UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

OR

FOR THE TRANSITION PERIOD FROM                     TO                    .

Commission file number: 000-50463

Callidus Software Inc.

Callidus Software Inc.
160 West Santa Clara Street, Suite 1500
San Jose, CA 95113
(Address of principal executive offices, including zip code)

(408) 808-6400
(Registrant’s Telephone Number, including area code)

     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 requirements for the past 90 days. Yes þ No o

     Indicate by check mark if the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended). Yes o No þ

     There were 26,130,098 shares of the registrant’s common stock, par value $0.001, outstanding on May 10, 2005, the latest practicable date prior to the filing of this report.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CALLIDUS SOFTWARE INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amount; unaudited)

See accompanying notes to condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

CALLIDUS SOFTWARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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CALLIDUS SOFTWARE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies

     Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements included in the Callidus Software Inc. Annual Report on Form 10-K for the year ended December 31, 2004. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the Securities and Exchange Commission rules and regulations regarding interim financial statements. All amounts included herein related to the condensed consolidated financial statements as of March 31, 2005 and the three months ended March 31, 2005 and 2004 are unaudited and should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

     In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all necessary adjustments for the fair presentation of the Company’s financial position, results of operations and cash flows. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the full fiscal year ending December 31, 2005.

     Reclassifications

     As a result of reclassifying auction rate securities from cash equivalents to short-term investments for all periods presented, the Company reclassified the purchases and sales of its auction rate securities and short-term municipal bonds in its Consolidated Statements of Cash Flows, which increased purchases of investments by $1.7 million and increased maturities of investments by $18.3 million for the quarter ended March 31, 2004, with the offset to cash and cash equivalents.

     Principles of Consolidation

     The consolidated financial statements include the accounts of Callidus Software Inc. and its wholly owned subsidiaries (collectively, the Company) in the United Kingdom, Germany, Australia and Italy. All intercompany transactions and balances have been eliminated in consolidation.

     Use of Estimates

     Preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Management periodically evaluates such estimates and assumptions for continued reasonableness. Appropriate adjustments, if any, to the estimates used are made prospectively based upon such periodic evaluation. Actual results could differ from those estimates.

     Valuation Accounts

     Trade accounts receivable are recorded at the invoiced amount where revenue has been recognized and do not bear interest. The Company offsets gross trade accounts receivable with its allowance for doubtful accounts and sales return reserve. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days are reviewed individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The sales return reserve is the Company’s best estimate of the probable amount of remediation services it will have to provide for ongoing professional service arrangements. To determine the adequacy of the sales return reserve, the Company analyzes historical experience of actual remediation service claims as well as current

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information on remediation service requests. Provisions for allowance for doubtful accounts are recorded in general and administrative expenses, while provisions for sales returns are offset against maintenance and service revenues.

     Below is a summary of the changes in the Company’s valuation accounts for the three months ended March 31, 2005 and 2004 (in thousands):

     Restricted Cash

     Included in deposits and other assets in the condensed consolidated balance sheets at March 31, 2005 and December 31, 2004 is restricted cash of $674,000 and $282,000, respectively, to support letters of credit as security deposits on leased facilities for our New York, New York and San Jose, California offices. Restricted cash is included in deposits and other assets based on the expected term for the release of the restriction.

     Stock-Based Compensation

     The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB No. 25, deferred stock-based compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company’s stock and the exercise price of related equity awards. Deferred stock-based compensation is amortized and expensed on an accelerated basis over the corresponding vesting period, using the method outlined in Financial Accounting Standards Board (FASB) Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

     The following table illustrates the pro forma effect on net loss and loss per share as if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three months ended March 31, 2005 and 2004 (in thousands, except per share amounts):

     For purposes of the foregoing fair value calculations, the Company used the Black-Scholes method. The assumptions used in computing the fair value of stock options or stock purchase rights are discussed in the remainder of this paragraph. The Company estimated the expected useful lives, giving consideration to the vesting and purchase periods, contractual lives, and the relationship between the exercise price and the fair market value of the Company’s common stock, among other factors. The expected volatility

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was estimated giving consideration to the expected useful lives of the stock options and recent volatility of the Company’s common stock, among other factors. The risk-free rate is the U.S. Treasury bill rate for the relevant expected life. The fair value of stock options was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

     The estimated fair value of stock-based awards to employees is based on a multiple-option valuation approach, and amortized over the options’ vesting period of generally four years with forfeitures being recognized as they occur. Purchase rights granted under the Employee Stock Purchase Plan are amortized over the respective purchase periods of six or twelve months.

     The weighted-average estimated fair value of stock options granted during the three months ended March 31, 2005 and 2004 was $1.92 and $7.43 per share, respectively. No stock option grants were made during the three months ended March 31, 2005 or 2004 with exercise prices below market price on the date of grant. The weighted-average estimated fair value of stock purchase rights granted under the Employee Stock Purchase Plan during the three months ended March 31, 2005 and 2004 was $1.88 and $5.72 per share, respectively, including the 15% discount from the quoted market price.

     Net Loss Per Share

     Basic net loss per share is calculated by dividing net loss attributable to common stockholders for the period by the weighted average common shares outstanding during the period. Diluted net loss per share is calculated by dividing the net loss for the period by the weighted average common shares outstanding, adjusted for all dilutive potential common shares, which includes shares issuable upon the exercise of outstanding common stock options and warrants to the extent these shares are dilutive.

     Diluted net loss per share does not include the effect of the following potential common shares because to do so would be antidilutive for the periods presented (in thousands):

     The weighted-average exercise price of stock options excluded during the three months ended March 31, 2005 and 2004 were $3.91 and $3.36, respectively. The weighted average exercise price of warrants excluded during the three months ended March 31, 2005 and 2004 was $20.15 and $3.14, respectively.

     Recent Accounting Pronouncements

     On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123R (revised 2004), Share-Based Payment (“SFAS 123R”), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure will no longer be an alternative. SFAS 123R will be effective for annual periods beginning after June 15, 2005 and, accordingly, the Company must adopt the new accounting provisions effective January 1, 2006.

     Upon the adoption of SFAS No. 123R, the Company can elect to recognize stock-based compensation related to employee equity awards in its consolidated statements of operations using the fair value method on a modified prospective basis and disclose the pro

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forma effect on net income or loss assuming the use of the fair value method in the notes to the consolidated financial statements for periods prior to adoption. Since the Company currently accounts for equity awards granted to its employees using the intrinsic value method under APB No. 25, the adoption of SFAS No. 123R is expected to have a significant impact on the Company’s results of operations.

2. Investments

     The Company classifies debt and marketable equity securities based on the liquidity of the investment and management’s intention on the date of purchase and re-evaluates such designation as of each balance sheet date. Debt and marketable equity securities are classified as available-for-sale and carried at fair value, which is determined based on quoted market prices, with net unrealized gains and losses, net of tax effects, included in accumulated other comprehensive income (loss) in the accompanying condensed consolidated financial statements. Interest and amortization of premiums and discounts for debt securities are included in interest and other income, net, in the accompanying condensed consolidated financial statements. Realized gains and losses are calculated using the specific identification method. The components of the Company’s debt and marketable equity securities as of March 31, 2005 were as follows (in thousands):

     There were no realized gains or losses on the sales of these securities for the quarters ended March 31, 2005 and 2004, respectively.

3. Debt

     The Company had a master loan and security agreement (Master Agreement) that included a revolving line of credit of $10 million that expired in March 2005. The Company decided not to renew the revolving line of credit. The Master Agreement requires the Company to maintain certain financial covenants relating to the outstanding loans. As of March 31, 2005, the Company was in compliance with all covenants.

4. Commitments and Contingencies

     In July 2004, a purported securities class action complaint was filed in the United States District Court for the Northern District of California against the Company and certain of its present and former executives and directors. The suit alleges that the Company and these executives and directors made false or misleading statements or omissions in violation of federal securities laws. The suit seeks damages on behalf of a purported class of individuals who purchased the Company’s stock during the period from November 19, 2003 through June 23, 2004. In October 2004, the court appointed a lead plaintiff. In November 2004, the lead plaintiff filed an amended complaint naming Messrs. Fior and Taussig as well as the Company as defendants and amending purported class to include individuals who purchased the Company’s stock during the period from January 22, 2004 through June 23, 2004. In addition, in each

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of July and October 2004, derivative complaints were also filed against the Company and certain of its present and former directors and officers in the California State Superior Court in Santa Clara, California and United States District Court for the Northern District of California. The derivative complaints allege state law claims relating to the matters alleged in the purported class action complaint referenced above. The federal derivative case has been deemed related to the federal securities case and assigned to the same judge. In February 2005, the parties stipulated to a stay of the state derivative case in favor of the federal derivative case. In February 2005, the Company filed a motion to dismiss the amended complaint. The court has scheduled a hearing on the Company’s motion for May 2005. The Company believes that the claims in the securities and derivative actions are without merit and intends to continue to vigorously defend against these claims. As of March 31, 2005, the Company has accrued approximately $130,000 for anticipated future legal costs up to the amount of its insurance retention.

