Accounting Standards No. 144 (SFAS 144), Accounting for the Impairment and Disposal of Long-Lived Assets. An impairment review is
performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors the Company considers important which could trigger an impairment review include, but are not limited to, significant
under-performance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the Companys overall business, and significant industry or economic trends.
When the Company determines that the carrying value of the long-lived assets may not be recoverable based upon the existence of one or more of the above indicators, the Company determines the recoverability by comparing the carrying amount of the
asset to net future undiscounted cash flows that the asset is expected to generate. The impairment recognized is the amount by which the carrying amount exceeds the fair market value of the asset. The Company recognized impairment charges for
certain internal use software in 2004 and 2005 as detailed below under Capitalized Software Development CostsInternal Use.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of net tangible and identified intangible assets acquired
in business combinations. Goodwill is not amortized but is evaluated at least annually for impairment or when a change in facts and circumstances indicate that the fair value of the goodwill may be below its carrying value.

The Company tests goodwill for impairment at the reporting unit level (Reporting Unit) at least annually and more frequently if
events merit. The Company performs this test in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets(SFAS 142). The Company has determined that it has only one
reporting segment and one Reporting Unit. Accordingly, goodwill is tested for impairment in a two-step process. First, the Company determines if the carrying amount of the Reporting Unit exceeds the fair value of the Reporting Unit,
which may initially indicate that goodwill could be impaired. If the Company determines that such impairment could have occurred, it would compare the implied fair value of the goodwill as defined by SFAS 142 to its carrying amount
to determine the impairment loss, if any. No impairment of goodwill was identified in 2003, 2004 or 2005.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the assets, which are three years for computer equipment, three years for furniture and fixtures, the shorter of ten years or the life of the lease for leasehold improvements, and five years for internal use software.
Upon retirement or sale, the cost and related accumulated depreciation are removed from the accounts and any related gain or loss is reflected in operations. Maintenance and repairs are charged to operations as incurred.

Capitalized Software Development CostsInternal Use

Software development costs for internal use software are capitalized pursuant to the provisions of Statement of Position 98-1, Accounting for Software Development Costs. Such costs include costs incurred
to purchase third party software, and are capitalized beginning when the Company has determined certain factors are present, including among others, that technology exists to achieve the performance requirements, buy versus internal development
decisions have been made and the Companys management has authorized the funding of the project. Capitalization of software costs ceases when the software is substantially complete and is ready for its intended use. The resulting asset is
amortized over its estimated useful life using the straight-line method.

When events or circumstances indicate the carrying value of
internal use software might not be recoverable, the Company will assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating
cash flows. The



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amount of impairment, if any, is recognized to the extent that the carrying value exceeds the projected discounted future
operating cash flows and is recognized as a write-down of the asset. In addition, when it is no longer probable that the software being developed will be placed in service, the asset will be recorded at the lower of its carrying value or fair value,
if any, less direct selling costs.

In the fourth quarter ended December 31, 2004, the Company reviewed its operations and technology
requirements, and decided to discontinue its use of certain internal use software, which resulted in a non-cash impairment charge of $1.1 million.

In the first quarter ended March 31, 2005, the Company reviewed all continuing operating expenses across the entire company, including our technology requirements. One result of this review was a decision to discontinue the use of
other internal use software. The total non-cash impairment charge related to this software was $6.3 million in the first quarter of 2005.

Accounting
for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed

Software development costs are expensed as incurred
until technological feasibility of the underlying software product is achieved. After technological feasibility is established, software development costs are capitalized until general availability of the product. Capitalized costs are then
amortized on the greater of straight line basis over the estimated product life, or the ratio of current revenue to total projected product revenue. To date, technological feasibility and general availability of such software have occurred
simultaneously and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any software development costs.

Restructuring Activities

The Company has recorded a facilities consolidation charge before
2003 for its estimated future lease commitments on excess facilities, net of estimated future sublease income. The estimates used in calculating the charge are reviewed on a quarterly basis and are revised if estimated future vacancy rates and
sublease rates vary from the Companys original estimates. To the extent that new estimates vary adversely from the original estimates, the Company may incur additional losses that are not included in the accrued balance at December 31,
2005. Conversely, unanticipated improvements in vacancy rates or sublease rates, or termination settlements for less than the Companys accrued amounts, may result in a reversal of a portion of the accrued balance and a benefit on the
Companys statement of operations in a future period.

The majority of restructuring reserve was originally recorded pursuant to
provisions of Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring,
(EITF 94-3) and continues to be evaluated pursuant to the requirements thereof. For facilities vacated and employees terminated after December 2002, the corresponding restructuring charge was recorded pursuant to the provisions of
Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (SFAS 146)

Stock-based Compensation

The Company generally grants stock options to its employees for a fixed number of shares
with an exercise price equal to the fair market value of the stock on the date of grant. As permitted under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended by
SFAS No. 148 Accounting for Stock-Based CompensationTransition and Disclosure (collectively referred to as SFAS 123), the Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to



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Employees and related interpretations in accounting for stock awards to employees. Accordingly, no compensation
expense is recognized in the Companys consolidated financial statements in connection with employee stock awards where the exercise price of the award is equal to or greater than the fair market value of the stock on the date of grant. When
stock options are granted with an exercise price that is lower than the fair market value of the stock on the date of grant, the difference is recorded as deferred compensation and amortized to expense on an accelerated basis over the vesting term
of the stock options.

Pro forma information regarding net loss and net loss per share is required by SFAS 123. This information is
required to be determined as if the Company had accounted for its employee stock options (including shares issued under the Employee Stock Purchase Plan, collectively called stock-based awards) under the fair value method of
SFAS 123. Stock-based awards have been valued using the Black-Scholes valuation model.

For purposes of pro forma disclosures, the
estimated fair value of the stock-based awards is amortized to expense over the vesting periods of the awards. The pro forma stock-based employee compensation expense has no impact on the Companys cash flows. For purposes of this
reconciliation, the Company adds back to previously reported net loss all stock-based employee compensation expense that relates to awards made below fair market value, then deducts the pro forma stock-based employee compensation expense determined
under the fair value method for all awards. The Companys pro forma information is as follows (in thousands, except per share amounts):



|                                                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                              |  | Year Ended December 31, |        
|                                                                                                              |  | 2005                    |         |   | 2004 |   |         | 2003 | 
|Net loss, as reported                                                                                         |  | $                       | (17,966 | ) |      | $ | (21,768 | )    |  | $ | (21,179 | )
|Add: Stock-based employee compensation expense included in reported net loss                                  |  |                         | 38      |   |      |   | 810     |      |  |   | 648     |  
|Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards |  |                         | (7,393  | ) |      |   | (10,663 | )    |  |   | (5,003  | )
|                                                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss, pro forma                                                                                           |  | $                       | (25,321 | ) |      | $ | (31,621 | )    |  | $ | (25,534 | )
|                                                                                                              |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share:                                                                         |  |                         |         |   |      |   |         |      |  |   |         |  
|As reported                                                                                                   |  | $                       | (0.58   | ) |      | $ | (0.75   | )    |  | $ | (0.88   | )
|Pro forma                                                                                                     |  | $                       | (0.82   | ) |      | $ | (1.09   | )    |  | $ | (1.06   | )

For purposes of the above pro forma calculation, the value of each option granted was estimated on
the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions:



|     |  |              |   |  |       |  |            |   |  |              |   |  |        |  |            |  
|---- |  | ------------ | - |  | ----- |  | ---------- | - |  | ------------ | - |  | ------ |  | ---------- | -
|     |  | Options      |   |  | ESPP  | 
|     |  | InterestRate |   |  | Term  |  | Volatility |   |  | InterestRate |   |  | Term   |  | Volatility |  
|2005 |  | 3.91         | % |  | 5 yrs |  | 99         | % |  | n/a          |   |  | n/a    |  | n/a        |  
|2004 |  | 2.66         | % |  | 5 yrs |  | 104        | % |  | 1.86         | % |  | 6 mths |  | 105        | %
|2003 |  | 2.11         | % |  | 5 yrs |  | 111        | % |  | 1.08         | % |  | 6 mths |  | 73         | %

In November 2005, due to the Companys delisting from The NASDAQ National Market, the Company
cancelled its 1999 Employee Stock Purchase Plan (ESPP) and refunded to employees all withholdings from November 2004 to April 2005. No withholdings were made after April 2005. The Company issued no shares in 2005 under the ESPP.

The weighted-average fair value of the Companys stock-based awards to employees was estimated assuming no expected dividends.



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The weighted-average fair value and exercise price of options granted in 2005 whose exercise price is
equal to the market price of the stock on the grant date was $1.23 and $1.60, respectively. The weighted-average fair value and exercise price of options granted in 2005 who exercise price exceeds the market price of the stock on the grant date was
$1.07 and $1.87, respectively. The weighted-average fair value of options granted in 2004 and 2003 was $3.87 and $2.27, respectively. The fair values are calculated using the Black-Scholes valuation model.

Foreign Currency

Generally, the functional
currency of our international subsidiaries is the local currency. The financial statements of these subsidiaries are translated to U.S. dollars using month-end exchange rates for assets and liabilities, and average exchange rates for revenues, costs
and expenses. Translation gains and losses are deferred and recorded in accumulated other comprehensive income (loss) as a component of stockholders equity (deficit).

Transaction gains and losses that arise from exchange rate changes denominated in other than the local currency are included in general and
administrative expenses in the statements of operations and are not considered material for all periods presented.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising expense was $243,000, $700,000, and $700,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.

Research and Development Costs

Research and development expenses consist primarily of compensation and related costs for personnel responsible for the research and development of new
products and services, as well as significant improvements to existing products and services. We expense research and development costs as they are incurred.

Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to reduce deferred tax assets to an amount where realization is more
likely than not.

Net Loss per Share

Basic net loss per share is computed using the weighted average number of outstanding shares of common stock. Diluted net loss per share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive,
shares of common stock issuable upon exercise of options and warrants deemed outstanding using the treasury stock method. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):



|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                    |  | Year Ended December 31, |        
|                                                    |  | 2005                    |         |   | 2004 |   |         | 2003 | 
|Basic and diluted net loss per share:               |  |                         |         |   |      |   |         |      |  |   |         |  
|Numerator:                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Net Loss                                            |  | $                       | (17,966 | ) |      | $ | (21,768 | )    |  | $ | (21,179 | )
|Denominator:                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Weighted average common shares outstanding          |  |                         | 30,814  |   |      |   | 28,950  |      |  |   | 24,033  |  
|Less: Weighted average shares subject to repurchase |  |                         |        |   |      |   |        |      |  |   | (2      | )
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Denominator for basic and diluted calculation       |  |                         | 30,814  |   |      |   | 28,950  |      |  |   | 24,031  |  
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share                |  | $                       | (0.58   | ) |      | $ | (0.75   | )    |  | $ | (0.88   | )
|                                                    |  |                         |         |   |      |   |         |      |  |   |         |  



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Outstanding warrants and stock options of 10,882,000, 9,307,000 and 8,628,000 at December 31, 2005,
2004, and 2003, respectively, have been excluded from the calculation of diluted net loss per share as all such securities were anti-dilutive for all periods presented.

Comprehensive Income (Loss)

The Company reports comprehensive income (loss) in accordance
with the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income, which establishes standards for reporting comprehensive income (loss) and its components in the financial statements. The
components of other comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments. Comprehensive income (loss) and the components of accumulated other comprehensive income are presented in the accompanying
consolidated statements of stockholders equity (deficit).

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004) (SFAS 123R) Share Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). SFAS 123R requires compensation costs relating to share-based payment transactions be recognized in financial statements. The pro forma disclosure previously permitted under SFAS 123 will no longer
be an acceptable alternative to recognition of expenses in the financial statements. SFAS 123R became effective for the Company on January 1, 2006. Through December 31, 2005, the Company has reported compensation costs related to share-based
payments under APB 25, as allowed by SFAS 123, and provides disclosure in the notes to financial statements as required by SFAS 123. We have adopted the modified prospective application method and the Black Scholes valuation model to
determine the fair value of our stock as provided by the provisions of SFAS 123R. We have evaluated the requirements of SFAS 123R and we expect that the adoption of SFAS 123R will have a material adverse impact on our
consolidated results of operations and net loss per share.

In December 2004, the FASB issued FASB Staff Position (FSP) No.
109-2 (FSP 109-2), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004, which provides guidance under SFAS No. 109, Accounting for Income Taxes,
with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the Jobs Act) on income tax expense and deferred tax liabilities. FSP 109-2 allows companies additional time to
evaluate whether foreign earnings will be repatriated under the repatriation provisions of the Jobs Act and requires specified disclosures for companies needing the additional time to complete the evaluation. Once a decision is made to repatriate
the foreign earnings, companies must reflect the deferred tax liabilities attributable to foreign earnings in the period that the decision is made to remit those earnings. The deduction is subject to a number of limitations and uncertainty remains
as to how to interpret numerous provisions in the Jobs Act. Although FSP 109-2 is effective immediately, until the Treasury Department or Congress provides additional clarifying language on key elements of the repatriation provision, we do not
believe we will have any foreign earnings that we would repatriate. Therefore, we do not believe adoption of FSP 109-2 will have a material effect on our consolidated financial position, results of operations or cash flows.

In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement
Obligation.FIN 47 clarifies that an entity must record a liability for a conditional asset retirement obligation if the fair value of the obligation can be reasonably estimated. FIN 47 also clarifies when an entity
would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of the fiscal year ending after December 15, 2005. We do not expect our adoption of FIN 47 to have a
material impact on our consolidated financial position, results of operations or cash flows.

In March 2005, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 107. In accordance with this Bulletin, effective January 1, 2006, we will no longer present stock-based compensation separately on our statements of operations. Instead we will present
stock-based compensation in the same lines as cash compensation paid to the same individuals.

In May 2005, the FASB issued SFAS No. 154
(SFAS 154), Accounting Changes and Error Corrections, which replaces Accounting Principles Board Opinions No. 20 Accounting Changes and SFAS 3 Reporting Accounting Changes in Interim financial Statements - an amendment
of APB No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application to prior periods financial statements, as the required method for reporting
a change in accounting principle and restatement with respect to the reporting of a correction of an error. SFAS 154 is effective for accounting changes and a correction of errors made in fiscal years beginning after December 15, 2005 and is
required to be adopted by KANA in the first quarter of fiscal 2006. We do not expect the adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.



In November 2005, the FASB issued FSP Nos. FAS 115-1 and FAS 124-1, The
Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. FSP Nos. FAS 115-1 and FAS 124-1 amend SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities,SFAS No. 124,
Accounting for Certain Investments Held by Not-for-Profit Organizations,as well as APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. This guidance nullifies certain requirements of EITF 03-1,
The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. FSP Nos. FAS 115-1 and FAS 124-1 include guidance for evaluating and recording impairment losses on debt and equity investments, as well as new
disclosure requirements for investments that are deemed to be temporarily impaired. FSP Nos. FAS 115-1 and FAS 124-1 also require other-than-temporary impaired debt securities to be written down to their impaired value, which becomes the new cost
basis. FSP Nos. FAS 115-1 and FAS 124-1 are effective for fiscal years beginning after December 15, 2005. We do not believe that adoption of FSP Nos. FAS 115-1 and FAS 124-1 on January 1, 2006 will have a material effect on our
financial position, cash flows or results of operations.

Note 2. Business Combinations

On February 10, 2004, the Company completed the acquisition of a 100% equity interest in Hipbone, Inc. (Hipbone), a provider of online
customer interaction solutions. The acquisition allowed the Company to add Hipbones web collaboration, chat, co-browsing and file-sharing capabilities to its products. This transaction was accounted for using the purchase method of accounting,
and operations of Hipbone for the periods beginning after February 10, 2004 are included in the Companys statements of operations for the year ended December 31, 2004. Under the terms of the agreement, the Company paid $265,000 in cash
and issued a total of 262,500 shares of the Companys



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common stock valued at approximately $926,000 using the five-trading-day average price surrounding the date the
acquisition was announced on January 5, 2004, or $3.62 per share. The Company incurred a total of approximately $169,000 in direct transaction costs. The estimated purchase price was approximately $1.4 million, summarized as follows (in
thousands):



|                                  |  |   |      
|--------------------------------- |  | - | -----
|Fair market value of common stock |  | $ | 926  
|                                  | 
|Cash consideration                |  |   | 265  
|Acquisition related costs         |  |   | 169  
|                                  |  |   |      
|Subtotal                          |  |   | 434  
|                                  |  |   |      
|Total                             |  | $ | 1,360
|                                  |  |   |      

As of the acquisition date, the Company recorded the fair market value of Hipbones assets
and liabilities. Fair market value is defined as the amount at which an asset could be bought or sold in a current transaction between willing parties. The values of Hipbones intangible assets were determined primarily using the income
approach. To the extent that the purchase price exceeded the fair value of the assets and liabilities assumed, goodwill was recorded. The resulting intangible assets acquired in connection with the acquisition are being amortized over a three-year
period. The allocation of the purchase price to assets acquired and liabilities assumed was as follows (in thousands):



|                                         |  |   |       |  
|---------------------------------------- |  | - | ----- | -
|Cash acquired                            |  | $ | 13    |  
|Tangible assets acquired (less cash)     |  |   | 166   |  
|Identifiable intangible assets acquired: |  |   |       |  
|Purchased technology                     |  |   | 250   |  
|Customer relationships                   |  |   | 150   |  
|Goodwill                                 |  |   | 1,175 |  
|Liabilities assumed                      |  |   | (394  | )
|                                         |  |   |       |  
|Net assets acquired                      |  | $ | 1,360 |  
|                                         |  |   |       |  

Pro forma results of operations have not been presented as the effects of this acquisition were
not material to the Companys financial position, results of operations or cash flows for the periods presented.

