##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the Quarterly Period Ended March 31, 2007



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

For the transition period from  to

Commission File number 000-27163



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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 ofIncorporation or Organization) |  | (I.R.S. EmployerIdentification No.)

181 Constitution Drive

Menlo Park, California 94025

(Address of Principal Executive Offices)

Registrants Telephone Number, Including Area Code: (650) 614-8300



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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (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    x  NO

On April 30, 2007, approximately 36,208,055 shares
of the registrants Common Stock, $0.001 par value per share, were outstanding.



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##### Table of Contents

Kana Software, Inc.

Form 10-Q

Quarter Ended March 31, 2007

Table of Contents



|                              |  |                                                                                                        |  |   
|----------------------------- |  | ------------------------------------------------------------------------------------------------------ |  | --
|PART I. FINANCIAL INFORMATION |  |                                                                                                       
|                              |  |                                                                                                       
|Item 1.                       |  | Financial Statements                                                                                   |  |   
|                              |  |                                                                                                       
|                              |  | Condensed Consolidated Balance SheetsMarch 31, 2007 and December 31, 2006 (unaudited)                 |  | 3 
|                              |  |                                                                                                       
|                              |  | Condensed Consolidated Statements of OperationsThree Months Ended March 31, 2007 and 2006 (unaudited) |  | 4 
|                              |  |                                                                                                       
|                              |  | Condensed Consolidated Statements of Cash FlowsThree Months Ended March 31, 2007 and 2006 (unaudited) |  | 5 
|                              |  |                                                                                                       
|                              |  | Notes to the Unaudited Condensed Consolidated Financial Statements                                     |  | 6 
|                              |  |                                                                                                       
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                  |  | 16
|                              |  |                                                                                                       
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                             |  | 40
|                              |  |                                                                                                       
|Item 4T.                      |  | Controls and Procedures                                                                                |  | 40
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                       
|                              |  |                                                                                                       
|Item 1.                       |  | Legal Proceedings                                                                                      |  | 42
|                              |  |                                                                                                       
|Item 1A.                      |  | Risk Factors                                                                                           |  | 42
|                              |  |                                                                                                       
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 42
|                              |  |                                                                                                       
|Item 3.                       |  | Defaults Upon Senior Securities                                                                        |  | 42
|                              |  |                                                                                                       
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                    |  | 43
|                              |  |                                                                                                       
|Item 5.                       |  | Other Information                                                                                      |  | 43
|                              |  |                                                                                                       
|Item 6.                       |  | Exhibits                                                                                               |  | 44
|                              |  |                                                                                                       
|                              |  | Signatures                                                                                             |  | 45
|                              |  |                                                                                                       
|                              |  | Exhibit Index                                                                                          |  | 46
|                              |  |                                                                                                       
|                              |  | Certifications                                                                                         |  |   



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM I. | FINANCIAL STATEMENTS
|------- | --------------------

KANA SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)



|                                                                                                                       |  |               |            |   |                  |   |            |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ---------------- | - | ---------- | -
|                                                                                                                       |  | March 31,2007 |            |   | December 31,2006 |  
|ASSETS                                                                                                                 |  |               |            |   |                  |   |            |  
|Current assets:                                                                                                        |  |               |            |   |                  |   |            |  
|Cash and cash equivalents                                                                                              |  | $             | 5,313      |   |                  | $ | 5,719      |  
|Restricted cash                                                                                                        |  |               | 75         |   |                  |   | 74         |  
|Accounts receivable, net of allowance of $200 and $155 at March 31, 2007 and December 31, 2006, respectively           |  |               | 7,789      |   |                  |   | 8,756      |  
|Prepaid expenses and other current assets                                                                              |  |               | 2,121      |   |                  |   | 1,967      |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total current assets                                                                                                   |  |               | 15,298     |   |                  |   | 16,516     |  
|Restricted cash, long-term                                                                                             |  |               | 991        |   |                  |   | 990        |  
|Property and equipment, net                                                                                            |  |               | 1,175      |   |                  |   | 1,221      |  
|Goodwill                                                                                                               |  |               | 8,623      |   |                  |   | 8,623      |  
|Acquired intangible assets, net                                                                                        |  |               |           |   |                  |   | 15         |  
|Other assets                                                                                                           |  |               | 2,820      |   |                  |   | 2,970      |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total assets                                                                                                           |  | $             | 28,907     |   |                  | $ | 30,335     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                  |  |               |            |   |                  |   |            |  
|Current liabilities:                                                                                                   |  |               |            |   |                  |   |            |  
|Loan payable                                                                                                           |  | $             | 2,000      |   |                  | $ |           |  
|Note payable                                                                                                           |  |               | 221        |   |                  |   | 327        |  
|Accounts payable                                                                                                       |  |               | 4,024      |   |                  |   | 2,684      |  
|Accrued liabilities                                                                                                    |  |               | 5,617      |   |                  |   | 6,880      |  
|Accrued restructuring                                                                                                  |  |               | 1,955      |   |                  |   | 1,844      |  
|Deferred revenue                                                                                                       |  |               | 15,511     |   |                  |   | 15,825     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total current liabilities                                                                                              |  |               | 29,328     |   |                  |   | 27,560     |  
|Deferred revenue, long-term                                                                                            |  |               | 281        |   |                  |   | 410        |  
|Accrued restructuring, long-term                                                                                       |  |               | 3,608      |   |                  |   | 4,258      |  
|Other long-term liabilities                                                                                            |  |               | 1,120      |   |                  |   | 1,239      |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total liabilities                                                                                                      |  |               | 34,337     |   |                  |   | 33,467     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|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; 36,204,944 and 35,972,283 shares issued and outstanding |  |               | 36         |   |                  |   | 36         |  
|Additional paid-in capital                                                                                             |  |               | 4,303,974  |   |                  |   | 4,302,495  |  
|Accumulated other comprehensive income                                                                                 |  |               | 144        |   |                  |   | 171        |  
|Accumulated deficit                                                                                                    |  |               | (4,309,584 | ) |                  |   | (4,305,834 | )
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total stockholders deficit                                                                                            |  |               | (5,430     | ) |                  |   | (3,132     | )
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total liabilities and stockholders deficit                                                                            |  | $             | 28,907     |   |                  | $ | 30,335     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  

See accompanying notes to unaudited condensed consolidated financial statements.



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KANA SOFTWARE, INC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                                                             |  |                             |        |   |                   |   |        |  
|---------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ----------------- | - | ------ | -
|                                                                             |  | Three Months EndedMarch 31, |       
|                                                                             |  | 2007                        |        |   | 2006 Restated (2) |  
|                                                                             |  | (unaudited)                 |       
|Revenues:                                                                    |  |                             |        |   |                   |   |        |  
|License fees                                                                 |  | $                           | 3,616  |   |                   | $ | 2,861  |  
|Services                                                                     |  |                             | 9,418  |   |                   |   | 8,572  |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Total revenues                                                               |  |                             | 13,034 |   |                   |   | 11,433 |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Costs and expenses (1):                                                      |  |                             |        |   |                   |   |        |  
|Cost of license fees                                                         |  |                             | 287    |   |                   |   | 451    |  
|Cost of services                                                             |  |                             | 3,068  |   |                   |   | 2,287  |  
|Amortization of acquired intangible assets                                   |  |                             | 15     |   |                   |   | 33     |  
|Sales and marketing                                                          |  |                             | 6,193  |   |                   |   | 3,749  |  
|Research and development                                                     |  |                             | 3,652  |   |                   |   | 2,570  |  
|General and administrative                                                   |  |                             | 3,503  |   |                   |   | 2,289  |  
|Restructuring                                                                |  |                             |       |   |                   |   | 10     |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Total costs and expenses                                                     |  |                             | 16,718 |   |                   |   | 11,389 |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Income (loss) from operations                                                |  |                             | (3,684 | ) |                   |   | 44     |  
|Interest and other income (expense), net                                     |  |                             | (19    | ) |                   |   | (658   | )
|Registration rights penalty                                                  |  |                             |       |   |                   |   | (337   | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Loss before income tax expense                                               |  |                             | (3,703 | ) |                   |   | (951   | )
|Income tax expense                                                           |  |                             | (47    | ) |                   |   | (28    | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Net loss                                                                     |  | $                           | (3,750 | ) |                   | $ | (979   | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Basic and diluted net loss per share                                         |  | $                           | (0.10  | ) |                   | $ | (0.03  | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Shares used in computing basic and diluted net loss per share                |  |                             | 36,019 |   |                   |   | 33,924 |  
|                                                                             |  |                             |        |   |                   |   |        |  
|                                                                             |  |                             |        |   |                   |   |        |  
|(1)    Employee stock-based compensation included in the expense line items: |  |                             |        |   |                   |   |        |  
|                                                                             |  |                            
|Cost of services                                                             |  | $                           | 68     |   |                   | $ | 54     |  
|Sales and marketing                                                          |  |                             | 223    |   |                   |   | 190    |  
|Research and development                                                     |  |                             | 69     |   |                   |   | 92     |  
|General and administrative                                                   |  |                             | 392    |   |                   |   | 44     |  
|                                                                             |  |                             |        |   |                   |   |        |  

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|(2) | Subsequent to the issuance of the Companys interim condensed consolidated statements for the quarter ended March 31, 2006, the Company determined that non-cash
compensation expenses relating to certain options granted in 1999 were incorrectly recorded in the first quarter of 2006. Additionally, certain other expense items were recorded in the improper quarter within 2006. As a result, the operating results
for the quarter ended March 31, 2006 have been restated. See Restatement relating to stock-based compensation and other revenue and expense items included in Note 1 to the condensed consolidated financial statements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

See accompanying notes to unaudited condensed consolidated financial statements.