     In addition, the Company is from time to time a party to various other litigation matters incidental to the conduct of its business, none of which, at the present time is likely to have a material adverse effect on the Company’s future financial results.

     Other Contingencies

     The Company generally warrants that its products will perform to its standard documentation. Under the terms of the warranty, should a product not perform as specified in the documentation, the Company will repair or replace the product and if the Company is unable to repair or replace the product, the Company shall return the product fees paid by the customer. Such warranties are accounted for in accordance with SFAS 5, Accounting for Contingencies. To date the Company has not incurred material costs related to warranty obligations.

     The Company’s product license agreements include a limited indemnification provision for claims from third parties relating to the Company’s intellectual property. Such indemnification provisions are accounted for in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The indemnification is limited to the amount paid by the customer. To date the Company has not incurred any costs related to such indemnification provisions.

5. Segment, Geographic and Customer Information

     SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method of determining what information is reported is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision maker is considered to be the Company’s chief executive officer (CEO). The CEO reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. By this definition, the Company operates in one business segment, which is the development, marketing and sale of enterprise software.

Geographic Information:

     Total revenues consist of (in thousands):

     Substantially all of the Company’s long-lived assets are located in the United States. Long-lived assets located outside the United States are not significant.

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     Significant customers (including resellers when product is sold through them to an end user) as a percentage of total revenues:

     NA = Customer balance did not represent more than 10% during the period.

6. Comprehensive Loss

     Comprehensive loss includes net loss, unrealized gains (losses) on investments, net and foreign currency translation adjustments. Comprehensive loss is comprised of the following (in thousands):

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion of financial condition and results of operations should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004 and with the condensed consolidated financial statements and the related notes hereto contained elsewhere in this Quarterly Report on Form 10-Q . This section of the Quarterly Report on Form 10-Q, 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. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements concerning the following: our newly appointed President and Chief Executive Officer, our hiring of a vice president of sales, changes in and expectations with respect to maintenance and service and license revenues and gross margins, future operating expense levels, the impact of quarterly fluctuations of revenue and operating results, levels of capital expenditure, staffing and expense levels, expected future cash outlays, the adequacy of our capital resources to fund operations and growth, the likely outcome of pending litigation, the extent of stock-based compensation charges and expectations with respect to research and development spending. These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from any future results, level of activity, performance or achievements expressed or implied by these statements. Many of these trends and uncertainties are described in “Factors That Could Affect Future Results” set forth elsewhere in this Quarterly Report on Form 10-Q. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

Overview of the Results for the Three Months Ended March 31, 2005

     We are a leading provider of Enterprise Incentive Management (EIM) software systems to global companies across multiple industries. Large enterprises use EIM systems to model, administer, analyze and report on incentive compensation, or pay-for-performance plans, which compensate employees and business partners for the achievement of targeted quantitative and qualitative objectives, such as sales quotas, product development milestones and customer satisfaction. We sell our EIM products both directly through our sales force and indirectly through our strategic partners pursuant to perpetual software licenses, and offer professional services, including configuration, integration and training, generally on a time and materials basis. We also generate maintenance and support revenues associated with our product licenses, which are recognized ratably over the term of the maintenance agreement.

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     In April 2005, we concluded our CEO search and announced the appointment of Robert H. Youngjohns as President and Chief Executive Officer effective May 31, 2005. Mr. Youngjohns will replace our Interim President and CEO, David Pratt. Mr. Pratt will continue as a member of our Board of Directors. Prior to joining Callidus Software, Mr. Youngjohns was Executive Vice President of Strategic Development and Sun Financing at Sun Microsystems. Previously, Mr. Youngjohns served as Executive Vice President of Sun’s global sales organization. Before joining Sun, he spent 15 years at IBM in a variety of roles ranging from systems engineering to general management. Mr. Youngjohns has extensive experience in international sales, marketing and business development in the Americas, Asia and Europe.

     In the first quarter of 2005, our operating results continue to be affected by a generally more challenging selling environment and extended sales cycles. Despite these factors we were able to maintain strong and predictable revenue and margins in our services organization and manage the increase in our operating expenses to the low end of what was targeted in the prior quarter. Our Cash and investments balance increased by $1.9 million from the prior quarter and license revenues decreased by $0.5 million from the fourth quarter of 2004. Our net loss increased by $1.2 million in the first quarter of 2005 compared to the fourth quarter 2004. This was the result of a small reduction in license revenue and an increase in our operating expenses compared to the fourth quarter of 2004. In the first quarter of 2005, we incurred expenses associated with our annual sales conference, an executive search fee, severance costs related to our former senior vice president of operations and payroll expenses and costs related to consulting services for our Sarbanes-Oxley compliance.

     During the quarter we continued to add industry leading customers to our customer base including Avaya, Janus and the Rollins Corporation. We also signed our first charter customer for our TrueAnalytics product currently under development. Additionally, we had several existing customers complete their implementations and go live with our products. These customers include Allstate Insurance Company, Allianz, and AAA of Michigan.

     We continue to invest in product development and are scheduled to release our next version, Version 5.0, of TrueComp, TrueInformation, and TrueResolution in the third quarter of this year. We also have a dedicated development team working on our new TrueAnalytics product. TrueAnalytics will provide our customers with pre-built sales performance dashboards that highlight the effectiveness of incentive compensation programs as well as sophisticated ad hoc analytical capabilities and integrated security with the TrueComp product suite.

     When comparing the first quarter of 2005 to the first quarter of 2004, our license revenues in both quarters were dependent on our ability to close a relatively small number of transactions. For the three months ended March 31, 2005, total revenues were $14.5 million as compared to $16.5 million for the three months ended March 31, 2004. As a percentage of total revenues license revenues represented 24% for the three months ended March 31, 2005 compared to 28% for the three months ended March 31, 2004. Maintenance and service revenues were $11.0 million and $11.9 million for the three months ended March 31, 2005 and 2004, respectively. Although we experienced a higher average billing rate in the three months ended March 31, 2005 compared to the three months ended March 31, 2004, we had fewer billable consultants which reduced our overall maintenance and service revenue. Notwithstanding the reduced maintenance and service revenues, we experienced an increase in maintenance and service gross margins from 28% for the three months ended March 31, 2004 compared to 35% for the three months ended March 31, 2005 due to an increase in higher margin maintenance revenue compared to lower margin service revenue. Our near term focus continues to be on execution efforts and achieving continued incremental growth in license revenues.

     Our gross margins for the three months ended March 31, 2005 and 2004 were 50% and 46%, respectively. Our gross margins depend, in large part, on the mix of license revenues and maintenance and service revenues. License revenues carry a much higher margin than maintenance and services revenues. We expect our gross margin to continue to fluctuate significantly in future quarters. In addition, we expect maintenance and service revenues will continue to make up a substantial part of the overall mix. Our goal for the next few quarters is to keep license margins at or above 95% and maintenance and service margins between 30% and 32%.

     Operating expenses were $10.0 million for the three months ended March 31, 2005, a decrease of $3.8 million from the same quarter of 2004. In the first half of 2004, we significantly increased our operating expenses based on our fiscal 2003 revenue growth and our revenue projections for fiscal 2004. We reduced our operating expenses starting in the third quarter of 2004 to better align with our overall revenues. The $3.8 million decrease was the result of reductions in a few areas. Personnel related expenses decreased by $1.0 million due to reductions in headcount. Stock-based compensation expenses decreased by $1.3 million due to lower amortization of deferred stock-based compensation expense. We also reduced marketing programs by $0.6 million in the first quarter of 2005 compared to the first quarter of 2004. Furthermore, in the first quarter of 2004, we incurred $0.5 million in contract

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development work from Cezanne Software for our now discontinued TruePerformance product. We expect operating expenses in the second quarter of 2005 to increase slightly from the first quarter of 2005 due to an increase in Sarbanes-Oxley compliance related consulting and audit fees, executive search fees for a vice president of sales, higher commission costs, increased marketing program costs and an increase in stock-based compensation resulting from the hiring of our new president and chief executive officer.