Note 3. Financial Statement
Detail

Cash and cash equivalents are carried at cost, which appropriates fair value and consisted of the following (in thousands):



|                   |  |              |       |      |   |       
|------------------ |  | ------------ | ----- | ---- | - | ------
|                   |  | December 31,
|                   |  | 2005         |       | 2004
|Cash               |  | $            | 4,617 |      | $ | 9,659 
|Money market funds |  |              | 1,599 |      |   | 4,113 
|                   |  |              |       |      |   |       
|                   |  | $            | 6,216 |      | $ | 13,772
|                   |  |              |       |      |   |       



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Short-term investments consisted of the following (in thousands):



|                                                                                                                                                     |  |              |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                     |  | 2005         |         |   | 2004 |  
|Available-for-sale securities:                                                                                                                       |  |              |         |   |      |   |         |  
|Municipal securities                                                                                                                                 |  | $            |        |   |      | $ | 2,375   |  
|Corporate notes / bonds                                                                                                                              |  |              |        |   |      |   | 3,986   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | $            |        |   |      | $ | 6,361   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Unrealized gains and losses on available-for-sale securities at December 31, 2005 were zero and at December 31, 2004, were immaterial.               |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Prepaid expenses and other current assets consisted of the following (in thousands):                                                                 |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                     |  | 2005         |         |   | 2004 |  
|Prepaid royalties                                                                                                                                    |  | $            | 1,209   |   |      | $ | 1,369   |  
|Other prepaid expenses                                                                                                                               |  |              | 1,650   |   |      |   | 1,939   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | $            | 2,859   |   |      | $ | 3,308   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Property and equipment, net consisted of the following (in thousands):                                                                               |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                     |  | 2005         |         |   | 2004 |  
|Computer equipment                                                                                                                                   |  | $            | 10,408  |   |      | $ | 10,489  |  
|Furniture and fixtures                                                                                                                               |  |              | 602     |   |      |   | 790     |  
|Leasehold improvements                                                                                                                               |  |              | 3,939   |   |      |   | 3,939   |  
|Internal use software                                                                                                                                |  |              | 561     |   |      |   | 13,248  |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |              | 15,510  |   |      |   | 28,466  |  
|Less accumulated depreciation and amortization                                                                                                       |  |              | (13,664 | ) |      |   | (18,342 | )
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | $            | 1,846   |   |      | $ | 10,124  |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Amortization of internal use software was $544,000, $3.0 million and $3.0 million for the years ended December 31, 2005, 2004 and 2003
respectively. |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Other assets consisted of the following (in thousands):                                                                                              |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                     |  | 2005         |         |   | 2004 |  
|Deposits                                                                                                                                             |  | $            | 2,062   |   |      | $ | 2,242   |  
|Prepaid royalties                                                                                                                                    |  |              | 894     |   |      |   | 1,022   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | $            | 2,956   |   |      | $ | 3,264   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  |             
|Accrued liabilities consisted of the following (in thousands):                                                                                       |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | December 31, |        
|                                                                                                                                                     |  | 2005         |         |   | 2004 |  
|Accrued payroll and related expenses                                                                                                                 |  | $            | 2,693   |   |      | $ | 2,664   |  
|Accrued royalties                                                                                                                                    |  |              | 2,027   |   |      |   | 2,044   |  
|Other accrued liabilities                                                                                                                            |  |              | 3,986   |   |      |   | 4,754   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  
|                                                                                                                                                     |  | $            | 8,706   |   |      | $ | 9,462   |  
|                                                                                                                                                     |  |              |         |   |      |   |         |  



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Other income (expense), net consisted of the following (in thousands):



|                 |  |                         |      |   |      |   |      |      |  |   |      |  
|---------------- |  | ----------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                 |  | Year Ended December 31, |     
|                 |  | 2005                    |      |   | 2004 |   |      | 2003 | 
|Interest income  |  | $                       | 265  |   |      | $ | 294  |      |  | $ | 315  |  
|Interest expense |  |                         | (513 | ) |      |   | (180 | )    |  |   | (174 | )
|Other            |  |                         | 336  |   |      |   | 14   |      |  |   | 45   |  
|                 |  |                         |      |   |      |   |      |      |  |   |      |  
|                 |  | $                       | 88   |   |      | $ | 128  |      |  | $ | 186  |  
|                 |  |                         |      |   |      |   |      |      |  |   |      |  

Note 4. Goodwill and Intangible Assets

Consideration paid in connection with acquisitions is required to be allocated to the acquired assets, including identifiable intangible assets, and
liabilities acquired. Acquired assets and liabilities are recorded based on the Companys estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates. For intangible assets other than
goodwill, the Company is required to estimate the useful life of the asset and recognize its cost as an expense over the useful life. The Company uses the straight-line method to expense long-lived assets (including identifiable intangibles).
Amortization of goodwill ceased as of January 1, 2002 upon the Companys adoption of SFAS 142. Instead, the Company is now required to test goodwill for impairment under certain circumstances and write down goodwill when it is deemed to be
impaired.

The Company regularly evaluates its business for potential indicators of impairment of goodwill and intangible assets. The
Companys judgments regarding the existence of impairment indicators are based on market conditions, operational performance of the business and considerations of any events that are likely to cause impairment. Future events could cause the
Company to conclude that impairment indicators exist and that goodwill and other intangible assets associated with the Companys acquired businesses are impaired. The Company currently operates in one reportable segment, which is also the only
reporting unit for the purposes of FAS 142.

The Company performed its annual impairment tests at June 30, 2005,
2004, and 2003 and concluded that goodwill was not impaired as the fair value of the Company exceeded its carrying value, including goodwill. No events have occurred since June 30, 2005 that would require an interim impairment analysis of
goodwill.

Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated
useful lives of the assets, which is three years. The Company reported amortization expense on purchased intangible assets of $133,000, $119,000, and $1.5 million for the years ended December 31, 2005, 2004, and 2003, respectively.

The Companys identifiable intangible assets are reviewed for impairment whenever events or changes in circumstance indicate that the carrying
amount of an intangible may not be recoverable.

Expected amortization expense is $133,000 in 2006 and $15,000 in 2007. Of these amounts,
62.5% relates to purchased technology and 37.5% relates to customer relationships, based upon the allocation of the Hipbone purchase price above.



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The components of goodwill and other intangibles are as follows (in thousands):



|                               |  |              |         |   |      |   |         |  
|------------------------------ |  | ------------ | ------- | - | ---- | - | ------- | -
|                               |  | December 31, |        
|                               |  | 2005         |         |   | 2004 |  
|Goodwill                       |  | $            | 8,623   |   |      | $ | 8,623   |  
|                               |  |              |         |   |      |   |         |  
|Intangibles:                   |  |              |         |   |      |   |         |  
|Customer Relationships         |  | $            | 150     |   |      | $ | 150     |  
|Purchased technology           |  |              | 14,650  |   |      |   | 14,650  |  
|Less: accumulated amortization |  |              | (14,652 | ) |      |   | (14,519 | )
|                               |  |              |         |   |      |   |         |  
|Intangibles, net               |  | $            | 148     |   |      | $ | 281     |  
|                               |  |              |         |   |      |   |         |  

Note 5. Line of Credit

On November 30, 2005, the Company paid off the loan to Silicon Valley Bank and established a new banking relationship with Bridge Bank N.A. (Bridge). In addition, on November 30, 2005, the Company entered
into a Business Financing Agreement and Intellectual Property Security Agreement with Bridge under which the Company has access to a Loan facility of $7.0 million (Loan). This Loan is made up of two parts, (i) a Formula Revolving Line of
Credit of up to $5.0 million and (ii) a Non-Formula Revolving Line of Credit of up to $6.0 million of which $2.0 million is available for a borrowing base for stand-by letters of credits, settlement limits on foreign exchange contracts (FX) or cash
management products. The combined total borrowing under the two parts cannot exceed $7.0 million. The Formula Revolving Line of Credit is collateralized by all of our assets and expires November 29, 2006 at which time the entire balance under the
line of credit will be due. Interest for the Formula Revolving Line of Credit accrues at Bridges Prime Lending Rate plus 2% while interest for the Non-Formula Revolving Line of Credit will accrue at Bridges Prime Lending Rate plus 0.50%.
On December 29, 2005, the Company entered into a Business Financing Agreement, which provided for additional advances up to $1.5 million based on an advance rate of 80% of eligible receivables. The overall Loan Facility was increased to $7.5
million. As of December 31, 2005, the Company had $7.4 million drawn against the Loan and the Business Financing Agreement and had pledged approximately $1.9 million of accounts receivable as collateral for the Business Financing Agreement. On
March 30, 2006, the Company modified the Business Financing Agreement with Bridge Bank to increase the additional advances for accounts receivable to $2.0 million and the overall Loan Facility to $8.0 million.

The terms of the Line of Credit require us to maintain certain reporting and financial covenants and as of December 31, 2005, the Company was in
compliance with the respective covenants.

Note 6. Commitments and Contingencies

(a) Lease Obligations

The Company leases its facilities under non-cancelable operating leases with
various expiration dates through January 2011. In connection with its existing leases, the Company entered into letters of credit totaling $900,000 expiring in 2006 through 2011. The Companys letters of credit are supported by either
restricted cash or the Companys line of credit.

Future minimum lease payments under non-cancelable operating leases are as follows
(in thousands):



|                         |  |                                  |        |                         |   |       |  |   |      
|------------------------ |  | -------------------------------- | ------ | ----------------------- | - | ----- |  | - | -----
|Year Ending December 31, |  | Non-cancelableOperatingLeases(1) |        | (Less)SubleaseIncome(2) |   | Net  
|2006                     |  | $                                | 5,309  |                         | $ | 1,446 |  | $ | 3,863
|2007                     |  |                                  | 4,170  |                         |   | 1,922 |  |   | 2,248
|2008                     |  |                                  | 3,237  |                         |   | 1,530 |  |   | 1,707
|2009                     |  |                                  | 3,130  |                         |   | 1,877 |  |   | 1,253
|2010                     |  |                                  | 1,959  |                         |   | 1,076 |  |   | 883  
|Thereafter               |  |                                  | 53     |                         |   | 19    |  |   | 34   
|                         |  |                                  |        |                         |   |       |  |   |      
|                         |  | $                                | 17,858 |                         | $ | 7,870 |  | $ | 9,988
|                         |  |                                  |        |                         |   |       |  |   |      



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---

|(1) | Includes leases for properties included in the restructuring liability.
|--- | -----------------------------------------------------------------------



|(2) | Includes only subleases that are under contract as of December 31, 2005 and excludes future estimated sublease income for agreements not yet signed.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------

Rent expense for properties in use, net of sublease payments, was approximately $1.9 million, $2.5 million and $2.5 million for the years ended
December 31, 2005, 2004 and 2003, respectively.

(b) Other Contractual Obligations

At December 31, 2005, the Company had other future contractual obligations requiring payments of $4.1 million, $674,000, and $200,000 for the years
ended December 2006, 2007 and 2008, respectively, with no required payments thereafter. These contractual obligations represent minimum payments to four vendors for future royalty fees, minimum payments to one vendor for software services, minimum
payments to one outsourcing company, and minimum payments for severance obligations.

(c) Litigation

The underwriters for the Companys initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Soundview
Capital Corp as well as the Company and certain current and former officers of the Company were named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The
cases allege violations of various securities laws by more than 300 issuers of stock, including the Company, and the underwriters for such issuers, on behalf of a class of plaintiffs who, in the case of the Company, purchased the Companys
stock between September 21, 1999 and December 6, 2000 in connection with the Companys initial public offering. Specifically, the complaints allege that the underwriter defendants engaged in a scheme concerning sales of the
Companys and other issuers securities in the initial public offering and in the aftermarket. In July 2003, the Company decided to join in a settlement negotiated by representatives of a coalition of issuers named as defendants in this
action and their insurers. In April 2005, the court requested a modification to the original settlement arrangement which was approved by the Company. Although the Company believes that the plaintiffs claims have no merit, the Company has
decided to accept the settlement proposal to avoid the cost and distraction of continued litigation. The proposed settlement agreement is subject to final approval by the court. Should the court fail to approve the settlement agreement, the Company
believes it has meritorious defenses to these claims and would defend the action vigorously. Because the settlement will be funded entirely by the Companys insurers, the Company does not believe that the settlement will have any effect on its
financial condition, results of operation or cash flows and accordingly, the Company has not accrued an amount for this loss contingency in its consolidated financial statements at December 31, 2005.

Third parties have from time to time claimed, and others may claim in the future that the Company has infringed their past, current or future
intellectual property rights. The Company has in the past been forced to litigate such claims. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business
or could require the Company to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm the Companys business.

(d) Indemnification

Many of our software license agreements require us to indemnify our customers from any claim or finding
of intellectual property infringement. We periodically receive notices from customers regarding patent license inquiries they have received which may or may not implicate our indemnity obligations. Any litigation, brought by others, or us could
result in the expenditure of significant financial resources and the diversion of managements time and efforts. In addition, litigation in which we are accused of infringement might cause product shipment delays, require us to develop
alternative technology or require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all. If a successful claim of infringement was made against us and we could not develop non-infringing
technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed. Such indemnification provisions are accounted for in accordance with SFAS No. 5 Accounting for
Contingencies (SFAS 5). To date, the Company has not incurred any costs related to any claims under such indemnifications provisions; accordingly, the amount of such obligations



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cannot be reasonably estimated. No liabilities have been recorded for these obligations on the Companys
consolidated balance sheets as of December 31, 2005 or December 31, 2004. There were no outstanding claims at December 31, 2005 and 2004.

(e) Warranties

The Company generally provides a warranty for its software products and services to its customers. The
Companys products are generally warranted to perform substantially as described in the associated product documentation for a period of 90 days. The Companys services are generally warranted to be performed consistent with industry
standards for a period of 90 days from delivery. In the event there is a failure of such warranties, the Company generally is obligated to correct the product or service to conform to the warranty provision or, if the Company is unable to do so, the
customer is entitled to seek a refund of the purchase price of the product or service. Such warranties are accounted for in accordance with SFAS 5. The Company has not provided for a warranty accrual as of December 31, 2005 or December 31,
2004. To date, the Companys product warranty expense has not been significant.

Note 7. Stockholders Equity (Deficit)

(a) Issuance of Common Stock and Warrants

In June
2005, the Company completed a private placement of unregistered securities for the issuance of 1,631,541 shares of common stock and warrants to purchase 815,769 shares of common stock for gross proceeds of $2.4 million. The warrants have an exercise
price of $2.452 per share. The warrants were valued at $581,000 using the Black-Scholes valuation model and recorded as a liability on the date of issue. These warrants were amended in September 2005 to become exercisable on March 28, 2006, and
expire on September 29, 2010. The modification resulted in an increase of $21,000 to the value of the warrants. See Note 8 for further details regarding the accounting of these warrants as a liability.

In September 2005, the Company completed a private placement of unregistered securities for the issuance of 2,626,912 shares of common stock and warrants
to purchase 945,687 shares of common stock for gross proceeds of $4.0 million. The warrants had an exercise price of $2.284 per share. These warrants will become exercisable on March 28, 2006, and expire on September 29, 2010. The warrants
were valued at $672,000 using the Black-Scholes valuation model and recorded as a liability on the date of issue. These warrants were amended to have an exercise price of $1.966 per share in October 2005. The modification resulted in an increase of
$49,000 to the value of the warrants. See Note 8 for further details regarding the accounting of these warrants as a liability.

The terms
for the September 2005 private placement require additional shares of common stock and warrants to be issued in the case that the Companys stock is delisted from The NASDAQ National Market. In October 2005, the Companys common stock was
delisted from The NASDAQ National Market and the Company issued an additional 425,358 shares of common stock and warrants to purchase 153,130 shares of common stock to the respective investors of the June and September 2005 private placements
(Investors). These additional warrants have an exercise price of $1.966 per share and will become exercisable on April 24, 2006, and will expire on October 25, 2010. These warrants were valued at $98,000 using the Black-Scholes
valuation model and recorded as a liability on the date of issue. See Note 8 for further details regarding the accounting of these warrants as a liability.

In May 2006, the Company amended the Registration Agreement related to the June and September 2005 private placements (collectively referred to as Private Placements) to extend the registration deadline of
the shares of common stock and underlying shares of common stock of the warrants issued to the Investors to September 30, 2006 from January 27, 2006, in exchange for the issuance of 593,854 shares of common stock to the Investors. If the
registration deadline is not met by September 30, 2006, an additional 59,383 shares of common stock will be issued to the Investors for a maximum of 653,237 shares to be issued if the registration requirements are never met.



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In December 2003, the Company issued to a customer a warrant to purchase 230,000 shares of common stock
at $5.00 per share in connection with a marketing agreement. The warrant was valued at approximately $459,000, using the Black-Scholes valuation model with an assumed interest rate of 5.0% and volatility of 100%. This amount was accounted for as a
reduction of revenue in the fourth quarter of 2003. The warrant is fully exercisable and expires five years from the date of issuance. As of December 31, 2005, the warrants were unexercised.

In November 2003 the Company sold 4,692,000 shares of its common stock at a price to the public of $3.00 per share, for gross proceeds of $14.1 million
(before transaction-related costs of $1.0 million).

(b) Stock Compensation Plans

The Companys ESPP allowed eligible employees to purchase common stock through payroll deductions of up to 15% of an employees compensation.
Each offering period had a maximum duration of 24 months and consisted of four six-month purchase periods. The purchase price of the common stock was equal to 85% of the fair market value per share on the participants entry date into the
offering period, or, if lower, 85% of fair market value per share on each semi-annual purchase date. The ESPP qualified as an employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986, as amended. In November 2005, the
Company cancelled the ESPP and refunded to employees all withholdings since November 2004, the date of the last ESPP share issuance.

The
Companys 1999 Stock Incentive Plan (the 1999 Stock Incentive Plan), as successor to the 1997 Stock Option Plan (the 1997 Stock Option Plan), provides for shares of the Companys common stock to be granted to
employees, independent contractors, officers, and directors. Options are granted at an exercise price equivalent to the closing fair market value on the date of grant. All options are granted at the discretion of the Companys Board of
Directors and have a term not greater than 10 years from the date of grant. Options are immediately exercisable when vested and generally vest monthly over four years.



