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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





FORM 10-Q





QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934





FOR THE QUARTER ENDED JUNE 30, 2002

COMMISSION FILE NUMBER: 000-26273





PRIMUS KNOWLEDGE SOLUTIONS, INC.





(Exact name of Registrant as specified in its charter)





WASHINGTON

91-1350484(State or other jurisdiction of

(I.R.S. Employerincorporation or organization)

Identification No.)





1601 Fifth Avenue, Suite 1900


Seattle, Washington 98101


(Address of principal executive offices)





(206) 834-8100


(Registrants telephone number, including area code)





Indicate by check mark whether
the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days:





Yes  x  No  ̈





As of August 6, 2002 there were 19,111,904 shares of the Registrants Common Stock outstanding.




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Primus Knowledge Solutions, Inc.


Form 10-Q


June 30, 2002





INDEX





PART I.

FINANCIAL INFORMATION

PAGEITEM 1.

Condensed Consolidated Financial Statements (Unaudited)  Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001

3  Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001

4  Condensed Consolidated Statements of Shareholders Equity for the three and six months ended June 30, 2002

5  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001

6  Notes to Condensed Consolidated Financial Statements

7ITEM 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

15ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

39PART II.

OTHER INFORMATIONITEM 1.

Legal Proceedings

40ITEM 2.

Change in Securities

40ITEM 6.

Exhibits and Reports on Form 8-K

40




Page 2 of 41




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PART I.    FINANCIAL INFORMATION





ITEM 1.    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





CONDENSED CONSOLIDATED BALANCE SHEETS


(In thousands, except share and per share data)


(Unaudited)





June 30, 2002


December 31, 2001ASSETSCurrent assets:Cash, cash equivalents and short-term investments

$
15,018


$
18,499Accounts receivable, net of allowance for doubtful accounts of $610 and $1,524 at June 30, 2002 and December 31, 2001,
respectively


4,173



5,932Prepaid expenses and other current assets


812



1,120Total current assets


20,003



25,551Property and equipment, net of accumulated depreciation and amortization of $5,143 and $4,020 at June 30, 2002 and
December 31, 2001, respectively


3,443



4,473Goodwill, net of amortization of $550 at December 31, 2001






2,281Note receivable from related party


750



750Other assets


247



239Total assets

$
24,443


$
33,294LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
704


$
1,683Accrued and other liabilities


1,580



1,756Compensation-related accruals


1,603



1,392Deferred revenue, including related party amounts of $395 and $353 at June 30, 2002 and December 31, 2001,
respectively


6,475



6,432Total current liabilities


10,362



11,263Shareholders equity:Common stock, $.025 par value, 50,000,000 shares authorized, issued and outstanding 19,036,904 and 18,945,513 shares at
June 30, 2002 and December 31, 2001, respectively


476



474Additional paid-in-capital


110,242



110,178Accumulated other comprehensive (loss) income


(12
)


17Accumulated deficit


(96,625
)


(88,638
)Total shareholders equity


14,081



22,031Total liabilities and shareholders equity

$
24,443


$
33,294





The accompanying notes are an integral part of these condensed consolidated
financial statements.




Page 3 of 41




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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(In thousands, except share and per share data)


(Unaudited)





Three Months Ended June 30,


Six Months Ended June 302002


2001


2002


2001Revenue:License:Third party

$
1,108


$
2,129


$
3,344


$
6,806Related partyPrimus KK






247



221



1,5371,108



2,378


$
3,565


$
8,343Service:Third party


2,985



3,861



6,330



7,686Related partyPrimus KK


147



280



372



5663,132



4,141



6,702



8,252Total revenue


4,240



6,517



10,267



16,595Cost of revenue:License


44



68



117



202Service


1,148



2,206



2,443



4,592Total cost of revenue


1,192



2,274



2,560



4,794Gross profit


3,048



4,243



7,707



11,801Operating expenses:Sales and marketing


2,925



4,966



5,992



11,239Research and development


2,099



3,323



4,484



6,298General and administrative


1,282



1,657



2,635



3,547Amortization of goodwill






79







79Restructuring charges










435



Total operating expenses


6,306



10,025



13,546



21,163Loss from operations


(3,258
)


(5,782
)


(5,839
)


(9,362
)Other income, net


93



388



203



915Loss before income taxes and cumulative effect of change in accounting principle


(3,165
)


(5,394
)


(5,636
)


(8,447
)Income tax expense






(43
)


(70
)


(269
)Loss before cumulative effect of change in accounting principle


(3,165
)


(5,437
)


(5,706
)


(8,716
)Cumulative effect of change in accounting principle










(2,281
)


Net loss

$
(3,165
)

$
(5,437
)

$
(7,987
)

$
(8,716
)Basic and diluted loss per common share:Loss before cumulative effect of change in accounting principle

$
(0.17
)

$
(0.30
)

$
(0.30
)

$
(0.48
)Cumulative effect of change in accounting principle










(0.12
)


Net loss

$
(0.17
)

$
(0.30
)

$
(0.42
)

$
(0.48
)Weighted average shares used in computing basic and diluted loss per common share


18,949,722



18,356,093



18,947,723



18,210,908





The accompanying notes are an integral part of these condensed consolidated
financial statements.




Page 4 of 41




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CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND


COMPREHENSIVE (LOSS) INCOME


(In thousands, except share data)


(Unaudited)





Common stock

Additional paid-in capital

Accumulated other comprehensive (loss)
income


Accumulated deficit


Total shareholders equityShares

Par valueBalance at December 31, 2001

18,945,513

$
474

$
110,178

$
17


$
(88,638
)

$
22,031Exercise of stock options

144
















Comprehensive loss:Foreign currency translation loss










(21
)






Unrealized loss on securities available for sale










(58
)






Net loss














(4,822
)


Total comprehensive loss










(79
)


(4,822
)


(4,901
)Balance at March 31, 2002

18,945,657

$
474

$
110,178

$
(62
)

$
(93,460
)

$
17,130Exercise of stock options

3,427





3










3Stock issued for employee stock purchase plan

87,820


2


61










63Comprehensive income:Foreign currency translation gain










71







Unrealized loss on securities available for sale










(21
)






Net loss














(3,165
)


Total comprehensive loss










50



(3,165
)


(3,115
)Balance at June 30, 2002

19,036,904

$
476

$
110,242

$
(12
)

$
(96,625
)

$
14,081








The accompanying notes are an
integral part of these condensed consolidated financial statements.




Page 5 of 41




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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)


(Unaudited)





Six Months Ended June 30,2002


2001CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(7,987
)

$
(8,716
)Adjustments to reconcile net loss to net cash used in operating activities:Cumulative effect of change in accounting principle


2,281



Option and warrant expense






15Depreciation and amortization


1,133



1,199Changes in assets and liabilities:Accounts receivable


1,736



2,614Prepaid expenses and other current assets


483



(129
)Other assets


(4
)


6Accounts payable and accrued liabilities


(1,151
)


(1,783
)Compensation-related accruals


194



(1,406
)Deferred revenue


43



(513
)Net cash used in operating activities


(3,272
)


(8,713
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of short-term investments






(9,179
)Proceeds from maturities of short-term investments


2,000



31,782Purchases of property and equipment


(101
)


(967
)Issuance of note receivable from related party






(750
)Cash paid in acquisition, net of cash assumed






237Net cash provided by investing activities


1,899



21,123CASH FLOWS FROM FINANCING ACTIVITIES:Repayments of long-term debt and obligations under credit facility






(118
)Proceeds from the exercise of stock options and purchases of common stock under the employee stock purchase
plan


66



353Net cash provided by financing activities


66



235Effect of exchange rate changes on cash


(51
)


253Net (decrease) increase in cash and cash equivalents


(1,358
)


12,898Cash and cash equivalents at beginning of period


13,370



10,502Cash and cash equivalents at end of period

$
12,012


$
23,400NON-CASH INVESTING AND FINANCING ACTIVITIES:Value of shares issued for acquisition of AnswerLogic, Inc.





$
2,955Assets and liabilities assumed in acquisition:Current assets






144Property and equipment






1,300Goodwill






2,831Accounts payable and accrued liabilities






490Compensation-related accruals






287Obligations under credit facility






781





The accompanying notes are an integral part of these condensed consolidated
financial statements.




Page 6 of 41




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





June 30, 2002


(Unaudited)





Note 1.    Description of
the Business and Basis of Presentation





Description of the Business and Basis of Presentation





Primus Knowledge Solutions, Inc. and subsidiaries provides application software that enables companies to
improve customer service by allowing them to access, analyze and improve information. Primus ® software provides an infrastructure that captures and shares knowledge, increasing the efficiency and effectiveness of customer service. Our software products can be implemented as a suite or as individual products, depending on the customers
preference and/or business need. Our software is flexible and easily implemented. In addition to software applications, we offer professional services to assist customers with software implementation, integration, hosting, training and support.





We target mid- to large-sized organizations, and our products are used by call centers, IT helpdesks, human
resources organizations, marketing organizations, and eService businesses. In addition to our traditional markets of technology and telecommunications, we touch vertical markets that include aerospace, financial services, manufacturing and retail.
We develop our products and market and sell our software and services primarily through a direct sales force and a minority owned Japanese joint venture. We have offices throughout the United States, and in the United Kingdom and France.





License fees for our software varies with each application, but our products are typically licensed on a
per-processor basis, per-user basis or based on the number of users authorized to access our software at any given time. Our typical license agreement provides the licensee a perpetual, nontransferable license to use our software.





The Primus software suite consists of Primus ® eServer, Primus ® eSupport, Primus ® Answer Engine, Primus ® IView and Primus ® Quick Resolve. Product license revenue and related service revenue from Primus eServer and Primus eSupport products accounted for over 90% of total revenue for the three and six months
ended June 30, 2002 and 2001.





We are subject to certain business risks that could affect future operations and
financial performance. These risks include, but are not limited to, changing computing environments, rapid technological change, development of new products, limited protection of proprietary technology, claims of intellectual property infringement
and competitive products and pricing.





The unaudited condensed consolidated financial statements include the
accounts of Primus and its wholly owned subsidiaries, including its foreign subsidiaries, Primus Knowledge Solutions (UK) Limited and Primus Knowledge Solutions France. All significant intercompany balances and transactions have been eliminated.





We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any
obligations of unconsolidated entities nor have we any commitment or intent to provide any funding to any such entity. As such, we are not exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such
relationships.







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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







On May 31, 2001, we acquired AnswerLogic, Inc. (AnswerLogic).
AnswerLogics technology provided us with natural language programming and semantic understanding capabilities. These capabilities allow our customers to provide direct answers to their customer questions from unstructured data
sourcesHTML, PDF and text formatsas well as structured information contained in the Primus knowledgebase. We have accounted for the AnswerLogic business combination using the purchase method of accounting and have included
AnswerLogics operating results in our consolidated operating results beginning on June 1, 2001 (see Note 3).





During the third quarter of 2001, we discontinued funding future product development for our 2order subsidiary. On September 29, 2001, 2order sold the intellectual property associated with the current shipping versions of the
Primus ® eSales product line and certain other assets to its leading reseller. As a result of this
transaction, our reseller rights for the Primus eSales product line were cancelled. The gain on the disposal of substantially all of the 2order assets was recorded as an extraordinary gain in our consolidated financial statements for the quarter
ended September 30, 2001, since the disposed assets were acquired in an acquisition accounted for using the pooling-of-interests method of accounting and were disposed of within two years of the business combination.





Unaudited Interim Financial Information





The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim
financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In our opinion, the unaudited condensed consolidated financial statements
include all adjustments necessary (which are of a normal and recurring nature) for the fair presentation of the results of the interim periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with
our audited consolidated financial statements for the year ended December 31, 2001 included in our Form 10-K filed with the SEC in March of 2002. The results of operations for any interim period are not necessarily indicative of the results of
operations for any other interim period or for a full fiscal year.





Reclassifications





Certain balances have been reclassified to conform to the current period presentation.





Cash, Cash Equivalents and Short-Term Investments





Cash, cash equivalents and short-term investments are comprised of the following (in thousands):





June 30, 2002

December 31, 2001Cash and cash equivalents

$
12,012

$
13,370Short-term investments


3,006


5,129Total cash, cash equivalents and short-term investments

$
15,018

$
18,499




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







Note 2.    Summary of Significant Accounting Policies





Revenue Recognition





We recognize revenue in accordance with accounting standards established for software companies. These include 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 and Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101).
Revenue is recognized when persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable and there is vendorspecific objective evidence to allocate the total fee to the elements of the arrangement.





Vendor-specific objective evidence (VSOE) is typically based on the price charged when an element is sold
separately, or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. In multiple element arrangements in
which VSOE exists only for undelivered elements, the fair value of the undelivered elements is deferred and the residual arrangement fee is assigned to the delivered elements. If evidence of fair value for any of the undelivered elements does not
exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered.





