Edgar Filing: CHORDIANT SOFTWARE INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2006

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

For the transition period from to

Commission File Number 000-29357

Chordiant Software, Inc.

(Exact name of Registrant as specified in its Charter)

Delaware	93-1051328
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

20400 Stevens Creek Boulevard, Suite 400

Cupertino, CA 95014

(Address of Principal Executive Offices including Zip Code)

(408) 517-6100

(Registrant’s Telephone Number, Including Area Code)

(Former name, former address and former fiscal year if changed since last report)

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

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

Large accelerated filer ¨

Accelerated filer x

Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of January 31, 2007, there were 79,842,253 shares of the registrant’s common stock outstanding.

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CHORDIANT SOFTWARE, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED DECEMBER 31, 2006

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION		Page No.

Item 1.	Financial Statements (unaudited)	3

	Condensed Consolidated Balance Sheets as of December 31, 2006 and September 30, 2006	3

	Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended December 31, 2006 and 2005	4

	Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2006 and 2005	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	39

Item 4.	Controls and Procedures	40

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	42

Item 1A.	Risk Factors	44

Item 6.	Exhibits	53

	Signatures	53

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

CHORDIANT SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)

		December 31, 2006			September 30, 2006

ASSETS
Current assets:
Cash and cash equivalents	$	47,386		$	45,278
Restricted cash		162			185
Accounts receivable, net, including $44 and $142 due from related parties at December 31, 2006 and September 30, 2006, respectively		40,835			19,025
Prepaid expenses and other current assets		8,663			5,210
Total current assets		97,046			69,698
Restricted cash—long-term		440			334
Property and equipment, net		2,885			2,630
Goodwill		32,044			32,044
Intangible assets, net		3,634			3,937
Other assets		3,451			2,860
Total assets	$	139,500		$	111,503

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable, including $162 and $132 due to related parties at December 31, 2006 and September 30, 2006, respectively`	$	5,436		$	7,665
Accrued expenses		20,762			15,706
Deferred revenue, including related party balances of $50 and $112 at December 31, 2006 and September 30, 2006, respectively		45,131			23,909
Current portion of capital lease obligations		40			95
Total current liabilities		71,369			47,375
Deferred revenue—long-term		16,385			5,596
Restructuring costs, net of current portion		3,409			1,239
Other long-term liabilities		289			68
Total liabilities		91,452			54,278
Commitments and contingencies (Notes 6, 7 and 8)

Stockholders’ equity:
Preferred stock, $0.001 par value; 51,000 shares authorized; none issued and outstanding at December 31, 2006 and September 30, 2006		—			—
Common stock, $0.001 par value; 300,000 shares authorized; 79,842 and 80,075 shares issued and outstanding at December 31, 2006 and September 30, 2006, respectively		80			80
Additional paid-in capital		287,512			286,392
Accumulated deficit		(243,692	)		(232,943	)
Accumulated other comprehensive income		4,148			3,696
Total stockholders’ equity		48,048			57,225
Total liabilities and stockholders’ equity	$	139,500		$	111,503

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CHORDIANT SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended December31,
		2006			2005
					(restated) (1)
Revenues:
License	$	7,162		$	9,126
Service, including related party items aggregating $144 and $65 for the three months ended December 31, 2006 and 2005, respectively.		15,777			13,432
Total revenue		22,939			22,558
Cost of revenues:
License		454			443
Service including related party items aggregating $177 and nil for the three months ended December 31, 2006 and 2005, respectively		7,466			6,385
Amortization of intangible assets		303			303
Total cost of revenue		8,223			7,131
Gross profit		14,716			15,427
Operating expenses:
Sales and marketing		7,264			8,140
Research and development		6,296			4,517
General and administrative		5,611			4,719
Restructuring expense		6,472			—
Total operating expense		25,643			17,376
Loss from operations		(10,927	)		(1,949	)
Interest income, net		304			199
Other income (expense), net		(15	)		118
Loss before income taxes		(10,638	)		(1,632	)
Provision for income taxes		111			121
Net loss	$	(10,749	)	$	(1,753	)

Other comprehensive loss:
Foreign currency translation gain (loss)		452			(293	)
Comprehensive loss	$	(10,297	)	$	(2,046	)

Net loss per share— basic and diluted	$	(0.14	)	$	(0.02	)
Weighted average shares used in computing basic and diluted loss per share		79,312			76,824

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CHORDIANT SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Three Months Ended December 31,
		2006			2005
					(restated) (1)
Cash flows from operating activities:
Net loss	$	(10,749	)	$	(1,753	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		350			281
Amortization of intangibles and capitalized software		528			528
Non-cash stock-based compensation expense		976			1,100
Provision (benefit) for doubtful accounts and sales returns		111			(25	)
Loss on disposal of assets		489			—
Other non-cash charges		445			—
Changes in assets and liabilities:
Accounts receivable		(22,698	)		(376	)
Prepaid expenses and other current assets		(3,497	)		(1,255	)
Other assets		(263	)		(57	)
Accounts payable		(2,298	)		(963	)
Accrued expenses		7,273			2,494
Deferred revenue		31,727			1,532
Net cash provided by operating activities		2,394			1,506
Cash flows from investing activities:
Property and equipment purchases		(1,058	)		(134	)
Proceeds from release of (increase in) restricted cash		(81	)		1,485
Net cash provided by (used for) investing activities		(1,139	)		1,351
Cash flows from financing activities:
Proceeds from exercise of stock options		221			528
Payment on capital leases		(56	)		(52	)
Net cash provided by financing activities		165			476
Effect of exchange rate changes		688			(413	)
Net increase in cash and cash equivalents		2,108			2,920
Cash and cash equivalents at beginning of period		45,278			38,546
Cash and cash equivalents at end of period	$	47,386		$	41,466

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1—THE COMPANY

Chordiant Software, Inc. (“the Company”, “Chordiant”, or “we”) is an enterprise software vendor that offers software solutions for global business-to-consumer companies that seek to improve the quality of their customer interactions and to reduce costs through increased employee productivity and process efficiencies. The Company concentrates on serving global customers in retail, financial services, insurance, healthcare, communications and other consumer direct industries.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The accompanying Condensed Consolidated Financial Statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The September 30, 2006 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended September 30, 2006 (“2006 Form 10-K”) filed with the SEC.

All adjustments, consisting of only normal recurring adjustments, which in the opinion of management, are necessary to state fairly the financial position, results of operations and cash flows for the interim periods presented have been made. The results of operations for interim periods are not necessarily indicative of the results expected for the full fiscal year or for any future period.

Restatement relating to stock-based compensation

The financial information as of, and for the three months ended December 31, 2005 is labeled restated as it has been revised from the amounts previously filed in our Quarterly Report on Form 10-Q filed with the SEC on February 9, 2007. The restatement is further discussed in the Explanatory Note preceding Part 1, Item 1 and in Note 3 of the Consolidated Financial Statements in the Company’s 2006 Form 10-K.

Reclassifications

Certain reclassifications have been made to prior period balances to conform to the current period’s presentation.

Principles of consolidation

The accompanying unaudited Condensed Consolidated Financial Statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of estimates

The preparation of Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

On an on-going basis, the Company evaluates the estimates, including those related to the allowance for doubtful accounts, valuation of goodwill and intangible assets, valuation of deferred tax assets, certain variables associated with the valuation of stock-based compensation, restructuring costs, contingencies, vendor specific evidence of fair value in multiple element arrangements and the estimates associated with the percentage-of-completion method of accounting for certain of our revenue contracts. The Company bases these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Revenue recognition

The Company derives revenue from licensing our software and related services, which include assistance in implementation, customization and integration, post-contract customer support, training and consulting. All revenue amounts are presented net of sales taxes in the Company’s condensed consolidated statements of operations. The amount and timing of revenue is difficult to predict and any shortfall in revenue or delay in recognizing revenue could cause operating results to vary significantly from period to period and could result in additional operating losses. The accounting rules related to revenue recognition are complex and are affected by interpretation of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant estimates based on judgment.

Software license revenue is recognized in accordance with Statement of Position No. 97-2 “Software Revenue Recognition,” as amended by Statement of Position No. 98-9 “Software Revenue Recognition with Respect to Certain Arrangements” (collectively “SOP 97-2”).

For arrangements with multiple elements, the Company recognizes revenue for services and post-contract customer support based upon VSOE of fair value of the respective elements. VSOE of fair value for the services element is based upon the standard hourly rates charge for the services when such services are sold separately. The VSOE of fair value for annual post-contract customer support is generally established with the contractual future renewal rates included in the contracts when the renewal rate is substantive and consistent with the fees when support services are sold separately. When contracts contain multiple elements and VSOE of fair value exists for all undelivered elements, the Company accounts for the delivered elements, principally the license portion, based upon the “residual method” as prescribed by SOP 97-2. In multiple element transactions where VSOE is not established for an undelivered element, revenue is recognized upon the establishment of VSOE for that element or when the element is delivered.

At the time a transaction is entered into, the Company assesses whether any services included within the arrangement require significant implementation or customization essential to the functionality of our products. For contracts for products that do not involve significant implementation or customization essential to the product functionality, the Company recognizes license revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred as prescribed by SOP 97-2. For contracts that involve significant implementation or customization essential to the functionality of our products, the license and professional consulting services revenue is recognized using either the percentage-of-completion method or the completed contract method as prescribed by Statement of Position No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts” (“SOP 81-1”).

The percentage-of-completion method is applied when the Company has the ability to make reasonable dependable estimates of the total effort required for completion using labor hours incurred as the measure of progress towards completion. The progress toward completion is measured based on the “go-live” date. The “go-live” date is defined as the date the essential product functionality has been delivered or the application enters into a production environment or the point at which no significant additional Chordiant supplied professional service resources are required. Estimates are subject to revisions as the contract progresses to completion. The changes are accounted for as changes in accounting estimates when the information becomes known. Information impacting estimates obtained after the balance sheet date but before the issuance of the financial statements is used to update the estimates. Provisions for estimated contract losses, if any, are recognized in the period in which the loss becomes probable and can be reasonably estimated. When additional licenses are sold related to the original licensing agreement, revenue is recognized upon delivery if the project has reached the go-live date, or if the project has not reached the go-live date, revenue is recognized under the percentage-of-completion method. Revenue from these arrangements are classified as license and service revenue based upon the estimated fair value of each element using the residual method.