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A summary of stock option activity is as follows:



|                              |  |                          |   |  |                     |   |  |                              |      
|----------------------------- |  | ------------------------ | - |  | ------------------- | - |  | ---------------------------- | -----
|                              |  |                          |   |  | Options Outstanding
|                              |  | SharesAvailablefor Grant |   |  | Number ofShares     |   |  | WeightedAverageExercisePrice
|Balances, December 31, 2002   |  | 4,444,172                |   |  | 7,204,853           |   |  | $                            | 25.42
|Adjustment for ESPP shares    |  | (339,460                 | ) |  |                    |   |  |                              |     
|Additional shares authorized  |  | 2,119,726                |   |  |                    |   |  |                              |     
|Options granted               |  | (4,088,102               | ) |  | 4,088,102           |   |  |                              | 3.30 
|Options exercised             |  |                         |   |  | (442,001            | ) |  |                              | 1.61 
|Options cancelled and retired |  | 2,959,668                |   |  | (2,959,668          | ) |  |                              | 27.21
|                              |  |                          |   |  |                     |   |  |                              |      
|Balances, December 31, 2003   |  | 5,096,004                |   |  | 7,891,286           |   |  |                              | 14.91
|Additional shares authorized  |  | 2,420,849                |   |  |                    |   |  |                              |     
|Options granted               |  | (3,592,500               | ) |  | 3,592,500           |   |  |                              | 3.61 
|Options exercised             |  |                         |   |  | (132,635            | ) |  |                              | 2.06 
|Options cancelled and retired |  | 2,328,680                |   |  | (2,328,680          | ) |  |                              | 16.26
|                              |  |                          |   |  |                     |   |  |                              |      
|Balances, December 31, 2004   |  | 6,253,033                |   |  | 9,022,471           |   |  |                              | 10.26
|Additional shares authorized  |  |                         |   |  |                    |   |  |                              |     
|Options granted               |  | (2,468,730               | ) |  | 2,468,730           |   |  |                              | 1.63 
|Options exercised             |  |                         |   |  | (14,480             | ) |  |                              | 1.41 
|Options cancelled and retired |  | 2,736,179                |   |  | (2,803,613          | ) |  |                              | 9.59 
|                              |  |                          |   |  |                     |   |  |                              |      
|Balances, December 31, 2005   |  | 6,520,482                |   |  | 8,673,108           |   |  | $                            | 8.03 
|                              |  |                          |   |  |                     |   |  |                              |      

The following table summarizes information about options outstanding at
December 31, 2005:



|             |  |                     |  |                                         |  |                              |       |                  |           |                              |   |                  |  |                              |  |   |      
|------------ |  | ------------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ---------------- | --------- | ---------------------------- | - | ---------------- |  | ---------------------------- |  | - | -----
|             |  | Options Outstanding |  | Options Exercisable                     |  | Options Vested              
|             |  | Number of shares    |  | WeightedAverageRemainingContractualLife |  | WeightedAverageExercisePrice |       | Number of shares |           | WeightedAverageExercisePrice |   | Number of shares |  | WeightedAverageExercisePrice
|$0.10$1.59  |  | 82,603              |  | 6.49                                    |  | $                            | 0.77  |                  | 68,519    |                              | $ | 0.68             |  | 77,853                       |  | $ | 0.71 
|$1.59$1.60  |  | 1,570,499           |  | 9.16                                    |  | $                            | 1.59  |                  | 330,470   |                              | $ | 1.59             |  | 330,470                      |  | $ | 1.59 
|$1.63$1.73  |  | 1,353,647           |  | 7.54                                    |  | $                            | 1.67  |                  | 831,227   |                              | $ | 1.65             |  | 833,478                      |  | $ | 1.65 
|$1.75$2.88  |  | 1,353,010           |  | 8.10                                    |  | $                            | 2.50  |                  | 941,540   |                              | $ | 2.46             |  | 966,472                      |  | $ | 2.46 
|$2.95$3.32  |  | 1,395,771           |  | 7.55                                    |  | $                            | 3.12  |                  | 847,084   |                              | $ | 3.12             |  | 859,523                      |  | $ | 3.13 
|$3.32$8.76  |  | 1,428,921           |  | 7.03                                    |  | $                            | 5.63  |                  | 990,418   |                              | $ | 6.11             |  | 1,047,373                    |  | $ | 6.03 
|$9.48$1,297 |  | 1,488,657           |  | 5.80                                    |  | $                            | 32.97 |                  | 1,441,917 |                              | $ | 29.49            |  | 1,458,366                    |  | $ | 30.18
|             |  |                     |  |                                         |  |                              |       |                  |           |                              |   |                  |  |                              |  |   |      
|             |  | 8,673,108           |  | 7.53                                    |  | $                            | 8.03  |                  | 5,451,175 |                              | $ | 10.18            |  | 5,573,535                    |  | $ | 10.29
|             |  |                     |  |                                         |  |                              |       |                  |           |                              |   |                  |  |                              |  |   |      



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The number of shares exercisable at December 31, 2005, 2004, and 2003 were 5,451,175, 4,006,253, and
3,054,365 respectively, and the weighted average exercise price of such shares for the same periods were $10.18, $16.53, and $26.94, respectively. In certain situations, a stock option will be vested but not exercisable. This is due to the fact that
the Company does not show options as exercisable unless and until it has received the signed agreement related to such grant. In addition, there are a number of shares that are vested, but are not exercisable until a certain time in the future (as
provided by contract). At December 31, 2005, 2004, and 2003, the total number of vested but unexercisable shares, were 122,360, 34,732, and 50,561, respectively, and had a weighted average exercise price of $15.31, $56.12, and $51.37,
respectively.

The Company uses the intrinsic-value method in accounting for its stock-based compensation plans. Accordingly, compensation
cost has been recognized in the financial statements for those options issued with exercise prices at less than fair value on the date of grant. These amounts are included as a component of stockholders equity (deficit) and were being
amortized on an accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option
or Award Plans (FIN 28). No options were granted with an exercise price below the fair market value during fiscal years 2005, 2004, and 2003.

Note 8. Warrant Liability

The warrants issued to the Investors in June, September, and October 2005 (collectively referred
to as the Warrants) have cash penalty clauses for the failure to register the underlying shares of common stock. Pursuant to EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in,
a Companys Own Stock (EITF 00-19), the Company recorded the Warrants as liabilities at their fair value using the Black-Scholes valuation model with changes in value reported to other income or expense each period. For the year
ended December 31, 2005, $331,000 was recorded to other income for the change in fair value of the Warrants.

The Warrants require
physical settlement but allow for net-share settlement if the underlying shares of common stock are not registered. A maximum of 1,914,586 shares of common stock could be issued to settle the Warrants under a net-share settlement.

As discussed in Note 7 above, in May 2006, the Company amended the Registration Agreement related to the Private Placements to extend the registration
deadline of the shares of common stock and underlying shares of common stock of the warrants issued to the Investors to September 30, 2006 from January 27, 2006, in exchange for the issuance of 593,854 shares of common stock to the Investors. The
Company amended the penalty for failure to register the underlying shares of common stock from cash to share-based payments, whereby, if the registration deadline is not met by September 30, 2006, an additional 59,383 shares of common stock will be
issued to the Investors for a maximum of 653,237 shares to be issued if the registration requirements are never met. Pursuant to EITF 00-19, with the elimination of these cash penalties, the fair value of the Warrants on the date of this amendment
will be reclassified to equity from liability, and gains or losses recorded to account for the contract at fair value during the period that the contract was classified as a liability will not be reversed.

Note 9. Restructuring Costs

As of December 31,
2005, the Company has $7.6 million in recorded restructuring liabilities primarily related to excess leased facilities exited before 2003. The majority of this restructuring reserve was originally recorded pursuant to provisions of EITF 94-3 and
continues to be evaluated pursuant to the requirements thereof. For facilities vacated after December 2002, the corresponding restructuring charge was recorded pursuant to the provisions of SFAS 146 and were recorded as a result a change in
evaluation of the real estate conditions in the United Kingdom as well as a change in sublease estimates based on communications with current and potential subtenants in the United States. Additionally, the Company vacated two buildings during 2005.
These charges totaled $0.2 million, $3.4 million and $1.7 million for the years ended December 31, 2005, 2004 and 2003, respectively, and have been recorded in the Companys consolidated statements of operations as restructuring costs.

In December 2005, the Company consolidated its research and development operations into one location in Menlo Park, California to optimize
the Companys research and development processes and decrease overall operating expenses. As a result, the Company terminated the employment of 15 employees based in New Hampshire. As a result of this consolidation, the Company incurred a
restructuring charge of $282,000 related to employee termination costs.

Should facilities operating lease rental rates continue to
decrease in these markets or should it take longer than expected to find a suitable tenant to sublease these facilities, the actual loss could exceed this estimate. Future cash outlays are anticipated through January 2011 unless the Company
negotiates to exit the leases at an earlier date. Sublease payments received were approximately $494,000, $141,000 and $348,000 in the years ended December 31, 2005, 2004 and 2003, respectively.



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A summary of restructuring expenses, payments, and liabilities for the years ended December 31,
2003, 2004, and 2005 is as follows (in thousands):



|                                           |  |           |      |   |            |   |        |       |  |   |        |  
|------------------------------------------ |  | --------- | ---- | - | ---------- | - | ------ | ----- |  | - | ------ | -
|                                           |  | Severance |      |   | Facilities |   |        | Total | 
|Restructuring reserve at December 31, 2002 |  | $         | 217  |   |            | $ | 10,731 |       |  | $ | 10,948 |  
|Restructuring charge                       |  |           |     |   |            |   | 1,704  |       |  |   | 1,704  |  
|Payments made                              |  |           | (33  | ) |            |   | (2,773 | )     |  |   | (2,806 | )
|Sublease payments received                 |  |           |     |   |            |   | 348    |       |  |   | 348    |  
|                                           |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at December 31, 2003 |  |           | 184  |   |            |   | 10,010 |       |  |   | 10,194 |  
|Restructuring charge                       |  |           |     |   |            |   | 3,400  |       |  |   | 3,400  |  
|Payments made                              |  |           | (184 | ) |            |   | (2,757 | )     |  |   | (2,941 | )
|Sublease payments received                 |  |           |     |   |            |   | 141    |       |  |   | 141    |  
|                                           |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at December 31, 2004 |  |           |     |   |            |   | 10,794 |       |  |   | 10,794 |  
|Restructuring charge                       |  |           | 282  |   |            |   | 186    |       |  |   | 468    |  
|Payments made                              |  |           |     |   |            |   | (4,204 | )     |  |   | (4,204 | )
|Sublease payments received                 |  |           |     |   |            |   | 494    |       |  |   | 494    |  
|                                           |  |           |      |   |            |   |        |       |  |   |        |  
|Restructuring reserve at December 31, 2005 |  | $         | 282  |   |            | $ | 7,270  |       |  | $ | 7,552  |  
|                                           |  |           |      |   |            |   |        |       |  |   |        |  

Note 10. Retirement Plan

The Company has a 401(k) retirement plan, which covers substantially all employees. Eligible employees may make salary deferral (before tax) contributions up to a specified amount. The Company, at its discretion, may
make additional matching contributions on behalf of the participants of the retirement plan. The Company made no contributions for the years ended December 31, 2005, 2004 and 2003.

Note 11. Income Taxes

The 2005, 2004 and 2003 income tax benefit differed from the amounts computed
by applying the U.S. federal income tax rate of 34% to pretax loss as a result of the following (in thousands):



|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                       |  | Year Ended December 31, |       
|                                                                                       |  | 2005                    |        |   | 2004 |   |        | 2003 | 
|Federal tax benefit at statutory rate                                                  |  | $                       | (6,042 | ) |      | $ | (7,294 | )    |  | $ | (7,283 | )
|Current year net operating losses and temporary differences, no tax benefit recognized |  |                         | 5,979  |   |      |   | 7,191  |      |  |   | 6,683  |  
|Amortization and goodwill impairment                                                   |  |                         |       |   |      |   |       |      |  |   | 494    |  
|Change in valuation allowance                                                          |  |                         |       |   |      |   |       |      |  |   |       |  
|Other permanent differences                                                            |  |                         | 63     |   |      |   | 103    |      |  |   | 106    |  
|Foreign taxes                                                                          |  |                         | 196    |   |      |   | 314    |      |  |   | 318    |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  
|Total tax expense                                                                      |  | $                       | 196    |   |      | $ | 314    |      |  | $ | 318    |  
|                                                                                       |  |                         |        |   |      |   |        |      |  |   |        |  

In 2005, 2004 and 2003 certain foreign subsidiaries were profitable, based upon application of the
Companys intercompany transfer pricing agreements, which resulted in income tax expense totaling approximately $196,000, $314,000 and $318,000 respectively, in those foreign jurisdictions.



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The types of temporary differences that give rise to significant portions of the Companys deferred
tax assets and liabilities are set as follows (in thousands):



|                          |  |                         |          |   |      |   |          |  
|------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | -
|                          |  | Year Ended December 31, |         
|                          |  | 2005                    |          |   | 2004 |  
|Deferred tax assets:      |  |                         |          |   |      |   |          |  
|Accruals and reserves     |  | $                       | 1,085    |   |      | $ | 1,197    |  
|Property and equipment    |  |                         | 8,715    |   |      |   | 7,764    |  
|Credit carryforward       |  |                         | 2,110    |   |      |   | 2,110    |  
|Stock based compensation  |  |                         | 24,664   |   |      |   | 25,487   |  
|Other                     |  |                         | 2,152    |   |      |   | 2,486    |  
|Net operating loss        |  |                         | 173,951  |   |      |   | 168,044  |  
|                          |  |                         |          |   |      |   |          |  
|Gross deferred tax assets |  |                         | 212,677  |   |      |   | 207,088  |  
|Valuation allowance       |  |                         | (212,677 | ) |      |   | (207,088 | )
|                          |  |                         |          |   |      |   |          |  
|Net deferred tax assets   |  | $                       |         |   |      | $ |         |  
|                          |  |                         |          |   |      |   |          |  

The net change in the valuation allowance for the year ended December 31, 2005 was an
increase of approximately $5.6 million due to current year losses net of the effect of the expiration of tax carryforwards and other assets. Management believes that sufficient uncertainty exists as to whether the deferred tax assets will be
realized, and accordingly, a valuation allowance is required.

A portion of deferred tax assets relating to net operating losses pertain to
acquired net operating loss carryforwards of approximately $8.9 million. When recognized, the tax benefit of these loss carryforwards will be accounted for as a credit to reduce goodwill or acquired intangibles, if remaining, rather than a reduction
of income tax expense.

As of December 31, 2005, the Company had net operating loss carryforwards for federal and state income tax
purposes of approximately $444.6 million and $345.6 million, respectively. The federal and state net operating loss carryforwards, if not offset against future taxable income, will expire by 2025. The Company also had foreign net operating loss
carryforwards of approximately $20.0 million. The foreign losses expire at various dates and some can be carried forward indefinitely.

Pursuant to the Internal Revenue Code, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the
Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. The portion of the net operating loss and tax credit carryforwards subject to potential
limitation has not been included in deferred tax assets.

A portion of deferred tax assets relating to net operating losses, pertains to
net operating loss carryforwards resulting from tax deductions upon the exercise of employee stock options of approximately $6.3 million. When recognized, the tax benefit of these loss carryforwards will be accounted for as a credit to additional
paid-in capital rather than a reduction of the income tax expense.

The Company has deferred calculating U.S. income tax on certain foreign
earnings that are deemed to be permanently re-invested overseas. Determination of the unrecognized deferred tax liability is not currently practicable and the amount is not expected to be material.

Note 12. Information About Geographic Areas

The
Companys chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing
financial performance. Accordingly, the Company considers itself to be in a single



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industry segment: specifically the licensing and support of its software applications. Revenue classification is based
upon customer location. Geographic information on revenue for the years ended December 31, 2005, 2004, and 2003 is as follows (in thousands):



|              |  |                         |        |      |   |        |  |   |       
|------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|              |  | Year Ended December 31,
|              |  | 2005                    |        | 2004 |   | 2003  
|North America |  | $                       | 30,039 |      | $ | 31,739 |  | $ | 43,851
|Europe        |  |                         | 11,848 |      |   | 15,537 |  |   | 14,979
|Asia Pacific  |  |                         | 1,241  |      |   | 1,624  |  |   | 2,176 
|              |  |                         |        |      |   |        |  |   |       
|              |  | $                       | 43,128 |      | $ | 48,900 |  | $ | 61,006
|              |  |                         |        |      |   |        |  |   |       

Geographic information on the Companys long-lived assets (Property and Equipment, net, and
Other Assets), based on physical location, is as follows (in thousands):



|              |  |                         |       |      |   |       
|------------- |  | ----------------------- | ----- | ---- | - | ------
|              |  | Year Ended December 31,
|              |  | 2005                    |       | 2004
|United States |  | $                       | 2,835 |      | $ | 11,108
|International |  |                         | 1,967 |      |   | 2,280 
|              |  |                         |       |      |   |       
|              |  | $                       | 4,802 |      | $ | 13,388
|              |  |                         |       |      |   |       

Note 13. Related Party Transactions

The Company provided support services to a company that is affiliated with Massood Zarrabian, a director of the Company until August 2003. The Company
recognized approximately $54,800 in revenue related to the company during the year ended December 31, 2003.

In addition, the Company
purchased software and support services from this company totaling approximately $96,000 during the year ended December 31, 2003. Management reviewed the contractual rates and terms to assess that they were comparable with those entered into
with independent third parties.

Note 14. Subsequent Event

As discussed in Note 7 and Note 8 above, in May 2006, the Company amended the Registration Agreement related to the June and September 2005 private placements (collectively referred to as Private
Placements) to extend the registration deadline of the shares of common stock and underlying shares of common stock of the warrants issued to the Investors to September 30, 2006 from January 27, 2006, in exchange for the issuance of 593,854
shares of common stock to the Investors. The Company amended the penalty for failure to register the underlying shares of common stock from cash to share-based payments, whereby, if the registration deadline is not met by September 30, 2006, an
additional 59,383 shares of common stock will be issued to the Investors for a maximum of 653,237 shares to be issued if the registration requirements are never met. Pursuant to EITF 00-19, with the elimination of these cash penalties, the fair
value of the Warrants on the date of this amendment will be reclassified to equity from liability, and gains or losses recorded to account for the contract at fair value during the period that the contract was classified as a liability will not be
reversed.

On March 16, 2006, Polaris IP, LLC filed suit against Sirius Satellite Radio, Inc., KANA Software, Priceline.com, Capital
One, Continental Airlines, Inc., and E*Trade Financial, in the U.S. District Court for the Eastern District of Texas, alleging infringement of U.S. Patent No. 6,411,947 and U.S. Patent No. 6,278,996, and seeking injunctive relief, damages and
attorneys fees. We believe that we have meritorious defenses to these claims and intend to defend the action vigorously.



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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

In July
2004, PricewaterhouseCoopers LLP (PwC) resigned as our independent registered public accounting firm. In September 2004, we appointed Deloitte & Touche LLP (D&T) as our new independent registered public
accounting firm.

In January 2006, D&T informed us that it would resign as our independent registered public accounting firm upon the
completion of its review of our unaudited financial statements for the quarter and six months ended June 30, 2005.

In March 2006, we
appointed Burr, Pilger & Mayer LLP as our new independent registered public accounting firm.

PwC did not include in their report
on the Companys financial statements as of December 31, 2003 and 2002, and for the years then ended an adverse opinion or a disclaimer of opinion, or a qualification or modification as to uncertainty, audit scope, or accounting principle,
nor were there disagreements between the Company and PwC on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to PwCs satisfaction, would have
caused PwC to make reference to the subject matter of the disagreement in connection with its reports on the Companys financial statements as of and for the years ended December 31, 2003 and 2002.