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KANA SOFTWARE, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                             |  |                             |        |   |                   |   |        |  
|---------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ----------------- | - | ------ | -
|                                                                             |  | Three Months EndedMarch 31, |       
|                                                                             |  | 2007                        |        |   | 2006 Restated (1) |  
|                                                                             |  | (unaudited)                 |       
|Cash flows from operating activities:                                        |  |                             |        |   |                   |   |        |  
|Net loss                                                                     |  | $                           | (3,750 | ) |                   | $ | (979   | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |                             |        |   |                   |   |        |  
|Depreciation                                                                 |  |                             | 265    |   |                   |   | 396    |  
|Loss on the disposal of property and equipment                               |  |                             |       |   |                   |   | 46     |  
|Amortization of acquired intangible assets                                   |  |                             | 15     |   |                   |   | 33     |  
|Stock-based compensation                                                     |  |                             | 870    |   |                   |   | 606    |  
|Provision for doubtful accounts                                              |  |                             | 45     |   |                   |   | 55     |  
|Restructuring                                                                |  |                             |       |   |                   |   | 10     |  
|Registration rights penalty                                                  |  |                             |       |   |                   |   | 337    |  
|Non-cash interest accretion                                                  |  |                             | 34     |   |                   |   | 23     |  
|Change in fair value of warrant liability                                    |  |                             |       |   |                   |   | 562    |  
|Changes in operating assets and liabilities, net of effects of acquisitions: |  |                             |        |   |                   |   |        |  
|Accounts receivable                                                          |  |                             | 955    |   |                   |   | (146   | )
|Prepaid expenses and other assets                                            |  |                             |       |   |                   |   | 486    |  
|Accounts payable and accrued liabilities                                     |  |                             | (45    | ) |                   |   | (2,688 | )
|Accrued restructuring                                                        |  |                             | (543   | ) |                   |   | (750   | )
|Deferred revenue                                                             |  |                             | (487   | ) |                   |   | (1,010 | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Net cash used in operating activities                                        |  |                             | (2,641 | ) |                   |   | (3,019 | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Cash flows from investing activities:                                        |  |                             |        |   |                   |   |        |  
|Purchases of property and equipment                                          |  |                             | (219   | ) |                   |   | (51    | )
|(Increase) decrease in restricted cash                                       |  |                             | (2     | ) |                   |   | 18     |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Net cash used in investing activities                                        |  |                             | (221   | ) |                   |   | (33    | )
|                                                                             |  |                             |        |   |                   |   |        |  
|Cash flows from financing activities:                                        |  |                             |        |   |                   |   |        |  
|Borrowings on loan payable, net                                              |  |                             | 2,000  |   |                   |   | 457    |  
|Borrowings on note payable                                                   |  |                             | 71     |   |                   |   |       |  
|Repayments on note payable                                                   |  |                             | (219   | ) |                   |   |       |  
|Net proceeds from issuances of common stock and warrants                     |  |                             | 609    |   |                   |   |       |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Net cash provided by financing activities                                    |  |                             | 2,461  |   |                   |   | 457    |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Effect of exchange rate changes on cash and cash equivalents                 |  |                             | (5     | ) |                   |   | 25     |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Net decrease in cash and cash equivalents                                    |  |                             | (406   | ) |                   |   | (2,570 | )
|Cash and cash equivalents at beginning of period                             |  |                             | 5,719  |   |                   |   | 6,216  |  
|                                                                             |  |                             |        |   |                   |   |        |  
|Cash and cash equivalents at end of period                                   |  | $                           | 5,313  |   |                   | $ | 3,646  |  
|                                                                             |  |                             |        |   |                   |   |        |  

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|(1) | Subsequent to the issuance of the Companys interim condensed consolidated financial statements for the quarter ended March 31, 2006, the Company determined that non-cash
compensation expenses relating to certain options granted in 1999 were incorrectly recorded in the first quarter of 2006. Additionally, certain other expense items were recorded in the improper quarter within 2006. As a result, the statement of cash
flows for the quarter ended March 31, 2006 has been restated. See Restatement relating to stock-based compensation and other revenue and expense items included in Note 1 to the condensed consolidated financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

See accompanying notes to unaudited condensed consolidated financial statements.



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KANA SOFTWARE, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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. References to we, our and us collectively refer to KANA, our predecessor and our subsidiaries and its predecessors.

Principles of Consolidation

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

Unaudited Interim Financial
Information

The unaudited condensed consolidated financial statements have been prepared by KANA and reflect all normal, recurring
adjustments that, in the opinion of management, are necessary for a fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for
any subsequent quarter or for the entire year ending December 31, 2007. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United
States of America have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (SEC). These unaudited condensed consolidated financial statements and notes included herein should be read in
conjunction with KANAs audited consolidated financial statements and notes included in KANAs Annual Report on Form 10-K for the year ended December 31, 2006, filed with the SEC on April 2, 2007. The year-end condensed
consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Restatement relating to stock-based compensation and other revenue and expense items

The financial information as of and for the three months ended March 31, 2006 is restated since it has been revised from the amounts previously
stated in our Quarterly Report on Form 10-Q filed with the SEC on July 28, 2006. Subsequent to the issuance of the Companys interim condensed consolidated financial statements for the quarter ended March 31, 2006, the Company
determined that non-cash compensation expenses relating to certain options granted in 1999 were incorrectly recorded in the first quarter of 2006. Additionally, certain other expense items were recorded in the improper quarter within 2006. The
restatement is further discussed in Note 14 of the consolidated financial statements in the Companys Form 10-K for the year ended December 31, 2006 filed with the SEC on April 2, 2007.

Use of Estimates

The preparation of the
interim unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the
financial statements and the accompanying notes. Actual results could differ materially from those estimates.

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 (SOP 97-2), 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, Software Revenue Recognition, 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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##### Table of Contents

For all sales the Company uses either a signed license agreement, a signed amendment to an existing
license agreement, a signed order form, a binding purchase order where we either have a signed master license agreement or an order form signed by the Company, or a signed statement of work as evidence of an arrangement.

Software delivery is primarily by electronic means. If the software or other deliverable is subject to acceptance for a specified period after the
delivery, revenue is deferred until the acceptance period has expired or the acceptance provision has been met.

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, OnDemand and hosting. Consulting services revenues and the related cost of services are generally recognized on a time and materials basis. For consulting services
contracts that have a fixed fee, the Company recognizes the license and professional consulting services revenues using either the percentage-of-completion method or the completed contract method as prescribed by AICPA SOP No. 81-1,
Accounting for Performance of Construction-Type and Certain Product-Type Contracts (SOP 81-1). 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. OnDemand includes our KANA OnDemand software as a service and outsourcing
offerings as well as Advanced Customer Services. OnDemand revenue is recognized in accordance with the SEC Staff Accounting Bulletin No. 104, Revenue Recognition, corrected copy (SAB 104). Revenues from OnDemand services
are recognized ratably over the term of the arrangement, while application fees are recognized ratably over the sum of the term of the arrangement and the term of expected renewals. Hosting service arrangements are a means of deployment whereby the
customers software and data is physically located in third party facilities. Customers pay a fee to remotely access the hosted software and data via a secure internet connection. Hosting fees are recognized as the hosting service is delivered
in accordance with SAB 104.

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 support services is generally based on the price charged when an element is sold separately or the stated contractual renewal rates.



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Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which requires the
measurement and recognition of compensation expense for all stock-based awards made to employees and directors, including employee stock options and employee stock purchases under an employee stock purchase plan, based on estimated fair values.

Stock-based compensation expense recognized during the three months ended March 31, 2007 is based on awards ultimately expected to
vest and has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We use the Black-Scholes
option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-based awards, including the
options expected term and the price volatility of the underlying stock.

Employee stock-based compensation expense recognized under
SFAS 123(R) for the three months ended March 31, 2007 and 2006 was $752,000 and $380,000, respectively.

For stock options granted to
non-employees, the Company recognizes compensation expense in accordance with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, which require such equity instruments to be recorded at their fair value on the measurement date. The measurement of
stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. The Company amortizes compensation expense related to non-employee stock options in accordance with Financial Accounting Standards Board
(FASB) Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans (FIN 28). In 2005 and 2006, Company extended the vesting period of approximately
1,000,000 stock options held by four terminated employees who had agreements to provide consulting services. In fiscal year 2006, the Company granted a total of 57,500 stock options to four non-employees who had agreements to provide consulting
services. During the three months ended March 31, 2007 there were no stock option grants to non-employees.

As a result of these stock
option modifications to former employees and the stock option grants to consultants, the Company recorded non-employee stock-based compensation expense of $118,000 and $226,000 for the three months ended March 31, 2007 and 2006, respectively,
allocated as follows:



|                           |  |                             |         |                   |   |        
|-------------------------- |  | --------------------------- | ------- | ----------------- | - | -------
|                           |  | Three Months EndedMarch 31,
|                           |  | 2007                        |         | 2006 Restated (1)
|Sales and marketing        |  | $                           | 16,000  |                   | $ |       
|Research and development   |  |                             |        |                   |   | 10,000 
|General and administrative |  |                             | 102,000 |                   |   | 216,000
|                           |  |                             |         |                   |   |        
|                           |  | $                           | 118,000 |                   | $ | 226,000
|                           |  |                             |         |                   |   |        

---

|(1) | See Restatement relating to stock-based compensation and other revenue and expense itemsincluded in Note 1 to the condensed consolidated financial statements.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



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Effect of Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of
FASB Statement No. 115 (SFAS 159). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value. The standard requires companies to provide additional information that will help
investors and other users of financial statements to more easily understand the effect of a companys choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which a
company has chosen to use fair value on the face of the balance sheet. This statement is effective as of the beginning of an entitys first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of
the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157. The Company is currently evaluating whether the adoption of SFAS 159 will have a
material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132R (SFAS 158). SFAS 158 requires an entity to recognize in its statement of
financial position an asset for a defined benefit postretirement plans over funded status or a liability for a plans under funded status. The requirement to recognize the funded status of a defined postretirement plan and the disclosure
requirements are effective for fiscal years ending after December 31, 2006. The Company does not expect the adoption of SFAS 158 to have a material impact on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). The purpose of SFAS 157 is to define
fair value, establish a framework for measuring fair value and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for the Company beginning in the first quarter of fiscal 2008. The Company is
currently evaluating the effects of implementing SFAS 157.

In June 2006, the FASB issued FASB Interpretation No. 48 Accounting
for Uncertain Tax Positions  An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance
with SFAS No. 109 Accounting for Income Taxes. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN
48 on January 1, 2007. During the implementation, the Company identified, evaluated, and measured the amount of income tax benefits to be recognized for all material income tax positions. The net income tax assets recognized under FIN 48 did
not materially differ from the net assets recognized before adoption, and, therefore, the Company did not record an adjustment related to the adoption of FIN 48. At the adoption date of January 1, 2007, the Company had $145,000 of unrecognized
tax benefits, all of which would affect the Companys effective tax rate if recognized. At March 31, 2007, the Company had $145,000 of unrecognized tax benefits.

Our continuing practice is to recognize interest and/or penalties related to income tax matters as a component of income tax expense. As of
March 31, 2007, we have approximately $28,000 of accrued interest and penalties related to uncertain tax positions.

The tax years
2003-2006 remain open to examination by the major taxing jurisdiction to which the Company is subject.

Note 2. Goodwill and Intangible Assets

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 $15,000 and $33,000 for the three month ended March 31, 2007 and 2006, respectively. The Companys identifiable intangible
assets have been fully amortized as of March 31, 2007. The components of goodwill and other intangibles are as follows (in thousands):



|                               |  |                |         |   |                   |   |         |  
|------------------------------ |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                               |  | March 31, 2007 |         |   | December 31, 2006 |  
|Goodwill                       |  | $              | 8,623   |   |                   | $ | 8,623   |  
|                               |  |                |         |   |                   |   |         |  
|Intangibles:                   |  |                |         |   |                   |   |         |  
|Customer Relationships         |  | $              | 150     |   |                   | $ | 150     |  
|Purchased technology           |  |                | 14,650  |   |                   |   | 14,650  |  
|Less: accumulated amortization |  |                | (14,800 | ) |                   |   | (14,785 | )
|                               |  |                |         |   |                   |   |         |  
|Intangibles, net               |  | $              |        |   |                   | $ | 15      |  
|                               |  |                |         |   |                   |   |         |  



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Note 3. Stockholders Deficit



|(a) | Issuance of Common Stock and Warrants
|--- | -------------------------------------

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 September 30, 2006 from January 27, 2006 and to change the penalty for failure to register the underlying shares of common stock from a cash penalty to a share-based payment, in exchange for
the issuance of 593,854 shares of common stock. The shares were valued at approximately $1.0 million based on the fair market value of the Companys common stock on the date of the amendment less a 10% discount to reflect that unregistered
stock was issued. Registration rights penalties of $337,000 and $695,000 were recorded as non-operating expenses during the first and second quarters of 2006, respectively. The September 30, 2006 registration deadline was not met and an
additional 59,383 shares of common stock was issued. The shares were valued at approximately $166,000 based on the fair market value of the Companys common stock on September 30, 2006 less a 10% discount to reflect that unregistered stock
was issued. This amount was recorded as a non-operating expense during the third quarter of 2006.