The completed contract method is applied when the Company is unable to obtain reasonable dependable estimates of the total effort required for completion. Under the completed contract method, all revenue and related costs of revenue are deferred and recognized upon completion.

For product co-development arrangements relating to software products in development prior to the consummation of the individual arrangements, where the Company retains the intellectual property being developed, and intend to sell the resulting products to other customers, license revenue is deferred until the delivery of the final product, provided all other requirements of SOP 97-2 are met. Expenses associated with these co-development arrangements are accounted for under SFAS 86 and are normally expensed as incurred as they are considered to be research and development costs that do not qualify for capitalization or deferral.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Revenue from subscription or term license agreements, which include software and rights to unspecified future products or maintenance, is recognized ratably over the term of the subscription period. Revenue from subscription or term license agreements, which include software, but exclude rights to unspecified future products or maintenance, is recognized upon delivery of the software if all conditions of recognizing revenue have been met including that the related agreement is non-cancelable, non-refundable and provided on an unsupported basis.

Revenue for post-contract customer support is recognized ratably over the support period which ranges from one to three years.

Training and consulting services revenue is recognized as such services are performed on an hourly or daily basis for time and material contracts. For consulting services arrangements with a fixed fee, revenue is recognized on a percentage-of-completion method.

For all sales, either a signed license agreement or a binding purchase order with an underlying master license agreement is used as evidence of an arrangement. Sales through third party systems integrators are evidenced by a master agreement governing the relationship together with binding purchase orders or order forms on a transaction-by-transaction basis. Revenues from reseller arrangements are recognized on the “sell-through” method, when the reseller reports to the Company the sale of our software products to end-users. The Company’s agreements with customers and resellers do not contain product return rights.

Collectibility is assessed based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. Collateral is generally not requested from our customers. If it is determined that the collection of a fee is not probable, the revenue is recognized at the time the collection becomes probable, which is generally upon the receipt of cash. If a transaction includes extended payment terms, the revenue is recognized as the payments become due and payable.

Restricted cash

At December 31, 2006 and September 30, 2006, interest-bearing certificates of deposit were classified as restricted cash. These deposits serve as collateral for letters of credit securing certain facility and equipment lease obligations. The increase of less than $0.1 million in restricted cash during the quarter ended December 31, 2006, resulted from a bank guarantee associated with the property lease for the Company’s Netherlands office.

Concentrations of credit risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, restricted cash and accounts receivable. To date, the Company has invested excess funds in money market accounts. The Company has cash and cash equivalents with various high quality institutions domestically and internationally.

Our accounts receivable are derived from sales to customers located in North America and Europe. The Company performs ongoing credit evaluations of our customers’ financial condition and, generally, require no collateral from our customers. The Company maintains an allowance for doubtful accounts when deemed necessary. To date, bad debts have not been material and have been within management expectations. The Company estimates its allowance for doubtful accounts is $0.2 million and $0.1 million as of December 31, 2006 and September 30, 2006, respectively.

The following table summarizes the revenues from customers and resellers that accounted for 10% or more of total revenues:

	Three Months Ended December 31,
		2006		2005
Citicorp Credit Services, Inc.		13	%	*
International Business Machines (“IBM”)		11	%	*
Lloyds TSB Bank plc		10	%	*
ING Canada, Inc.		*		10	%

* Represents less than 10% of total revenues.

As previously announced, the Company has agreed to license certain of its software to IBM’s customers. At December 31, 2006, Citicorp Credit Services, Inc. and IBM accounted for 51% and 13%, of our accounts receivable, respectively. At September 30, 2006, IBM and Cash America International accounted for 26% and 14% of our accounts receivable, respectively.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Research and Development

Costs incurred in the research and development of new products and enhancements to existing products are charged to expense as incurred until the technological feasibility of the product or enhancement has been established. Technological feasibility of the product is determined after the completion of a detailed program design and a determination has been made that any uncertainties related to high-risk development issues have been resolved. If the process of developing the product does not include a detail program design, technological feasibility is determined only after completion of a working model. After establishing technological feasibility, additional development costs incurred through the date the product is available for general release to customers are capitalized and amortized over the estimated product life.

When technological feasibility is established through the completion of a working model, the period of time between achieving technological feasibility and the general release of new product is generally short and software development costs qualifying for capitalization have historically been insignificant.

During the quarter ended September 30, 2006, technological feasibility to port an existing product to a new platform was established through the completion of a detailed program design. Costs aggregating $0.3 million associated with this product have been capitalized and included in Other Assets as of September 30, 2006. This product has not been completed as of December 31, 2006, accordingly the costs capitalized have not been amortized.

During the quarter ended September 30, 2005, the Company began amortizing capitalized software costs associated with its banking product. The capitalized costs included in Other Assets are being amortized using the straight-line method over the remaining estimated economic life of the product which is 36 months. For the three months ended December 31, 2006 and 2005, amortization expense, included in cost of revenue for licenses, related to this product was $0.2 million.

Income Taxes

Income taxes are accounted for using an asset and liability approach, which requires the recognition of taxes payable or refundable for the current period and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

The Company provides a valuation allowance for deferred tax assets when it is more likely than not that the net deferred tax assets will not be realized. Based on a number of factors, including the lack of a history of profits, future taxable income and the fact that the market in which the Company competes is competitive and characterized by rapidly changing technology, it is believed that there is sufficient uncertainty regarding the realization of deferred tax assets such that a full valuation allowance has been provided. At December 31, 2006, the Company had approximately $161.1 million and $10.2 million of net operating loss carryforwards for federal and state purposes, respectively, and net operating loss carryforwards of approximately $35.8 million in the United Kingdom.

Under U.S. tax rules, Section 382 of the Internal Revenue Code (IRC), as amended, certain limitations are imposed on the use of net operating losses following certain defined changes in ownership. The Company performed an analysis of it’s historical ownership changes and concluded that four such changes have occurred since inception. As a result of the IRC Section 382 study, approximately $2.7 million of the $161.1 million of net operating loss carryforwards at December 31, 2006 will expire unutilized.

Subsequent ownership changes, as defined in Section 382, could further limit the amount of net operating loss carryforwards and research and development credits that can be utilized annually to offset future taxable income, if any.

Net loss per share

Basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period excluding common stock subject to repurchase. The calculation of diluted net loss per share excludes potential common shares as their effect is anti-dilutive. Potential common shares consist of common shares issuable upon the exercise of stock options, warrants (using the treasury stock method) and common shares subject to repurchase by the Company.

The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except for per share data):

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

	Three Months Ended December 31,
		2006			2005
					(restated)(1)
Net loss available to common stockholders	$	(10,749	)	$	(1,753	)
Weighted average common stock outstanding		79,705			78,561
Common stock subject to repurchase		(393	)		(1,737	)
Denominator for basic and diluted calculation		79,312			76,824
Net loss per share - basic and diluted	$	(0.14	)	$	(0.02	)

(1) - See the above paragraph “Restatement relating to stock-based compensation” included in this Note.

The following table sets forth the potential total common shares that are excluded from the calculation of diluted net loss per share as their effect is anti-dilutive as of the dates indicated (in thousands):

	December 31, 2006	December 31, 2005
Warrants outstanding	—	1,662
Employee stock options	8,860	8,240
Restricted stock	393	1,737
	9,253	11,639

Recent Accounting Pronouncements

In December 2006, the Financial Accounting Standards Board (FASB) issued Staff Position (FSP) EITF 00-19-2, “Accounting for Registration Payment Arrangements.” This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, “Accounting for Contingencies.” The guidance is effective for fiscal years beginning December 15, 2006. The Company has evaluated the new pronouncement and has determined that it will not have a significant impact on the determination or reporting of our financial results.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The guidance is applicable for fiscal years ending after November 15, 2006. The Company has evaluated the new statement and has determined that it will not have a significant impact on the determination or reporting of our financial results.

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurement” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and also expands disclosures about fair value measurements. The SFAS 157 is effective for periods beginning after November 15, 2007. The Company is currently evaluating the effects of implementing this new standard.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in its financial statements the impact of a tax position based on the technical merits of the position. This interpretation is effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings; accordingly, the Company expects to adopt this standard in its fiscal year commencing October 1, 2007. The Company is currently evaluating the effects of implementing this new standard.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 3—BALANCE SHEET COMPONENTS

Accounts receivable

Accounts receivable, net consists of the following (in thousands):

		December 31, 2006			September 30, 2006
Accounts receivable, net:
Accounts receivable	$	41,029		$	19,108
Less: allowance for doubtful accounts		(194	)		(83	)
	$	40,835		$	19,025

Prepaid expenses and other current assets

Prepaid expense and other current assets consist of the following (in thousands):

		December 31, 2006		September 30, 2006
Prepaid expense and other current assets:
Prepaid commissions and royalties	$	6,142	$	3,265
Other prepaid expenses and current assets		2,521		1,945
	$	8,663	$	5,210

Property and equipment

Property and equipment, net consists of the following (in thousands):

		December 31, 2006			September 30, 2006
Property and equipment, net:
Computer hardware (useful lives of 3 years)	$	3,675		$	3,313
Purchased internal-use software (useful lives of 3 years)		2,180			2,254
Furniture and equipment (useful lives of 3 to 7 years)		841			1,043
Computer equipment and software under capital leases (useful lives of 3 years)		549			549
Leasehold improvements (shorter of 7 years or the term of the lease)		2,961			2,729
		10,206			9,888
Accumulated depreciation and amortization		(7,321	)		(7,258	)
	$	2,885		$	2,630

Intangible assets

Intangible assets consists of the following (in thousands):

	December 31, 2006							September 30, 2006
		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Intangible assets:
Developed technologies	$	6,904	$	(4,197	)	$	2,707	$	6,904	$	(3,972	)	$	2,932
Customer list and trade-names		2,732		(1,805	)		927		2,732		(1,727	)		1,005
	$	9,636	$	(6,002	)	$	3,634	$	9,636	$	(5,699	)	$	3,937

All of our acquired intangible assets are subject to amortization and are carried at cost less accumulated amortization. Amortization is computed on a straight line basis over the estimated useful lives of five years. Aggregate amortization expense for intangible assets totaled $0.3 million for each of the quarters ended December 31, 2006 and 2005, respectively. The Company expects amortization expense on acquired intangible assets to be $0.9 million for the remainder of fiscal year 2007, $1.2 million in fiscal year 2008, $1.2 million in fiscal year 2009 and $0.6 million in fiscal year 2010.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Other assets

Other assets consist of the following (in thousands):

		December 31, 2006		September 30, 2006
Other assets:
Long-term accounts receivable	$	985	$	—
Other assets		2,466		2,860
	$	3,451	$	2,860

The long-term accounts receivable balance represents a receivable from a single customer related to a sale transaction that occurred during the quarter ended December 31, 2006. This amount represents the third and final payment which is due in the quarter ending December 2008. All revenue associated with this receivable has been deferred and will not be recognized until the payment becomes due. As of December 31, 2006, an allowance has not been provided for this receivable based on the Company’s assessment of the underlying customer’s credit worthiness.

