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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004



COMMISSION FILE NUMBER: 000-26273



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PRIMUS KNOWLEDGE SOLUTIONS, INC.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|WASHINGTON                                                     |  | 91-1350484                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer 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)



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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 ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).    Yes ̈No  x



As of August 3, 2004
there were 23,853,519 shares of the Registrants Common Stock outstanding.



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##### Table of Contents

Primus Knowledge Solutions, Inc.

Form 10-Q

June 30, 2004



INDEX



|                              |  |                                                                                                                                                      |  |     
|----------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                                                      |  | PAGE
|PART I.
FINANCIAL INFORMATION |  |                                                                                                                                                     
|                              |  |                                                                                                                                                     
|ITEM 1.                       |  | Condensed Consolidated Financial Statements (Unaudited)                                                                                              |  |     
|                              |  |                                                                                                                                                     
|                              |  |       
Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003                                                              |  | 3   
|                              |  |                                                                                                                                                     
|                              |  |       
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2004 and 2003                                    |  | 4   
|                              |  |                                                                                                                                                     
|                              |  |       
Condensed Consolidated Statements of Shareholders Equity and Comprehensive Loss for the three months ended March 31, 2004 and June 30, 2004 |  | 5   
|                              |  |                                                                                                                                                     
|                              |  |       
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003                                              |  | 6   
|                              |  |                                                                                                                                                     
|                              |  |       
Notes to Condensed Consolidated Financial Statements                                                                                         |  | 7   
|                              |  |                                                                                                                                                     
|ITEM 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                |  | 14  
|                              |  |                                                                                                                                                     
|ITEM 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                           |  | 41  
|                              |  |                                                                                                                                                     
|ITEM 4.                       |  | Controls and Procedures                                                                                                                              |  | 42  
|                              | 
|PART II.
OTHER INFORMATION    |  |                                                                                                                                                     
|                              |  |                                                                                                                                                     
|ITEM 1.                       |  | Legal Proceedings                                                                                                                                    |  | 42  
|                              |  |                                                                                                                                                     
|ITEM 2.                       |  | Change in Securities                                                                                                                                 |  | 43  
|                              |  |                                                                                                                                                     
|ITEM 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                                                  |  | 43  
|                              |  |                                                                                                                                                     
|ITEM 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                                     |  | 44  



Page 2 of 45



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##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)



|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                          |  | June 30, 2004 |          |   | December 31, 2003 |  
|ASSETS                                                                                                                                                                    |  |               |          |   |                   |   |          |  
|Current assets:                                                                                                                                                           |  |               |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                 |  | $             | 8,335    |   |                   | $ | 12,154   |  
|Accounts receivable, net of allowance for doubtful accounts of $139 and $174 at June 30, 2004 and December 31, 2003,
respectively                                         |  |               | 2,730    |   |                   |   | 5,475    |  
|Prepaid expenses and other current assets                                                                                                                                 |  |               | 827      |   |                   |   | 1,001    |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Total current assets                                                                                                                                                      |  |               | 11,892   |   |                   |   | 18,630   |  
|                                                                                                                                                                          |  |              
|Property and equipment, net of accumulated depreciation and amortization of $8,189 and $7,743 at June 30, 2004 and December 31, 2003,
respectively                        |  |               | 1,166    |   |                   |   | 1,415    |  
|Goodwill                                                                                                                                                                  |  |               | 11,841   |   |                   |   | 11,785   |  
|Other intangible assets, net of accumulated amortization of $651 and $68 at June 30, 2004 and December 31, 2003, respectively                                             |  |               | 3,075    |   |                   |   | 3,608    |  
|Other assets                                                                                                                                                              |  |               | 225      |   |                   |   | 225      |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Total assets                                                                                                                                                              |  | $             | 28,199   |   |                   | $ | 35,663   |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                      |  |               |          |   |                   |   |          |  
|                                                                                                                                                                          |  |              
|Current liabilities:                                                                                                                                                      |  |               |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                          |  | $             | 2,028    |   |                   | $ | 2,555    |  
|Accrued and other liabilities                                                                                                                                             |  |               | 1,457    |   |                   |   | 2,170    |  
|Compensation-related accruals                                                                                                                                             |  |               | 980      |   |                   |   | 1,733    |  
|Obligations due under credit facility                                                                                                                                     |  |               | 349      |   |                   |   | 395      |  
|Deferred revenue, including related party amounts of $121 and $94 at June 30, 2004 and December 31, 2003, respectively                                                    |  |               | 7,230    |   |                   |   | 8,797    |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                 |  |               | 12,044   |   |                   |   | 15,650   |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Commitments and contingencies                                                                                                                                             |  |               |          |   |                   |   |          |  
|                                                                                                                                                                          |  |              
|Shareholders equity:                                                                                                                                                     |  |               |          |   |                   |   |          |  
|Common stock, $.025 par value, authorized 50,000,000 shares, issued and outstanding 23,851,794 and 23,257,082 shares at June 30, 2004 and
December 31, 2003, respectively |  |               | 596      |   |                   |   | 581      |  
|Additional paid-in-capital                                                                                                                                                |  |               | 123,110  |   |                   |   | 122,051  |  
|Accumulated other comprehensive income                                                                                                                                    |  |               | 337      |   |                   |   | 188      |  
|Accumulated deficit                                                                                                                                                       |  |               | (107,888 | ) |                   |   | (102,807 | )
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Total shareholders equity                                                                                                                                                |  |               | 16,155   |   |                   |   | 20,013   |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  
|Total liabilities and shareholders equity                                                                                                                                |  | $             | 28,199   |   |                   | $ | 35,663   |  
|                                                                                                                                                                          |  |               |          |   |                   |   |          |  



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



Page 3 of 45



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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)

(Unaudited)



|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|-------------------------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                                       |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|                                                                                       |  | 2004                        |            |   | 2003                      |   |            | 2004 |  |   | 2003       |  
|Revenue:                                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|License:                                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Third party                                                                            |  | $                           | 1,517      |   |                           | $ | 455        |      |  | $ | 3,031      |   |  | $ | 2,541      |  
|Related partyPrimus KK                                                                |  |                             |           |   |                           |   | 11         |      |  |   | 139        |   |  |   | 300        |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|                                                                                       |  |                             | 1,517      |   |                           |   | 466        |      |  |   | 3,170      |   |  |   | 2,841      |  
|Service:                                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Third party                                                                            |  |                             | 4,175      |   |                           |   | 3,142      |      |  |   | 8,546      |   |  |   | 6,124      |  
|Related partyPrimus KK                                                                |  |                             | 63         |   |                           |   | 109        |      |  |   | 113        |   |  |   | 240        |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|                                                                                       |  |                             | 4,238      |   |                           |   | 3,251      |      |  |   | 8,659      |   |  |   | 6,364      |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total revenue                                                                          |  |                             | 5,755      |   |                           |   | 3,717      |      |  |   | 11,829     |   |  |   | 9,205      |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Cost of revenue:                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|License                                                                                |  |                             | 134        |   |                           |   | 57         |      |  |   | 366        |   |  |   | 154        |  
|Service                                                                                |  |                             | 1,431      |   |                           |   | 1,242      |      |  |   | 2,946      |   |  |   | 2,381      |  
|Amortization of purchased intangibles                                                  |  |                             | 374        |   |                           |   |           |      |  |   | 587        |   |  |   |           |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total cost of revenue                                                                  |  |                             | 1,939      |   |                           |   | 1,299      |      |  |   | 3,899      |   |  |   | 2,535      |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Gross profit                                                                           |  |                             | 3,816      |   |                           |   | 2,418      |      |  |   | 7,930      |   |  |   | 6,670      |  
|Operating expenses:                                                                    |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Sales and marketing                                                                    |  |                             | 2,307      |   |                           |   | 2,527      |      |  |   | 5,207      |   |  |   | 5,125      |  
|Research and development                                                               |  |                             | 2,135      |   |                           |   | 1,874      |      |  |   | 4,487      |   |  |   | 3,690      |  
|General and administrative                                                             |  |                             | 1,469      |   |                           |   | 702        |      |  |   | 2,766      |   |  |   | 1,675      |  
|Restructuring charges                                                                  |  |                             |           |   |                           |   |           |      |  |   | 461        |   |  |   |           |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                                                               |  |                             | 5,911      |   |                           |   | 5,103      |      |  |   | 12,921     |   |  |   | 10,490     |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Loss from operations                                                                   |  |                             | (2,095     | ) |                           |   | (2,685     | )    |  |   | (4,991     | ) |  |   | (3,820     | )
|Other income (expense), net                                                            |  |                             | 2          |   |                           |   | 12         |      |  |   | (24        | ) |  |   | 67         |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Loss before income                                                                     |  |                             | (2,093     | ) |                           |   | (2,673     | )    |  |   | (5,015     | ) |  |   | (3,753     | )
|Income tax expense                                                                     |  |                             | (24        | ) |                           |   | (31        | )    |  |   | (66        | ) |  |   | (81        | )
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net loss                                                                               |  | $                           | (2,117     | ) |                           | $ | (2,704     | )    |  | $ | (5,081     | ) |  | $ | (3,834     | )
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Basic and diluted net loss per share amounts                                           |  | $                           | (0.09      | ) |                           | $ | (0.14      | )    |  | $ | (0.22      | ) |  | $ | (0.20      | )
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average shares used in computing basic and diluted net loss per share amounts |  |                             | 23,766,889 |   |                           |   | 19,053,898 |      |  |   | 23,610,565 |   |  |   | 19,053,860 |  
|                                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  



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



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CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSS

(In thousands, except share amounts)

(Unaudited)



|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|---------------------------------------------- |  | ------------ |  | ------------------------- | --- | -------------------------------------------- | - | ------- | ------------------ | - | ---- | ------------------------- |  | - | -------- | - |  | - | ------ | -
|                                               |  | Common stock |  | Additional paid-inCapital |     | Accumulated other comprehensiveIncome (loss) |   |         | Accumulateddeficit |   |      | Total shareholdersequity | 
|                                               |  | Shares       |  | Par value                 |     |                                              |   |        
|Balance at December 31, 2003                   |  | 23,257,082   |  | $                         | 581 |                                              | $ | 122,051 |                    | $ | 188  |                           |  | $ | (102,807 | ) |  | $ | 20,013 |  
|Exercise of stock options                      |  | 406,532      |  |                           | 10  |                                              |   | 683     |                    |   |     |                           |  |   |         |   |  |   | 693    |  
|Stock issued in exchange for services          |  | 35,000       |  |                           | 1   |                                              |   | 176     |                    |   |     |                           |  |   |         |   |  |   | 177    |  
|Comprehensive income:                          |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Foreign currency translation gain              |  |             |  |                           |    |                                              |   |        |                    |   | 320  |                           |  |   |         |   |  |   |       |  
|Net loss                                       |  |             |  |                           |    |                                              |   |        |                    |   |     |                           |  |   | (2,964   | ) |  |   |       |  
|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Total comprehensive loss                       |  |             |  |                           |    |                                              |   |        |                    |   | 320  |                           |  |   | (2,964   | ) |  |   | (2,644 | )
|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Balance at March 31, 2004                      |  | 23,698,614   |  |                           | 592 |                                              |   | 122,910 |                    |   | 508  |                           |  |   | (105,771 | ) |  |   | 18,239 |  
|Exercise of stock options                      |  | 96,152       |  |                           | 2   |                                              |   | 166     |                    |   |     |                           |  |   |         |   |  |   | 168    |  
|Stock issued from employee stock purchase plan |  | 57,028       |  |                           | 2   |                                              |   | 34      |                    |   |     |                           |  |   |         |   |  |   | 36     |  
|Comprehensive loss:                            |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Foreign currency translation loss              |  |             |  |                           |    |                                              |   |        |                    |   | (171 | )                         |  |   |         |   |  |   |       |  
|Net loss                                       |  |             |  |                           |    |                                              |   |        |                    |   |     |                           |  |   | (2,117   | ) |  |   |       |  
|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Total comprehensive loss                       |  |             |  |                           |    |                                              |   |        |                    |   | (171 | )                         |  |   | (2,117   | ) |  |   | (2,288 | )
|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  
|Balance at June 30, 2004                       |  | 23,851,794   |  | $                         | 596 |                                              | $ | 123,110 |                    | $ | 337  |                           |  | $ | (107,888 | ) |  | $ | 16,155 |  
|                                               |  |              |  |                           |     |                                              |   |         |                    |   |      |                           |  |   |          |   |  |   |        |  