Application of Critical Accounting Policies and Use of Estimates

     Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The application of GAAP requires our management to make estimates that affect our reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation of our financial condition or results of operations will be affected.

     In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Our management has reviewed these critical accounting policies, our use of estimates and the related disclosures with our audit committee.

     Revenue Recognition

     We generate revenues primarily by licensing software and providing maintenance and professional services to our customers. Our software arrangements typically include: (i) an end-user license fee paid in exchange for the use of our products in perpetuity, generally based on a specified number of payees; and (ii) a maintenance arrangement that provides for technical support and product updates, generally over a period of twelve months. If we are selected to provide integration and configuration services, then the software arrangement will also include professional services, generally priced on a time-and-materials basis. Depending upon the elements in the arrangement and the terms of the related agreement, we recognize license revenues under either the residual or the contract accounting method.

     Residual Method. License fees are recognized upon delivery when licenses are either sold separately from integration and configuration services, or together with integration and configuration services, provided that (i) the criteria described below have been met, (ii) payment of the license fees is not dependent upon performance of the integration and configuration services, and (iii) the services are not otherwise essential to the functionality of the software. We recognize these license revenues using the residual method pursuant to the requirements of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Software Revenue Recognition with Respect to Certain Transactions. Under the residual method, revenues are recognized when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e., professional services and maintenance), but does not exist for one or more of the delivered elements in the arrangement (i.e., the software product). Each license arrangement requires careful analysis to ensure that all of the individual elements in the license transaction have been identified, along with the fair value of each undelivered element.

     We allocate revenue to each undelivered element based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. For a certain class of transactions, the fair value of the maintenance portion of our arrangements is based on stated renewal rates rather than stand-alone sales. The fair value of the professional services portion of the arrangement is based on the hourly rates that we charge for these services when sold independently from a software license. If evidence of fair value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue from the arrangement is deferred until evidence of fair value can be established, or until the items for which evidence of fair value cannot be established are delivered. If the only undelivered element is maintenance, then the entire amount of revenue is recognized over the maintenance delivery period.

     Contract Accounting Method. For arrangements where services are considered essential to the functionality of the software, such as where the payment of the license fees is dependent upon performance of the services, both the license and services revenues are

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recognized in accordance with the provisions of SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We generally use the percentage-of-completion method because we are able to make reasonably dependable estimates relative to contract costs and the extent of progress toward completion. However, if we cannot make reasonably dependable estimates, we use the completed-contract method. If total cost estimates exceed revenues, we accrue for the estimated loss on the arrangement.

     For all of our software arrangements, we will not recognize revenue until persuasive evidence of an arrangement exists and delivery has occurred, the fee is fixed or determinable and collection is deemed probable. We evaluate each of these criteria as follows:

     Evidence of an Arrangement. We consider a non-cancelable agreement signed by us and the customer to be evidence of an arrangement.

     Delivery. We consider delivery to have occurred when media containing the licensed programs is provided to a common carrier or, in the case of electronic delivery, the customer is given access to the licensed programs. Our typical end-user license agreement does not include customer acceptance provisions.

     Fixed or Determinable Fee. We consider the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within our standard payment terms. We consider payment terms greater than 90 days to be beyond our customary payment terms. If the fee is not fixed or determinable, we recognize the revenue as amounts become due and payable.

     Collection is Deemed Probable. We conduct a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the customer. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the recognition of revenue until cash collection.

     A customer typically prepays maintenance for the first twelve months, and the related revenues are deferred and recognized over the term of the initial maintenance contract. Maintenance is renewable by the customer on an annual basis thereafter. Rates for maintenance, including subsequent renewal rates, are typically established based upon a specified percentage of net license fees as set forth in the arrangement.

     Professional services revenues primarily consist of integration and configuration services related to the installation of our products and training revenues. Our implementation services do not involve customization to, or development of, the underlying software code. Substantially all of our professional services arrangements are on a time-and-materials basis. To the extent we enter into a fixed-fee services contract, a loss will be recognized any time the total estimated project cost exceeds project revenues.

     Certain arrangements result in the payment of customer referral fees to third parties that resell our software products. In these arrangements, license revenues are recorded, net of such referral fees, at the time the software license has been delivered to a third-party reseller and an end-user customer has been identified.

Allowance for Doubtful Accounts and Sales Return Reserve

     We must make estimates of the uncollectibility of accounts receivable. The allowance for doubtful accounts, which is netted against accounts receivable on our balance sheets, totaled approximately $327,000 and $320,000 at March 31, 2005 and December 31, 2004, respectively. We record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Management specifically analyzes accounts receivable and historical bad debts experience, customer creditworthiness, current economic trends, international situations (such as currency devaluation) and changes in our customer payment history when evaluating the adequacy of the allowance for doubtful accounts. Should any of these factors change, the estimates made by management will also change, which could affect the level of our future provision for doubtful accounts. Specifically, if the financial condition of our customers were to deteriorate, affecting their ability to make payments, an additional provision for doubtful accounts may be required and such provision may be material.

     We generally guarantee that our services will be performed in accordance with the criteria agreed upon in the statement of work. Should these services not be performed in accordance with the agreed upon criteria, we would provide remediation services until such time as the criteria are met. In accordance with Statement of Financial Accounting Standards (SFAS) 48, Revenue Recognition When Right of Return Exists, management must use judgments and make estimates of sales return reserves related to potential future

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requirements to provide remediation services in connection with current period service revenues. When providing for sales return reserves, we analyze historical experience of actual remediation service claims as well as current information on remediation service requests as they are the primary indicators for estimating future service claims. Material differences may result in the amount and timing of our revenues if for any period actual returns differ from management’s judgments or estimates. The sales return reserve balance, which is netted against our accounts receivable on our balance sheets, was approximately $394,000 and $537,000 at March 31, 2005 and December 31, 2004, respectively.

Stock-Based Compensation

     We have adopted SFAS 123, Accounting for Stock-Based Compensation, but in accordance with SFAS 123, we have elected not to apply fair value-based accounting for our employee stock option plans. Instead, we measure compensation expense for our employee stock option plans using the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) 25, Accounting for Stock Issued to Employees, and related interpretations. We record deferred stock-based compensation to the extent the fair value of our common stock for financial accounting purposes exceeds the exercise price of stock options granted to employees on the date of grant, and amortize these amounts to expense using the accelerated method over the vesting schedule of the options, generally four years. For options granted after our initial public offering, the fair value of our common stock is the closing price on the date of grant. For options which were granted prior to our initial public offering, the deemed fair value of our common stock was determined by our board of directors. The board of directors determined the deemed fair value of our common stock by considering a number of factors, including, but not limited to, our operating performance, significant events in our history, issuances of our convertible preferred stock, trends in the broad market for technology stocks and the expected valuation we obtained in an initial public offering.

     Amortization of deferred stock-based compensation was approximately $0.4 million and $1.7 million for the three months ended March 31, 2005 and 2004 respectively. We expect stock-based compensation expense to be $0.7 million for the three months ended June 30, 2005 due to amortization of deferred stock-based compensation and stock-based compensation related to our new chief executive officer. Had different assumptions or criteria been used to determine the deemed fair value of the stock options, materially different amounts of stock compensation expenses could have been reported. Please see our “Recent Accounting Pronouncements” for additional discussion of FASB Statement No. 123R.

     As required by SFAS 123, as modified by SFAS 148, Accounting for Stock Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123, we provide pro forma disclosure of the effect of using the fair value-based method of measuring stock-based compensation expense. For purposes of the pro forma disclosure, we estimate the fair value of stock options issued to employees using the Black-Scholes option valuation model. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of subjective assumptions including the expected life of options and our expected stock price volatility. Therefore, the estimated fair value of our employee stock options could vary significantly as a result of changes in the assumptions used. See Note 1 to our condensed consolidated financial statements included elsewhere in this Annual Report on Form 10-Q.

Income Taxes

     We are subject to income taxes in both the United States and foreign jurisdictions and we use estimates in determining our provision for income taxes. Deferred tax assets, related valuation allowances and deferred tax liabilities are determined separately by tax jurisdiction. This process involves estimating actual current tax liabilities together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. Our deferred tax assets consist primarily of net operating loss carryforwards. We assess the likelihood that deferred tax assets will be recovered from future taxable income, and a valuation allowance is recognized if it is more likely than not that some portion of the deferred tax assets will not be recognized. We provided a full valuation allowance against our net deferred tax assets at March 31, 2005. In the event we were to determine that we would be able to realize all or a portion of our deferred tax assets in the future, an adjustment to the valuation allowance would increase net income and stockholders’ equity in the period such determination was made. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business.