Prior to the fourth quarter of 2001, for our eServer and eSupport products, revenue from software license agreements was recognized over the software core installation
period (if sold with installation services) or upon delivery of software (if sold without installation services), provided all of the other revenue recognition requirements of Statement of Position No. 97-2 had been met. During the fourth quarter of
2001, we released new versions of these software products, which do not require significant installation efforts. Accordingly, revenue from software license arrangements are now generally recognized upon the delivery of the software, regardless of
whether installation services are sold, provided all other revenue recognition requirements of Statements of Position No. 97-2 and 98-9 and SAB 101 have been met. This change did not have a material impact on our operating results.





If a customer requires an acceptance period, revenue is recognized upon the earlier of customer acceptance or the expiration of
the acceptance period. Revenue from license arrangements with payment terms extending beyond one year is recognized as payments become due, provided all other conditions for revenue recognition are met.





Services revenue consists of maintenance and support fees and consulting, training and hosting fees. Maintenance and ongoing hosting fees
are recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis under separate service arrangements related to the use of our
software products. Revenue from consulting and training services is recognized as services are performed. If a transaction includes both license and service elements, license fees are recognized separately upon delivery of the software, provided
services do not include significant customization or modification of the base product, and the licenses are not subject to acceptance criteria.





From time to time we enter into distribution agreements with resellers that typically provide for sublicense fees based on a percentage of list prices. Sublicense fees are generally recognized upon
delivery of software if pervasive evidence of an arrangement between the distributor and their customer exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists for the undelivered elements. Our
agreements with our customers and resellers do not contain product return rights.





Accounts Receivable





We perform a quarterly analysis to determine the appropriate allowance for doubtful accounts. This analysis
includes various analytical procedures and a review of factors, including specific individual balances selected from a cross-section of the accounts that comprise total accounts receivable, our history of collections, as well as




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







the overall economic environment.





Recently Issued Accounting Pronouncements





In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). This
statement requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. We will adopt the provisions of SFAS 146 no later than January 1, 2003. We are currently
assessing the impact of this statement on our results of operations, financial position and cash flows.





In
October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of Operations  Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the
disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or
in a distribution to owners) or is classified as held for sale. The adoption of this statement on January 1, 2002 did not have a material impact on our financial statements.





In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction,
development and (or) normal use of the asset. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The
fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. If the obligation is settled for other than the carrying amount of the liability, we
will recognize a gain or loss on settlement. We will adopt the provisions of SFAS No. 143 on January 1, 2003. We believe the adoption of this statement will not have a material impact on our financial statements.





Note 3.    Business Combination and Goodwill





On May 31, 2001, we acquired AnswerLogic. AnswerLogics technology provided us with natural language programming and semantic understanding capabilities that are a natural extension to our product
suite. These new capabilities will allow our customers to provide direct answers to customer questions from unstructured data sourcesHTML, PDF and text formatsas well as structured information contained in the Primus knowledgebase. At
the closing of the acquisition, all of the outstanding equity securities and certain outstanding convertible subordinated promissory notes of AnswerLogic were converted into 750,000 shares of Primus common stock.





The acquisition was accounted for by the purchase method whereby the purchase price of approximately $2.9 million was allocated to the
assets acquired and liabilities assumed based on their fair values at the acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $2.8 million was recorded as goodwill and was
being amortized on a straight-line basis over the estimated useful life of three years. The fair value of the common stock issued in the acquisition was $3.94 per share, based on the average market price for a three-day period before and after May
21, 2001.




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







The following unaudited pro forma condensed consolidated financial
information presents the results of operations of Primus and AnswerLogic as if the acquisition had occurred on January 1, 2001 after giving effect to certain adjustments, primarily amortization of goodwill. The unaudited pro forma condensed
consolidated financial information does not purport to be indicative of what would have occurred had the acquisition been made as of those dates or of results that may occur in the future. The unaudited pro forma condensed consolidated financial
information is as follows (in thousands, except per share data):





Six Months Ended June 30, 2001Total revenue

$
16,627Net loss


(12,561
)Pro forma net loss per shareBasic and diluted


(0.67
)





This pro forma presentation includes the amortization of goodwill
of $472,000, which was required under generally accepted accounting principles prior to the adoption of SFAS No. 142 Goodwill and Other Intangible Assets discussed below.





In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets, which requires that goodwill no longer be amortized to earnings, but instead be tested at least annually for impairment. The amortization of goodwill ceases upon the required adoption date of the Statement, which for us was January 1,
2002. At the date of adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The implied fair value of goodwill was calculated based upon a comparison of
the book value of the Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002. Accordingly, we recognized an approximately $2.3 million transitional impairment loss as the
cumulative effect of a change in accounting principle as a result of the adoption of SFAS No. 142.





Net Loss and
loss per share for the quarter and six months ended June 30, 2001, and for the year ended December 31, 2001, adjusted to exclude goodwill amortization expense are as follows (in thousands, except per share data):





Quarter ended June 30,
2001


Six Months Ended June 30, 2001


Year Ended December 31, 2001Net Loss:Reported loss before extraordinary item

$
(5,437
)

$
(8,716
)

$
(21,821
)Goodwill amortization


79



79



550Adjusted loss before extraordinary item


(5,358
)


(8,637
)


(21,271
)Extraordinary item










566Adjusted net loss

$
(5,358
)

$
(8,637
)

$
(20,605
)Basic and diluted loss before extraordinary item per share:Reported basic and diluted loss per share

$
(0.30
)

$
(0.48
)

$
(1.18
)Goodwill amortization


0.01



0.01



0.03Adjusted basic and diluted loss before extraordinary item per share


(0.29
)


(0.47
)


(1.15
)Extraordinary item










0.03Adjusted net loss

$
(0.29
)

$
(0.47
)

$
(1.12
)




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







There was no goodwill amortization in 2000 or 1999.





Note 4.    Loss Per Common Share





In accordance with FASB SFAS No. 128, Earnings Per Share, we report both basic and diluted net loss per common share for each period presented. Basic net loss per common share is computed
on the basis of the weighted-average number of common shares outstanding for the period. Diluted net loss per common share is computed on the basis of the weighted-average number of common shares plus dilutive potential common shares outstanding.
Dilutive potential common shares are calculated under the treasury stock method. Securities that could potentially dilute basic income per share consist of outstanding stock options and warrants. As we had a net loss available to common shareholders
in each of the periods presented, basic and diluted net loss per common share are the same. All outstanding warrants and stock options to acquire common shares were excluded from the computation of diluted earnings per share for the three and six
months ended June 30, 2002 and 2001, as the effect was anti-dilutive.





Potential common shares consisted of
options and warrants to purchase 7,827,015 and 6,933,842 common shares at June 30, 2002 and 2001, respectively.





Note
5.    Comprehensive Loss





Comprehensive loss consists of net loss, foreign currency
translation adjustments and net unrealized gains (losses) from securities available-for-sale and is presented in the accompanying statement of stockholders equity and comprehensive loss (income). SFAS No. 130, Reporting Comprehensive
Income, requires only additional disclosures in the financial statements; it does not affect our financial position or operations. The following table reconciles net loss as reported to total comprehensive loss for the three and six months
ended June 30, 2002 and 2001(in thousands):





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Net loss

$
(3,165
)

$
(5,437
)

$
(7,987
)

$
(8,716
)Other comprehensive (loss) income:Foreign currency translation gain (loss)


71



(7
)


50



(41
)Unrealized gain (loss) on securities available-for-sale


(21
)


(10
)


(79
)


19Total comprehensive loss

$
(3,115
)

$
(5,454
)

$
(8,016
)

$
(8,738
)





There was no significant tax effect on the components of other
comprehensive (loss) income for the three and six-month periods ended June 30, 2002 and 2001.





Note 6.    Related
Party Transactions





On April 12, 2001, the Companys Board of Directors approved an unsecured loan to
Michael Brochu, the Companys President and Chief Executive Officer, for $750,000 bearing interest at 4.9%. The maturity date of the loan is April 16, 2007 with principal and accrued interest payments due annually starting on April 16, 2005.
This note is subject to full forgiveness in the event of Mr. Brochus termination of employment without cause or for good reason following a change of control.





In 1997, Primus Knowledge Solutions, K.K. (Primus KK), a distributor whose majority shareholder is also a significant shareholder of ours, became a reseller of certain of
our products and a provider of support services in Japan. The distribution agreement provides for sublicense fees based on a percentage of list prices. Sublicense




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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)




fees are generally recognized upon delivery of software if pervasive evidence of an arrangement between Primus KK and their customer
exists, collection is probable, the fee is fixed or determinable and vendor-specific objective evidence for all undelivered elements exists. Our agreement with Primus KK does not contain product return rights. Revenue recognized under the reseller
agreement totaled approximately $147,000 and $527,000, for the quarters ended June 30, 2002 and 2001, respectively, and revenue deferred at June 30, 2002 and December 31, 2001 was approximately $395,000 and $353,000, respectively, and accounts
receivable at June 30, 2002 and December 31, 2001 were approximately $176,000 and $326,000, respectively.





Note
7.    Business Segment Information





We are principally engaged in the design, development,
marketing, sale and support of eServer, eSupport, Answer Engine and Quick Resolve software products. Substantially all revenue results from the licensing of our software products and related consulting, hosting and customer support (maintenance)
services. Our chief operating decision-maker reviews financial information presented on a consolidated basis, accompanied by disaggregated revenue information.





The majority of our revenue is derived from customers in the United States of America. Our international sales are principally in Europe and Japan. The following geographic information is presented for
the three and six months ended June 30, 2002 and 2001 (in thousands):





Three Months Ended June 30,

Six Months Ended June 30,2002

2001

2002

2001United States

$
3,617

$
5,426

$
8,341

$
13,242Japan


147


527


593


2,103Other


476


564


1,333


1,250Total Revenue

$
4,240

$
6,517

$
10,267

$
16,595





Revenue from Japan was principally derived from sales through our
Japanese joint venture, Primus KK, in which we hold a 19.6% minority interest. We recognize software license revenue for sales to this distributor in accordance with our revenue recognition policy as described in Notes 2 and 6.





Note 8.    Restructuring Charges





During the first quarter of 2002, we executed a further restructuring of our workforce and as a result recorded restructuring charges totaling $435,000 for severance, benefits and associated costs due
to a 12% reduction in our worldwide workforce. We reduced our research and development workforce by 10 employees, or 14%, our sales marketing workforce by 7 employees, or 11%, our professional services and support workforce by 4 employees, or 10%,
and our general and administrative workforce by 3 employees, or 13%, for a total workforce reduction of 24 people, or 12% of our employee base in March 2002. At December 31, 2001, we had accrued approximately $600,000 for the reduction of excess
facilities as part of our fourth quarter 2001 restructuring plan. A portion of this charge was based on the estimated period to sublease certain excess facilities and current estimated lease rental rates for leases in the respective market. Should
lease rental rates continue to decrease in this market or should it take longer than expected to find a suitable tenant to sublease this facility, the actual loss could exceed this estimate. The $600,000 of future cash outlays as of December 31,
2001 were anticipated to occur through December 2003 unless we are able to negotiate to exit the lease at an earlier date. At June 30, 2002, the remaining accrued balance was approximately $335,000 and there had not been any material changes to
these lease related estimates. The decreases in the accrual balance from December 31, 2001 to March 31 and June 30, 2002 were substantially due to cash payments.







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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







Note 9.    Liquidity





Our operations have historically been financed through issuances of common and preferred stock. For the six-month period ended June 30,
2002, the Company incurred a net loss of $8.0 million and used cash in operating activities of approximately $3.3 million. At June 30, 2002, the Company has working capital of approximately $9.6 million. We believe we have sufficient resources to
continue as a going concern through at least June 30, 2003. To reduce the cash used in operations, we put in place cost containment efforts during the third quarter of 2001 and restructured our operations during the fourth quarter of 2001 and the
first quarter of 2002, reducing our headcount by 96 employees and eliminating excess facilities. During the third quarter of 2002, we expect to take a restructuring charge as part of our ongoing cost reduction initiative. We expect this initiative
will result in the reduction of worldwide staffing levels by at least 12%. We are working on finalizing other components of this plan including possible reductions in facilities and associated overhead. We expect the restructuring charge for the
third quarter to include severance, and it may include a charge for reduction of excess facilities and overhead. Our plan to address our liquidity issues is to generate sufficient revenue from customer contracts or further reduce costs to provide
positive cash flows from operations. There can be no assurance that we will be able to generate sufficient revenue from customer contracts, or further reduce costs sufficiently, to provide positive cash flows from operations. If we are not able to
generate positive cash flows from operations, we will need to consider alternative financing sources. Alternative financing sources may not be available when and if needed by us or on favorable terms.