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



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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                                                 |  |                           |        |   |      |   |        |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                 |  | Six Months Ended June 30, |       
|                                                                                                                 |  | 2004                      |        |   | 2003 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                            |  |                           |        |   |      |   |        |  
|Net loss                                                                                                         |  | $                         | (5,081 | ) |      | $ | (3,834 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                      |  |                           |        |   |      |   |        |  
|Depreciation and amortization                                                                                    |  |                           | 1,023  |   |      |   | 909    |  
|Application of support balance included in deferred revenue to license purchase                                  |  |                           | (1,053 | ) |      |   |       |  
|Changes in assets and liabilities:                                                                               |  |                           |        |   |      |   |        |  
|Accounts receivable                                                                                              |  |                           | 2,749  |   |      |   | 1,498  |  
|Prepaid expenses and other current assets                                                                        |  |                           | 172    |   |      |   | (107   | )
|Other assets                                                                                                     |  |                           |       |   |      |   | 44     |  
|Accounts payable and accrued liabilities                                                                         |  |                           | (1,130 | ) |      |   | 6      |  
|Compensation-related accruals                                                                                    |  |                           | (753   | ) |      |   | (21    | )
|Deferred revenue                                                                                                 |  |                           | (553   | ) |      |   | (628   | )
|                                                                                                                 |  |                           |        |   |      |   |        |  
|Net cash used in operating activities                                                                            |  |                           | (4,626 | ) |      |   | (2,133 | )
|                                                                                                                 |  |                           |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                            |  |                           |        |   |      |   |        |  
|Purchases of short-term investments                                                                              |  |                           |       |   |      |   | (394   | )
|Proceeds from maturities of short-term investments                                                               |  |                           |       |   |      |   | 1,395  |  
|Purchases of property and equipment                                                                              |  |                           | (187   | ) |      |   | (75    | )
|                                                                                                                 |  |                           |        |   |      |   |        |  
|Net cash provided (used in) by investing activities                                                              |  |                           | (187   | ) |      |   | 926    |  
|                                                                                                                 |  |                           |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                            |  |                           |        |   |      |   |        |  
|                                                                                                                 |  |                          
|Repayment of obligations under credit facility                                                                   |  |                           | (53    | ) |      |   |       |  
|Proceeds from the exercise of stock options and purchases of common stock under the employee stock purchase plan |  |                           | 897    |   |      |   | 22     |  
|                                                                                                                 |  |                           |        |   |      |   |        |  
|Net cash provided by financing activities                                                                        |  |                           | 844    |   |      |   | 22     |  
|                                                                                                                 |  |                           |        |   |      |   |        |  
|Effect of exchange rate changes on cash                                                                          |  |                           | 150    |   |      |   | (14    | )
|                                                                                                                 |  |                          
|Net decrease in cash and cash equivalents                                                                        |  |                           | (3,819 | ) |      |   | (1,199 | )
|                                                                                                                 |  |                          
|Cash and cash equivalents at beginning of period                                                                 |  |                           | 12,154 |   |      |   | 11,948 |  
|                                                                                                                 |  |                           |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                                                       |  | $                         | 8,335  |   |      | $ | 10,749 |  
|                                                                                                                 |  |                           |        |   |      |   |        |  
|                                                                                                                 |  |                          
|NON CASH FINANCING ACTIVITIES                                                                                    |  |                           |        |   |      |   |        |  
|                                                                                                                 |  |                          
|Payment of acquisition related accrued expense in common stock                                                   |  | $                         | 177    |   |      |   |       |  



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



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2004

(Unaudited)



Note 1. Description of the Business and Basis of Presentation



Description of the Business and Basis of Presentation



We provide software solutions that enable companies to deliver a superior customer experience via contact centers, information technology (IT) help desks,
Web (Intranet and Internet) self-service, and electronic communication channels. Our technology powers every interaction with knowledge to increase customer satisfaction and reduce operational costs. We provide application software that enables
companies to find, capture and communicate enterprise knowledge to deliver answers to questions and solutions to problems. We also offer electronic communication solutions, such as web self-service, email management, chat, and wireless
communications. Our software products can be implemented as a suite or as individual modules as part of a comprehensive eService solution, customer service delivered through web based applications. Our solutions can be used in combination with
leading CRM (Customer Relationship Management) and IT helpdesk applications, including those from Amdocs/Clarify, Kana, Onyx, Oracle CRM, PeopleSoft, Remedy, Siebel, SAP, and others. In addition to software applications, we offer professional
services to assist customers with software implementation, integration, hosting, training and support.



Acquisitions and Other Intangible Assets



Acquisition of Broad Daylight, Inc.



On August 12, 2003, we signed a definitive merger agreement and announced our intent to acquire 100% of the voting interest in Broad Daylight, Inc. (Broad Daylight) an e-service software developer
specializing in solutions for customer and employee self-service. The merger of Broad Daylight with a subsidiary of ours closed on September 3, 2003. Under the terms of the agreement, we purchased all of the outstanding shares of Broad Daylight in
exchange for 2,131,009 shares of our common stock valued at approximately $2.5 million, plus cash of approximately $140,000 and direct acquisition costs of approximately $198,000. The fair value of the common stock issued for the acquisition was
$1.19 per share, based on the average market price for a period before and after August 12, 2003.



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 $3.3 million has been recorded as goodwill.



Acquisition of Amacis Group Limited



On December 22, 2003, we signed a share purchase agreement to acquire 100% of the voting interest in Amacis Group Limited
(Amacis), a leading provider of electronic commerce management solutions to global enterprises. The acquisition of Amacis further extended our breadth and depth in the eService marketplace by adding complementary email and wireless
technologies to our customer service and support software solutions. The acquisition of Amaciss shares closed on December 22, 2003. Under the terms of the agreement, we purchased all of the outstanding shares of Amacis in exchange for
1,234,692 shares of our common stock valued at approximately $7.4 million, and assumed all employee stock options outstanding under an existing Amacis stock option plan (100% vested), valued at approximately $1.1 million and incurred direct
acquisition costs of approximately $364,000. The fair value of the common stock issued by us upon the acquisition was $6.00 per share, based on the average market price for a period before and after December 22, 2003.



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The purchase price of approximately $8.9 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 $8.4 million has been recorded as goodwill.



Other Intangible Assets



Other intangible assets acquired in the Broad Daylight and Amacis
acquisitions consist of the following at cost (in thousands):



|                              |  |               |       |  
|----------------------------- |  | ------------- | ----- | -
|                              |  | June 30, 2004 |      
|Acquired technology           |  | $             | 3,300 |  
|Maintenance contracts         |  |               | 240   |  
|Customer relationships        |  |               | 70    |  
|Hosting contracts             |  |               | 60    |  
|Trade names                   |  |               | 56    |  
|Less accumulated amortization |  |               | (651  | )
|                              |  |               |       |  
|                              |  | $             | 3,075 |  
|                              |  |               |       |  



Other intangible
assets related to the Amacis acquisition consist of acquired technology of approximately $2.8 million and maintenance and hosting contracts. Acquired technology is amortized over its estimated useful live of seven years, and maintenance and hosting
contracts were fully amortized as of June 30, 2004. Other intangible assets related to the Broad Daylight acquisition consist of acquired technology of $450,000 and customer relationships and trade names, and are amortized over their estimated
useful lives ranging from 16 months to three years. During the quarter ended June 30, 2004, a customer terminated a maintenance contract with a remaining life of approximately 54 months, and the associated remaining unamortized intangible asset
balance of approximately $220,000 was expensed. Amortization expense for the three and six months ended June 30, 2004 was approximately $374,000 and $587,000, respectively. Based on identified intangible assets recorded as of June 30, 2004, and
assuming no subsequent impairment of the underlying assets, the annual amortization expense is expected to be approximately as follows (in thousands):



|                  |  |   |      
|----------------- |  | - | -----
|Remainder of 2004 |  |   | 282  
|2005              |  |   | 523  
|2006              |  |   | 500  
|2007              |  |   | 495  
|2008              |  |   | 465  
|2009              |  |   | 405  
|2010              |  |   | 405  
|                  |  |   |      
|Total             |  | $ | 3,075
|                  |  |   |      



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, 2003
included in our Form 10-K filed with the SEC in March of 2004. 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.



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Stock-Based Compensation



We apply the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an interpretation
of APB Opinion No. 25, issued in March 2000, to account for its fixed plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise
price. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, an Amendment of SFAS Statement
No. 123, established accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. As permitted by existing accounting standards, we have elected to continue to apply the
intrinsic value based method of accounting described above, and have adopted only the disclosure requirements of SFAS No. 123, as amended. The following table illustrates the effect on net loss if the fair value based method had been applied to all
outstanding and unvested awards in each period (in thousands, except per share data):



|                                                                                                            |  |                             |       |                           |   |       |  |      |       |  |   |      
|----------------------------------------------------------------------------------------------------------- |  | --------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                                                                                                            |  | Three Months Ended June 30, |       | Six Months Ended June 30,
|                                                                                                            |  | 2004                        |       | 2003                      |   | 2004  |  | 2003
|Net loss, as reported                                                                                       |  | $                           | 2,117 |                           | $ | 2,704 |  | $    | 5,081 |  | $ | 3,834
|Add total stock-based employee compensation expense determined under fair value-based method for all awards |  |                             | 865   |                           |   | 2,893 |  |      | 2,059 |  |   | 5,824
|                                                                                                            |  |                             |       |                           |   |       |  |      |       |  |   |      
|Pro forma net loss                                                                                          |  | $                           | 2,982 |                           | $ | 5,597 |  | $    | 7,140 |  | $ | 9,658
|                                                                                                            |  |                             |       |                           |   |       |  |      |       |  |   |      
|Basic and diluted net loss per share:                                                                       |  |                             |       |                           |   |       |  |      |       |  |   |      
|As reported                                                                                                 |  | $                           | 0.09  |                           | $ | 0.14  |  | $    | 0.22  |  | $ | 0.20 
|SFAS No. 123 pro forma                                                                                      |  | $                           | 0.13  |                           | $ | 0.29  |  | $    | 0.30  |  | $ | 0.51 



Investment in
Primus Knowledge Solutions, K.K.



In December 1995, we
invested $50,000 for a 50% interest in Primus Knowledge Solutions, KK (Primus KK), a Japanese distributor, with Trans Cosmos, Inc., a Japanese company (TCI), a significant shareholder of Primus. We accounted for our investment using the equity
method and wrote down our investment to zero in March 1997 as a result of recognizing our portion of the investees losses to date. In September 1997, we renegotiated our agreement with TCI, reducing our ownership to 14.3%. In August 2000, the
arrangement was further amended and our ownership percentage in Primus KK was increased to 19.6%. Primus KK is accounted for using the cost method, as we do not have significant influence over the operations of Primus KK, have not guaranteed any of
its obligations and do not have any commitment or intent to provide any funding. The carrying value of our investment in Primus KK is zero at June 30, 2004 and December 31, 2003.



Note 2. Restructuring Charges



During March of 2004, we executed a restructuring of our workforce in an effort to realize the efficiencies and synergies from our recent acquisitions and
as a result recorded restructuring charges of approximately $461,000 for severance and benefits and associated costs due to a reduction in our worldwide workforce of 20 employees, or approximately 10%. Additionally, we anticipate consolidating our
Santa Clara operations into other existing locations and we may record an excess facility and/or asset impairment charge during the remainder of 2004. There were no restructuring charges incurred during 2003.



