SWK Holdings Corp - Quarter Report: 2009 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended September 30, 2009

For the transition period from              to             

Commission File number 000-27163

Kana Software, Inc.

(Exact Name of Registrant as Specified in its Charter)

181 Constitution Drive

Menlo Park, California 94025

(Address of Principal Executive Offices)

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

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  YES     ¨  NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

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 October 30, 2009, 41,215,041 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

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Kana Software, Inc.

Form 10-Q

Quarter Ended September 30, 2009

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PART I. FINANCIAL INFORMATION

KANA SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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KANA SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Nature of Operations

Kana Software, Inc. (together with its subsidiaries, “the Company” or “KANA”) was incorporated in July 1996 in California and reincorporated in Delaware in September 1999. KANA develops, markets, sells and supports customer communications software products. The Company sells its products primarily in North America, Europe and Asia, through its direct sales force and third party integrators.

Proposed Sale of Substantially All of the Company’s Assets

As discussed below under Note 11, “Subsequent Events,” on October 26, 2009, the Company entered into a definitive Asset Purchase Agreement (the “Asset Purchase Agreement”) with Kay Technology Corp, Inc. (“Purchaser”), an affiliate of Accel-KKR Capital Partners III, L.P. (“Accel-KKR”). Pursuant to the terms of the Asset Purchase Agreement, the Company will sell substantially all of its assets to Purchaser and Purchaser will assume substantially all of the Company’s liabilities (the “Asset Sale”). If the Asset Sale is completed, the Company will be entitled to receive approximately $48.9 million in cash, subject to certain adjustments set forth in the Asset Purchase Agreement.

Liquidity/Basis of Presentation

The condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As of September 30, 2009, the Company had an accumulated deficit of $4.3 billion and has experienced recurring losses. Historically, the Company has financed its operations through a combination of debt financings, proceeds from common stock offerings, and sales of its products. The Company expects to finance future cash needs primarily through sales of its products and from proceeds from equity or debt financings; however, it cannot be assured that such financings will be available on acceptable terms, or at all. The Company continues to take steps to lower the expenses related to cost of revenues, sales and marketing, and general and administrative areas of the Company.

Since 1997 the Company has incurred substantial costs to develop its products and to recruit, train and compensate personnel for its engineering, sales, marketing, client services, and administration departments. As a result, the Company has incurred substantial losses since inception. On September 30, 2009, the Company had cash and cash equivalents of $1.8 million and borrowings outstanding under a line of credit of $3.6 million due in June 2010 and borrowings outstanding under notes payable of $985,000 due in varying monthly installments through June 30, 2010. As of September 30, 2009, the Company had negative working capital of $5.5 million, excluding $11.1 million of deferred revenue, and stockholders’ deficit of $2.2 million. Losses from operations were $1.5 and $5.2 million for the three and nine months ended September 30, 2009, respectively. Net cash used in operating activities was $1.9 million for the nine months ended September 30, 2009. Based on the Company’s current revenue expectations for 2009 and 2010, it is unlikely that cash and cash equivalents will be sufficient to meet the Company’s working capital and capital expenditure needs through September 30, 2010 without additional cash raised from debt or equity financing. If the Company does not meet its 2009 and 2010 revenue expectations, there may be doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not reflect any adjustments that might be required as a result of this uncertainty. The proposed Asset Sale discussed in Note 11 may also affect the liquidity and operating forecasts of the Company.

During the third quarter of 2009, the Company reduced headcount by 15 employees to reduce expenses. Additionally, during the second quarter of 2009 and the third quarter of 2008, the Company reduced headcount by 27 and 14 employees, respectively, to better align its cost structure with its revenues. The Company is continuing to find ways to lower costs without materially changing support for its customers. If the Company experiences lower than anticipated demand for its products, it will need to further reduce costs, issue equity securities or borrow money to meet its cash requirements. Any such equity issuances could be dilutive to the Company’s stockholders, and any equity or debt financings may be on unfavorable terms, if at all.

Subsequent Events

In Note 11 below, the Company’s management has evaluated and disclosed subsequent events from the balance sheet date of September 30, 2009 through November 13, 2009, the day before the date that these financial statements were filed with the Securities and Exchange Commission (the “SEC”) in this Quarterly Report on Form 10-Q.

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, 2009. 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

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under the rules and regulations of the 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, 2008, filed with the SEC on May 15, 2009. The year-end condensed consolidated balance sheet data was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”).

Use of Estimates

The preparation of the 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. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, stock-based compensation, provision for doubtful accounts, fair value of acquired intangible assets and goodwill, useful lives of property and equipment, income taxes, restructuring costs, and contingencies and litigation, among others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from those estimates under different assumptions or conditions.

Reclassification

Certain reclassifications have been made to the 2008 presentation to conform to the 2009 presentation, none of which had an effect on net loss, total assets, or total stockholders’ equity.

Fair Value of Financial Instruments

The carrying values of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their relatively short maturities or payment terms. Based on prevailing borrowing rates for lines of credit and notes payable with similar terms, the carrying value of the Company’s line of credit and note payable obligations approximate fair value as of September 30, 2009.

Stock-based Compensation

Employee stock-based compensation expense recognized in the condensed consolidated statements of operations for the three months ended September 30, 2009 and 2008 related to stock options was $420,000 and $561,000, respectively and was $1.2 million and $1.7 million for the nine months ended September 30, 2009 and 2008, respectively. The estimated fair value of the Company’s stock-based awards, less expected forfeitures, is amortized over the awards’ vesting period on a straight-line basis.

Net Loss per Share

Basic net loss per share is computed using the weighted average number of outstanding shares of common stock. Diluted net loss per share is computed using the weighted average number of outstanding shares of common stock and, when dilutive, shares of common stock issuable upon exercise of options and warrants deemed outstanding using the treasury stock method.

For each of the three and nine months ended September 30, 2009, outstanding stock options and warrants to purchase common stock in an aggregate of approximately 9,228,000 shares, and for each of the three and nine months ended September 30, 2008, outstanding stock options and warrants to purchase common stock in an aggregate of approximately 10,984,000 shares, have been excluded from the calculation of diluted net loss per share as all such securities were anti-dilutive.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued guidance for certain revenue arrangements that include software elements, to provide guidance for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality are excluded from existing software revenue recognition guidance. In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance. This guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We are currently evaluating the appropriate timing for the adoption of this guidance and its potential impact on the Company’s consolidated financial statements.

         In October 2009, the FASB issued guidance for multiple deliverable revenue arrangements, which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit. This guidance amends the criteria of revenue recognition for multiple-element arrangements, to establish a selling price hierarchy for determining the selling price of a deliverable, based on vendor specific objective evidence, acceptable third party evidence, or estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, the disclosures required for

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multiple-deliverable revenue arrangements are expanded. This guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We are currently evaluating the appropriate timing for the adoption of this guidance and its potential impact on the Company’s consolidated financial statements and disclosures.

In June 2009, the FASB issued The FASB Accounting Standards Codification (“Codification”). The Codification became the single source for all authoritative GAAP recognized by the FASB and has been applied to financial statements issued for the periods ended after September 15, 2009. The Codification does not change GAAP and will not have an effect on our financial position, results of operations or liquidity.