Note 10.    Legal Proceedings





The Company, an officer, former officer and FleetBoston Robertson Stephens, Inc., J.P. Morgan Securities Inc., U.S. Bancorp Piper Jaffray Inc., CIBC World Markets, Dain Rauscher, Inc. and Salomon Smith
Barney Holdings Inc., the underwriters of our initial public offering, have been named as defendants in an action filed during December 2001 in the United States District Court for the Southern District of New York on behalf of persons who purchased
Primus common stock during the period from June 30, 1999 through December 6, 2000, which was issued pursuant to the June 30, 1999 registration statement and prospectus for the Companys initial public offering. The complaint alleges that the
Company and the individual defendants violated the Securities Act of 1933 by failing to disclose excessive commissions allegedly obtained by the Companys underwriters pursuant to a secret arrangement whereby the underwriters allocated IPO
shares to certain investors in exchange for the excessive commissions, referred to as laddering. The complaint also asserts claims against the underwriters under the 1933 Act and the Securities Exchange Act of 1934 in connection with the allegedly
undisclosed commissions. The Company intends to vigorously defend itself and its current and former officers against this action. The results of any litigation matter are inherently uncertain and litigation frequently involves substantial
expenditures and can require significant management attention, even if the Company ultimately prevails. Accordingly, while we do not believe it is probable that the outcome of this litigation matter will be unfavorable to the Company, we cannot
provide assurances that this action will not materially and adversely affect our business, our results of operation or our stock price.





In January 2002, Mindfabric, Inc. served a complaint against Primus in the United States District Court for the Northern District of California, which alleged that aspects of our technology infringe one or more patents
alleged to be held by the plaintiff. Effective April 15, 2002, we entered into a settlement and release agreement under which Primus was released from all claims and potential damages for past infringement and was granted a five-year license under
the patents for Primus products and services. After January 1, 2007, depending on the products Primus is then selling and the status of the Mindfabric patents, Primus may need to either obtain a commercially reasonable license under the patents for
the remainder of their patent life or potentially defend an action for post January 1, 2007 alleged infringement. Under the terms of the settlement, Primus made cash payments to Mindfabric on July 1, 2002 and will deliver 75,000 shares of registered
Primus common stock, subject to certain resale and volume limitations. In connection with this settlement, the Company recorded an approximate charge of $275,000 to general and administrative expenses during the three months ended March 31, 2002,
net of the value of 112,500 Primus shares withheld under the AnswerLogic acquisition escrow.







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PRIMUS KNOWLEDGE SOLUTIONS, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





June 30, 2002


(Unaudited)







Note 11.    Subsequent Events





During the third quarter of 2002, we expect to take a restructuring charge as part of our ongoing cost reduction initiative. This will
result in the reduction of worldwide staffing levels by approximately 12%. We are working on finalizing other components of this plan including possible reductions in facilities and associated overhead. We expect this restructuring charge for the
third quarter to include severance, and it may include a charge for the reduction of excess facilities and overhead.





As of August 2, 2002 our common stock has traded under a minimum $1.00 for the previous 30 trading days. As a result our common stock is out of compliance with the minimum bid price listing requirements for NASDAQ National Market. In
order to regain compliance with this NASDAQ National Market listing requirement, the bid price of our common stock must close at $1.00 per share or more for a minimum of 10 consecutive trading days at anytime before October 31, 2002. If market
trading does not result in the increase of the trading price of our common stock, we may comply with this listing requirement by implementing a company board approved reverse stock split and/or we may elect to transfer our securities from the NASDAQ
National Market to the NASDAQ SmallCap Market.





|ITEM  2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|-------- |  | -------------------------------------------------------------------------------------




Forward-Looking Statements





This report contains certain forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These forward-looking statements involve risks and uncertainties, including, but not limited to, those identified in the section of this
Form 10-Q entitled Factors That May Affect Results Of Operations and Financial Condition, which may cause actual results to differ materially from those discussed in such forward-looking statements. When used in this document, the words
believes, expects, anticipates, intends, plans and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive
means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this report
should be read as being applicable to all related forward-looking statements wherever they appear in this report. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed in our Annual
Report on Form 10-K, a copy of which is on file at the Securities and Exchange Commission. We undertake no obligation to release publicly the results of any revision to these forward-looking statements that may be made to reflect events or
circumstances occurring subsequent to the filing of this Form 10-Q with the SEC. Readers are urged to review and carefully consider the various disclosures made by us in this report and in our other reports filed with the SEC that attempt to advise
interested parties of the risk and factors that may affect our business.





Overview





We provide application software that enables companies to deliver great service by accessing, analyzing and improving information. Primus
software offers a significant measurable value to businesses by providing an infrastructure that captures and shares knowledge, increasing the efficiency and effectiveness of customer service. Primus software products can be implemented as a suite
or as individual products, depending on the customers preference and/or business need. Primus software is flexible and easily implemented. Our solutions integrate with leading CRM applications, including those from Amdocs/Clarify, Kana, Onyx,
Oracle, Peregrine Systems/Remedy, and Siebel. In addition to software applications, Primus offers professional services to assist customers with software implementation, integration, training and support.





To compete in todays business environment, companies must maximize their relationships with their existing customers. The need to
develop and sell more deeply into their existing customer base has led many




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companies to implement CRM initiatives and software. CRM software is designed to enable companies to
interact with their customers using both traditional and eBusiness communication channelsincluding the phone, web, email, chat, and voice over IP (VOIP)and to manage customer information in a way that helps companies maximize the value
of each customer interaction. Facilitating more efficient communications with customers can help to improve the level and quality of customer service companies deliver and, in turn, increase customer satisfaction and retention and cross-sell and
up-sell opportunities.





We market our software and services on a worldwide basis through our direct sales
organization in the United States and Europe. Primus KK, a Japanese joint venture in which we hold a minority interest has exclusive distribution rights to distribute our Primus eServer and Primus eSupport products in Japan. Our international sales
constituted 15% and 17% of our revenue for the quarters ended June 30, 2002 and 2001, respectively. We believe that international revenue, as a percentage of our total revenue, will fluctuate in the future. We have not guaranteed any obligations of
the joint venture nor do we have any commitment or intent to provide any funding.





The Primus software suite
consists of Primus eServer, Primus eSupport, Primus Answer Engine, Primus ® IView and Primus
Quick Resolve. Product license revenue and related service revenue from Primus eServer and Primus eSupport products accounted for over 90% of total revenue for the three and six months ended June 30, 2002, and we expect these products to continue to
account for a substantial portion of our revenue for the remainder of 2002. As a result, factors adversely affecting the demand for these products and our products in general, such as competition, pricing or technological change, could materially
and adversely affect our business, financial condition, operating results and stock price. Our future financial performance will substantially depend on our ability to sell current versions of our entire suite of products, including products based
on the technology acquired from AnswerLogic, and our ability to develop and sell enhanced versions of our products.





To help us execute our long-term growth strategy, we have invested heavily in product development and in building our sales, marketing, finance, administrative and professional services organizations. We have incurred quarterly net
losses since inception, and as of June 30, 2002, had an accumulated deficit of approximately $97 million. We anticipate that our operating expenses will continue to be substantial for the foreseeable future as we continue to invest in product
development, sales and marketing, finance, administration and professional services.





History of Operations





Primus, formerly named Symbologic Corporation, was incorporated in October 1986 and initially focused on a software development
tool for creation of systems to gather organizational expertise. In 1993, we licensed that product line to another company and founded the Customer Support Consortium, a consortium of leading software and hardware companies focused on advancing
customer-support strategies, models and standards. From 1993 to 1995, we directed our attention to customer-support products and began developing our SolutionSeries products. In 1995, we changed our name to Primus Knowledge Solutions, Inc. and
released SolutionBuilder ® , our first SolutionSeries product. We launched our first Web-based
products, SolutionPublisher ® and SolutionExplorer ® , in 1996 and 1997, respectively. In 1997, we also divested our interest in the Customer Support Consortium in conjunction with its transition to
an independent nonprofit entity. Also in 1997, Primus KK became a reseller of the Companys products and a provider of support services in Japan.





We completed our initial public offering on June 30, 1999, offering 4,772,500 shares of Primus common stock, at an aggregate offering price of approximately $50.8 million. Net proceeds after accounting
for $3.6 million in underwriting discounts and commissions and approximately $1.0 million in other expenses were $46.2 million.





Acquisitions and Restructuring





On May 31, 2001, we acquired AnswerLogic.
AnswerLogics technology provided us with natural language




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capabilities that were a logical extension to our product suite. These new capabilities allow our
customers to provide direct answers to customer questions from unstructured data sourcesHTML, PDF and text formatsas well as structured information contained in the Primus knowledgebase. We have accounted for the AnswerLogic business
combination using the purchase method and have included AnswerLogics operating results in its consolidated operating results since June 1, 2001.





During the third quarter of 2001, we discontinued funding product development for 2order, a wholly owned subsidiary. On September 29, 2001, 2order sold substantially all of its assets to its leading
reseller. As a result of this transaction, our reseller rights for the eSales product line were cancelled. The gain on the disposal of substantially all of the 2order assets was recorded as an extraordinary gain in our consolidated financial
statements for the quarter ended September 30, 2001, since the disposed assets were acquired in an acquisition accounted for using the pooling-of-interests method of accounting and were disposed of within two years of the business combination.





During the fourth quarter of 2001, we developed and executed a restructuring plan and as a result incurred
charges of approximately $2.5 million related to the reduction in our workforce and costs associated with certain excess leased facilities and asset impairments. The charges included approximately $800,000 for the assets disposed of or removed from
operations, which consisted primarily of leasehold improvements, computer equipment and related software, office equipment, and furniture and fixtures. Also included was an expense of approximately $1.1 million for severance, benefits and related
costs due to the reduction in workforce. In October 2001, we reduced our workforce by 72 people, or 26% of our employee base, and all functional areas were affected by the reductions. Additionally, the charge included an expense of $600,000 due to
our decision to reduce some facilities. A portion of this charge was based on then current estimated lease rental rates for leases in the respective market. Should facilities operating lease rental rates continue to decrease in this market or should
it take longer than expected to find a suitable tenant to sublease this facility, the actual loss could exceed this estimate. The $600,000 of future cash outlays are anticipated through December 2003 unless we are able to negotiate to exit the lease
at an earlier date. As of June 30, 2002 the remaining accrued balance was approximately $335,000 and there had not been any material changes to these lease related estimates.





During the first quarter of 2002, we executed a further restructuring of our workforce and as a result recorded restructuring charges of approximately $435,000 for
severance, benefits and associated costs due to a 12% reduction in our worldwide workforce, which was paid during the second quarter of 2002. We reduced our research and development workforce by 10 employees, or 14%, our sales marketing workforce by
7 employees, or 11%, our professional services and support workforce by 4 employees, or 10%, and our general and administrative workforce by 3 employees, or 13%, for a total workforce reduction of 24 people, or 12% of our employee base in March
2002.





During the third quarter of 2002, we expect to take a restructuring charge as part of our ongoing cost
reduction initiative. We expect this initiative will result in the reduction of worldwide staffing levels by at least 12%. We are working on finalizing other components of this plan including possible reductions in facilities and associated
overhead. We expect the restructuring charge for the third quarter to include severance, and it may include a charge for reduction of excess facilities and overhead.





As we continue to evaluate our underlying cost structure to improve our operating results and better position ourselves for growth, we may incur further restructuring
charges, including severance, benefits and related costs due to a reduction in workforce and charges for assets disposed of or removed from operations as a direct result of a reduction in workforce.





Significant Accounting Policies and Estimates





Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The preparation of these unaudited condensed




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consolidated financial statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on other assumptions that we
believe 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.





Our significant accounting policies include the following:





Revenue Recognition





We recognize revenue in accordance with accounting standards established for software companies. These include 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 and Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101).
Revenue is recognized when persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable and there is vendorspecific objective evidence to allocate the total fee to the elements of the arrangement.





Vendor-specific objective evidence (VSOE) is typically based on the price charged when an element is sold
separately, or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. In multiple element arrangements in
which VSOE exists only for undelivered elements, the fair value of the undelivered elements is deferred and the residual arrangement fee is assigned to the delivered elements. If evidence of fair value for any of the undelivered elements does not
exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered.





Prior to the fourth quarter of 2001, for our eServer and eSupport products, revenue from software license agreements was recognized over the software core installation
period (if sold with installation services) or upon delivery of software (if sold without installation services), provided all of the other revenue recognition requirements of Statement of Position No. 97-2 had been met. During the fourth quarter of
2001, we released new versions of these software products, which do not require significant installation efforts. Accordingly, revenue from software license arrangements are now generally recognized upon the delivery of the software, regardless of
whether installation services are sold, provided all other revenue recognition requirements of Statement of Position No. 97-2 have been met. This change did not have a material impact on our operating results.