On November 9, 2006, the Company
completed the registration of the shares of common stock and shares of common stock underlying the warrants issued to the Investors.



|(b) | Stock Compensation Plans
|--- | ------------------------

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.

The following table summarizes activity under the equity incentive plans for the indicated periods:



|                                                                                           |  |                     |   |  |                              |      |                                         |      |                         |   |          
|------------------------------------------------------------------------------------------ |  | ------------------- | - |  | ---------------------------- | ---- | --------------------------------------- | ---- | ----------------------- | - | ---------
|                                                                                           |  | Options Outstanding
|                                                                                           |  | Number ofShares     |   |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractualTerm |      | AggregateIntrinsicValue
|Balances, December 31, 2006                                                                |  | 9,201,921           |   |  | $                            | 6.12 |                                         |      |                         |   |          
|Options cancelled and retired                                                              |  | (231,847            | ) |  |                              | 3.97 |                                         |      |                         |   |          
|Options exercised                                                                          |  | (232,661            | ) |  |                              | 2.59 |                                         |      |                         | $ | 218,319  
|Options granted                                                                            |  | 1,487,400           |   |  |                              | 3.19 |                                         |      |                         |   |          
|                                                                                           |  |                     |   |  |                              |      |                                         |      |                         |   |          
|Balances, March 31, 2007                                                                   |  | 10,224,813          |   |  | $                            | 5.82 |                                         | 7.53 |                         | $ | 8,048,851
|                                                                                           |  |                     |   |  |                              |      |                                         |      |                         |   |          
|Options vested and exercisable and expected to be vested and exercisable at March 31, 2007 |  | 8,575,556           |   |  | $                            | 6.26 |                                         | 7.22 |                         | $ | 6,718,135
|Options vested and exercisable at March 31, 2007                                           |  | 5,142,126           |   |  | $                            | 7.74 |                                         | 6.07 |                         | $ | 3,790,755

At March 31, 2007, the Company had 7,047,768 options available for grant under its equity
incentive plans.

Options vested and exercisable at March 31, 2007 exclude certain options which are vested but not yet exercisable.
In certain situations, a stock option will be vested but not exercisable. The number of shares vested and exercisable at March 31, 2007 was 5,142,126 and the weighted average exercise price of such shares was $7.74 per share. At March 31,
2007, the total number of vested but unexercisable shares was 309,517 and had a weighted average exercise price of $28.81.

At
March 31, 2007, the Company had $4.5 million of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock options that will be recognized over the weighted average remaining period of 2.7 years.
This amount excludes unrecognized stock-based compensation expense that relates to non-employee stock options, which cannot be estimated prior to the measurement date.



10



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##### Table of Contents

The following table summarizes significant ranges of outstanding and exercisable options as of
March 31, 2007:



|                         |  |                     |  |                                                        |  |                                           |        |                    |           |                                           |   |       
|------------------------ |  | ------------------- |  | ------------------------------------------------------ |  | ----------------------------------------- | ------ | ------------------ | --------- | ----------------------------------------- | - | ------
|                         |  | Options Outstanding |  | Options Vested and Exercisable                        
|Range of Exercise Prices |  | Number Outstanding  |  | Weighted Average Remaining Contractual Life (in Years) |  | Weighted Average Exercise Price per Share |        | Number Exercisable |           | Weighted Average Exercise Price per Share
|$  0.10      1.73       |  | 1,501,583           |  | 7.20                                                   |  | $                                         | 1.61   |                    | 776,373   |                                           | $ | 1.59  
|1.75      2.88          |  | 687,406             |  | 3.71                                                   |  |                                           | 2.40   |                    | 616,824   |                                           |   | 2.42  
|2.95      2.95          |  | 3,639,686           |  | 8.99                                                   |  |                                           | 2.95   |                    | 1,361,577 |                                           |   | 2.95  
|3.01      3.13          |  | 1,666,943           |  | 8.72                                                   |  |                                           | 3.11   |                    | 423,187   |                                           |   | 3.10  
|3.22      4.74          |  | 1,360,445           |  | 7.86                                                   |  |                                           | 3.81   |                    | 632,038   |                                           |   | 4.13  
|4.74  889.40            |  | 1,368,584           |  | 4.18                                                   |  |                                           | 24.98  |                    | 1,331,961 |                                           |   | 21.75 
|998.50  998.50          |  | 166                 |  | 2.76                                                   |  |                                           | 998.50 |                    | 166       |                                           |   | 998.50
|                         |  |                     |  |                                                        |  |                                           |        |                    |           |                                           |   |       
|Total                    |  | 10,224,813          |  | 7.53                                                   |  | $                                         | 5.82   |                    | 5,142,126 |                                           | $ | 7.74  
|                         |  |                     |  |                                                        |  |                                           |        |                    |           |                                           |   |       

The Company uses the Black-Scholes option pricing model for estimating the fair value of options
granted under the Companys equity incentive plans. There were no stock options granted or exercised during the three months ended March 31, 2006. The weighted average assumptions that were used to calculate the grant date fair value of
the Companys employee stock option grants for the three months ended March 31, 2007 are as follows:



|                         |  |                             
|------------------------ |  | ----------------------------
|                         |  | Three Months Ended March 31,
|                         |  | 2007                        
|Risk-free interest rate  |  | 4.76%                       
|Expected volatility      |  | 53%                         
|Expected life (in years) |  | 5                           
|Dividend yield           |  | 0%                          

Risk-free interest rates for the options were taken from the Daily Federal Yield Curve Rates on
the grant dates for the expected life of the options as published by the Federal Reserve.

The expected volatility of the stock options was
based upon historical data and other relevant factors such as the Companys changes in historical volatility and its capital structure in addition to mean reversion.

In the analysis of expected life the Company used an approach that determines the time from grant to exercise for options that have been exercised and adjusts this number for the expected time to exercise for options
that have not yet been exercised. The expected time to exercise for options that have not yet been exercised is calculated from grant as the midpoint of contractual termination of the option and the later of measurement date or vesting date. All
times are weighted by number of option shares in developing the expected life assumption.

The weighted-average fair value of options
granted during the three months ended March 31, 2007 was $1.58 per share.

The forfeiture rate of employee stock options for 2007 was
calculated using the Companys historical terminations data.

Note 4. Warrant Liability

The warrants issued in June, September and October 2005 (collectively referred to as the Warrants) had cash penalties for the failure to
register the underlying shares of common stock. Pursuant to Emerging Issues Task Force 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 three months ended March 31, 2006,
$562,000 was recorded to other expense for the change in fair value of the Warrants.



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##### Table of Contents

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 noted above in Note 3, in May 2006, the Company amended the registration agreements 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. The Company amended the penalty for failure to register the underlying shares of common stock from cash to share-based payments, with a maximum limit of 59,383 penalty shares to be issued. Pursuant to EITF 00-19, with the elimination of
these cash penalties and a maximum limit on penalty shares, the fair value of the Warrants on the date of this amendment was 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 were not reversed.

Note 5. Comprehensive Loss

Comprehensive loss is comprised of net loss and foreign currency translation adjustments. The total changes in comprehensive loss during the three month
periods ended March 31, 2007 and 2006 were as follows (in thousands):



|                                         |  |                             |        |   |                   |   |        |  
|---------------------------------------- |  | --------------------------- | ------ | - | ----------------- | - | ------ | -
|                                         |  | Three Months EndedMarch 31, |       
|                                         |  | 2007                        |        |   | 2006 Restated (1) |  
|Net Loss                                 |  | $                           | (3,750 | ) |                   | $ | (979   | )
|Foreign currency translation gain (loss) |  |                             | (27    | ) |                   |   | (44    | )
|                                         |  |                             |        |   |                   |   |        |  
|Comprehensive loss                       |  | $                           | (3,777 | ) |                   | $ | (1,023 | )
|                                         |  |                             |        |   |                   |   |        |  

---

|(1) | See Restatement relating to stock-based compensation and other revenue and expense items included in Note 1 to the condensed consolidated financial statements.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

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 $781,000 expiring in 2007 and through 2011. The
Companys letters of credit can be supported by either restricted cash or the Companys line of credit. At March 31, 2007, the Company had a $14.7 million in non-cancelable operating lease obligations off set by $5.0 million of
sublease income from subleases that are under contract.



|(b) | Other Contractual Obligations
|--- | -----------------------------

At March 31,
2007, the Company had other future contractual obligations requiring payments of $3.3 million. The obligation represents payments on a legal settlement, minimum payments to vendors for future royalty fees, marketing services, training services,
consulting services, engineering services, and sales events.



|(c) | Litigation
|--- | ----------

On January 24, 2007, RightNow
Technologies, Inc. (RightNow) filed a suit against the Company and four former RightNow employees who had joined the Company in the Eighteenth Judicial District Court of Gallatin County, Montana. The suit alleges violation of certain
provisions of employment agreements, misappropriation of trade secrets, as well as other claims, and seeks damages. The Company is undertaking to defend itself and the named individuals to the extent required by applicable laws. The Company believes
it has meritorious defenses to these claims and intends to defend against this action vigorously.

On March 16, 2006, Polaris IP, LLC
filed a suit against the Company, Sirius Satellite Radio, Inc., 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 Nos.
6,411,947 and 6,278,996 and seeking injunctive relief, damages and attorneys fees. On March 23, 2007, the parties entered into a settlement agreement and this matter was dismissed with prejudice on April 26, 2007.



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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 against 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 consolidated 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
March 31, 2007.

Other 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 in the past has 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.

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



|(d) | Indemnification
|--- | ---------------

Many of our software license
agreements require us to indemnify our customers for 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). In prior periods, the Company has incurred minimal costs related to such claims under such indemnifications provisions; accordingly, the
amount of such obligations cannot be reasonably estimated. The Company did however record a settlement charge resulting from a settlement of an infringement claim on the Companys consolidated statement of operations for the year ended
December 31, 2006, which was not considered material. Except for those related to the Polaris matter, there were no outstanding claims of infringement at March 31, 2007.

As permitted by Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the
officer is, or was, serving at the Companys request in such capacity. The term of the indemnification period is for the officers or directors lifetime. The maximum potential amount of future payments the Company could be required
to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and enables the Company to recover a portion of any such amounts. As a result of the
Companys insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is insignificant. Accordingly, the Company has no liabilities recorded for these agreements as of March 31, 2007.