Accrued expenses

Accrued expenses consist of the following (in thousands):

		December 31, 2006		September 30, 2006
Accrued expenses:
Accrued payroll, payroll taxes and related expenses	$	10,618	$	7,627
Accrued restructuring expenses, current portion (Note 4)		2,613		655
Accrued third party consulting fees		1,096		1,491
Accrued income, sales and other taxes		4,143		2,545
Accrued professional fees		1,012		1,630
Other accrued liabilities		1,280		1,758
	$	20,762	$	15,706

NOTE 4—RESTRUCTURING

Restructuring Costs

Through December 31, 2006, the Company has approved certain restructuring plans to, among other things, reduce its workforce and consolidate facilities. Restructuring and asset impairment charges have been recorded to align our cost structure with changing market conditions and to create a more efficient organization. Our restructuring charges have been comprised primarily of: (i) severance and termination benefit costs related to the reduction of our workforce; and (ii) lease termination costs and costs associated with permanently vacating certain facilities. The Company accounted for each of these costs in accordance with SFAS No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities” or previous guidance under EITF 94-3.

Retroactive application of SFAS 146 to periods prior to January 1, 2003, was prohibited; accordingly, the accrual relating to facilities vacated prior to the effective date of SFAS 146 continues to be accounted for in accordance with the guidance of EITF 94-3. The accrual for facilities does not reflect any adjustments relating to the estimated net present value of cash flows associated with the facilities.

For each of the periods presented herein, restructuring charges consist solely of:

• Severance and Termination Benefits—These costs represent severance and payroll taxes related to restructuring plans.

• Excess Facilities—These costs represent future minimum lease payments related to excess and abandoned office space under lease, the disposal of property and equipment including facility leasehold improvements, net of estimated sublease income and planned company occupancy.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

As of December 31, 2006, the total restructuring accrual of $6.0 million consisted of the following (in thousands):

	Current		Non-Current		Total
Severance and termination	$	673	$	—	$	673
Excess facilities		1,940		3,409		5,349
Total	$	2,613	$	3,409	$	6,022

As of December 31, 2006, and September 30, 2006, $2.6 million and $0.7 million related to the restructuring reserve are included in the accrued expenses line item on the balance sheet, respectively. The allocation between current portion and long term portion is based on the current lease agreements.

The Company expects the remaining severance and termination benefit accrual will be substantially paid by September 30, 2007.

Included in the facilities reserve is a note payable associated with the buyout of an office lease located in New York City. The amount of the note payable is $0.1 million and is payable in quarterly installments through June 2011. The Company expects to pay the excess facilities amounts related to restructured or vacated leased office space as follows (in thousands):

Fiscal Year Ended September 30,		Total Future Minimum Payments
2007 (remaining nine months)	$	1,765
2008		1,101
2009		922
2010		1,411
2011		150
Total	$	5,349

Included in the future minimum lease payments schedule is an estimated offset of $1.8 million for sublease rental income. As of January 2007, the Company has not yet identified sublease tenants for either of the two vacated facilities.

Fiscal Year 2007 Restructuring

In October 2006, the Company initiated a restructuring plan intended to align its resources and cost structure with expected future revenues. The restructuring plan included a balancing of service resources worldwide, elimination of duplicative functions internationally, and a shift in the U.S. field organization toward a focus on domain-based sales and pre-sales teams. As a result of the restructuring plan, management undertook a reduction of 33 positions or approximately 10% of the Company’s workforce and consolidation of the European headquarters and the closure of the France office. In connection with this action, the Company incurred a one-time restructuring charge of $6.5 million in the first quarter ended December 31, 2006 for severance and termination benefits, and excess facilities charged to restructuring expense in the condensed consolidated statements of operations. The Company accrued lease costs pertaining to the consolidation of excess facilities relating to lease terminations and non-cancelable lease costs. This expense is net of estimated sublease income based on current comparable rates for leases in the respective markets. If facilities rental rates decrease in these markets or if it takes longer than expected to sublease these facilities, the maximum amount by which the actual loss could exceed the original estimate is approximately $0.6 million.

The following table summarizes the activity related to the fiscal year 2007 restructuring (in thousands):

		Severance and Benefits			Excess Facilities			Total
Reserve balance as of September 30, 2006	$	—		$	—		$	—
Total charges		1,710			4,762			6,472
Non-cash		(6	)		(1,096	)		(1,102	)
Cash paid		(1,064	)		—			(1,064	)
Reserve balance as of December 31, 2006	$	640		$	3,666		$	4,306

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Fiscal Year 2005 Restructuring

In May 2005, the Company appointed a task force to improve profitability and control expenses. The goal of the task force was to create a better alignment of functions within the Company, to make full utilization of the Company’s India development center, to develop a closer relationship between the Company’s field operations and customers, to review the sales and implementation models, as well adjust as the organization model to flatten management levels, to review the Company’s product line, and to enhance the Company’s business model for profitability and operating leverage. This work resulted in an approximate 10% reduction in the Company’s workforce, and in July 2005 affected employees were notified. In connection with this action, the Company incurred a one-time restructuring charge of $1.1 million in the fourth quarter ended September 30, 2005 for severance and termination benefits.

The following table summarizes the activity related to the fiscal year 2005 restructuring (in thousands):

		Severance and Benefits
Reserve balance as of September 30, 2006	$	32
Non-cash		1
Cash paid		—
Reserve balance as of December 31, 2006	$	33

Prior Restructurings

During fiscal year 2002, based upon our continued evaluation of economic conditions in the information technology industry and our expectations regarding revenue levels, we restructured several areas of the Company to reduce expenses and improve our revenue per employee. This restructuring program included a worldwide workforce reduction, and consolidation of excess facilities and certain business functions. We believe that these reductions and realignments have resulted in a more responsive management structure. As part of these restructuring programs, we recorded a total workforce reduction expense relating to severance and termination benefits of approximately $2.0 million and $3.8 million for years ended December 31, 2003 and 2002, respectively. In addition to these costs, we accrued lease costs related to excess facilities of $0.2 million and $2.8 million during the years ended December 31, 2003 and 2002, respectively, pertaining to the consolidation of excess facilities relating to lease terminations and non-cancelable lease costs. This expense is net of estimated sublease income based on current comparable rates for leases in the respective markets. If facilities rental rates decrease in these markets or if it takes longer than expected to sublease these facilities, the maximum amount by which the actual loss could exceed the original estimate is approximately $1.2 million.

The following table summarizes the activity related to the restructuring for the three months ended December 31, 2006 (in thousands):

		Facilities
Reserve balance as of September 30, 2006	$	1,862
Cash paid		(179	)
Reserve balance as of December 31, 2006	$	1,683

NOTE 5—RELATED PARTY TRANSACTIONS

In August 2005, the Company entered into a service provider agreement with Infogain Corporation. Samuel T. Spadafora, one of our former directors and executive officers, is a director of Infogain. Mr. Spadafora terminated his relationship with the Company in November 2006. Pursuant to the service provider agreement, revenue from Infogain was $0.1 million and less than $0.1 million for three months ended December 31, 2006 and 2005, respectively. Cost of revenues for services provided to Infogain was $0.2 million and nil for the three months ended December 31, 2006 and 2005, respectively. Accounts receivable was less than $0.1 million as of December 31, 2006 and September 30, 2006. Payments made to Infogain Corporation for the three months ended December 31, 2006 was $0.1 million and the corresponding accounts payable balance at December 31, 2006 was $0.2 million. Payments made to Infogain Corporation for the three months ended December 31, 2005 was less than $0.1 million and the corresponding accounts payable balance at December 31, 2005 was $0.1 million.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Charles E. Hoffman, a director of the Company, is the President and Chief Executive Officer of Covad Communications Group, Inc. (“Covad”), a customer of ours. Pursuant to software license and services agreements, revenue from Covad was $0.1 million for the three months ended December 31, 2006 and 2005, respectively. Accounts receivable from Covad was nil and $0.2 million as of December 31, 2006 and September 30, 2006, respectively.

NOTE 6—BORROWINGS

Revolving line of credit

The Company’s revolving line of credit with Comerica Bank was amended and restated on March 8, 2006 and was extended to March 7, 2008. The terms of the agreement include a $5.0 million line of credit and require the Company to maintain (i) at least a $5.0 million cash balance in Comerica Bank accounts, (ii) a minimum quick ratio of 2.00 to 1.00, and (iii) subordinate any debt issuances subsequent to the effective date of the agreement, and certain other covenants. All assets of the Company have been pledged as collateral on the credit facility. Due to the Company failing to timely file its periodic reports on Form 10-K for the year ended September 30, 2006 and on Form 10-Q for the quarter ended June 30, 2006, the line of credit agreement was amended in August 2006, November 2006, and December 2006 to extend the deadline related to the filing of its periodic reports to February 20, 2007. As of the date of this Quarterly Report on Form 10-Q, the Company is current with its SEC regulatory filings.