In May 2009, the FASB issued guidance on subsequent events which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance required the Company to disclose the date through which the Company has evaluated subsequent events and the basis for the date. This guidance was effective for interim periods which ended after June 15, 2009. See Note 1, “Kana Software, Inc. and Summary of Significant Accounting Policies – Subsequent Events,” for disclosure of the date to which subsequent events are disclosed and Note 11, “Subsequent Events,” for disclosure of subsequent events.

In April 2009, the FASB issued guidance about interim disclosures about fair value of financial instruments. The guidance requires an entity to provide disclosures about fair value of financial instruments in interim reporting periods. This guidance is applied prospectively and is effective for interim and annual periods ending after June 15, 2009. The new guidance did not have a material impact on the Company’s results of operations, financial position or cash flows.

In June 2008, the FASB issued guidance about determining whether an instrument or embedded feature is indexed to an entity’s own stock. This is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early application is not permitted. It also provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for accounting under derivative instruments and hedging activity rules. The adoption of this guidance in our first quarter of 2009 resulted in a decrease of $1.9 million to additional paid-in capital and a decrease to accumulated deficit of $1.8 million and an increase to accrued liabilities of $102,000 on the Company’s condensed consolidated balance sheet. There was no material impact on the Company’s results of operations or cash flows and net loss per share. See further analysis at Note 10.

In February 2008, the FASB issued guidance about deferring the effective date of fair value accounting for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The guidance did not have a material impact on the Company’s results of operations, financial position or cash flows.

In December 2007, the FASB issued guidance for business combinations which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The guidance also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The guidance is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008 and is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The Company adopted this guidance in the first quarter of 2009 and expects that it will have an impact on its accounting for future business combinations but the effect is dependent upon the acquisitions that are made in the future.

Note 2. Fair Value Measurement

The Company considers fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Valuation techniques used to measure fair value are either observable or unobservable. Observable inputs reflect assumptions that market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based on their own market assumptions. The Company utilizes the following three-level fair value hierarchy to establish the priorities of the inputs used to measure fair value:

Level 1 - instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets.

Level 2 - instrument valuations are obtained from sources other than quoted market prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 - instrument valuations are obtained without observable market values and require a high level of judgment to determine the fair value.

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The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2009 (in thousands):

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Note 3. 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 five years. The Company reported amortization expense on acquired intangible assets of $125,000 for each of the three months ended September 30, 2009 and 2008 and $375,000 for each of the nine months ended September 30, 2009 and 2008. The components of goodwill and other intangible assets are as follows (in thousands):

The estimated future amortization expense of purchased intangible assets as of September 30, 2009 is as follows (in thousands):

Note 4. Stockholders’ Equity (Deficit)

Stock Compensation Plans

The Company’s 1999 Stock Incentive Plan and the Broadbase Software, Inc. 1999 Equity Incentive Plan, which the Company assumed pursuant to an acquisition, both expired in July 2009. As a result, there are no options available for grant under the Company’s stock compensation plans. Any replacement stock compensation plans will require shareholder approval.

Options are granted at an exercise price equivalent to the closing fair market value on the date of grant. All options are granted at the discretion of the Company’s Board of Directors and have a term not greater than 10 years from the date of grant. Options are immediately exercisable when vested and generally vest monthly over four years.

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The following table summarizes activities under all of the Company’s stock compensation plans, including the 1999 Stock Incentive Plan and stock compensation plans assumed by the Company pursuant to the acquisition of certain companies, for the indicated periods:

At September 30, 2009, the Company had $1.6 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 1.8 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.

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The following table summarizes significant ranges of outstanding and exercisable options as of September 30, 2009:

Employee stock-based compensation is calculated using the Black-Scholes option pricing model for estimating the fair value of options granted under the Company’s equity incentive plans. 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 and nine months ended September 30, 2009 and 2008 were as follows:

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 expected 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 and nine months ended September 30, 2009 was $0.33 per share.

The forfeiture rate of employee stock options for 2009 was calculated using the Company’s historical terminations data.

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Note 5. Comprehensive Loss

Comprehensive loss is comprised of net loss and foreign currency translation adjustments. The total comprehensive losses during the three and nine month periods ended September 30, 2009 and 2008 were as follows (in thousands):

Note 6. Commitments and Contingencies

(a) Litigation

On October 16, 2009, the Company and RightNow Technologies, Inc. (“RightNow”) entered into an agreement to settle all legal disputes and release all claims between the two companies in connection with a lawsuit brought by RightNow in the Eighteenth Judicial District Court of Gallatin County, Montana on January 24, 2007 against KANA and four former employees of RightNow alleging violation of certain provisions of employment agreements, misappropriation of trade secrets, and other claims. Under the general release and settlement agreement, KANA agreed to pay RightNow $1.0 million (the “settlement amount”) with $100,000 due within ten days of executing the settlement agreement and the remainder due over nine consecutive quarters beginning with the quarter commencing January 1, 2010 or sooner upon a change in control. KANA also provided RightNow with a subordinated security interest in its assets as collateral for the amounts payable to RightNow. During the three months ended September 30, 2009, the Company recorded a $1.0 million settlement accrual in connection with the settlement.

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 of the Company’s current and former officers 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 “District Court”). 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 Company’s case, 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 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 had no merit, the Company decided to accept the settlement proposal to avoid the cost and distraction of continued litigation. The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the District Court. However, while the settlement was awaiting final approval by the District Court, in December 2006, the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied the plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a September 26, 2007 status conference, the District Court approved a stipulation withdrawing the proposed settlement. On August 14, 2007, the plaintiffs filed an amended complaint in the six focus cases to test the sufficiency of their class allegations. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases, which was withdrawn on October 10, 2008. On November 13, 2007, the defendants filed a motion to dismiss the complaint for failure to state a claim, which the District Court denied in March 2008. Plaintiffs, the issuer defendants (including the Company) and underwriter defendants and the insurance carriers for the defendants have engaged in mediation and settlement negotiations. The parties have reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009. On June 10, 2009, the District Court granted preliminary approval of the proposed settlement agreement. A hearing was held on September 10, 2009 to determine whether the proposed settlement should be granted final approval. On October 6, 2009, the district court granted final approval of the proposed settlement and directed the court clerk to close the consolidated action and all the individual actions that comprised the consolidated action, which includes the action against the Company. As part of this settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the settlement. Several objectors to the settlement have filed notices of appeal, and there can be no guarantee that the appeals will not succeed in whole or in part. The Company believes that it has meritorious defenses to these claims. If the litigation continues against the Company following the appeal, the Company would continue to defend against this action vigorously.

