##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C. 20549




---

Form 10-K



---



|  |                                                                                           
|- | ------------------------------------------------------------------------------------------
|þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) 
     OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31,
2001



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

For the transition period
from                     to

Commission File
Number

Exchange Applications, Inc.

(Exact name of registrant as specified in its
charter)

|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 04-3338916                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|                                                                  
|89 South Street
    Boston, Massachusetts                          |  | 02111                                   
|(Address of principal executive
    offices)                       |  | (Zip Code)                              

617-737-2244

(Registrants telephone number, including
area code)


Securities registered pursuant to
Section 12(b) of the Act:

None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $0.001 par value

(Title of Class)


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 þ     No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K.     o

The aggregate market value of the shares of
Common Stock of the registrant held by non-affiliates as of
May 13, 2002 was $1,523,232.

As of May 13, 2002, there were 1,153,979
shares of the registrants Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information required under Part III of
this Annual Report, to the extent not set forth herein, is
incorporated by reference from the registrants definitive
proxy statement relating to the annual meeting of stockholders
to be held on June 10, 2002, which definitive proxy
statement shall be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year
to which this Annual Report relates. The exhibit index is
located on page 35.



---






---

TABLE OF CONTENTS



|                                                                                           |                                                                                               |  |  |  |  |  |  | 
|------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                                                                    
|                                                                                           | Item 1. Business                                                                             
|                                                                                           | Item 2. Properties                                                                           
|                                                                                           | Item 3. Legal Proceedings                                                                    
|                                                                                           | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                                                                   
|                                                                                           | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|                                                                                           | Item 6. Selected Consolidated Financial Data                                                 
|                                                                                           | Item 7. Managements Discussion and Analysis of Financial Condition and Results Of Operations
|RISK FACTORS                                                                              
|                                                                                           | Item 7A. Quantitative and Qualitative Disclosure about Market Risk                           
|                                                                                           | Item 8. Financial Statements and Supplementary Data                                          
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                                
|REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS                                                  
|CONSOLIDATED BALANCE SHEETS                                                               
|CONSOLIDATED STATEMENTS OF OPERATIONS                                                     
|CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                                     
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                
|PART III                                                                                  
|                                                                                           | Item 10. Directors and Executive Officers of the Registrant                                  
|                                                                                           | Item 11. Executive Compensation                                                              
|                                                                                           | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                                                                                           | Item 13. Certain Relationships and Related Transactions                                      
|PART IV                                                                                   
|                                                                                           | Item 14. Exhibits and Financial Statement Schedules                                          
|SIGNATURES                                                                                
|Ex-10.28 Amend. No.1 to Warrant to Purchase Stock                                         
|Ex-10.29 Employment Agreement Andrew Frawley                                              
|Ex-10.30 Employment Agreement Christopher Wagner                                          
|Ex-10.31 Form of Software Marketing Agreement                                             
|Ex-21.1  Subsidiaries                                                                     
|Ex-23.1  Consent of Arthur Andersen  LLP                                                  
|Ex-99.10 Letter to Commission                                                             
|Ex-99.11 Form of Amend. & Restated Loan & Sec.                                            
|Ex-99.12 Form of Receivable Accounts Financing ...                                        
|Ex-99.13 Security Agreement                                                               
|Ex-99.14 Form of Senior Secured Note                                                      
|Ex-99.15 Form of Contingent Value Right                                                   
|Ex-99.16 Form of Securities Purchase Agreement                                            



---



##### Table of Contents






PART I




Item 1.     Business

Introduction

Exchange Applications, Inc., now doing business
as Xchange, Inc. (Xchange or the
Company) is a provider of analytical customer
relationship management (CRM) solutions.
Xchanges solutions enable large global companies to lower
costs and maximize profits by Capturing Value in Play
through continuous customer conversations across all channels.
Xchanges suite of CRM software and services features the
depth and open architecture large companies require to extract
more value from their existing CRM investments by synchronizing
online and offline multi-channel customer campaigns that are
integrated with call centers and all other customer touch-points
in real-time. Using our solutions, companies improve their
business performance by:



| |   |                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |  | Identifying customers with the greatest profit
	potential.                                                                                     
|
| |  | Avoiding allocation of resources on customers
	that never will be profitable.                                                                  
|
| |  | Directing the right offers to the right customers
	via the right channels to grow value.                                                       
|
| |  | Capturing and cultivating each customers
	lifetime value.                                                                                     
|
| |  | Synchronizing customer communication across all
	channels within the organization.                                                             
|
| |  | Creating a profit-focused discipline throughout
	an organizations culture.                                                                    
|
| |  | Measuring and analyzing the entire process to
	continually refine and boost the return on investment
	(ROI) of ongoing marketing initiatives.

