In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. The forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions. Words such as "anticipate," "believe," "estimate," "expects," "intend," "plan," "will" and variations of these words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described in "Risk Factors" and elsewhere in this report. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or false.

The following discussion should be read in conjunction with our Annual Report on Form 10-K filed on March 17, 2008, 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. In June 2007 we acquired eVergance which expanded our professional services group's capabilities and resources. 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 by subjecting 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 June 30, 2008, we had cash and cash equivalents of $3.2 million. As of June 30, 2008, we had an accumulated deficit of $4.3 billion and a negative working capital of $10.9 million, of which $15.6 million relates to deferred revenue. We recorded a loss from operations of $53,000 and $3,000 for the three and six month periods ended June 30, 2008, and a loss from operations of $3.4 million loss and $7.1 million for the three and six month periods ended June 30, 2007, respectively. Net losses were $137,000 and $216,000 for the three and six months ended June 30, 2008, respectively and $3.5 million and $7.3 million for the three and six months ended June 30, 2007, respectively. Net cash used in operating activities was $951,000 and $4.9 million the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, we had 234 full-time employees, which represents an increase from 225 employees at December 31, 2007 and a decrease from 244 employees at June 30, 2007.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates 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 filed with the Securities and Exchange Commission on March 17, 2008. We believe there have been no material changes to our critical accounting policies and estimates during the six months ended June 30, 2008 compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007.

Recent Accounting Pronouncements

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

Results of Operations

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



                                                  Three Months Ended              Six Months Ended
                                                       June 30,                       June 30,
                                                 2008            2007           2008           2007
                                                     (unaudited)                    (unaudited)
Revenues:
License fees                                         24 %            26 %           28 %           27 %
Services                                             76              74             72             73

Total revenues                                      100             100            100            100

Costs and expenses:                                                                                -
Cost of license fees                                  *               2              2              2
Cost of services                                     32              27             31             25
Amortization of acquired intangible assets            *               *              *              *
Sales and marketing                                  30              50             32             49
Research and development                             21              23             19             25
General and administrative                           16              23             17             25
Restructuring recovery                               -               -              (1 )           -

Total costs and expenses                            100             125            100            127

Loss from operations                                  *             (25 )            *            (27 )
Interest and other income (expense), net              *               *              *              *

Loss before income tax expense                        *             (26 )            *            (27 )
Income tax expense                                    *               *              *              *

Net loss                                              * %           (26 )%           * %          (28 )%

* Less than 1%

Revenues

Total revenues increased by 24% to $16.7 million for the three months ended June 30, 2008 from $13.4 million for the three months ended June 30, 2007, as a result of higher license and services revenues in 2008 than in 2007. Total revenues increased by 32% to $34.9 million for the six months ended June 30, 2008 from $26.4 million for the six months ended June 30, 2007, as a result of higher license and services revenues in 2008 than in 2007 based on increased demand for our products.

License revenues include licensing fees only, and exclude associated support and consulting revenue. The majority of our licenses to customers are perpetual and associated revenues are recognized upon delivery provided that all revenue recognition criteria are met as discussed in "Revenue Recognition" under Note 1 to the unaudited condensed consolidated financial statements of this Quarterly Report on Form 10-Q. License revenues increased by 13% to $4.0 million for the three

months ended June 30, 2008 from $3.5 million for the same period in the prior year. License revenues increased by 36% to $9.7 million for the six months ended June 30, 2008 from $7.1 million for the same period in the prior year. While we had a lower numbers of transactions, the average transaction value increased due to the closing of one and three large transactions during the three and six months ended June 30, 2008, respectively. While we are focused on increasing license revenue, we are unable to predict such revenue from period to period with any degree of accuracy because, among other things, the market for our products is unpredictable and intensely competitive, and our sales cycle is long and unpredictable. The length of our sales cycle has increased in recent periods due to uncertain economic conditions.

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. Professional services revenues relate to providing consulting, training and implementation services to our customers including enterprise on-demand. Services revenues increased 28% to $12.7 million for the three months ended June 30, 2008, compared to $9.9 million for the same period in 2007. Services revenues increased 31% to $25.2 million for the six months ended June 30, 2008, compared to $19.3 million for the same period in 2007. Support revenues are the largest component of services revenues. While there was an increase in support revenues in the three and six months ended June 30, 2008, the most significant increase was in consulting and training revenues that increased as a result of increased license sales in prior quarters and new consulting business from our acquisition of eVergance. Customers who purchase licenses frequently purchase implementation consulting and training services, which usually occur subsequent to the license sales.