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In October 2007, a lawsuit was filed in the U.S. District Court for the Western District of Washington by Ms. Vanessa Simmonds against certain of the underwriters of the Company’s initial public offering. The plaintiff alleges that the underwriters violated Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeks disgorgement of profits from the underwriters in amounts to be proven at trial. On February 25, 2008, Ms. Simmonds filed an amended complaint. The suit names the Company as a nominal defendant, contains no claims against the Company, and seeks no relief from the Company. This lawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints. In addition, certain issuer defendants filed a joint motion to dismiss the complaints. The parties entered into a stipulation, entered as an order by the Court that the Company was not required to answer or otherwise respond to the amended complaint. Accordingly, the Company did not join in the motions to dismiss. This matter was dismissed with prejudice on March 12, 2009. On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order, and thereafter the underwriter defendants filed a cross appeal to a portion of the District Court’s order that dismissed thirty (30) of the cases without prejudice following the moving issuers’ motion to dismiss. On May 22, 2009, the Ninth Circuit issued an order granting the parties’ joint motion filed on May 22, 2009 to consolidate the 54 appeals and 30 cross-appeals, and on May 27, 2009, the Ninth Circuit issued an order stating that the cases were not selected for inclusion in the mediation program. Under the current schedule, the briefing on the appeal will be completed on November 17, 2009. No date has been set for a hearing in the Ninth Circuit.

On September 2, 2009, the Company agreed to pay $45,000 in attorneys’ fees and costs to a former stockholder of the Company, KVO Capital Management, LLC (“KVO”) in connection with a lawsuit filed by KVO in Delaware Chancery Court on June 22, 2009, that sought to enjoin and postpone the Company’s 2009 annual meeting of stockholders, which had been properly scheduled for July 15, 2009, and which the Company subsequently rescheduled to December 1, 2009, mooting KVO’s claims in the lawsuit. In exchange for the payment of attorneys’ fees and costs, KVO agreed to and an order was filed with the Delaware Chancery Court to dismiss the action with prejudice on October 7, 2009.

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 has in the past been forced to litigate such claims. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in the Company’s 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 our 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 consolidated results of operations, balance sheets and cash flows due to defense costs, and divert management resources.

b) Indemnification

Many of the Company’s software license agreements require the Company to indemnify its customers for any claim or finding of intellectual property infringement. KANA periodically receives notices from customers regarding patent license inquiries they have received which may or may not implicate these indemnity obligations. Any litigation, brought by others, or the Company could result in the expenditure of significant financial resources and the diversion of management’s time and efforts. In addition, litigation in which the Company is accused of infringement might cause product shipment delays, require KANA to develop alternative technology or require KANA 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 the Company and it could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, the Company’s business could be significantly harmed. In prior periods, the Company incurred minimal costs related to such claims under such indemnifications provisions; accordingly, the amount of such obligations cannot be reasonably estimated. There were no outstanding claims of infringement at September 30, 2009.

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 September 30, 2009.

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(c) Warranties

The Company generally provides a warranty for its software products and services to its customers. The Company’s products are generally warranted to perform substantially as described in the associated product documentation for a period of 90 days. The Company’s services are generally warranted to be performed consistent with industry standards for a period of 90 days from delivery. In the event there is a failure of such warranties, the Company generally is obligated to correct the product or service to conform to the warranty provision or, if the Company is unable to do so, the customer is entitled to seek a refund of the purchase price of the product or service. The Company has not provided for a warranty accrual as of September 30, 2009 or December 31, 2008 because, to date, the Company’s product warranty expense has not been significant. The Company assesses the need for a warranty reserve on a quarterly basis and there can be no guarantee that a warranty reserve will not become necessary in the future.

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Note 7. Restructuring Costs

The following table provides a summary of restructuring activity during the nine months ended September 30, 2009 and 2008 (in thousands):

In March 2008, the Company was notified by the subtenant of one of the facilities included in the restructuring accrual of the subtenant’s intent to lease additional space and extend its sublease through the end of the Company’s lease term. As a result of this agreement, the Company recorded a restructuring recovery of approximately $482,000. The agreement was executed in May 2008.

In July 2008, the Company implemented various cost reduction and restructuring activities to reduce operating costs. The expense related to this reduction in work force was approximately $737,000 and the expense related to ceasing use of two of the Company’s offices was approximately $64,000. Additionally, the Company expensed approximately $263,000 of capitalized costs related to an internal use software project that was abandoned.

In April 2009, the Company signed a Settlement and Release Agreement with RMJM Group, Inc. (“RMJM”), the sub landlord for one of the properties included in the restructuring accrual that provided for RMJM to draw down a letter of credit held by RMJM as collateral for the Company’s sublease from RMJM. The proceeds of the draw down and current cash deposit held by RMJM will be applied to all remaining lease payments and estimated additional operating costs for the remainder of the lease that expires in January 2010. The funds in excess of the remaining rent and estimated additional operating costs will be returned to the Company. The Company remains responsible for any additional charges over the estimate through the remaining lease term.

In April 2009, the Company implemented various cost reduction activities to reduce operating costs. The expense related to reduction in workforce was approximately $532,000 and the expense related to the Settlement and Release Agreement with RMJM was approximately $167,000. Additionally, in June 2009, the Company had another facility settlement for one of its European offices and the related expense was approximately $106,000. During the three months ended September 30, 2009, the Company recognized approximately $498,000 of expense related to a reduction in workforce and $38,000 of facilities related costs.

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.

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Geographic information on revenues for the three and nine months ended September 30, 2009 and 2008 is as follows (in thousands):

During the three months ended September 30, 2009 and 2008, one customer accounted for 13% and 12% of total revenue, respectively. During the nine months ended September 30, 2009 and 2008, no customer accounted for greater than 10% of total revenues. As of September 30, 2009, one customer receivable represented approximately 26% of our gross accounts receivable.

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):

Note 9. Line of Credit and Note Payable

(a) Line of Credit

On November 30, 2005, the Company established a 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 had access to a loan facility of $7.0 million. The Company entered into a Second Amended and Restated Loan and Security Agreement with Bridge on March 28, 2008, which has been amended and under which the Company currently has access to a loan facility of $6.0 million (“March Loan Facility”). The March Loan Facility is a formula-based revolving line of credit based on 80% of eligible receivables subject to a sublimit of $2.5 million that is available for stand-by letters of credit, foreign exchange contracts or cash management products. Existing equipment advances under the line of credit were converted into a 33 month term loan on March 26, 2008 in the amount of $1.6 million. An additional $500,000 borrowed under the additional equipment financing provision was converted into a 36 month term loan on September 30, 2008. The total combined borrowing under the March Loan Facility and sublimits cannot exceed $6.0 million. The March Loan Facility is collateralized by all of the Company’s assets and expires June 30, 2010, at which time the entire balance under the formula-based line of credit will be due. Interest for the formula-based revolving line of credit, the existing equipment advances and the additional equipment financing accrues at the Wall Street Journal’s (“WSJ”) Prime Lending Rate (with a floor rate set at 4%) plus 2.50%, and was 6.50% as of September 30, 2009. The March Loan Facility 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 March Loan Facility, Bridge has the right to declare an event of default and all of the outstanding balances owed under the March Loan Facility would become immediately due and payable.

On March 17, 2009, the Company entered into a Loan and Security Modification Agreement with Bridge that provided a one-time waiver for non-compliance with the financial covenants for the quarter ended December 31, 2008, and increased the interest rate to the WSJ Prime Lending Rate (with a floor rate of 4%) plus 2.50% until compliance with financial covenants can be shown.