Todays increasingly competitive business
environment has driven companies to examine whether or not their
customers are helping or hurting the bottom line. Xchange gives
organizations the ability to reach that conclusion, and then
provides the right communication to move each relationship
toward greater profitability.

Xchanges software solution unifies all
customer data collected from disparate channels in real time,
analyzes the data to generate recommendations that will increase
customer value, and distributes those recommendations
consistently to each customer channel. In addition, Xchange
offers consulting services and methodologies to develop
measurements, best practices and business processes to create a
customer-centric, marketing focused environment throughout all
levels of an organization.

Xchange offers a suite of CRM software and
services, known collectively as the Xchange 8 solution, that are
designed for Global 2000 and mid-sized companies spanning
several vertical markets, including financial services,
telecommunications, retail, insurance, utilities, travel and
hospitality, automotive and others. Its clients are primarily
business-to-consumer marketers who need to communicate with
customers and prospects via both online and offline channels.

Xchange 8 consists of the following components:



| |   |                                                                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Xchange Analytics:Xchanges unique vertical-specific analytics software that
	provides the critical customer and profit analyses required to
	conduct intelligent, economics-based marketing, sales and
	service campaigns and then measure the results.
|
| |  | Xchange Campaign:Xchanges award-winning campaign management software, that
	enables companies to plan, create and execute highly targeted,
	cross-channel marketing campaigns.                                                                         
|
| |  | Xchange Real Time:Real-time decisioning software that helps companies serve up
	offers on the fly in response to inbound customer and prospect
	inquiries.                                                                                              

With our solution, businesses seek to achieve
greater profitability by actively managing the economics of each
customer relationship toward its full profit potential. Using
Xchange 8, businesses are able to measure

1



---



##### Table of Contents



customer value and provide incentives through
campaigns or on the fly responses that influence and optimize
customer behavior. Our solution offers the following key
benefits:




| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Improved Profitability and Revenue
	Growth.Through the use of our
	solution, businesses have achieved increased customer retention
	rates, lower acquisition costs, more efficient cross selling and
	better customer satisfactions due to more relevant treatment,
	incentives and communications.
|
| |  | Comprehensive
	Solution.Our software, architectural
	platform and consulting create a complete solution for customer
	value management that goes beyond software to include the best
	practices that drive an organizational shift required for
	successful CRM initiatives.                       
|
| |  | Enterprise Wide Customer
	Optimization.Xchange 8 enables
	organizations to access and use data gathered through any
	channel, and powers personalized communications in every channel.                                                                                                             
|
| |  | Open Extensible
	Architecture.Xchange 8 leverages
	and adds analytic decisioning to existing CRM infrastructure
	investments due to its open, easy to use, scaleable architecture.                                                                                                                 
|
| |  | Measurable Results.Measurable ROI separates Xchange from other CRM vendors who have
	left clients wondering what the return is on their CRM
	investments.                                                                                                                                          

Background

A number of industry trends are driving the
adoption of CRM solutions. Among them are:



| |   |                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |  | Companies need to not only acquire, retain
	and expand customer relationships, but also to drive more
	profitability from their customer base;
|
| |  | A growing realization among companies that the
	customer is the profit center;                                                                 
|
| |  | The growing complexity of companies
	customer communication channels, due to new channels such as the
	Web, email and wireless devices; and   
|
| |  | Increasing demand to quantify the ROI of
	marketing investments.                                                                               

Several best practices for CRM have emerged that,
according to industry research organizations, help increase a
companys chances for success with CRM. Xchange has
embodied these best practices in its Xchange 8 solution.
Examples of these best practices are:



| |   |                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Analytics are an essential part of the planning
	process as well as the results-measurement process.                                                                                                                                
|
| |  | Companies must gain a cross-channel view of
	customers, and in turn provide customers with a single view of
	their company by coordinating messages across all channels.                                                            
|
| |  | Real-time marketing is an imperative in order to
	provide customers and prospects with instantly rendered,
	personalized offers based on up-to-the-second customer profiles.
	This includes both real time rules and real time data.
|
| |  | Companies who want to maximize customer income
	streams cant ignore manned channels such as branches and
	retail stores.                                                                                                           
|
| |  | Opt-in principals are a necessity when it comes
	to email marketing.                                                                                                                                                                

Evolution of
CRM

Over the past several years, the analytic CRM
industry has evolved considerably. This evolution can be viewed
in three distinct phases:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Database Marketing:These solutions are characterized by single-channel, outbound
	customer communications (usually mail or telephone) that are
	targeted according to simple demographic data such as zip code.
	Target segments tend to be very large since precise targeting is
	not possible. Measurement of campaign success, if performed at
	all, is generally limited to simple metrics such as response
	rates. In its simplest form, Database Marketing enables
	businesses to target their messages to