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The components of the 2004 charge and a rollforward of the related liability included within accrued and
other liabilities follows (in thousands):



|                                        |  |                             |     |                                            |   |                                |  |   |                          |   |  |   |    
|--------------------------------------- |  | --------------------------- | --- | ------------------------------------------ | - | ------------------------------ |  | - | ------------------------ | - |  | - | ---
|                                        |  | Balance atDecember 31, 2003 |     | Charge for the quarter endedMarch 31, 2004 |   | Net Cash Payments &Impairments |  |   | Balance atMarch 31, 2004
|Excess facilities and asset impairments |  | $                           | 27  |                                            | $ |                               |  | $ | (21                      | ) |  | $ | 6  
|Employee separation costs               |  |                             |    |                                            |   | 461                            |  |   | (43                      | ) |  |   | 418
|                                        |  |                             |     |                                            |   |                                |  |   |                          |   |  |   |    
|Total                                   |  | $                           | 27  |                                            | $ | 461                            |  | $ | (64                      | ) |  | $ | 424
|                                        |  |                             |     |                                            |   |                                |  |   |                          |   |  |   |    
|                                        |  |                             |     |                                           
|                                        |  | Balance atMarch 31, 2004    |     | Charge for thequarter endedJune 30, 2004   |   | Net CashPayments &Impairments  |  |   | Balance atJune 30, 2004 
|Excess facilities and asset impairments |  | $                           | 6   |                                            | $ |                               |  | $ | (6                       | ) |  | $ |   
|Employee separation costs               |  |                             | 418 |                                            |   |                               |  |   | (382                     | ) |  |   | 36 
|                                        |  |                             |     |                                            |   |                                |  |   |                          |   |  |   |    
|Total                                   |  | $                           | 424 |                                            | $ |                               |  | $ | (388                     | ) |  | $ | 36 
|                                        |  |                             |     |                                            |   |                                |  |   |                          |   |  |   |    



Note 3. Loss Per Common Share



In accordance with SFAS No. 128, Earnings Per
Share, we have reported 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 generally consist of outstanding stock options. As we had a net loss applicable to common shareholders in each of the periods presented, basic and diluted net loss per common share are the same.
Dilutive potential securities outstanding were not included in the computation of diluted net loss per common share, because to do so would have been anti-dilutive. Dilutive potential securities as of June 30, 2004 and 2003 included options to
purchase approximately 5,710,534 and 6,892,341, common shares, respectively.



Note 4. Other Comprehensive Loss



SFAS No.
130, Reporting Comprehensive Income establishes standards for the reporting and presentation of comprehensive income (loss) and its components in a full set of financial statements. Comprehensive loss consists of net loss, foreign
currency translation adjustments and net unrealized gains and losses from securities available-for-sale and is presented in the accompanying statements of stockholders equity and comprehensive loss. SFAS No. 130 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, 2004 and 2003 (in
thousands):



|                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                        |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                        |  | 2004                       |        |   | 2003                     |   |        | 2004 |  |   | 2003   |  
|Net loss                                                |  | $                          | (2,117 | ) |                          | $ | (2,704 | )    |  | $ | (5,081 | ) |  | $ | (3,384 | )
|Other comprehensive income (loss):                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Foreign currency translation gain (loss)                |  |                            | (171   | ) |                          |   | 58     |      |  |   | 149    |   |  |   | 41     |  
|Unrealized gain (loss) on securities available-for-sale |  |                            |       |   |                          |   | 1      |      |  |   |       |   |  |   | (4     | )
|                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total comprehensive loss                                |  | $                          | (2,288 | ) |                          | $ | (2,645 | )    |  | $ | (4,932 | ) |  | $ | (3,797 | )
|                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



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Note 5. Related Party Transactions



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 arrangement with Primus KK continues until terminated by mutual agreement or, if Primus KK has not completed the listing
of its common stock on a recognized public stock exchange by December 31, 2004 or if certain performance goals are not met, its expiration on March 31, 2006. In July 2002, January 2003, May 2003, and again in September 2003, we amended the
distribution agreement with Primus KK, and Primus KK has assumed a more significant role in product localization and support for the Japanese market. After the September 2003 amendment, the current royalty fee structure had guaranteed minimum
payments from Primus KK of $125,000 per quarter through the quarter ended March 31, 2004. We are presently negotiating with Primus KK concerning the appropriate level of guaranteed minimum payments for calendar quarters after March 31, 2004. No
guaranteed minimum payment has been made or recognized for the quarter ended June 30, 2004. The amended distribution agreement provides for sublicense fees based on a percentage of net fees collected by Primus KK from its customers (subject to
certain minimums). The guaranteed minimum payments from Primus KK do not constitute an advance inventory purchase nor can such payments be credited or carried over from one year to another. Guaranteed minimum royalty payments, to the extent they
exceed sublicense fees due, are recognized in the period earned. As a result of the changing and uncertain business climate and operating results for Primus KK, we are currently engaged in discussions and are negotiating a further amendment to its
the Primus KK distribution agreement. Our agreement with Primus KK does not contain product return rights. We recognized revenue from sublicense fees and guaranteed minimum payments of $0 and $11,000 for the three months ended June 30, 2004 and
2003, respectively, and $139,000 and $300,000 for the six months ended June 30, 2004 and 2003, respectively. Revenue deferred at June 30, 2004 and December 31, 2003 was approximately $121,000 and $94,000, respectively, and accounts receivable at
June 30, 2004 and December 31, 2003 were approximately $0 and $6,000, respectively.



Note 6. Business Segment Information



We
operate primarily in one business segment and are principally engaged in the design, development, marketing, sale and support of Primus® Knowledge Center (encompassing functionality from Primus® eServer Primus® eSupport, Primus® iView, Primus® Quick Resolve, and Primus® Enterprise Search) and Primus® Communications Center (formerly Primus® Visibility) 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, 2004 and 2003 (in thousands):



|                         |  |                            |       |                          |   |       |  |      |        |  |   |      
|------------------------ |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ------ |  | - | -----
|                         |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                         |  | 2004                       |       | 2003                     |   | 2004  |  | 2003
|United States of America |  | $                          | 3,537 |                          | $ | 2,994 |  | $    | 7,548  |  | $ | 6,650
|Japan                    |  |                            | 63    |                          |   | 120   |  |      | 252    |  |   | 540  
|Other                    |  |                            | 2,155 |                          |   | 603   |  |      | 4,029  |  |   | 2,015
|                         |  |                            |       |                          |   |       |  |      |        |  |   |      
|Total revenue            |  | $                          | 5,755 |                          | $ | 3,717 |  | $    | 11,829 |  | $ | 9,205
|                         |  |                            |       |                          |   |       |  |      |        |  |   |      



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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 Item 5.



Note 7. Liquidity



Our operations have historically been financed through issuances of common and preferred stock. For the six-month period ended June 30, 2004, we incurred
a net loss of approximately $5.1 million and we utilized cash in our operating activities of approximately $4.6 million. At June 30, 2004, we have working capital (current assets minus current liabilities, excluding deferred revenue) of
approximately $7.1 million. Our management believes it has sufficient resources to continue as a going concern through at least June 30, 2005. Management plans to fund our growth by generating sufficient revenue from customer contracts; if they are
unable to do so, management would seek to further reduce operating costs in an attempt 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 8. Commitments and
Contingencies



We have entered into various agreements
that allow for incorporation of licensed technology into our products. We incur royalty fees under these agreements that are based on a predetermined fee per license sold. Royalty costs incurred under these agreements are recognized over the periods
that the related revenue is recognized and is included in cost of revenue. During the three and six months ended June 30, 2004, we incurred royalty expenses of approximately $40,000 and $65,000, respectively, under these agreements.



In January 2003, we engaged an offshore development team to accelerate our
development efforts. Our minimum commitment under this agreement is to incur up to approximately $125,000 per month for development work through January 2005. During the three and six months ended June 30, 2004, we incurred software development
expenses of approximately $385,000 and $770,000, respectively, related to this agreement.



We also lease office space under operating leases with various expiration dates through 2006.



We have no material long-term commitments or obligations other than those under these agreements.



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 our initial public offering. This is one of a number of actions coordinated for pretrial purposes. Plaintiffs in the coordinated proceeding have brought claims under the federal securities laws
against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities concerning the



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allocation of shares in the IPOs of more than 300 companies during the period from late 1998 through 2000.
Specifically, among other things, the plaintiffs allege that the prospectus pursuant to which shares of Primus common stock were sold in our IPO contained certain false and misleading statements regarding the practices of our underwriters with
respect to their allocation of shares of common stock in our IPO to their customers and their receipt of commissions from those customers related to such allocations, and that such statements and omissions caused our post-IPO stock price to be
artificially inflated. The individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. In June 2003 the plaintiffs in this action announced a proposed settlement with the issuer defendants and their
insurance carriers. We have elected to participate in the settlement, which generally provides that our insurance carrier is responsible for any payments other than legal fees we incurred before June 2003. On March 4, 2004, plaintiffs
executive committee advised the court that the negotiators for plaintiffs and issuers had agreed on the terms of the settlement. The court must still approve the settlement. If the settlement does not occur, and litigation against us continues, we
believe we have meritorious defenses and intend to defend the case vigorously. While we cannot predict with certainty the outcome of the litigation or whether the settlement will be approved, we do not expect any material adverse impact to our
business from this matter.



In October 2003, we received notice
that ServiceWare, Inc. had filed a complaint against Primus in the United States District Court for the Western District of Pennsylvania, which alleges that aspects of our technology infringe one or more patents issued in 1998 alleged to be held by
the plaintiff. The complaint was served on us on January 28, 2004. In February of 2004, we filed our answer, denying all substantive claims, raising multiple affirmative defenses (including that the patents are invalid and unenforceable, that Primus
products dont infringe the patents in any event and that these claims on 1998 patents are barred by equitable estoppel and latches) and including a number of counterclaims. In May 2004, ServiceWare, Inc. filed counterclaims in this lawsuit,
including allegations of interference, defamation and unfair competition. This case is currently in the discovery phase. We intend to vigorously defend against the allegations asserted in this complaint and we believe the plaintiffs claims are
without merit.



From time to time we are, and expect to
continue to be, subject to legal proceedings and claims in the ordinary course of our business, including employment claims, contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual
property rights. These claims, including those described above, even if not meritorious, could force us to spend significant financial and managerial resources. We may incur substantial expenses in defending against third party claims. In the event
of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our financial position and results of operations.



As of June 30, 2004, other than accrued legal fees and expense incurred,
no amounts have been accrued as a liability associated with the aforementioned legal proceedings as the incurrence and amount of a liability, if any, is not considered reasonably estimable or probable.



Note 9. Guarantees



In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope
of Financial Accounting Standards Board Interpretations (FIN) No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, except for standard indemnification,
warranty and hosting uptime provisions that are contained within many of our customer license and service agreements, and give rise only to the disclosure requirements prescribed by FIN No. 45. Indemnification, warranty and hosting uptime provisions
contained within our customer license and service agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally do not exceed 90 days following delivery or installation of our products. We
have not incurred significant obligations under customer indemnification, warranty or hosting uptime provisions historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain accruals for potential
customer indemnification or warranty-related obligations.



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



Forward-Looking Statements



This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning Primus
performance and financial results. There are a variety of factors that could cause actual events or results to differ materially from those projected in the forward-looking statements, including, without limitation: our ability to successfully
implement sales of our software solutions; competition, adoption and implementation of our software solutions by our customers; changes in general economic conditions, or other unforeseen developments in the industries in which we operate (See also
Risks and Uncertainties Associated with Our Business and Future Operating Results). Accordingly, there can be no assurance that future activities or results will be as anticipated. In some cases, you can identify forward-looking
statements by terminology such as may, should, expects, plans, anticipates, believes, estimates, predicts, potential, continue,
or the negative of these terms or other comparable terminology. 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 software solutions that enable companies to deliver a superior customer experience via contact centers, information technology (IT) help desks,
Web (Intranet and Internet) self-service, and electronic communication channels. Our technology powers every interaction with knowledge to increase customer satisfaction and reduce operational costs. We provide application software that enables
companies to find, capture and communicate enterprise knowledge to deliver answers to questions and solutions to problems. We also offer electronic communication solutions, such as web self-service, email management, chat, and wireless
communications. Our software products can be implemented as a suite or as individual modules as part of a comprehensive eService solution, customer service delivered through web based applications. Our solutions can be used in combination with
leading CRM (Customer Relationship Management) and IT helpdesk applications, including those from Amdocs/Clarify, Kana, Onyx, Oracle CRM, PeopleSoft, Remedy, Siebel, SAP, and others. In addition to software applications, we offer professional
services to assist customers with software implementation, integration, hosting, training and support.