On May 26, 2009, the Company entered into another Loan and Security Modification Agreement (“May Amendment”) with Bridge that provided a one-time waiver for non-compliance with the financial covenants for the quarter ended March 31, 2009 and the month ended April 30, 2009. The May Amendment set the total loan facility amount to $6.0 million and extended the maturity date to June 30, 2010. As a requirement of the May Amendment, availability under the existing revolving line of credit was used to prepay all amounts outstanding under the existing term loans for equipment. Additionally, modifications were made to the existing restrictive covenants and certain covenants were added related to raising additional capital. In addition, the Company’s existing credit facilities prohibit the payment of cash or stock dividends on its capital stock without the lender’s prior written consent.

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On July 30, 2009, the Company entered into a Loan and Security Modification Agreement to the March Loan Facility (“July Amendment”) that modified the March Loan Facility to provide for subordinated indebtedness of $1.0 million from Agility Capital, LLC (“Agility”).

As of September 30, 2009, the Company had $3.6 million outstanding under the March Loan Facility revolving credit line. The available balance of the March Loan Facility was lowered by the amount outstanding on the subordinated indebtedness from Agility and was also lowered by $116,000 which is used as collateral for a letter of credit related to a building lease, leaving an available balance of $1.3 million as of September 30, 2009. The Company was in compliance with all loan covenants as of September 30, 2009.

(b) Notes Payable

On July 30, 2009, the Company entered into a Loan Agreement (“Loan”) with Agility for $1.0 million. The Loan is repayable in equal monthly installments of $90,000 plus interest at 15% per year and is due on June 30, 2010 or upon a change of control of the Company, if that event occurs earlier. The Loan provides for a facility origination fee of $40,000 due on closing and a fee of $350,000 due on the maturity date or repayment date, whichever is earlier.

As of September 30, 2009, there was $985,000 classified as current portion of notes payable. The notes payable consist of three obligations: (1) a term loan for general working capital, which had an 11 month term, of which 9 months were remaining as of September 30, 2009, and an annual interest rate of 15%; and (2) a capital lease obligation for office furniture and equipment, which had a 5 year term, of which 9 months were remaining, and an annual interest rate of 8.58%; and (3) a short term financing for computer equipment, which has 3 monthly payments remaining, and an annual interest rate of 9%.

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Note 10. Warrants

Effective January 1, 2009 the Company adopted authoritative guidance issued by the FASB eliminating an exemption to derivative treatment for certain financial instruments. As a result of adopting this guidance, warrants to purchase 1,914,586 of the Company’s common stock previously treated as equity pursuant to the derivative treatment exemption were no longer afforded equity treatment. These warrants have exercise prices ranging from $1.97 to $2.45 and expire in September 2010 and October 2010. Effective January 1, 2009, the Company reclassified the fair value of these common stock purchase warrants, from equity to liability status, as if these warrants were treated as a derivative liability since their date of issue. On January 1, 2009, the Company reclassified the effects of prior accounting for the warrants in the amount of $1.8 million from additional paid-in capital to accumulated deficit, and $108,000 from additional paid-in capital to warrant liability. The fair value of these common stock purchase warrants is included with accrued liabilities on the condensed consolidated balance sheets. The fair value decreased to $67,000 as of September 30, 2009. Accordingly, the Company recognized a $37,000 gain from the change in fair value of these warrants for the three months ended September 30, 2009 and a $41,000 gain from the change in fair value for the nine months ended September 30, 2009. The fair value was calculated using the Black-Scholes option pricing model. The assumptions that were used to calculate fair value as of January 1, 2009, and September 30, 2009 were as follows:

Note 11. Subsequent Events

On October 7, 2009, the action brought by KVO in the Delaware Chancery Court seeking to enjoin and postpone the Company’s 2009 annual meeting of stockholders was dismissed with prejudice in exchange for the Company’s payment of $45,000 in attorneys’ fees and costs incurred by KVO in connection with the lawsuit, as described in more detail above under Note 6 “Commitments and Contingencies – (a) Litigation.”

On October 16, 2009, the Company and RightNow Technologies, Inc. (“RightNow”) entered into an agreement to settle all legal disputes and release all claims between the two companies in connection with a lawsuit brought by RightNow in the Eighteenth Judicial District Court of Gallatin County, Montana on January 24, 2007 against KANA and four former employees of RightNow alleging violation of certain provisions of employment agreements, misappropriation of trade secrets, and other claims. Under the general release and settlement agreement, KANA agreed to pay RightNow $1.0 million (the “settlement amount”) with $100,000 due within ten days of executing the settlement agreement and the remainder due over nine consecutive quarters beginning with the quarter commencing January 1, 2010 or sooner upon a change in control. KANA also provided RightNow with a subordinated security interest in its assets as collateral for the amounts payable to RightNow. During the three months ended September 30, 2009, the Company recorded a $1.0 million settlement accrual in connection with the settlement.

On October 26, 2009, the Company entered into an Asset Purchase Agreement with Purchaser. Pursuant to the terms and subject to the conditions set forth in the Asset Purchase Agreement, Purchaser, an affiliate of Accel-KKR, will buy substantially all of the Company’s assets and assume substantially all of the Company’s liabilities for a purchase price of approximately $48.9 million in cash, subject to adjustment based on closing net working capital, net indebtedness, transaction expenses and other adjustments set forth in the Asset Purchase Agreement. The transaction is subject to specified closing conditions, including stockholder approval of the Asset Sale and the Asset Purchase Agreement and the transactions contemplated thereby. If the proposed Asset Sale is completed, KANA’s current operating business, which includes software, services and licensing, will operate as a privately-held company under its current KANA brand. At that time, the OTC Bulletin Board-listed entity will be renamed and will continue to be publicly traded under a new trading symbol with the net cash proceeds from the transaction and more than $400 million of net operating loss (NOLs) carry-forwards. Under the Asset Purchase Agreement, if the Asset Sale is not consummated, KANA may be required to pay Purchaser a termination fee of approximately $1.8 million under circumstances specified in the Asset Purchase Agreement.

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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 and those related to the proposed sale of substantially all of our assets to Kay Technology Corp, Inc. 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 May 15, 2009, 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

We offer an innovative approach to customer service with cost-effective solutions that enhance the quality of multi-channel customer interactions. Built on open standards for a high degree of adaptability and integration, our solutions intelligently automate the processes needed to successfully serve our clients’ customers, so that our clients can deliver higher value service at lower cost, increasing customer retention and loyalty. We provide an integrated solution that enables organizations to deliver consistent, managed service across all channels, including e-mail, chat, call centers and Web self-service, ensuring a consistent service experience across communication channels.

Our revenues are primarily derived from the sale of our software and related maintenance and support of the software. We also derive revenues from consulting, training and other services. Our products are generally installed by our customers using either a systems integrator, such as IBM or Accenture, or our professional services group. Our 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. We also rely on IBM and other systems integrators to recommend and install our software. This provides leverage in the selling phase, and also allows us to realize higher gross margins by selling primarily software licenses and support, which typically have higher margins than consulting and implementation services. In the past, we supplied specialists (who were subject matter experts) to work with IBM and other systems integrators. While we continue this practice, we are increasingly providing consulting and implementation services directly to our customers especially following our acquisition of eVergance. These services may be provided to our existing customers who would like us to review their implementations or to new customers who are not quite large enough to gain the interest of a large systems 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 systems integrator; these services generally increase the cost of the project substantially and subject their purchase to more levels of required approvals and scrutiny of projected cost savings in their customer service and marketing departments. 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.