2



---



##### Table of Contents



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | certain segments of recipients, but does not
	allow for multi-level segmentation, a high degree of
	personalization, or complex analytics. Because traditional
	Database Marketing campaigns requiring the involvement of
	Information Systems personnel, as well as marketers, are
	typically sent to large audiences, most businesses are limited
	to performing small quantities of campaigns per year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Behavior-Based Marketing:These solutions enable businesses to
	target marketing messages based on a customers or
	prospects historical behavior. Though Behavior-Based
	Marketing is also limited to outbound channels, it can often
	accommodate multiple channels within a campaign, allowing
	companies to, for instance, send the same offer by either
	telephone or mail. Because Behavior-Based Marketing helps
	companies perform more precise targeting, campaigns tend to be
	smaller than Database Marketing campaigns, and companies can
	thus execute them more often. However, Behavior-Based Marketing
	solutions have drawbacks. First, they perform historical
	analysis, but not prospective analysis. Second, the applications
	required for Behavior-Based Marketing tend to be complex and
	slow, and thus not well suited for Internet communications.                                                                                                                           
|
| | Strategic CRM:Xchange refers to the latest phase of evolution as Strategic
	CRM, distinguished from Database Marketing and Behavior-Based
	Marketing in four important ways. First, Strategic CRM solutions
	are designed to provide businesses with an integrated, single
	view of customers across all channels, both inbound (i.e., Web
	marketing and sales) and outbound (i.e., Web service and
	support). Second, these solutions incorporate sophisticated
	analytical capabilities that enable businesses to make educated
	guesses about what customers or prospects are likely to want or
	need in the future. Third, they provide real-time
	synchronization of information among customer channels, so that
	Internet communications can be integrated with an
	organizations offline marketing. Fourth, because CRM
	solutions are designed to provide a 360-degree view of
	customers, they can enable more sophisticated analysis and
	metrics, including return-on-investment analysis.

The CRM
Opportunity

Xchanges own research has shown that many
companies are disillusioned about CRM technology, having spent
millions of dollars on hardware and software and received little
in the way of measurable ROI. Xchange believes that several
shortcomings have led to this disappointment.



| |   |                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | So-called end-to-end CRM suites tend
	to offer very light capabilities in areas such as analytics and
	marketing campaign management, crucial to identifying profitable
	or potentially profitable customers and optimizing customer
	marketing investments.
|
| |  | Integration among vendors remains poor, causing
	each customer touch point to interact with customers in
	isolation.                                                                                                                                          
|
| |  | Companies arent able to track results,
	measure the effectiveness of their efforts, and learn from past
	campaigns.                                                                                                                                          

As a result of these three factors, Xchange
believes that most companies are not able to provide customers
with a consistent experience across channels, which in turn has
a negative impact on the profits companies earn from customer
relationships.

Xchange 8, which has the ability to
integrate with CRM solutions from other leading vendors, solves
these problems by:



| |   |                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Creating vertical-specific analyses that identify
	profitable and potentially profitable customer groups;                                                                                                       
|
| |  | Providing personalized offers to each channel so
	that inbound customer inquiries are responded to with the very
	best, most relevant offer based on up-to-the-second customer
	profiles;                       
|
| |  | Driving consistent customer communications out
	across all customer channels, including the Web, email, call
	centers, branches and retail locations and the field sales force;                                 
|
| |  | Synchronizing front-office applications and
	legacy applications to share customer information in real-time,
	so that customers receive a consistent and personalized
	experience regardless of the channel; and

3



---



##### Table of Contents





| |   |                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Enabling companies to measure the results of
	their efforts with vertical-specific, Web-based reports that
	contain critical statistics such as profitability-by-channel,
	cross-sell success rates, profit-per-customer and attrition rate
	trends.

Thus, Xchanges strategy is not to replace
companies existing CRM infrastructures, but rather to
provide software and services that leverage a companys
previous CRM investments, and help companies realize the ROI
theyd expected from CRM initiatives.

Xchange believes that CRM software and solutions
represent a significant opportunity across many industries.
Businesses are adopting these technologies at different rates
based on their access to customer information, their level of
database marketing sophistication, and the marginal economic
impact of changes in the behavior of their customers and the
degree of competitiveness within their industry. Xchange
believes that the demand for these technologies will grow
rapidly as additional industries increasingly recognize CRM as a
competitive requirement. Significant opportunities exist for
solutions that enable businesses to transition from Database
Marketing to Behavior-Based Marketing and then to
enterprise-wide Strategic CRM environments. These transitions
require highly automated software and services solutions that
integrate people, processes and technology across the enterprise
to insure adherence to a common customer management methodology.

Strategy

Most CRM offerings, such as sales force
automation (SFA), call center software and customer
service software, are focused on improving the operational
efficiency of interactions with customers through one particular
customer channel. This alone fails to consider the profitability
of each customer interaction, and alienates customers by driving
inconsistent treatment as they move between channels.