Note 7. Restructuring Costs

The
following table provides a summary of restructuring activity during the three months ended March 31, 2006 and 2007 (in thousands):



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##### Table of Contents

|                                |  |            |        |   |                       |   |      |       |  |   |        |  
|------------------------------- |  | ---------- | ------ | - | --------------------- | - | ---- | ----- |  | - | ------ | -
|                                |  | Facilities |        |   | Severance and Related |   |      | Total | 
|Restructuring accruals:         |  |            |        |   |                       |   |      |       |  |   |        |  
|Accrual as of December 31, 2005 |  | $          | 7,270  |   |                       | $ | 282  |       |  | $ | 7,552  |  
|Restructuring recoveries        |  |            | 46     |   |                       |   | (36  | )     |  |   | 10     |  
|Payments made                   |  |            | (796   | ) |                       |   | (173 | )     |  |   | (969   | )
|Sublease payments received      |  |            | 250    |   |                       |   |     |       |  |   | 250    |  
|                                |  |            |        |   |                       |   |      |       |  |   |        |  
|Accrual as of March 31, 2006    |  | $          | 6,770  |   |                       | $ | 73   |       |  | $ | 6,843  |  
|                                |  |            |        |   |                       |   |      |       |  |   |        |  
|Accrual as of December 31, 2006 |  | $          | 6,102  |   |                       | $ |     |       |  | $ | 6,102  |  
|Payments made                   |  |            | (1,078 | ) |                       |   |     |       |  |   | (1,078 | )
|Sublease payments received      |  |            | 539    |   |                       |   |     |       |  |   | 539    |  
|                                |  |            |        |   |                       |   |      |       |  |   |        |  
|Accrual as of March 31, 2007    |  | $          | 5,563  |   |                       | $ |     |       |  | $ | 5,563  |  
|                                |  |            |        |   |                       |   |      |       |  |   |        |  

Note 8. 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 industry segment: specifically the licensing and support of
its software applications. Revenue classification is based upon customer location.

Geographic information on revenues for the three months
ended March 31, 2007 and 2006 is as follows (in thousands):



|              |  |                             |        |      |   |       
|------------- |  | --------------------------- | ------ | ---- | - | ------
|              |  | Three Months EndedMarch 31,
|              |  | 2007                        |        | 2006
|North America |  | $                           | 9,224  |      | $ | 8,608 
|Europe        |  |                             | 3,632  |      |   | 2,549 
|Asia Pacific  |  |                             | 178    |      |   | 276   
|              |  |                             |        |      |   |       
|Total         |  | $                           | 13,034 |      | $ | 11,433
|              |  |                             |        |      |   |       

During the three months ended March 31, 2007 and 2006, no customer represented 10% of total
revenues.

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):



|                                 |  |               |       |                  |   |      
|-------------------------------- |  | ------------- | ----- | ---------------- | - | -----
|                                 |  | March 31,2007 |       | December 31,2006
|United States                    |  | $             | 1,762 |                  | $ | 1,974
|International (primarily Europe) |  |               | 2,233 |                  |   | 2,217
|                                 |  |               |       |                  |   |      
|Total                            |  | $             | 3,995 |                  | $ | 4,191
|                                 |  |               |       |                  |   |      

Note 9. Loan Payable and Note Payable



|(a) | Loan Payable
|--- | ------------

On November 30, 2005, the
Company established a new banking relationship with Bridge Bank N.A. (Bridge) and 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 (November Loan). This November 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 stand-by letters of credits, settlement limits on foreign exchange contracts 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 expired on November 29, 2006. 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 accrues at
Bridges Prime Lending Rate plus 0.50%. On December 29, 2005, the Company entered into a Business Financing Agreement with Bridge, which provided for additional advances up to $1.5 million based on an advance rate of 80% of eligible
receivables. The overall November Loan was increased to $7.5 million.



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On March 30, 2006, the Company modified the Business Financing Agreement with Bridge to increase the
additional advances for accounts receivable to $2.0 million and the overall November Loan to $8.0 million.

On November 28, 2006 the
Business Financing Agreement was further modified to extend the expiration date to February 28, 2007.

On February 27, 2007, the
Company entered into an Amended and Restated Loan and Security Agreement with Bridge under which the Company has access to a Loan facility of $10.0 million (February Loan). The February Loan is a formula based revolving line of credit
based on 80% of eligible receivables subject to two sub limits; a sub limit of $2.5 million that is available for stand-by letters of credit, settlement limits on foreign exchange contracts or cash management products and a maximum amount of $5.0
million available as a term loan. The total combined borrowing under the February Loan and sub limits cannot exceed $10.0 million. The February Loan is collateralized by all of the Companys assets and expires February 27, 2009 at which
time the entire balance under the formula based line of credit will be due. The Company has a twelve month period to draw down against the term loan, which is repaid over a 36 month period. Interest for the formula based revolving line of credit
accrues at the Wall Street Journals (WSJ) Prime Lending Rate plus 1.25% while interest for the term loan accrues at the WSJs Prime Lending Rate plus 1.75%. The February Loan contains certain restrictive covenants including
but not limited to certain financial covenants such as maintaining profitability net of stock-based compensation and maintenance of certain key ratios. If the Company is not in compliance with the covenants of the February Loan, Bridge has the right
to declare an event of default and all of the outstanding balances owed under the February Loan would become immediately due and payable. As of March 31, 2007, the Company had $2.0 million drawn against the February Loan all of which is shown
as current on the condensed consolidated balance sheet as the Company was not in compliance with certain financial covenants. See Note 12 for further details.



|(b) | Note Payable
|--- | ------------

As of March 31, 2007, there was
$221,000 classified as current portion of note payable and $200,000 classified as long-term. The long term portion was included in other long-term liabilities on the condensed consolidated balance sheet. The note payable consists of two obligations.
The first is a promissory note with De Lage Landen Financial Services, Inc. for the financing of software license and support purchased and has a fixed interest rate of 3.15%, payable in monthly installments of principal and interest. The second
obligation is with First Insurance Funding Corp of California for short-term financing of Errors and Omissions insurance and has a fixed interest rate of 9.87%, payable in monthly installments of principal and interest. At March 31, 2007, the
Company had future payments of $179,000 for the nine months ending December 2007, and $170,000 and $72,000 for the years ending December 2008 and 2009, respectively, with no required payments thereafter. As of December 31, 2006, there was
$327,000 classified as current portion of note payable and $242,000 classified as long-term.

Note 11. Related Party Transactions

On October 30, 2006, the Company entered into a consulting agreement (the Consulting Agreement) with William T. Clifford, a member of
KANAs Board of Directors. Mr. Clifford provided consulting services to KANAs management as an independent contractor on matters pertaining to strategic planning and business (in addition to his role as a member of the Board of
Directors) for a period of twelve months that commenced on January 24, 2006. During the three months ended March 31, 2007, the Company paid Mr. Clifford a fee of $59,900 in consideration for his consulting services pursuant to the
terms of the Consulting Agreement.

Note 12. Subsequent Events

On May 4, 2007, the Company executed a definitive agreement with the members of eVergance Partners, LLC (eVergance) to acquire all of their membership interests. The transaction is
subject to customary closing conditions and is expected to close during the second quarter of 2007.

On May 7, 2007, the Company
entered into a First Amendment to Loan and Security Agreement with Bridge (Amendment), in which Bridge waived the Companys compliance with certain financial ratios for any period prior to the month and quarter ending June 30, 2007
and consented to the Companys acquisition of eVergance. The terms of the Amendment limit the maximum borrowing under the February Loan to $5 million until the Company has met certain restrictive covenants for two consecutive quarters.



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|ITEM 2. | 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 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.

The following discussion should be read in conjunction
with our Annual Report on Form 10-K filed on April 2, 2007, and the consolidated financial statements and notes thereto. 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 Software, Inc. and its subsidiaries (the Company or KANA and, references to we, our,
us, and similar pronouns refer to KANA) offer an innovative approach to customer service with cost-effective solutions that enhance the quality of customer interaction. Built on open standards for a high degree of adaptability and
integration, KANA solutions intelligently automate the processes needed to successfully serve our clients customers, so that our clients can deliver higher value service at lower cost. KANA provides an integrated solution which enables
organizations to deliver consistent, managed service across all channels, including email, chat, call centers, and Web self-service, ensuring a consistent service experience across communication channels.

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 larger customers often use a systems integrator, such as IBM, Accenture or BearingPoint, for the project to install KANA software as well as do the business process, workflow, and other associated required
work. KANAs professional services group assists the integrators as subject matter experts, and in some cases will act as the prime contractor for implementation of our software. While the Company continues this practice, the Company is
increasingly providing consulting and implementation services directly to our customers. These services may be provided to our existing customers who would prefer us to review their KANA implementations or to new customers who are not large enough
to gain the interest of a system integrator to provide such services. However, in the case of most of the initial installations of our applications that are generally installed by our customers using a system integrator, these services generally
increase the cost of a project substantially and subject their purchase to more approval levels and cost savings reviews resulting in longer sales cycles. This contributes to the difficulty that we face in predicting the quarter in which sales to
expected customers will occur and 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 May 2007, we executed a definitive agreement with the members of eVergance Partners, LLC (eVergance) to acquire all of their membership interests. eVergance is a management consulting and systems integration firm, and we expect our
service revenues and related expenses to increase when we consummate this acquisition.

In addition, we recently began offering our
software on a hosted basis for a subscription fee, through our OnDemand service.

In late 2005, we made a decision to eliminate outsourced
product development and bring core technology development back to our personnel in the United States in a process that we refer to as back-shoring and, by the end of the third quarter of 2006, we brought back all core technology
development to the United States, except for one product group. We also back-shored our technical support. As we continue to rebuild the sales organization and increase our marketing, our sales and marketing expenses increased in 2007 due to
increases in headcount, commissions as a result of higher revenues, and marketing programs. We will strive to match our spending with the anticipated revenue but, given the unpredictability of our license revenue, we are unable to predict with any
certainty the period(s) when the Company will be profitable, if at all.

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 March 31, 2007, the Company had
ending cash and cash equivalents of $5.3 million including $2.0 million of borrowings outstanding under a loan payable. As of March 31, 2007, the Company had an accumulated deficit of $4.3 billion and a negative working capital of $14.0
million. Loss from operations was $3.7 million for the first three months of 2007. Income from operations was $44,000 for the first three months of 2006. Net cash used for operating activities was $2.6 million and $3.0 million for the first three
months of 2007 and 2006, respectively.



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As of March 31, 2007, we had 194 full-time employees which represent an increase from 181 employees
at December 31, 2006 and an increase from 123 employees at March 31, 2006.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed 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 condensed 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.

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 (SOP 97-2), 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, Software Revenue Recognition,
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.

For all sales, the Company uses either a signed license agreement, a signed amendment to an existing license agreement, a signed order form, a binding purchase order where we either have a signed master license
agreement or an order form signed by the Company, or a signed statement of work as evidence of an arrangement.

Software delivery is
primarily by electronic means. If the software or other deliverable is subject to acceptance for a specified period after the delivery, revenue is deferred until the acceptance period has expired or the acceptance provision has been met.

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, and OnDemand and hosting. Consulting services revenues and the
related cost of services are generally recognized on a time and materials basis. For consulting services contracts that have a fixed fee, the Company recognizes the license and professional consulting services



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revenues using either the percentage-of-completion method or the completed contract method as prescribed by AICPA SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Product-Type Contracts (SOP 81-1). 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. OnDemand includes our KANA OnDemand software as a service and outsourcing offerings as well as
Advanced Customer Services. OnDemand revenue is recognized in accordance with the SEC Staff Accounting Bulletin No. 104, Revenue Recognition, corrected copy (SAB 104). Revenues from OnDemand services are recognized
ratably over the term of the arrangement, while application fees are recognized ratably over the sum of the term of the arrangement and the term of expected renewals. Hosting service arrangements are a means of deployment whereby the customers
software and data is physically located in third party facilities. Customers pay a fee to remotely access the hosted software and data via a secure internet connection. Hosting fees are recognized as the hosting service is delivered in accordance
with SAB 104.