If a customer requires an acceptance period, revenue is recognized upon the earlier of customer acceptance or the expiration of the
acceptance period. Revenue from license arrangements with payment terms extending beyond one year is recognized as payments become due, provided all other conditions for revenue recognition are met.





Services revenue consists of maintenance and support fees and consulting, training and hosting fees. Maintenance and ongoing hosting fees
are recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis under separate service arrangements related to the use of our
software products. Revenue from consulting and training services is recognized as services are performed. If a transaction includes both license and service elements, license fees are recognized separately upon delivery of the software, provided
services do not include significant customization or modification of the base product, and the licenses are not subject to acceptance criteria.





From time to time we enter into distribution agreements with resellers that typically provide for sublicense fees based on a percentage of list prices. Sublicense fees are generally recognized upon
delivery of software if pervasive evidence of an arrangement between the distributor and their customer exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists for the undelivered elements. Our




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agreements with our customers and resellers do not contain product return rights.





Accounts Receivable





We perform a quarterly analysis to determine the appropriate allowance for doubtful accounts. This analysis includes various analytical procedures and a review of factors, including specific individual
balances selected from a cross-section of the accounts that comprise total accounts receivable, our history of collections, as well as the overall economic environment.





Goodwill





In July 2001, the
FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill no longer be amortized to earnings, but instead be tested at least annually for impairment. The amortization of goodwill ceases upon the
required adoption date of the Statement, which for us was January 1, 2002. At the date of adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The
implied fair value of goodwill was calculated based upon a comparison of the book value of the Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002. Accordingly, we recognized
an approximately $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of the adoption of SFAS No. 142.




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Results of Operations for the Three and Six Months Ended June 30, 2002 and 2001





The following table sets forth certain financial data, derived from our unaudited condensed consolidated statements of
operations, as a percentage of total revenue for the periods indicated. The operating results for the three and six months ended June 30, 2002 and 2001 are not necessarily indicative of the results that may be expected for any future period.





Three Months Ended June 30,


Six Months Ended June
30,2002


2001


2002


2001Revenue:License:Third party

26.1
%

32.7
%

32.5
%

41.0
%Related partyPrimus KK




3.8


2.2


9.326.1


36.5


34.7


50.3Service:Third party

70.4


59.2


61.7


46.3Related partyPrimus KK

3.5


4.3


3.6


3.473.9


63.5


65.3


49.7Total revenue

100.0


100.0


100.0


100.0Cost of revenue:License

1.0


1.0


1.1


1.2Service

27.1


33.9


23.8


27.7Total cost of revenue

28.1


34.9


24.9


28.9Gross profit

71.9


65.1


75.1


71.1Operating expenses:Sales and marketing

69.0


76.2


58.4


67.7Research and development

49.5


51.0


43.7


38.0General and administrative

30.2


25.4


25.7


21.4Goodwill




1.2





0.5Restructuring charges







4.2


Total operating expenses

148.7


153.8


132.0


127.6Loss from operations

(76.8
)

(88.7
)

(56.9
)

(56.5
)Other income, net

2.2


5.9


2.0


5.5Loss before income taxes and cumulative effect of change in accounting principle

(74.6
)

(82.8
)

(54.9
)

(51.0
)Income tax expense




(0.6
)

(0.7
)

(1.5
)Loss before cumulative effect of change in accounting principle

(74.6
)

(83.4
)

(55.6
)

(52.5
)Cumulative effect of change in accounting principle







(22.2
)

Net loss

(74.6
)%

(83.4
)%

(77.8
)%

(52.5
)%





Revenue





Total revenue was $4.2 million and $6.5 million for the three months ended June 30, 2002 and 2001, respectively, representing a decrease of $2.3 million,
or 35%. During the three months ended June 30, 2002 revenue from sales to one customer represented approximately 20% of total revenue. International revenue decreased $470,000 over the three-month period and $1.4 million over the six-month period.
Our international sales constituted 15% and 17% of our second quarter 2002 and 2001 total revenue, respectively, and 19% and 20% of our revenue for the six months ended June 30, 2002 and 2001, respectively. We believe that international revenue, as
a percentage of our total revenue, will continue to fluctuate in the future. During the three months




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ended June 30, 2001, no single customer accounted for 10% or more of total revenue. Total revenue was
$10.3 million and $16.6 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease of $6.3 million, or 38%. During the six months ended June 30, 2002 and 2001, other than related party sales to Primus KK of
$2,103,000 for the six months ended June 30, 2001, no single customer accounted for 10% or more of total revenue.





License Revenue.    Total license revenue was $1.1 million and $2.4 million for the three months ended June 30, 2002 and 2001, respectively, representing a decrease of $1.3 million, or 53%. Total license
revenue was $3.6 million and $8.3 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease of $4.7 million, or 57%. We experienced a decrease in the sales of our software in the second quarter of 2002, when
compared to the same quarter of 2001, and we believe the weakening of the worldwide economy and the continued global slow down in information technology spending in the last twelve months contributed to this decline. During the second quarter of
2002, the buying patterns of our potential customers were different than in the same quarter of the prior year, and resulted in a longer sales cycle, making it difficult to predict when license sales would close. License revenue as a percentage of
total revenue was 26 % and 36% for the three months ended June 30, 2002 and 2001, respectively and 35% and 50% for the six months ended June 30, 2002 and 2001, respectively. This decrease in software license revenue as a percentage of total revenue
for the three and six-month periods ended June 30, 2002 is primarily due to the decrease in the sale of software licenses. We believe that the depth and duration of the current economic slowdown will continue to have a material impact on our
operating results.





Service Revenue.    Total service revenue was $3.1 million and $4.1
million for the three months ended June 30, 2002 and 2001, respectively, representing a decrease of $1.0 million, or 24%, and was the result of a decrease in maintenance and support contract revenue of $770,000 and a decrease in consulting fees of
$270,000 over the same period. Service revenue as a percentage of total revenue was 74% and 64% for the three months ended June 30, 2002 and 2001, respectively. Total services revenue was $6.7 million and $8.3 million for the six months ended June
30, 2002 and 2001, respectively, representing a decrease of $1.6 million, or 19%, and was the result of a decrease in maintenance and support contract revenue of $1.0 million and a decrease in consulting fees of approximately $580,000 million over
the same period. Services revenue as a percentage of total revenue was 65% and 50% for the six months ended June 30, 2002 and 2001, respectively. The substantial decrease in license revenue resulted in the significant change in the percentage of
revenue generated from licenses and services. The decreases in maintenance and support contract revenue and consulting fees are by-products of continued pricing pressures, the termination of certain low margin support and maintenance contracts and
the declines in both license revenue and information technology spending experienced during the last twelve months. We expect the amount of and proportion of services revenue to total revenue to fluctuate in the future, depending primarily on the
dollar amount of software license sales and our customers use of third-party consulting and implementation services providers.





Cost of Revenue





Total cost of revenue was $1.2 million and $2.3 million for the three
months ended June 30, 2002 and 2001, respectively, representing a decrease of $1.1 million, or 48%. Total cost of revenue was $2.6 million and $4.8 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease of
$2.2 million, or 47%.





Cost of License Revenue.    Cost of license revenue consists
primarily of media, product packaging and shipping, documentation and other production costs, and third party royalties. Cost of license revenue was $44,000 and $68,000 for the three months ended June 30, 2002 and 2001, respectively. This decrease
in the cost of license revenue is primarily due to the decrease in license revenue for the three months ended June 30, 2001 compared to the three months ended June 30, 2002. Cost of license revenue as a percentage of license revenue for the three
months ended June 30, 2002 and 2001 was 4% and 3%, respectively. Cost of license revenue was $117,000 and $202,000 for the six months ended June 30, 2002 and 2001, respectively. This decrease in the cost of license revenue is primarily due to the
decrease in license revenue for the six months ended June 30, 2001




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compared to the six months ended June 30, 2002. We anticipate that our cost of license revenue will vary
in absolute dollars and as a percent of license revenue due to increases or decreases in the volume of software product sales, the sales mix and the costs of third party technology integrated with our solutions.





Cost of Service Revenue.    Cost of services revenue consists primarily of salaries, benefits and allocated
overhead costs related to customer support, consulting, training and global services personnel, including the cost of services provided by third-party consultants engaged by Primus. Cost of service revenue was $1.1 million and $2.2 million for the
three months ended June 30, 2002 and 2001, respectively, representing a decrease of approximately $1.1 million, or 48%. Cost of service revenue as a percentage of service revenue was 37% and 53%, or a gross margin of 63% and 47%, for the three
months ended June 30, 2002 and 2001, respectively. Cost of service revenue was $2.4 million and $4.6 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease of approximately $2.2 million, or 47%. Cost of
service revenue as a percentage of service revenue was 36% and 56%, or a gross margin of 64% and 44%, for the six months ended June 30, 2002 and 2001, respectively. The decrease in cost of service revenue as a percentage of service revenue was
primarily due to higher utilization rates for our professional services staff, continued cost containment efforts and the cost savings realized from workforce reductions since the second quarter of 2001 within the professional services and customer
support organizations. Cost of service revenue will vary depending on the mix of services that we provide between support and maintenance, training, implementation and consulting services, as well as staffing levels, utilization rates, overhead
costs and customer needs. Gross profit margins are generally higher for post contract customer support and maintenance services, which include the delivery of software enhancements and upgrades, than for training, implementation and consulting
services. We anticipate that cost of service revenue will continue to decrease in 2002 as compared to 2001, primarily as a result of our second half of 2001 and first quarter of 2002 workforce reductions and our continued cost containment efforts.





Operating Expenses





Sales and Marketing.    Sales and marketing expenses consist primarily of salaries, bonuses, commissions and benefits earned by sales and marketing personnel, direct expenditures such as travel,
communication and occupancy for direct sales offices and marketing expenditures related to direct mail, online marketing, advertising, trade shows, public relations and new product launches. Sales and marketing expenses were approximately $2.9
million and $5.0 million for the three months ended June 30, 2002 and 2001, respectively, representing a decrease of approximately $2.1 million or 41%. Sales and marketing expenses were approximately $6.0 million and $11.2 million for the six months
ended June 30, 2002 and 2001, respectively, representing a decrease of approximately $5.2 million or 47%. This decrease is primarily due to the reduction in the variable component of total compensation related costs (i.e. bonuses, commissions and
related payroll taxes) which are related to the decrease in revenue for the periods presented; as well as reductions in sales and marketing headcount since the second quarter of 2001, travel and entertainment costs, recruiting expenses, and
consulting and marketing expenditures (e.g. advertising, public relations, tradeshows and collateral materials) as part of our overall cost containment efforts. Sales and marketing expenses as a percentage of total revenue was 69% and 76% for the
three months ended June 30, 2002 and 2001, respectively, and 58% and 68% for the six months ended June 30, 2002 and 2001, respectively. This decrease as a percentage of total revenue is primarily due to the significant decrease in total sales and
marketing expenses from 2001 to 2002, partially offset by the decline in revenue over the same period. We believe that a significant sales and marketing effort is essential for us to maintain market position and further increase market acceptance of
our products, and we anticipate that we will continue to invest significantly in sales and marketing for the foreseeable future. We anticipate that sales and marketing expenses, as an absolute dollar amount will decrease in 2002 as compared to 2001,
primarily as a result of our second half of 2001 and first quarter of 2002 workforce reductions and our continued cost containment efforts. In subsequent periods we expect that sales and marketing expense, as an absolute dollar amount will
fluctuate, depending primarily on the volume of future revenue, staffing levels, overhead costs and our assessment of market opportunities and sales channels.





Research and Development.    Research and development expenses include development costs associated with new products, enhancements and upgrades of existing products and
quality assurance activities, and consist




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primarily of salaries, benefits, and contractors fees for software engineers, program and product
managers, technical writers, linguistic specialists and quality assurance personnel. Research and development expenses were approximately $2.1 million and $3.3 million for the three months ended June 30, 2002 and 2001, respectively, representing a
decrease of approximately $1.2 million or 37%. Research and development expenses were approximately $4.5 million and $6.3 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease of approximately $1.8 million or
29%. The decrease was primarily due to the discontinuance of funding for 2order during the third quarter of 2001, reductions in research and development headcount since the second quarter of 2001 and our continued cost containment efforts, partially
offset by increases in research and development headcount related to our May 31, 2001 acquisition of AnswerLogic. Research and development expenses as a percentage of total revenue was 50% and 51% for the three months ended June 30, 2002 and 2001,
respectively, and 44% and 38% for the six months ended June 30, 2002 and 2001, respectively. This increase as a percentage of total revenue is primarily due to the significant decrease in total revenue for the three months ended June 30, 2001
compared to the three months ended June 30, 2002. We believe that a significant research and development investment is essential for us to maintain our market position, to continue to expand our knowledge application software and to develop
additional applications. Accordingly, we anticipate that we will continue to invest in product research and development for the foreseeable future. We anticipate that research and development costs, as an absolute dollar amount will decrease in 2002
as compared to 2001, primarily as a result of our second half of 2001 and first quarter of 2002 workforce reductions and our continued cost containment efforts. In subsequent periods, we expect that research and development expense, as an absolute
dollar amount will fluctuate, depending primarily on the volume of future revenue, customer needs, staffing levels, overhead costs and our assessment of market demand.