To compete in todays business environment, companies must maximize their relationships with prospective and existing customers. This has led many
companies to implement eService initiatives and software. eService software is designed to enable companies to interact with their customers and 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 and, in turn, increase customer satisfaction and retention and cross-sell and up-sell opportunities.



Our software suite consists primarily of Primus Knowledge Center
(encompassing functionality from Primus eServer, eSupport, Primus iView, Primus Quick Resolve and Primus Enterprise Search) and Primus



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Communications Center (formerly Primus Visibility). Revenue from Primus Knowledge Center related products accounted for
approximately 65% and 100% of total revenue for the quarters ended June 30, 2004 and 2003, respectively, and revenue from Primus Knowledge Center and other products accounted for approximately 35% and 0% for the quarters ended June 30, 2004 and
2003, respectively. This change in revenue mix is primarily due to the acquisition of Amacis and the Visibility product platform. License fees for our software vary with each application, but our products are typically licensed on a per-processor
basis, per-user basis, per number of email messages processed 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. We deploy our solutions either in-house at the customers facility as installed software or in a hosted environment operated and maintained by us. Customers using our hosted offerings can take advantage of our hosting expertise,
thereby reducing the demands on their own information technology resources while receiving the full benefit of secure and reliable access to our applications.



We target mid- to large-sized organizations, and our products are used by contact centers, IT helpdesks, field service organizations, human resources
organizations, marketing organizations, and eService businesses. Our customers include companies from many industry verticals, such as: High-tech, Telecommunications, Outsourced Services Providers, Financial Services, Manufacturing and Government.
We develop our products and market and sell our software and services primarily through a direct sales force and a minority owned Japanese entity. We have offices throughout the United States, and in the United Kingdom and France. Our principal
executive offices are located at 1601 Fifth Avenue, Suite 1900, Seattle, WA 98101.



We market our software and services on a worldwide basis primarily 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 revenue constituted 39% and 19% of our total revenue for the quarters ended June 30, 2004 and 2003, respectively. We believe that
international revenue, as a percentage of our total revenue, will continue to fluctuate in the future. We have not guaranteed any obligations of our Japanese joint venture nor do we have any commitment or intent to provide any funding.



We incorporated in Washington State in 1986 and our common shares were
originally listed on the Nasdaq National Market® on
June 30, 1999, and were transferred to the Nasdaq Small Cap Market on or about November 1, 2002, and publicly trade under the symbol PKSI.



Available Information



We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (SEC) under the
Securities Exchange Act of 1934 as amended (Exchange Act). You can inspect and copy our reports, proxy statements, and other information filed with the SEC at the offices of the SECs Public Reference Rooms in Washington, D.C., New York, New
York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Rooms. The SEC maintains an Internet Website at <http://www.sec.gov/> where you can obtain most of our SEC filings. In addition,
you can inspect our reports, proxy materials and other information at the offices of the Nasdaq Stock Market at 1735 K Street NW, Washington D.C. 20006. We also make available free of charge on our website at www.primus.com our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after they are filed electronically with
the SEC. You can also obtain copies of these reports by contacting Investor Relations at investor.relations@primus.com or by phone at 206-834-8100.



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 cumulative net losses since inception, and as of June 30, 2004, had an accumulated deficit of approximately $108 million. We anticipate that our operating expenses will
continue to be substantial for the foreseeable future as we continue to invest in product development and sales and marketing.



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Factors adversely affecting the demand for our products and services, 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 and our ability to develop and sell enhanced versions of our products. 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 (See also Risks and Uncertainties
Associated with Our Business and Future Operating Results).



Acquisitions



Acquisition of Broad
Daylight, Inc.



On August 12, 2003, we signed a definitive
merger agreement and announced our intent to acquire 100% of the voting interest in Broad Daylight, Inc. (Broad Daylight) an e-service software developer specializing in solutions for customer and employee self-service. The merger of
Broad Daylight with a subsidiary of Primus closed on September 3, 2003. Under the terms of the agreement, we purchased all of the outstanding shares of Broad Daylight in exchange for 2,131,009 shares of Primus common stock valued at approximately
$2.5 million, plus cash of approximately $140,000 and direct acquisition costs of approximately $198,000. The fair value of the common stock issued for the acquisition was $1.19 per share, based on the average market price for a period before and
after August 12, 2003.



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 $3.3 million
has been recorded as goodwill.



Acquisition of Amacis Group
Limited



On December 22, 2003, we signed a share purchase
agreement to acquire 100% of the voting interest in Amacis Group Limited (Amacis), a leading provider of electronic commerce management solutions to global enterprises. The acquisition of Amacis further extended our breadth and depth in
the eService marketplace by adding complementary email and wireless technologies to our customer service and support software solutions. The acquisition of Amaciss shares closed on December 22, 2003. Under the terms of the agreement, we
purchased all of the outstanding shares of Amacis in exchange for 1,234,692 shares of Primus common stock valued at approximately $7.4 million, and assumed all employee stock options outstanding under an existing Amacis stock option plan (100%
vested), valued at approximately $1.1 million and incurred direct acquisition costs of approximately $364,000. The fair value of the common stock issued by Primus upon the acquisition was $6.00 per share, based on the average market price for a
period before and after December 22, 2003.



The purchase price
of approximately $8.9 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 $8.4 million has been recorded as goodwill.



Restructurings



During March of 2004, we executed a further restructuring
of our workforce to realize the efficiencies and synergies from our recent acquisitions and as a result recorded restructuring charges of approximately $461,000 for severance and benefits and associated costs due to a reduction in our worldwide
workforce of 20 employees, or approximately 10%. Additionally, we anticipate consolidating our Santa Clara operations into other existing locations and may record an excess facility and/or asset impairment charge during the remainder of 2004.



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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 excess facilities or assets disposed of or removed from operations as a
direct result of a reduction in workforce.



Critical Accounting Policies and
Estimates



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



Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation
of our consolidated financial statements.



Restructuring



During March of 2004 we recorded significant accruals in
connection with our restructuring program under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These accruals include estimates pertaining to employee separation costs. Although we believe that we have
made reasonable estimates of our restructuring costs in calculating these accruals, the actual costs could differ from these estimates.



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 (SAB) No. 104 Revenue Recognition, which
was issued in December 2003 and supercedes SAB No.101, Revenue Recognition in Financial Statements. 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 (VSOE) to allocate the total fee to the elements of the arrangement.



For all sales, we use either a binding purchase order or signed agreement, depending on the nature of the transaction, as evidence of an arrangement.
Sales through our resellers or distributors are evidenced by a master agreement governing the relationship together with binding purchase orders or signed agreements on a transaction-by-transaction basis.



For software license fees in single element arrangements and multiple element
arrangements that do not include customization or consulting services, delivery typically occurs when the product is made available to the customer for download or when products are shipped to the customer. For hosting and consulting revenue,
delivery typically occurs as the services are being performed.



At the time of each transaction, we assess whether the fee associated with our revenue transaction is fixed and determinable and whether or not collection is probable. We assess whether the fee is fixed and determinable based on the payment
terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, we consider the fee to not be fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable.



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We initially assess the probability of collection based on a number of factors, including past
transaction history with the customer and the current financial condition of the customer. If we determine that collection of a fee is not probable, we defer revenue until the time collection becomes probable, which is generally upon receipt of
cash.



For multiple element arrangements, when company-specific
objective evidence of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements in the arrangement, we recognize revenue under the residual method. Under the residual
method, at the outset of the arrangement with a customer, we defer revenue for the fair value of the arrangements undelivered elements such as consulting services and product support and maintenance, and recognize the revenue for the remainder
of the arrangement fee attributable to the elements initially delivered, such as software licenses, when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support and maintenance of standard products for
which no installation or customization is required based upon the amounts we charge when support and maintenance are sold separately. Company-specific objective evidence is established for consulting, implementation and installation services based
on the hourly rates we charge for our employees when they are performing these services, provided we have the ability to accurately estimate the hours required to complete a project based upon our experience with similar projects or if the
arrangement is based upon a stipulated hourly or daily rate. For multiple element arrangements involving installation, implementation or customization, company-specific objective evidence is established for hosting and support and maintenance
arrangements if our customers have an optional annual renewal rate specified in the arrangement and the rate is substantive.



Service revenues include payments under hosting and support and maintenance contracts and consulting services. Hosting and support and maintenance revenue
is generally recognized ratably over the term of the contract, which for support and maintenance revenue typically is twelve months. Consulting and other service revenue is recognized as the services are performed.



From time to time we enter into distribution agreements with resellers that
typically provide for sublicense fees based on a percentage of list prices. Our distribution agreement with Primus KK, a related party, provided for sublicense fees based on a percentage of net fees collected by Primus KK from its customers, subject
to certain guaranteed minimum royalty payments. Sublicense fees are recognized upon delivery of software to Primus KK 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. Guaranteed minimum royalty payments, to the extent they exceed sublicense fees due, are recognized in the period earned. Our agreements with our customers
and resellers, including Primus KK, 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. At June 30, 2004 and December 31, 2003, the allowance for doubtful accounts was $139,000 and $174,000, respectively.



Goodwill



Goodwill represents the excess of costs over fair value of assets of
businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions
of SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.



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We assess the impairment of goodwill on an annual basis or whenever events or changes in circumstances
indicate that the fair value of the reporting unit to which goodwill relates is less than the carrying value. Factors we consider important which could trigger an impairment review include the following:



| |  | poor economic performance relative to historical or projected future operating results
| | - | --------------------------------------------------------------------------------------



| |  | significant negative industry, economic or company specific trends
| | - | ------------------------------------------------------------------



| |  | changes in the manner of our use of the assets or the plans for our business
| | - | ----------------------------------------------------------------------------



| |  | loss of key personnel
| | - | ---------------------



If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill, based upon the annual test or the
existence of one or more of the above indicators of impairment, we measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined
by allocating the fair value of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of reporting
unit goodwill. To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference.



In the fourth quarter of 2003, we performed an analysis as described above,
in connection with our annual impairment test required under SFAS No. 142. Our 2003 annual impairment analysis did not require us to recognize an impairment loss.



Results of Operations for the Three and Six Months Ended June 30, 2004 and 2003



The following table sets forth certain financial data, derived from our
unaudited condensed consolidated statements of operations, as a percentage of total revenues for the periods indicated. The operating results for the three and six months ended June 30, 2004 and 2003 are not necessarily indicative of the results
that may be expected for any future period.