Recent Accounting Pronouncements

     On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123R (revised 2004), Share-Based Payment (SFAS 123R), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-

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based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure will no longer be an alternative. The new standard will be effective at the beginning of the first annual period beginning after June 15, 2005 and, accordingly, we must adopt the new accounting provisions effective January 1, 2006.

     Upon the adoption of SFAS No. 123R, we can elect to recognize stock-based compensation related to employees’ equity awards in our consolidated statements of operations using the fair value method on a modified prospective basis and disclose the pro forma effect on net income or loss assuming the use of the fair value method in the notes to the consolidated financial statements for periods prior to adoption. Since we currently account for equity awards granted to employees using the intrinsic value method under APB No. 25, we expect the adoption of SFAS No. 123R will have a significant impact on our results of operations.

Results of Operations

Comparison of the Three Months Ended March 31, 2005 and 2004

Revenue, cost of revenues and gross profit

     The table below sets forth the changes in revenue, cost of revenue and gross profit from the three months ended March 31, 2004 to the three months ended March 31, 2005 (in thousands, except percentage data):

Revenues

     License Revenues. License revenues decreased $1.0 million or 23% for the three months ended March 31, 2005 compared to March 31, 2004 due to fewer large dollar transactions being completed, a decrease in average license value and a generally more challenging selling environment with longer selling cycles. We recognized fewer license deals in the first quarter of 2005 compared to the same quarter of 2004 which decreased our license revenue. Furthermore, we had no transactions in the first quarter of 2005 that accounted for $1.0 million or more of license revenue compared to two transactions in excess of $1.0 million in the same quarter of 2004. In addition, the average license revenue per transaction in the first quarter of 2005 was $0.4 million compared to $0.5 million per transaction in the first quarter of 2004. We expect our license revenues to continue to fluctuate from quarter to quarter since we generally complete a relatively small number of transactions in a quarter and the prices on those software license sales can vary widely.

     Maintenance and Service Revenues. Maintenance and service revenues decreased $0.9 million or 8% for the three months ended March 31, 2005 compared to March 31, 2004 due to a decrease in overall billable hours based on fewer outside contractors. We did, however, experience a higher average billing rate for the three months ended March 31, 2005 compared to the three months ended March 31, 2004. We expect maintenance and service revenues to increase in the second quarter of 2005.

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Cost of Revenues and Gross Margin

     Cost of License Revenues. Cost of license revenues decreased $0.2 million or 63% for the three months ended March 31, 2005 compared to March 31, 2004. The decrease was attributable to lower volume of license sales resulting in lower third-party royalties. In addition, in the first quarter of 2004 we amortized approximately $100,000 of expense related to the TruePerformance source code that is now discontinued. We expect through the end of 2005 to keep license margins at or above 95%.

     Cost of Maintenance and Service Revenues. Cost of maintenance and service revenues decreased $1.4 million or 17% for the three months ended March 31, 2005 compared to March 31, 2004. We experienced an increase in maintenance and service gross margin from 28% for the three months ended March 31, 2004 compared to 35% for the three months ended March 31, 2005. The increase in maintenance and service gross margin as compared to the first quarter of 2004 was due to an increase in the percentage of higher margin maintenance revenue as compared to lower margin service revenue in the first quarter of 2005. For the three months ended March 31, 2005, professional fees expense for sub-contractors decreased $1.0 million as a result of the increase in use of our internal workforce and travel expenses decreased by $0.7 million. These decreases were partially offset by an increase in personnel costs of $0.2 million. For the second quarter of 2005, we expect to keep maintenance and service gross margins between 30% and 32%.

     Gross Margin. Our overall gross margin increased from 46% for the three months ended March 31, 2004 to 50% for the three months ended March 31, 2005. The increase in our overall gross margin is primarily attributable to the reduction of lower margin maintenance and service revenues compared to license revenues which represented 76% in the first quarter of 2005 compared to 72% in the first quarter of 2004. In addition, we experienced an increase in maintenance and service gross margin primarily attributable to the mix of higher margin maintenance revenue compared to generally lower margin service revenues. In the future, we expect our gross margins to fluctuate depending on the mix of license versus maintenance and service revenues recorded.

Operating Expenses

     The table below sets forth the changes in operating expenses from the three months ended March 31, 2004 to the three months ended March 31, 2005 (in thousands, except percentage data):

     Sales and Marketing. Sales and marketing expenses decreased $2.0 million or 31% for the three months ended March 31, 2005 compared to March 31, 2004. The decrease was primarily attributable to declines in personnel costs of $0.9 million due to a reduction in headcount, marketing programs of $0.6 million and travel of $0.5 million. We also incurred an expense of $238,000 related to separation costs paid to our former senior vice president, operations. We expect sales and marketing expenses to increase in the second quarter of 2005 compared to the first quarter of 2005 due to increased commissions, marketing programs and executive search fees for the hiring of a new Vice President of Sales.

     Research and Development. Research and development expenses decreased $0.8 million or 20% for the three months ended March 31, 2005 compared to March 31, 2004. The decreases were primarily due to declines in personnel costs of $0.3 million and reduction of contract development fees of $0.5 million related to the termination of our Cezanne research and development team in Italy that supported our now discontinued TruePerformance product. We expect our research and development expenses will increase slightly in the second quarter of 2005 compared to the first quarter of 2005 due to a planned increase in headcount.

     General and Administrative. General and administrative expenses increased $0.2 million or 12% for the three months ended March 31, 2005 compared to March 31, 2004. The increase included $115,000 of personnel costs and professional fees of $168,000 primarily due to consulting expenses relating to our Sarbanes-Oxley 404 certification project and an executive search fee for our new president and chief executive officer. We expect our general and administrative expenses to increase in the second quarter of 2005 compared to the first quarter of 2005 primarily due to professional fees associated with documenting and testing our internal controls under section 404 of the Sarbanes-Oxley Act.

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     Stock-based Compensation. Stock-based compensation expense decreased $1.3 million or 75% for the three months ended March 31, 2005 compared to March 31, 2004. The decrease is attributable to the decrease in deferred compensation that remains to be amortized. Notwithstanding the reduction, we incurred stock-based compensation expense of approximately $159,000 related the modification of stock options associated with the resignation of our senior vice president, operations in the first quarter of 2005 and also reversed $116,000 of unamortized deferred stock-based compensation as of February 28, 2005 related to unvested options held by the same individual. We expect stock-based compensation to total approximately $0.7 million for the second quarter of 2005 due to amortization of stock-based compensation and new stock-based compensation related to the appointment of our new president-elect and chief executive officer Robert Youngjohns.

Interest Expense and Interest and Other Income, Net

     The table below sets forth the changes in other income (expense) from the three months ended March 31, 2004 to the three months ended March 31, 2005 (in thousands, except percentage data):

     Interest expense decreased $68,000 or 86% for the three months ended March 31, 2005 compared to March 31, 2004. For the three months ended March 31, 2005, compared to the three months ended March 31, 2004, interest expense paid on outstanding debt decreased by approximately $9,000 due to lower average outstanding debt balances in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. Amortization of loan discounts associated with warrants granted in connection with our credit facility also decreased by $59,000 in the three months ended March 31, 2005 compared to the three months ended March 31, 2004. The warrants were fully amortized as of December 31, 2004.

     Interest and other income, net increased $51,000 or 19% for the three months ended March 31, 2005 compared to March 31, 2004. Interest and other income, net primarily includes interest income generated from cash and investment balances.

Provision for Income Taxes

     Provision for income taxes was $25,000 for the three months ended March 31, 2005 and 2004. The provision relates to income taxes currently payable on income generated from non-U.S. tax jurisdictions and state net worth taxes. We maintained a full valuation allowance against our deferred tax assets based on the determination that it was more likely than not that the deferred tax assets would not be realized.

Liquidity and Capital Resources

     As of March 31, 2005, we had $11.1 million of cash and cash equivalents and short-term investments of $50.6 million.

     Net Cash Provided by Operating Activities. Net cash provided by operating activities was $0.8 million and $21,000 for the three months ended March 31, 2005 and 2004, respectively. The significant cash receipts and outlays for the two periods are as follows (in thousands):

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     Net cash provided by operating activities increased $0.8 million for the three months ended March 31, 2005 compared to March 31, 2004. The increase was primarily attributable to decreases in employee related costs of $1.0 million due in part to reduced travel costs and professional service costs of $2.3 million primarily resulting from a $1.9 million decrease in fees paid to outside contractors in our services organization. In addition, personnel costs decreased $0.5 million due to a 9% reduction in average headcount. The decreases were partially offset by a reduction in collections of $3.6 million.