Revenues from domestic sales were $12.4 million and $9.3 million for the three months ended June 30, 2008 and 2007, respectively and $26.6 million and $18.5 million for the six months ended June 30, 2008 and 2007, respectively. Revenues from international sales were $4.3 million and $4.1 million for the three months ended June 30, 2008 and 2007, respectively and $8.3 million and $7.9 million for the six months ended June 30, 2008 and 2007, respectively. Our international revenues were derived from sales in Europe and Asia Pacific.

Costs and Expenses

Total cost of revenues increased by 43% to $5.6 million for the three months ended June 30, 2008 from $3.9 million for the same period in 2007. Total cost of revenues increased by 58% to $11.6 million for the six months ended June 30, 2008 from $7.3 million for the same period in 2007.

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 fees was 4% for the three months ended June 30, 2008, compared to 7% for the same period in the prior year. Cost of license fees as a percentage of license fees was 6% for the six months ended June 30, 2008, compared to 7% for the same period in the prior year. The decrease was partially due to a reduction in royalty costs associated with a relatively lower proportion of non-revenue-related shipments, such as upgrades and updates, as we had a lower proportion of such shipments during the first six months of 2008 and the phase out of certain royalty bearing products. This reduction was partially offset by a referral fee incurred during the six-month period in 2008. We expect that our cost of license fees as a percentage of sales will vary based on changes in the mix of products we sell and the timing of upgrades and that cost of license fees will generally range from approximately 5% to 10% of license revenue. We are continuing to look at alternatives for some original equipment manufacturer ("OEM") products embedded in KANA products.

Services. Cost of services consists primarily of compensation and related expenses for our customer support, consulting and training and enterprise on-demand services organizations, and allocation of facility costs and system costs incurred in providing customer support. Cost of services increased to 42% of service revenues, or $5.3 million, for the three months ended June 30, 2008 compared to 37% of service revenues, or $3.7 million, for the same period in 2007. Cost of services increased to 43% of service revenues, or $10.8 million, for the six months ended June 30, 2008 compared to 35% of service revenues, or $6.7 million, for the same period in 2007. The decrease in service margins in the three and six month periods ended June 30, 2008 compared to the same periods in 2007 was due to an increase in professional services revenues as a percent of total service revenues, as the professional services have a higher cost of revenue. As of June 30, 2008, we had 67 employees in the support, consulting, training and enterprise on-demand organizations compared to 72 employees as of June 30, 2007, a decrease of 7%. This decrease was more than offset by the use of outside consultants.

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-month periods ended June 30, 2008 and 2007 related to $2.5 million of identifiable intangibles purchased in connection with the eVergance acquisition in June 2007. The amortization of acquired intangible assets recorded in the six-month period ended June 30, 2008 related to assets purchased in connection with the eVergance acquisition in June 2007. The amortization of

acquired intangible assets recorded in the six-month period ended June 30, 2007 related to assets purchased in connection with the eVergance acquisition in June 2007 and to $400,000 of identifiable assets purchased in connection with the Hipbone acquisition in February 2004. Acquired intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the assets (three and five years). The intangibles purchased in connection with the Hipbone acquisition were fully amortized in the first quarter of 2007.

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 25% to $5.0 million for the three months ended June 30, 2008, from $6.7 million for the same period in 2007. Sales and marketing expenses decreased by 12% to $11.3 million for the six months ended June 30, 2008, from $12.9 million for the same period in 2007. This was primarily due to lower compensation costs as a result of decreased headcount and a reduction in our marketing programs. As of June 30, 2008, we had 64 employees in sales and marketing compared to 81 employees as of June 30, 2007, a decrease of 21%.

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

Research and Development.Research and development expenses consist primarily of compensation and related costs for research and development employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses increased by 11% to $3.4 million for the three months ended June 30, 2008 from $3.1 million for the same period in 2007. Research and development expenses increased to $6.8 million for the six months ended June 30, 2008 from $6.7 million for the same period in 2007. The increase was attributable primarily to higher compensation and related costs as a result of an increase in head count offset by a reduction in the use of outside consultants. As of June 30, 2008, we had 61 employees in research and development compared to 48 employees as of June 30, 2007, an increase of 27%.

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 15% to $2.6 million for the three months ended June 30, 2008 from $3.1 million for the three months ended June 30, 2007. General and administrative expenses decreased by 12% to $5.8 million for the six months ended June 30, 2008 from $6.6 million for the six months ended June 30, 2007. The decrease in expenses during the three and six months ended June 30, 2008 was primarily due to lower legal fees and reduced cost of outside consultants offset for the six month period by higher auditing fees due to our 2007 audit of internal control over financial reporting. As of June 30, 2008, we had 42 employees in general and administrative and information technology combined compared to 43 employees as of June 30, 2007, a 2% 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 Costs. During the six months ended June 30, 2008 we recorded a restructuring recovery of $482,000 as a result of the extension of a sublease on one of the properties in our restructuring accrual. There was no restructuring cost during the three or six months ended June 30, 2007.