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 September 30, 2009, we had cash and cash equivalents of $1.8 million. As of September 30, 2009, we had negative working capital of $5.5 million, excluding $11.1 million of deferred revenue, and stockholders’ deficit of $2.2 million. We recorded losses from operations of $1.5 million and $5.2 million for the three and nine months ended September 30, 2009, respectively, and losses from operations of $753,000 and $756,000 for the three and nine months ended September 30, 2008, respectively. Net losses were $1.8 million and $5.6 million for the three and nine months ended September 30, 2009, respectively, and $887,000 and $1.1 million for the

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three and nine months ended September 30, 2008, respectively. Net cash used in operating activities was $1.9 million and $2.2 million for the nine months ended September 30, 2009 and 2008, respectively. As of September 30, 2009, we had 183 full-time employees, a decrease from 229 employees at December 31, 2008 and a decrease from 220 employees at September 30, 2008.

Recent Developments

On October 26, 2009, we entered into a definitive Asset Purchase Agreement with Kay Technology Corp. Inc., or Purchaser, an affiliate of Accel-KKR Capital Partners III, L.P., or Accel-KKR. Pursuant to the terms and subject to the conditions set forth in the Asset Purchase Agreement, Purchaser will buy substantially all of our assets and assume substantially all of our liabilities for a purchase price of approximately $48.9 million in cash, subject to adjustment based on closing net working capital, net indebtedness, transaction expenses and other adjustments set forth in the Asset Purchase Agreement. The transaction is subject to specified closing conditions, including stockholder approval of the Asset Sale and the Asset Purchase Agreement and the transactions contemplated thereby. If the proposed Asset Sale is completed, our current operating business, which includes software, services and licensing, will operate as a privately-held company under our current KANA brand. At that time, the OTC Bulletin Board-listed entity will be renamed and will continue to be publicly traded under a new trading symbol with the net cash proceeds from the transaction and more than $400 million of net operating loss (NOLs) carry-forwards. Under the Asset Purchase Agreement, if the Asset Sale is not consummated, we may be required to pay Purchaser a termination fee of approximately $1.8 million under circumstances specified in the Asset Purchase Agreement.

For additional information regarding potential risks and uncertainties associated with the proposed Asset Sale, please see “Risks Related to the Proposed Asset Sale” below.

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. 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 that our most critical accounting policies are those that require management to make difficult, subjective and complex judgments, and are most important to the portrayal of our financial condition and results of operations. We believe the following critical accounting policies are used in the preparation of our condensed consolidated financial statements:

The critical accounting estimates associated with these policies are described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on May 15, 2009. We believe there have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2009 compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2008.

Recent Accounting Pronouncements

Information with respect to Recent Accounting Pronouncements may be found in Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements in “Part I. Financial Information — Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

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Results of Operations

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

Revenues

Total revenues decreased by 23% to $12.8 million for the three months ended September 30, 2009 from $16.7 million for the three months ended September 30, 2008, as a result of lower license and services revenues in the third quarter of 2009 compared to the same period in 2008. Total revenues decreased by 31% to $35.6 million for the nine months ended September 30, 2009 from $51.6 million for the nine months ended September 30, 2008, as a result of lower license and services revenues in 2009 compared to the same period in 2008.

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. License revenues decreased by 56% to $2.4 million for the three months ended September 30, 2009 from $5.3 million for the same period in the prior year. The decrease in license revenues was primarily due to closing no large revenue transactions that exceeded $1.0 million in revenue during the three months ended September 30, 2009 while there were two large transactions included in license revenues for the three months ended September 30, 2008. License revenues decreased by 66% to $5.1 million for the nine months ended September 30, 2009 from $15.0 million for the same period in the prior year due to closing no large transactions that exceeded $1.0 million in revenue during the nine months ended September 30, 2009 while there were five large transactions included in license revenues for the nine months ended September 30, 2008. While we are focused on increasing license revenues, we are unable to predict such revenues 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. The length of our sales cycle has increased in recent periods due to uncertain economic conditions.

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Our services revenues consist of support revenues and professional services fees. Support revenues relate to providing customer support, product maintenance and updates to our customers. Support revenues are the largest component of services revenues. Professional services revenues relate to providing consulting, training and implementation services to our customers including enterprise on-demand. Services revenues decreased 8% to $10.4 million for the three months ended September 30, 2009, compared to $11.3 million for the same period in 2008. Services revenues decreased 17% to $30.5 million for the nine months ended September 30, 2009, compared to $36.6 million for the same period in 2008. The decrease primarily resulted from lower consulting services as there were revenues from two large projects in the three months ended September 30, 2008 that did not recur in 2009. There was also a decrease in support revenues due to the sale of certain KANA products during 2008 and the effect of foreign exchange rates on foreign currency denominated deferred revenue. Additionally, certain support contracts did not renew during the quarter. Customers who purchase licenses frequently purchase support, consulting and training services, which usually occur subsequent to the license sales. Given the decrease in new license sales, revenues from these associated services also decreased.

Revenues from domestic sales were $10.2 million and $12.5 million for the three months ended September 30, 2009 and 2008, respectively, and $27.5 million and $39.1 million for the nine months ended September 30, 2009 and 2008, respectively. Revenues from international sales were $2.6 million and $4.1 million for the three months ended September 30, 2009 and 2008, respectively, and $8.1 million and $12.5 million for the nine months ended September 30, 2009 and 2008, respectively. Our international revenues were derived from sales in Europe and Asia Pacific.

Costs and Expenses

Total cost of revenues decreased by 10% to $4.6 million for the three months ended September 30, 2009 from $5.0 million for the same period in 2008. Total cost of revenues decreased by 20% to $13.3 million for the nine months ended September 30, 2009 from $16.6 million for the same period in 2008.

License Fees. Cost of license fees consists of third party software royalties, referral fees, and costs of documentation. Cost of license fees as a percentage of license revenues was 31% for the three months ended September 30, 2009, compared to 4% for the same period in the prior year. Cost of license fees as a percentage of license revenues was 22% for the nine months ended September 30, 2009, compared to 5% for the same period in the prior year. The absolute dollar amount and the cost of license fees as a percentage of license revenue increased significantly, due to third party royalties associated with a new product, fees associated with an enterprise license, and a one-time expense of third party royalties for both the three months and nine months ended September 30, 2009. We expect that our cost of license fees as a percentage of revenues from license sales will vary based on changes in the mix of products we sell and the timing of upgrades and that cost of license fees will generally range from approximately 25% to 35% of license revenue. The projected range is higher than our historical ranges due the fact that we have new royalty agreements for our new product.

Services. Cost of services consists primarily of compensation and related expenses for our customer support, consulting and training and enterprise on-demand services organizations, and allocation of facility costs and system costs incurred in providing customer support. Cost of services decreased to 35% of services revenue, or $3.7 million, for the three months ended September 30, 2009 compared to 41% of services revenue, or $4.7 million, for the same period in 2008. Cost of services decreased to 39% of services revenue, or $11.8 million, for the nine months ended September 30, 2009 compared to 42% of services revenue, or $15.4 million, for the same period in 2008. Both the absolute dollar amount and percentage of services revenue of cost of services decreased in the three months and nine months ended September 30, 2009 compared to the same period in 2008, primarily due to the use of fewer outside consultants. As of September 30, 2009 and 2008, we had 61 and 66 employees, respectively, in the support, consulting, training and enterprise on-demand organizations. During the first quarter of 2009, there was an increase in headcount due to the transfer of seven employees from the sales organization who are now primarily performing consulting work on an hourly billable basis or performing customer support functions, which was offset by other headcount reductions.