     Net Cash Provided by/Used in Investing Activities. Net cash provided by investing activities was $1.0 million for the three months ended March 31, 2005 compared to net cash used of $2.7 million for the three months ended March 31, 2004. Our cash provided by investing activities during the three months ended March 31, 2005 was primarily due to net maturities of investments of $1.3 million compared to net purchase of investments of $1.9 million for the three months ended March 31, 2004. Purchases of equipment, software, furniture and leasehold improvements were $0.4 million and $0.7 million for the three months ended March 31, 2005 and March 31, 2004, respectively.

     Net Cash Provided by/Used in Financing Activities. Net cash provided by financing activities was approximately $1.7 million for the three months ended March 31, 2005, which was a result of proceeds from stock option exercises of approximately $1.8 million, partially offset by long-term debt paydowns of approximately $149,000. Net cash used in financing activities was approximately $141,000 for the three months ended March 31, 2004, consisting of payments of approximately $188,000 for long-term debt partially offset by net proceeds from the issuance of common stock of approximately $47,000.

     We had a revolving line of credit that expired in March 2005 that permitted borrowings from time to time of up to $10 million bearing interest at the prime rate. We decided not renew the revolving line of credit. We have no off-balance sheet arrangements, with the exception of operating lease commitments, that have not been recorded in our condensed consolidated financial statements.

Contractual Obligations and Commitments

     The following table summarizes our contractual cash obligations and commercial commitments (in thousands) at March 31, 2005 and the effect such obligations are expected to have on liquidity and cash flow in future periods.

     Other obligations include two letters of credit outstanding at March 31, 2005, totaling approximately $674,000 related to our New York, New York and San Jose, California offices.

     We believe our existing cash and investment balances will be sufficient to meet our anticipated short and long term cash requirements, debt obligations and operating lease commitments. Our future capital requirements will depend on many factors, including our ability to achieve revenue growth, the timing and extent of spending to support product development efforts, sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the continuing market acceptance of our products and our ability to achieve and sustain profitability.

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Factors That Could Affect Future Results

     We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

We have a history of losses, and we cannot assure you that we will achieve and sustain profitability.

     We incurred net losses of $25.5 million and $19.1 million in fiscal 2004 and fiscal 2002, respectively, and had net income of approximately $835,000 in fiscal 2003. For the three months ended March 31, 2005, we had a net loss of $2.5 million. We have taken steps to reduce our expense levels to better track with our revenues, however, we expect to incur a loss in fiscal 2005 and cannot assure you that we will be able to achieve and sustain profitability on a quarterly or annual basis. If we cannot increase our quarterly license revenues, our future results of operations and financial condition will be harmed.

We have recently experienced changes in our senior management team and the loss of other key personnel or any inability of these personnel to perform in their new roles could adversely affect our business.

     We have recently announced the hiring of a permanent president and chief executive officer and are also in the process of hiring a new vice president of sales. In June 2004, Reed D. Taussig, who had served as our president and chief executive officer since 1997, resigned from Callidus and our board of directors and David B. Pratt, who joined our board of directors in May 2004, was appointed interim president and chief executive officer. In September 2004, Daniel J. Welch, senior vice president of EMEA and general manager of TruePerformance left the company and in February 2005, Christopher W. Cabrera, senior vice president, operations, also resigned. We currently have an acting vice president of sales.

     Our success will depend to a significant extent on our ability to assimilate our new president and chief executive officer and our ability to hire an effective vice president of sales. While our new chief executive officer is expected to join Callidus on May 31, 2005, we cannot provide any assurances that he will start on that date or at all. In addition, if we lose the services of one or more of our current executives or key employees or if one or more of our current or former executives or key employees decides to join a competitor or otherwise compete directly or indirectly with us, this could harm our business and could affect our ability to successfully implement our business plan.

Our quarterly revenues and operating results can be difficult to predict and can fluctuate substantially, which may harm our results of operations.

     Our revenues, particularly our license revenues, are difficult to forecast and are likely to fluctuate significantly from quarter to quarter due to a number of factors, many of which are outside of our control. For example, in fiscal 2004, our license revenues were substantially lower than expected due to delays in purchasing by our customers and failures to close transactions resulting in a net loss for the year.

     Factors that may cause our quarterly revenue and operating results to fluctuate include:

	•	The discretionary nature of our customers’ purchase and budget cycles and changes in their budgets for software and related purchases;
	•	competitive conditions in our industry, including new products, product announcements and special pricing offered by our competitors;
	•	our ability to hire, train and retain appropriate sales and professional services staff;
	•	customers’ concerns regarding Sarbanes-Oxley Section 404 compliance and implementing large, enterprise-wide deployments of our products;
	•	varying size, timing and contractual terms of orders for our products, which may delay the recognition of revenues;

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	•	sales cycles
	•	strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;
	•	our ability to timely complete our service obligations related to product sales;
	•	general weakening of the economy resulting in a decrease in the overall demand for computer software and services;
	•	the utilization rate of our professional services personnel and the degree to which we use third-party consulting services;
	•	changes in our pricing policies;
	•	timing of product development and new product initiatives; and
	•	changes in the mix of revenues attributable to higher-margin product license revenues as opposed to substantially lower-margin service revenues.

     In addition, we make assumptions and estimates as to the timing and amount of future revenues in budgeting our future operating costs and capital expenditures. Specifically, our sales personnel monitor the status of all proposals, including the estimated closing date and potential dollar amount of such transactions. We aggregate these estimates periodically to generate our sales forecasts and then evaluate the forecasts to identify trends in our business. Although we have reduced our expenses for future quarters to better align our costs with expected revenues, our costs are relatively fixed in the short term and a substantial portion of our license revenue contracts are completed in the latter part of a quarter. As a result, failure to complete one or more license transactions at the end of a quarter would cause our quarterly results of operations to be worse than anticipated, which could adversely affect our stock price.

Our quarterly license revenues are dependent on a relatively small number of transactions involving sales of our products to new customers, and any delay or failure in closing one or more of these transactions could adversely affect our results of operations.

     If we are unable to substantially increase our license revenues, we many be unable to achieve and sustain profitability. Our quarterly license revenues are dependent upon a relatively small number of transactions involving sales of our products to new customers, and to date recurring license revenues from existing customers have not comprised a substantial part of our revenues. As such, variations in the rate and timing of conversion of our sales prospects into revenues could result in our failure to meet revenue objectives in future periods. In addition, based upon the terms of our customer contracts, we recognize the bulk of our license revenues for a given sale either at the time we enter into the agreement and deliver the product, or over the period in which we perform any services that are essential to the functionality of the product. Unexpected changes in the size of transactions or other contractual terms late in the negotiation process or changes in the mix of contracts we enter into could therefore materially and adversely affect our license revenues in a quarter. Delays or reductions in the amount of customers’ purchases would adversely affect our revenues, results of operations and financial condition and could cause our stock price to decline.

Our stock price is likely to remain volatile.

     The trading price of our common stock has in the past and may in the future be subject to wide fluctuations in response to a number of factors, including those listed in this “Factors That Could Affect Future Results” section of this Quarterly Report and others such as:

	•	Our operating performance and the performance of other similar companies;
	•	changes in our management team;
	•	developments with respect to intellectual property rights;
	•	publication of research reports about us or our industry by securities analysts;
	•	speculation in the press or investment community;

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	•	terrorist acts; and
	•	announcements by us or our competitors of significant contracts, results of operations, projections, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments.

Our products have long sales cycles, which make it difficult to plan our expenses and forecast our results.

     The sales cycles for our products have historically been between six and twelve months for the majority of our sales, and in some cases have taken longer. In addition, we have recently been experiencing lengthening of our selling cycles. It is therefore difficult to predict the quarter in which a particular sale will occur and to plan our expenditures accordingly. The period between our initial contact with a potential customer and its purchase of our products and services is relatively long due to several factors, including:

	•	The complex nature of our products;
	•	the need to educate potential customers about the uses and benefits of our products;
	•	the requirement that a potential customer invest significant resources in connection with the purchase and implementation of our products;
	•	budget cycles of our potential customers that affect the timing of purchases;
	•	customer requirements for competitive evaluation and internal approval before purchasing our products;
	•	potential delays of purchases due to announcements or planned introductions of new products by us or our competitors; and
	•	the lengthy approval processes of our potential customers, many of which are large organizations.