The revolving line of credit contains a provision for a sub-limit of up to $5.0 million for issuances of standby commercial letters of credit. As of December 31, 2006, the Company had utilized $1.0 million of the standby commercial letter of credit limit of which $0.5 million serves as collateral for computer equipment leases for Ness (see Note 7). The revolving line of credit also contains a provision for a sub-limit of up to $3.0 million for issuances of foreign exchange forward contracts. As of December 31, 2006, the Company had not entered into any foreign exchange forward contracts. Pursuant to the amendment in March 2006, the Company is required to secure our standby commercial letters of credit and foreign exchange forward contracts through March 7, 2008. If these have not been secured to Comerica Bank’s satisfaction, our cash and cash equivalent balances held by Comerica Bank automatically secure such obligations to the extent of the then continuing or outstanding and undrawn letters of credit or foreign exchange contracts.

Borrowings under the revolving line of credit bear interest at the lending bank’s prime rate. Except for the standby commercial letters of credit, as of December 31, 2006, there was no outstanding balance on our revolving line of credit. Advances are available on a non-formula basis up to $5.0 million.

NOTE 7—COMMITMENTS AND CONTINGENCIES

The Company leases our facilities and certain equipment under non-cancelable operating leases that expire on various dates through 2013. Rent expense is recognized on a straight line basis over the lease term. In addition, the Company has entered into non-cancelable capital leases having expiration dates through 2007. Future minimum lease payments as of December 31, 2006 are as follows (in thousands):

		Capital Leases			Operating Leases
Fiscal year ended September 30:
2007 (remaining nine months)	$	40		$	3,664
2008		—			4,065
2009		—			3,324
2010		—			3,096
2011		—			1,535
Thereafter		—			1,209
Total minimum payments	$	40		$	16,893
Less: amount representing interest		—
Present value of minimum lease payments		40
Less: current portion of capital lease obligations		(40	)
Capital lease obligations, non-current	$	—

Operating lease payments in the table above include approximately $7.2 million for operating lease commitments for

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

facilities that are included in restructuring charges. As of December 31, 2006, the Company does not have any sublease income contractually committed for future periods relating to facilities under operating leases. See Note 4, Restructuring Charges, for a further discussion.

Ness Technologies

The Company entered into an agreement with Ness Technologies Inc., Ness Global Services, Inc. and Ness Technologies India, Ltd. (collectively, “Ness”), effective December 15, 2003, pursuant to which Ness provides our customers with technical product support through a worldwide help desk facility, a sustaining engineering function that serves as the interface between technical product support and our internal engineering organization, product testing services and product development services (collectively, the “Services”). The agreement had an initial term of three years and was extended for an additional one year term. Under the terms of the agreement, the Company pays for services rendered on a monthly fee basis, including the requirement to reimburse Ness for approved out-of-pocket expenses. The agreement may be terminated for convenience by the Company, subject to the payment of a termination fee. On June 16, 2004, March 15, 2005, January 30, 2006, and May 30, 2006, and September 11, 2006 the Company further expanded its agreement with Ness whereby Ness is providing certain additional technical and consulting services. The additional agreements can be cancelled at the option of the Company without the payment of a termination fee. The remaining minimum purchase commitment under these agreements, if Chordiant was to cancel the contracts, was approximately $0.6 million at December 31, 2006. In addition to service agreements, the Company has also guaranteed certain equipment lease obligations of Ness (see Note 6). Ness may procure equipment to be used in performance of the Services, either through leasing arrangements or direct cash purchases, for which the Company is obligated under the agreement to reimburse them. In connection with the procurement of equipment, Ness has entered into a 36 month equipment lease agreement with IBM India and, in connection with the lease agreement the Company has issued a standby letter of credit in the amount of $0.5 million in guarantee of Ness’ financial commitments under the lease. Over the term of the lease, our obligation to reimburse Ness is approximately equal to the amount of the guarantee.

The Company has evaluated the obligation under the standby letter of credit and, pursuant to the requirements as set forth under FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” a liability equal to the estimated fair value of the guarantee was included in accrued expenses at December 31, 2006. The amount is less than $0.1 million.

Indemnification

As permitted under Delaware law, the Company has agreements whereby the Company indemnify our officers, directors and certain employees for certain events or occurrences while the employee, officer or director is, or was serving, at our request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a Director and Officer insurance policy that limits our exposure and may enable the Company to recover a portion of any future amounts paid. Future payments may be required to defend current and former directors in the derivative class action lawsuits described in Note 8. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2006.

The Company entered into standard indemnification agreements in our ordinary course of business. Pursuant to these agreements, the Company agrees to indemnify, defend, hold harmless, and to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners or customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. The Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2006.

The Company enters into arrangements with our business partners, whereby the business partners agree to provide services as subcontractors for our implementations. The Company may, at our discretion and in the ordinary course of business, subcontract the performance of any of our services. Accordingly, the Company enters into standard indemnification agreements with our customers, whereby the Company indemnifies them for other acts, such as personal property damage by our subcontractors. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has general and umbrella insurance policies that may enable the Company to recover a portion of any amounts paid. The Company has not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2006.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

When, as part of an acquisition, the Company acquires all of the stock or all of the assets and liabilities of a company, the Company may assume the liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments, if any, the Company could be required to make for such obligations is undeterminable at this time. Accordingly, the Company has no amounts recorded for these contingent liabilities as of December 31, 2006.

The Company warrants that our software products will perform in all material respects in accordance with our standard published specifications and documentation in effect at the time of delivery of the licensed products to the customer for a specified period of time. Additionally, the Company warrants that our maintenance and consulting services will be performed consistently with generally accepted industry standards. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history, however, the Company has not incurred significant expense under our product or services warranties to date. As a result, the Company believes the estimated fair value on these warranties is minimal. Accordingly, the Company has no amounts recorded for these contingent liabilities as of December 31, 2006.

NOTE 8—LITIGATION

Beginning in July 2001, the Company and certain of our officers and directors (“Individuals”) were named as defendants in a series of class action stockholder complaints filed in the United States District Court for the Southern District of New York, now consolidated under the caption, “In re Chordiant Software, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-6222”. In the amended complaint, filed in April 2002, the plaintiffs allege that the Company, the Individuals, and the underwriters of our initial public offering (“IPO”) violated section 11 of the Securities Act of 1933 and section 10(b) of the Exchange Act of 1934 based on allegations that the our registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, our IPO underwriters. The complaint also contains claims against the Individuals for control person liability under Securities Act section 15 and Exchange Act section 20. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same court against hundreds of other public companies (“Issuers”) that conducted IPO’s of their common stock in the late 1990s or in the year 2000 (collectively, the “IPO Lawsuits”).

In August 2001, all of the IPO Lawsuits were consolidated for pretrial purposes before United States Judge Shira Scheindlin of the Southern District of New York. In July 2002, the Company joined in a global motion to dismiss the IPO Lawsuits filed by all of the Issuers (among others). In October 2002, the Court entered an order dismissing the Individuals from the IPO Cases without prejudice, pursuant to an agreement tolling the statute of limitations with respect to the Individuals. In February 2003, the court issued a decision denying the motion to dismiss the Section 11 claims against Chordiant and almost all of the other Issuers and denying the motion to dismiss the Section 10(b) claims against Chordiant and many of the Issuers.

In June 2003, Issuers and plaintiffs reached a tentative settlement agreement that would, among other things, result in the dismissal with prejudice of all claims against the Issuers and Individuals in the IPO Lawsuits, and the assignment to plaintiffs of certain potential claims that the Issuers may have against the underwriters. The tentative settlement also provides that, in the event that plaintiffs ultimately recover less than a guaranteed sum of $1 billion from the IPO underwriters, plaintiffs would be entitled to payment by each participating Issuer’s insurer of a pro rata share of any shortfall in the plaintiffs’ guaranteed recovery. In September 2003, in connection with the possible settlement, those Individuals who had entered tolling agreements with plaintiffs (described above) agreed to extend those agreements so that they would not expire prior to any settlement being finalized. In June 2004, Chordiant and almost all of the other Issuers entered into a formal settlement agreement with the plaintiffs. On February 15, 2005, the Court issued a decision certifying a class action for settlement purposes, and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the Court reaffirmed class certification and preliminary approval of the modified settlement in a comprehensive Order, and directed that Notice of the settlement be published and mailed to class members beginning November 15, 2005. On February 24, 2006, the Court dismissed litigation filed against certain underwriters in connection with the claims to be assigned to the plaintiffs under the settlement. On April 24, 2006, the Court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower Court's earlier decision certifying as class actions the six IPO Lawsuits designated as "focus cases." The Court has ordered a stay of all proceedings in all of the IPO Lawsuits pending the outcome of Plaintiffs' rehearing petition to the Second Circuit. Accordingly, the Court's decision on final approval of the settlement remains pending.

If this settlement is not finalized as proposed, then this action may divert the efforts and attention of our management and, if determined adversely to us, could have a material impact on our business, results of operations, financial condition or cash flows.

On August 1, 2006, a stockholder derivative complaint was filed in the United States District Court for the Northern District of California by Jesse Brown under the caption Brown v. Kelly, et al. Case No. C06-04671 JW (N.D. Cal.). On September 13, 2006, a second stockholder derivative complaint was filed in the United States District Court for the Northern District of

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

California by Louis Suba under the caption Suba v. Kelly et al., Case No. C06-05603 JW (N.D. Cal.). Both complaints were brought purportedly on behalf of the Company against certain of certain current and former officers and directors. On November 27, 2006, the court entered an order consolidating these actions and requiring the plaintiffs to file a consolidated complaint. The consolidated complaint was filed on January 11, 2007. The consolidated complaint alleges, among other things, that the named officers and directors: (a) breached their fiduciary duties as they colluded with each other to backdate stock options, (b) violated section 10(b), 14(a) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder through their alleged actions, and (c) were unjustly enriched by their receipt and retention of such stock options. The Company's response to the complaint is due on February 28, 2007.

In September 2006, the Company received a letter from Acacia Technologies Group, a patent holding company, suggesting that the Company may be infringing on two patents, designated by United States Patent Numbers 5,537,590 and 5,701,400, which are held by one of their patent licensing and enforcement subsidiaries. The Company is currently reviewing the validity of these patents and whether the Company’s products may infringe upon them. The Company has not formed a view of whether the

Company may have liability for infringement of these patents. Any related claims, whether or not they have merit, could be costly and time-consuming to defend, divert our management’s attention or cause product delays. If any of our products were found to infringe such patents, the patent holder could seek an injunction to enjoin our use of the infringing product. If the Company was required to settle such a claim, it could have a material impact on our business, results of operations, financial condition or cash flows.