General and Administrative.    General and administrative expenses consist primarily of salaries, benefits and related costs for executive,
finance, human resource, legal, administrative and information services personnel, occupancy costs, bad debt expense and costs associated with being a public company, including, but not limited to, annual and other public-reporting costs,
directors and officers liability insurance, investor-relations programs and professional-services fees. General and administrative expenses were approximately $1.3 million and $1.7 million for the three months ended June 30, 2002 and
2001, respectively, representing a decrease of approximately $375,000 or 23%. General and administrative expenses were approximately $2.6 million and $3.5 million for the six months ended June 30, 2002 and 2001, respectively, representing a decrease
of approximately $910,000 or 26%. This decrease is primarily due to the current year reductions in the variable component of total compensation related costs, reductions in general and administrative headcount since the second quarter of 2001 and
second quarter of 2002 reductions in third party consulting fees, travel costs, recruiting expenses and professional service fees; partially offset by increases in legal expenses during the second quarter of 2002. The decrease in absolute dollars
incurred for general and administrative expenses for the three and six-month periods ended June 30, 2002 reflects the continued impact of the overall cost containment measures taken by us during the last twelve months. General and administrative
expenses as a percentage of total revenue were 30% and 25% for the three months ended June 30, 2002 and 2001, respectively, and 26% and 21% for the six months ended June 30, 2002 and 2001, respectively. The increase of general and administrative
expense as a percentage of total revenue is primarily attributable to the significant decrease in total revenue over the same period. We believe that our general and administrative expenses will fluctuate in absolute dollars in future periods,
depending primarily on the volume of future revenue, staffing levels, overhead costs and corporate infrastructure requirements including insurance, professional services, bad debt expense, legal expense and other administrative costs.





Restructuring Charges.    During the first quarter of 2002, we executed a further restructuring of
our workforce and as a result recorded restructuring charges of approximately $435,000 for severance, benefits and associated costs due to a 12% reduction in our worldwide workforce. We reduced our research and development workforce by 10 employees,
or 14%, our sales marketing workforce by 7 employees, or 11%, our professional services and support workforce by 4 employees, or 10%, and our general and administrative workforce by 3 employees, or 13%, for a total workforce reduction of 24 people,
or 12% of our employee base in March 2002.




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During the third quarter of 2002, we expect to take a restructuring charge as part of our ongoing cost
reduction initiative. We expect this initiative will result in the reduction of worldwide staffing levels by at least 12%. We are working on finalizing other components of this plan including possible reductions in facilities and associated
overhead. We expect the restructuring charge for the third quarter to include severance, and it may include a charge for reduction of excess facilities and overhead.





As we continue to evaluate our underlying cost structure to improve our operating results and better position ourselves for growth, we may incur further restructuring
charges, including severance, benefits and related costs due to a reduction in workforce and/or charges for assets disposed of or removed from operations as a direct result of a reduction in workforce.





Other Income, Net.    Other income, net of other expense, was $93,000 and $388,000 for the three months ended
June 30, 2002 and 2001, respectively and $203,000 and $915,000 for the six months ended June 30, 2002 and 2001, respectively. The decrease from period to period is primarily due to decreases in the average combined cash, cash equivalents and
short-term investment balances as well as declining investment yields. We expect to continue to yield investment income on our cash and cash equivalents and short-term investments at an average rate that is less than that experienced in 2001.





Income Taxes.    We have not recorded income tax benefits related to the net operating
losses for the six months ended June 30, 2002 or 2001 as a result of the uncertainties regarding the realization of the net operating losses. Income tax expense recorded in both the second quarter of 2002 and 2001 and the six months ended June 30,
2002 and 2001 primarily relates to our foreign operations.





Cumulative Effect of Change in Accounting
Principle.    We recognized an approximately $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of the adoption of SFAS No. 142 on January 1, 2002. In July 2001,
the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill no longer be amortized to earnings, but instead be tested at least annually for impairment. The amortization of goodwill ceases upon the
required adoption date of the Statement, which for us was January 1, 2002. At the date of adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The
implied fair value of goodwill was calculated based upon a comparison of the book value of the Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002.





Liquidity and Capital Resources





Prior to our initial public offering, we had primarily financed our operations through the private sale of our equity securities. To a lesser extent, we have financed our operations through equipment financing and traditional lending
arrangements. In July 1999, we completed our initial public offering in which we received approximately $46.2 million in cash, net of underwriting discounts, commissions, and other offering costs.







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As of June 30, 2002, we had cash, cash equivalents and short-term investments of
$15.0 million, representing a decrease of $3.5 million from our December 31, 2001 balance of $18.5 million. As of June 30, 2002, our working capital was $9.6 million compared to $14.3 million at December 31, 2001.





Our operating activities resulted in net cash outflows of $3.3 million and $8.7 million for the six months ended June 30, 2002 and 2001,
respectively. For the six months ended June 30, 2002, adjustments to the $8.0 million net loss to reconcile to cash used in operating activities includes uses of cash of approximately $1.2 million for the decrease in accounts payable and accrued
liabilities and other assets. This is offset by cash provided by operations of approximately $2.5 million for the decreases in accounts receivable, prepaid expenses and other current assets and the increases in compensation related accruals and
deferred revenue, combined with $1.1 million in depreciation and the cumulative effect of change in accounting principle of $2.3 million.





Investing activities provided cash of $1.9 million during the six months ended June 30, 2002, through the proceeds from the maturity of a short-term investment offset by the purchase of property and
equipment.





Financing activities provided cash of $66,000 during the six-month period ended June 30, 2002 from the
issuance of common stock.





Our principal source of liquidity at June 30, 2002 was our cash, cash equivalents and
short-term investments of $15 million. We also have a line of credit totaling $3.0 million, which is secured by substantially all of our assets, bears interest at the banks prime rate plus 1% (5.75% as of June 30, 2002) and expires in December
2002. As of June 30, 2002, we were in compliance with our financial covenants in connection with the line of credit and there were no borrowings outstanding.





We currently anticipate that we will continue to experience fluctuations in our operating expenses for the foreseeable future as we:





| |  |  | enter new markets for our products and services, including through potential acquisitions of complementary businesses, technology or other assets
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | increase or decrease research and development spending
| | - |  | ------------------------------------------------------




| |  |  | increase or decrease sales and marketing activities
| | - |  | ---------------------------------------------------




| |  |  | develop new distribution channels
| | - |  | ---------------------------------




| |  |  | improve our operational and financial systems
| | - |  | ---------------------------------------------




| |  |  | broaden our professional services capabilities
| | - |  | ----------------------------------------------




We continue to focus on maximizing the performance of our core business and controlling costs to respond to the economic environment. During the six months ended June 30, 2002, we reduced worldwide
staffing levels by approximately 12%, across the entire business. During the third quarter of 2002, we expect to take a restructuring charge as part of our present cost reduction initiative. We expect this initiative to result in the reduction of
worldwide staffing levels by at least 12%. We are working on finalizing other components of this plan including possible reductions in facilities and associated overhead. We expect the restructuring charge for the third quarter to include severance,
and it may include a charge for reduction of excess facilities and overhead.





During the fourth quarter of 2001,
we had accrued approximately $600,000 due to our decision to reduce excess facilities. A portion of this was based on the estimated period to sublease certain excess facilities and then current estimated lease rental rates for leases in the
respective market. Should lease rental rates continue to decrease in this market or should it take longer than expected to find a suitable tenant to sublease this facility, the actual loss could exceed this estimate. The $600,000 of future cash
outlays as of December 31, 2001 were anticipated to occur through December 2003 unless we are able to negotiate to exit the lease at an earlier date. At June 30, 2002 the remaining accrued balance was approximately $335,000 and there had not been
any material changes to these lease related estimates.




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As we continue to evaluate our underlying cost structure to improve our operating
results and better position ourselves for growth, we may incur further restructuring charges, including severance, benefits and related costs due to a reduction in workforce and/or charges for assets disposed of or removed from operations as a
direct result of a reduction in workforce. We will adopt the provisions of SFAS 146 no later than January 1, 2003. We are currently assessing the impact of this statement on our results of operations, financial position and cash flows.





In the near-term, we believe our costs and operating expenses, excluding restructuring-related charges, will continue to
decrease to a level that is closer to our expected revenue while allowing us to continue to invest in accordance with our strategic priorities. However, we may be unable to achieve these expense reductions without adversely affecting our business
and results of operations. We expect to continue to experience losses and negative cash flows in the near term, even if sales of our products and services grow.





We lease office space under operating leases with various expiration dates through 2005. We have no material long-term commitments or obligations other than those under these leases. We do not have any
relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor have we any commitment or intent to provide any funding to any such entity. As such, we are not materially
exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.





While we will continue to implement cost containment efforts across our business, our operating expenses, including costs to defend and/or settle legal actions that have been or may be brought against us, will consume a material
amount of our cash resources. We believe that the total amount of our cash, cash equivalents and short-term investments, along with our commercial credit facilities, will be sufficient to meet our anticipated cash needs for working capital or other
purposes for at least the next twelve months. Thereafter, depending on the development of our business, we will likely require additional funds to support our working capital requirements, unanticipated problems or expenses, opportunities for
acquisitions or other business initiatives we encounter and may seek to raise such additional funds through public or private equity or debt (including debt convertible into equity) financing or from other sources. We may not be able to obtain
adequate or favorable financing at that time. Our recent history of declining market valuation, volatility in our stock price and doubts surrounding our future eligibility to remain listed on the Nasdaq National Market could make it difficult for us
to raise capital on favorable terms. Any financing we obtain may dilute or otherwise impair our current shareholders ownership interest in the Company.





Risks Associated with Our Business and Future Operating Results





Our future
operating results may vary substantially from period to period. The price of our common stock will fluctuate in the future, and an investment in our common stock is subject to a variety of risks, including but not limited to the specific risks
identified below. The risks described below are not the only risks facing our company. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may impair our business operations. Prospective and existing
investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this report and our other public filings. If any of the following risks actually occur, our business, financial condition and operating
results could be materially adversely affected and the trading price of our common stock could decline.





We
have a history of losses and may not be profitable in the future and may not be able to generate sufficient revenue or funding to continue as a going concern.





Since we began operations our revenue has not been sufficient to support our operations, and we have incurred substantial operating losses in every quarter. As of June 30,
2002, our accumulated deficit was approximately $97 million. Our history of losses has caused some of our potential customers to question our viability and hampered our ability to sell some of our products. Our revenue has been affected by the




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increasingly uncertain economic conditions both generally and in our market. Although our revenue grew significantly in 2000, we have
experienced a significant decline in sales since then. Although we have restructured our operations to reduce operating expenses, we will need to increase our revenue and/or further reduce our operating expenses to achieve profitability and positive
cash flows from operations, and our revenue may decline, or fail to grow, in future periods. Our expectations as to when we can achieve positive cash flows from operations, and as to our future cash balances, are subject to a number of assumptions,
including assumptions regarding improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control. In addition we may require additional financing, which might not be available on
acceptable terms, if at all.





As a result of uncertainties in our business and the general economic slowdown, we
have experienced and expect to continue to experience difficulties in collecting outstanding receivables from our customers and attracting new customers. As a result, we may continue to experience losses, even if sales of our products and services
grow.





Quarterly fluctuations in our operating results may adversely affect our stock price.