|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|------------------------------------- |  | -------------------------- | -- |  | ------------------------ | -- |  | ----- | -- |  | ----- | --
|                                      |  | Three MonthsEnded June 30, |    |  | Six MonthsEnded June 30, |   
|                                      |  | 2004                       |    |  | 2003                     |    |  | 2004  |    |  | 2003  |   
|Revenue:                              |  |                            |    |  |                          |    |  |       |    |  |       |   
|License:                              |  |                            |    |  |                          |    |  |       |    |  |       |   
|Third party                           |  | 26.4                       | %  |  | 12.2                     | %  |  | 25.6  | %  |  | 27.6  | % 
|Related partyPrimus KK               |  |                           |    |  | 0.3                      |    |  | 1.2   |    |  | 3.3   |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|                                      |  | 26.4                       |    |  | 12.5                     |    |  | 26.8  |    |  | 30.9  |   
|                                      |  |                            |    | 
|Service:                              |  |                            |    |  |                          |    |  |       |    |  |       |   
|Third party                           |  | 72.5                       |    |  | 84.6                     |    |  | 72.2  |    |  | 66.5  |   
|Related partyPrimus KK               |  | 1.1                        |    |  | 2.9                      |    |  | 1.0   |    |  | 2.6   |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|                                      |  | 73.6                       |    |  | 87.5                     |    |  | 73.2  |    |  | 69.1  |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Total revenue                         |  | 100.0                      |    |  | 100.0                    |    |  | 100.0 |    |  | 100.0 |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Cost of revenue:                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|License                               |  | 2.3                        |    |  | 1.5                      |    |  | 3.1   |    |  | 1.7   |   
|Service                               |  | 24.9                       |    |  | 33.4                     |    |  | 24.9  |    |  | 25.9  |   
|Amortization of purchased intangibles |  | 6.5                        |    |  |                         |    |  | 5.0   |    |  |      |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Total cost of revenue                 |  | 33.7                       |    |  | 34.9                     |    |  | 33.0  |    |  | 27.5  |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Gross profit                          |  | 66.3                       |    |  | 65.0                     |    |  | 67.0  |    |  | 72.5  |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Operating expenses                    |  |                            |    |  |                          |    |  |       |    |  |       |   
|Sales and marketing                   |  | 40.1                       |    |  | 68.0                     |    |  | 44.0  |    |  | 55.7  |   
|Research and development              |  | 37.1                       |    |  | 50.4                     |    |  | 37.9  |    |  | 40.1  |   
|General and administrative            |  | 25.5                       |    |  | 18.9                     |    |  | 23.4  |    |  | 18.2  |   
|Restructuring charges                 |  |                           |    |  |                         |    |  | 3.9   |    |  |      |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Total operating expenses              |  | 102.7                      |    |  | 137.3                    |    |  | 109.2 |    |  | 114.0 |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Loss from operations                  |  | (36.4                      | )  |  | (72.3                    | )  |  | (42.2 | )  |  | (41.5 | ) 
|Other income (expense), net           |  |                           |    |  | 0.3                      |    |  | (0.2  | )  |  | 0.7   |   
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Loss before income taxes              |  | (36.4                      | )  |  | (71.9                    | )  |  | (42.4 | )  |  | (40.8 | ) 
|Income tax expense                    |  | (0.4                       | )  |  | (0.8                     | )  |  | (0.6  | )  |  | (0.9  | ) 
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   
|Net loss                              |  | (36.8                      | )% |  | (72.7                    | )% |  | (43.0 | )% |  | (41.7 | )%
|                                      |  |                            |    |  |                          |    |  |       |    |  |       |   



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Revenue



Total revenue was $5.8 million and $3.7 million for the three months ended June 30, 2004 and 2003, respectively, representing an increase of $2.0 million,
or 55%. During the three and six months ended June 30, 2004, revenue to one international customer represented approximately 22% and 11% of total revenue, respectively. During the six months ended June 30, 2003, revenue from an enterprise sale to
one international customer represented approximately 13% of total revenue. No other single customer accounted for 10% or more of total revenue in the three or six months ended June 30, 2004 or 2003. International revenue was $2.2 million and
$723,000 for the three months ended June 30, 2004 and 2003, respectively, representing an increase of $1.5 million or 207%. International revenue was $4.3 million and $2.6 million for the six months ended June 30, 2004 and 2003, respectively,
representing an increase of $1.7 million or 68%. Total revenue was $11.8 million and $9.2 million for the six months ended June 30, 2004 and 2003, respectively, representing an increase of $2.6 million, or 29%. During the second half of 2003, we
acquired Broad Daylight, Inc. and Amacis Group Limited (the Acquired Companies) and our financial statements include the results of their operations since the respective dates of acquisition. We believe that 2004 increases in
international revenue are primarily due to sales of Amacis Group Limited (Amacis) products and international revenue as an absolute dollar amount and as a percentage of our total revenue will continue to fluctuate in the future.



License Revenue.Total license revenue
was $1.5 million and $466,000 for the three months ended June 30, 2004 and 2003, respectively, representing an increase of approximately $1.1 million, or 226%. Total license revenue was $3.2 million and $2.8 million for the six months ended June 30,
2004 and 2003, respectively, representing an increase of $329,000, or 12%. Included in license revenue for the three months ended June 30, 2004 is an enterprise sale of Primus Communication Center to a pre-existing Amacis customer. They elected to
apply an existing prepaid support deposit balance (which was previously included in deferred revenue) against all amounts due. This customer had previously purchased the Amacis Visibility product and was not entitled to upgrades under their prepaid
support agreement. As such, this transaction did not result in an increase to cash or receivables during the period. License revenue for the six months ended June 30, 2004 includes approximately $1.9 million attributed to the sale of Primus
Communication Center related products to two of Amacis pre-existing customers. License revenue as a percentage of total revenue was 26% and 13% for the three months ended June 30, 2004 and 2003, respectively and 27% and 31% for the six months
ended June 30, 2004 and 2003, respectively.Although we experienced an increase in the sales of our software in 2004 as compared to 2003, we continued to experience long and unpredictable sales cycles, making it difficult to predict when
license sales may close. We believe software license revenue increased in absolute dollars primarily due to sales to certain of Amacis pre-existing customers, partially offset by certain of our customers utilizing hosted license model for our
software during the second half of 2003 and the first half of 2004. The changes in license revenue as a percentage of total revenue are primarily due to the absolute dollar increases in license revenue and total revenue. The general economic and
business conditions have been extremely challenging during 2003 and the first half of 2004, and we expect them to continue to affect capital-spending initiatives of our targeted new and existing customer base. Additionally, our license revenues
depend on the overall demand for customer relationship management products and information technology helpdesk applications.



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Service Revenue. Total service revenue was $4.2 million and $3.2 million for the three months
ended June 30, 2004 and 2003, respectively, representing an increase of $987,000, or 30%, and was the result of an increase in hosting fees of approximately $1.1 million, partially offset by declines in maintenance and support contract revenue and
consulting fees over the same period. Service revenue as a percentage of total revenue was 74% and 87% for the three months ended June 30, 2004 and 2003, respectively. Total service revenue was $8.7 million and $6.4 million for the six months ended
June 30, 2004 and 2003, respectively, representing an increase of approximately $2.3 million, or 36%, and was primarily the result of an increase in hosting revenue of approximately $2.2 million over the same period. Service revenue as a percentage
of total revenue was 73% and 69% for the six months ended June 30, 2004 and 2003, respectively. During 2004, total service revenue related to products of the Acquired Companies was approximately $1.3 million. Hosting and consulting revenue was
approximately $1.5 million and $500,000 for the three months ended June 30, 2004 and 2003, respectively, and approximately $3.3 million and $830,000 for the six months ended June 30, 2004 and 2003, respectively. The increase in consulting and
hosting fees is primarily attributable to an increase in the types of our hosting offerings and the number of customers we are providing hosting services for, as well as billings for consulting services to pre-existing customers of the Acquired
Companies. Hosting and consulting revenue from two Primus customers was approximately 55% and 52% of total hosting and consulting revenue for the three and six months ended June 30, 2004, respectively. Hosting services are typically provided under
renewable contracts that range in length from one to twelve months. There can be no assurances that customers will renew these agreements as they expire. Maintenance and support contract revenue was approximately $2.7 million and $2.8 million for
the quarters ended June 30, 2004 and 2003, respectively, and $5.4 million and $5.5 million for the six months ended June 30, 2004 and 2003, respectively. We expect the amount of and proportion of total service revenue to total revenue to fluctuate
in the future, depending primarily on the dollar amounts of software license revenue, maintenance and support contract revenue, hosting and consulting fees and our customers use of third-party consulting and implementation services providers
and the ongoing renewals of customer maintenance and support and hosting contracts.



Cost of Revenue



Total cost of revenue was
$1.9 million and $1.3 million for the three months ended June 30, 2004 and 2003, respectively, representing an increase of $640,000, or 49%. Total cost of revenue was $3.9 million and $2.5 million for the six months ended June 30, 2004 and 2003,
respectively, representing an increase of $1.4 million, or 54%.



Cost of License Revenue. Cost of license revenue consists primarily of media, product packaging and shipping, documentation and other production costs, and third party software costs and royalties. Cost of license revenue was
$134,000 and $57,000 for the three months ended June 30, 2004 and 2003, respectively. Cost of license revenue was $366,000 and $154,000 for the six months ended June 30, 2004 and 2003, respectively. Cost of license revenue as a percentage of license
revenue was 9% and 12% for the three months ended June 30, 2004 and 2003, respectively, and 12% and 5% for the six months ended June 30, 2004 and 2003, respectively. The increase in the cost of license revenue as an absolute dollar amount and the
change as a percentage of license revenue is primarily due to a charge of approximately $80,000 taken during the first quarter of 2004 related to the estimated net realizable value of certain purchased third party software held for resale as well as
an increase in the cost of royalties and third party software purchased and resold during 2004 as compared to 2003. 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 resold or integrated with our solutions.



Cost of Service Revenue. Cost of service revenue consists primarily of salaries, benefits and allocated overhead costs related to customer support,
consulting, hosting, training and global services personnel, including the cost of any third-party consultants engaged by Primus. It also includes costs directly relating to the provision of hosting services, such as depreciation of capital
equipment used in our hosted network, cost of support for the third party software and lease costs paid to remote co-location centers. Cost of service revenue was $1.4 million and



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$1.2 million for the three months ended June 30, 2004 and 2003, respectively, representing an increase of approximately
$189,000, or 15%. Cost of service revenue as a percentage of service revenue was 34% and 38%, or a gross margin of 66% and 62%, for the three months ended June 30, 2004 and 2003, respectively. Cost of service revenue was $2.9 million and $2.4
million for the six months ended June 30, 2004 and 2003, respectively, representing an increase of approximately $565,000, or 24%. Cost of service revenue as a percentage of service revenue was 34% and 37%, or a gross margin of 66% and 63%, for the
six months ended June 30, 2004 and 2003, respectively. The increase in cost of service revenue for the three and six months ended June 30, 2004 is primarily due to increases in payroll and payroll related costs of approximately $105,000 and
$305,000, respectively, as a result of incremental headcount increases, significantly related to the Acquired Companies, as well as costs related to services provided to customers under hosting contracts in 2004, partially offset by reductions in
total overhead costs and other costs as part of our continued close monitoring of our expenses and further implementation of our cost control initiatives. The decrease in cost of service revenue as a percentage of services revenue was primarily due
to certain higher margin hosting contracts, higher utilization rates for our professional services staff and reductions in allocated overhead costs. Cost of service revenue will vary depending on the mix of services that we provide between support
and maintenance, hosting, training, implementation and integration services, as well as staffing levels, 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 integration services.



Amortization of Purchased Intangibles. Amortization of purchased intangibles consists entirely of amortization related to the intangibles recorded
in connection with the acquisition of the Acquired Companies during 2003. Other intangible assets related to the Amacis acquisition consist of acquired technology, maintenance and hosting contracts and customer relationships, and totaled $3.1
million. These intangible assets were being amortized over their estimated useful life ranging from four to 60 months for certain maintenance and hosting contracts and seven years for acquired technology. Intangible assets recorded in connection
with the acquisition of Broad Daylight consist of acquired technology and maintenance and hosting contracts and totaled $576,000 and are being amortized over their estimated useful lives ranging from 16 months to three years. During the quarter
ended June 30, 2004, a customer terminated a maintenance contract with a remaining life of approximately 54 months, and the associated remaining unamortized intangible asset balance of approximately $220,000 was expensed.