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 support services is generally based on the price charged when an element is sold separately or the stated contractual renewal rates.

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.

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 condensed consolidated statements of operations. In the first quarter ended March 31, 2005, 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 $6.3 million.

As of March 31, 2007, we had $561,000 of capitalized costs for internal use software less $551,000 of accumulated amortization for a net balance of $10,000.

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; Framingham, Massachusetts; and Marlow in the United Kingdom.
Remaining lease commitments terminate over various dates beginning in April 2007 and through January 2011. We are seeking to sublease or renegotiate the obligations associated with the excess space. We have subleased some of the excess space, but in
all cases, the sublease income is less than the rent we pay the landlord. We had $5.6 million in accrued restructuring costs as of March 31, 2007, 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 March 31, 2007, our estimate of accrued restructuring cost included an assumption that we



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would receive $861,000 in sublease payments that are not subject to any contractual arrangement as of March 31, 2007. We have assumed that the majority
of these assumed sublease payments will begin in 2007 and continue through the end of the related leases. In December 2006, we determined that we may not be able to sublease a leased facility in Princeton, New Jersey, and we changed our assumption
of subleasing this excess space. We recorded a restructuring charge of $739,000 during the three months ended December 31, 2006 mainly related to this change in estimate of sublease assumption that is not subject to any contractual arrangement.

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 March 31, 2007 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, 2006, the date of our last 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

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based
Payment (SFAS 123(R)), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including employee stock options and employee stock purchases under an
employee stock purchase plan based on estimated fair values.

Stock-based compensation expense recognized during the three months ended
March 31, 2007 is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. We use the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which
determine the fair value of stock-based awards, including the options expected term and the price volatility of the underlying stock.

Employee stock-based compensation expense recognized under SFAS 123(R) for the three months ended March 31, 2007 and 2006 were $752,000 and $380,000, respectively.



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For stock options granted to non-employees, the Company recognizes compensation expense in accordance
with the provisions of SFAS No. 123, Accounting for Stock-Based Compensation and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services, which require such equity instruments to be recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the
underlying equity instruments vest. The Company amortizes compensation expense related to non-employee stock options in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 28, Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans (FIN 28). In 2005 and 2006,, the company extended the vesting period of approximately 1,000,000 stock options held by four terminated employees who had
agreements to provide consulting services. In fiscal year 2006, the Company granted a total of 57,500 stock options to four non-employees who had agreements to provide consulting services. As a result of these stock option modifications to former
employees and the stock option grants to consultants, the Company recorded non-employee stock-based compensation expense of $118,000 and $226,000 for the three months ended March 31, 2007 and 2006, respectively.

Also see stock-based compensation in Note 1 to the condensed consolidated financial statements.

Effect of Recent Accounting Pronouncements

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 provides companies with an
option to report selected financial assets and liabilities at fair value. The standard requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the
companys choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. This Statement is
effective as of the beginning of an entitys first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days
of that fiscal year and also elects to apply the provisions of SFAS No. 157, Fair Value Measurements (SFAS 157). The Company is currently evaluating whether the adoption of SFAS 159 will have a material effect on its
financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 158, Employers
Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132R (SFAS 158). SFAS 158 requires an entity to recognize in its statement of financial position an
asset for a defined benefit postretirement plans over funded status or a liability for a plans under funded status. The requirement to recognize the funded status of a defined postretirement plan and the disclosure requirements are
effective for fiscal years ending after December 31, 2006. The Company does not expect the adoption of SFAS 158 to have a material impact on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS 157. The purpose of SFAS 157 is to define fair value, establish a framework for measuring fair value and enhance
disclosures about fair value measurements. The measurement and disclosure requirements are effective for the Company beginning in the first quarter of fiscal 2008. The Company is currently evaluating the effects of implementing SFAS 157.

In June 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertain Tax Positions  An Interpretation of FASB Statement
No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with SFAS No. 109 Accounting for Income Taxes. It
prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007. During the implementation the Company
identified, evaluated, and measured the amount of income tax benefits to be recognized for all material income tax positions. The net income tax assets recognized under FIN 48 did not materially differ from the net assets recognized before adoption,
and, therefore, the Company did not record an adjustment related to the adoption of FIN 48. At the adoption date of January 1, 2007, the Company had $145,000 of unrecognized tax benefits, all of which would affect the Companys effective
tax rate if recognized. At March 31, 2007 the Company had $145,000 of unrecognized tax benefits.

Our continuing practice is to
recognize interest and/or penalties related to income tax matters as a component of income tax expense. As of March 31, 2007, we have approximately $28,000 of accrued interest and penalties related to uncertain tax positions.

The tax years 2003-2006 remain open to examination by the major taxing jurisdiction to which the Company is subject.



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Results of Operations Data

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



|                                           |  |                             |    |  |                   |   
|------------------------------------------ |  | --------------------------- | -- |  | ----------------- | --
|                                           |  | Three Months EndedMarch 31, |   
|                                           |  | 2007                        |    |  | 2006 Restated (1) |   
|                                           |  | (unaudited)                 |   
|Revenues:                                  |  |                             |    |  |                   |   
|License fees                               |  | 28                          | %  |  | 25                | % 
|Services                                   |  | 72                          |    |  | 75                |   
|                                           |  |                             |    |  |                   |   
|Total revenues                             |  | 100                         |    |  | 100               |   
|                                           |  |                             |    |  |                   |   
|Costs and Expenses:                        |  |                             |    |  |                   |   
|Cost of license fees                       |  | 2                           |    |  | 4                 |   
|Cost of services                           |  | 24                          |    |  | 20                |   
|Amortization of acquired intangible assets |  | *                           |    |  | *                 |   
|Sales and marketing                        |  | 48                          |    |  | 33                |   
|Research and development                   |  | 28                          |    |  | 23                |   
|General and administrative                 |  | 27                          |    |  | 20                |   
|Restructuring costs                        |  |                            |    |  | *                 |   
|                                           |  |                             |    |  |                   |   
|Total costs and expenses                   |  | 128                         |    |  | 100               |   
|                                           |  |                             |    |  |                   |   
|Income (loss) from operations              |  | (28                         | )  |  | *                 |   
|Interest and other income (expense), net   |  | *                           |    |  | (6                | ) 
|Registration rights penalty                |  |                            |    |  | (3                | ) 
|                                           |  |                             |    |  |                   |   
|Loss before income taxes                   |  | (28                         | )  |  | (8                | ) 
|Income tax expense                         |  | *                           |    |  | *                 |   
|                                           |  |                             |    |  |                   |   
|Net loss                                   |  | (29                         | )% |  | (9                | )%
|                                           |  |                             |    |  |                   |   

---

|* | Less than 1%
|- | ------------

|(1) | See Restatement relating to stock-based compensation and other revenue and expense itemsincluded in Note 1 to the condensed consolidated financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues

Total revenues
increased by 14% to $13.0 million for the three months ended March 31, 2007 from $11.4 million for the three months ended March 31, 2006, as a result of higher license and services revenues in 2007 than in 2006.

License revenues include licensing fees only, and exclude associated support and consulting revenue. The majority of our licenses to customers are
perpetual and associated revenues are recognized upon delivery provided that all revenue recognition criteria are met as discussed in Revenue Recognition under Critical Accounting Policies above. License revenues increased by
26% to $3.6 million for the three months ended March 31, 2007 from $2.9 million for the same period in the prior year. This increase in license revenue was based, in part, on increased demand for our products, with a greater number of license
transactions, and increased average transaction value. While we are focused on increasing license revenue, we are unable to predict such revenue from period to period with any degree of accuracy because, among other things, the market for our
products is unpredictable and intensely competitive, and our sales cycle is long and unpredictable.

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. Professional services revenues relate to providing consulting, training and implementation
services to our customers including OnDemand, software as a service option. Service revenues increased to $9.4 million for the three months ended March 31, 2007, compared to $8.6 million for the same period in 2006. Support revenues are the
largest component of service revenues, and during the three months ended March 31, 2007, support revenues remained flat compared to the same period in 2006, because support revenues from new maintenance contracts associated with new license
transactions offsetted support renewal cancellations. The other part of service revenues are professional services fees that increased for the three months ended March 2007 compared to the same period in 2006 mainly due to an increase in consulting,
training and OnDemand revenues. Consulting and training revenues increased as a result of increased license sales in prior quarters. Customers who purchase licenses frequently purchase implementation consulting and training, which usually occur
subsequent to the license sales.



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Revenues from domestic sales were $9.2 million and $8.6 million for the three months ended March 31,
2007 and 2006, respectively. Revenues from international sales were $3.8 million and $2.8 million for the three months ended March 31, 2007 and 2006, respectively. Our international revenues were derived from sales in Europe and Asia Pacific.

Costs and Expenses

Total cost of
revenues increased by 22% to $3.4 million for the three months ended March 31, 2007 from $2.8 million for the three months ended March 31, 2006.

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 fees was 8% for the three months ended March 31, 2007, compared to 16% for the same period in the prior year. The decrease was partially due to a reduction in royalty costs associated with a relatively lower proportion of
non-revenue-related shipments, such as upgrades and updates, as we had a lower proportion of such shipments during the first three months in 2007. The decrease also reflected our increased license revenues. In addition, we reduced our royalty costs
by replacing certain third-party technology with a lower cost alternative. Therefore, even though license revenue increased by 26% for the three months ended March 31, 2007 compared to the same period in the prior year, there was a significant
decrease in cost of license in the first three months in 2007 compared to the same period in 2006. We expect that our cost of license fees as a percentage of sales will vary based on changes in the mix of products we sell and the timing of upgrades.
We are not able to predict when customers will choose to upgrade their software which will then cause us to incur this royalty cost. We are continuing to look at alternatives for some original equipment manufacturer (OEM) products
embedded in KANA products.

Services. Cost of services consists primarily of compensation and related expenses for our customer
support, consulting and training and OnDemand services organizations, and allocation of facility costs and system costs incurred in providing customer support. Cost of services increased to 33% of service revenues, or $3.1 million, for the three
months ended March 31, 2007 compared to 27% of service revenues, or $2.3 million, for the same period in 2006. The decrease in service margins in the first three months in 2007 compared to the same period in 2006 was due to OnDemand related
costs as well as an increase in professional service staffing levels in 2007. As of March 31, 2007, we had 46 employees in the support, consulting, training and OnDemand organizations compared to 27 employees as of March 31, 2006, an
increase of 70%.

Cost of services may increase or decrease depending on the demand for these services. The expenses may also be affected
by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

Amortization of Acquired Intangible Assets.The amortization of acquired intangible assets is recorded in the three-month periods ended March 31, 2007 and 2006 related to $400,000 of identifiable
intangibles purchased in connection with the Hipbone acquisition in February 2004. Acquired intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the asset (three years) and
was fully amortized in the first quarter of 2007. Amortization expense may increase if we acquire another company.