     The delay or failure to complete sales in a particular quarter would reduce our revenues in that quarter, as well as any subsequent quarters over which revenues for the sale would likely be recognized. If our sales cycle unexpectedly lengthens in general or for one or more large orders, it would adversely affect the timing of our revenues. If we continue to experience delays on one or more large orders our operating results will continue to be adversely affected.

If we are unable to increase sales of new product licenses, our maintenance and service revenues will be materially and adversely affected.

     While our license revenues have declined from 2003 levels, our maintenance and service revenues have remained relatively constant. A substantial portion of our maintenance and services revenues, however, are derived from providing professional integration and configuration services associated with product licenses sold in prior periods. As such, if we are unable to increase sales of our product licenses, our services revenue will decline as well.

If we do not compete effectively with companies selling EIM software, our revenues may not grow and could decline.

     We have experienced, and expect to continue to experience, intense competition from a number of software companies. We compete principally with vendors of EIM software, enterprise resource planning software, and customer relationship management software. Our competitors may announce new products, services or enhancements that better meet the needs of customers or changing industry standards. Increased competition may cause price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, results of operations and financial condition.

     Many of our enterprise resource planning competitors and other potential competitors have significantly greater financial, technical, marketing, service and other resources than we have. Many of these companies also have a larger installed base of users, longer operating histories or greater name recognition than we have. Some of our competitors’ products may also be more effective than our products at performing particular EIM system functions or may be more customized for particular customer needs in a given market. Even if our competitors provide products with more limited EIM system functionality than our products, these products may incorporate other capabilities, such as recording and accounting for transactions, customer orders or inventory management data. A product that performs these functions, as well as some of the functions of our software solutions, may be appealing to some customers

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because it would reduce the number of different types of software used to run their business. Further, our competitors may be able to respond more quickly than we can to changes in customer requirements.

     Our products must be integrated with software provided by a number of our existing or potential competitors. These competitors could alter their products in ways that inhibit integration with our products, or they could deny or delay access by us to advance software releases, which would restrict our ability to adapt our products to facilitate integration with these new releases and could result in lost sales opportunities.

Our maintenance and service revenues produce substantially lower gross margins than our license revenues, and decreases in license revenues relative to service revenues have harmed, and may continue to harm, our overall gross margins.

     Our maintenance and service revenues, which include fees for consulting, implementation, maintenance and training, were 76%, 78% and 48% of our revenues for the three months ended March 31, 2005 and fiscal years 2004 and 2003, respectively. Our maintenance and service revenues have substantially lower gross margins than our license revenues. The decrease in the percentage of total revenues represented by license revenues in the three months ended March 31, 2005 and fiscal 2004 as compared to fiscal 2003 has adversely affected our overall gross margins. Failure to increase our higher margin license revenues in the future would again adversely affect our gross margin and operating results.

     Maintenance and service revenues as a percentage of total revenues have varied significantly from period to period due to fluctuations in licensing revenues, economic changes, change in the average selling prices for our products and services, our customers’ acceptance of our products and our sales force execution. In addition, the volume and profitability of services can depend in large part upon:

	•	Competitive pricing pressure on the rates that we can charge for our professional services;
	•	the complexity of the customers’ information technology environment;
	•	the resources directed by customers to their implementation projects; and
	•	the extent to which outside consulting organizations provide services directly to customers.

We expect maintenance and services revenue to continue to make up a substantial majority of our overall revenues for the foreseeable future and any erosion of our margins for our maintenance and service revenues would adversely affect our operating results.

Managing large-scale deployments of our products requires substantial technical implementation and support by us or third-party service providers. Failure to meet these requirements could cause a decline or delay in recognition of our revenues and an increase in our expenses.

     Our customers may require large, enterprise-wide deployments of our products, which require a substantial degree of technical implementation and support. It may be difficult for us to manage the timeliness of these deployments and the allocation of personnel and resources by us or our customers. Failure to successfully manage this process could harm our reputation and cause us to lose existing customers, face potential customer disputes or limit the number of new customers that purchase our products, each of which could adversely affect our revenues and increase our technical support and litigation costs.

     Our software license customers have the option to receive implementation, maintenance, training and consulting services from our internal professional services organization or from outside consulting organizations. In the future, we may be required to increase our use of third-party service providers to help meet our implementation and service obligations. If we require a greater number of third-party service providers than we currently have available, we will be required to negotiate additional arrangements, which may result in lower gross margins for maintenance or service revenues.

     If a customer selects a third-party implementation service provider and such implementation services are not provided successfully and in a timely manner, our customers may experience increased costs and errors, which may result in customer dissatisfaction and costly remediation and litigation, any of which could adversely impact our operating results and financial condition.

Our success depends upon our ability to develop new products and enhance our existing products. Failure to successfully introduce new or enhanced products to the market may adversely affect our operating results.

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     The enterprise application software market is characterized by:

	•	Rapid technological advances in hardware and software development;
	•	evolving standards in computer hardware, software technology and communications infrastructure;
	•	changing customer needs; and
	•	frequent new product introductions and enhancements.

     To keep pace with technological developments, satisfy increasingly sophisticated customer requirements and achieve market acceptance, we must enhance and improve existing products and we must also continue to introduce new products and services. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results. Further, any new products we develop may not be introduced in a timely manner and may not achieve the broad market acceptance necessary to generate significant revenues. For example, we introduced our TruePerformance product in the first quarter of 2003 and discontinued this product in June 2004. In connection with the discontinuation of the TruePerformance product line, we recorded impairment charges of approximately $3.8 million in the second quarter of 2004. If we are unable to successfully develop new products or enhance and improve our existing products or if we fail to position and/or price our products to meet market demand, our business and operating results will be adversely affected.

A substantial majority of our revenues are derived from TrueComp and related products and services and a decline in sales of these products and services could adversely affect our operating results and financial condition.

     We derive a substantial majority of our revenues from TrueComp and related products and services, and revenues from these products and services are expected to continue to account for a substantial majority of our revenues for the foreseeable future. Because we generally sell licenses to our products on a perpetual basis and deliver new versions and enhancements to customers who purchase maintenance contracts, our future license revenues are substantially dependent on sales to new customers. In addition, substantially all of our TrueInformation product sales have historically been made in connection with TrueComp sales. As a result of these factors, we are particularly vulnerable to fluctuations in demand for TrueComp. Accordingly, if demand for TrueComp and related products and services declines significantly, our business and operating results will, as was in the case in 2004, be adversely affected.

If we are required to change our pricing models to compete successfully, our margins and operating results will be adversely affected.

     The intensely competitive market in which we do business may require us to reduce our prices. If our competitors offer deep discounts on certain products or services in an effort gain market share or to sell other software or hardware products, we may be required to lower prices or offer other favorable terms to compete successfully. Any such changes would reduce our margins and could adversely affect our operating results. Some of our competitors may bundle software products that compete with ours for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that we can charge for our products. If we cannot offset price reductions with a corresponding increase in the number of sales or with lower spending, then the reduced revenues resulting from lower prices would adversely affect our margins and operating results.

We depend on technology of third parties licensed to us for our rules engine and the analytics and web viewer functionality for our products and the loss or inability to maintain these licenses, or errors in such software could result in increased costs or delayed sales of our products.

     We license technology from several software providers for our rules engine, analytics and web viewer. We anticipate that we will continue to license technology from third parties in the future. This software may not continue to be available on commercially reasonable terms, if at all. Some of the products we license from third parties could be difficult to replace, and implementing new software with our products could require six months or more of design and engineering work. The loss of any of these technology licenses could result in delays in the license of our products until equivalent technology, if available, is developed or identified, licensed and integrated. In addition, our products depend upon the successful operation of third-party products in conjunction with our products, and therefore any undetected errors in these products could prevent the implementation or impair the functionality of our products, delay new product introductions and/or injure our reputation. Our use of additional or alternative third-party software would

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require us to enter into license agreements with third parties, which could result in higher royalty payments and a loss of product differentiation.

Errors in our products could affect our reputation, result in significant costs to us and impair our ability to sell our products.

     Our products are complex and, accordingly, they may contain errors, or “bugs,” that could be detected at any point in their product life cycle. Errors in our products could materially and adversely affect our reputation, result in significant costs to us and impair our ability to sell our products in the future. Customers relying on our products to calculate and pay incentive compensation may have a greater sensitivity to product errors and security vulnerabilities than customers for software products in general. The costs incurred in correcting any product errors may be substantial and would adversely affect our operating margins. While we plan to continually test our products for errors and work with customers through our customer support services organization to identify and correct bugs, errors in our products may be found in the future.