Operating Expenses



Overhead costs. Allocated overhead costs generally include compensation related benefits, facilities costs
(occupancy, utilities, telephone, Internet, postage and freight), depreciation and amortization related to property and equipment, general supplies and repair and maintenance costs, and bank fees and charges. Allocated overhead costs are allocated
to Cost of Service Revenue (customer support, consulting, training and global services personnel), Sales and Marketing expense, Research and Development expense and General and Administrative expense based primarily upon headcount, and were
approximately $1.1 million and $1.4 million for the three months ended June 30, 2004 and 2003, respectively, a decrease of approximately $294,000, or 21%, and $2.0 million and $2.7 million for the six months ended June 30, 2004 and 2003,
respectively, or a decrease of $723,000 or 26%. These decreases are primarily due to reductions during the three and six month periods ended June 30, 2004 in compensation related benefits of approximately $190,000 and $400,000, respectively, and
depreciation and amortization expense related to property and equipment of approximately $250,000 and $530,000, respectively, as well as smaller cost reductions in other areas as a direct result of our continued close monitoring of our expenses and
further implementation of our cost control initiatives; partially offset by increases in facilities costs and overhead personnel costs (primarily related to the Acquired Companies) of approximately $140,000 and $400,000, respectively. Total
allocated overhead costs are as follows (in thousands):



|                               |  |                           |       |                             |   |       |  |      |       |  |   |      
|------------------------------ |  | ------------------------- | ----- | --------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                               |  | Six Months Ended June 30, |       | Three Months Ended June 30,
|                               |  | 2004                      |       | 2003                        |   | 2004  |  | 2003
|Cost of service revenue        |  | $                         | 484   |                             | $ | 599   |  | $    | 256   |  | $ | 303  
|Sales and marketing            |  |                           | 547   |                             |   | 758   |  |      | 287   |  |   | 377  
|Research and development       |  |                           | 741   |                             |   | 999   |  |      | 387   |  |   | 495  
|General and administrative     |  |                           | 253   |                             |   | 392   |  |      | 146   |  |   | 195  
|                               |  |                           |       |                             |   |       |  |      |       |  |   |      
|Total allocated overhead costs |  | $                         | 2,025 |                             | $ | 2,748 |  | $    | 1,076 |  | $ | 1,370
|                               |  |                           |       |                             |   |       |  |      |       |  |   |      



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The decrease in compensation related benefits expense is the direct result of favorable claims experience
during 2004 under our self-insured health benefits plan. The net decrease in depreciation and amortization expense related to property and equipment was primarily due to the aging of our property and equipment, resulting in more of those assets
becoming fully depreciated. The increase in facilities costs and facility-related personnel costs during 2004 was due to an increase in the total square footage under lease and an increase in the number of facilities personnel primarily related to
the Acquired Companies.



Sales and Marketing.
Sales and marketing expenses consist primarily of salaries, bonuses, commissions and benefits earned by sales and marketing personnel, allocated overhead costs, 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 $2.3 million and $2.5 million for the three months ended June
30, 2004 and 2003, respectively, representing a decrease of approximately $220,000 or 9%. This decrease is primarily the result of decreases in sales and marketing payroll and related expenses primarily as a result of our March 2004 restructuring,
travel and entertainment costs, recruiting expenses and marketing expenditures (e.g., advertising, promotions, public relations, telemarketing, tradeshows and events and collateral materials) and total overhead costs; partially offset by increases
in consulting and temporary personnel expenses and telephony and connectivity-related costs and other costs as part of our continued close monitoring of our expenses and further implementation of our cost control initiatives. Sales and marketing
expenses were approximately $5.2 million and $5.1 million for the six months ended June 30, 2004 and 2003, respectively, representing an increase of approximately $82,000 or 2%. This increase is primarily the result of increases in consulting and
temporary personnel costs, travel and entertainment costs, recruiting expenses and training expenses (primarily related to the Acquired Companies) and telephony and connectivity related costs; partially offset by reductions in payroll and related
expenses, total overhead costs and marketing expenditures (e.g. advertising, promotions, public relations, telemarketing, tradeshows and events and collateral materials) and other costs as part of our continued close monitoring of our expenses and
further implementation of our cost control initiatives. Sales and marketing expenses during the six months ended June 30, 2004 included approximately $470,000 as a result of incremental payroll and associated expenses related to the absorption of
employees from the Acquired Companies during the first quarter of 2004. Sales and marketing expenses as a percentage of total revenue was 40% and 68% for the three months ended June 30, 2004 and 2003, respectively, and 44% and 56% for the six months
ended June 30, 2004 and 2003, respectively. This decrease as a percentage of total revenue is primarily due to the significant increase in total revenues for the three and six month periods ended June 30, 2004 compared to the same periods in 2003.
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.



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 primarily of salaries, benefits and contractors fees for
software engineers, program and product managers, technical writers, linguistic specialists, quality assurance personnel, allocated overhead costs, as well as costs related to the use of third party development firms. Research and development
expenses were approximately $2.1 million and $1.9 million for the three months ended June 30, 2004 and 2003, respectively, representing an increase of approximately $260,000 or 14%. The increase was primarily due to increase in research and
development headcount and related expenses during 2004 as compared to 2003, primarily related to the Acquired Companies, increases in research and development spending of approximately $70,000 related to our engagement of an offshore development
team in January of 2003 and increases in travel expenses; partially offset by reductions in total overhead costs and other costs, as a result of our continued close monitoring of our expenses and further implementation of our cost control
initiatives. Research and development expenses were approximately $4.5 million and $3.7 million for the six months ended June 30, 2004 and 2003, respectively, representing an increase of



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approximately $797,000 or 22%. The increase was primarily due to increases in research and development spending of
approximately $280,000 related to our engagement of an offshore development team in January of 2003 and increases in research and development headcount during 2004 as compared to 2003, primarily related to the Acquired Companies, and increases in
travel related costs. Research and development expenses during the first quarter of 2004 included approximately $430,000 as a result of incremental payroll and associated expenses related to the absorption of employees from the Acquired Companies.
These increases were partially offset by reductions in total overhead costs and other costs, as a result our continued close monitoring of our expenses and further implementation of our cost control initiatives. Research and development expenses as
a percentage of total revenue was 37% and 50% for the three months ended June 30, 2004 and 2003, and 38% and 40% for the six months ended June 30, 2004 and 2003, respectively. This decrease as a percentage of total revenue is primarily due to the
significant increase in total revenue in 2004, partially offset by the increase in total research and development spending from 2003 to 2004. 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. When required, we also use third-party development firms to expand the capacity and technical expertise of our internal research and
development teams and in January of 2003 we engaged an offshore development team to accelerate our development efforts. Accordingly, we anticipate that we will continue to invest in product research and development for the foreseeable future, and we
anticipate research and development costs 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, professional-services fees and total overhead costs. General and administrative expenses
were approximately $1.5 million and $702,000 for the three months ended June 30, 2004 and 2003, respectively, representing an increase of approximately $767,000 or 109%. This increase is primarily due to increases in legal, accounting and
administrative fees (Legal Fees), an increase in bad debt expense of $100,000, as well as increases in the reporting and compliance costs of being a public company; partially offset by reductions in total overhead costs and other costs,
primarily as a result of our continued close monitoring of our expenses and further implementation of our cost control initiatives. Legal Fees increased by approximately $725,000 during the three months ended June 30, 2004, due primarily to the
favorable settlement of a legal matter during the three months ended June 30, 2003, which resulted in the reversal of an accrual in the amount of $250,000, and increases in Legal Fees related to current legal proceedings (See Item 1 Note 8
Commitments and Contingencies - Legal Proceedings), as well as increases in general legal and accounting professional fees. General and administrative expenses were approximately $2.8 million and $1.7 million for the six months ended June 30,
2004 and 2003, respectively, representing an increase of approximately $1,1 million or 65%. This increase is primarily due to increases legal, accounting and administrative fees Legal Fees, increases in the reporting and compliance costs of being a
public company, as well as increases in bad debt expense of $50,000 and increases in corporate insurance costs related to the Acquired Companies. These increases are partially offset by reductions in total overhead costs and other costs, primarily
as a result our continued close monitoring of our expenses and further implementation of our cost control initiatives. General and administrative expenses during the first quarter of 2004 included approximately $100,000 as a result of incremental
payroll and associated expenses related to the absorption of employees from the Acquired Companies. Legal Fees increased by approximately $1.0 million during 2004, due primarily to the settlement of the above mentioned legal matter in the second
quarter of 2003, as well as Legal Fees related to current legal proceedings and increases in general legal and accounting professional fees. General and administrative expenses as a percentage of total revenue were 26% and 19% for the three months
ended June 30, 2004 and 2003, respectively, and 23% and 18% for the six months ended June 30, 2004 and 2003, respectively. The increase of general and administrative expense as a percentage of total revenue is primarily attributable to the
significant increase in general and administrative expenses during 2004, partially offset by the increase in revenue during 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.



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Restructuring Charges. There were no restructuring charges for the three months ended June 30,
2004 or June 30, 2003, or for the six months ended June 30, 2003. During March of 2004, we executed a restructuring of our workforce in an effort to realize the efficiencies and synergies from our recent acquisitions and as a result recorded
restructuring charges of approximately $461,000 for severance and benefits and associated costs due to a reduction in our worldwide workforce of 20 employees, or approximately 10%. Additionally, we anticipate consolidating our Santa Clara operations
into other existing locations and may record an excess facility and/or asset impairment charge during the remainder of 2004.



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 (Expense), Net. Other income, net of other expense, was
$2,000 and $12,000 for the three months ended June 30, 2004 and 2003, respectively and $(24,000) and $67,000 for the six months ended June 30, 2004 and 2003, respectively. The decrease from period to period is primarily due to an increase in the
losses realized on foreign currency transactions, as well as a decrease in investment yields and interest earned in 2004 related to a receivable from a customer during the first quarter of 2003. We expect to continue to yield investment income on
our average balance of cash and cash equivalents at an average rate that is approximately the same as that experienced in 2003, and we do not expect to earn interest income in 2004 on the customer receivable as the balance financed was fully paid in
December 2003.



Income Taxes. We have not recorded
income tax benefits related to the net operating losses for the six months ended June 30, 2004 or 2003 as a result of the uncertainties regarding the realization of the net operating losses. Income tax expense recorded in both the second quarter of
2004 and the six months ended June 30, 2004 and 2003 primarily relates to our foreign operations.



Liquidity and Capital Resources



As of June 30, 2004, we had cash and cash equivalents of $8.3 million, representing a decrease of $3.8 million from our December 31, 2003 balance of $12.1 million. As of June 30, 2004, our working capital (current assets minus current
liabilities, excluding deferred revenue) was $7.1 million compared to $11.8 million at December 31, 2003.



We used net cash of approximately $4.6 million and $2.1 million in operating activities during the six-month periods ended June 30, 2004 and 2003,
respectively. In 2004, adjustments to the $5.1 million net loss to reconcile to cash used in operating activities include approximately $3.5 million for the increase in accounts payable and accrued liabilities, compensation-related accruals and
deferred revenue; offset by decreases in accounts receivable and prepaid expenses of approximately $2.9 million, as well as approximately $1.0 million in depreciation and amortization. Cash used in operations/cash provided by operations is dependent
upon our ability to achieve positive earnings and the timing of our payments and collections and we expect that it will fluctuate from period to period.



Investing activities used cash of $187,000 during the six months ended June 30, 2004 and provided cash of $926,000 during the six months ended June 30,
2003. Investing activities for the six months ended June 30, 2004 consisted solely of purchases of property and equipment.



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Financing activities provided cash of $844,000 and $22,000 for the six-month periods ended June 30, 2004
and 2003, respectively. We received proceeds from the issuance of common stock of $897,000 and made repayments of obligations under a credit facility of $53,000 during the six months ended June 30, 2004.



Our principal source of liquidity at June 30, 2004 was our cash and cash
equivalents. 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% (5.25% as of June 30, 2004) and expires in March 2005. There were no
borrowings outstanding as of June 30, 2004 under this line of credit. As of June 30, 2004 we were in compliance with our financial covenants in connection with the line of credit. If we are unable to maintain compliance in the future, this $3.0
million line of credit may not be available in its entirety.



In connection with the December 2003 acquisition of Amacis, we assumed Amaciss outstanding obligation under a credit facility with a bank. The facility is payable in monthly installments of approximately $9,000, including interest at
a rate of the banks rate plus 2% (6.5% as of June 30, 2004), due June 2008. Due to the purchase of all of Amaciss common shares by us, the facility is payable upon demand. We anticipate repaying this obligation in its entirety during
2004. The loan is denominated in British pounds sterling. The balance at June 30, 2004 was approximately $349,000.



We currently anticipate that we will continue to experience fluctuations in results of operations 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
| | - | ----------------------------------------------



| |  | release new product versions
| | - | ----------------------------



| |  | provide hosted application services concerning our solutions
| | - | ------------------------------------------------------------



We continue to focus on maximizing the performance of our core business and controlling costs to respond to the economic environment and will continue to
evaluate our underlying cost structure to improve our operating results and better position ourselves for growth. During March of 2004, we executed a restructuring of our workforce to realize the efficiencies and synergies from our recent
acquisitions and as a result recorded restructuring charges of approximately $461,000, of which approximately $382,000 was paid during the quarter ended June 30, 2004, for severance and benefits and associated costs due to a reduction in our
worldwide workforce of 20 employees, or approximately 10%. Additionally, we anticipate consolidating our Santa Clara operations into other existing locations and we may record an excess facility and/or asset impairment charge during the remainder of
2004.