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 increased by 65% to $6.2 million for the three months ended March 31, 2007, from $3.7 million for the same period in 2006. This was primarily due to an increase in compensation and related costs as a result of our strategy of
increasing our sales and marketing personnel and an increase in our marketing programs. As of March 31, 2007, we had 68 employees in sales and marketing compared to 46 employees as of March 31, 2006, an increase of 48%.

Sales and marketing expenses may increase or decrease, depending primarily on the amount of future revenues and our assessment of market opportunities
and sales channels. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

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 increased by 42% to $3.7 million for the three months ended March 31, 2007 from $2.6 million for the same period
in 2006. This was attributable primarily to higher compensation and related costs as a result of an increase in head count as well as retention bonuses paid to some employees. As of March 31, 2007, we had 43 employees in research and
development compared to 24 employees as of March 31, 2006, an increase of 79%.



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Research and development expenses including related head count may increase or decrease, depending
primarily on the amount of future revenues, customer needs, and our assessment of market demand. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to
employees and consultants leaving the Company.

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 53% to $3.5 million for the three months ended March 31, 2007 from $2.3 million for the three months ended March 31, 2006. The increase in expenses during the three months ended March 31, 2007 was primarily due to higher auditing
and legal fees, an increase in employee stock-based compensation due to new grants, higher compensation and related costs as a result of new hires, and expenses related to the world-wide employee meeting held in February 2007. As of March 31,
2007, we had 37 employees in general and administrative and information technology combined compared to 27 employees as of March 31, 2006, a 37% increase.

General and administrative expenses may increase or decrease, depending primarily on the amount of future revenues and corporate infrastructure requirements including insurance, professional services, taxes, bad debt
expense, and other administrative costs. The expenses may also be impacted by the amount, type and valuation of stock options granted as well as the amount of stock options cancelled due to employees and consultants leaving the Company.

Restructuring Costs.There was no restructuring cost during the three months ended March 31, 2007. During the three months ended
March 31, 2006, there was a restructuring charge of $46,000 for lease-hold improvements off set by a recovery of $36,000 due to the changes in the assumptions related to severance of employees in our New Hampshire facility.

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 was approximately
$22,000 and $58,000 for the three months ended March 31, 2007 and 2006, respectively. The decrease in interest income related to lower cash and cash equivalents balances in the three months ended 2007 compared to the same period in 2006.
Interest expense relates primarily to our loan payable and was approximately $39,000 and $144,000 for the three months ended March 31, 2007 and 2006, respectively. The decrease in interest expense related to lower borrowings against the loan
payable in the three months ended 2007 compared to the same period in 2006. Interest and other income (expense), net also consists of changes in the fair value of warrant liabilities of approximately $562,000 for the three month ended March 31,
2006.

Provision for Income Taxes

We
have incurred net operating losses on a consolidated basis for all periods from inception through March 31, 2007. 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. During the three months ended March 31, 2007 and 2006, 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 $47,000 and $28,000 for the three months ended March 31, 2007 and 2006, respectively, in those foreign jurisdictions.

Liquidity and Capital Resources

As of March 31,
2007, we had $5.3 million in cash and cash equivalents, compared to $5.7 million in cash and cash equivalents at December 31, 2006. As of March 31, 2007, we had negative working capital of $14.0 million, compared to negative working
capital of $11.0 million as of December 31, 2006. As of March 31, 2007, our current liabilities included $15.5 million of deferred revenue (primarily reflecting payments received for future maintenance services to be provided to our
customers).

History and Recent Trends

We have had negative cash flow from operating activities 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. The rate of
cash we have used in operations was $13.1 million in 2004, $16.3 million in 2005, $1.7 million in 2006 and $2.6 million in the first three months of 2007. In 2003, 2004 and 2005, we implemented successive net workforce reductions of approximately
154, 30 and 56 employees, respectively. During 2006 and the first three months in 2007, we had a net increase of 56 and 12 employees, respectively. Staffing is expected to change from time to time based upon a number of factors, including
anticipated demand for our products and the balancing of roles between employees and outsourced staffing. We



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experienced negative cash flow from operations during 2006 and during the first three months of 2007 due to continued net losses. While our cash flow has
benefited from our continuing emphasis on cost management, that benefit has been partially offset by continued cash outflow for rent on excess facilities. Our cash collections during any quarter are driven primarily by the amount of sales booked in
the previous quarter, and we cannot be certain that we will meet our revenue expectations in any given period.

Primary Driver of Cash Flow

Our ability to generate cash in the future depends upon our success in generating sufficient sales transactions, especially new
license transactions. We expect our support renewals in 2007 to continue to be relatively flat from 2006. Since our new license transactions are relatively small in number 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 assets and liabilities, such as changes in levels of accounts receivable and accounts payable, may also affect our cash flows.

Operating Cash Flow

We had negative cash flow
from operating activities of $2.6 million for the first three months of 2007, which included a $3.8 million net loss, a $45,000 decrease in accounts payable and accrued liabilities, a $543,000 decrease in accrued restructuring and a $487,000
decrease in deferred revenue, partially offset by non-cash charges of $870,000 for stock-based compensation expense and $265,000 of depreciation, as well as a $955,000 decrease in accounts receivable. Our operating activities used $3.0 million of
cash and cash equivalents for the three months ended March 31, 2006.

Investing Cash Flow

Our investing activities used $221,000 and $33,000 of cash for the first three months of 2007 and 2006, respectively, which consisted primarily of the
purchase of property and equipment.

Financing Cash Flow

Our financing activities provided $2.5 million of cash for the three months ended March 31, 2007, which consisted primarily of $2.0 million of cash related to net borrowings under our bank loan payable, $609,000
in proceeds from issuances of common stock, and borrowings of $71,000 on note payable offset in part by the repayment of $219,000 on note payable. For the first three months of 2006, our financing activities provided $457,000 of cash and cash
equivalents.



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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 had access to a Loan Facility of $7.0 million. We have since amended our agreement with
Bridge, and most recently on February 27, 2007, whereby the Company entered into an Amended and Restated Loan and Security Agreement with Bridge under which the Company has access to a Loan Facility of $10.0 million (February Loan).
The February Loan is a formula based revolving line of credit based on 80% of eligible receivables subject to two sub limits; a sub limit of $2.5 million that is available for stand-by letters of credit, settlement limits on foreign exchange
contracts or cash management products and a maximum amount of $5.0 million available as a term loan. The total combined borrowing under the February Loan and sublimits cannot exceed $10.0 million. The February Loan is collateralized by all of the
Companys assets and expires February 27, 2009 at which time the entire balance under the formula based line of credit will be due. The Company has a twelve month period to draw down against the term loan, which is repaid over a 36 month
period. Interest for the formula based revolving line of credit accrues at the Wall Street Journals (WSJ) Prime Lending Rate plus 1.25% while interest for the term loan accrues at the WSJs Prime Lending Rate plus 1.75%. The
February Loan contains certain restrictive covenants including but not limited to certain financial covenants such as maintaining profitability net of stock-based compensation and maintenance of certain key ratios. If we are not in compliance with
the covenants of the February Loan, Bridge Bank has the right to declare an event of default and all of the outstanding balances owed under the February Loan would become immediately due and payable. As of March 31, 2007, the Company had $2.0
million drawn against the February Loan all of which is shown as current on the condensed consolidated balance sheet as the Company was not in compliance with certain financial covenants. On March 30, 2006, the Company modified the Business
Financing Agreement with Bridge to increase the additional advances for accounts receivable to $2.0 million and the overall November Loan to $8.0 million. As of March 31, 2006, the Company had $7.9 million drawn against the November Loan. On
November 28, 2006, the Business Financing Agreement was modified to extend the expiration date to February 28, 2007.

On May 7, 2007,
the Company entered into a First Amendment to Loan and Security Agreement with Bridge (Amendment), in which Bridge waived the Companys compliance with certain financial ratios for any period prior to the month and quarter ending
June 30, 2007 and consented to the Companys acquisition of eVergance. The terms of the Amendment limit the maximum borrowing under the February Loan to $5 million until the Company has met certain restrictive covenants for two consecutive
quarters.

Our future payments due under debt and lease obligations and other contractual commitments as of March 31, 2007 are as
follows (in thousands):



|                                              |  |                        |        |   |                 |   |        |            |  |   |            |   |  |                  |       |   |  |   |  
|--------------------------------------------- |  | ---------------------- | ------ | - | --------------- | - | ------ | ---------- |  | - | ---------- | - |  | ---------------- | ----- | - |  | - | -
|                                              |  | Payments Due By Period
|                                              |  | Total                  |        |   | Less than1 year |   |        | 1 - 3years |  |   | 3 - 5years |   |  | More than5 years
|Contractual obligations:                      |  |                        |        |   |                 |   |        |            |  |   |            |   |  |                  |       |   |  |   |  
|Loan payable                                  |  | $                      | 2,000  |   |                 | $ | 2,000  |            |  | $ |           |   |  | $                |      |   |  | $ | 
|Note payable                                  |  |                        | 421    |   |                 |   | 221    |            |  |   | 200        |   |  |                  |      |   |  |   | 
|Non-cancelable operating lease obligation (1) |  |                        | 14,692 |   |                 |   | 4,903  |            |  |   | 8,206      |   |  |                  | 1,583 |   |  |   | 
|Less: Sublease income (2)                     |  |                        | (4,950 | ) |                 |   | (1,495 | )          |  |   | (2,755     | ) |  |                  | (700  | ) |  |   | 
|Other contractual obligations (3)             |  |                        | 3,318  |   |                 |   | 2,361  |            |  |   | 557        |   |  |                  | 400   |   |  |   | 
|                                              |  |                        |        |   |                 |   |        |            |  |   |            |   |  |                  |       |   |  |   |  
|Total                                         |  | $                      | 15,481 |   |                 | $ | 7,990  |            |  | $ | 6,208      |   |  | $                | 1,283 |   |  | $ | 
|                                              |  |                        |        |   |                 |   |        |            |  |   |            |   |  |                  |       |   |  |   |  

---

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

|(2) | Includes only subleases that are under contract as of March 31, 2007, and excludes future estimated sublease income for agreements not yet signed.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Represents payments on a legal settlement, minimum payments to vendors for future royalty fees, marketing services, training services, consulting services, engineering services, and
sales events.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Outlook

Based on our current 2007 revenue expectations, we expect our cash and cash equivalents will be sufficient to meet our working capital and capital expenditure needs through March 31, 2008. However, 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 our 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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Risk Factors That Could Affect Future Results

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

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
every year. As of March 31, 2007, our accumulated deficit was approximately $4.3 billion, which includes approximately $2.7 billion related to goodwill impairment charges. Our stockholders deficit at March 31, 2007 was $5.4
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, even if sales of our products and services grow, we may continue to experience losses, which may cause the price of our stock to decline.

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 revenues and results of operations may fluctuate as a result of a variety of factors. Our 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. Fluctuations in our results of operations may be due to a number of additional factors, including, but not limited to, our ability to retain and
increase our customer base, changes in our pricing policies or those of our competitors, the timing and success of new product introductions by us or our competitors, the sales cycle for our products, our fixed expenses, the purchasing and budgeting
cycles of our clients, and general economic, industry and marketing conditions.

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 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. 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



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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.

Furthermore, we rely to a significant extent 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 additional 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.

