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 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. In June 2007 we acquired eVergance Partners LLC ("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 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 June 30, 2009, we had cash and cash equivalents of $2.9 million. As of June 30, 2009, we had negative working capital of $2.1 million, excluding $13.7 million of deferred revenue, and stockholders' deficit of $693,000. We recorded losses from operations of $546,000 and $3.7 million for the three and six month periods ended June 30, 2009, respectively, and losses from operations of $53,000 and $3,000 for the three and six month periods ended June 30, 2008, respectively. Net losses were $607,000 and $3.9 million for the three and six month periods ended June 30, 2009, respectively, and $137,000 and $216,000 for the three and six month periods ended June 30, 2008, respectively. Net cash used in operating activities was $406,000 and $951,000 for the six months ended June 30, 2009 and 2008, respectively. As of June 30, 2009, we had 198 full-time employees, a decrease from 229 employees at December 31, 2008 and a decrease from 234 employees at June 30, 2008.

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:

• revenue recognition;

• accounting for internal-use software;

• restructuring;

• goodwill and intangible assets;

• income taxes;

• contingencies and litigation; and

• stock-based compensation.

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 six months ended June 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.

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,
                                                 2009             2008          2009           2008
                                                      (unaudited)                  (unaudited)
Revenues:
License fees                                        13 %             24 %          12 %          28 %
Services                                            87               76            88            72

Total revenues                                     100              100           100           100


Costs and expenses:
Cost of license fees                                 2                *             2             2
Cost of services                                    30               32            35            31
Amortization of acquired intangible assets           1                *             1             *
Sales and marketing                                 19               30            23            32
Research and development                            28               21            31            19
General and administrative                          18               16            21            17
Restructuring                                        7               -              4            (1 )

Total costs and expenses                           105              100           116           100

Loss from operations                                (5 )              *           (16 )           *
Interest and other income (expense), net             *                *             *             *

Loss before income tax expense                      (5 )              *           (17 )           *
Income tax expense                                   *                *             *             *

Net loss                                            (5 )%            *  %         (17 )%         *  %

* Less than 1%

Revenues

Total revenues decreased by 28% to $11.9 million for the three months ended June 30, 2009 from $16.7 million for the three months ended June 30, 2008, as a result of lower license and services revenues in the second quarter of 2009 than in 2008. Total revenues decreased by 35% to $22.8 million for the six months ended June 30, 2009 from $34.9 million for the six months ended June 30, 2008, as a result of lower license and services revenues in both the first and second quarters of 2009 compared to the same periods 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 62% to $1.5 million for the three months ended June 30, 2009 from $4.0 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 June 30, 2009 while there was one large transaction included in license revenues for the three months ended June 30, 2008. License revenues decreased by 72% to $2.7 million for the six months ended June 30, 2009 from $9.7 million for the same period in the prior year due to closing no large transactions that exceeded $1.0 million in revenue during the six months ended June 30, 2009 while there were three large transactions included in license revenues for the six months ended June 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.

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 18% to $10.4 million for the three months ended June 30, 2009, compared to $12.7 million for the same period in 2008. Services revenues decreased 20% to $20.1 million for the six months ended June 30, 2009, compared to $25.2 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 June 30, 2008 that did not reoccur 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 $9.6 million and $12.4 million for the three months ended June 30, 2009 and 2008, respectively, and $17.3 million and $26.6 million for the six months ended June 30, 2009 and 2008, respectively. Revenues from international sales were $2.3 million and $4.3 million for the three months ended June 30, 2009 and 2008, respectively, and $5.5 million and $8.3 million for the six months ended June 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 30% to $3.9 million for the three months ended June 30, 2009 from $5.6 million for the same period in 2008. Total cost of revenues decreased by 25% to $8.7 million for the six months ended June 30, 2009 from $11.6 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 12% for the three months ended June 30, 2009, compared to 4% for the same period in the prior year. Cost of license fees as a percentage of license revenues was 14% for the six months ended June 30, 2009, compared to 6% for the same period in the prior year. While the absolute dollar amount of cost of license fees increased slightly, due to fees associated with an enterprise license, in the three months ended June 30, 2009, the cost of license fees as a percentage of license revenues increased due primarily to the significantly lower license revenues during the period. During the six months ended June 30, 2009 compared to the same period in the prior year, the absolute dollar amount of cost of license fees decreased while the percentage of license revenues increased due to significantly lower license revenues. 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 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 decreased to 35% of services revenue, or $3.6 million, for the three months ended June 30, 2009 compared to 42% of services revenue, or $5.3 million, for the same period in 2008. Cost of services decreased to 40% of services revenue, or $8.1 million, for the six months ended June 30, 2009 compared to 43% of services revenue, or $10.8 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 six months ended June 30, 2009 compared to the same period in 2008, primarily due to the use of fewer outside consultants. As of June 30, 2009 and 2008, we had 67 employees 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 six month periods ended June 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 56% to $2.2 million for the three months ended June 30, 2009, from $5.0 million for the same period in 2008. Sales and marketing expenses decreased by 54% to $5.2 million for the six months ended June 30, 2009, from $11.3 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 June 30, 2009, we had 33 employees in sales and marketing compared to 64 employees as of June 30, 2008, a decrease of 48%. The decrease was partially due to the transfer of seven employees to the consulting services organization as discussed above.