     Because our customers depend on our software for their critical business functions, any interruptions could result in:

	•	Lost or delayed market acceptance and sales of our products;
	•	product liability suits against us;
	•	lost sales revenues;
	•	diversion of development resources;
	•	injury to our reputation; and
	•	increased service and warranty costs.

     While our software license agreements typically contain limitations and disclaimers that purport to limit our liability for damages for errors in our software, such limitations and disclaimers may not be enforced by a court or other tribunal or otherwise effectively protect us from such claims.

Potential customers that outsource their technology projects offshore may come to expect lower rates for professional services than we are able to provide profitably, which could impair our ability to win customers and achieve profitability.

     Many of our potential customers have begun to outsource technology projects offshore to take advantage of lower labor costs, and we believe that this trend will continue. Due to the lower labor costs in some countries, these customers may demand lower hourly rates for the professional services we provide, which may erode our margins for our maintenance and service revenues or result in lost business.

Our revenues might be harmed by resistance to adoption of our software by information technology departments.

     Some potential customers may have already made a substantial investment in other third-party or internally developed software designed to model, administer, analyze and report on pay-for-performance programs. These companies may be reluctant to abandon these investments in favor of our software. In addition, information technology departments of potential customers may resist purchasing our software solutions for a variety of other reasons, particularly the potential displacement of their historical role in creating and running software and concerns that packaged software products are not sufficiently customizable for their enterprises. If the market for our products does not grow for any of these reasons, our revenues may be harmed.

We will not be able to achieve or sustain sales growth if we do not attract and retain qualified sales personnel.

     We depend on our direct sales force for most of our sales and have made significant expenditures in past periods to expand our sales force. Despite our efforts to expand our sales force, however, we have also experienced sales force attrition and otherwise found it difficult to retain qualified sales professionals. For example, our head of sales, resigned effective February 28, 2005. While it is our goal to hire and retain qualified replacements, we face intense competition for sales personnel in the software industry, and cannot be sure that we will be successful in hiring a new vice president of sales or in retaining key sales individuals in accordance with our plans. If we fail to successfully develop a strong sales force, our future sales will be adversely affected.

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We may lose sales opportunities and our business may be harmed if we do not successfully develop and maintain strategic relationships to implement and sell our products.

     We have relationships with third-party consulting firms, systems integrators and software vendors. These third parties may provide us with customer referrals, cooperate with us in marketing our products and provide our customers with systems implementation services or overall program management. However, we do not have formal agreements governing our ongoing relationship with certain of these third-party providers and the agreements we do have generally do not include obligations with respect to generating sales opportunities or cooperating on future business. Should any of these third parties go out of business or choose not to work with us, we may be forced to increase the development of those capabilities internally, incurring significant expense and adversely affecting our operating margins. Any of our third-party providers may offer products of other companies, including products that compete with our products. We could lose sales opportunities if we fail to work effectively with these parties or they choose not to work with us.

For our business to succeed, we need to attract, train and retain qualified employees and manage our employee base effectively. Failure to do so may adversely affect our operating results.

     Our success depends on our ability to hire, train and retain qualified employees and to manage our employee base effectively. Competition for qualified personnel is intense, particularly in the San Francisco Bay area where our headquarters is located, and the high cost of living increases our recruiting and compensation costs. We cannot assure you that we will be successful in hiring, training or retaining qualified personnel. If we are unable to do so, our business and operating results will be adversely affected.

If we fail to adequately protect our proprietary rights and intellectual property, we may lose valuable assets, experience reduced revenues and incur costly litigation to protect our rights.

     We rely on a combination of copyrights, trademarks, service marks, trade secret laws and contractual restrictions to establish and protect our proprietary rights in our products and services. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. Despite our precautions, it may be possible for unauthorized third parties to copy our products and use information that we regard as proprietary to create products and services that compete with ours. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we engage in international activities, our exposure to unauthorized copying and use of our products and proprietary information will increase.

     We enter into confidentiality or license agreements with our employees and consultants and with the customers and corporations with whom we have strategic relationships and business alliances. No assurance can be given that these agreements will be effective in controlling access to and distribution of our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products. Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources, either of which could seriously harm our business.

Our results of operations may be adversely affected if we are subject to a protracted infringement claim or one that results in a significant damage award.

     From time to time, we receive claims that our products or business infringe or misappropriate the intellectual property of third parties. Our competitors or other third parties may challenge the validity or scope of our intellectual property rights. We believe that software developers will be increasingly subject to claims of infringement as the functionality of products in our market overlaps. A claim may also be made relating to technology that we acquire or license from third parties. If we were subject to a claim of infringement, regardless of the merit of the claim or our defenses, the claim could:

	•	Require costly litigation to resolve;
	•	absorb significant management time;
	•	cause us to enter into unfavorable royalty or license agreements;

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	•	require us to discontinue the sale of our products;
	•	require us to indemnify our customers or third-party systems integrators; or
	•	require us to expend additional development resources to redesign our products.

     We may also be required to indemnify our customers and third-party systems integrators for third-party products that are incorporated into our products and that infringe the intellectual property rights of others. Although many of these third parties are obligated to indemnify us if their products infringe the rights of others, this indemnification may not be adequate.

     In addition, from time to time there have been claims challenging the ownership of open source software against companies that incorporate open source software into their products. We use a limited amount of open source software in our products and may use more open source software in the future. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software. Any of this litigation could be costly for us to defend, have a negative effect on our results of operations and financial condition or require us to devote additional research and development resources to change our products.

If we do not adequately manage and evolve our financial reporting and managerial systems and processes, our ability to manage and grow our business may be harmed.

     Our ability to successfully implement our business plan and comply with regulations, including the Sarbanes-Oxley Act of 2002, requires an effective planning and management process. We expect that we will need to continue to improve existing, and implement new, operational and financial systems, procedures and controls to manage our business effectively in the future. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to accurately forecast sales demand, manage our supply chain and record and report financial and management information on a timely and accurate basis.

Mergers of or other strategic transactions by our competitors could weaken our competitive position or reduce our revenues.

     If one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could adversely affect our ability to compete effectively. Our competitors may also establish or strengthen cooperative relationships with our current or future systems integrators, third-party compensation consulting firms or other parties with whom we have relationships, thereby limiting our ability to promote our products and limiting the number of consultants available to implement our software. Disruptions in our business caused by these events could reduce our revenues.

We may expand our international operations but do not have substantial experience in international markets, and may not achieve the expected results.

     We may in the future expand our international operations. Any international expansion would require substantial financial resources and a significant amount of attention from our management. International operations involve a variety of risks, particularly:

	•	Unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
	•	differing ability to protect our intellectual property rights;
	•	differing labor regulations;
	•	greater difficulty in supporting and localizing our products;
	•	changes in a specific country’s or region’s political or economic conditions;
	•	greater difficulty in establishing, staffing and managing foreign operations; and
	•	fluctuating exchange rates.

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     We have limited experience in marketing, selling and supporting our products and services abroad. If we invest substantial time and resources in order to grow our international operations and are unable to do so successfully and in a timely manner, our business and operating results could be seriously harmed.

Acquisitions and investments present many risks, and we may not realize the anticipated financial and strategic goals for any such transactions.

     We may in the future acquire or make investments in other complementary companies, products, services and technologies. Such acquisitions and investments involve a number of risks, including:

	•	As was the case with our acquisition of an assembled workforce and source code license from Cezanne Software, we may find that the acquired business or assets do not further our business strategy, or that we overpaid for the business or assets, or that economic conditions change, all of which may generate a future impairment charge;
	•	we may have difficulty integrating the operations and personnel of the acquired business, and may have difficulty retaining the key personnel of the acquired business;
	•	we may have difficulty incorporating the acquired technologies or products with our existing product lines;
	•	there may be customer confusion where our products overlap with those of the acquired business;
	•	we may have product liability associated with the sale of the acquired business’ products;
	•	our ongoing business and management’s attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically and culturally diverse locations;
	•	we may have difficulty maintaining uniform standards, controls, procedures and policies across locations;
	•	the acquisition may result in litigation from terminated employees or third-parties; and
	•	we may experience significant problems or liabilities associated with product quality, technology and legal contingencies.

     These factors could have a material adverse effect on our business, results of operations and financial condition or cash flows, particularly in the case of a larger acquisition or multiple acquisitions in a short period of time. From time to time, we may enter into negotiations for acquisitions or investments that are not ultimately consummated. Such negotiations could result in significant diversion of management time, as well as out-of-pocket expenses.