The Xchange solution acts as the brains behind a
businesss operational CRM systems to make them more
efficient and effective at driving customer value. Xchange
unifies a real time, single view of each customers
behavior across all channels, and identifies each
customers current profitability and full potential. The
solution then provides the right offer or communication in each
channel to move customers to their full profit potential.

Xchanges objective is to continue its
leadership role in the Strategic CRMmarket by enabling
large global companies to lower costs and maximize profits
through continuous customer conversations across all channels.
Our sales strategy for continuing to be a market leader is to
focus on growing business with existing customers, adding new
customers and involving third-party services providers in the
sales process.

Key to accomplishing this objective is executing
on key areas including:

Delivering Key Product Solution Attributes
including:



| |                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a.     Usability 
	The Xchange solution features an easy-to-use interface for the
	suite of offerings and includes workflow wizards.                                                
|
| | b.     Scalability 
	The Xchange solution is designed with a scalable architecture.                                                                                                 
|
| | c.     Extensibility 
	The Xchange solution delivers an open platform to integrate with
	existing CRM infrastructures to allow to capitalize on their
	existing knowledge and tools.



| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Marketing and Selling in Key Vertical Marketsleverage the companys in-depth
	knowledge and experience with these industries including retail,
	financial services and telecommunications.                                     
|
| | Positioning its solutions not as a replacement
	for companies existing CRM
	infrastructures, but rather as a way
	to leverage their previous CRM investments in order to achieve
	the ROI theyd expected from the technology.
|
| | Continuing to integrate new components into
	its solution includingdevelopment
	efforts that will provide users of multiple components with a
	more seamless experience.                                                       
|
| | Increasing sales globally through partners.Xchange currently maintains and is
	expanding its direct sales forces in North America, Europe and
	Asia/ Pacific. Xchange plans to expand its relationships                        

4



---



##### Table of Contents



| |                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------
| | further with value-added service providers and
	complementary software providers to expand coverage and revenue
	penetration.

Products and
Services

The Xchange 8 product suite unifies all customer
data collected from disparate channels in real time, analyzes
the data to generate recommendations that will increase customer
value, and distributes those recommendations consistently to
each customer channel. In addition, Xchange 8 features
consulting services and methodologies to develop measurements,
best practices and business processes to create a
customer-centric, sales focused environment throughout all
levels of an organization. Xchange 8 offers the following
features and capabilities.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Multi-channel marketing
	automation Xchange 8
	enables marketers to conduct inbound and outbound customer
	communications that send the right message to the right customer
	at the right time through the right channel to make the customer
	more profitable. It also minimizes the work and cost of IT
	support so marketers can devote more resources to marketing.                                                                                                                                                                                             
|
| |  | Advanced
	Analytics Xchange 8
	focuses on simple, useable analysis for targeting opportunities
	with the most value potential by providing the most effective
	reports for each clients business. The Xchange 8
	platform comes standard with built-in Value in Play analytics
	and ROI reports                                                                                                                                                                                                                                                                    
|
| |  | Real-time touch point
	integration Xchange 8
	can drive communications on any touchpoint including Web, call
	center, email, ATM, branch or agents in real time. This
	capability is also crucial to maximizing customer value, because
	it enables a consistent, economics-driven conversation from one
	channel to the next. This ensures that all available information
	is utilized effectively, and drives the value of existing CRM
	infrastructure by delivering content to disparate front office
	systems like Siebel, PeopleSoft, Broadvision or Vignette.
|
| |  | Real-time information to improve decision
	making Xchange 8
	ensures consistent outbound and inbound communications by
	combining information from three essential sources: internal,
	external and in-session data, regardless of how a customer
	contacts a company or a company contacts the customer. With
	Xchange 8, a company can change a customer offer in real
	time based on data gathered during an interaction.
	Xchange 8 can also deliver this insight to personnel, and
	establish automated responses to customer behavior in real time.           

Xchange
Solution Services

Xchange solution services help companies ensure
the successful deployment of the CRM initiatives and help them
plot long-term full CRM solutions. These services include:



| |   |                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Professional Servicesinclude Business Assessments,
	Technical Assessments, Installation and Configuration, Touch
	Point Integration, Data Transformation, and Engagement
	Management.                                                                                                    
|
| |  | Education Servicesprovide clients with the knowledge
	required to successfully use, operate, and maintain Xchange 8.
	Training is available for both end-users of the product and
	operations/ IT staff who are typically charged with making sure
	that the product is up and running.
|
| |  | Customer Support Servicesare offered to supplement the basic
	maintenance support services included with the product(s). In
	cases where an Xchange 8 component becomes
	mission-critical, Xchange can develop support
	services tailored to meet the clients requirements.           