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.



In the near-term, we believe our costs and operating expenses, excluding restructuring-related charges, will track to a
level that is close 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 levels without adversely affecting our business and results of
operations. We may continue to experience losses and negative cash flows in the near term, even if sales of our products and services grow.



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While we will continue to implement cost containment efforts across our business, our operating expenses,
will consume a material amount of our cash resources. We believe that the total amount of our cash and cash equivalents 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 expenses, opportunities for acquisitions or
other business initiatives we encounter and we may seek to raise such additional working capital through public or private equity or debt financing (including debt convertible into equity) or from other sources. We may not be able to obtain adequate
or favorable financing at that time. Our history of declining market valuation and volatility in our stock price 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.



We have
entered into various agreements that allow for incorporation of licensed technology into our products. We incur royalty fees under these agreements that are based on a predetermined fee per license sold. Royalty costs incurred under these agreements
are recognized over the periods that the related revenue is recognized and is included in cost of revenue. During the three and six months ended June 30, 2004, we incurred royalty expenses of approximately $40,000 and $65,000, respectively, under
these agreements. We also lease office space under operating leases with various expiration dates through 2006. In January 2003, we engaged an offshore development team to accelerate our development efforts. Our minimum commitment under this
agreement is to incur up to approximately $125,000 per month for development work through January 2005. During the six months ended June 30, 2004, we incurred development expenses of approximately $770,000 related to this agreement. We have no
material long-term commitments or obligations other than those under these agreements.



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 do we have 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.



Risks and Uncertainties 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 able to generate sufficient revenues to support our business and require additional financing, failure to obtain such financing would affect our ability to maintain our operations and to grow our business, and the terms of any
financing we obtain may impair the rights of our existing stockholders.



In the future, we may be required to seek additional financing to fund our operations or growth. Since we began operations, our revenue has not been sufficient to support our operations, and we have incurred operating
losses in every quarter, except for the quarters ended September 30, and December 31, 2003. As of June 30, 2004,



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our accumulated deficit was approximately $108 million. Our history of losses may cause some of our potential customers
to question our viability and hamper our ability to sell some of our products. Although we have restructured our operations to reduce operating expenses, we will need to increase our revenue from existing levels and/or further reduce our operating
expenses to achieve and/or maintain profitability and positive cash flows from operations, and our revenue may decline, or fail to grow, in future periods. We expect an increase in operating expenses from our recent acquisitions of Broad Daylight
and Amacis. Our expectations as to whether we can achieve and/or maintain profitability on a quarterly or annual basis, revenue growth on an annual basis, 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. As a result, we may continue to experience losses, even if sales
of our products and services grow.



Factors such as the
commercial success of our existing products and services, the timing and success of any new products and services, the progress of our research and development efforts, our results of operations, the status of competitive products and services, and
the timing and success of potential strategic alliances or potential opportunities to acquire or sell technologies or assets may require us to seek additional funding sooner than we expect. In the event that we require additional cash, we may not be
able to secure additional financing on terms that are acceptable to us, especially in the uncertain market climate, and we may not be successful in implementing or negotiating such other arrangements to improve our cash position. If we raise
additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and the securities we issue might have rights, preferences and privileges senior to those of our current
stockholders. If adequate funds were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or
enhance products or services, or otherwise respond to competitive pressures would be significantly limited.



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



Fluctuations in our operating results, particularly compared to the
expectations of investors and 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 of the length of our sales cycle, delays in customer buying decisions and variation in the size of
individual license transactions from quarter to quarter. 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 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 other subheadings of this Risk Factors section as well as:



| |  | general economic conditions that adversely affect our customers capital investment levels in customer service solutions, including eService, knowledge management systems and
electronic commerce management solutions
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | budget and spending decisions by information technology and customer support 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
| | - | -----------------------------------------------------------



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| |  | 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 and hosting 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 integrate successfully the operations of businesses that we may acquire
| | - | --------------------------------------------------------------------------------------



| |  | 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
| | - | ----------------------------------------------------------------------------------------------------



| |  | changes in accounting, legal and regulatory requirements
| | - | --------------------------------------------------------



Due to the protracted slowdown in the national and global economy from the year 2000, geopolitical uncertainties and uncertainties concerning the extent
or timing of any meaningful economic recovery, we believe that many existing and potential customers are carefully evaluating and reprioritizing their planned technology and Web-related investments and deferring purchasing decisions or electing to
purchase smaller initial implementations of software solutions. As a result, there is uncertainty with respect to our expected revenue, and any 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 occupancy expenses, 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 SmallCap Market listing is not assured, which would make the trading market for our stock more illiquid and could make it more difficult to raise capital.



The NASDAQ SmallCap Market has a number of continued listing requirements.
We are presently in compliance with all the continued listing requirements. If we were to fail to meet the minimum maintenance requirements in the future, then we would be subject to a delisting process, which presently involves grace periods to
regain compliance, from the NASDAQ SmallCap Market. Delisting from the NASDAQ SmallCap Market would make trading our shares more difficult for investors and would likely result in a significant decline in the liquidity of the trading market,
potentially leading to further volatility and declines in our share price. Further, if we were delisted it would also make it more difficult for us to raise additional capital and we would likely also incur additional costs under state blue-sky laws
in connection with any sales of our securities.



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



Standards for accounting for goodwill and other intangible assets acquired in a business combination require recognition of goodwill and other
intangible assets as assets but do not permit the amortization of goodwill. Instead goodwill must be separately tested for impairment. Other intangible assets are required to be amortized over their estimated useful life.



In the future, we will incur amortization expense related to other intangible
assets and may incur impairment charges related to goodwill arising out of the Broad Daylight and/or Amacis acquisitions, or future acquisitions, if



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any. We may also incur large write-offs and difficulties in assessment of the relative percentages of in-process research
and development expense that can be immediately written off as compared to the amount, which must be amortized over the appropriate life of the asset. We may also incur amortization expenses related to other intangible assets resulting from future
acquisitions, if any. Current and future accounting charges like these could harm our operating results.



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



We generally 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 recognize revenue from a customer sale when
persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve 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 software customization services from Primus, recognition of the associated license and service revenue would 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 and integrations.
Implementation and integration typically involves working with sophisticated software, computing and communications systems. If we experience difficulties with implementation or integrations 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 has resulted in
pricing pressures that may reduce our margins or may lead to the failure of our products to achieve market acceptance.



The market for our products is rapidly evolving, and becoming 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 eService 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. The high level of competition in our market has resulted in pricing pressures,
which if such conditions continue or increase, could harm our results of operations.



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 products and/or more attractive terms. Some of the companies providing e-commerce, advanced natural language self service and traditional customer relationship management solutions that may compete with us include
Amdocs/Clarify, eGain, Inquira, iPhrase Technologies, Kana, Kanisa, Oracle, PeopleSoft, RightNow Technologies, ServiceWare, Siebel Systems and Supportsoft.



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The principal competitive factors in our industry include:



|                                                                                |  |                                                                                
|------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------
|      vendor and product reputation                                            |  |       product ease-of-use                                                     
|      product and services prices and fees                                     |  |       the quality of customer support services, documentation and training    
|      the availability of products on the Web and multiple operating platforms |  |                                                                                
|      measurable economic return on investment                                 |  |       the quality, speed and effectiveness of application development services
|      ability to use customers as references                                   |  |                                                                                
|      product quality, performance and price                                   |  |       the effectiveness of sales and marketing efforts                        
|      breadth of product functionality and features                            |  |       product integration with other enterprise applications                  
|      product scalability                                                      |  |       breadth of product application suite                                    
|      vendor financial viability                                               |  |                                                                                



As the market for
eService 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 impacted 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.



We rely on sales of one
product family.



Product license revenue and related
service revenue from our Primus Knowledge Center (encompassing functionality from Primus eServer, eSupport, Primus iView, Primus Quick Resolve and Primus Enterprise Search) related products accounted for approximately 65% of our total revenue during
the three and six month ended June 30, 2004, and we expect these products to continue to account for a substantial portion of our revenue for 2004. For our business to succeed, the market for this software will have to grow substantially and we will
have to achieve broad market acceptance of our products. 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 have a corresponding effect on our stock price. Our future financial performance will substantially depend on our ability to sell current versions of our entire suite of products 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 or more. 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.



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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 economy does not improve or
worsens, or prospective customers were to extend their purchasing cycles, 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 additional 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 situation. 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 products, necessary solutions will not be added to the database, and the database may be inadequate. If an
enterprise deploying our software fails to maintain a current database, the value of our software to our users may be impaired. Successful deployment and broad acceptance of our products will depend in part on the quality of the users existing
database of solutions, which is outside our control.



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 and Oracle 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.



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



If sales of new software
licenses increased rapidly or if we were to sign an agreement for a particularly large or complex integration, 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 assist in the implementation of our products, we would be unable to meet customer demands for integration and
support services related to our products.



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We may have potential contingent liabilities under service level agreements.



In connection with certain hosting and consulting services arrangements, we
have agreed to specific levels of service performance. If we fail to meet the specific level of service performance promised, we could face certain negotiated fee credits or liquidated damage payments to affected customers. As we expand our hosting
services and consulting services business, the potential could exist for material, contingent liabilities related to negotiated fee credits or liquidated damages for failure to meet agreed performance criteria.



Unplanned system interruptions and capacity constraints and failure to
effect efficient transmission of data of customer communications and data over the Internet could harm our business and reputation.



We could experience interruptions to our hosted operations due to natural disasters, Internet traffic disruptions (by, for example, malicious service
attacks and hacking into operating systems, viruses and worms), hardware and operating system failures. As a result, our business may suffer if we experience frequent or long system interruptions that result in the unavailability or reduced
performance of our hosted operations. We may experience occasional temporary capacity constraints due to sharply increased traffic or other Internet wide disruptions, which may cause unanticipated system disruptions, slower response times and
degradation in levels of customer service.



The regulatory
environment surrounding accounting and corporate governance subjects us to certain legal uncertainties in the operation of our business and may continue to increase our cost of doing business.



We face increased regulatory scrutiny associated with the highly publicized
financial scandals and the various accounting and corporate governance rules promulgated under the Sarbanes-Oxley Act of 2002 and regulations in addition to those rules promulgated under the Sarbanes-Oxley Act of 2002. We have reviewed and will
continue to monitor all of our accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including those related to relationships with our independent accountants, enhanced financial
disclosures, internal controls, board and board committee practices, corporate responsibility and executive officer loan practices, and intend to fully comply with such laws. Nevertheless, such increased scrutiny and penalties involve risks to both
Primus and our executive officers and directors in monitoring and ensuring compliance. A failure to properly navigate the legal disclosure environment and implement and enforce appropriate policies and procedures, if needed, could harm our business
and prospects, including our ability to recruit and retain skilled officers and directors. In addition, we may be adversely affected as a result of new or revised legislation or regulations imposed by the Securities Exchange Commission, other U.S.
or foreign governmental regulatory authorities or self-regulatory organizations that supervise the financial markets. We also may be adversely affected by changes in the interpretation or enforcement of existing laws and rules by these governmental
authorities and self-regulatory organizations.



Our
workforce reductions 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 several restructurings 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.



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



Our
reductions in work force since July of 2001 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, we may need to hire to replace personnel lost due to attrition, or to accommodate growth in specific customer needs and/or 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 since 2000, stock-based compensation, including options to purchase our common stock, may have
diminished effectiveness as employee hiring and retention devices. If 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 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 such qualifications and experience, and
competition for qualified personnel is intense in our industry. Our recent reductions in force may also impair our ability to recruit skilled sales personnel. 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.



Our acquisitions of Broad Daylight and/or Amacis may not achieve their
anticipated benefits.