Cost of services may increase or decrease depending on the demand for these services and the revenue mix of such 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 recorded in the three and nine months ended September 30, 2009 and 2008 related to $2.5 million of identifiable intangibles purchased in connection with the eVergance acquisition in June 2007. Acquired intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the assets (five years).

         Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related costs for sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials. Sales and marketing expenses decreased by 60% to $2.1 million for the three months ended September 30, 2009, from $5.3 million for the same period in 2008. Sales and marketing expenses decreased by 55% to $7.4 million for the nine months ended September 30, 2009, from $16.6 million for the same period in 2008. This was primarily due to lower compensation costs as a result of decreased headcount, lower commissions as a result of lower revenues and a reduction in our marketing programs. As of September 30, 2009, we had 26 employees in sales and marketing compared to 60 employees as of September 30, 2008, a decrease of 57%. The decrease was partially due to the transfer of seven employees to the consulting services organization as discussed above.

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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 decreased by 12% to $3.0 million for the three months ended September 30, 2009, from $3.4 million during the three months ended September 30, 2008. Research and development expenses decreased by 1% to $10.1 million for the nine months ended September 30, 2009 from $10.2 million for the same period in 2008. The decrease for the three months ended September 30, 2009 compared to the same period in the prior year was attributable primarily to a reduction in the use of outside consultants as our new product was released on June 30, 2009 and was partially offset by an increase in the number of employees. As of September 30, 2009, we had 67 employees in research and development compared to 59 employees as of September 30, 2008, an increase of 14%.

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 decreased by 11% to $2.3 million for the three months ended September 30, 2009 from $2.6 million for the three months ended September 30, 2008. General and administrative expenses decreased by 17% to $7.0 million for the nine months ended September 30, 2009 from $8.4 million for the nine months ended September 30, 2008. The decrease in expenses was primarily due to lower compensation and related costs as a result of a decrease in head count and lower bonuses offset by an increase in outside accounting fees and legal costs. As of September 30, 2009, we had 29 employees in general and administrative and information technology combined compared to 35 employees as of September 30, 2008, a 17% decrease.

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 Expense. During the three months ended September 30, 2009 we recorded $536,000 of restructuring expense related to a reduction in workforce. During the three months ended September 30, 2008, we recorded $1.1 million of restructuring expense related to a reduction of workforce, the ceased use of two of our offices and the expense related to capitalized costs of an internal use software project that was abandoned. During the nine months ended September 30, 2009, we recorded $1.3 million of restructuring expense related to a reduction of workforce and adjustment of facility costs for facilities previously included in the restructuring accrual. During the nine months ended September 30, 2008, we recorded $582,000 of restructuring expense, which included $737,000 related to a reduction in workforce, $263,000 of capitalized costs related to an internal use software project that was abandoned and $64,000 related to ceasing use of two facilities, partially offset by a restructuring recovery of $482,000 as a result of the extension of a lease on one of our properties.

Transaction Costs. During the three months ended September 30, 2009 we recorded $745,000 of transaction costs related to the proposed Asset Sale to Purchaser.

Legal Settlement. During the three months ended September 30, 2009 we recorded a $1.0 million settlement accrual related to the settlement of the RightNow lawsuit.

Interest and Other Income (Expense), Net

Interest and other income (expense), net consists primarily of interest income, interest expense and the change in fair value of warrant liability. Interest income and other income consists primarily of interest earned on cash and cash equivalents and was approximately $1,000 and $4,000 for the three months ended September 30, 2009 and 2008, respectively, and $6,000 and $20,000 for

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the nine months ended September 30, 2009 and 2008, respectively. The decrease in interest income related to lower interest rates and lower cash and cash equivalents balances in the three months ended September 30, 2009 compared to the same period in 2008. Interest expense and other expense relates primarily to interest expense on our line of credit and notes payable and was approximately $211,000 and $95,000 for the three months ended September 30, 2009 and 2008, respectively, and $353,000 and $278,000 for the nine months ended September 30, 2009 and 2008, respectively. The three and nine months ended September 30, 2009 include a $37,000 and $41,000 decrease in the fair value of the warrant liability, respectively. Interest expense varies from period-to-period based on the timing of borrowings and repayments.

Provision for Income Taxes

We have a history of net losses on a consolidated basis from inception through September 30, 2009. 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 and nine months ended September 30, 2009 and 2008, 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 $31,000 and $43,000 for the three months ended September 30, 2009 and 2008, respectively, and approximately $57,000 and $89,000 for the nine months ended September 30, 2009 and 2008, respectively, in those foreign jurisdictions.

Liquidity and Capital Resources

As of September 30, 2009, we had $1.8 million in cash and cash equivalents, compared to $7.0 million in cash and cash equivalents at December 31, 2008. As of September 30, 2009, we had negative working capital of $5.5 million, compared to negative working capital of $895,000 as of December 31, 2008. As of September 30, 2009, our current liabilities included $11.1 million of deferred revenue (primarily reflecting payments received for future maintenance services to be provided to our customers) which is not included in our working capital. The timing of accounts receivable collections can significantly impact our cash balance from quarter to quarter.

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. 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

Our operating activities used $1.9 million of cash for the first nine months of 2009, which included a $5.6 million net loss, a $1.6 million decrease in deferred revenue and net payments of $946,000 against accrued restructuring partially offset by a $1.5 million increase in accounts payable and accrued liabilities, a $1.1 million decrease in accounts receivable and non-cash charges of $1.2 million for stock-based compensation expense and $951,000 of depreciation expense.

Our operating activities used $2.2 million of cash for the first nine months of 2008, which included a $1.1 million net loss, a $2.4 million increase in accounts receivable, a $2.7 million decrease in deferred revenue, net payments of $919,000 against accrued restructuring, partially offset by non-cash charges of $1.7 million for stock-based compensation expense and $927,000 of depreciation expense.

Investing Cash Flow

Our investing activities provided $107,000 of cash during the first nine months of 2009 primarily due to a decrease in restricted cash of $446,000 partially offset by purchases of property and equipment of $339,000. Our investing activities used $1.1 million of cash during the first nine months of 2008 primarily due to purchases of property and equipment.

Financing Cash Flow

Our financing activities used $3.3 million of cash for the nine months ended September 30, 2009, which consisted of $2.4 million of net repayments on the line of credit and the repayment of $2.0 million on notes payable partially offset by new borrowings of $1.2 million. Our financing activities generated $723,000 of cash for the nine months ended September 30, 2008, which consisted of $2.9 million of net borrowings under the line of credit partially offset by the repayment of $2.2 million on notes payable.