The Company is also subject to various other claims and legal actions arising in the ordinary course of business. The ultimate disposition of these various other claims and legal actions is not expected to have a material effect on our business, financial condition, results of operations or cash flows. However, litigation is subject to inherent uncertainties.

NOTE 9—STOCK OPTION AND EMPLOYEE BENEFIT PLANS

2005 Equity Incentive Plan

As of December 31, 2006, there were approximately 5.4 million shares available for future grant and approximately 6.7 million options that were outstanding under the 2005 Plan. In January 2007, the Board amended the plan to increase the number of shares reserved for future issuance by 4.0 million shares. This amendment will be submitted to the stockholders for their approval at the 2007 annual meeting of stockholders’ which the Company anticipates will take place in April of 2007.

2000 Nonstatutory Equity Incentive Plan

In January 2007, the Board amended the 2000 Plan to reduce the number of shares available for future issuance to zero. No additional stock options will be granted under the 2000 Nonstatutory Equity Incentive Plan.

As of December 31, 2006, there were approximately 1.7 million shares subject to outstanding stock option grants and approximately 0.5 million shares available for future grant (plus any shares that might be returned to the 2000 Plan in the future as a result of cancellations or expirations of granted options and the repurchase of unvested restricted stock and stock bonuses).

1999 Non-Employee Directors’ Option Plan

As of December 31, 2006, approximately 1.6 million shares of common stock are available for future grant and 0.4 million are outstanding under the Director Plan. In January 2007, the Board amended and restated the Director Plan to decrease the number of shares reserved for future issuance upon the exercise of new options to 0.8 million shares and to eliminate the automatic increase provision. The adoption of the amended and restated Director Plan will be submitted to the stockholders for their approval at the 2007 annual meeting of stockholders’ which the Company anticipates will take place in April of 2007.

Stock Option Activity

The following table summarizes stock option and restricted stock activity under our stock option plans (in thousands, except per share data):

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

				Options Outstanding
	Shares Available for Grant			Shares			Weighted Average Exercise Price
Balance at September 30, 2006		6,553			9,219		$	2.53
Authorized		413			—			—
Options granted		(237	)		237			2.98
Options exercised		—			(109	)		1.13
Cancellation of unvested restricted stock		332			—			—
Options cancelled		487			(487	)		3.27
Balance at December 31, 2006		7,548			8,860		$	2.52

Because the Company was delinquent in its periodic SEC filings during the quarter ended December 31, 2006, 2.1 million stock options approved in November 2006 could not be priced or issued until the Company became current in its filing of reports. These options are not included in the table above.

The following table summarizes information about stock options outstanding and exercisable at December 31, 2006 (in thousands, except exercise prices and contractual life data):

	Options Outstanding and Exercisable								Options Vested
Range of Exercise Prices	Number Outstanding		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Aggregate Intrinsic Value Closing Price at 12/31/2006 of $3.31		Number Exercisable		Weighted Average Exercise Price		Aggregate Intrinsic Value Closing Price at 12/31/2006 of $3.31
$0.14-0.88		970		3.13	$	0.66	$	2,569		967	$	0.66	$	2,564
0.90-1.00		944		6.29		0.99		2,191		895		0.99		2,078
1.19-1.70		1,111		7.00		1.59		1,916		842		1.57		1,481
1.80-2.59		888		6.46		2.14		1,038		643		2.06		802
2.60-2.96		976		7.74		2.73		566		529		2.70		321
2.97-3.01		1,032		8.35		2.99		328		389		2.99		126
3.03-3.19		1,226		9.00		3.17		170		270		3.17		37
3.22-4.17		1,281		7.91		3.81		6		723		4.08		2
4.21-18.00		432		5.82		5.91		—		396		6.02		—
$0.14-18.00		8,860		7.04	$	2.52	$	8,784		5,654	$	2.29	$	7,411

The aggregate intrinsic value in the preceding table represents the total intrinsic value, based on the Company’s closing stock price of $3.31 as of December 31, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of December 31, 2006 was approximately 4.6 million. As of December 31, 2006, approximately 5.7 million outstanding options were exercisable, and the weighted average exercise price was $2.29. The total intrinsic value of options exercised during the three months ended December 31, 2006 and 2005 was $0.2 million for each period. The fair value of options vested was $0.6 million and $1.4 million for the three months ended December 31, 2006 and 2005, respectively. As of December 31, 2006, total unrecognized compensation costs related to non-vested stock options was $3.8 million, which is expected to be recognized as expense over a weighted-average period of approximately 1.3 years.

The Company had 0.4 million unvested restricted stock awards as of December 31, 2006, which were excluded from the preceding tables. The total fair value of the unvested restricted stock awards at grant date was $0.8 million. Aggregate intrinsic value of the unvested restricted stock awards at December 31, 2006 was $1.3 million. During the three months ended December 31, 2006, approximately 0.3 million shares vested related to restricted stock awards. There were no shares of restricted stock awarded during the three months ended December 31, 2006. The weighted average fair value at grant date of the unvested restricted stock awards was $2.10 as of December 31, 2006. As of December 31, 2006, total unrecognized compensation costs related to unvested restricted stock awards was $0.1 million which is expected to be recognized as expense over a weighted average period of approximately 1.0 year.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company settles stock option exercises and restricted stock awards with newly issued common shares.

Valuation and Expense Information under SFAS 123(R)

On October 1, 2005, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including employee stock options, restricted stock awards and employee stock purchases related to the ESPP based on estimated fair values. The following table summarizes stock-based compensation expense related to employee stock options and restricted stock awards for the three months ended December 31, 2006 and 2005, respectively, which was allocated as follows (in thousands):

	Three Months Ended December 31,
		2006 (under SFAS 123(R))		2005 (under SFAS 123(R))
				(restated)(1)
Stock-based compensation expense:
Cost of revenues	$	107	$	26
Sales and marketing		329		722
Research and development		93		59
General and administrative		447		293
Total stock-based compensation expense	$	976	$	1,100

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

The weighted-average estimated fair value of stock options granted during the three months ended December 31, 2006 and 2005 was $1.61 and $1.70 per share, respectively, using the Black-Scholes model with the following weighted-average assumptions:

	Three Months Ended December 31,
		2006		2005
Expected lives in years		3.6		3.9
Risk free interest rates		4.6	%	4.3	%
Volatility		71	%	87	%
Dividend yield		0	%	0	%

The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model with the weighted-average assumptions for volatility, expected term, and risk free interest rate. With the adoption of SFAS 123(R) on October 1, 2005, the Company used the trinomial lattice valuation technique to determine the assumptions used in the Black-Scholes model. The trinomial lattice valuation technique was used to provide a better estimate of fair values and meet the fair value objectives of SFAS 123(R). The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility rate is based on the historical volatility of our stock price.

As stock-based compensation expense recognized in the condensed consolidated statement of operations for the three months ended December 31, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Our estimated forfeiture rate for the three months ended December 31, 2006 was based on our historical forfeiture experience.

Accuracy of Fair Value Estimates

The Company uses third-party analyses to assist in developing the assumptions based on a trinomial lattice valuation technique used in the Black-Scholes model. The company is responsible for determining the assumptions used in estimating the fair value of share-based payment awards.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Because the Company’s employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s employee stock options and restricted stock awards. Although the fair value of employee stock options and restricted stock awards is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

NOTE 10—SEGMENT INFORMATION

Our chief operating decision maker reviews financial information presented on a consolidated basis, accompanied by desegregated information about revenues by geographic regions for purposes of making operating decisions and assessing financial performance. Accordingly, the Company has concluded that the Company has one reportable segment.

The following table summarizes license revenue by product emphasis (in thousands):

	Three Months Ended December 31,
		2006		2005
License revenue:
Enterprise solutions	$	3,545	$	4,357
Marketing solutions		989		3,519
Decision management solutions		2,628		1,250
Total	$	7,162	$	9,126

The following table summarizes service revenue consisting of consulting assistance and implementation, customization and integration and post-contract customer support, training and certain reimbursable out-of-pocket expenses by product emphasis (in thousands):

	Three Months Ended December 31,
		2006		2005
Service revenue:
Enterprise solutions	$	12,199	$	9,823
Marketing solutions		2,605		3,093
Decision management solutions		973		516
Total	$	15,777	$	13,432

Foreign revenues are based on the country in which the customer order is generated. The following is a summary of total revenues by geographic area (in thousands):

	Three Months Ended December 31,
		2006		2005
North America	$	13,221	$	12,849
Europe		9,718		9,709
Total	$	22,939	$	22,558

Included in foreign revenue results for Europe are revenue from the United Kingdom of $6.3 million and $6.0 million for the three months ended December 31, 2006 and 2005, respectively.

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CHORDIANT SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Property and equipment information is based on the physical location of the assets. The following is a summary of property and equipment by geographic area (in thousands):

	December 31, 2006		September 30, 2006
North America	$	1,790	$	1,844
Europe		1,095		786
Total	$	2,885	$	2,630

NOTE 11—SUBSEQUENT EVENTS

Reverse Stock Split

On December 13, 2006, the Company announced that the Board of Directors had approved a reverse stock split of common stock such that each outstanding two and a half shares of common stock would be combined into and become one share and that it will seek stockholder approval of the reverse stock split at a special meeting of stockholders on February 15, 2007.

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

This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this report and the 2006 audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended September 30, 2006 filed with the SEC. Operating results are not necessarily indicative of results that may occur in future periods.

The following discussion and analysis contains forward-looking statements. These statements are based on our current expectations, assumptions, estimates and projections about our business and our industry, and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s results, levels of activity, performance or achievement to be materially different from any future results, levels of activity, performance or achievements expressed or implied in or contemplated by the forward-looking statements. Words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “should,” “estimate,” “predict,” “guidance,” “potential,” “continue” or the negative of such terms or other similar expressions, identify forward-looking statements. Our actual results and the timing of events may differ significantly from those discussed in the forward-looking statements as a result of various factors, including but not limited to, those discussed under the subheading “Risk Factors” and those discussed elsewhere in this report, in our other SEC filings and under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2006 Form 10-K. Chordiant undertakes no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

As an enterprise software vendor, we generate substantially all of our revenues from the financial services, insurance, healthcare, telecommunications, and retail industries. Our customers typically fund purchases of our software and services out of their lines of business and information technology budgets. As a result, our revenues are heavily influenced by our customers’ long-term business outlook and willingness to invest in new enterprise information systems and business applications.