Experienced consultants supported by the Xchange
Services Delivery Process deliver these services. This
implementation process allows the Company to leverage the best
practices it has have developed at over 150 implementations
worldwide. We believe it is critical to approach implementations
with a plan that encompasses not only technology tasks, but also
addresses changes required in business process, organization,
and business metrics to achieve optimal returns from your
customers.

5



---



##### Table of Contents



Xchange and our systems-integration partners help
companies prepare, install, and optimize Xchange CRM products
for optimal effectiveness. Our services and support specialists
include: project managers, systems-integration experts,
strategic process and CRM consultants, technical consultants,
and eMarketing Consultants, who are assigned to specific
clients, serving as their business partner.

Product
Development

Xchange originally introduced Campaign
(previously known as VALEX), the basis for the current Xchange
Campaign software, in July 1996 and has subsequently made a
number of product revisions and enhancements, the latest being a
Web-based version that became available in the first quarter of
2001. Xchange eMessaging (previously known as eXstatic) was
introduced by the Company in August 1999 as part of the
acquisition of Gino Borland Inc. Xchange Real Time was
introduced in November 1999, and Xchange Analytics was announced
in January 2000. Xchanges ongoing product development
efforts are focused on the continued expansion of the features,
functionality, and integration of the Xchange 8 CRM
solution outlined earlier in this Form 10-K. In addition,
Xchange is continuously reevaluating the needs of customers and
marketplace trends to identify new products for development. Our
research and development expenses were approximately
$9.8 million, $19.0 million and $17.3 million in
1999, 2000 and 2001, respectively.

Sales and
Marketing

Xchange markets its software and services through
its direct sales force of 19 quota-carrying sales
representatives and indirectly through re-sellers and
co-marketers. As of December 31, 2001, Xchange had sales
offices in Boston, London and Sydney. Xchanges sales force
consists of teams made up of sales executives, managers and
pre-sale engineers organized by geographic territory.

Xchange currently has re-seller relationships
with Acxiom, Epsilon, Experian, IBM, Harte-Hanks, Fair Isaacs,
and others, which grant these companies the right to re-market
its software and utilize Xchanges marketing materials. In
addition, Xchange has co-marketing arrangements with companies
such as Cap Gemini Ernst & Young to generate leads and
participate in sales efforts. None of the agreements governing
the re-seller or co-marketing relationships with these
organizations includes any commitments on the part of these
organizations to effect any minimum number of sales of the
Xchanges software, or to otherwise provide Xchange with
business. No assurances can be given that any revenue will be
realized by Xchange from any of these relationships.

Clients

Xchange focuses on selling its CRM solutions to
leading businesses in targeted vertical industries; primarily
financial services, telecommunications, retail, insurance,
utilities, travel and hospitality and automotive. As of
December 31, 2001, Xchanges products and services
were licensed for use at approximately 300 client sites in 33
countries.

|                   |  |                      |  |              |  |          
|------------------ |  | -------------------- |  | ------------ |  | ---------
|Financial Services |  | Telecommunications   |  | Retail       |  | Others   
|                   |  |                      |  |              |  |          
|JP Morgan Chase    |  | Sasktel              |  | Circuit City |  | Acxiom   
|PNC Bank           |  | Qwest Communications |  | NEBS         |  | Microsoft
|Citicorp           |  | Verizon              |  | Staples      |  | Ford     

In 1999, two clients, Acxiom and MicroStrategy,
Inc., accounted for 11.3% and 10.4% of Xchanges revenues,
respectively. In 2000, one client, MicroStrategy, Inc. accounted
for 10.2% of Xchanges revenue. In 2001, one customer,
Carreker Corporation (Carreker), accounted for 25.8%
of Xchanges revenue. Acxiom is a re-seller of
Xchanges products and services and revenues from Acxiom
were comprised of sales to multiple end user businesses. Xchange
entered into a reseller arrangement with MicroStrategy in
December 1999 whereby Xchange recognized $4.5 and
$3.5 million of revenue in 1999 and 2000, respectively, of
software license fees for the resale of the Xchange eMessaging
product to affiliates of MicroStrategys Strategy.com web
service. In March 2001, Xchange entered into a royalty
arrangement with Carreker whereby Carreker was granted exclusive
rights to sell the EnAct software product into the financial
services vertical in exchange for

6



---



##### Table of Contents



guaranteed royalty payments. The EnAct software
was Xchanges frontline marketing automation software that
helps local marketers tap central customer information and apply
it to local campaigns, and feed local market intelligence back
into central marketing for future targeting. Xchange recognized
$11.5 million of revenue in 2001 as a result of this
arrangement. The agreement ended on December 31, 2001,
whereby Xchange sold to Carreker all rights to the EnAct
software. Xchange does not anticipate significant further
revenue from Carreker or the EnAct software product in the
future. Revenue in 2002 could be adversely impacted if the
Company is unable to replace the revenue volume supplied by
Carreker in 2001.