Existence and Timing of Contractual Obligations

On November 30, 2005, we established a banking relationship with Bridge Bank N.A. (“Bridge”) and entered into a Business Financing Agreement and Intellectual Property Security Agreement with Bridge under which we had access to a loan facility of $7.0 million. On March 28, 2008, we entered into a Second Amended and Restated Loan and Security Agreement with Bridge, which has

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been amended and under which we currently have access to a loan facility of $6.0 million (“March Loan Facility”). The March Loan Facility is a formula based revolving line of credit that is limited to 80% of eligible receivables subject to a sublimit of $2.5 million that is available for stand-by letters of credit, foreign exchange contracts or cash management products. Existing equipment advances under our line of credit were converted into a 33 month term loan on March 26, 2008 in the amount of $1.6 million. An additional $500,000 borrowed under the additional equipment financing provision was converted into a 36 month term loan on September 30, 2008. The total combined borrowing under the March Loan Facility and sublimits cannot exceed $6.0 million. The March Loan Facility is collateralized by all of our assets and expires June 30, 2010 at which time the entire balance under the formula-based revolving line of credit will be due. Interest for the formula-based revolving line of credit, the existing equipment advances and the additional equipment financing accrues at the Wall Street Journal’s (“WSJ”) Prime Lending Rate (with a floor rate set at 4%) plus 2.50%, and was 6.50% as of September 30, 2009. The March Loan Facility 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 March Loan Facility, Bridge has the right to declare an event of default and all of the outstanding balances owed under the March Loan Facility would become immediately due and payable.

On March 17, 2009, we entered into a Loan and Security Modification Agreement with Bridge that provided a one-time waiver for non-compliance with certain financial covenants for the quarter ended December 31, 2008, and increased the interest rate to the WSJ Prime Lending Rate (with a floor of 4%) plus 2.5% until compliance with financial covenants can be shown.

On May 26, 2009, we entered into another Loan and Security Modification Agreement (“May Amendment”) with Bridge that provided a one-time waiver for non-compliance with certain financial covenants for the quarter ended March 31, 2009 and the month ended April 30, 2009. The May Amendment also set the total loan facility amount to $6.0 million and extended the maturity date to June 30, 2010. As a requirement of the May Amendment, availability under the existing revolving line of credit was used to prepay all amounts outstanding under the existing term loans for equipment. Additionally, modifications were made to the existing restrictive covenants and certain covenants were added related to raising additional capital.

On July 30, 2009, we entered into a Loan and Security Modification Agreement to the March Loan Facility (“July Amendment”) that modified the March Loan Facility to provide for subordinated indebtedness of $1.0 million from Agility Capital, LLC (“Agility”).

As of September 30, 2009, we had $3.6 million outstanding under the March Loan Facility revolving credit line. The available balance of the March Loan Facility was lowered by the amount outstanding on the subordinated indebtedness from Agility and was also lowered by $116,000 which is used as collateral for a letter of credit related to a building lease, leaving an available balance of $1.3 million as of September 30, 2009.

Our future payments due under debt and lease obligations and other contractual commitments as of September 30, 2009 are as follows (in thousands):

Off-Balance-Sheet Arrangements

As of September 30, 2009, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

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Outlook

We believe that based on our current revenue expectations for 2009 and 2010, it is unlikely that our cash and cash equivalents, including the $1 million loan closed on July 30, 2009, will be sufficient to meet our working capital and capital expenditure needs through September 30, 2010 without additional cash raised through debt or equity financing. In addition, if we do not experience anticipated demand for our products, we may need to further reduce costs, in addition to securing additional financing to meet our cash requirements. We can give no assurances as to whether we will be able to implement cost reduction initiatives, increase revenues, or obtain debt or equity financing, in order to provide sufficient liquidity for us to continue as a going concern.

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 anticipated increases in our revenues, improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control.

In addition, the proposed Asset Sale could impact our financing needs.

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 the Proposed Asset Sale

If we fail to complete the Asset Sale, our business may be harmed.

We cannot assure you that the Asset Sale will be completed. The completion of the Asset Sale is subject to the satisfaction of a number of conditions, including, among others, the requirement that we obtain stockholder approval of the Asset Sale and the Asset Purchase Agreement and the requirement that we obtain certain required consents, including customer consents representing 93% of the aggregate maintenance revenue represented by all customer contracts requiring consent. In addition, Purchaser may terminate the Asset Purchase Agreement if we do not cure breaches, if any, of a material provision of the Asset Purchase Agreement within 30 days of notice of such breach. We cannot guarantee that we will be able to meet all of the closing conditions of the Asset Purchase Agreement. If we are unable to meet all of the closing conditions, Purchaser is not obligated to purchase our assets. We also cannot be sure that other circumstances, for example, a material adverse effect, will not arise that would allow Purchaser to terminate the Asset Purchase Agreement prior to closing. If the Asset Sale is not approved or does not close, our Board of Directors will be forced to evaluate other alternatives, which may be less favorable to us than the proposed Asset Sale. In order to continue as a going concern in this event, KANA would need to seek financing immediately, and such financing may not be available to it, or may be available on terms that are unfavorable, and are dilutive to existing stockholders. In addition, in 2010, KANA will be required to repay approximately $5,400,000 of outstanding indebtedness, and KANA does not anticipate that it will be able to repay such indebtedness unless it is able to secure new financing.

Under the Asset Purchase Agreement, KANA will be required to pay a termination fee of $1,834,050 plus Purchaser’s out-of-pocket fees and expenses to the extent not previously reimbursed if, among other things, the Asset Purchase Agreement is terminated by Purchaser because the Asset Sale and the Asset Purchase Agreement are not approved and adopted by our stockholders, and prior to the Annual and Special Meeting or such termination, an acquisition proposal was made and not publicly withdrawn and within twelve months following such termination, KANA consummates an alternative acquisition (at any valuation) or enters into a definitive agreement for an alternative acquisition (and an alternative acquisition is subsequently consummated). In addition, we have agreed to reimburse Purchaser for all of its out-of-pocket fees and expenses in the event that, among other things, the Asset Purchase Agreement is terminated due to the failure to obtain stockholder approval of the Asset Sale.

As a result of our announcement of the Asset Sale, third parties may be unwilling to enter into material agreements with us. New or existing customers and business partners may prefer to enter into agreements with our competitors who have not expressed an intention to sell their business because customers and business partners may perceive that such new relationships are likely to be more stable. Our employees may become concerned about the future of the business and lose focus or seek other employment. If we fail to complete the Asset Sale, the failure to maintain existing business relationships or enter into new ones could adversely affect our business, results of operations and financial condition.

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In addition, if the Asset Sale is not consummated, our directors, executive officers and other employees will have expended extensive time and effort and will have experienced significant distractions from their work during the pendency of the transaction and we will have incurred significant transaction costs, in each case, without any commensurate benefit, which may have a material and adverse effect on our stock price and results of operations.

You are not guaranteed any of the proceeds from the Asset Sale.

The purchase price for the Asset Sale will be paid directly to KANA and KANA could spend or invest the net proceeds from the Asset Sale in ways with which our stockholders may not agree. The investment of these proceeds may not yield a favorable return and may not benefit from KANA’s net operating losses.

We will be a very small public company with a large cash balance.

Once the Asset Sale is completed, we will remain a publicly traded company and will continue to be subject to SEC rules and regulations, including the Sarbanes-Oxley Act of 2002. As a result, we will continue to incur additional ongoing operating expenses and we cannot assure how much of the cash proceeds, if any, will ultimately be distributed to stockholders.