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 remained flat at $3.4 million for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. Research and development expenses increased by 4% to $7.0 million for the six months ended June 30, 2009 from $6.8 million for the same period in 2008. The increase was attributable primarily to higher compensation and related costs as a result of an increase in head count and a minimum royalty fee partially offset by a reduction in the use of outside consultants. As of June 30, 2009, we had 67 employees in research and development compared to 61 employees as of June 30, 2008, an increase of 10%.

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 20% to $2.1 million for the three months ended June 30, 2009 from $2.6 million for the three months ended June 30, 2008. General and administrative expenses decreased by 19% to $4.7 million for the six months ended June 30, 2009 from $5.8 million for the six months ended June 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 auditing fees as we were not required to have an audit of internal control over financial reporting offset by higher legal fees. As of June 30, 2009, we had 31 employees in general and administrative and information technology combined compared to 42 employees as of June 30, 2008, a 26% 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 (Recovery). During the three and six months ended June 30, 2009 we recorded $805,000 of restructuring expense related to a reduction in workforce of 27 employees and the adjustment of rent related to two facilities included in our restructuring accrual. There was no restructuring activity during the three months ended June 30, 2008. During the six months ended June 30, 2008, there was a restructuring recovery of $482,000 based on an extension of a sublease for one of the restructured properties.

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 $6,000 for the three months ended June 30, 2009 and 2008, respectively, and $5,000 and $17,000 for the six months ended June 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 June 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 $52,000 and $70,000 for the three months ended June 30, 2009 and 2008, respectively, and $142,000 and $184,000 for the six months ended June 30, 2009 and 2008, 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, 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 six months ended June 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 $10,000 and $20,000 for the three months ended June 30, 2009 and 2008, respectively, and approximately $26,000 and $46,000 for the six months ended June 30, 2009 and 2008, respectively, in those foreign jurisdictions.

Liquidity and Capital Resources

As of June 30, 2009, we had $2.9 million in cash and cash equivalents, compared to $7.0 million in cash and cash equivalents at December 31, 2008. As of June 30, 2009, we had negative working capital of $15.8 million, compared to negative working capital of $13.8 million as of December 31, 2008. As of June 30, 2009, our current liabilities included $13.7 million of deferred revenue (primarily reflecting payments received for future maintenance services to be provided to our customers). 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 $406,000 of cash for the first six months of 2009, which included a $3.9 million net loss, a $715,000 reduction in accounts payable and accrued liabilities, and net payments of $554,000 against accrued restructuring partially offset by a $1.5 million decrease in accounts receivable, a $893,000 increase in deferred revenue and non-cash charges of $814,000 for stock-based compensation expense, and $662,000 of depreciation. 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, 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.

Investing Cash Flow

Our investing activities provided $162,000 during the first six months of 2009 primarily due to a decrease in restricted cash of $446,000 partially offset by purchases of property and equipment of $284,000. Our investing activities used $759,000 during the first six months of 2008 primarily due to purchases of property and equipment.

Financing Cash Flow

Our financing activities used $3.7 million of cash for the six months ended June 30, 2009, which consisted of $2.1 million of net repayments on the line of credit and the repayment of $1.8 million on notes payable. 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 partially offset by the repayment of $1.4 million on notes payable.

Existence and Timing of Contractual Obligations . . .