Interest and Other Income (Expense), Net

Interest and other income (expense), net consists primarily of interest income and interest expense. Interest income and other income consists primarily of interest earned on cash and cash equivalents and was approximately $6,000 and $25,000 for the three months ended June 30, 2008 and 2007, respectively and $17,000 and $48,000 for the six months ended June 30, 2008 and 2007, respectively. The decrease in interest income related to lower cash and cash equivalents balances in the six months ended June 30, 2008 compared to the same period in 2007. Interest expense and other expense relates primarily to our line of credit and loan payable and was approximately $70,000 and $112,000 for the three months ended June 30, 2008 and 2007, respectively, and $184,000 and $154,000 for the six months ended June 30, 2008 and 2007, 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 June 30, 2008. Accordingly, we have recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future realization of the tax benefit is not currently more likely than not. During the three months ended June 30, 2008 and 2007, 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 $20,000 and $54,000 for the three months ended June 30, 2008 and 2007, respectively, and approximately $46,000 and $101,000 for the six months ended June 30, 2008 and 2007, respectively, in those foreign jurisdictions.

Liquidity and Capital Resources

As of June 30, 2008, we had $3.2 million in cash and cash equivalents, compared to $4.3 million in cash and cash equivalents at December 31, 2007. As of June 30, 2008, we had negative working capital of $10.9 million, compared to negative working capital of $11.6 million as of December 31, 2007. As of June 30, 2008, our current liabilities included $15.6 million of deferred revenue (primarily reflecting payments received for future maintenance services to be provided to our customers).

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 $951,000 of cash for the first six months of 2008, which included a $216,000 net loss, a $1.4 million increase in accounts receivable, a $609,000 decrease in deferred revenue, and net payments of $695,000 against accrued restructuring and a restructuring recovery of $482,000, partially offset by non-cash charges of $1.1 million for stock-based compensation expense, and $587,000 of depreciation. Our operating activities used $4.9 million of cash and cash equivalents for the six months ended June 30 2007, due mainly to our net loss of $7.3 million, a $1.1 million decrease in accrued restructuring and a $442,000 increase in accounts receivable, partially offset by $1.5 million of non-cash stock-based compensation expense, as well as a $1.8 million increase in deferred revenue.

Investing Cash Flow

Our investing activities used $759,000 and $1.5 million of cash for the first six months of 2008 and 2007, respectively, which consisted primarily of the purchase of property and equipment and the purchase of eVergance in 2007.

Financing Cash Flow

Our financing activities generated $701,000 of cash for the six months ended June 30, 2008, which consisted of $2.1 million of borrowings under the line of credit offset by the repayment of $1.4 million on notes payable. For the first six months of 2007, our financing activities provided $5.1 million of cash and cash equivalents, due mainly to our borrowing of $4.2 million on our line of credit and $1.1 million of proceeds from issuance of common stock.

Existence and Timing of Contractual Obligations

On November 30, 2005, we established a banking relationship with Bridge Bank N.A. ("Bridge")entering 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. We have since amended our agreement with Bridge, most recently on March 28, 2008, when we entered into a Second Amended and Restated Loan and Security Agreement with Bridge under which we had access to a loan facility of $10.0 million ("March Loan Facility"). The March Loan Facility is a formula based revolving line of credit based on 80% of eligible receivables subject to three sublimits; 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 term loan as of March 26, 2008 in the amount of $1.6 million which is payable in 33 monthly installments of principal plus interest. A maximum amount of $500,000 is available for additional equipment financing. The total combined borrowing under the March Loan Facility and sublimits cannot exceed $10.0 million. The March Loan Facility is secured by all of our assets and expires February 27, 2010 at which time the entire balance under the formula-based line of credit will be due. We have until September 30, 2008 to draw down against the additional equipment financing, which is repayable over a 36 month period. 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 plus 1.25%. 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.

As of June 30, 2008, we had $1.4 million outstanding under the March Loan Facility under the existing equipment loan provision. This amount is repayable in 31 monthly installments of principal and interest. It is shown on the condensed consolidated balance sheet under the headings of notes payable (current portion) and notes payable long-term. We have also drawn $1.5 million against the formula-based revolving line of credit and $226,000 against the . . .