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 $5.3 million at March 31, 2007. It is possible that our cash position could
decrease over the next few quarters and some customers could become increasingly concerned about our cash situation and our ongoing ability to update and maintain our products. This could significantly harm our sales efforts.

Factors such as the commercial success of 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.



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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 support 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. Any such changes would likely reduce margins and could adversely affect operating results.

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. Furthermore, we could lose market share if our competitors introduce new competitive products, add
new functionality, acquire competitive products, reduce prices or form strategic alliances with other companies. 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 electronic CRM platforms are larger, more
established companies such as Oracle, which recently acquired Siebel Systems. The rate at which competitors are consolidating is increasing. We also face competition from Chordiant Software, ATG, Amdocs, Knova (a subsidiary of Consona Corporation),
Talisma, eGain, RightNow, Instranet, and Pegasystems with respect to specific applications we 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. As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or client requirements or devote
greater resources to the promotion and sale of their products and services than we can. 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.



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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, or SIs 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 depends on leads generated by 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 remain high. 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 quantities of our products, are not bound to promote our products exclusively, and may act as
indirect sales channels for our competitors. If SIs 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.

Because certain customers account for a substantial portion of our revenues, the loss of a significant
customer could cause a substantial decline in our revenues.

One customer, IBM who resells our software to its customers, accounted
for 9%, 11% and 11% of our revenue in 2006, 2005 and 2004 respectively. Given that we derive a significant portion of our license and service revenues from IBM, the loss of this customer could cause a decrease in revenues and operating results.
Furthermore, if we lose major customers, or if a contract is delayed or cancelled or we do not contract with new major customers, our revenues and net loss would be adversely affected. In addition, customers that have accounted for significant
revenues in the past may not generate revenues in any future period, and our failure to obtain new significant customers or additional orders from existing customers could materially affect our operating results.

We may not receive significant revenues from our current research and development efforts for several years, if at all.



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Developing and localizing software is expensive and the investment in product development often involves
a long payback cycle. We have and expect to continue making significant investments in software research and development and related product opportunities. Enhancing our products and pursuing new product developments require high levels of
expenditures for research and development that could adversely affect our operating results if not offset by revenue increases. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to
maintain our competitive position. However, we do not expect to receive significant revenues from these investments for several years, if at all.

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

We reduced our employee headcount in 2005 from a total of 181 as of December 31, 2004 to 125 as of December 31, 2005 and then increased to 181 as of December 31, 2006 and to 194 as of March 31, 2007. The majority of the
2005 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, a strategy we have since reversed
through our back-shoring process. We reduced the size of our research and development department from 34 employees as of December 31, 2004, to 30 employees as of December 31, 2005 and then increased to 37 as of
December 31, 2006 and to 43 as of March 31, 2007. In addition, we reduced the level of our expenditures on outsourced development in 2005, and, in December 2005, we consolidated a significant portion of our research and development
operations into one location in Menlo Park, California to optimize our research and development processes and decrease overall operating expenses. As a result, we terminated the employment of 15 employees based in our New Hampshire office. The
changes 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, and which was not replaced in our more recent headcount increases. As a result, 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.

We rely on the continued service of our senior management and other key employees and the hiring of new qualified employees. In the software industry, there is substantial and continuous competition for highly skilled business, product
development, technical and other personnel. Given the concern over our long-term financial strength, we may not be successful in recruiting new personnel and retaining and motivating existing personnel, 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. Additionally, we need to recruit experienced developers as a result of our back-shoring
initiative.

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



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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.

Our success depends upon our ability to develop new products and enhance our existing products on a timely basis.

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;
| | - |  | -------------------



| |  |  | 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 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.



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Defects in third-party products associated with our products could impair our products functionality and
injure our reputation.

The effective implementation of our products depends upon the successful operation of third-party products
in conjunction with our products. Any undetected defects in these third-party products could prevent the implementation or impair the functionality of our products, delay new product introductions or injure our reputation.

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 former independent registered public
accounting firm identified and reported material weaknesses in our internal controls 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. Soon thereafter, our former Chief Executive Officer and current Chief Financial Officer performed an evaluation of our
disclosure controls and procedures and found that they were not effective. 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 was exacerbated by changes in management and accounting personnel and insufficient training of our accounting department. Moreover, 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. Furthermore, during the first quarter of 2005, our Audit Committee of the Board of Directors (the 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 former 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.

The material weaknesses in our internal control over financial reporting delayed the
completion of our consolidated financial statements for the years ended December 31, 2004 and 2005, as well as our financial statements for each of the quarters in 2005 and the first quarter of 2006, which prevented us from timely filing our
Form 10-K for the each of the years ended December 31, 2004 and 2005 and our quarterly filings on Form 10-Q for all the quarters in 2005 and the first quarter of 2006. In particular, as a result of the lack of sufficient documentation and
existing analysis to support the consolidated financial statements, significant analysis was required to support our consolidated financial statements, and the delay involved by the need for this analysis was exacerbated by insufficient staffing in
our accounting and reporting function. This delay also impacted and continued to affect our ability to timely file our periodic reports throughout 2005 and up to the first quarter of 2006, as we were not able to commence preparation of these reports
until we had completed and filed the Form 10-K for the year ended December 31, 2004 and completed the remediation of these material weaknesses.

We have determined that the material weaknesses mentioned as of December 31, 2004, with the exception of the material weakness relating to travel and entertainment expenses, continued to exist during 2005 and
through the third quarter of 2006. We believe that these material weaknesses mentioned above did not have a material impact on our consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2006
due to the fact that the material weaknesses were remediated as of December 31, 2006, and we performed substantial analyses on the prior period consolidated financial statement balances, including historical account reconciliations, had our
account balance analyses reviewed by senior management and reconstructed certain account balances. However, these material weaknesses mentioned above and our delay in timely completing our consolidated financial statements and thus, the filing of
our periodic reports, increase the risk that a transaction will not be accounted for consistently and in accordance with established policy or generally accepted accounting principles, and increase the risk of error in our general accounting
processes and consolidated financial statements.

Our management, with the oversight of the Audit Committee, has addressed the material
weaknesses mentioned above and has implemented controls to remediate such weaknesses. Our 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. New processes and internal controls have been approved and implemented, and management concluded as of December 31, 2006, that these controls were operating effectively.

During the 2006 year-end close, however, we identified and reported a material weakness in our internal controls over financial reporting related to our
stock-based compensation. This material weakness related to our failure to complete a proper analysis of historical stock option vesting data within our system. This resulted in a net overstatement of our stock-based compensation during the interim
reporting periods for fiscal year 2006. As a result of this material weakness, the



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quarterly results of operations have been restated, as provided in Note 14 of the consolidated financial statements in the Companys 2006 Form 10-K
for the year ended December 31, 2006, and the prior period pro-forma informational disclosure of expenses has also been restated, as provided in Note 7 of the consolidated financial statements in the Companys 2006 Form 10-K for the
year ended December 31, 2006, and the Company was unable to conclude that our disclosure controls and procedures were effective as of December 31, 2006.

Our management, with the oversight of the Audit Committee of the Board of Directors, has begun to address this material weakness related to our stock-based compensation and is committed to effective remediation of
these deficiencies as expeditiously as possible. We have implemented a procedure to review the stock option reports on a quarterly basis to assure that only current employee options that are expected to vest are included in the employee stock-based
compensation expense for the period. Our material weakness 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 former and current 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, internal 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, delay our completion of our consolidated financial statements and our independent registered public accounting firms audit or review of our consolidated
financial statements which could cause us to fail to timely meet our periodic reporting obligations with the SEC or result in material misstatements in our consolidated financial statements which could also cause us to fail to timely meet our
periodic reporting obligations with the SEC. 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 Reports on Form 10-K for the years ended December 31, 2004 and 2005.

As a result of missing an established deadline with the NASDAQ 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 Qualifications 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 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, as amended (the Exchange Act) 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 delisted from The NASDAQ National Market and is currently quoted on the OTCBB.

Our common stock was delisted from The NASDAQ National Market effective at the opening of business on October 17, 2005. From October 17, 2005
to December 4, 2006, our common stock was quoted on the Pink Sheets and as of December 5, 2006, our common stock has been quoted on Over the Counter Bulletin Board (OTCBB). Quotation of our common stock on the OTCBB
will likely reduce the liquidity of our securities, could cause investors not to trade in our securities, 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 The NASDAQ Stock 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.

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;
| | - |  | -----------------------------------------------------------



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



| |  |  | 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 have, and particularly The NASDAQ Stock Market has, 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 timely file our Quarterly Report on Form 10-Q for the quarter ended
March 31, 2005 with the SEC. Our common stock is currently quoted on the OTCBB. The last reported sale price of our shares on April 30, 2007 was $3.58 per share.

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

Our success and ability to compete depend 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. Consequently, we may be unable to prevent our proprietary technology from being exploited abroad, which could diminish international sales or require costly efforts to protect our 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.



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The software industry is 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, and 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. Additionally, third parties may currently have, or may eventually be issued, patents upon which our current or future products or technology infringe and any of these third parties
might make a claim of infringement against us. For example, we have recently been involved in litigation brought by Polaris IP, LLC against us and certain of our customers that claimed that certain of our products violates patents held by them.

As we grow, the possibility of intellectual property rights claims against us increases. We may not be able to withstand any third-party
claims and regardless of the merits of the claim, any intellectual property claims could be inherently uncertain, time-consuming and expensive to litigate or settle. 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 may not be able to 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 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 new products and an immediate and significant loss of market share;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | loss of existing customers that upgrade to new products 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.
| | - |  | --------------------------

Any of
the foregoing potential results of errors in our software could adversely affect our business, financial condition and results of operations.

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



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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.

We have significant international
sales and are subject to risks associated with operating in international markets.

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 29% of our total revenues for the three months ended March 31, 2007, compared to 25% of our total
revenues for the three months ended March 31, 2006. We have established offices in the United States, Europe, Japan, and Hong Kong. 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. International operations are subject to many inherent risks, including:



| |  |  | political, social and economic instability, including conflicts in the Middle East and elsewhere abroad, terrorist attacks and security concerns in general;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adverse changes in tariffs, duties, price controls and other protectionist laws and business practices that favor local competitors;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | fluctuations in currency exchange rates;
| | - |  | ----------------------------------------



| |  |  | longer collection periods and difficulties in collecting receivables from foreign entities;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | exposure to different legal standards and burdens of complying with a variety of foreign laws, including employment, tax, privacy and data protection laws and
regulations;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reduced protection for our intellectual property in some countries;
| | - |  | -------------------------------------------------------------------



| |  |  | increases in tax rates;
| | - |  | -----------------------



| |  |  | greater seasonal fluctuations in business activity;
| | - |  | ---------------------------------------------------



| |  |  | expenses associated with localizing products for foreign countries, including translation into foreign languages; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | import and export license requirements and restrictions of the United States and each other country in which we operate.
| | - |  | ------------------------------------------------------------------------------------------------------------------------

We believe that international sales will continue to represent a significant portion of our revenue for the foreseeable future. Any of these factors may
adversely affect our future international sales and, consequently, affect our business, financial condition and 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. In May 2007, we executed a definitive agreement with the members of eVergance Partners, LLC (eVergance) to acquire all of their membership interests. We may not realize the anticipated benefits of
the Hipbone or eVergance acquisition or any other 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. Upon the acquisition of
eVergance, or 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, the potential loss of key employees of the acquired businesses, and the failure of the acquired businesses, products or technologies to
generate sufficient revenue to offset acquisition costs. If we fail to successfully integrate other companies that we may acquire, our business could be harmed. Also, acquisitions, including the acquisition of eVergance, can expose us to liabilities
and risks facing



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the company we acquire, such as 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. These factors could have an adverse effect on our business, results of operations, financial condition or cash flows.