D&T did not include in their report on the Companys financial statements as of December 31, 2004 and for the year then ended an adverse
opinion or a disclaimer of opinion, or a qualification or modification as to uncertainty, audit scope, or accounting principle, nor were there disagreements between the Company and D&T on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to D&Ts satisfaction, would have caused D&T to make reference to the subject matter of the disagreement in connection with its report
on the Companys financial statements as of and for the year ended December 31, 2004. In the course of the audit of KANAs consolidated financial statements for the year ended December 31, 2004, D&T identified and reported
material weaknesses in KANAs internal control over financial reporting. First, KANA had weaknesses in its general accounting processes related to insufficient documentation and analyses to support its consolidated financial statements, failure
to properly evaluate estimates of royalties due, inadequate reconciliation of inter-company accounts, insufficient staffing in the accounting and reporting function, which was exacerbated by changes in management and accounting personnel, and
insufficient training of its accounting department. Second, there was no independent review of journal entries, and insufficient documentation or support for journal entries and consolidation entries. In a number of cases, this required adjustments
to KANAs consolidated financial statements for the year ended December 31, 2004. Third, KANA had multiple and inconsistent travel and entertainment policies and inadequate processes and procedures for review of expense reimbursement requests
that were also a material weakness in internal controls.

ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934 require public companies, including our company, to maintain disclosure
controls and procedures, which are defined as controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuers management, including its principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer performed an evaluation of our disclosure controls and procedures as of the end of the
period covered by this report and found that they were not effective as a result of the material weaknesses described below.

Changes
in Internal Control over Financial Reporting

Regulations under the Securities Exchange Act of 1934 require public companies,
including our company, to evaluate any change in our internal control over financial reporting, which is defined as a process to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial
statements for external purposes in accordance with accounting principles generally accepted in the United States of America. In connection with their evaluation of our disclosure controls and procedures as of the end of the period covered by this



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report, our Chief Executive Officer and Chief Financial Officer did not identify any change in our internal control over
financial reporting during the three-month period ended December 31, 2005 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Material Weaknesses and Corrective Action Plans

As previously disclosed by us in our Form NT-10-K filed with the U.S. Securities and Exchange Commission on April 1, 2005, during the first quarter of 2005, our Audit Committee (the Audit Committee)
completed an examination of certain of our internal controls relating to travel and entertainment expenses and implemented a series of measures designed to enhance our internal controls with respect thereto.

As a result of the investigation, the Audit Committee concluded that during the 20022004 period, our then Chairman of the Board of Directors and
Chief Executive Officer, Chuck Bay, had received reimbursement for approximately $137,000 in expenses that did not comply with the Company policies, that lacked sufficient documentation, or that were otherwise erroneous or duplicative. The Audit
Committee also concluded that certain other executive officers received travel, entertainment, and other expense reimbursements in lesser amounts that did not comply with the Company policies, lacked sufficient documentation, or were otherwise
erroneous or duplicative. The Audit Committee did not conclude that the excess reimbursements were the result of willful misconduct on the part of Mr. Bay, or any other KANA employee. Rather, the Audit Committee primarily attributed the excess
reimbursements to the existence of multiple and inconsistent travel and entertainment policies, inadequate review of expense reimbursement requests and carelessness.

During the first quarter of 2005, the Audit Committee adopted various remedial measures, including a requirement that Mr. Bay and others immediately repay the amounts that the Audit Committee determined were
inappropriate. Mr. Bay and the other individuals have repaid these amounts in full. The Audit Committee has also directed that management adopt a single, comprehensive travel and entertainment reimbursement policy and implement enhanced
procedures and controls for the submission and review of expense reimbursement requests. Management has implemented these measures, and the Audit Committee will continue to monitor the effectiveness of these remedial measures. In addition, the
independent directors determined that it would be advisable to separate the roles of Chairman of the Board of Directors and Chief Executive Officer. Accordingly, Mr. Bay has resigned from his position as Chairman of the Board of Directors,
effective May 23, 2005, while he retained his positions as a director and as Chief Executive Officer. Subsequently, on August 25, 2005, Mr. Bay resigned from his position as Chief Executive Officer. Mr. Bays position as a
Director expired at the Annual Stockholders Meeting held in November 2005.

We have determined that the dollar amounts involved in the
excess reimbursements were not material for the financial periods 2002-2004. However, the existence of multiple and inconsistent travel and entertainment policies and inadequate processes and procedures for review of expense reimbursement requests
represented a material weakness in our internal controls. A material weakness in internal control is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or detected.

In the course of the audit of our consolidated financial
statements for the year ended December 31, 2004, our independent registered public accounting firm identified and reported additional material weaknesses in our internal control over financial reporting. First, we had weaknesses in our general
accounting processes related to insufficient documentation and analyses to support our consolidated financial statements, failure to properly evaluate estimates of royalties due, inadequate reconciliation of inter-company accounts, insufficient
staffing in the accounting and reporting function, which is exacerbated by changes in management and accounting personnel, and insufficient training of our accounting department. Second, there was no independent review of journal entries, and
insufficient documentation or support for journal entries and consolidation entries. In a number of cases, this required adjustments to our financial statements for the year ended December 31, 2004.

Our management has determined that these deficiencies constitute material weaknesses as of December 31, 2004 which continued to exist during 2005.
As a result, we concluded that our internal controls over financial reporting were not effective as of December 31, 2005. We believe that these deficiencies did not have a material impact on our consolidated financial statements included in
this report due to the fact that we performed substantial analysis on the December 31, 2005 and prior period financial statement balances, including performing historical



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account reconciliations, having account balance analyses reviewed by senior management, and reconstructing certain
account balances. However, these deficiencies increase the risk that a transaction will not be accounted for consistently and in accordance with established policy or accounting principles generally accepted in the United States of America, and they
increase the risk of error.

Management, with the oversight of the Audit Committee of the Board of Directors, has begun to address these
control deficiencies and is committed to effectively remediating these deficiencies as expeditiously as possible. The Chief Financial Officer joined the company in mid October 2004. Some new processes and controls have already been approved and are
being implemented. We will continue to develop and implement further improvements and additional controls. In addition, management believes that it has corrected the material weakness relating to travel and entertainment expense reimbursement by the
end of the first quarter of 2005. Our other weaknesses will not be considered corrected until new internal controls are developed and implemented, are operational for a period of time, are tested, and management concludes that these controls are
operating effectively.

ITEM 9B. OTHER INFORMATION.

Not applicable.



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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Board of Directors

Our Board of Directors currently consists of seven (7) directors and is divided into three classes with staggered three-year terms. The names of our
directors and certain biographical information about each (including their ages as of June 15, 2006) are set forth below:



|                     |  |     |  |                                                               
|-------------------- |  | --- |  | --------------------------------------------------------------
|Name                 |  | Age |  | Position                                                      
|Michael S. Fields    |  | 60  |  | Chairman of the Board of Directors and Chief Executive Officer
|Jerry R. Batt        |  | 55  |  | Director                                                      
|William T. Clifford  |  | 59  |  | Director                                                      
|Dr. Dixie L. Mills   |  | 58  |  | Director                                                      
|John F. Nemelka      |  | 40  |  | Director                                                      
|Michael J. Shannahan |  | 57  |  | Director                                                      
|Stephanie Vinella    |  | 51  |  | Director                                                      

Michael S. Fields.Mr. Fields joined our Board of Directors in June 2005 and since
July 24, 2005, has been serving as our Chairman of the Board of Directors. From July 24, 2005 to August 25, 2005, Mr. Fields served as acting President of KANA. On August 25, 2005, Mr. Fields was appointed Chief
Executive Officer of KANA. Mr. Fields has been the Chairman and Chief Executive Officer of The Fields Group, a venture capital and management consulting firm, since May 1997. In June 1992, Mr. Fields founded OpenVision Technologies, Inc.,
a supplier of computer systems management applications for open client/server computing environments, and served as its Chief Executive Officer from July 1992 to July 1995, and served as its Chairman of the Board of Directors from July 1992 to April
1997. Earlier in his career Mr. Fields managed sales organizations at a number of large corporations, including Oracle U.S.A., where he served as President, and Applied Data Research and Burroughs Corporation. Mr. Fields also serves on the
Board of Directors of Imation Corporation, and two privately-held companies, ViaNovus, Inc. and Crucian Global Services, Inc. Mr. Fields is a Class III Director whose current term expires at the annual meeting to be held in 2008.

Jerry R. Batt.Mr. Batt joined our Board of Directors in August 2003. Mr. Batt has served as Vice President and Chief Information
Officer of Pulte Home Corporation, a national home building and construction company, since September 2003. From July 2001 to February 2003, Mr. Batt was the Chief Information Officer and Vice President of Sprint PCS. From April 2000 to July
2001, Mr. Batt co-founded and was Chief Executive Officer of Foxfire Consulting, an IT consulting and systems integration firm specializing in the telecommunications industry. From 1973 to January 2000, Mr. Batt was responsible for
AT&Ts consumer long distance account management, billing and customer service platform. Mr. Batt holds a degree in Industrial Engineering and Operations Research from Virginia Tech University. Mr. Batt is a Class II Director
whose current term expires at the annual meeting to be held in 2007.

William T. Clifford. Mr. Clifford joined our Board of
Directors in December 2005. Since August 2005, Mr. Clifford has served as Chairman of the Board of Directors and Chief Executive Officer of Aperture Technologies, Inc., an enterprise software solution company. From 2001 to 2003,
Mr. Clifford served as a General Partner of The Fields Group, a venture capital and management consulting firm. From 1993 to 2000, Mr. Clifford served as President and Chief Executive Officer of Gartner Group, Inc., an information
technology research and market company. Prior to these positions, Mr. Clifford was President of the Central and National Account divisions, and Corporate Vice President, Information Systems Development at Automatic Data Processing, Inc.
Mr. Clifford holds a degree in Economics from University of Connecticut. Mr. Clifford also serves on the Board of Directors of two privately-held companies, ViaNovus, Inc. and GridApp, Inc. Mr. Clifford is a Class II Director whose
current term expires at the annual meeting to be held in 2007.



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Dr. Dixie L. Mills. Dr. Mills joined our Board of Directors in August 2003.
Dr. Mills has been the Dean of the College of Business at Illinois State University since 1997. Dr. Mills is a member of the board of trustees for the Preferred Group of Mutual Funds, managed by Caterpillar Investment Management, Ltd.
Dr. Mills received her B.A. degree in history from Georgetown College, and earned her M.B.A. and Ph.D. degrees in finance from the University of Cincinnati. Dr. Mills is a Class I Director whose current term expires at the annual meeting
to be held in 2006.

John F. Nemelka. Mr. Nemelka joined our Board of Directors in October 2005. Mr. Nemelka founded
NightWatch Capital Group, LLC, an investment management business, in July 2001 and has served as its Managing Principal since July 2001. From 1997 to 2000, Mr. Nemelka was a Principal at Graham Partners, a private investment firm and affiliate
of the privately-held Graham Group. From 2000 to 2001, Mr. Nemelka was a Consultant to the Graham Group. Mr. Nemelka holds a B.S. degree in Business Administration from Brigham Young University and a M.B.A. degree from the Wharton School
at University of Pennsylvania. Mr. Nemelka also serves on the Board of Directors of a privately-held company. Mr. Nemelka is a Class III Director whose current term expires at the annual meeting to be held in 2008.

Michael J. Shannahan.Mr. Shannahan joined our Board of Directors in June 2005. Since February 2005, Mr. Shannahan has served as Chief
Financial Officer of Medsphere Systems Corporation, a software company in the healthcare industry. Mr. Shannahan has also served as Chief Financial Officer of Chordiant, Software, Inc., a management software company, from October 2003 to
September 2004, Sanctum from October 2001 to November 2002 and Broadband Office from January 2001 to September 2001. Prior to these positions, Mr. Shannahan spent eighteen years with KPMG as a Partner in the Information, Communication and
Entertainment practice. Mr. Shannahan holds a B.S. degree in Business Administration with a concentration in Accounting and a B.A. degree from Rockurst College. Mr. Shannahan is a Class II Director whose current term expires at the annual
meeting to be held in 2007.

Stephanie Vinella. Ms. Vinella joined our Board of Directors in November 2004. Since January 2005,
Ms. Vinella has served as Chief Financial Officer of Nextance Inc., a provider of enterprise contract management solutions. From November 1999 to August 2004, Ms. Vinella served as Chief Financial Officer of AlphaBlox Corporation, a
business analytic software company. From 1990 to 1999, Ms. Vinella served as Chief Financial Officer of Edify Corporation, a software company. Ms. Vinella holds a B.S. degree in Accounting from the University of San Francisco and a M.B.A.
degree from Stanford University. Ms. Vinella is a Class I Director whose current term expires at the annual meeting to be held in 2006.

Executive
Officers

The names of our current executive officers and certain biographical information about each (including their ages as of
June 15, 2006) are set forth below:



|                      |  |     |  |                                                     
|--------------------- |  | --- |  | ----------------------------------------------------
|Name                  |  | Age |  | Position                                            
|Michael S. Fields (1) |  | 60  |  | Chairman of the Board and Chief Executive Officer   
|John M. Thompson      |  | 60  |  | Executive Vice President and Chief Financial Officer

---

|(1) | Mr. Fields biographical information appears above. See Board of Directors.
|--- | -----------------------------------------------------------------------------



John Thompson. Mr. Thompson joined KANA in October 2004 and currently
serves as our Executive Vice President and Chief Financial Officer. Mr. Thompson was Chief Financial Officer of Veraz Networks, Inc., a provider of Voice Over IP solutions to the telecom industry, from January 2003 to October 2004. From May
2001 to January 2003, Mr. Thompson was Chief Financial Officer of Interwise, Inc., a provider of web-based communication products. From December 1998 to January 2001, Mr. Thompson was Chief Financial Officer of



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Manage.com, a software company. Mr. Thompson holds B.S. degrees in Mathematics and Industrial Management from Purdue
University and a M.S. degree in Industrial Administration from Carnegie-Mellon University.

Audit Committee

We have a separately-designated standing audit committee established in accordance with Rule 10A-3 promulgated under the Securities Exchange Act of 1934,
as amended (the Exchange Act), and currently comprised of Mr. Shannahan, Dr. Mills and Ms. Vinella, each of whom meets the independence and other requirements to serve on our Audit Committee under applicable
securities laws and the rules of the SEC and listing standards of The NASDAQ Stock Market. Our Board of Directors has determined that Mr. Shannahan and Ms. Vinella are each an audit committee financial expert as defined in the
rules of the SEC.

Section 16(a) Beneficial Ownership Reporting Compliance

The members of our Board of Directors, our executive officers and persons who hold more than 10% of our outstanding common stock are subject to the
reporting requirements of Section 16(a) of the Exchange Act, which requires them to file reports with respect to their ownership of our common stock and their transactions in such common stock. Based on our review of reporting forms we have
received from our executive officers and board members, we believe that such persons have filed, on a timely basis, the reports required under Section 16(a) of the Exchange Act for fiscal year 2005.

Code of Ethics

Our Board of Directors has adopted a
Code of Ethics and Conduct applicable to all of our directors, officers and employees, as required by applicable securities laws and the rules of the SEC and listing standards of The NASDAQ Stock Market. A copy of the Code of Ethics and Conduct is
posted in the Corporate Governance section of our Internet website at www.kana.com under Investor Relations.

ITEM 11. EXECUTIVE COMPENSATION.

Summary Compensation Table. The following table sets forth
certain information concerning compensation earned for 2003, 2004 and 2005, by:



| |  |  | our Chief Executive Officer;
| | - |  | ----------------------------



| |  |  | each of our other most highly compensated executive officers who were serving at the end of 2005 and whose salary and bonus for 2005 exceeded $100,000; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | up to two additional individuals who would have been named, but for the fact that such individual was not serving as an executive officer at the end of 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

The listed individuals are referred to in this report as the Named Executive Officers.

The salary figures include amounts the employees invested into our tax-qualified plan pursuant to Section 401(k) of the Internal Revenue Code.
However, compensation in the form of perquisites and other personal benefits that constituted less than the lesser of either $50,000 or 10% of the total annual salary and bonus of each of the Named Executive Officers in 2005 is excluded. The option
grants reflected in the table below were made under our equity incentive plans, including the KANA Software, Inc. 1999 Stock Incentive Plan, as amended, the Broadbase Software, Inc. 1999 Equity Incentive Plan and the Broadbase Software, Inc. 2000
Stock Incentive Plan.



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|                                                                            |  |              |  |                    |                       |           |   |                              |  |                          |  |   |        
|--------------------------------------------------------------------------- |  | ------------ |  | ------------------ | --------------------- | --------- | - | ---------------------------- |  | ------------------------ |  | - | -------
|                                                                            |  |              |  | AnnualCompensation |                       |           |   | Long-TermCompensation Awards
|                                                                            |  |              |  |                    |                       |           |   | SecuritiesUnderlyingOptions  |  | All OtherCompensation($)
|Name and Principal Positions                                                |  | Year         |  | Salary ($)         |                       | Bonus ($) |   |                             
|Michael S. Fields (1)Chief Executive Officer and Chairman of the Board      |  | 2005         |  | $                  | 126,557               |           | $ | 102,532                      |  | 0                        |  | $ | 30,000 
|                                                                            |  |              |  |                    |                      
|Chuck Bay (2)Former Chief Executive Officer                                 |  | 200520042003 |  |                    | 260,223300,000250,000 |           |   | 20,00035,000100,000          |  | 260,100150,000275,000    |  |   |      
|                                                                            |  |              |  |                    |                      
|John M. Thompson (3)Executive Vice President and Chief Financial Officer    |  | 20052004     |  |                    | 235,00048,959         |           |   | 77,667                       |  | 33,100350,000            |  |   |        
|                                                                            |  |              |  |                    |                      
|Brian Kelly (4)Former President, Connectify                                 |  | 200520042003 |  |                    | 201,042205,000100,401 |           |   | 63,000119,08070,000          |  | 72,500100,000300,000     |  |   | 150,000
|                                                                            |  |              |  |                    |                      
|Alan Hubbard (5)Former Executive Vice President of Research and Development |  | 200520042003 |  |                    | 217,500205,000163,100 |           |   | 89,550109,674100,000         |  | 90,50040,000254,876      |  |   |      
|                                                                            |  |              |  |                    |                      
|Tim Angst (6)Former Executive Vice President, Worldwide Operations          |  | 200520042003 |  |                    | 134,106134,102       |           |   | 46,494                     |  | 102,600400,000          |  |   | 66,440

---

|(1) | Mr. Fields served as President of KANA from July 25, 2005 to August 25, 2005 on a consulting basis before he was appointed Chief Executive Officer of KANA on
August 25, 2005. Mr. Fields bonus amount is for services performed during fiscal year 2005, but paid in the first quarter of fiscal year 2006 and Mr. Fields Other Compensation represents the compensation he
received for his consulting services.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Mr. Bay resigned from his executive position with KANA on August 25, 2005; therefore, his 2005 annual salary represents only eight months of compensation.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Mr. Thompson joined KANA in October 2004; therefore, his 2004 annual salary and bonus represents only two and one half months of compensation.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Mr. Kellys Other Compensation in 2003 represents a signing bonus. Mr. Kellys executive position with KANA terminated on June 1, 2006.
Mr. Kellys title of his position at KANA changed from Executive Vice President of Marketing and Product Strategy to President, Connectify on February 16, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Mr. Hubbard resigned from his executive position with KANA on February 14, 2006.
|--- | --------------------------------------------------------------------------------



|(6) | Mr. Angst joined KANA in April 2004; therefore, his 2004 annual salary represents only eight months of compensation. Mr. Angsts Other Compensation
represents commissions Mr. Angst earned in 2004. Mr. Angst ceased providing services in early June 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock Options

Table of Option Grants in Fiscal 2005. The following table sets forth information with respect to stock options granted to each
of the Named Executive Officers in the year ended December 31, 2005. We granted options



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to purchase up to a total of 2,332,730 shares to employees during the year ended December 31, 2005 and the
tables percentage column shows how much of that total was granted to the Named Executive Officers. No stock appreciation rights were granted to the Named Executive Officers during 2005.