Fluctuations in our operating results, particularly compared to the expectations of investors or market analysts, could cause
severe volatility in the price of our common stock. Our revenue and operating results have fluctuated substantially from quarter to quarter and are likely to continue to do so in the future. Our quarterly revenue and operating results are difficult
to predict and may fluctuate significantly from quarter to quarter particularly because our products and services are relatively new and our prospects are uncertain. We believe that period-to-period comparisons of our operating results may not be
meaningful and you should not rely on these comparisons as an indication of our future performance. We will continue to base our decisions regarding operating expenses on anticipated revenue trends. Therefore, to the extent our actual revenue falls
short of our expectations, our operating results will suffer and our stock price will likely decline. If quarterly revenue or operating results fall below the expectations of investors or market analysts, the price of our common stock could decline
substantially. Factors that might cause quarterly fluctuations in our operating results include the factors described under the subheadings of this Risks Associated with Primus Business and Future Operating Results section as well
as:





| |  |  | general economic conditions that adversely affect our customers capital investment levels in CRM and knowledge management systems
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------




| |  |  | the evolving and varying demand for our software products and services
| | - |  | ----------------------------------------------------------------------




| |  |  | budget and spending decisions by information technology departments of our customers
| | - |  | ------------------------------------------------------------------------------------




| |  |  | order deferrals in anticipation of new products or product enhancements introduced by our competitors or us
| | - |  | -----------------------------------------------------------------------------------------------------------




| |  |  | our ability to manage our expenses
| | - |  | ----------------------------------




| |  |  | the timing of new releases of our products
| | - |  | ------------------------------------------




| |  |  | changes in our pricing policies or those of our competitors
| | - |  | -----------------------------------------------------------




| |  |  | the timing of execution of large contracts that materially affect our operating results
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | uncertainty regarding the timing of delivery of our products
| | - |  | ------------------------------------------------------------




| |  |  | changes in the level of sales of professional services as compared to product licenses
| | - |  | --------------------------------------------------------------------------------------




| |  |  | the mix of sales channels through which our products and services are sold
| | - |  | --------------------------------------------------------------------------




| |  |  | the mix of our domestic and international sales
| | - |  | -----------------------------------------------




| |  |  | costs related to the customization of our products
| | - |  | --------------------------------------------------




| |  |  | our ability to expand our operations, and the amount and timing of expenditures related to this expansion
| | - |  | ---------------------------------------------------------------------------------------------------------




| |  |  | decisions by customers and potential customers to delay purchasing of our products
| | - |  | ----------------------------------------------------------------------------------




| |  |  | a trend of continuing consolidation in our industry
| | - |  | ---------------------------------------------------




| |  |  | global economic and political conditions, as well as those specific to our customers or our industry
| | - |  | ----------------------------------------------------------------------------------------------------






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Due to the slowdown in the national and global economy and the uncertainties
resulting from acts of terrorism during 2001, we believe that many existing and potential customers are reducing or reassessing their planned technology and Internet-related investments and deferring purchasing decisions. As a result, there is
increased uncertainty with respect to our expected revenue, and further delays or reductions in business spending for information technology could have a material adverse effect on our revenue, operating results and stock price.





Our expenses are generally fixed and we will not be able to reduce these expenses quickly if we fail to meet our revenue
forecasts.





Most of our expenses, such as employee compensation and rent, are relatively fixed in the short
term. Moreover, our budget is based, in part, on our expectations regarding future revenue levels. As a result, if total revenue for a particular quarter is below expectations, we could not proportionately reduce operating expenses for that quarter.
Accordingly, such a revenue shortfall would have a disproportionate effect on our expected operating results for that quarter.





Our continued Nasdaq National Market listing is not assured, which could make it more difficult to raise capital and which could result in a default under our convertible notes.





Our common stock is presently authorized for quotation on the Nasdaq National Market. We remain subject to all requirements of our listing
agreement with The Nasdaq Stock Market, Inc. (Nasdaq). Among the events which could cause us to have our status as a Nasdaq National Market issuer terminated are:





| |  |  | Failure to maintain a minimum bid price for the common stock of either $1.00 per share or $5.00 per share, depending on, among other things, whether or not
tangible net assets for the company are greater than or less than $4 million;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Failure to maintain an audit committee which comports to the independence and other standards of the Nasdaq and the U.S. Securities and Exchange Commission
(SEC);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Failure to timely hold annual meetings of stockholders and comply with other corporate governance requirements; and
| | - |  | -------------------------------------------------------------------------------------------------------------------




| |  |  | Failure to meet certain minimum market cap requirements; and
| | - |  | ------------------------------------------------------------




| |  |  | Failure to maintain at least 400 shareholders, each holding at least 100 shares of our common stock.
| | - |  | ----------------------------------------------------------------------------------------------------




As of August 2, 2002 our common stock has traded under a minimum $1.00 for the previous 30 trading days. As a result our common stock is
out of compliance with the minimum bid price listing requirements for NASDAQ National Market. In order to regain compliance with this NASDAQ National Market listing requirement, the bid price of our common stock must close at $1.00 per share or more
for a minimum of 10 consecutive trading days at anytime before October 31, 2002. If market trading does not result in the increase of the trading price of our common stock, we may comply with this listing requirement by implementing a company board
approved reverse stock split and/or we may elect to transfer our securities from the NASDAQ National Market to the NASDAQ SmallCap Market. Our failure to maintain a sufficient number of independent directors on the board of directors to satisfy
Nasdaqs audit committee requirements could also lead to Nasdaq initiating delisting procedures.





If we lose
our Nasdaq National Market status, our common stock would trade either as a Nasdaq Small Cap issue or in the over-the-counter market, both of which are viewed by most investors as less desirable, less liquid marketplaces. Among other things, our
common stock would then constitute penny stock, which would place increased regulatory burden upon brokers, making them less likely to make a market in the stock. Loss of our Nasdaq National Market status could make it more difficult for
us to raise capital or complete acquisitions and would also complicate compliance with state blue-sky laws.





We
may incur non-cash charges resulting from acquisitions, which could harm our operating results.





A new
standard for accounting for goodwill acquired in a business combination has recently been adopted. This new standard requires recognition of goodwill as an asset but does not permit amortization of goodwill. Instead goodwill must be separately
tested for impairment. As a result, our goodwill amortization charges ceased in 2002 and on January 1, 2002, we recognized an approximately $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a
result of the adoption of this standard.




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In the future, we may incur impairment charges related to goodwill arising out of
future acquisitions, if any. Current and future accounting charges like these could delay our achievement of net income.





Our quarterly operating results may depend on a small number of large orders.





We may
derive a significant portion of our product license revenue in each quarter from a small number of relatively large orders. Our operating results for a particular fiscal quarter could be materially adversely affected if we are unable to complete one
or more substantial license sales forecasted for that quarter. Additionally, we also often offer volume-based pricing, which may affect operating margins.





Factors outside our control may cause the timing of our license revenue to vary from quarter-to-quarter, possibly adversely affecting our operating results.





Applicable accounting policies may cause us to report new license agreements as deferred revenue. We generally recognize revenue from a
customer sale when persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve significant customization of the software, the license fee is fixed or determinable and collection of the fee is
probable. If an arrangement requires acceptance testing or significant customization services from Primus, recognition of the associated license and service revenue could be delayed. The timing of the commencement and completion of the these
services is subject to factors that may be beyond our control, as this process may require access to the customers facilities and coordination with the customers personnel after delivery of the software. In addition, customers could
delay product implementations. Implementation typically involves working with sophisticated software, computing and communications systems. If we experience difficulties with implementation or do not meet project milestones in a timely manner, we
could be obligated to devote more customer support, engineering and other resources to a particular project. Some customers may also require us to develop customized features or capabilities. If new or existing customers have difficulty deploying
our products or require significant amounts of our professional services support for customized features, our revenue recognition could be further delayed and our costs could increase, causing increased variability in our operating results.





The high level of competition in our market may result in pricing pressures, reduced margins or the failure of
our products to achieve market acceptance.





The market for our products is new and rapidly evolving, and is
expected to become increasingly competitive as current competitors expand their product offerings and new companies enter the market. Our suite of products competes against various vendor software tools designed to address a specific element or
elements of the complete set of CRM processes, including e-mail management, support, knowledge management, and web-based customer self-service and assisted service. We also face competition from in-house designed products and third-party custom
development efforts.





In addition, competition may increase as a result of software industry consolidations and
formations of alliances among industry participants or with third parties. Some current and potential competitors have longer operating histories and significantly greater financial, technical, marketing, service, support and other resources, and
thus may be able to respond more quickly to new or changing opportunities, technologies and customer requirements. Also, many current and potential competitors have wider name recognition and more extensive customer bases that they could leverage.
They might be able to undertake more extensive promotional activities, adopt more aggressive pricing strategies, and offer purchasers more attractive terms. Some of the companies providing e-commerce and traditional customer relationship management
solutions that may compete with us include Amdocs/Clarify, Autonomy, eGain, Kana, Oracle, Peoplesoft, Right Now Technologies, ServiceWare and Siebel. Competitors to our Primus Answer Engine product offerings may include Answerfriend, Ask Jeeves and
Kanisa.




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The principal competitive factors in our industry include:








vendor and product reputation

product ease-of-usethe availability of products on the Internet and

the quality of customer support services, documentation andmultiple operating platforms

trainingmeasurable economic return on investment

the quality, speed and effectiveness of applicationability to use customers as references

development servicesproduct quality, performance and price

the effectiveness of sales and marketing effortsbreadth of product functionality and features

product integration with other enterprise applicationsproduct scalability

breadth of product application suite





As the market for CRM and knowledge management software matures, it
is possible that additional and possibly larger companies will enter the market, existing competitors will form alliances or current and potential competitors could acquire, be acquired by or establish cooperative relationships with third parties.
The resulting organizations could have greater technical, marketing and other resources and improve their products to address the needs of our existing and potential users, thereby increasing their market share. Increased competition could result in
pricing pressures, reduced margins or the failure of our products to achieve or maintain market acceptance.





Seasonality may adversely affect our quarterly operating results.





We expect to experience
seasonality in our revenue. To date, we believe that other factors, such as large orders and the timing of personnel changes in our sales staff, have masked seasonality. Our customers purchase decisions are often affected by fiscal budgetary
factors and by efforts of our direct sales force to meet or exceed sales quotas.





The limited sales history of
our products makes it difficult to evaluate our business and prospects.





We released our first
knowledge-enabling software product during the first quarter of 1995. Accordingly, the basis upon which you can evaluate our prospects in general, and market acceptance of our products in particular, is limited. For our business to succeed, the
market for this software will have to grow significantly, and we will have to achieve broad market acceptance of our products.





If eBusiness sales and marketing solutions are not widely adopted, we may not be successful.





We are broadening our current product suite to integrate with various aspects of eBusiness solutions. These products address a new and emerging market for eBusiness sales and marketing solutions. The failure of this market to
develop, or a delay in the development of this market, would seriously harm our business. The success of eBusiness sales and marketing solutions depends substantially upon the continued growth and the widespread adoption of the Internet as a primary
medium for commerce and business applications. The Internet infrastructure may not be able to support the demands placed on it by the continued growth upon which our success depends. Moreover, reliability, cost, accessibility, security and quality
of service remain unresolved and may negatively affect the growth of Internet use or the attractiveness of commerce and business communication over the Internet.





We rely on sales of only one product family.





Product
license revenue and related service revenue from our Primus eServer and Primus eSupport products accounted for over 90% of our total revenue for the six months ended June 30, 2002 and 2001, and we expect these products to continue to account for a
substantial portion of our revenue for the remainder of 2002. As a result, factors adversely affecting the demand for these products and our products in general, such as competition, pricing or technological change, could materially adversely affect
our business, financial condition, operating results and value of our stock price. Our future financial performance will substantially depend on our ability to




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sell current versions of our entire suite of products, including products based on the technology acquired from AnswerLogic, and our ability to
develop and sell enhanced versions of our products.





We may not be able to forecast revenue accurately because
our products have a long and variable sales cycle.





To date, the typical sales cycles for our products have
taken 3 to 12 months. The length of our sales cycles may cause license revenue and operating results to vary significantly from period to period. Our sales cycles have required pre-purchase evaluation by a significant number of individuals in our
customers organizations. Along with third parties that jointly market our software, we invest significant amounts of time and resources educating and providing information to prospective customers regarding the use and benefits of our
products. Many of our customers evaluate our software deliberately, depending on their specific technical capabilities, the size of the deployment, the complexity of their network environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products. In the event that the current national and global economic downturn were to continue, the sales cycle for our products may become longer and we may require more time and resources to complete sales.





We depend on increased business from new customers, and if we fail to grow our customer base or generate
repeat business, our operating results could be harmed.





Our business model generally depends on the sale of
our products to new customers as well as on expanded use of our products within our existing customers organizations. If we fail to grow our customer base or generate repeat and expanded business from our current and future customers, our
business and operating results will be seriously harmed. In some cases, our customers initially make a limited purchase of our products and services for pilot programs. These customers may not purchase additional licenses to expand their use of our
products. If these customers do not successfully develop and deploy initial applications based on our products, they may choose not to purchase deployment licenses or additional development licenses.





In addition, as we introduce new versions of our products or new products, our current customers might not require the functionality of
our new products and might not ultimately license these products. Because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn
in our software license revenue would negatively affect our future services revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could decline significantly. Further, some of our customers are
telecom or information technology companies, which have been forced to significantly reduce their operations in light of limited access to sources of financing and the current national and global economic slowdown. If customers are unable to pay for
their current products or are unwilling to purchase additional products, our revenue will decline and this will likely materially impact adversely our revenue, operating results and stock price.





Factors outside our control may make our products less useful.