     The consideration paid in connection with an investment or acquisition also affects our financial condition and operating results. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash to consummate such acquisitions. To the extent we issue shares of stock or other rights to purchase stock, including options or other rights, existing stockholders may be diluted and earnings per share may decrease. In addition, acquisitions may result in the incurrence of debt, large one-time write-offs (such as of acquired in-process research and development costs) and restructuring charges. They may also result in goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges.

     For instance, in December 2003, we purchased a non-exclusive license to copy, create, modify, and enhance the source code for our TruePerformance product, and in May 2004, we acquired a part of the development team of Cezanne Software in order to continue the development of the TruePerformance product. However, given our lower revenue projections and our plan to lower expenses, we made the decision to discontinue the TruePerformance product in June of 2004 and recorded a total impairment of intangible assets charge of $3.8 million.

Class action and derivative lawsuits have been filed against us and additional lawsuits may be filed.

     In July 2004, a purported class action lawsuit was filed against us and certain of our current directors and officers, by or on behalf of persons claiming to be our shareholders and persons claiming to have purchased or otherwise acquired our securities during the period from November 19, 2003 through June 23, 2004. In addition, in each of July and October 2004 derivative lawsuits were filed

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against us and certain of our current directors and officers. In February 2005, the parties stipulated to a stay of the state derivative case in favor of the federal derivative case. In February 2005, the Company filed a motion to dismiss the amended complaint. The court has scheduled a hearing on the Company’s motion for May 2005. Additional lawsuits may be filed against us in the future. We currently have director and officer insurance to cover claims that may arise in connection with these lawsuits and we believe that the claims are without merit. However, in the event of an adverse result in one of these cases, the Company’s insurance may not be sufficient to satisfy a damage award and thus such an adverse result could have a material negative financial impact on the Company. Regardless of the outcome of any of these actions, however, it is likely that such actions will cause a diversion of our management’s time and attention.

Natural disasters or other incidents may disrupt our business.

     Our business communications, infrastructure and facilities are vulnerable to damage from human error, physical or electronic security breaches, power loss and other utility failures, fire, earthquake, flood, sabotage, vandalism and similar events. Although the source code for our software products is held by escrow agents outside of the San Francisco Bay Area, our internal-use software and back-up are both located in the San Francisco Bay Area. If a natural or man-made disaster were to hit this area, we may lose all of our internal-use software data. Despite precautions, a natural disaster or other incident could result in interruptions in our service or significant damage to our infrastructure. In addition, failure of any of our telecommunications providers could result in interruptions in our services and disruption of our business operations. Any of the foregoing could impact our provision of services and fulfillment of product orders, and our ability to process product orders and invoices and otherwise timely conduct our business operations.

Our current officers, directors and entities affiliated with us may be able to exercise control over matters requiring stockholder approval.

     Our current officers, directors and entities affiliated with us together beneficially owned a significant portion of the outstanding shares of common stock as of March 31, 2005. As a result, if some of these persons or entities act together, they have the ability to control all matters submitted to our stockholders for approval, including the election and removal of directors, amendments to our certificate of incorporation and bylaws and the approval of any business combination. This may delay or prevent an acquisition or cause the market price of our stock to decline. Some of these persons or entities may have interests different than yours.

Provisions in our charter documents, our stockholder rights plan and Delaware law may delay or prevent an acquisition of our company.

     Our certificate of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. For example, if a potential acquirer were to make a hostile bid for us, the acquirer would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors has staggered terms, which means that replacing a majority of our directors would require at least two annual meetings. The acquirer would also be required to provide advance notice of its proposal to replace directors at any annual meeting, and would not be able to cumulate votes at a meeting, which would require the acquirer to hold more shares to gain representation on the board of directors than if cumulative voting were permitted. In addition, we are a party to a stockholder rights agreement, which effectively prohibits person from acquiring more than 15% (subject to certain exceptions) of our common stock without the approval of our board of directors.

     Furthermore, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. All of these factors make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders.

     Our board of directors could choose not to negotiate with an acquirer that it did not believe was in our strategic interests. If an acquirer is discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by these or other measures, you could lose the opportunity to sell your shares at a favorable price.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign exchange rates. We do not hold or issue financial instruments for trading purposes.

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     Interest Rate Risk. We invest our cash in a variety of financial instruments, consisting primarily of investments in money market accounts, high quality corporate debt obligations or United States government obligations. Our investments are made in accordance with an investment policy approved by our Board of Directors. All of our investments are classified as available-for-sale and carried at fair value, which is determined based on quoted market prices, with net unrealized gains and losses included in accumulated other comprehensive income in the accompanying condensed consolidated balance sheets.

     Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities, that typically have a shorter duration, may produce less income than expected if interest rates fall. Due in part to these factors, our investment income may decrease in the future due to changes in interest rates. At March 31, 2005, the average maturity of our investments was five months. The following table presents certain information about our financial instruments at March 31, 2005 that are sensitive to changes in interest rates (in thousands, except for interest rates):

     Our exposure to market risk also relates to the increase or decrease in the amount of interest expense we must pay on our outstanding debt instruments. We have outstanding term loans totaling $0.4 million. The term loans bear a variable interest rate based on the lender’s prime rate and prime rate plus 0.50%, respectively. The risk associated with fluctuating interest expense is limited to these debt instruments. Due to our low amount of debt as of March 31, 2005, we do not believe that any change in the prime rate would have a significant impact on our interest expense.

     Foreign Currency Exchange Risk. Our revenues and our expenses, except those related to our United Kingdom, German, Italian and Australian operations, are generally denominated in United States dollars. For the three months ended March 31, 2005, we derived approximately 13% of our revenues from our international operations. As a result, we have relatively little exposure to currency exchange risks and foreign exchange losses have been minimal to date. We expect to continue to do a majority of our business in United States dollars. We have not entered into forward exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if we believe our foreign currency exposure has increased, we may consider entering into hedging transactions to help mitigate that risk.

Item 4. Controls and Procedures

     Our chief executive officer and chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report of Callidus Software Inc. on Form 10-Q, have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were adequate and designed to ensure that material information related to us and our consolidated subsidiaries would be made known to them by others within these entities.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     In July 2004, a purported securities class action complaint was filed in the United States District Court for the Northern District of California against the Company and certain of its present and former executives and directors. The suit alleges that the Company and these executives and directors made false or misleading statements or omissions in violation of federal securities laws. The suit seeks damages on behalf of a purported class of individuals who purchased the Company’s stock during the period from November 19, 2003 through June 23, 2004. In October 2004, the court appointed a lead plaintiff. In November 2004, the lead plaintiff filed an amended complaint naming Messrs. Fior and Taussig as well as the Company as defendants and amending purported class to include individuals who purchased the Company’s stock during the period from January 22, 2004 through June 23, 2004. In addition, in each of July and October 2004, derivative complaints were also filed against the Company and certain of its present and former directors and officers in the California State Superior Court in Santa Clara, California and United States District Court for the Northern District of California. The derivative complaints allege state law claims relating to the matters alleged in the purported class action complaint referenced above. The federal derivative case has been deemed related to the federal securities case and assigned to the same judge. In February 2005, the parties stipulated to a stay of the state derivative case in favor of the federal derivative case. In February 2005, the Company filed a motion to dismiss the amended complaint. The court has scheduled a hearing on the Company’s motion for May 2005. The Company believes that the claims in the securities and derivative actions are without merit and intends to continue to vigorously defend against these claims. As of March 31, 2005, the Company has accrued approximately $130,000 for anticipated future legal costs up to the amount of its insurance retention.

     In addition, the Company is from time to time a party to various other litigation matters incidental to the conduct of its business, none of which, at the present time is likely to have a material adverse effect on the Company’s future financial results.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     We have used and intend to continue to use the net proceeds of our initial public offering for working capital and general corporate purposes, including expanding our sales efforts, research and development and international operations. Pending use for these or other purposes, we have invested the net proceeds of the offering in interest-bearing, investment-grade securities.

Item 6. Exhibits

(a) Exhibits

Availability of this Report

     We intend to make this quarterly report on Form 10-Q publicly available on our website (www.callidussoftware.com) without charge immediately following our filing with the Securities and Exchange Commission. We assume no obligation to update or revise any forward-looking statements in this quarterly report on Form 10-Q, whether as a result of new information, future events or otherwise, unless we are required to do so by law.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on May 11, 2005.

	CALLIDUS SOFTWARE INC.
	By:	/s/ RONALD J. FIOR
		Ronald J. Fior, Chief Financial Officer, Vice President Finance

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EXHIBIT INDEX
TO
CALLIDUS SOFTWARE, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005