Beginning in late calendar 2000, the financial services and telecommunications industries entered into a steep and long economic downturn, with industry sales dropping from late 2000 through the first part of 2003. Over the past several years, our customers have focused on controlling costs and reducing risk, including constraining information technology and lines of business expenditures and requiring more favorable pricing terms from their suppliers and pursuing consolidation within their own industries. As a result of this downturn, our license fee revenues declined 19% in fiscal 2003.

Beginning in the latter part of 2003, economic conditions began to show signs of improvement, which were reflected in increases in various economic indicators such as productivity, labor statistics and consumer confidence. This trend has continued through our fiscal year 2006 and appears to have had a favorable impact, specifically in information technology spending. For the year ended 2006, we were able to grow total revenues 16% on a year over year basis.

For the three months ended December 31, 2006, total revenues increased 2% and backlog increased 88% compared to the three months ended December 31, 2005. For the quarter ending December 31, 2006, backlog increased $34 million or 94% compared to the previous quarter ended September 30, 2006. This increase is primarily related to two large customer transactions completed during the quarter totaling $34 million. We did not recognize license revenue associated with these transactions during the quarter. We expect to begin to recognize license revenue on the smaller of the two transactions, $14 million, in the March 2007 quarter using the percentage-of-completion basis. We expect to begin recognizing license revenue on the second larger transaction, $20 million, in the June 2007 quarter on a percentage-of-completion basis.

Software Industry Consolidation and Possible Increased Competition

The software industry in general is continuing to undergo a period of consolidation, and there has been recent consolidation in sectors of the software industry in which we operate. During 2006, Oracle completed the acquisition of i-flex Solutions Ltd., a banking software maker headquartered in Mumbai, India, acquired Siebel Systems, Inc., a maker of customer relationship management software products and acquired Portal Software, a provider of billing and revenue management solutions for the communications and media industry. Also, during 2006, IBM acquired Webify, a provider of middleware to companies primarily in the insurance industry.

In September 2005, IBM acquired DWL, a provider of middleware to companies in the banking, insurance, retail and telecommunications industries. In September 2005, SSA Global Technologies acquired Epiphany, Inc., a maker of customer relationship management software products. While we do not believe that these acquired companies are direct competitors of Chordiant, the acquisition activity of these large corporations of software providers to the industries we target may indicate that we will face increased competition from significantly larger and more established entities in the future.

Financial Trends

Backlog. An increasingly material portion of our revenues has been derived from large orders, as major customers deployed

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our products. As of December 31, 2006 and 2005, we had approximately $69.8 million and $37.2 million in backlog, respectively, which we define as contractual commitments by our customers through purchase orders or contracts. Backlog is comprised of:

• software license orders which have not been accepted by customers or have not otherwise met all of the required criteria for revenue recognition. This component includes billed amounts classified as deferred revenue;

• deferred revenue from customer support contracts;

• consulting service orders representing the unbilled remaining balances of consulting contracts not yet completed or delivered, plus deferred consulting revenue; and

• education orders for services not yet completed or delivered.

Backlog is not necessarily indicative of revenues to be recognized in a specified future period. There are many factors that would impact Chordiant’s conversion of backlog as recognizable revenue, such as Chordiant’s progress in completing projects for its customers, Chordiant’s customers’ meeting anticipated schedules for customer-dependent deliverables and customers increasing the scope or duration of a contract causing license revenue to be deferred for a longer period of time.

Chordiant provides no assurances that any portion of its backlog will be recognized as revenue during any fiscal year or at all, or that its backlog will be recognized as revenues in any given period. In addition, it is possible that customers from whom we expect to derive revenue from backlog will default and as a result we may not be able to recognize expected revenue from backlog.

Due to several large customer orders signed during the quarters ended September 30, 2006 and December 31, 2006, a significant portion of our near term license revenues are expected to be recognized under the percentage-of-completion method of accounting. These orders will require consulting services that are essential to the functionality of the respective licenses.

Product development. Chordiant has entered into several product co-development arrangements with its customers. These projects relate to software products that were in various stages of development prior to the consummation of the individual arrangements. Upon the completion of the software, the Company intends to license these products to other customers. All revenue relating to these arrangements will be deferred until the delivery of the final products, provided all other requirements of SOP 97-2 are met. Expenses associated with these co-development arrangements are expensed as incurred as they are considered to be research and development costs that do not qualify for capitalization or deferral. The accounting for these transactions differs from the percentage of completion method, as expenses are recognized in the period incurred and no revenue is recognized until the final product is delivered. As of December 31, 2006, revenue aggregating approximately $2.6 million associated with these arrangements had been deferred. We expect that research and development costs will increase as the volume of co-development activities increase.

Gross margins. Management focuses on license and service gross margin in evaluating our financial condition and operating performance. Gross margins on license revenues were 94% and 95% for the three months ended December 31, 2006 and 2005, respectively. The 1% decrease is primarily a function of the fixed periodic amortization costs associated with capitalized software costs being divided by a smaller license amount quarter-over-quarter. We expect license gross margin on current products to range from 94% to 96% in the foreseeable future. The margin will fluctuate with the mix of products sold. Historically, the enterprise solution products have higher associated third party royalty expense than the marketing solution products and decision management products. The banking product that was completed during the year ended September 30, 2005 has higher royalties than other products.

Gross margins on service revenues were 53% and 52% for the three months ended December 31, 2006 and 2005, respectively. The increase in gross margins for the three months period ending December 31, 2006 is primarily due to improved consulting services utilization rates and increased support and maintenance revenue. We expect that gross margins on service revenues to range between 50% and 54% in the foreseeable future. Margins are also negatively impacted during, and immediately following, periods in which service department headcounts increase, as resources are not immediately billable.

Service revenues. Service revenues as a percentage of total revenues were 69% and 60% for the three months ended December 31, 2006 and 2005, respectively. We expect that service revenues will represent between 55% and 65% of our total revenues in the foreseeable future.

Revenues from international customers versus North America revenues. For all periods presented, revenues were principally derived from customer accounts in North America and Europe. For the three months ended December 31, 2006 and 2005, international revenues were $9.7 million, or approximately 42% and 43% of our total revenues, respectively. We believe international revenues will continue to represent a significant portion of our total revenues in future periods. International revenues were favorably impacted for the fiscal quarter ended December 31, 2006, as compared to fiscal quarter ended December

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31, 2005, as both the British Pound and the Euro increased in average value by approximately 10% and 8%, respectively, as compared to the U.S. Dollar.

For the three months ended December 31, 2006 and 2005, North America revenues were $13.2 million and $12.8 million, or approximately 58% and 57% of our total revenues, respectively. We believe North America revenues will continue to represent the majority of our total revenues in the foreseeable future.

Costs related to compliance with the Sarbanes-Oxley Act of 2002. Significant professional services are included in general and administrative costs relating with efforts to comply with the Sarbanes-Oxley Act of 2002. For the three months ended December 31, 2006 and 2005, these costs were $0.2 million and $0.5 million, respectively. While these costs are expected to decline as compared to the costs incurred for the year ended September 30, 2006, the level and timing of the decline is uncertain.

Costs related to stock option investigation. Significant professional services are included in general and administrative costs associated with the Company’s stock option investigation which began in July 2006 and was completed during the quarter ended March 2007. This issue is more fully described in the Note 2 of the Consolidated Financial Statements in our 2006 Form 10-K. For the quarter ended December 31, 2006, these costs were $1.0 million. We have incurred additional costs through the quarter ended March 2007.

Reduction in workforce. In October 2006, the Company initiated a restructuring plan intended to align its resources and cost structure with expected future revenues. The restructuring plan included a balancing of services resources worldwide, an elimination of duplicative functions internationally, and a shift in the U.S. field organization toward a focus on domain-based sales and pre-sales teams.

The restructuring plan included an immediate reduction in positions of slightly more than ten percent of the Company's workforce, consolidation of our European facilities, and the closure of our France office. A majority of the positions eliminated were in Europe. The plan was committed to on October 24, 2006, and we began notifying employees on October 25, 2006.

For the three months ended December 31, 2006, we recorded a pre-tax cash restructuring charge of $6.5 million. The charge is composed of $1.7 million for severance costs and $4.8 million for exiting excess facilities. The facilities are subject to operating leases expiring through 2010. The Company anticipates that approximately $5.4 million of the charge will result in cash expenditures. $1.1 million of the charge is associated with non-cash charges for the write-off of leasehold improvements and the reversal of favorable purchase price adjustment related to the France office lease. As of December 31, 2006, $1.0 million of the severance and benefits charge had been paid. The remaining $0.7 million of severance and benefits charge is expected to be paid through September 2007 and the remaining $3.7 million of facilities charges will be paid over the remaining term of the facility leases.

Past results may not be indicative of future performance. We believe that period-to-period comparisons of our operating results should not be relied upon as indicative of future performance. Our prospects must be considered given the risks, expenses and difficulties frequently encountered by companies in early stages of development, particularly companies in new and rapidly evolving businesses. There can be no assurance we will be successful in addressing these risks and difficulties. Moreover, we may not achieve or maintain profitability in the future.

Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

On an on-going basis, we evaluate the estimates, including those related to our allowance for doubtful accounts, valuation of stock-based compensation, valuation of goodwill and intangible assets, valuation of deferred tax assets, restructuring costs, contingencies, vendor specific objective evidence (“VSOE”) of fair value in multiple element arrangements and the estimates associated with the percentage-of-completion method of accounting for certain of our revenue contracts. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recognition of revenue and expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting judgments and estimates are used in the preparation of our consolidated financial statements:

• Revenue recognition, including estimating the total estimated time required to complete sales arrangements involving significant implementation or customization essential to the functionality of our products;

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• Estimating valuation allowances and accrued liabilities, specifically the allowance for doubtful accounts, and assessment of the probability of the outcome of our current litigation;

• Stock-based compensation expense;

• Accounting for income taxes;

• Valuation of long-lived and intangible assets and goodwill;

• Restructuring costs; and

• Determining functional currencies for the purposes of consolidating our international operations.