The effectiveness of our software depends in part on widespread adoption and effective use of our software by an enterprises personnel, partners, and customers and the value derived by each such
usage. In addition, the effectiveness of our knowledge-enabled approach is somewhat dependent upon a current database. If customer-support personnel do not adopt and effectively use our Primus eServer and Primus eSupport products, necessary
solutions will not be added to the database, and the database will be inadequate. If an enterprise deploying our software fails to maintain a current database, the value of our Primus eServer and Primus eSupport software to our users will be
impaired. Successful deployment and broad acceptance of our Primus eServer and Primus eSupport products will depend in part on the quality of the users existing database of solutions, which is outside our control.




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The loss of access to, or a problem with, third party databases could
adversely affect our business.





Historically, we incorporated a database licensed from Versant into certain of
our products. Presently, our products support IBM DB-2, Microsoft SQL Server, Oracle and Versant databases. Because many of the products we have shipped historically rely on these databases, we continue to depend on these companies to support the
databases in a timely and effective manner.





Failure to sufficiently expand our sales and marketing
infrastructure would adversely affect our sales.





To date, we have licensed our products primarily through our
direct sales force. Our future revenue growth will depend in large part on our ability to recruit, train, manage and retain additional sales and marketing personnel and to expand our indirect distribution channels. We may experience difficulty in
recruiting qualified sales and marketing personnel or in establishing third-party relationships. We may not be able to successfully expand our direct sales force or other distribution channels and any such expansion may not result in increased
revenue. Our business, financial condition, operating results and stock price may be materially adversely affected if we fail to effectively expand our sales and marketing resources.





Our inability to sufficiently expand our implementation and consulting capabilities would limit our ability to grow.





If sales of new licenses increased rapidly or if we were to sign an agreement for a particularly large or complex implementation, our
customer support and professional services personnel may be unable to meet the demand for services. In that case, if we were unable to retain or hire highly trained consulting personnel or establish relationships with third-party systems-integrators
and consultants to implement our products, we would be unable to meet customer demands for implementation and support services related to our products.





Our workforce reduction and financial performance may adversely affect the morale and performance of our personnel and our ability to hire new personnel.





In connection with our effort to streamline operations, and reduce costs, we have engaged in recent restructuring of our organization with
substantial reductions in our workforce. There have been and may continue to be substantial costs associated with this or other workforce reductions related to severance and other employee-related costs, and our restructuring plans may yield
unanticipated consequences, such as attrition beyond our planned reductions in workforce. As a result of these reductions, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities.





In addition, many of the employees who were terminated possessed specific knowledge or expertise that may prove
to be important to our operations. In that case, their absence may create significant difficulties. Personnel reductions may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us
to incur significant expense.





Our failure to attract and retain skilled technical personnel may adversely
affect our product development, sales and customer satisfaction.





Our recent reductions in force may affect
employee morale and may create concern among existing employees about job security, which may lead to increased turnover and reduce our ability to meet the needs of our current and future customers. As a result of the reduction in force, we may need
to hire to accommodate attrition, growth in specific customer needs and acquire new skill sets. We may be unable to hire and/or retain the skilled personnel necessary to develop and grow our business. Although a number of technology companies have
recently implemented staff reductions, there remains substantial competition for experienced personnel, particularly in the greater Seattle area, where we are headquartered, due to the limited number of people available with the necessary technical
skills.





Because our stock price has suffered a significant decline, stock-based compensation, including options
to purchase our common stock, may have diminished effectiveness as employee hiring and retention devices. If




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employee turnover increases, our ability to provide client service and execute our strategy would be negatively affected. We may also face
difficulties in hiring and retaining qualified sales personnel to sell our products and services, which could impair our revenue growth.





We may be adversely affected if we lose key personnel.





Our success
depends largely on the skills, experience and performance of some key members of our management and technical staff. If we lose one or more of these key employees, our business, operating results and financial condition could be materially adversely
affected. Much of our success also depends on Michael A. Brochu, our President and Chief Executive Officer. The loss of Mr. Brochus services could harm our business.





We may face difficulties in hiring and retaining qualified sales personnel to sell our products and services, which could impair our revenue growth.





Our ability to increase revenue in the future depends considerably upon our success in recruiting, training, managing and
retaining additional direct sales personnel and the success of the direct sales force. We might not be successful in these efforts. Our products and services require sophisticated sales backgrounds. There is a shortage of sales personnel with the
qualifications and experience, and competition for qualified personnel is intense in our industry. Also, it may take a new salesperson a number of months to become a productive member of our sales force. Our business will be harmed if we fail to
hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than anticipated.





Acquisitions could disrupt our business and harm our financial condition.





In order to remain competitive, we may find it necessary to acquire additional businesses, products and technologies. In the event that we do complete an acquisition, we could be required to do one or
more of the following:





| |  |  | issue equity securities, which would dilute current shareholders percentage ownership
| | - |  | --------------------------------------------------------------------------------------




| |  |  | assume contingent, unrecorded and warranty liabilities
| | - |  | ------------------------------------------------------




| |  |  | incur a one-time charge
| | - |  | -----------------------




| |  |  | amortize other intangible assets
| | - |  | --------------------------------




| |  |  | incur future goodwill impairment charges
| | - |  | ----------------------------------------




| |  |  | restructure our business
| | - |  | ------------------------




These difficulties could disrupt our ongoing business, divert management resources and/or increase our expenses.





Conversely, we may believe that we need to acquire additional businesses, products and technologies to remain competitive, however we may be unable to complete the acquisition due to constrained financial resources.





If we do not integrate acquired technology quickly and effectively, many of the potential benefits of any
acquisition may not be realized.





From time to time, we evaluate various acquisition opportunities and if we
successfully complete any such acquisition transaction, we cannot assure you that we will be able to integrate the acquired technology quickly and effectively. In order to obtain the certain benefits of any such acquisition, the acquired technology,
products and services need to operate together with our technology, products and services. We may be required to spend additional time or money on integration, which would otherwise be spent on developing our business and services or other matters.
If we do not integrate the technologies effectively or if management and technical staff spend too much time on integration issues, it could harm our business, financial condition and results of operations, which may adversely affect our stock
price. In addition, the success of any such acquisition may also




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depend on our ability to successfully integrate and manage the acquired operations and retain or replace the key employees of the acquired
business.





Our international operations are subject to additional risks.





For the three and six month periods ended June 30, 2002, revenue from customers outside of North America represented approximately
$620,000 and $1.9 million, or 15% and 17%, respectively. We currently customize certain of our products for select foreign markets. In the future, we plan to develop additional localized versions of our products and localization of our products will
create additional costs and would cause delays in new product introductions. In addition, our international operations will continue to be subject to a number of other risks, including:





| |  |  | costs and complexity of customizing products for foreign countries
| | - |  | ------------------------------------------------------------------




| |  |  | laws and business practices favoring local competition
| | - |  | ------------------------------------------------------




| |  |  | compliance with multiple, conflicting and changing laws and regulations
| | - |  | -----------------------------------------------------------------------




| |  |  | longer sales cycles
| | - |  | -------------------




| |  |  | greater difficulty or delay in accounts receivable collection
| | - |  | -------------------------------------------------------------




| |  |  | import and export restrictions and tariffs
| | - |  | ------------------------------------------




| |  |  | difficulties in staffing and managing foreign operations
| | - |  | --------------------------------------------------------




| |  |  | investing at appropriate levels in foreign operations to compete effectively
| | - |  | ----------------------------------------------------------------------------




| |  |  | political and economic instability
| | - |  | ----------------------------------




Our international operations also face foreign-currency-related risks. To date, substantially all of our revenue has been denominated in U.S. dollars, but we believe that in the future, an increasing
portion of our revenue may be denominated in foreign currencies, including the Euro, British Pound and Yen. Fluctuations in the value of foreign currencies may cause further volatility in our operating results, reduce the accuracy of our financial
forecasts and could have a material adverse effect on our business, operating results and financial condition.





Fluctuations in the market value of our short-term investments and in interest rates may affect our operating results.





For additional information regarding the sensitivity of and risks associated with the market value of short-term investments and interest rates, see Part I, Item 2,
Managements Discussion and Analysis of Financial Condition and Results of Operations contained in this Report.





Our failure to adapt to technology trends and evolving industry standards would hinder our competitiveness.





Our market is susceptible to rapid changes due to technology innovation, evolving industry standards, and frequent new service and product introductions. New services and products based on new
technologies or new industry standards expose us to risks of technical or product obsolescence. We will need to use leading technologies effectively, continue to develop our technical expertise and enhance our existing products on a timely basis to
compete successfully in this industry. We cannot be certain that we will be successful in using new technologies effectively, developing new products or enhancing existing products on a timely basis or that any new technologies or enhancements used
by us or offered to our customers will achieve market acceptance.





Our inability to continue integration of our
products with other third-party software could adversely affect market acceptance of our products.





Our
ability to compete successfully also depends on the continued compatibility and interoperability of our products with products and systems sold by various third parties, including traditional CRM software sold by




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Amdocs/Clarify, Kana, Onyx, Oracle, Peoplesoft, Peregrine Systems/Remedy, Siebel and others. Currently, these vendors have open applications
program interfaces, which facilitate our ability to integrate with their systems. These vendors have also been open to licensing us rights to use their development tools to build integrations to their products. If any one of them should close their
programs interface, fail to grant us necessary licenses or if they should acquire one of our competitors, our ability to provide a close integration of our products could become more difficult and could delay or prevent our products
integration with future systems.





Failure to successfully develop versions and updates of our products that run
on the operating systems used by our current and prospective customers could reduce our sales.





Many of our
products run on the Microsoft Windows NT, Microsoft Windows 2000 or certain versions of the Sun Solaris Unix operating systems, and some require the use of third party software. Any change to our customers operating systems could require us to
modify our products and could cause us to delay product releases. In addition, any decline in the market acceptance of these operating systems we support may force us to ensure that all of our products and services are compatible with other
operating systems to meet the demands of our customers. If potential customers do not want to use the Microsoft or Sun Solaris operating systems we support, we will need to develop more products that run on other operating systems adopted by our
customers. If we cannot successfully develop these products in response to customer demands, our business could be adversely impacted. The development of new products in response to these risks would require us to commit a substantial investment of
resources, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead potential customers to choose alternative products.





We rely on software licensed to us by third parties for features we include in our solutions.





We incorporate software licensed from third parties into our solutions. As we develop enhanced versions of our software, some of the additional functionality and
capabilities of our solutions may be a result of additional third party applications. A significant interruption in the availability of any of the licensed third-party software could adversely affect our sales, unless and until we can replace this
software with other software that performs similar functions. Because our solutions incorporate software developed and maintained by third parties, we depend on these third parties abilities to deliver and support reliable products, enhance
their current products, develop new products on a timely and cost-effective basis, and respond to emerging industry standards and other technological changes. If third-party software offered now or in the future in conjunction with our solutions
becomes obsolete or incompatible with future versions of our solutions, we may not be able to continue to offer some of the features we presently include in our solutions unless we can license alternative software or develop the features ourselves.





Our stock price has been volatile and could fluctuate in the future.





The market price of our common stock has been highly volatile and is subject to wide fluctuations. We expect our stock price to continue
to fluctuate:





| |  |  | in response to quarterly variations in operating results
| | - |  | --------------------------------------------------------




| |  |  | in response to announcements of technological innovations or new products by us or our competitors
| | - |  | --------------------------------------------------------------------------------------------------




| |  |  | because of market conditions in the enterprise software industry
| | - |  | ----------------------------------------------------------------




| |  |  | in reaction to changes in financial estimates by securities analysts, and our failure to meet or exceed the expectations of analysts or investors
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | in response to our announcements of significant acquisitions, strategic relationships or joint ventures
| | - |  | -------------------------------------------------------------------------------------------------------




| |  |  | in response to sales of our common stock
| | - |  | ----------------------------------------




In the past, following periods of volatility in the market price of a particular companys securities, securities class action litigation has often been brought against that company. We are
currently subject to a securities class action and the volatility of our stock price could make us a target for additional suits. Securities class action litigation could result in substantial costs and a diversion of our managements attention
and resources. See the




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discussion of the Companys pending legal matters in Part II, Item 1 Legal Proceedings. Volatility in our stock price could
make it more difficult for us to raise capital or complete acquisitions on favorable terms.





Our efforts to
protect our proprietary rights may be inadequate.





Our success depends in part on our ability to protect our
proprietary rights. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions such as those
contained in license agreements with customers, consultants and vendors. We have not signed such agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and
use information that we regard as proprietary. Other parties may breach such confidentiality agreements and other protective contracts. We may not become aware of, or have adequate remedies in the event of, such breaches.