The table includes the potential realizable value over the 10-year term of the options, based on assumed rates of stock price appreciation of 5% and 10%,
compounded annually. The potential realizable value is calculated based on the closing price of the common stock on the date of grant, assuming that price appreciates at the indicated rate for the entire term of the option and that the option is
exercised and sold on the last day of its term at the appreciated price. All options listed have a term of 10 years. The stock price appreciation rates of 5% and 10% are assumed pursuant to the rules of the SEC. We can give no assurance that the
actual stock price will appreciate over the 10-year option term at the assumed levels or at any other defined level. Actual gains, if any, on stock option exercises will be dependent on the future performance of our common stock. Unless the market
price of the common stock appreciates over the option term, no value will be realized from the option grants made to the Named Executive Officers.

Option Grants in Fiscal 2005



|                  |  |                                                 |  |                                                         |        |                                |  |                 |  |                                                                                              |   |  |        
|----------------- |  | ----------------------------------------------- |  | ------------------------------------------------------- | ------ | ------------------------------ |  | --------------- |  | -------------------------------------------------------------------------------------------- | - |  | -------
|                  |  |                                                 |  | Individual Grants                                       |        |                                |  |                 | 
|Name              |  | Number ofSecuritiesUnderlyingOptionsGranted (#) |  | % of TotalOptions Grantedto Employees inFiscal Year2005 |        | ExercisePrice Per Share ($/sh) |  | Expiration Date |  | Potential Realizable Value atAssumed Annual Rates ofStock Price Appreciation forOptions Term
|                  |  |                                                 |  |                                                         | 5% ($) |                                |  | 10% ($)        
|Michael S. Fields |  |                                                |  |                                                        |        |                               |  |                |  |                                                                                             |   |  |       
|Chuck Bay (1)     |  | 125,000                                         |  | 5.36                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 125,028
|                  |  | 100,000                                         |  | 4.29                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 100,023
|                  |  | 35,100                                          |  | 1.50                                                    |        | 1.870                          |  | 03/23/2015      |  | (7,020                                                                                       | ) |  | 29,831 
|                  |  |                                                 |  |                                                         |        |                               
|John M. Thompson  |  | 17,500                                          |  | 0.75                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 17,504 
|                  |  | 15,600                                          |  | 0.67                                                    |        | 1.870                          |  | 03/23/2015      |  | (3,120                                                                                       | ) |  | 13,258 
|                  |  |                                                 |  |                                                         |        |                               
|Brian Kelly (2)   |  | 72,500                                          |  | 3.11                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 72,516 
|Alan Hubbard (3)  |  | 72,500                                          |  | 3.11                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 72,516 
|                  |  | 18,000                                          |  | 0.77                                                    |        | 1.870                          |  | 03/23/2015      |  | (3,600                                                                                       | ) |  | 15,298 
|                  |  |                                                 |  |                                                         |        |                               
|Tim Angst (4)     |  | 72,500                                          |  | 3.11                                                    |        | 1.591                          |  | 03/01/2015      |  | 0                                                                                            |   |  | 72,516 
|                  |  |                                                 |  |                                                         |        |                               
|                  |  | 30,100                                          |  | 1.29                                                    |        | 1.870                          |  | 03/23/2015      |  | (6,020                                                                                       | ) |  | 25,582 

---

|(1) | Mr. Bay resigned as our Chief Executive Officer on August 25, 2005.
|--- | -------------------------------------------------------------------



|(2) | Mr. Kellys executive position with KANA terminated on June 1, 2006.
|--- | --------------------------------------------------------------------



|(3) | Mr. Hubbard resigned on February 14, 2006.
|--- | ------------------------------------------



|(4) | As of June 2005, Mr. Angst ceased providing services to KANA.
|--- | -------------------------------------------------------------

Table of Aggregated Option Exercises and Fiscal Year-End Values.The following table sets forth the number of shares underlying exercisable and unexercisable options held by the Named Executive Officers as of
December 31, 2005 and the value of such options. None of the Named Executive Officers held any stock appreciation rights at the end of the year.



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The value realized is based on the fair market value of our common stock on the date of exercise, minus
the exercise price payable for the shares, except in the event of a same day sale transaction, in which case the actual sale price is used.

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values



|                  |  |                                         |             |                   |               |                                                                         |             |                                                                    |               |   |        |  |   |      
|----------------- |  | --------------------------------------- | ----------- | ----------------- | ------------- | ----------------------------------------------------------------------- | ----------- | ------------------------------------------------------------------ | ------------- | - | ------ |  | - | -----
|Name              |  | Number ofSharesAcquired on Exercise (#) |             | Value Realized($) |               | # of Securities UnderlyingUnexercised Options/SARsat Fiscal Year-End(#) |             | Value of Unexercisedin-the-Money Options/SARsat Fiscal Year-End($)
|                  |  |                                         | Exercisable |                   | Unexercisable |                                                                         | Exercisable |                                                                    | Unexercisable
|Michael S. Fields |  |                                        |             |                  |               | 0                                                                       |             | 0                                                                  |               | $ | 0      |  | $ | 0    
|Chuck Bay (1)     |  |                                        |             |                  |               | 1,549,117                                                               |             | 445,312                                                            |               |   | 4,439  |  |   |     
|John M. Thompson  |  |                                        |             |                  |               | 120,965                                                                 |             | 262,135                                                            |               |   |       |  |   |     
|Brian Kelly (2)   |  |                                        |             |                  |               | 240,677                                                                 |             | 231,823                                                            |               |   |       |  |   |     
|Alan Hubbard (3)  |  |                                        |             |                  |               | 253,102                                                                 |             | 177,398                                                            |               |   | 16,332 |  |   | 3,768
|Tim Angst (4)     |  |                                        |             |                  |               | 221,714                                                                 |             |                                                                   |               |   |       |  |   |     

---

|(1) | Mr. Bay resigned as our Chief Executive Officer on August 25, 2005.
|--- | -------------------------------------------------------------------

|(2) | Mr. Kellys executive position with KANA terminated on June 1, 2006.
|--- | --------------------------------------------------------------------

|(3) | Mr. Hubbard resigned on February 14, 2006.
|--- | ------------------------------------------

|(4) | As of June 2005, Mr. Angst ceased providing services to KANA.
|--- | -------------------------------------------------------------

Compensation of Directors

Until 2005 we did not compensate any non-employee member of our Board of Directors other
than through option grants. In November 2005, the Board of Director restated the director cash compensation arrangements for each of the Directors for all periods up to December 31, 2005 and decided to address cash compensation for future
periods in 2006. For services up to December 31, 2005, Ms. Vinella received $40,000 in cash compensation ($30,000 for participation on our Board of Directors, $5,000 for acting as our Audit Committee Chairperson during the last half of
2004 and $5,000 for acting as our Audit Committee Chairperson in the first half of 2005); Dr. Mills received $35,000 ($30,000 for participation on our Board of Directors and $5,000 for acting as our Governance Committee Chairperson);
Mr. Batt received $35,000 ($30,000 for participation on our Board of Directors and $5,000 for acting as our Compensation Committee Chairperson); and Mr. Shannahan received $25,000 ($15,000 for participation on our Board of Directors and
$10,000 for acting as our Audit Committee Chairperson during the last half of 2005). Messrs. Fields, Clifford and Nemelka received no cash compensation for 2005.

In April 2006, our Board of Directors approved new director cash compensation arrangements that became effective retroactively from January 1, 2006, under which each non-employee director will be paid (i) an
annual fee of $10,000, and (ii) an additional $2,500 for each of the four (4) regularly scheduled Board of Directors meetings that such director attends. Moreover, our Board of Directors approved the following cash compensation for
chairpersons of our committees of the Board of Directors: the chairperson of the Audit Committee will be paid $15,000 per annum and the chairpersons of the Compensation Committee and the Governance and Nominating Committee will each be paid $5,000
per annum.

Our non-employee directors are eligible to receive discretionary option grants and stock issuances from the KANA 1999 Stock
Incentive Plan. In February 2005, Ms. Vinella was granted an option to purchase an aggregate of 100,000 shares of common stock at $1.70 per share as her initial grant as a new non-employee director. All of these options were granted under the
KANA 1999 Stock Incentive Plan, and each option will vest and become exercisable, for as long as Ms. Vinella is serving as a member of the Board of Directors, as to 1/48th of the total



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shares granted each month. If there is a change of control of at least 50% of our voting stock, and, in connection with
the change of control, there is an involuntary termination of Ms. Vinellas service as a member of our Board of Directors (or our successor), then any remaining unvested shares will immediately vest. In addition, under the KANA 1999 Stock
Incentive Plan, each new non-employee director will receive an automatic option grant for 40,000 shares upon his or her initial appointment or election to the Board of Directors, and each continuing non-employee director will receive an automatic
option grant for 10,000 shares on the date of the annual meeting of stockholders thereafter.

On November 18, 2005, we formally
entered into a consulting agreement (the Consulting Agreement) with Mr. Fields, with respect to his service as acting President of KANA between July 25, 2005 and August 25, 2005. Pursuant to the terms of the
Consulting Agreement, Mr. Fields was paid a fee of $30,000 for his services. In addition, on November 18, 2005, we formally entered into an employment offer letter with Mr. Fields for the position of Chief Executive Officer and
Chairman of the Board of Directors (the Board), effective August 26, 2005 (the Start Date). Our Compensation Committee of the Board of Directors has recommended that Mr. Fields be granted
options to purchase 768,000 shares of our common stock divided into two grants and subject to a reference collar, which means that if the closing price of our common stock on the date on which Mr. Fields options are granted is
greater than the closing price of our common stock on Mr. Fields Start Date ($1.63), then the number of shares for which Mr. Fields options may become exercisable will be increased by the relative percent difference in the
grant date price and $1.63. Conversely, if the closing price of KANAs common stock on the grant date is less than $1.63, then the number of shares for which Mr. Fields options may become exercisable will be decreased by the relative
percent difference in the grant date price and $1.63. The first grant of options will become exercisable for 25% of the shares upon the completion of six months of service and the remaining shares will become exercisable over eighteen equal monthly
installments. The second grant of options will become exercisable for 12.5% of the shares upon the completion of six months of service and the remaining shares will become exercisable over forty-two equal monthly installments.

Employment Contracts, Termination of Employment and Change-in-Control Arrangements

Executive Officers Acceleration of Option Vesting in the Event of a Change of Control. Options held by our continuing Named Executive Officers provide for full acceleration of vesting and exercisability
with respect to all unvested shares upon a change of control if, following such change of control, the Named Executive Officer is not offered a similar position in the combined entity.

In Mr. Fields employment offer letter, we agreed that in the event of a change in control if Mr. Fields is not offered a similar position
of the combined entity as held prior to the change of control, then all of the unvested shares of his proposed second option grant of 384,000 shares of our common stock will immediately vest only if such change in control event occurs after the
first anniversary of his (August 26, 2006) Start Date.

John M. Thompson. On October 8, 2004, we entered into an
employment offer letter with Mr. Thompson. Under the employment offer letter, Mr. Thompson will receive an annual salary of $235,000 and will be eligible for an incentive bonus of an additional $65,000 per year based on the
achievement of his objectives. In addition, we agreed to recommend to our Board of Directors that Mr. Thompson be granted an option to purchase 350,000 shares of our common stock that are subject to an acceleration of vesting upon a change
of control as described in Executive Officers Acceleration of Option Vesting in the Event of a Change of Control.

Indemnification Agreements. We have entered into indemnity agreements with certain of our executive officers which provide, among other things, that we will indemnify such executive officers, under the circumstances and to
the extent provided for in the agreements, for expenses, damages, judgments, fines and settlements he or she may be required to pay in actions or proceedings which he or she is or may be made a party to by reason of his or her position as an
executive officer of KANA, and otherwise to the full extent permitted under Delaware law and our bylaws.



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Chuck Bay. On August 25, 2005, Mr. Bay retired from his position as our Chief Executive
Officer and on November 14, 2005, we entered into an Employment Termination, Release and Consulting Agreement (the Bay Termination Agreement) with Mr. Bay. Pursuant to the Bay Termination Agreement, Mr. Bay
agreed to perform consulting services for us for twenty-four (24) months at a monthly rate equal to fifty percent of his monthly salary in effect prior to his retirement as Chief Executive Officer. During his consulting period,
Mr. Bays unvested options will continue to vest so long as Mr. Bay complies with the Bay Termination Agreement, and at the end of his consulting period, all of Mr. Bays unvested options will become fully vested so long as
Mr. Bay continuously complies with the Bay Termination Agreement. Mr. Bay also agreed to be bound by a non-competition obligation and agreed to not solicit our employees, customers and partners during his consulting period.

We had an employment agreement with Mr. Bay which provided for (i) eighteen (18) months of acceleration of unvested stock options upon a change of
control if, following such change of control, Mr. Bay is not offered a similar position in the combined entity, (ii) full acceleration of unvested stock options immediately prior to such change in control if the successor entity does not fully
assume or replace such stock options with equivalent substitute stock options, and (iii) a lump sum payment of eighteen (18) months of Mr. Bays base salary and payment of up to eighteen (18) months of health insurance benefits if KANA is
subject to a change of control and Mr. Bay is not offered a similar position in the combined entity following such change of control. This agreement was cancelled in connection with the Bay Termination Agreement described above.

Alan Hubbard. On February 14, 2006, we entered into an Employment Termination, Release and Consulting Agreement (the Hubbard
Termination Agreement) with Mr. Hubbard, our former Executive Vice President, Research & Development. Pursuant to the Hubbard Termination Agreement, we agreed to pay Mr. Hubbard a separation bonus of $17,500 (less
applicable federal and state withholding) and Mr. Hubbard has agreed to perform consulting services for us for six (6) months at a monthly rate equal to his monthly salary in effect prior to his resignation. During his consulting period,
Mr. Hubbards unvested options will continue to vest and at the end of his consulting period, all of Mr. Hubbards unvested options will become fully vested so long as Mr. Hubbard continuously complies with the terms of the
Hubbard Termination Agreement. Mr. Hubbard has also agreed to be bound by a non-competition obligation and agreed to not solicit our employees, customers and partners during his consulting period.

Brian Kelly. On June 7, 2006, we entered into an Employment Termination, Release and Consulting Agreement (the Kelly Termination
Agreement) with Mr. Kelly, our former President of Connectify. Pursuant to the terms of the Kelly Termination Agreement, Mr. Kellys employment with us terminated effective June 1, 2006; we will extend
Mr. Kellys medical insurance coverage until May 31, 2007 and Mr. Kelly has agreed to perform consulting services for us for eleven (11) months at a monthly rate equal to his monthly salary in effect prior to his
resignation. During his consulting period, Mr. Kellys unvested options will continue to vest so long as Mr. Kelly complies with the terms of the Kelly Termination Agreement and Mr. Kelly will have a period of ninety
(90) days following the end of his consulting period to exercise his vested options. Mr. Kelly has also agreed to be bound by a non-competition obligation and agreed to not solicit our employees, customers and suppliers during his
consulting period.

We entered into an employment offer letter, dated as of June 16, 2003, with Mr. Kelly. Under the
employment offer letter, Mr. Kelly was to receive an annual salary of $175,000 with a signing bonus and an incentive bonus of an additional $75,000 per year based on the achievement of his objections. In addition, we agreed to recommend to
our Board of Directors that Mr. Kelly be granted an option to purchase 300,000 shares of our common stock that are subject to an acceleration of vesting upon a change of control as described in Executive Officers Acceleration of
Option Vesting in the Event of a Change of Control.This agreement was cancelled in connection with the Kelly Termination Agreement described above.

Tim Angst. On September 30, 2005, we entered into a Confidential Separation Agreement and Mutual Release (the Separation Agreement) with Mr. Angst to finalize the termination
of his employment as Executive Vice President, Worldwide Operations. Pursuant to the terms of the Separation Agreement, in addition to receiving payment of salary up to Mr. Angsts effective termination date (September 1, 2005), we agreed
to pay Mr. Angst $83,335 which constitutes the equivalent of five (5) months of base salary for Mr. Angst that was in effect as of April 28, 2005, less deductions and withholdings, over five (5) months beginning on
October 8, 2005 on a monthly



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basis. In exchange for the release of claims against us, 50,729 options held by Mr. Angst (which represents an
additional vesting of his options of five (5) months) became vested and exercisable (the Accelerated Options). Mr. Angst will have the later of the full ninety (90) days from the date on which we become
authorized to allow option exercises or May 5, 2006 to exercise his Accelerated Options and options that were vested as of September 1, 2005.

We entered into an employment offer letter, dated as of April 28, 2004, with Mr. Angst. Under the employment offer letter, Mr. Angst was to receive an annual salary of $200,000 so that his at
target pay including base salary and variable pay would be $400,000. In addition, we agreed to recommend to our Board of Directors that Mr. Angst be granted an option to purchase 400,000 shares of our common stock that are subject to
an acceleration of vesting upon a change of control as described in Executive Officers Acceleration of Option Vesting in the Event of a Change of Control.This agreement was cancelled in connection with the Separation
Agreement described above.

Compensation Committee Interlocks and Insider Participation

From January 1, 2005 through April 16, 2005, our Compensation Committee consisted of Messrs. Batt and Thomas Galvin. Effective April 16,
2005, Mr. Galvin resigned from our Board of Directors. Ms. Vinella was appointed to our Compensation Committee in April 2005. Between April 16, 2005 through December 31, 2005, Mr. Batt and Ms. Vinella served on our
Compensation Committee. No members of our Compensation Committee were also employees of KANA or its subsidiaries during 2005 or at any time prior to 2005. None of our executive officers serves on the Board of Directors or Compensation Committee of
any entity that has one or more executive officers serving as a member of our Board of Directors or Compensation Committee.