Competition

The market for CRM and related services is highly
competitive. The Gartner Group estimates there are 15
competitors supplying CRM software solutions in the marketplace.
Some of our competitors have longer operating histories,
significantly greater financial, technical, marketing or other
resources, or greater name recognition than we do. Our
competitors may be able to respond more quickly than we can to
new or emerging technologies and changes in customer
requirements. Our competitors have made and may continue to make
strategic acquisitions or establish cooperative relationships
among themselves or with other software vendors. They may also
establish or strengthen cooperative relationships with our
current or future partners, thereby limiting our ability to
promote our product through these partners. There can be no
assurance that Xchange will maintain its competitive position
against current and potential competitors, especially those with
significantly greater financial, marketing, service, support,
technical and other resources.

Xchanges products and services are targeted
at the emerging market for CRM solutions. The Companys
competitors are diverse in their orientation and history.
Xchanges current and potential competitors fall into the
following categories: campaign management vendors such as
Chordiant Software (as a result of their acquisition of Prime
Response in February 2001), and Recognition Systems, analytical
applications vendors such as E.piphany, and front-office and
application providers such as Siebel Systems. Xchange also
essentially competes with companies internal information
technology departments that attempt to build their own systems.

The principal competitive factors that favor the
Company include: domain expertise and intellectual property in
CRM; reputation of the Company and its employees and products;
the number of installed customers using components of the
Xchange 8 solution; the cross-channel capabilities of its
solutions; open and flexible architecture; strong marketing
automation, and campaign management functionality; international
presence; its strong real-time decisioning capabilities; and
speed and ease of implementation and use of its solutions.
However, there can be no assurance that the Company will be able
to compete successfully with existing or new competitors or that
competition will not have a material adverse effect on the
Companys business, operating results and financial
condition. See Risk Factors  Competition could
reduce our market share and harm our business.

Proprietary
Rights and Licenses

The Company relies primarily on a combination of
copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions to protect its proprietary
rights. In addition, the Company generally licenses it products
to end users in object code (machine readable) format, and the
Companys license agreements generally allow the use of its
products solely by the customer for internal purposes without
the right to sublicense or transfer Companys products.
However, certain customers have required the Company to maintain
a source code escrow account with a third-party software escrow
agent, and a failure by the Company to perform its obligations
under the related license and maintenance agreements or the
insolvency of the Company could conceivably cause the release of
the Companys source code to such customers for certain
limited purposes. The Company believes that the foregoing
measures afford only limited protection. Despite the
Companys efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the
Companys products or to obtain and use information that
the Company regards as proprietary. Policing 10 unauthorized use
of the Companys products is difficult, and while the
Company is unable to determine the extent to which piracy of its
software products exists, software piracy is a viable risk. In
addition, the laws of some foreign countries do not protect the
Companys proprietary rights to the same

7



---



##### Table of Contents



extent as the laws of the United States.
Furthermore, there can be no assurance that the Companys
competitors will not independently develop technology similar to
that of the Company. The Company may increasingly be subject to
claims of intellectual property as the number of products and
competitors in the Companys industry segment grows and the
functionality of products in different industry segments
overlaps. Although the Company is not aware that any of its
products infringe upon the proprietary rights of third parties,
there can be no assurance that third parties will not claim
infringement by the Company with respect to current or future
products. Any such claims, with or without merit, could be
time-consuming, result in costly litigation, cause product
shipment delays or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if
required, might not be available on terms acceptable to the
Company or at all, which could have a material adverse effect
upon the Companys business, operating results and
financial condition. See Risk Factors 
Intellectual Property Rights; Use of Licensed Technology.


The Company has in the past and may in the future
resell certain software, which it licenses from third parties.
There can be no assurance that these third party software
licenses will continue to be available to the Company on
commercially reasonable terms. The loss of or inability to
maintain or obtain any of these software licenses could result
in delays or reductions in product shipments until equivalent
software could be identified, licensed and integrated, which
could adversely affect the Companys business, operating
results and financial condition.

Employees

As of December 31, 2001, the Company had 175
full-time employees, including 63 primarily engaged in research
and development and 39 sales and marketing. The Companys
future success depends in significant part upon the continued
service of its key technical and senior management personnel and
its continuing ability to attract and retain highly qualified
technical and managerial personnel. Competition for such
personnel is intense and there can be no assurance that the
Company can retain its key managerial and technical employees or
that it can attract, assimilate or retain other highly qualified
technical and managerial personnel in the future. None of the
Companys employees is represented by collective bargaining
units and the Company, to date, has not experienced a work
stoppage. The Company believes that its employee relations are
good.