Our ability to execute our strategy following the Asset Sale depends on our ability to recruit and retain qualified management and/or advisors.

We do not anticipate that we will retain any of our current management employees following the closing of the Asset Sale, and our ability to execute our strategy following the closing of the asset purchase requires that we recruit personnel with experience in identifying attractive acquisition candidates and executing acquisition transactions.

We may make acquisitions that may not prove successful.

We may not be able to identify suitable acquisition candidates at prices we consider appropriate. If we do identify an appropriate acquisition candidate, we may not be able to successfully and satisfactorily negotiate the terms of the acquisition. The integration of acquisitions involves a number of risks and presents financial, managerial and operational challenges.

We may not be able to consummate a business combination within the required time frame, in which case we, may be required to dissolve and liquidate our assets.

If we are unable to complete a business combination within the six months following the closing of the Asset Sale, our stockholders could vote to dissolve and liquidate our assets. If our stockholders vote to liquidate, we cannot provide any assurance as to the per share liquidation distribution because of our general and administrative expenses, the anticipated costs associated with seeking a business combination and any claims of our creditors. According, if we liquidate or dissolve, you may receive less than the current trading price of our common stock.

A significant portion of our working capital could be expended in pursuing business combinations that are not consummated.

It is anticipated that the investigation of each specific acquisition target and the negotiation, drafting and execution of relevant agreements, disclosure documents, and other instruments will require substantial time and attention and substantial costs for accountants, attorneys and others. In addition, we may opt to make down payments or pay exclusivity or similar fees in connection with structuring and negotiating a business combination. If a decision is made not to complete a specific business combination, the costs incurred up to that point in connection with the abandoned transaction, potentially including down payments or exclusivity or similar fees, will not be recoverable. Furthermore, even if an agreement is reached relating to a specific acquisition target, we may fail to consummate the transaction for any number of reasons including those beyond our control. Any such event will result in a loss to us of the related costs incurred, which could materially and adversely affect our subsequent attempts to locate and combine with another business.

We may be unable to obtain additional financing, if required, to complete a business combination or to fund the operations and growth of an acquisition target.

In connection with the capital requirements that will be required for any particular business combination, if the proceeds from the Asset Sale prove to be insufficient for a proposed acquisition, we may be required to seek additional financing through the issuance of equity or debt securities or other financing arrangements. We cannot assure you that such financing will be available on acceptable terms, if at all. To the extent that additional financing proves to be unavailable when needed to consummate a particular business combination, we may be compelled to restructure or abandon that particular business combination and seek alternative acquisition targets. In addition, if we complete a business combination, we may require additional financing to fund the operations or growth of acquisition target. The failure to secure additional financing could have a material adverse effect on the continued development or growth of our combined business or businesses.

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Risks Related to Our Business and Industry

Current uncertainty in global economic conditions makes it particularly difficult to predict demand and other related matters and makes it more likely that our actual results could differ materially from expectations.

Our operations and performance depend on worldwide economic conditions, which have deteriorated significantly in the United States and other countries, and may remain depressed for the foreseeable future. These conditions make it difficult for our customers and potential customers to accurately forecast and plan future business activities, and could cause our customers and potential customers to slow or reduce spending on our products and services. Furthermore, during challenging economic times, our customers may face issues gaining timely access to sufficient credit, which could impact their willingness to make purchases or their ability to make timely payments to us. If that were to occur, we may experience decreased sales, be required to increase our allowance for doubtful accounts and our days sales outstanding could be negatively impacted. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery, worldwide, in the United States, or in our industry. These and other economic factors could have a material adverse effect on demand for our products and services, on our ability to predict future operating results, and on our financial condition and operating results.

In periods of worsening economic conditions, our exposure to credit risk and payment delinquencies on our accounts receivable significantly increases.

A substantial majority of our outstanding accounts receivables are not covered by collateral. In addition, our standard terms and conditions permit payment within a specified number of days following the receipt of our product. While we have procedures to monitor and limit exposure to credit risk on our receivables, there can be no assurance such procedures will effectively limit our credit risk and avoid losses. As economic conditions deteriorate, certain of our customers have faced and may face liquidity concerns and have delayed and may delay or may be unable to satisfy their payment obligations, which would have a material adverse effect on our financial condition and operating results.

We have a history of losses and may not be able to generate sufficient revenues 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 September 30, 2009, our accumulated deficit was approximately $4.3 billion, which includes approximately $2.7 billion related to goodwill impairment charges. Our stockholders’ deficit at September 30, 2009 was $2.2 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 revenues 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 revenues have been affected by the current downturn in economic conditions, 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.

Our ability to continue as a going concern is at risk.

Our independent registered public accounting firm has issued an opinion on our December 31, 2008 consolidated financial statements that states that the consolidated financial statements were prepared assuming we will continue as a going concern and further states that our recurring losses from operations, negative working capital, negative cash flow from operations and accumulated deficit raise substantial doubt about our ability to continue as a going concern. The global economic downturn created a substantially more difficult business environment in 2008 and thus far in 2009, affecting our liquidity and operating performance. If our revenues do not improve and we are unable to reduce operating expenses sufficiently and we do not obtain additional financing, we may become unable to pay our operating expenses on a timely basis due to a lack of sufficient liquidity. We can give no assurances as to whether we will be able to implement cost reduction initiatives, increase revenues, or obtain debt or equity financing, in order to provide sufficient liquidity for us to continue as a going concern.

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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 revenues in any quarter, particularly as we have focused on larger enterprise customers, on licensing our more comprehensive integrated products, and have involved systems 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 the decline in general economic, industry and market conditions.

This dependence on large orders makes our revenues 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 integrators for sales.

The long sales cycle for our products may cause license revenues 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 9 months. Our sales cycle typically requires pre-purchase evaluation by a significant number of individuals within our customers’ organizations. Along with third parties that often jointly market our software with us, we invest significant amount of time and resources educating and providing information to prospective customers regarding the use and benefits of our products. Many of our customers evaluate our software slowly and deliberately, depending on the specific technical capabilities of the customer, the size of the deployment, the complexity of the customer’s network environment, and the quantity of hardware and the degree of hardware configuration necessary to deploy our products.

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.

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.

If we fail to generate sufficient revenues to support our business, we may need to seek additional financing to fund our operations or growth. 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. Moreover, because of current volatility in the global capital markets and among financial institutions, including a tightening in the capital and credit markets, if we were to seek funding from the capital or credit markets, we may not be able to secure funding on terms acceptable to us or at all. 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. 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

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cash equivalents of $1.8 million at September 30, 2009, and as of such date, had contractual commitments of $10.1 million due during the next twelve months. 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.

Our cash and cash equivalents could be adversely affected if the financial institutions in which we hold our cash and cash equivalents fail.

Our cash and cash equivalents are highly liquid investments with original maturities of three months or less at the time of purchase. We maintain the cash and cash equivalents with reputable major financial institutions. Deposits with these banks exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits or similar limits in foreign jurisdictions. While we monitor daily the cash balances in the operating accounts and adjust the balances as appropriate, these balances could be impacted if one or more of the financial institutions with which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurance that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial and credit markets.

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, 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 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 of the benefits of purchasing substantial new software packages that provide 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.