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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

Security
Ownership of Certain Beneficial Owners and Management

The table below sets forth information regarding the beneficial ownership of our
common stock as of June 15, 2006, by the following individuals or groups:



| |  |  | each person or entity who is known by us to own beneficially more than five percent of our outstanding stock;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | each of those officers and former officers of KANA whose summary compensation information is provided below under Summary of Cash and Certain Other Compensation for Executive
Officers (referred to as the Named Executive Officers);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | each of our directors; and
| | - |  | --------------------------



| |  |  | all current directors and executive officers as a group.
| | - |  | --------------------------------------------------------

Beneficial ownership is determined under the rules of the SEC and generally includes voting or investment power with respect to securities. Applicable percentage ownership in the following table is based on 34,518,171 shares of common stock
outstanding as of June 15, 2006, as adjusted to include options and warrants exercisable within 60 days of June 15, 2006 held by the indicated stockholder or stockholders.

Unless otherwise indicated, the principal address of each of the stockholders below is c/o Kana Software, Inc., 181 Constitution Drive, Menlo Park, CA
94025. Except as otherwise indicated, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock held by them. To determine the number of shares
beneficially owned by persons other than our directors, executive officers and their affiliates, we have relied on beneficial ownership reports filed by such persons with the SEC.



|                                                                         |  |                                  |  |                                          |  
|------------------------------------------------------------------------ |  | -------------------------------- |  | ---------------------------------------- | -
|Name and Address of Beneficial Owner                                     |  | Number ofSharesBeneficiallyOwned |  | Percentageof SharesBeneficiallyOwned (%) |  
|Executive Officers and Directors:                                        |  |                                  |  |                                          |  
|Michael S. Fields (1)                                                    |  | 0                                |  | *                                        |  
|John M. Thompson (2)                                                     |  | 234,923                          |  | *                                        |  
|Alan Hubbard (3)                                                         |  | 11,474                           |  | *                                        |  
|Brian Kelly (4)                                                          |  | 299,871                          |  | *                                        |  
|Tim Angst (5)                                                            |  | 235,464                          |  | *                                        |  
|Chuck Bay (6)                                                            |  | 1,747,853                        |  | 4.8                                      | %
|Jerry R. Batt (7)                                                        |  | 85,000                           |  | *                                        |  
|William T. Clifford (8)                                                  |  | 1,000                            |  | *                                        |  
|Dr. Dixie L. Mills (9)                                                   |  | 85,000                           |  | *                                        |  
|John F. Nemelka (10)                                                     |  | 7,513,240                        |  | 21.8                                     | %
|Stephanie Vinella (11)                                                   |  | 43,762                           |  | *                                        |  
|Michael J. Shannahan (12)                                                |  | 0                                |  | *                                        |  
|All current directors and executive officers as a group (9 persons) (13) |  | 2,744,347                        |  | 7.4                                      | %
|                                                                         |  |                                 
|5% Stockholders:                                                         |  |                                  |  |                                          |  
|NightWatch Capital Management, LLC (14)                                  |  | 7,513,240                        |  | 21.8                                     | %
|Empire Capital Partners, L.P. (15)                                       |  | 2,059,215                        |  | 6.0                                      | %
|Empire Overseas Funds / Charter Oak Funds (16)                           |  | 2,950,466                        |  | 8.5                                      | %

---

|* | Less than one percent of KANAs outstanding common stock.
|- | ---------------------------------------------------------



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|(1) | Mr. Fields was appointed as a member of KANAs Board of Directors in June 2005. On August 25, 2005, Mr. Fields was appointed KANAs Chief Executive Officer
and Chairman of the Board of Directors.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Represents 60,000 shares held by Mr. Thompson and 174,923 options that will be exercisable as of August 14, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------



|(3) | Represents 11,474 shares held by Mr. Hubbard. Mr. Hubbard served as our Executive Vice President of Research & Development of KANA until February 14, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Represents 9,975 shares held by Mr. Kelly and options that will be exercisable as to 289,896 shares as of August 14, 2006. Mr. Kelly served as President of Connectify
of KANA until June 1, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Represents 13,750 shares held by Mr. Angst and options that will be exercisable as to 221,714 shares as of August 14, 2006. Mr. Angst served as our Executive Vice
President, Worldwide Operations of KANA until June 2005.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Represents 4,736 shares held by Mr. Bay and options that will be exercisable as to 1,743,117 shares as of August 14, 2006. Mr. Bay served as our Chief Executive
Officer until August 25, 2005.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) | Represents options that will be exercisable as to 85,000 shares as of August 14, 2006. Mr. Batt is a director of KANA.
|--- | ----------------------------------------------------------------------------------------------------------------------



|(8) | Represents 1,000 shares held by Mr. Clifford. Mr. Clifford is a director of KANA.
|--- | ---------------------------------------------------------------------------------



|(9) | Represents options that will be exercisable as to 85,000 shares as of August 14, 2006. Dr. Mills is a director of KANA.
|--- | -----------------------------------------------------------------------------------------------------------------------



|(10) | Mr. Nemelka is a director of KANA. Based solely on information contained in an amended Schedule 13D filed by NightWatch Capital Management, LLC (NWCM) on January
26, 2006, Schedule 13D filed by NWCM on April 29, 2005 and Form 4 filed by NWCM on May 10, 2006. Includes 3,191,912 shares of common stock held by NightWatch Capital Partners, L.P. (NWCP), 2,725,876 shares of common stock held by
NightWatch Capital Partners II, L.P. (NWCP II), warrants to purchase 873,267 shares of common stock by NWCP and warrants to purchase 722,185 shares of common stock by NWCP II. Acting through its managing member, NightWatch Capital Group,
LLC (NWCG), NightWatch Capital Advisors, LLC (NWCA) has the sole power to vote or direct the vote and to dispose or to direct the disposition of these securities. Accordingly, NWCA may be deemed to be the beneficial owner of
these securities. Acting through its managing member, NightWatch Capital Management, LLC (NWM), and in its capacity as the managing member of NWCA, NWCG has the sole power to vote or to direct the vote and to dispose or to direct the
disposition of these securities. Accordingly, NWCG may be deemed to be the beneficial owner of these securities. Acting through its managing member, JFN Management, LLC (JFNM), and in its capacity as the managing member of NWCG, NWM has
the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities. Accordingly, NWM may be deemed to be the beneficial owner of these securities. Acting through its managing member, Mr. Nemelka, and in its
capacity as the managing member of NWM, JFNM has the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities. Accordingly, JFNM may be deemed to be the beneficial owner of these securities. In his
capacity as managing member of JFNM, Mr. Nemelka has the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities. Accordingly, Mr. Nemelka may be deemed to be the beneficial owner of these securities.
However, Mr. Nemelka disclaims beneficial ownership of the shares held by NWCP and NWCP II except to the extent of any indirect pecuniary interest (within the meaning of Rule 16a-1 of the Exchange Act). The principal business address of NWCM is 3311
North University Avenue, Suite 200, Provo, Utah 84604.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Represents 262 shares held by Ms. Vinella and options that will be exercisable as to 43,500 shares as of August 14, 2006. Ms. Vinella is a director of KANA.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) | Mr. Shannahan is a director of KANA.
|---- | ------------------------------------



|(13) | Represents 101,197 shares held and options that will be exercisable as to 2,643,150 shares as of August 14, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------



|(14) | Based solely on information contained in an amended Schedule 13D filed by NightWatch Capital Management, LLC (NWCM) on January 26, 2006, Schedule 13D filed by NWCM on
April 29, 2005 and Form 4 filed by NWCM on May 10, 2006. Includes 3,191,912 shares of common stock held by NightWatch Capital Partners, L.P. (NWCP), 2,725,876 shares of common stock held by NightWatch Capital Partners II, L.P.
(NWCP II), warrants to purchase 873,267 shares of common stock by NWCP and warrants to purchase 722,185 shares of common stock by NWCP II. Acting through its managing member, NightWatch Capital Group, LLC (NWCG), NightWatch
Capital Advisors, LLC (NWCA) has the sole power to vote or direct the vote and to dispose or to direct the disposition of these securities. Accordingly, NWCA may be deemed to be the beneficial owner of these securities. Acting through
its managing member, NightWatch Capital Management, LLC (NWM), and in its capacity as the managing member of NWCA, NWCG has the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities.
Accordingly, NWCG may be deemed to be the beneficial owner of these securities. Acting through its managing member, JFN Management, LLC (JFNM), and in its capacity as the managing member of NWCG, NWM has the sole power to vote or to
direct the vote and to dispose or to direct the disposition of these securities. Accordingly, NWM may be deemed to be the beneficial owner of these securities. Acting through its managing member, Mr. Nemelka, and in its capacity as the managing
member of NWM, JFNM has the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities. Accordingly, JFNM may be deemed to be the beneficial owner of these securities. In his capacity as managing member
of JFNM, Mr. Nemelka has the sole power to vote or to direct the vote and to dispose or to direct the disposition of these securities. Accordingly, Mr. Nemelka may be deemed to be the beneficial owner of these securities. However, Mr. Nemelka
disclaims beneficial ownership of the shares held by NWCP and NWCP II except to the extent of any indirect pecuniary interest (within the meaning of Rule 16a-1 of the Exchange Act). The principal business address of NWCM is 3311 North University
Avenue, Suite 200, Provo, Utah 84604.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(15) | Based solely on information contained in an amended Schedule 13G filed by Empire Capital Partners, L.P. (Empire Capital), Empire GP, L.L.C.
(Empire GP), Empire Capital Management L.L.C., Scott A. Fine and Peter J. Richards on February 14, 2006 with the SEC. Empire Capital, Empire GP and Messrs. Fine and Richards share voting and dispositive power over
2,059,215 of these shares. By reason of the provisions of Rule 13d-3 of the Exchange Act, each may be deemed to beneficially own 2,059,215 of these shares of common stock directly owned by Empire Capital. The principal business address of Empire
Capital, Empire GP and Messrs. Fine and Richards is 1 Gorham Island, Westport, CT 06880.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(16) | Based solely on information contained in an amended Schedule 13G filed by Empire Capital Partners, L.P., Empire GP, L.L.C., Empire Capital Management L.L.C. (Empire
Management), Scott A. Fine and Peter J. Richards on February 14, 2006 with the SEC. Empire Management and Messrs. Fine and Richards share voting and dispositive power over 2,950,466 of these shares. By reason of the provisions of
Rule
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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13d-3 of the Exchange Act, each may be deemed to beneficially own 2,950,466 of these shares of common stock directly
owned by Empire Capital Partners, Ltd., Empire Capital Partners II, Ltd. (the Empire Overseas Funds), Charter Oak Partners, L.P. and Charter Oak Partners II, L.P. (the Charter Oak Funds). The
principal business address of Empire Management and Messrs. Fine and Richards is 1 Gorham Island, Westport, CT 06880.



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EQUITY COMPENSATION PLAN INFORMATION

We maintain the Kana Software, Inc. 1999 Stock Incentive Plan, as amended (the 1999 Stock Incentive Plan), and the Kana
Software, Inc. 1999 Employee Stock Purchase Plan, as amended (the 1999 Employee Stock Purchase Plan), which have been approved by our stockholders, and the Kana Software, Inc. 1997 Stock Option Plan (the 1997
Stock Option Plan), the Kana Software, Inc. 1999 Special Stock Option Plan (the 1999 Special Stock Option Plan) and equity compensation plans assumed by us pursuant to acquisitions of certain companies
described further below, which have not been approved by our stockholders.

Securities Authorized for Issuance Under Equity Compensation
Plans

The following table summarizes our equity compensation plans as of December 31, 2005:



|                                                                  |  |                                                                                             |  |                                                                            |        |                                                                                                                                            |          
|----------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------- | ------ | ------------------------------------------------------------------------------------------------------------------------------------------ | ---------
|Plan category                                                     |  | (a) Number ofsecurities to beissued upon exercise
ofoutstanding options,warrants and rights |  | (b)Weighted-averageexercise price ofoutstandingoptions, warrantsand rights |        | (c) Number of securitiesremaining available forfuture issuance underequity compensation plans(excluding securitiesreflected in column
(a))
|Equity compensation plans approved by security holders (1)(3)     |  | 4,809,748                                                                                   |  | $                                                                          | 7.73   |                                                                                                                                            | 2,457,224
|Equity compensation plans not approved by security holders (2)(3) |  | 51,827                                                                                      |  | $                                                                          | 150.36 |                                                                                                                                            |         
|Total                                                             |  | 4,861,575                                                                                   |  | $                                                                          | 9.25   |                                                                                                                                            | 2,457,224

---

|(1) | Under the terms of the 1999 Stock Incentive Plan, on the first trading day of January of each year, the aggregate number of shares of our Common Stock reserved for issuance
thereunder is increased automatically by a number of shares equal to 4.25% of the total number of shares of our outstanding common stock on the last trading day in December of the immediately preceding calendar year, up to a maximum of 1,000,000
shares per year. Under the terms of the 1999 Employee Stock Purchase Plan, on the first trading day of January of each year, the aggregate number of shares of our Common Stock reserved for issuance thereunder is increased automatically by a number
of shares equal to 0.75% of the total number of shares of our outstanding common stock on the last trading day in December of the immediately preceding calendar year, up to a maximum of 400,000 shares per year.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Includes outstanding options to purchase shares of our common stock under the 1997 Stock Option Plan and 1999 Special Stock Option Plan and excludes options, warrants and other
equity rights assumed by us in connection with mergers and acquisitions. Please see below for a description of our equity compensation plans that do not require the approval of, and have not been approved by, our stockholders.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | This table excludes an aggregate of 3,811,533 shares of our common stock that are outstanding upon the exercise of options and an aggregate of 4,063,258 shares of our common stock
that are available for future issuance upon the exercise of options, with a weighted-average exercise price of $6.49 per share, under equity compensation plans of the following entities that we have acquired: Broadbase, Software, Inc., Silknet
Software, Inc., NetDialog and Connectify Inc. We assumed these options in connection with the acquisition of these companies and have also assumed the following equity compensation plans: Broadbase Software, Inc. 1999 Equity Incentive Plan,
Broadbase Software, Inc. 2000 Stock Incentive Plan, Silknet Software, Inc. 1999 Employee Stock Purchase Plan, Silknet Software, Inc. 1999 Stock Option and Stock Incentive Plan, Silknet Software, Inc. 1999 Non-Employee Director Stock Option Plan,
Silknet Software, Inc. Employee Stock Option Plan and Insite Marketing Technology, Inc. 1997 Stock Option Plan.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Equity Compensation Plans Not Approved By Stockholders.

Kana Software, Inc. 1997 Stock Option Plan. Our 1997 Stock Option Plan provides for stock options to be granted to employees, independent
contractors, officers, and directors. Options are generally granted at an exercise price equivalent to the estimated fair market value per share at the date of grant, as determined by the Companys Board of Directors. All options are granted at
the discretion of the Companys Board of Directors and have a term not greater than 10 years from the date of grant. Options are immediately exercisable and generally vest over four years, 25% one year after the grant date and the remainder at
a rate of 1/36 per month thereafter.

Kana Software, Inc. 1999 Special Stock Option Plan. In December 1999, our Board of Directors
approved the 1999 Special Stock Option Plan and 1,000,000 shares of common stock were reserved for issuance under this plan. The 1999 Special Stock Option Plan has similar terms as those of the 1997 Stock Option Plan, except that options may be
granted with an exercise price less than, equal to, or greater than the fair market value of the option shares on the grant date.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

We have granted options to our executive
officers and directors and we have assumed options granted by Broadbase Software, Inc. to such individuals. See Compensation of Directors and Stock Options. We have entered into an indemnification agreement with each of our
executive officers and directors containing provisions that may require us, among other things, to indemnify our executive officers and directors against liabilities that may arise by reason of their status or service as executive officers or
directors (other than liabilities arising from willful misconduct of a culpable nature) and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified.

Pursuant to the terms of the Common Stock and Warrant Purchase Agreement, dated September 29, 2005, by and among KANA, NighWatch Capital Partners,
LP, NightWatch Capital Partners II, LP and RHP Master Fund, Ltd. (collectively, Investors), so long as the NightWatch funds own in excess of 12.5% (calculated on an as-converted basis with respect to the NightWatch funds)
of our issued and outstanding common stock, the NightWatch funds will have the right to appoint one (1) member to our Board of Directors. The NightWatch funds have designated Mr. Nemelka to be such appointee.

Based solely on information provided on an amended Schedule 13G filed by NightWatch Capital Management, LLC with the SEC on January 27, 2006,
NightWatch Capital Management, LLC has sole voting and dispositive power over the aggregate 6,890,771 shares of our common stock issued to the NightWatch funds during the private placements described below (includes the shares of our common stock
issuable upon the exercise of warrants). Mr. Nemelka is the Managing Principal and President of NightWatch Capital Management, LLC.

On June 30, 2005, we completed a private placement of unregistered securities pursuant to which Investors paid KANA an aggregate of approximately $2,400,000 to purchase 1,631,541 shares of our common stock at $1.471 per share and
warrants to purchase up to 815,769 shares of our common stock. On September 29, 2005, we completed a second private placement of unregistered securities pursuant to which Investors paid us an aggregate of approximately $4,000,000 to purchase
units, each consisting of one share of our common stock and 0.36 of a warrant, for $1.5227 per unit. We issued an aggregate of 2,626,912 shares of our common stock and warrants to purchase up to 945,687 shares of our common stock.

In the second private placement, we agreed to reset the purchase price per unit (through the issuance of additional shares and warrants to the Investors)
at a price equal to the volume weighted average trading price per share of common stock for the three consecutive trading day period following the issuance of our press release announcing the delisting if our common stock is delisted from The NASDAQ
National Market due to our failure to timely file our Quarterly Report on Form 10-Q for the quarters ended March 31, 2005, June 30, 2005 and September 30, 2005. We were not able to timely file our Quarterly Report on Form 10-Q



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for the quarter ended March 31, 2005 and on October 17, 2005, our common stock was delisted from The NASDAQ
National Market. Accordingly, we issued to the Investors 425,358 additional shares of our common stock and warrants to purchase up to 153,130 shares of our common stock at an exercise price of $1.966 per share.

On May 8, 2006, we amended the Registration Rights Agreements entered into with the Investors to provide for a new deadline to register the
registrable securities issued to the Investors pursuant to the first and second private placements and agreed to issue an aggregate of 593,854 shares of our common stock to the Investors.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

On July 16, 2004, PricewaterhouseCoopers LLP
(PwC) resigned as our independent registered public accounting firm and, on September 7, 2004, we retained Deloitte & Touche LLP (D&T) as our new independent registered public
accounting firm. On January 5, 2006, D&T notified us that it would resign as our independent registered public accounting firm upon the completion of its review of our unaudited financial statements for the quarter and six months ended
June 30, 2005. On February 23, 2006, our Audit Committee appointed Burr, Pilger & Mayer LLP to serve as our independent registered public accounting firm. Burr, Pilger & Mayer LLP has reviewed our financial statements for
the quarter and nine months ended September 30, 2005 and our fiscal year for the year ended December 31, 2005. On June 9, 2005, we filed our Form 10-Q for the quarter ended June 30, 2005, and on June 9, 2006, D&T
resigned as our independent registered public accounting firm.