Executive
Officers Of The Registrant

Set forth below is certain information concerning
the directors and executive officers of Company.

|                      |  |     |    |          |  |                                                
|--------------------- |  | --- | -- | -------- |  | -----------------------------------------------
|Name                  |  | Age |    | Position
|                      |  |     |    |         
|Andrew J. Frawley     |  |     | 39 |          |  | Chairman of the Board of Directors             
|J. Christopher Wagner |  |     | 41 |          |  | President, Chief Executive Officer and Director
|Michael Collins       |  |     | 38 |          |  | Chief Marketing Officer & Senior Vice          
|                      |  |     |    |          |  | President, Global Marketing                    
|N. Wayne Townsend     |  |     | 38 |          |  | Senior Vice President, Services                
|Robert Whirley        |  |     | 32 |          |  | Senior Vice President, Global Sales            
|Kris Zaepfel          |  |     | 38 |          |  | Senior Vice President, Human Resources         

Mr. Frawley founded Xchange in November 1994
and is currently Chairman of the Board of Directors.
Mr. Frawley served as Xchanges Chief Executive
Officer from its incorporation in November 1996 until July 2001.
Mr. Frawley was elected Chairman of the Board of Directors
of the Company in January 1998. From July 1993 until founding
the Company, Mr. Frawley served as a principal of Grant
& Partners Limited Partnership, a management consulting
company. Mr. Frawley holds a B.S. in accounting from the
University of Maine and an M.B.A. from Babson College.
Mr. Frawley has more than 15 years of experience in
the high technology industry.

8



---



##### Table of Contents



Mr. Wagner joined Xchange in August 2001 as
President and Chief Executive Officer. From 2000 through August
2001, Mr. Wagner served as Chief Executive Officer of
Metiom, Inc. From 1998 through 2000, Mr. Wagner served as
Executive Vice President and General Manager of Consulting
Services for Computer Associates, Inc. From 1995 through 1998,
Mr. Wagner served as Senior Vice President responsible for
Sales and Marketing for Computer Associates, Inc.

Mr. Collins joined Xchange in August 2001 as
Senior Vice President and Chief Marketing Officer. From January
2000 until May 2001, he was employed by Metiom, Inc., an
internet e-commerce software provider. From August 1997 through
January 2000, Mr. Collins was Vice President of Worldwide
Corporate Marketing at SAGA SOFTWARE, Inc., a developer of
enterprise integration software. From October 1994 until August
1997, Mr. Collins was Senior Director of Worldwide
Corporate Marketing at Iomega Corporation, a manufacturer of
personal storage peripherals. Mr. Collins holds a BA in
Communications/ Journalism from Rowan University.
Mr. Collins has more than 10 years of experience in the
high technology industry.

Mr. Townsend joined Xchange in April 1996 as
Vice President, Integration Services, was appointed to the
position of Vice President, Financial Services Solutions in
December 1998, and was appointed to the position of Senior Vice
President, Solutions in January 2000. From April 1994 until
joining Xchange, Mr. Townsend was a Project Director at
Epsilon, a database marketing services company.
Mr. Townsend holds a B.S. in mechanical engineering from
the Massachusetts Institute of Technology and an M.S. in
mechanical engineering from the University of Dayton.
Mr. Townsend has more than 10 years of experience in
the systems integration industry.

Mr. Whirley joined Xchange in October 2001
as Senior Vice President of North American Sales and was
appointed Senior Vice President of Global Sales in January 2002.
Prior to Xchange, Mr. Whirley worked from 1997 to 2001 at
Computer Associates, a software company, where he was Senior
Vice President and Regional Sales Manager for the New York
region. Previously he was Group General Manager for eBusiness
and held other Senior Vice President regional roles during his
four years with Computer Associates. Prior to 1997,
Mr. Whirley held various regional and sales management
positions at Cabletron Systems, a networking hardware company.
Mr. Whirley holds a BS degree in Communications and
Business Finance from the University of Southern Maine.

Ms. Zaepfel joined Xchange in January 1998
and is currently Senior Vice President Human Resources. From
March 1997 until January 1998, she was Director, Staffing and
Employee Relations at HPR, Inc., a healthcare information
technology company. Ms. Zaepfel holds a certificate in
Human Resources Management from Bentley College in Waltham, MA,
and a B.A. in Psychology from Allegheny College in Meadville, PA.