We pursue the registration of some of our trademarks and service marks in the United States and in certain other countries, but we have
not secured registration of all our marks. Significant portions of our marks include the word Primus. Other companies use Primus in their marks alone or in combination with other words, and we cannot prevent all third-party
uses of the word Primus. We license certain trademark rights to third parties. Such licensees may not abide by compliance and quality control guidelines with respect to such trademark rights and may take actions that would adversely
affect our trademarks.





Other companies may claim that we infringe their intellectual property or proprietary
rights.





If any of our products are found to violate third party proprietary rights, we may be required to
reengineer our products or seek to obtain licenses from third parties, and such efforts may not be successful. We do not conduct comprehensive patent searches to determine whether the technology used in our products infringes patents held by third
parties. Product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, which are confidential when filed, with regard to potentially similar technologies. In
addition, other companies have filed trademark applications for marks similar to the names of our products. Although we believe that our products do not infringe the proprietary rights of any third parties, third parties could assert infringement
claims against us in the future. The defense of any such claims would require us to incur substantial costs and would divert managements attention and resources to defend against any claims relating to proprietary rights, which could
materially and adversely affect our financial condition and operations. If a party succeeded in making such a claim we could be liable for substantial damages, as well as injunctive or equitable relief that could effectively block our ability to
sell our products and services. Any such outcome could have a material adverse effect on our business, financial condition, operating results and stock price.





Product liability claims by our customers could result in unexpected costs and damage to Primus reputation.





Our license agreements with customers generally contain provisions designed to limit our exposure to potential product liability claims, such as disclaimers of warranties
and limitations on liability for special, consequential and incidental damages. In addition, our license agreements generally cap the amounts recoverable for damages to the amounts paid by the licensee to Primus for the product or services giving
rise to the damages. However, these contractual limitations on liability may not be enforceable and we may be subject to claims based on errors in its software or mistakes in performing its services including claims relating to damages to our
customers internal systems. A product liability claim, whether or not successful, could harm our business by increasing our costs, damaging our reputation and diverting managements attention and resources to defend any such claim, which
could materially and adversely affect our financial condition, our results of operations and our stock price.







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Control by inside shareholders of a large percentage of our voting stock may
permit them to influence us in a way that adversely affects our stock price.





Our officers, directors and
affiliated entities together beneficially own approximately 22% of the outstanding shares of our common stock. As a result, these shareholders are able to influence all matters requiring shareholder approval and, thereby, our management and affairs.
Some matters that typically require shareholder approval include:





| |  |  | election of directors
| | - |  | ---------------------




| |  |  | certain amendments to our articles of incorporation
| | - |  | ---------------------------------------------------




| |  |  | merger or consolidation
| | - |  | -----------------------




| |  |  | sale of all or substantially all our assets
| | - |  | -------------------------------------------




This concentration of ownership may delay, deter or prevent acts that would result in a change of control, which in turn could reduce the market price of our common stock.





Specific provisions of our articles of incorporation and bylaws and Washington law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our shareholders.





Our articles of incorporation and
bylaws establish a classified board of directors, eliminate the ability of shareholders to call special meetings, eliminate cumulative voting for directors and establish procedures for advance notification of shareholder proposals. The presence of a
classified board and the elimination of cumulative voting may make it more difficult for an acquirer to replace our board of directors. Further, the elimination of cumulative voting substantially reduces the ability of minority shareholders to
obtain representation on the board of directors.





Our board of directors has the authority to issue up to
5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by our shareholders. The issuance of preferred stock could
have the effect of delaying, deferring or preventing a change of control of Primus and may adversely affect the market price of the common stock and the voting and other rights of the holders of common stock.





Washington law imposes restrictions on some transactions between a corporation and significant shareholders. Chapter 23B.19 of the
Washington Business Corporation Act prohibits a target corporation, with some exceptions, from engaging in particular significant business transactions with an acquiring person, which is defined as a person or group of persons that beneficially owns
10% or more of the voting securities of the target corporation, for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporations board of
directors prior to the acquisition. Prohibited transactions include, among other things:





| |  |  | a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from, the acquiring person
| | - |  | -----------------------------------------------------------------------------------------------------------------------------




| |  |  | termination of 5% or more of the employees of the target corporation
| | - |  | --------------------------------------------------------------------




| |  |  | allowing the acquiring person to receive any disproportionate benefit as a shareholder
| | - |  | --------------------------------------------------------------------------------------




A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of Primus. The foregoing
provisions of our charter documents and Washington law could have the effect of making it more difficult or more expensive for a third party to acquire, or could discourage a third party from attempting to acquire Primus. These provisions may
therefore have the effect of limiting the price that investors might be willing to pay in the future of our common stock.







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Security breaches or equipment failure could damage our reputation and deter
customers from using our services.





We must protect our computer systems and networks from physical break-ins,
security breaches and other events such as electrical disruptions, equipment failure, and fire and water damage. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network,
which could adversely affect our ability to retain or attract customers, damage our reputation and subject us to litigation. We could be subject to denial of service, vandalism and other attacks on our computer systems by individuals with malicious
intentions. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage in certain circumstances may be
insufficient to cover losses that may result from such events.





Future taxation or regulation of the Internet
may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.





Local, state, federal and foreign regulators could adopt additional laws and regulations that impose additional costs or other burdens on those companies that conduct business online. These laws and regulations could discourage
web-based communications and customer self-service, which could reduce demand for our products and services.





The
growth and development of the market for online services may prompt calls for more stringent consumer protection laws for law that may inhibit the use of Internet-based communications or the information contained in these communications. The
adoption of any additional laws or regulations may decrease the expansion of the Internet. The imposition of taxes or other charges would likewise deter the use of the Internet. A decline in the growth of the Internet, particularly as it relates to
online communication and customer self-service, could decrease demand for our products and services and increase our costs of doing business, or otherwise harm our business. Any new legislation or regulation, the application of laws and regulations
from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and other online services could harm our growth and increase our costs, which could materially and adversely
affect our financial condition, results of operations and our stock price.





Terrorists attacks such as the
attacks that occurred in New York and Washington, D.C. on September 11, 2001 and other attacks or acts of war may adversely affect the markets on which our Common Stock trades, our financial condition and our results of operations.





On September 11, 2001, the United States was the target of terrorist attacks of unprecedented scope. These attacks have caused
major instability in the U.S. and other financial markets. There could be further acts of terrorism in the United States or elsewhere that could have a similar impact. Leaders of the U.S. government have announced their intention to actively pursue
and take military and other action against those behind the September 11, 2001 attacks and to initiate broader action against national and global terrorism. Armed hostilities or further acts of terrorism would cause further instability in financial
markets and could directly impact our financial condition and our results of operations. The insurance we maintain may not be adequate to cover our losses resulting from terrorist attacks or acts of war.





Certain of our facilities are located near known earthquake fault zones, and the occurrence of an earthquake or other catastrophic
disaster could cause damage to our facilities and equipment, which could require us to cease or curtail operations.





Our principal facilities are located in Seattle, Washington and are vulnerable to damage from earthquakes. We are also vulnerable to damage from other types of disasters, including fire, floods, power loss, communications failures
and similar events. If any disaster were to occur, our ability to operate our business at our principal facilities would be seriously, or potentially completely, impaired. In addition, the unique nature of our research activities could cause
significant delays in our programs and make it difficult for us to recover from a disaster. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other




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business interruptions. Accordingly, an earthquake or other disaster could materially and adversely harm our ability to conduct business.





You should not unduly rely on forward-looking statements because they are inherently uncertain.





You should not rely on forward-looking statements in this Report. This document contains forward-looking
statements that involve risks and uncertainties. We use words such as anticipates, believes, plans, expects, future and intends, and similar expressions to identify
forward-looking statements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Report. The forward-looking statements contained in this Report are subject to the provisions of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks described above and
elsewhere in this Report and in our other reports and documents on file with the U.S. Securities and Exchange Commission.





ITEM
3.    
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





We are exposed to the impact
of interest rate changes and related change in the market values of our investments and foreign currency exchange risk.





Interest Rate Risk.    We typically invest our excess cash in high quality corporate and municipal debt instruments. As a result, our related investment portfolio is exposed to the impact of short-term
changes in interest rates. Investments in both fixed rate and floating rate interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted by a rise in interest rates,
while floating rate securities may produce less income than expected if interest rates fall. As a result, changes in interest rates may cause us to suffer losses in principal if forced to sell securities that have declined in market value or may
cause our future investment income to fall short of expectations. Our investment portfolio is designated as available-for-sale, and accordingly is presented at fair value in the consolidated balance sheet.





We protect and preserve our invested funds with investment policies and procedures that limit default, market and reinvestment risk. We
have not utilized derivative financial instruments in our investment portfolio.





During the period ended June 30,
2002, decreases in interest rates on the fair market value of our cash, cash equivalents and marketable securities had an insignificant impact on our net loss. Fixed rate short-term investments at June 30, 2002 of approximately $3.0 million
had a weighted average interest rate of approximately 4.3% and are due through 2003. We believe that the impact on the fair market value of our securities and our earnings for 2002 from a hypothetical 10% increase or decrease in interest rates would
be insignificant.





Foreign Currency Exchange Risk.    We develop products in the United
States and sell them in North America, Europe, and, through Primus KK, Asia. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our
sales are predominantly priced in U.S. dollars and translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets. We have two foreign subsidiariesPrimus Knowledge Solutions (UK)
Limited and Primus Knowledge Solutions Francewhose expenses are incurred in their local currency. As exchange rates vary, their expenses, when translated, may vary from expectations and adversely impact overall expected profitability. Our
operating results have not been significantly affected by exchange rate fluctuations during the three months and six months ended June 30, 2002 and 2001. If, during 2002, the U.S. dollar uniformly increases or decreases in strength by 10% relative
to the currency of our foreign sales subsidiaries, our operating results for 2002 would likely not be significantly affected.







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PART II    OTHER INFORMATION





ITEM 1.    
LEGAL PROCEEDINGS





The Company, an officer, former officer and FleetBoston Robertson
Stephens, Inc., J.P. Morgan Securities Inc., U.S. Bancorp Piper Jaffray Inc., CIBC World Markets, Dain Rauscher, Inc. and Salomon Smith Barney Holdings Inc., the underwriters of our initial public offering, have been named as defendants in an action
filed during December 2001 in the United States District Court for the Southern District of New York on behalf of persons who purchased Primus common stock during the period from June 30, 1999 through December 6, 2000, which was issued pursuant to
the June 30, 1999 registration statement and prospectus for the Companys initial public offering. The complaint alleges that the Company and the individual defendants violated the Securities Act of 1933 by failing to disclose excessive
commissions allegedly obtained by the Companys underwriters pursuant to a secret arrangement whereby the underwriters allocated IPO shares to certain investors in exchange for the excessive commissions, referred to as laddering. The complaint
also asserts claims against the underwriters under the 1933 Act and the Securities Exchange Act of 1934 in connection with the allegedly undisclosed commissions. The Company intends to vigorously defend itself and its current and former officers
against this action. The results of any litigation matter are inherently uncertain and litigation frequently involves substantial expenditures and can require significant management attention, even if the Company ultimately prevails. Accordingly,
while we do not believe it is probable that the outcome of this litigation matter will be unfavorable to the Company, we cannot provide assurances that this action will not materially and adversely affect our business, our results of operation or
our stock price.





In January 2002, Mindfabric, Inc. served a complaint against Primus in the United States
District Court for the Northern District of California, which alleged that aspects of our technology infringe one or more patents alleged to be held by the plaintiff. Effective April 15, 2002, we entered into a settlement and release agreement under
which Primus was released from all claims and potential damages for past infringement and was granted a five-year license under the patents for Primus products and services. After January 1, 2007, depending on the products Primus is then selling and
the status of the Mindfabric patents, Primus may need to either obtain a commercially reasonable license under the patents for the remainder of their patent life or potentially defend an action for post January 1, 2007 alleged infringement. Under
the terms of the settlement, Primus made cash payments to Mindfabric on July 1, 2002 and will deliver 75,000 shares of registered Primus common stock, subject to certain resale and volume limitations. In connection with this settlement, the Company
recorded a charge of $275,000 to general and administrative expenses during the three months ended March 31, 2002, net of the value of 112,500 Primus shares withheld under the AnswerLogic acquisition escrow.





ITEM 2.    
CHANGE IN SECURITIES





(c)  Recent Sales of Unregistered Securities





During the period covered by this report on Form 10-Q, we had no issuance or sales of unregistered
securities.





ITEM 6.    
EXHIBITS AND REPORTS ON FORM 8-K





(a)  Exhibits





Exhibit 99.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002Exhibit 99.2

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002





(b)  Reports on Form 8-K.





None




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SIGNATURES





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





PRIMUS KNOWLEDGE SOLUTIONS, INC.By:

/s/    RONALD M.
STEVENSRonald M. Stevens Executive Vice President, Chief Financial Officer, and Treasurer 
(Principal financial and chief accounting officer)





Date: August 13, 2002




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