Fiscal 2005 and 2004 Audit Firm Fee Summary

From January 1, 2004 through July 16, 2004, PwC served as our independent registered public accounting firm. Set forth below are the fees (in
thousands) billed for the services of PwC in such period.



|                              |  |                             |    
|----------------------------- |  | --------------------------- | ---
|                              |  | Year EndedDecember 31, 2004
|Audit fees                    |  | $                           | 195
|Audit-related fees            |  |                             |   
|Tax fees                      |  |                             | 134
|All other fees:               |  |                             |    
|SOX 404 Process Documentation |  |                             | 27 
|                              |  |                             |    
|Total fees                    |  | $                           | 356
|                              |  |                             |    

From September 7, 2004 through December 31, 2004 and through fiscal year ended
December 31, 2005 and the subsequent interim period until June 9, 2006, D&T served as our independent registered public accounting firm. Set forth below are the fees (in thousands) billed for the services of D&T from
September 7, 2004 through December 31, 2005.



|                   |  |                         |     |      |   |      
|------------------ |  | ----------------------- | --- | ---- | - | -----
|                   |  | Year Ended December 31,
|                   |  | 2005                    |     | 2004
|Audit fees         |  | $                       | 998 |      | $ | 1,134
|Audit-related fees |  |                         |    |      |   |     
|Tax fees           |  |                         |    |      |   |     
|All other fees:    |  |                         |    |      |   |     
|                   |  |                         |     |      |   |      
|Total fees         |  | $                       | 998 |      | $ | 1,134
|                   |  |                         |     |      |   |      

The estimated fee billed for the services of D&T from January 1, 2006 until June 9,
2006 for review of our unaudited financial statements for the quarter and six months ended June 20, 2005 and our audited financial statements for the year ended December 31, 2004 and for this Annual Report on Form 10-K, is approximately
$176,000, which is included in the table above.



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Since February 23, 2006, Burr, Pilger & Mayer LLP served as our independent registered
public accounting firm and has reviewed our financial statements for the quarter and nine months ended September 30, 2005 and for the year ended December 31, 2005. The estimated fee billed by Burr, Pilger & Mayer LLP for such
services is approximately $300,000 which are not included in the above table.

Our Audit Committee considers at least annually whether the
provision of non-audit services by our independent registered public accounting firm is compatible with maintaining auditor independence. This process includes:



| |  | Obtaining and reviewing, on at least an annual basis, a letter from the independent auditors describing all relationships between the independent auditors and KANA required to be
disclosed by Independence Standards Board Standard No. 1, reviewing the nature and scope of such relationships, discussing these relationships with the independent auditors and discontinuing any relationships that the Committee believes could
compromise the independence of the auditors; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Obtaining reports of all non-audit services proposed to be performed by the independent auditors before such services are performed, reviewing and approving or prohibiting, as
appropriate, any non-audit services not permitted by applicable law. The Committee may delegate authority to review and approve or prohibit non-audit services to one or more members of the Committee, and direct that any approval so granted be
reported to the Committee at a following meeting of the Committee.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All services provided by our accounting firms in fiscal
2004 and fiscal 2005 were approved in advance by our Audit Committee.

Audit Committee Pre-Approval Policy

All audit and permitted non-audit services to be performed for us by our independent registered public accounting firm must be pre-approved by our Audit
Committee to assure that the provision of such services do not impair the firms independence. Our Audit Committee does not delegate its responsibility to pre-approve services performed by the independent auditors to management.

The annual audit services engagement terms are subject to the specific pre-approval of our Audit Committee. Our Audit Committee will approve, if
necessary, any changes in terms, conditions and fees resulting from changes in audit scope or other matters. All other audit services not otherwise included in the annual audit services engagement must be specifically pre-approved by our Audit
Committee.



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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a) The following documents are filed as part of this
Report:

1. Financial Statements:



|                                                                                                               |  |     
|-------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                               |  | Page
|Report of Independent Registered Public Accounting Firm                                                        |  | 44  
|Report of Independent Registered Public Accounting Firm                                                        |  | 45  
|Report of Independent Registered Public Accounting Firm                                                        |  | 46  
|Consolidated Balance Sheets as of December 31, 2005 and 2004                                                   |  | 47  
|Consolidated Statements of Operations for the Years ended December 31, 2005, 2004 and 2003                     |  | 48  
|Consolidated Statements of Stockholders Equity (Deficit) for the Years ended December 31, 2005, 2004 and 2003 |  | 49  
|Consolidated Statements of Cash Flows for the Years ended December 31, 2005, 2004 and 2003                     |  | 50  
|Notes to Consolidated Financial Statements                                                                     |  | 51  

2. Financial Statement Schedules:



|         |  |                                   |  |     
|-------- |  | --------------------------------- |  | ----
|Schedule |  | Title                             |  | Page
|II       |  | Valuation and Qualifying Accounts |  | 96  

Schedules not listed above have been omitted because they are not applicable, not required, or the
information required to be set forth therein is included in the consolidated financial statements or notes there.

3. Exhibits:





|              |  |                                                                                                                                                    |  |       |  |                           |  |         |  |            |  |              
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----- |  | ------------------------- |  | ------- |  | ---------- |  | -------------
|              |  |                                                                                                                                                    |  |       |  | Incorporated by Reference |  |        
|ExhibitNumber |  | Exhibit Description                                                                                                                                |  | Form  |  | File No.                  |  | Exhibit |  | FilingDate |  | FiledHerewith
|3.01          |  | Second Amended and Restated Certificate of Incorporation as amended by the Certificate of Amendment dated April 18, 2000.                          |  | 8-K   |  | 000-27163                 |  | 3.1     |  | 5/4/00     |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|3.02          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation dated April 18, 2001.                                     |  | S-8   |  | 333-64552                 |  | 4.02    |  | 7/3/01     |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|3.03          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation filed on December 11, 2001.                               |  | S-3   |  | 333-77068                 |  | 4.03    |  | 1/18/02    |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|3.04          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation dated November 21, 2005.                                  |  | 8-A   |  | 000-27163                 |  | 3.04    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|3.05          |  | Amended and Restated Bylaws, as amended October 12, 2001.                                                                                          |  | 10-K  |  | 000-27163                 |  | 3.05    |  | 3/28/03    |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|3.06          |  | Certificate of Designation of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of Delaware on January 27, 2006. |  | 8-K   |  | 000-27163                 |  | 3.01    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |       |  |                          
|4.01          |  | Form of Specimen Common Stock Certificate.                                                                                                         |  | S-1/A |  | 333-82587                 |  | 4.01    |  | 9/21/99    |  |              



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|      |  |                                                                                                                                                                                             |  |        |  |           |  |       |  |          |  |  
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ |  | --------- |  | ----- |  | -------- |  | -
|4.02  |  | Form of Rights Certificate.                                                                                                                                                                 |  | 8-K    |  | 000-27163 |  | 4.01  |  | 1/31/06  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|4.03  |  | Rights Agreement, dated as of January 26, 2006, by and between Kana Software, Inc. and U.S. Stock Transfer Corporation.                                                                     |  | 8-K    |  | 000-27163 |  | 4.02  |  | 1/31/06  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.01 |  | Kana Software, Inc. 1999 Stock Incentive Plan, as amended.**                                                                                                                                |  |        |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.02 |  | Kana Software, Inc. 1999 Employee Stock Purchase Plan, as amended.**                                                                                                                        |  | S-4/A  |  | 333-59754 |  | 10.23 |  | 5/18/01  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.03 |  | Kana Software, Inc. 1999 Special Stock Option Plan.**                                                                                                                                       |  | S-8    |  | 333-32460 |  | 99.01 |  | 3/14/00  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.04 |  | Kana Software, Inc. 1999 Special Stock Option PlanForm of Nonstatutory Stock Option Agreement4-year vesting.**                                                                            |  | S-8    |  | 333-32460 |  | 99.02 |  | 3/14/00  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.05 |  | Kana Software, Inc. 1999 Special Stock Option PlanForm of Nonstatutory Stock Option Agreement30-month vesting.**                                                                          |  | S-8    |  | 333-32460 |  | 99.03 |  | 3/14/00  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.06 |  | Broadbase Software, Inc. 2000 Stock Incentive Plan, adopted on May 3, 2000, and related forms of agreements.**                                                                              |  | S-8±   |  | 333-38480 |  | 4.09  |  | 6/02/00  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.07 |  | Broadbase Software, Inc. 1999 Equity Incentive Plan, as amended November 2, 2000.**                                                                                                         |  | S-4/A± |  | 333-4896  |  | 4.09  |  | 11/09/00 |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.08 |  | Lease Agreement, dated December 23, 1999, between Broadbase Software, Inc. and Bohannon Trusts Partnership II.                                                                              |  | 10-Q±  |  | 000-27163 |  | 10.03 |  | 5/11/00  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.09 |  | Lease Agreement, dated August 11, 2000, between Broadbase Software, Inc. and J. Robert S. Wheatley and Roger A. Fields, d.b.a. R & R Properties.                                            |  | 10-Q±  |  | 000-27163 |  | 10.4  |  | 11/13/00 |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.10 |  | Assignment Agreement and First Amendment of Lease dated November 11, 2002 between the Registrant and J. Robert S. Wheatley and Roger A. Fields, d.b.a. R & R Properties.                    |  | 8-K    |  | 000-27163 |  | 99.1  |  | 11/21/02 |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.11 |  | Warrant to Purchase Common Stock, dated August 7, 2001, between Kana Communications, Inc. and General Electric Capital Corporation.                                                         |  | S-3    |  | 333-77068 |  | 4.12  |  | 1/18/02  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.12 |  | Warrant to Purchase Common Stock, dated September 5, 2001, between Kana Communications, Inc. and Banca 121.                                                                                 |  | S-3    |  | 333-77068 |  | 4.13  |  | 1/18/02  |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.13 |  | Share Purchase Agreement by and among Kana Software, Inc., TCV IV, L.P., and TCV IV Strategic Partners, L.P., dated as of November 28, 2001.                                                |  | 8-K/A  |  | 000-27163 |  | 99.01 |  | 12/13/01 |  |  
|      |  |                                                                                                                                                                                             |  |        |  |          
|10.14 |  | Form of Contingent Warrant to purchase Common Stock issued in conjunction with the Share Purchase Agreement dated November 28, 2001 between the Registrant and the Investors named
therein. |  | 8-K/A  |  | 000-27163 |  | 99.02 |  | 12/13/01 |  |  



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|      |  |                                                                                                                                                                                                                                                              |  |       |  |           |  |       |  |          |  | 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----- |  | --------- |  | ----- |  | -------- |  | 
|10.15 |  | Form of Commitment Warrant to purchase Common Stock issued in conjunction with the Share Purchase Agreement dated November 28, 2001 between the Registrant and the Investors named
therein.                                                                  |  | 8-K/A |  | 000-27163 |  | 99.03 |  | 12/13/01 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.16 |  | Warrant to Purchase Common Stock, dated September 5, 2001 between Kana Software, Inc. and IBM.                                                                                                                                                               |  | 10-K  |  | 000-27163 |  | 10.20 |  | 3/19/04  |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.17 |  | Common Stock and Warrant Purchase Agreement, dated as of June 25, 2005, by and among Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                      |  | 8-K   |  | 000-27163 |  | 10.01 |  | 6/30/05  |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.18 |  | Registration Rights Agreement, dated as of June 25, 2005, by and among Kana Software, Inc. and Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                                 |  | 8-K   |  | 000-27163 |  | 10.02 |  | 6/30/05  |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.19 |  | Form of Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund, Ltd. in connection with the Common Stock
and Warrant Purchase Agreement, dated as of June 25, 2005. |  | 8-K   |  | 000-27163 |  | 10.03 |  | 6/30/05  |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.20 |  | Common Stock and Warrant Purchase Agreement, dated as of September 29, 2005, by and among Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master
Fund, Ltd.                                                 |  | 8-K   |  | 000-27163 |  | 10.01 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.21 |  | Registration Rights Agreement, dated as of September 29, 2005, between Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                                    |  | 8-K   |  | 000-27163 |  | 10.02 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.22 |  | Form of Stock Purchase Warrant issued by Kana Software, Inc. to Nightwatch Capital Partners, LP and NightWatch Capital Partners II, LP in connection with the Common Stock and Warrant Purchase
Agreement, dated as of September 29, 2005.                   |  | 8-K   |  | 000-27163 |  | 10.03 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.23 |  | Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., in connection with the Common Stock and Warrant Purchase Agreement, dated as of September 29, 2005.                                                                           |  | 8-K   |  | 000-27163 |  | 10.04 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.24 |  | Amendment to Registration Rights Agreement, dated September 29, 2005.                                                                                                                                                                                        |  | 8-K   |  | 000-27163 |  | 10.05 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                                                              |  |       |  |          
|10.25 |  | Form of Amended and Restated Stock Purchase Warrant issued by Kana Software, Inc. to Nightwatch Capital Partners, LP and NightWatch, dated September 29, 2005.                                                                                               |  | 8-K   |  | 000-27163 |  | 10.06 |  | 10/03/05 |  | 



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|      |  |                                                                                                                                                                                                                         |  |       |  |           |  |       |  |          |  | 
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----- |  | --------- |  | ----- |  | -------- |  | 
|10.26 |  | Amended and Restated Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., dated September 29, 2005.                                                                                           |  | 8-K   |  | 000-27163 |  | 10.07 |  | 10/03/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.27 |  | Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners, LP, dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as of
September 29, 2005.    |  | 8-K   |  | 000-27163 |  | 10.01 |  | 10/31/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.28 |  | Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners II, LP, dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as
of September 29, 2005. |  | 8-K   |  | 000-27163 |  | 10.02 |  | 10/31/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.29 |  | Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as of September
29, 2005.              |  | 8-K   |  | 000-27163 |  | 10.03 |  | 10/31/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.30 |  | Second Amendment to Registration Rights Agreement, dated May 8, 2006, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                   |  | 8-K   |  | 000-27163 |  | 10.01 |  | 5/11/06  |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.31 |  | First Amendment to Registration Rights Agreement, dated May 8, 2006, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                    |  | 8-K   |  | 000-27163 |  | 10.02 |  | 5/11/06  |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.32 |  | Offer letter to Brian Kelly. **                                                                                                                                                                                         |  | 10-Q  |  | 000-27163 |  | 10.1  |  | 8/13/03  |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.33 |  | Change of Control and Retention Agreement with Chuck Bay dated as of August 27, 2003.**                                                                                                                                 |  | 10-Q  |  | 000-27163 |  | 10.1  |  | 11/12/03 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.34 |  | Offer letter to Tim Angst dated April 23, 2004.**                                                                                                                                                                       |  | 10-Q  |  | 000-27163 |  | 10.2  |  | 5/13/04  |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.35 |  | Offer letter to John M. Thompson dated October 8, 2004.**                                                                                                                                                               |  | 10-Q  |  | 000-27163 |  | 10.2  |  | 11/15/04 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.36 |  | Confidential Separation Agreement and Mutual Release, between Kana Software, Inc. and Tim Angst, dated September 30, 2005.**                                                                                            |  | 8-K   |  | 000-27163 |  | 10.01 |  | 10/06/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.37 |  | Employment Termination, Release and Consulting Agreement, dated as of August 26, 2005, between Kana Software, Inc. and Chuck Bay.**                                                                                     |  | 8-K/A |  | 000-27163 |  | 10.01 |  | 11/18/05 |  | 
|      |  |                                                                                                                                                                                                                         |  |       |  |          
|10.38 |  | Employment Offer Letter, between Kana Software, Inc. and Michael S. Fields, dated as of September 9, 2005.**                                                                                                            |  | 8-K/A |  | 000-27163 |  | 10.01 |  | 11/23/05 |  | 



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|      |  |                                                                                                                                                                                 |  |       |  |           |  |       |  |          |  |  
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----- |  | --------- |  | ----- |  | -------- |  | -
|10.39 |  | Consulting Agreement, between Kana Software, Inc. and Michael S. Fields, dated as of July 25, 2005.**                                                                           |  | 8-K/A |  | 000-27163 |  | 10.02 |  | 11/23/05 |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.40 |  | Business Financing Agreement, dated as of November 30, 2005, between Bridge Bank, National Association and Kana Software, Inc.                                                  |  | 8-K   |  | 000-27163 |  | 10.01 |  | 12/07/05 |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.41 |  | Business Financing Agreement, dated as of December 29, 2005, between Bridge Bank, National Association and Kana Software, Inc.                                                  |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.42 |  | Business Financing Modification Agreement, dated as of December 29, 2005, between Kana Software, Inc. and Bridge Bank, National Association.                                    |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.43 |  | Business Financing Modification Agreement, dated as of March 30, 2006, between Kana Software, Inc. and Bridge Bank, National Association.                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.44 |  | Business Financing Modification Agreement, dated as of March 30, 2006, between Kana Software, Inc. and Bridge Bank, National Association.                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.45 |  | Employment Termination, Release and Consulting Agreement, between Kana Software, Inc. and Alan Hubbard, dated February 14, 2006.**                                              |  | 8-K   |  | 000-27163 |  | 10.01 |  | 2/21/06  |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.46 |  | Description of Director Cash Compensation Arrangements, adopted April 20, 2006.**                                                                                               |  | 8-K   |  | 000-27163 |  | 10.01 |  | 4/25/06  |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.47 |  | Employment Termination, Release and Consulting Agreement, between Kana Software, Inc. and Brian Kelly, dated May 31, 2006.**                                                    |  | 8-K   |  | 000-27163 |  | 10.01 |  | 6/13/06  |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.48 |  | Kana Software, Inc. 1997 Stock Option Plan.**                                                                                                                                   |  | S-1   |  | 333-82587 |  | 10.1  |  | 7/9/97   |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|10.49 |  | Letter Agreement, dated as of September 29, 2005, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II LP and RHP Master Fund Ltd. |  | 10-Q  |  | 000-27163 |  | 10.08 |  | 7/6/06   |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|16.01 |  | Letter dated January 11, 2006 from Deloitte & Touche LLP to the Securities and Exchange Commission.                                                                             |  | 8-K   |  | 000-27163 |  | 16.01 |  | 1/11/06  |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|16.02 |  | Letter dated June 14, 2006 from Deloitte & Touche LLP to the Securities and Exchange Commission.                                                                                |  | 8-K   |  | 000-27163 |  | 16.01 |  | 6/15/06  |  |  
|      |  |                                                                                                                                                                                 |  |       |  |          
|21.01 |  | List of subsidiaries of Registrant.                                                                                                                                             |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|23.01 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|23.02 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|23.03 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|24.01 |  | Power of Attorney (included on page 97 of this Annual Report on Form 10-K).                                                                                                     |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                 |  |       |  |          
|31.01 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                             |  |       |  |           |  |       |  |          |  | X



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|      |  |                                                                                                                                                   |  |  
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | -
|      |  |                                                                                                                                                  
|31.02 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               |  | X
|      |  |                                                                                                                                                  
|32.01 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * |  | X
|      |  |                                                                                                                                                  
|32.02 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * |  | X

---

|* | These certifications accompany KANAs Annual Report on Form 10-K; they are not deemed filed with the Securities and Exchange Commission and are not to be
incorporated by reference in any filing of KANA under the Securities Act of 1933, or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Indicates management contract or compensatory plan or arrangement.
|-- | ------------------------------------------------------------------

|± | Filed by Broadbase Software, Inc.
|- | ---------------------------------



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SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS

KANA SOFTWARE, INC.



|                                 |  |                           |       |                                         |   |        |            |  |   |                      |   |  |   |      
|-------------------------------- |  | ------------------------- | ----- | --------------------------------------- | - | ------ | ---------- |  | - | -------------------- | - |  | - | -----
|                                 |  | BalanceatBeginningof Year |       | Amountsrecorded inWrite-off andExpenses |   |        | Deductions |  |   | Balanceat Endof Year
|Allowance for Doubtful Accounts: |  |                           |       |                                         |   |        |            |  |   |                      |   |  |   |      
|Year ended December 31, 2005     |  | $                         | 586   |                                         | $ | 26     |            |  | $ | (463                 | ) |  | $ | 149  
|Year ended December 31, 2004     |  | $                         | 1,187 |                                         | $ | (569   | )          |  | $ | (32                  | ) |  | $ | 586  
|Year ended December 31, 2003     |  | $                         | 4,815 |                                         | $ | (2,004 | )          |  | $ | (1,624               | ) |  | $ | 1,187



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the city of Menlo Park, state of California, on July 6, 2006.