Revenue recognition. We derive revenues from licenses of our software and related services, which include assistance in implementation, customization and integration, post-contract customer support, training and consulting. The amount and timing of our revenue is difficult to predict and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in increased operating losses. The accounting rules related to revenue recognition are complex and are affected by interpretation of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant estimates based on judgment.

For arrangements with multiple elements, we recognize revenue for services and post-contract customer support based upon VSOE of fair value of the respective elements. VSOE of fair value for the services element is based upon the standard hourly rates we charge for the services when such services are sold separately. The VSOE of fair value for annual post-contract customer support is generally established with the contractual future renewal rates included in the contracts when the renewal rate is substantive and consistent with the fees when support services are sold separately. When contracts contain multiple elements and VSOE of fair value exists for all undelivered elements, we account for the delivered elements, principally the license portion, based upon the “residual method” as prescribed by SOP 97-2. In multiple element transactions where VSOE is not established for an undelivered element, we recognize revenue upon the establishment of VSOE for that element or when the element is delivered.

At the time we enter into a transaction, we assess whether any services included within the arrangement require us to perform significant implementation or customization essential to the functionality of our products.

For contracts for products that do not involve significant implementation or customization essential to the product functionality, we recognize license revenues when there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred as prescribed by SOP 97-2.

For contracts that involve significant implementation or customization essential to the functionality of our products, we recognize the license and professional consulting services revenue using either the percentage-of-completion method or the completed contract method as prescribed by Statement of Position No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts” (“SOP 81-1”).

The percentage-of-completion method is applied when we have the ability to make reasonable dependable estimates of the total effort required for completion using labor hours incurred as the measure of progress towards completion. The progress toward completion is measured based on the “go-live” date. We define the “go-live” date as the date the essential product functionality has been delivered or the application enters into a production environment or the point at which no significant additional Chordiant supplied professional service resources are required. Estimates are subject to revisions as the contract progresses to completion. We account for the changes as changes in accounting estimates when the information becomes known. Information impacting estimates obtained after the balance sheet date but before the issuance of the financial statements is used to update the estimates. Provisions for estimated contract losses, if any, are recognized in the period in which the loss becomes probable and can be reasonably estimated. When we sell additional licenses related to the original licensing agreement, revenue is recognized upon delivery if the project has reached the go-live date, or if the project has not reached the go-live date, revenue is recognized under the percentage-of-completion method. We classify revenues from these arrangements as license and service revenues based upon the estimated fair value of each element using the residual method.

The completed contract method is applied when we are unable to obtain reasonable dependable estimates of the total effort required for completion. Under the completed contract method, all revenue and related costs of revenue are deferred and recognized upon completion.

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For product co-development arrangements relating to software products in development prior to the consummation of the individual arrangements, we retain the intellectual property being developed, and intend to sell the resulting products to other customers, license revenue is deferred until the delivery of the final product, provided all other requirements of SOP 97-2 are met. Expenses associated with these co-development arrangements are accounted for under SFAS 86 and are normally expensed as incurred as they are considered to be research and development costs that do not qualify for capitalization or deferral.

We recognize revenue for post-contract customer support ratably over the support period which ranges from one to three years.

Our training and consulting services revenues are recognized as such services are performed on an hourly or daily basis for time and material contracts. For consulting services arrangements with a fixed fee, we recognize revenue on a percentage-of-completion method.

For all sales we use either a signed license agreement or a binding purchase order where we have a master license agreement as evidence of an arrangement. Sales through our third party systems integrators are evidenced by a master agreement governing the relationship together with binding purchase orders or order forms on a transaction-by-transaction basis. Revenues from reseller arrangements are recognized on the “sell-through” method, when the reseller reports to us the sale of our software products to end-users. Our agreements with customers and resellers do not contain product return rights.

We assess collectibility based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We generally do not request collateral from our customers. If we determine that the collection of a fee is not probable, we recognize revenue at the time collection becomes probable, which is generally upon the receipt of cash. If a transaction includes extended payment terms, we recognized revenue as the payments become due and payable.

Allowance for doubtful accounts. We must make estimates of the uncollectability of our accounts receivables. We specifically analyze accounts receivable and analyze historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Generally, we require no collateral from our customers. Our gross accounts receivable balance was $41.0 million with an allowance for doubtful accounts of $0.2 million as of December 31, 2006. Our gross accounts receivable balance was $19.1 million with an allowance for doubtful accounts of $0.1 million as of September 30, 2006. During the quarter ending December 31, 2006, a significant customer transaction was completed for $20.0 million, which remained uncollected at the end of the quarter. This transaction is primarily responsible for the increase in the receivable balance. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required. To date, bad debts have not been material and have been within management’s expectations.

Stock-based compensation expense. Upon adoption of Statement of Financial Accounting Standards (“SFAS”) 123(R) on October 1, 2005, we began estimating the value of employee stock options on the date of grant using the Black-Scholes model. Prior to the adoption of SFAS 123(R), the value of each employee stock option was estimated on the date of grant using the Black-Scholes model for the purpose of the pro forma financial disclosure in accordance with SFAS 123. Under SFAS 123(R), the determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The expected volatility is a blended rate based on both the historical volatility of our stock price and the volatility of certain peer company stock prices.

With the adoption of SFAS 123(R) on October 1, 2005, we used the trinomial lattice valuation technique to determine the assumptions used in the Black-Scholes model. The trinomial lattice valuation technique was used to provide better estimates of fair values and meet the fair value objectives of SFAS 123(R).

In connection with the Company’s restatement of its Condensed Consolidated Financial Statements, the Company has applied judgment related to revised measurement dates for prior options grants. Information regarding the restatement, including ranges of possible additional stock-based compensation expense if other measurement dates had been selected for certain grants, is set forth in the in Note 2 of the Notes to the Condensed Consolidated Financial Statements of this Form 10-Q.

Accounting for income taxes. As part of the process of preparing our Condensed Consolidated Financial Statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual

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current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

We have recorded a valuation allowance equal to 100% of the deferred tax assets as of December 31, 2006, due to uncertainties related to our ability to utilize our net deferred tax assets, primarily consisting of certain net operating losses carry forwards and foreign tax credits. Deferred tax assets have been fully reserved for in all periods presented.

Valuation of long-lived and intangible assets and goodwill. We assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Furthermore, we assess the impairment of goodwill annually. Factors we consider important which could trigger an impairment review include the following:

• Significant underperformance relative to expected historical or projected future operating results;

• Significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

• Significant negative industry or economic trends;

• Significant decline in our stock price for a sustained period;

• Market capitalization declines relative to net book value; and

• A current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

When one or more of the above indicators of impairment occurs we estimate the value of long-lived assets and intangible assets to determine whether there is impairment. We measure any impairment based on the projected discounted cash flow method, which requires us to make several estimates including the estimated cash flows associated with the asset, the period over which these cash flows will be generated and a discount rate commensurate with the risk inherent in our current business model. These estimates are subjective and if we made different estimates, it could materially impact the estimated fair value of these assets and the conclusions we reached regarding impairment. To date, we have not identified any triggering events noted above.

We are required to perform an impairment review of our goodwill balance on at least an annual basis. This impairment review involves a two-step process as follows:

Step 1—We compare the fair value of our reporting units to the carrying value, including goodwill, of each of those units. For each reporting unit where the carrying value, including goodwill, exceeds the unit’s fair value, we proceed on to Step 2. If a unit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.

Step 2—We perform an allocation of the fair value of the reporting unit to our identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. We then compare the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess. We determined that we have one reporting unit. We completed a goodwill impairment review for the period ending September 30, 2006 and performed Step 1 of the goodwill impairment analysis required by SFAS 142, “Goodwill and Other Intangible Assets,” and concluded that goodwill was not impaired as of September 30, 2006 using the methodology described above. Accordingly, Step 2 was not performed. We will continue to test for impairment on an annual basis and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying amount.

Restructuring costs. . During the quarter ending December 31, 2006, and in prior fiscal years 2005, 2003, and the nine month period ended September 30, 2004, we implemented cost-reduction plans as part of our continued effort to streamline our operations to reduce ongoing operating expenses. These plans resulted in restructuring charges related to, among others, the consolidation of excess facilities. These charges relate to facilities and portions of facilities we no longer utilize and either seek to terminate early or sublease. Lease termination costs and brokerage fees for the abandoned facilities were estimated for the remaining lease obligations and were offset by estimated sublease income. Estimates related to sublease costs and income are based on assumptions regarding the period required to locate and contract with suitable sub-lessees and sublease rates which can be achieved using market trend information analyses provided by a commercial real estate brokerage retained by us. Each

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reporting period we review these estimates and to the extent that these assumptions change due to new agreements with landlords, new subleases with tenants, or changes in the market, the ultimate restructuring expenses for these abandoned facilities could vary by material amounts.

Determining functional currencies for the purpose of consolidation. We have several foreign subsidiaries that together account for a significant portion of our revenues, expenses, assets and liabilities.

In preparing our Condensed Consolidated Financial Statements, we are required to translate the financial statements of the foreign subsidiaries from the currency in which they keep their accounting records, generally the local currency, into United States dollars. This process results in exchange gains and losses which, under the relevant accounting guidance are either included within the statement of operations or as a separate part of our net equity under the caption “accumulated other comprehensive income (loss).” Under the relevant accounting guidance, the treatment of these translation gains or losses is dependent upon our management’s determination of the functional currency of each subsidiary. The functional currency is determined based on management’s judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary conducts a majority of its transactions, including billings, financing, payroll and other expenditures would be considered the functional currency but any dependency upon the parent and the nature of the subsidiary’s operations must also be considered.

If any subsidiary’s functional currency were deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements would be included in cumulative translation adjustments. However, if the functional currency were deemed to be the United States dollar then any gain or loss associated with the translation of these financial statements would be included within our statement of operations. If we dispose of any of our subsidiaries, any cumulative translation gains or losses would be recognized in our statement of operations. If we determine that there has been a change in the functional currency of a subsidiary to the United States dollar, any translation gains or losses arising after the date of change would be included within our statement of operations.