Compliance with 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 non-accelerated public companies, are preparing for new accounting disclosures required by laws and regulations adopted in connection with the
Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act). 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.

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 of Directors 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 two-thirds 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 website users that the data captured after visiting certain websites 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.

The success of our products depends on the continued growth and acceptance of the Internet as a business and communications tool, and the related expansion of the
Internet infrastructure.

The future success of our products depends upon the continued and widespread adoption of the Internet as
a primary medium for commerce, communication and business applications. Our business growth would be impeded if the performance or perception of the Internet was harmed by security problems such as viruses, worms and other
malicious programs, reliability issues arising from outages and damage to Internet infrastructure, delays in development or adoption of new standards and protocols to handle increased demands of Internet activity, increased costs, decreased
accessibility and quality of service, or increased government regulation and taxation of Internet activity.



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The Internet has experienced, and is expected to continue to experience, significant user and traffic
growth, which has, at times, caused user frustration with slow access and download times. If Internet activity grows faster than Internet infrastructure or if the Internet infrastructure is otherwise unable to support the demands placed on it, our
business growth may be adversely affected.

General economic conditions could adversely affect our customers ability or willingness to purchase
our products, which could materially and adversely affect our results of operations.

Our customers consist of large and small
companies in nearly all industry sectors and geographies. Potential new clients or existing clients could defer purchases of our products because of unfavorable macroeconomic conditions, such as rising interest rates, fluctuations in currency
exchange rates, industry or national economic downturns, industry purchasing patterns, and other factors. Our ability to grow revenues may be adversely affected by unfavorable economic conditions.



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|ITEM 3. | 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 three months ended March 31, 2007 and the year ended December 31, 2006, revenues from customers outside of the
United States approximated 29% and 32%, 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 U.S. 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 March 31, 2007, 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 to be subject to interest rate risk due to their short maturities.



|ITEM 4T. | CONTROLS AND PROCEDURES.
|-------- | ------------------------

Evaluation of Disclosure Controls
and Procedures

Regulations under the Exchange Act 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 Exchange Act is recorded, processed,
summarized, and reported, within the time periods specified in the SEC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 Exchange 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 Exchange Act require public companies, including our Company, to evaluate any change in our internal
control over financial reporting as such term is defined in Rule 13a-15(f) and Rule 15d-15(f) of the Exchange Act. In connection with their evaluation of our disclosure controls and procedures as of the end of the period covered by this
report, our Chief Executive Officer and Chief Financial Officer did not identify any change in our internal control over financial reporting during the fiscal quarter covered by this report 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 SEC on April 1, 2005, 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 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 from 2002 to 2004, 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s policies, lacked sufficient documentation, or 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s 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



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the submission and review of expense reimbursement requests. Our management has implemented these measures, and the Audit Committee will continue to monitor
the effectiveness of these remedial measures. In addition, our 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 resigned
from his position as Chairman of the Board of Directors, effective May 23, 2005, but 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, and 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 2002-2004 financial periods. 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 a 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 former 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 was 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 the material weaknesses as of December 31, 2004 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 material weaknesses did not have a material impact on our consolidated financial statements
included in the Annual Report on Form 10-K for the year ended December 31, 2006 due to the fact that we performed substantial analyses on the December 31, 2005 consolidated financial statements and prior period financial statement
balances, including historical account reconciliations, review of account balance analyses by senior management, and reconstruction of certain account balances. However, these material weaknesses 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.

Our management, with the oversight of the Audit Committee, has addressed these material weaknesses and has implemented controls to remediate these
internal control weaknesses. Our management believes that it corrected the material weakness relating to travel and entertainment expense reimbursement by the end of the first quarter of 2005. New processes and internal controls have been approved
and implemented and management concluded as of December 31, 2006 that these controls were operating effectively.

During the 2006
year-end close, we identified and reported a material weakness in our internal controls over financial reporting related to stock-based compensation. This material weakness related to our failure to complete a proper analysis of historical stock
option vesting data within our system, which resulted in a net overstatement of our stock-based compensation during the interim reporting periods for fiscal year 2006. Due to this material weakness, quarterly results of operations have been
restated, as provided in Note 14 of the a consolidated financial statements in the Companys Form 10-K for the year ended December 31, 2006, and prior period pro-forma informational disclosure of expenses in accordance with SFAS 123 have
also been restated as provided in Note 7 of the of the a consolidated financial statements in the Companys Form 10-K for the year ended December 31, 2006. As a result, we are unable to conclude that our disclosure controls and procedures
were effective as of March 31, 2007.

Our management, with the oversight of the Audit Committee, has begun to address this material
weakness and is committed to effective remediation as expeditiously as possible. Our management has implemented a procedure to review the stock option reports on a quarterly basis to assure that only current employee options that are expected to
vest are included in the employee stock-based compensation expense for such period. This material weakness 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 our management concludes that these controls are operating effectively.



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PART II: OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

On January 24, 2007,
RightNow Technologies, Inc. (RightNow) filed a suit in the Eighteenth Judicial District Court of Gallatin County, Montana against the Company and four former RightNow employees who had joined the Company. The suit alleges violation of
certain provisions of employment agreements, misappropriation of trade secrets, as well as other claims, and seeks damages. We believe we have meritorious defenses to these claims and intend to defend against this action vigorously.

On March 16, 2006, Polaris IP, LLC (Polaris) filed suit against the Company, Sirius Satellite Radio, Inc., 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 Nos. 6,411,947 and 6,278,996, and seeking injunctive relief, damages and attorneys fees. In
exchange for payment of a quarterly license fee through 2011, Polaris granted the Company a perpetual license to certain patents, including those at issue in the litigation, and the parties dismissed their claims against each other with prejudice on
April 26, 2007. The terms of the settlement included the release and dismissal of the Companys customers named in the lawsuit.

The underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros., Hambrecht & Quist LLC and Wit Soundview Capital Corp., the Company and certain current and former officers of the Company were named as
defendants in federal securities class action lawsuits filed in the U. S. 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 common 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 the Company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 the Companys insurers, we do not believe that the settlement will have any effect on our 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 against 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 results of operations, consolidated balance sheets and cash flows, due to
defense costs, diversion of management resources and other factors.



|ITEM 1A. | RISK FACTORS.
|-------- | -------------

Information regarding the
Companys risk factors appears in Part I. Financial Information  Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q and in Part
I.  Item 1A. Risk Factors on our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2006 other than the material changes set forth below:



| |  |  | We have added our entry into a definitive agreement with eVergance in May 2007 to the risk factor entitled If we acquire companies, products, or technologies,
we may face risks associated with those acquisitions. This amended risk factor is provided in Part I. Financial Information  Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations of this
Quarterly Report on Form 10-Q.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
|------- | ------------------------------------------------------------

Not
applicable.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES.
|------- | --------------------------------

Not applicable.



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

Not
applicable.



|ITEM 5. | OTHER INFORMATION.
|------- | ------------------

Not applicable.



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|ITEM 6. | EXHIBITS
|------- | --------



|               |  |                                                                                                                                                                                                                                  |  |                           |  |          |  |         |  |             |  |                  
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | ------- |  | ----------- |  | -----------------
|               |  |                                                                                                                                                                                                                                  |  | Incorporated by Reference |  |         
|Exhibit Number |  | Exhibit Description                                                                                                                                                                                                              |  | Form                      |  | File No. |  | Exhibit |  | Filing Date |  | Provided Herewith
|               |  |                                                                                                                                                                                                                                  |  |                           |  |         
|10.01          |  | Amended and Restated Loan and Security Agreement, dated February 27, 2007, between Kana Software, Inc. and Bridge Bank, N.A., as modified by Loan and Security Agreement, dated February 28, 2007
and as amended on May 7, 2007. |  |                           |  |          |  |         |  |             |  | X                
|               |  |                                                                                                                                                                                                                                  |  |                           |  |         
|10.02          |  | Patent License and Settlement Agreement, dated March 23, 2007, between Kana Software, Inc. and Polaris IP, LLC.±                                                                                                                 |  |                           |  |          |  |         |  |             |  | X                
|               |  |                                                                                                                                                                                                                                  |  |                           |  |         
|31.01          |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.                                                                        |  |                           |  |          |  |         |  |             |  | X                
|               |  |                                                                                                                                                                                                                                  |  |                           |  |         
|31.02          |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.                                                                        |  |                           |  |          |  |         |  |             |  | X                
|               |  |                                                                                                                                                                                                                                  |  |                           |  |         
|32.01          |  | Certification of Principal 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 Principal Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*                                                                             |  |                           |  |          |  |         |  |             |  | X                

---

|± | Confidential treatment has been requested with regard to portions of the exhibit. Such portions were filed separately with the Securities and Exchange Commission.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | These certifications accompany KANAs Quarterly Report on Form 10-Q; 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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

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

May 14, 2007



Kana Software, Inc./s/ Michael S. FieldsMichael S. Fields Chairman of the Board of
Directors and Chief Executive Officer (Principal Executive Officer)/s/ John M. ThompsonJohn M. Thompson Chief Financial Officer
(Principal Financial and Accounting Officer)




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Exhibit Index



|              |  |                                                                                                                                                                                                                                  |  |                           |  |          |  |         |  |             |  |                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | -------- |  | ------- |  | ----------- |  | -----------------
|              |  |                                                                                                                                                                                                                                  |  | Incorporated by Reference |  |         
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                              |  | Form                      |  | File No. |  | Exhibit |  | Filing Date |  | Provided Herewith
|              |  |                                                                                                                                                                                                                                  |  |                           |  |         
|10.01         |  | Amended and Restated Loan and Security Agreement, dated February 27, 2007, between Kana Software, Inc. and Bridge Bank, N.A., as modified by Loan and Security Agreement, dated February 28, 2007
and as amended on May 7, 2007. |  |                           |  |          |  |         |  |             |  | X                
|              |  |                                                                                                                                                                                                                                  |  |                           |  |         
|10.02         |  | Patent License and Settlement Agreement, dated March 23, 2007, between Kana Software, Inc. and Polaris IP, LLC.±                                                                                                                 |  |                           |  |          |  |         |  |             |  | X                
|              |  |                                                                                                                                                                                                                                  |  |                           |  |         
|31.01         |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.                                                                        |  |                           |  |          |  |         |  |             |  | X                
|              |  |                                                                                                                                                                                                                                  |  |                           |  |         
|31.02         |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.                                                                        |  |                           |  |          |  |         |  |             |  | X                
|              |  |                                                                                                                                                                                                                                  |  |                           |  |         
|32.01         |  | Certification of Principal 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 Principal Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*                                                                             |  |                           |  |          |  |         |  |             |  | X                

---

|± | Confidential treatment has been requested with regard to portions of the exhibit. Such portions were filed separately with the Securities and Exchange Commission.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | These certifications accompany KANAs Quarterly Report on Form 10-Q; 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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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