Kana Software, Inc./S/ MICHAEL S. FIELDSMichael S. Fields Chief Executive Officer and Chairman of the Board (Principal Executive Officer)


POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS that each individual whose signature appears below constitutes and appoints Michael S. Fields and John M. Thompson,
and each of them, his or her true lawful attorneys-in-fact and agents, with full power of substitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form
10-K and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granted unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform
each an every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or
any of them, or his, her or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                   |  |    |  |                                                                                                  
|------------------ |  | -- |  | -------------------------------------------------------------------------------------------------
|Date: July 6, 2006 |  | By |  | /s/ MICHAEL S. FIELDS                                                                            
|                   |  |    |  | Michael S. Fields Chief Executive Officer and Chairman of the Board (Principal Executive Officer)
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ JOHN M. THOMPSON                                                                             
|                   |  |    |  | John Thompson Chief Financial Officer (Principal Financial and Accounting Officer)               
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ JERRY R. BATT                                                                                
|                   |  |    |  | Jerry R. Batt Director                                                                           
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ DIXIE L. MILLS                                                                               
|                   |  |    |  | Dixie L. Mills Director                                                                          
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ STEPHANIE VINELLA                                                                            
|                   |  |    |  | Stephanie Vinella Director                                                                       
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ MICHAEL J. SHANNAHAN                                                                         
|                   |  |    |  | Michael J. Shannahan Director                                                                    



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|                   |  |    |  |                             
|------------------ |  | -- |  | ----------------------------
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ WILLIAM T. CLIFFORD     
|                   |  |    |  | William T. Clifford Director
|                   |  |   
|Date: July 6, 2006 |  | By |  | /s/ JOHN F. NEMELKA         
|                   |  |    |  | John F. Nemelka Director    



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EXHIBIT INDEX

Incorporated by Reference



|              |  |                                                                                                                                                    |  |        |  |           |  |         |  |            |  |              
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------ |  | --------- |  | ------- |  | ---------- |  | -------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                |  | Form   |  | File No.  |  | Exhibit |  | FilingDate |  | FiledHerewith
|3.01          |  | Second Amended and Restated Certificate of Incorporation as amended by the Certificate of Amendment dated April 18, 2000.                          |  | 8-K    |  | 000-27163 |  | 3.1     |  | 5/4/00     |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|3.02          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation dated April 18, 2001.                                     |  | S-8    |  | 333-64552 |  | 4.02    |  | 7/3/01     |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|3.03          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation filed on December 11, 2001.                               |  | S-3    |  | 333-77068 |  | 4.03    |  | 1/18/02    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|3.04          |  | Certificate of Amendment to the Second Amended and Restated Certificate of Incorporation dated November 21, 2005.                                  |  | 8-A    |  | 000-27163 |  | 3.04    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|3.05          |  | Amended and Restated Bylaws, as amended October 12, 2001.                                                                                          |  | 10-K   |  | 000-27163 |  | 3.05    |  | 3/28/03    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|3.06          |  | Certificate of Designation of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of Delaware on January 27, 2006. |  | 8-K    |  | 000-27163 |  | 3.01    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|4.01          |  | Form of Specimen Common Stock Certificate.                                                                                                         |  | S-1/A  |  | 333-82587 |  | 4.01    |  | 9/21/99    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|4.02          |  | Form of Rights Certificate.                                                                                                                        |  | 8-K    |  | 000-27163 |  | 4.01    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|4.03          |  | Rights Agreement, dated as of January 26, 2006, by and between Kana Software, Inc. and U.S. Stock Transfer Corporation.                            |  | 8-K    |  | 000-27163 |  | 4.02    |  | 1/31/06    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.01         |  | Kana Software, Inc. 1999 Stock Incentive Plan, as amended.**                                                                                       |  |        |  |           |  |         |  |            |  | X            
|              |  |                                                                                                                                                    |  |        |  |          
|10.02         |  | Kana Software, Inc. 1999 Employee Stock Purchase Plan, as amended.**                                                                               |  | S-4/A  |  | 333-59754 |  | 10.23   |  | 5/18/01    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.03         |  | Kana Software, Inc. 1999 Special Stock Option Plan.**                                                                                              |  | S-8    |  | 333-32460 |  | 99.01   |  | 3/14/00    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.04         |  | Kana Software, Inc. 1999 Special Stock Option PlanForm of Nonstatutory Stock Option Agreement4-year vesting.**                                   |  | S-8    |  | 333-32460 |  | 99.02   |  | 3/14/00    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.05         |  | Kana Software, Inc. 1999 Special Stock Option PlanForm of Nonstatutory Stock Option Agreement30-month vesting.**                                 |  | S-8    |  | 333-32460 |  | 99.03   |  | 3/14/00    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.06         |  | Broadbase Software, Inc. 2000 Stock Incentive Plan, adopted on May 3, 2000, and related forms of agreements.**                                     |  | S-8±   |  | 333-38480 |  | 4.09    |  | 6/02/00    |  |              
|              |  |                                                                                                                                                    |  |        |  |          
|10.07         |  | Broadbase Software, Inc. 1999 Equity Incentive Plan, as amended November 2, 2000.**                                                                |  | S-4/A± |  | 333-4896  |  | 4.09    |  | 11/09/00   |  |              



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|      |  |                                                                                                                                                                                                                                                              |  |       |  |           |  |       |  |         
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----- |  | --------- |  | ----- |  | --------
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.08 |  | Lease Agreement, dated December 23, 1999, between Broadbase Software, Inc. and Bohannon Trusts Partnership II.                                                                                                                                               |  | 10-Q± |  | 000-27163 |  | 10.03 |  | 5/11/00 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.09 |  | Lease Agreement, dated August 11, 2000, between Broadbase Software, Inc. and J. Robert S. Wheatley and Roger A. Fields, d.b.a. R & R Properties.                                                                                                             |  | 10-Q± |  | 000-27163 |  | 10.4  |  | 11/13/00
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.10 |  | Assignment Agreement and First Amendment of Lease dated November 11, 2002 between the Registrant and J. Robert S. Wheatley and Roger A. Fields, d.b.a. R & R Properties.                                                                                     |  | 8-K   |  | 000-27163 |  | 99.1  |  | 11/21/02
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.11 |  | Warrant to Purchase Common Stock, dated August 7, 2001, between Kana Communications, Inc. and General Electric Capital Corporation.                                                                                                                          |  | S-3   |  | 333-77068 |  | 4.12  |  | 1/18/02 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.12 |  | Warrant to Purchase Common Stock, dated September 5, 2001, between Kana Communications, Inc. and Banca 121.                                                                                                                                                  |  | S-3   |  | 333-77068 |  | 4.13  |  | 1/18/02 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.13 |  | Share Purchase Agreement by and among Kana Software, Inc., TCV IV, L.P., and TCV IV Strategic Partners, L.P., dated as of November 28, 2001.                                                                                                                 |  | 8-K/A |  | 000-27163 |  | 99.01 |  | 12/13/01
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.14 |  | Form of Contingent Warrant to purchase Common Stock issued in conjunction with the Share Purchase Agreement dated November 28, 2001 between the Registrant and the Investors named
therein.                                                                  |  | 8-K/A |  | 000-27163 |  | 99.02 |  | 12/13/01
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.15 |  | Form of Commitment Warrant to purchase Common Stock issued in conjunction with the Share Purchase Agreement dated November 28, 2001 between the Registrant and the Investors named
therein.                                                                  |  | 8-K/A |  | 000-27163 |  | 99.03 |  | 12/13/01
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.16 |  | Warrant to Purchase Common Stock, dated September 5, 2001 between Kana Software, Inc. and IBM.                                                                                                                                                               |  | 10-K  |  | 000-27163 |  | 10.20 |  | 3/19/04 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.17 |  | Common Stock and Warrant Purchase Agreement, dated as of June 25, 2005, by and among Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                      |  | 8-K   |  | 000-27163 |  | 10.01 |  | 6/30/05 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.18 |  | Registration Rights Agreement, dated as of June 25, 2005, by and among Kana Software, Inc. and Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                                 |  | 8-K   |  | 000-27163 |  | 10.02 |  | 6/30/05 
|      |  |                                                                                                                                                                                                                                                              |  |       | 
|10.19 |  | Form of Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund, Ltd. in connection with the Common Stock
and Warrant Purchase Agreement, dated as of June 25, 2005. |  | 8-K   |  | 000-27163 |  | 10.03 |  | 6/30/05 



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|      |  |                                                                                                                                                                                                                                            |  |     |  |           |  |       |  |         
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --- |  | --------- |  | ----- |  | --------
|10.20 |  | Common Stock and Warrant Purchase Agreement, dated as of September 29, 2005, by and among Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP
Master Fund, Ltd.                               |  | 8-K |  | 000-27163 |  | 10.01 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.21 |  | Registration Rights Agreement, dated as of September 29, 2005, between Kana Software, Inc., Nightwatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                                  |  | 8-K |  | 000-27163 |  | 10.02 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.22 |  | Form of Stock Purchase Warrant issued by Kana Software, Inc. to Nightwatch Capital Partners, LP and NightWatch Capital Partners II, LP in connection with the Common Stock and Warrant Purchase
Agreement, dated as of September 29, 2005. |  | 8-K |  | 000-27163 |  | 10.03 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.23 |  | Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., in connection with the Common Stock and Warrant Purchase Agreement, dated as of September 29, 2005.                                                         |  | 8-K |  | 000-27163 |  | 10.04 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.24 |  | Amendment to Registration Rights Agreement, dated September 29, 2005.                                                                                                                                                                      |  | 8-K |  | 000-27163 |  | 10.05 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.25 |  | Form of Amended and Restated Stock Purchase Warrant issued by Kana Software, Inc. to Nightwatch Capital Partners, LP and NightWatch, dated September 29, 2005.                                                                             |  | 8-K |  | 000-27163 |  | 10.06 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.26 |  | Amended and Restated Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., dated September 29, 2005.                                                                                                              |  | 8-K |  | 000-27163 |  | 10.07 |  | 10/03/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.27 |  | Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners, LP, dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as of
September 29, 2005.                       |  | 8-K |  | 000-27163 |  | 10.01 |  | 10/31/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.28 |  | Stock Purchase Warrant issued by Kana Software, Inc. to NightWatch Capital Partners II, LP, dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as
of September 29, 2005.                    |  | 8-K |  | 000-27163 |  | 10.02 |  | 10/31/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.29 |  | Stock Purchase Warrant issued by Kana Software, Inc. to RHP Master Fund, Ltd., dated October 25, 2005, in connection with the Common Stock and Warrant Purchase Agreement, dated as of September
29, 2005.                                 |  | 8-K |  | 000-27163 |  | 10.03 |  | 10/31/05
|      |  |                                                                                                                                                                                                                                            |  |     | 
|10.30 |  | Second Amendment to Registration Rights Agreement, dated May 8, 2006, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master Fund,
Ltd.                                      |  | 8-K |  | 000-27163 |  | 10.01 |  | 5/11/06 



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|      |  |                                                                                                                                                                                                      |  |       |  |           |  |       |  |          |  |  
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----- |  | --------- |  | ----- |  | -------- |  | -
|10.31 |  | First Amendment to Registration Rights Agreement, dated May 8, 2006, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II, LP and RHP Master
Fund, Ltd. |  | 8-K   |  | 000-27163 |  | 10.02 |  | 5/11/06  |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.32 |  | Offer letter to Brian Kelly. **                                                                                                                                                                      |  | 10-Q  |  | 000-27163 |  | 10.1  |  | 8/13/03  |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.33 |  | Change of Control and Retention Agreement with Chuck Bay dated as of August 27, 2003.**                                                                                                              |  | 10-Q  |  | 000-27163 |  | 10.1  |  | 11/12/03 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.34 |  | Offer letter to Tim Angst dated April 23, 2004.**                                                                                                                                                    |  | 10-Q  |  | 000-27163 |  | 10.2  |  | 5/13/04  |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.35 |  | Offer letter to John M. Thompson dated October 8, 2004.**                                                                                                                                            |  | 10-Q  |  | 000-27163 |  | 10.2  |  | 11/15/04 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.36 |  | Confidential Separation Agreement and Mutual Release, between Kana Software, Inc. and Tim Angst, dated September 30, 2005.**                                                                         |  | 8-K   |  | 000-27163 |  | 10.01 |  | 10/06/05 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.37 |  | Employment Termination, Release and Consulting Agreement, dated as of August 26, 2005, between Kana Software, Inc. and Chuck Bay.**                                                                  |  | 8-K/A |  | 000-27163 |  | 10.01 |  | 11/18/05 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.38 |  | Employment Offer Letter, between Kana Software, Inc. and Michael S. Fields, dated as of September 9, 2005.**                                                                                         |  | 8-K/A |  | 000-27163 |  | 10.01 |  | 11/23/05 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.39 |  | Consulting Agreement, between Kana Software, Inc. and Michael S. Fields, dated as of July 25, 2005.**                                                                                                |  | 8-K/A |  | 000-27163 |  | 10.02 |  | 11/23/05 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.40 |  | Business Financing Agreement, dated as of November 30, 2005, between Bridge Bank, National Association and Kana Software, Inc.                                                                       |  | 8-K   |  | 000-27163 |  | 10.01 |  | 12/07/05 |  |  
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.41 |  | Business Financing Agreement, dated as of December 29, 2005, between Bridge Bank, National Association and Kana Software, Inc.                                                                       |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.42 |  | Business Financing Modification Agreement, dated as of December 29, 2005, between Kana Software, Inc. and Bridge Bank, National Association.                                                         |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.43 |  | Business Financing Modification Agreement, dated as of March 30, 2006, between Kana Software, Inc. and Bridge Bank, National Association.                                                            |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.44 |  | Business Financing Modification Agreement, dated as of March 30, 2006, between Kana Software, Inc. and Bridge Bank, National Association.                                                            |  |       |  |           |  |       |  |          |  | X
|      |  |                                                                                                                                                                                                      |  |       |  |          
|10.45 |  | Employment Termination, Release and Consulting Agreement, between Kana Software, Inc. and Alan Hubbard, dated February 14, 2006.**                                                                   |  | 8-K   |  | 000-27163 |  | 10.01 |  | 2/21/06  |  |  



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|      |  |                                                                                                                                                                                 |  |      |  |           |  |       |  |         |  |  
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- |  | --------- |  | ----- |  | ------- |  | -
|10.46 |  | Description of Director Cash Compensation Arrangements, adopted April 20, 2006.**                                                                                               |  | 8-K  |  | 000-27163 |  | 10.01 |  | 4/25/06 |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|10.47 |  | Employment Termination, Release and Consulting Agreement, between Kana Software, Inc. and Brian Kelly, dated May 31, 2006.**                                                    |  | 8-K  |  | 000-27163 |  | 10.01 |  | 6/13/06 |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|10.48 |  | Kana Software, Inc. 1997 Stock Option Plan.**                                                                                                                                   |  | S-1  |  | 333-82587 |  | 10.1  |  | 7/9/97  |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|10.49 |  | Letter Agreement, dated as of September 29, 2005, by and among Kana Software, Inc., NightWatch Capital Partners, LP, NightWatch Capital Partners II LP and RHP Master Fund Ltd. |  | 10-Q |  | 000-27163 |  | 10.08 |  | 7/6/06  |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|16.01 |  | Letter dated January 11, 2006 from Deloitte & Touche LLP to the Securities and Exchange Commission.                                                                             |  | 8-K  |  | 000-27163 |  | 16.01 |  | 1/11/06 |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|16.02 |  | Letter dated June 14, 2006 from Deloitte & Touche LLP to the Securities and Exchange Commission.                                                                                |  | 8-K  |  | 000-27163 |  | 16.01 |  | 6/15/06 |  |  
|      |  |                                                                                                                                                                                 |  |      |  |          
|21.01 |  | List of subsidiaries of Registrant.                                                                                                                                             |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|23.01 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|23.02 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|23.03 |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                       |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|24.01 |  | Power of Attorney (included on page 97 of this Annual Report on Form 10-K).                                                                                                     |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|31.01 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                             |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|31.02 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                             |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|32.01 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                               |  |      |  |           |  |       |  |         |  | X
|      |  |                                                                                                                                                                                 |  |      |  |          
|32.02 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                               |  |      |  |           |  |       |  |         |  | X

---

|* | These certifications accompany KANAs Annual Report on Form 10-K; they are not deemed filed with the Securities and Exchange Commission and are not to be
incorporated by reference in any filing of KANA under the Securities Act of 1933, or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Indicates management contract or compensatory plan or arrangement.
|-- | ------------------------------------------------------------------

|± | Filed by Broadbase Software, Inc.
|- | ---------------------------------



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