Based on our assessment of the factors discussed above, we consider the relevant subsidiary’s local currency to be the functional currency for each of our international subsidiaries. Accordingly, foreign currency translation gains and loses are included as part of accumulated other comprehensive income within our balance sheet for all periods presented.

The magnitude of these gains or losses is dependent upon movements in the exchange rates of the foreign currencies in which we transact business against the United States dollar. These currencies include the United Kingdom Pound Sterling, the Euro and the Canadian Dollar. Any future translation gains or losses could be significantly higher than those reported in previous periods. At December 31, 2006, approximately $34.7 million of our cash and cash equivalents were held by our subsidiaries outside of the United States.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, (“SFAS 157”) “Fair Value Measurement.” SFAS 157 defines fair value, establishes a framework for measuring fair value, and also expands disclosures about fair value measurements. The SFAS 157 is effective for periods beginning after November 15, 2007. The Company is currently evaluating the effects of implementing this new standard.

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Results of Operations

The following table sets forth, in dollars and as a percentage of total revenues, unaudited condensed consolidated statements of operations data for the periods indicated. This information has been derived from the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report.

	Three Months Ended December 31,
	2006					2005
						(restated)(1)
Statements of Operations Data:
Revenues:
License	$	7,162		31	%	$	9,126		40	%
Service		15,777		69			13,432		60
Total revenue		22,939		100			22,558		100
Cost of revenue:
License		454		2			443		2
Service		7,466		33			6,385		28
Amortization of intangible assets		303		1			303		1
Total cost of revenue		8,223		36			7,131		31
Gross profit		14,716		64			15,427		69
Operating expenses:
Sales and marketing		7,264		32			8,140		36
Research and development		6,296		27			4,517		20
General and administrative		5,611		25			4,719		21
Restructuring expense		6,472		28			—		—
Total operating expense		25,643		112			17,376		77
Loss from operations		(10,927	)	(48	)		(1,949	)	(8	)
Interest income, net		304		1			199		1
Other income (expense), net		(15	)	(—	)		118		—
Loss before income taxes		(10,638	)	(47	)		(1,632	)	(7	)
Provision for income taxes		111		—			121		1
Net loss	$	(10,749	)	(47	)%	$	(1,753	)	(8	)%

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

Comparison of the Three Months Ended December 31, 2006 and 2005 (Unaudited)

Revenues

Total revenues increased $0.4 million, or 2%, to $22.9 million for the three months ended December 31, 2006 compared to $22.6 million for the three months ended December 31, 2005. This increase was primarily due to a 17% increase in service revenue offset by a 22% decrease in license revenue.

The following summarizes the components of our total revenues:

License Revenue

The following table sets fourth our license revenue by product emphasis for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

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	Three Months Ended December 31,
License:	2006		2005		Change			%
Enterprise solutions	$	3,545	$	4,357	$	(812	)	(19	)%
Marketing solutions		989		3,519		(2,530	)	(72	)
Decision management solutions		2,628		1,250		1,378		110
Total license revenue	$	7,162	$	9,126	$	(1,964	)	(22	)%

Total license revenue decreased by $2.0 million from the three months ended December 31, 2005 to the three months ended December 31, 2006. The increase or decrease of total revenue and revenue occurring within the three different product emphases is dependent on the timing of when transactions are completed and whether a license transaction was sold with essential consulting services. License revenue sold with essential consulting services is recognized under percentage-of-completion method of accounting. The timing and amount of revenue for those transactions being recognized under the percentage-of-completion is influenced by progress of work performed relative to the project length of customer contracts and the dollar value of such contracts. Due to several large customer orders signed during the quarters ended September 30, 2006 and December 31, 2006 a significant portion of our near term license revenues are expected to be recognized under the percentage-of-completion method of accounting. These orders will require consulting services that are essential to functionality of the respective licenses.

Included in the license revenue for the three months ended December 31, 2006 is the third in a series of term licenses sold to the same customer in the amount of $1.3 million. The first term license was sold in the period ending March 31, 2006 and after its expiration a second term license was sold in the period ending June 30, 2006. After the expiration of the second term license, the third term license was sold in October 2006. The three term licenses totaled $8.8 million and are non-cancelable, non-refundable and provided on an unsupported basis; accordingly, revenue was recognized in full upon delivery of the software as there were no undelivered elements. These term licenses were negotiated with the customer as single, discrete arrangements for purposes of evaluating and testing the software.

After the conclusion of the third license term, the customer concluded its evaluation of the product and purchased perpetual licenses for existing product and a future product that is expected to be delivered and reach general availability release in the quarter ending June 2007. Accordingly, we will not begin to recognize revenue, including the related services and support revenue associated with the perpetual licenses, until the future product is delivered to the customer. Costs related to any deferred consulting revenue will also be deferred. At the time of delivery of the future product, we will recognize any deferred consulting costs and revenues and begin to recognize license revenue on the perpetual licenses on a percentage-of-completion basis due to the essential services required for the functionality of the software.

Service Revenue

Service revenues are primarily composed of consulting implementation and integration, consulting customization, training, post-contract customer support services, and certain reimbursable out-of-pocket expenses. The following table sets forth our service revenue by product emphasis for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

	Three Months Ended December 31,
Service:	2006		2005		Change			%
Enterprise solutions	$	12,199	$	9,823	$	2,376		24	%
Marketing solutions		2,605		3,093		(488	)	16
Decision management solutions		973		516		457		89
Total service revenue	$	15,777	$	13,432	$	2,345		17	%

Total service revenue, which includes reimbursement of out-of-pocket expenses, increased 17% for the quarter ended December 31, 2006 compared to December 31, 2005. The $2.3 million increase is primarily related to increases of $1.5 million in support and maintenance revenue, $0.9 million in consulting revenue, $0.3 million in reimbursement of out-of-pocket expense revenue, offset by a decrease of $0.4 million in training revenue.

Reimbursement of out-of-pocket expenses (which are included in total service revenues) increased 47% to $1.0 million for the three months ended December 31, 2006 compared to $0.7 million for the three months ended December 31, 2005. This increase is primarily driven by the increase in consulting service activity.

The increase or decrease of service revenue within the three different product emphases is primarily due to the timing of when license transactions are completed, whether or not the license was sold with essential consulting services, the sophistication

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of the customer’s application, and the expertise of the customer’s internal development team. For non-essential service transactions, service revenue will lag in timing compared to the period of when the license revenue is recognized.

Cost of revenue

License

Cost of license revenue includes third-party software royalties and amortization of capitalized software development costs. Royalty expenses can vary depending upon the mix of products sold within the period. The capitalized software development costs pertain to a banking product that was completed and available for general release in August 2005. Quarterly amortization expense associated with this product is $0.2 million. Amortization of these costs is expected through 2008. The following table sets forth our cost of license revenues for the three ended December 31, 2006 and 2005 (in thousands, except percentages):

	Three Months Ended December 31,
	2006			2005			Change		%
Cost of license revenue	$	454		$	443		$	11	2	%
Percentage of total revenue		2	%		2	%

These costs resulted in license gross margins of approximately 94% and 95% for the quarters ended December 31, 2006 and 2005, respectively. The 2% decrease is primarily a function of the fixed capitalized software cost amortization for the two comparative periods being divided by a smaller license amount quarter-over-quarter.

Service

Cost of service revenue consists primarily of personnel and related costs, third-party consulting costs, facility and travel costs incurred to provide consulting implementation and integration, consulting customization, training, post-contract customer support services. The following table sets forth our cost of service revenue for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

	Three Months Ended December 31,
	2006			2005			Change		%
					(restated)(1)
Cost of service revenue	$	7,466		$	6,385		$	1,081	17	%
Percentage of total revenue		33	%		28	%

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

Cost of service revenue increased by 17% from the three months ended December 31, 2005 to the three months ended December 31, 2006. This change is primarily due to a $0.5 million increase in personnel and associated costs related to an increase in headcount and a $0.4 million increase in travel expenses associated with an increase in consulting revenue activity. The 17% increase from period to comparable period is consistent with the 17% increase in service revenue.

During the quarter ended December 31, 2006, we completed a sales transaction involving licenses and essential consulting services to the functionality of the licenses. The licenses include a product to be delivered to the customer in the future. Due to this undelivered license element and the consulting services being essential to the functionality of the licenses, all license revenue, consulting revenue and consulting costs will be deferred until the delivery of the final license element occurs.

Amortization of intangible assets

Amortization of intangible assets cost consists primarily of the amortization of amounts paid for developed technologies, customer lists and tradenames resulting from business acquisitions. The following table sets forth our costs associated with amortization of intangible assets for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

	Three Months Ended December 31,
	2006			2005			Change		%
Amortization of intangible assets	$	303		$	303		$	—	—	%
Percentage of total revenues		1	%		1	%

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We expect amortization expense for intangible assets to be $0.3 million for each of the three remaining quarters in fiscal year 2007 and $1.2 million in fiscal year 2008, $1.2 million in fiscal year 2009 and $0.6 million in fiscal year 2010.

Operating expenses

Sales and marketing

Sales and marketing expense is composed primarily of costs associated with promoting and advertising our products, product demonstrations and customer sales calls. These costs consist primarily of employee salaries, commissions and bonuses, benefits, facilities, travel expenses and promotional and advertising expenses. The following table sets forth our sales and marketing expenses for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

	Three Months Ended December 31,
	2006			2005			Change			%
					(restated)(1)
Sales and marketing expense	$	7,264		$	8,140		$	(876	)	(11	)%
Percentage of total revenues		32	%		36	%

(1) - See Note 2 - “Restatement relating to stock-based compensation” in Notes to Condensed Consolidated Financial Statements

Sales and marketing expense decreased by 11% from the three months ended December 31, 2005 to the three months ended December 31, 2006, primarily due to a $0.9 million decreases in personnel and related expenses. Personnel costs decreased as the result of the average headcount decreasing 19% between the comparative periods.

Research and development

Research and development expense is composed primarily of costs associated with the development of new products, enhancements of existing products and quality assurance activities. These costs consist primarily of employee compensation, benefits, facilities, the cost of software and development tools, equipment and consulting costs, including costs for offshore consultants. The following table sets forth our research and development expenses for the three months ended December 31, 2006 and 2005 (in thousands, except percentages):

Three Months Ended December 31,

2006

2005

Change

(restated)(1)

Research and development expense