In September 2003, we acquired
Broad Daylight and in December 2003, we acquired Amacis. These acquisitions may not achieve their anticipated benefits unless we successfully integrate Broad Daylights and Amaciss operations with ours in a timely manner. Prior to the
acquisitions, Primus, Broad Daylight and Amacis each operated independently, each with its own business, business culture, markets, customers, employees and systems.



Integrating the operations associated with Broad Daylight and/or Amacis may be a challenging and expensive process that may
result in revenue disruption, loss of key employees, customer uncertainty, and other operational difficulties if not completed in a timely and efficient manner. We anticipate that for the foreseeable future, the operations associated with Amacis
will remain in Northern Ireland. The geographic separation could increase the



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operational risks associated with this acquisition. If we are not successful in addressing these risks or any other
problems encountered in connection with these acquisitions, our results of operations and business could be harmed.



Other acquisitions could disrupt our business and harm our financial condition.



In order to remain competitive, we may find it necessary or beneficial to acquire additional businesses, products and
technologies. In the event that we complete one or more acquisitions, 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/or warranty liabilities
| | - | ---------------------------------------------------------



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



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



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



| |  | incur additional obligations to fund payment of the accounts payable and other liabilities of the acquired entity
| | - | -----------------------------------------------------------------------------------------------------------------



Any one or a combination of one or more of these difficulties could disrupt
our ongoing business, divert management resources and/or increase our expenses.



In order to obtain the benefits of any such acquisition, the acquired technology, products and services must 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 products and services. 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 depend on our ability to successfully integrate and manage the acquired operations and
retain or replace the key employees of the acquired business.



Conversely, we may be unable to complete acquisitions that we need to remain competitive due to constrained financial resources, volatility in our stock price or other factors described in this section.



Potential losses from acquisitions may harm our business.



The acquisitions of Broad Daylight and Amacis have resulted in an
increase in our operating expenses. Revenues derived from the sale of Broad Daylight and Amacis products, services and maintenance may not be sufficient to offset the increase in operating expenses attributable to these acquired entities. Both Broad
Daylight and Amacis have a history of operating losses. Any future operating losses attributable to these consolidated subsidiaries could adversely affect our ability to achieve or maintain profitability on a consolidated basis in any given fiscal
period, which could result in a decrease in our stock price.



Our international operations are subject to additional risks.



Revenue from customers outside the United States was approximately $2.2 million, or 39% of our total revenue for the three months ended June 30, 2004, and approximately $4.3 million, or 36% of total revenue for the
six months ended June 30, 2004. This percentage has risen as a result of our acquisition of Amacis, and may continue to fluctuate in the future. We currently customize 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
| | - | ------------------------------------------------------------------



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



| |  | 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 British Pound, Euro 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.



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 eService software
sold by Amdocs/Clarify, BEA, Oracle, Peoplesoft, 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, Sun Solaris UNIX, Linux and various J2EE 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, Sun Solaris or J2EE 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.



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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 software products. As we develop enhanced versions of our software, some of the additional functionality and capabilities of our products 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 related lawsuit (See Item 1. Note 8 Commitments and Contingencies - Legal Proceedings) 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. 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.



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



If any of our products are found to violate third
party intellectual property or proprietary rights, we may be liable for damages and 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. We do
not carry any insurance against intellectual property infringement claims. See Item 1. Note 8 Commitments and Contingencies - Legal Proceedings for a discussion of an outstanding claim of patent infringement.



Product liability claims by our customers could result in unexpected costs
and damage to our 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 our software or mistakes in performing our 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.



Our network is subject to security risks that could harm
our business and reputation and expose us to litigation or liability.



Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to transmit
such information and data securely, and any costs associated with preventing or eliminating such problems, could harm our business. Online transmissions are subject to a number of security risks, including:



| |  | our own or licensed encryption and authentication technology, and access and security procedures, may be compromised, breached or otherwise be insufficient to ensure the security of
customer information or intellectual property;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the experience of unauthorized access, computer viruses, system interference or destruction, denial of service attacks and other disruptive problems, whether intentional
or accidental, that may inhibit or prevent access to our Web sites or use of our products and services; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | circumvention of our security measures to misappropriate our, our partners or our customers proprietary information or content or interrupt operations.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



The occurrence of any of these or similar events
could damage our business, hurt our ability to distribute and/or host products and services and collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation, and expose us to litigation or liability. We may
be required to expend significant capital or other resources to protect against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks.



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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 Web 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 or laws 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,
other acts of war or military actions may adversely affect the markets on which our Common Stock trades, our financial condition and our results of operations.



The September 11, 2001 terrorist attacks in the United States and more recent terrorist attacks in other parts of the world,
as well as continued threats of global terrorism, current and future military response to them and the current United States military presence in Iraq have created many economic and political uncertainties that make it extremely difficult for us,
our customers and our suppliers to accurately forecast and plan future business activities. This reduced predictability challenges our ability to operate profitably or to grow our business. In addition, the continued threats of terrorism and the
heightened security measures in response to such threats have caused and may continue to cause significant disruption to commerce throughout the world. Disruption in business in response to these threats or future attacks may cause customers to
defer their purchasing decisions. Disruptions in commerce could also cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economy. They also could result in
economic recession in the United States or abroad. Any of these occurrences could have a significant impact on our operating results, revenue and costs and may result in the volatility of the market price for our common stock and on the future price
of our common stock.



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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. There are additional risks to our ability to maintain our hosting facilities for use of our applications over the Internet in a disaster. In addition, a disaster could cause significant delays in our development efforts. The insurance we
maintain may not be adequate to cover our losses resulting from disasters or other business interruptions. Accordingly, an earthquake or other disaster could materially and adversely harm our ability to conduct business.



If requirements relating to accounting treatment for employee stock
options are changed, we may be forced to change our business practices.



We currently account for the issuance of stock options under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. If proposals currently under consideration by
administrative and governmental authorities are adopted, we may be required to treat the value of the stock options granted to employees as compensation expense. Such a change could have a negative effect on our earnings. In response to a
requirement to expense the value of stock options, we could decide to decrease the number of employee stock options granted to our employees. Such a reduction could affect our ability to retain existing employees and attract qualified candidates,
and increase the cash compensation we would have to pay to them.



If accounting interpretations relating to revenue recognition change, our reported revenues could decline or we could be forced to make changes in our business practices.



Over the last several years, the accounting profession has issued several standards and interpretations relating to revenue
recognition. For example, the Emerging Issues Task Force reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, the American Institute of Certified Public Accountants issued Statement of Position or SOP
97-2, Software Revenue Recognition, and SOP 98-9 Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. These standards address software revenue recognition matters primarily from a
conceptual level and do not include specific implementation guidance. In addition, in December 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, or
SAB 101, which explains how the SEC staff believes existing revenue recognition rules should be applied. In December 2003, the SEC issued Staff Accounting Bulletin No. 104, Revenue Recognition, or SAB 104, which revises or rescinds
certain sections of SAB 101, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. We believe that our revenue recognition policies are currently in
compliance with SOP 97-2, SOP 98-9 and SAB 101 as amended by SAB 104.



The accounting profession may continue to discuss revenue recognition standards with the objective of providing guidance on potential interpretations. These discussions and the possible issuance of interpretations, once finalized, could
lead to unanticipated changes in our current revenue accounting practices, which could cause us to recognize revenues differently from present practice and these changes may also increase administrative costs and otherwise harm our business.



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



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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 for our common stock.



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 may, should, expects, plans, anticipates, believes,
estimates, predicts, potential, continue, or the negative of these terms or other comparable terminology 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 money market and cash funds that contain 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.



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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 six months ended June 30, 2004, decreases in interest rates on the fair market value of our cash and cash equivalents caused an insignificant
increase in our net loss. We believe that the impact on the fair market value of our securities and our operating results for the remainder of 2004 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 the United Kingdom 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. We have three foreign subsidiariesPrimus Knowledge Solutions (UK) Limited, Amacis Group Limited (UK) 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 results. Our operating results have not been significantly affected by exchange rate fluctuations in 2003 and 2004. If, during the
remainder of 2004, 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 2004 would likely not be significantly affected.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of disclosure controls and procedures.Based on their evaluation as of the end of the period covered by this report, the Companys principal executive officer and principal financial officer have concluded that the
Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.



Changes in internal controls.There have been no changes in the
Companys internal controls over financial reporting that occurred during the three months ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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. This is one of a number of actions coordinated for pretrial purposes.
Plaintiffs in the coordinated proceeding have brought claims under the federal securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities



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concerning the allocation of shares in the IPOs of more than 300 companies during the period from late 1998 through
2000. Specifically, among other things, the plaintiffs allege that the prospectus pursuant to which shares of Company common stock were sold in the Companys IPO contained certain false and misleading statements regarding the practices of the
Companys underwriters with respect to their allocation of shares of common stock in the Companys IPO to their customers and their receipt of commissions from those customers related to such allocations, and that such statements and
omissions caused the Companys post-IPO stock price to be artificially inflated. The individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. In June 2003 the plaintiffs in this action
announced a proposed settlement with the issuer defendants and their insurance carriers. The Company has elected to participate in the settlement, which generally provides that our insurance carrier is responsible for any payments other than legal
fees we incurred before June 2003. On March 4, 2004, plaintiffs executive committee advised the court that the negotiators for plaintiffs and issuers had agreed on the terms of the settlement. The court must still approve the settlement. If
the settlement does not occur, and litigation against the Company continues, the Company believes it has meritorious defenses and intends to defend the case vigorously. While we cannot predict with certainty the outcome of the litigation or whether
the settlement will be approved, we do not expect any material adverse impact to its business from this matter.



In October 2003, we received notice that ServiceWare, Inc. had filed a complaint against Primus in the United States District Court for the Western
District of Pennsylvania, which alleges that aspects of our technology infringe one or more patents issued in 1998 alleged to be held by the plaintiff. The complaint was served on us on January 28, 2004. In February of 2004, we filed our answer,
denying all substantive claims, raising multiple affirmative defenses (including that the patents are invalid and unenforceable, that Primus products dont infringe the patents in any event and that these claims on 1998 patents are barred by
equitable estoppel and latches) and including a number of counterclaims. In May 2004, ServiceWare, Inc. filed counterclaims in this lawsuit, including allegations of interference, defamation and unfair competition. This case is currently in the
discovery phase. We intend to vigorously defend against the allegations asserted in this complaint and we believe the plaintiffs claims are without merit.



From time to time we are, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of our business, including
employment claims, contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, including those described above, even if not meritorious, could force us to spend
significant financial and managerial resources. We may incur substantial expenses in defending against third party claims. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our
business practices. Either of these could have a material adverse effect on our financial position and results of operations.



As of June 30, 2004, other than accrued legal fees and expenses incurred, no amounts have been accrued as a liability associated with the aforementioned
legal proceedings as the incurrence and the amount of a liability, if any, is not considered reasonably estimable or probable.



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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



An Annual Meeting of Shareholders of Primus Knowledge Solutions, Inc. (the Annual Meeting) was held on June 2, 2004. The matter voted on at the Annual Meeting and votes cast on such matter was the election
of one director, Promod Haque, to serve until the 2007 Annual Meeting of Shareholders or until such directors successor is elected and qualified. Votes cast for Mr. Haque totaled 20,592,439, and votes withheld totaled 230,731.



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The terms of the following directors continued after the Annual Meeting:



Antonio M. Audino

Michael A. Brochu

Yasuki Matsumoto

John A. Moga

Daniel C. Regis



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) | Exhibits
|--- | --------



Exhibit 31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



Exhibit 31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



Exhibit 32.2 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.
|--- | --------------------



Form 8-K furnished April 7, 2004 announcing the Companys preliminary financial results for the quarter ended March 31, 2004



Form 8-K furnished April 28, 2004 announcing the Companys financial
results for the quarter ended March 31, 2004



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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.
|                     |  |                                 
|Date: August 6, 2004 |  | By:                              |  | /s/ Ronald M. Stevens                             
|                     |  |                                  |  | Ronald M. Stevens                                 
|                     |  |                                  |  | Chief Operating Officer, Chief Financial Officer, 
|                     |  |                                  |  | and Treasurer                                     
|                     |  |                                 
|                     |  |                                  |  | (Principal financial and chief accounting officer)



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