Historical
Background of the Company

Xchange commenced operations in 1994 and was
incorporated in Delaware on November 7, 1996. Prior to
November 15, 1996, Xchange operated as a division of two
entities, Grant & Partners, Inc. (GPI) and Grant
& Partners Limited Partnership (GPLP). GPI was
incorporated in June 1993 and was primarily engaged in providing
management consulting services. In November 1994, GPI segregated
its operations into two business segments: a management
consulting practice and a software applications development
practice and designated management and financial resources to
the development of VALEX. On March 28, 1995, GPI entered
into a limited partnership agreement with Cyrk, Inc.
(Cyrk) to form GPLP to provide marketing and
customer management services for companies in a wide range of
industries including retailing, transportation, banking and
manufacturing. GPI, as the general partner of GPLP, contributed
all of its assets and liabilities to GPLP for a 50% limited
partnership interest. Cyrk purchased the remaining 50% limited
partnership interest in GPLP. GPLP operated as two separate
divisions: (i) the Exchange Applications division, which
focused on marketing program design and execution, customer
database construction and software application development; and
(ii) the Exchange Partners division, which focused on
providing a variety of management consulting services for
marketing organizations.

On November 15, 1996, Xchange and GPLP
entered into an assignment and assumption agreement whereby GPLP
sold the Exchange Applications division to the Company in
exchange for 2,300,000 shares of preferred stock of the Company.
In addition, the Company issued 165,625 shares of common stock
to certain

9



---



##### Table of Contents



employees. The Preferred Stock held by GPLP
contained voting rights equal to two votes for each share of
common stock into which the preferred stock would convert. As a
result, GPLP held approximately 70% of the voting rights of the
Company.


On August 20, 1999, Xchange acquired
eXstatic Software, Inc. (formerly known as Gino Borland, Inc.),
a Washington corporation (eXstatic). eXstatic
develops and markets software solutions that enable businesses
to plan, create and execute highly personalized,
permission-based email communications based on customer
profiles. The Company exchanged 40,486 shares of common stock
for all the outstanding shares of eXstatic common stock, and
exchanged options to purchase 9,261 shares of Company common
stock for all the outstanding options of eXstatic. This merger
has been accounted for as a pooling of interests, and
accordingly the historical results of operations have been
restated to reflect the results of eXstatic on a combined basis.

On March 31, 2000, Xchange acquired
Knowledge Stream Partners, Inc., a Delaware corporation,
(KSP) in a transaction accounted for under the
purchase method. KSP specializes in consulting and software
development for advanced data mining and online/offline
analytics. The Company exchanged 27,393 shares of its common
stock for all the outstanding shares of common stock of KSP. In
addition, the Company assumed all of the outstanding employee
stock options of KSP, which converted into options to acquire
4,495 shares of Company common stock.

In June 2000, Xchange acquired Customer
Analytics, Inc., a Delaware corporation (CA), in a
transaction accounted for under the purchase method. CA develops
and markets campaign management solutions focused on creating,
executing, analyzing and measuring customer communications at
the local or branch level. The Company exchanged 148,723 shares
of its common stock for all the outstanding shares of common
stock of CA; 25,387 of these shares issued were placed into
escrow as security for indemnification obligations of CA
pursuant to the merger agreement. In addition, Xchange assumed
all of the outstanding employee stock options of CA which
converted into options to acquire 23,826 shares of Company
common stock.

Unless the context otherwise requires, references
herein to Xchange the Company refer to
Exchange Applications, Inc., a Delaware corporation, and its
wholly owned subsidiaries: Exchange Applications, Ltd. was
incorporated in July 1997 in the United Kingdom and Exchange
Applications, Pty. was incorporated in April 1998 in Sydney,
Australia. Exchange Applications Securities Corporation, a
Massachusetts corporation, was incorporated in December 1998.




Item 2.     Properties

Xchanges primary offices are located in
approximately 20,000 square feet in Boston, Massachusetts
pursuant to an extended lease expiring in May 31, 2004.
Xchange also leases space for sales offices in Seattle, London
and Sydney.




Item 3.     Legal
Proceedings

From time to time, we are involved in litigation
relating to claims arising out of our operations in the normal
course of business. As of the date of this filing, it is
managements opinion that we are not a party to any legal
proceedings which, if decided adversely to Xchange, would have a
material adverse effect on our results of operations or
financial position.

Xchange and certain of our current and former
officers (the Xchange Defendants) and its certified
public accountants, Arthur Andersen, LLP, have been named
defendants in a consolidated class action lawsuit originally
filed on February 21, 2001 and subsequently filed as a
Consolidated Amended Class Action Complaint on August 2,
2001, filed on behalf of a purported class of purchasers of our
common stock during the period from December 9, 1998
through September 29, 2000. The Amended Class Action
Complaint alleges that we made false or misleading statements
that inflated our common stock price during the class period.
The relief sought is damages on behalf of the class; however, at
this time, we are unable to ascertain the monetary damages
sought by the class. Through our attorneys, we have filed a
Motion to Dismiss the

10



---



##### Table of Contents



Amended Class Action Complaint on October 3,
2001. The action is pending in the United States District Court
for the District of Massachusetts. We believe these allegations
are without merit and we intend to defend the litigation
vigorously.


Xchange, along with BT Alex Brown, Inc.,
Hambrecht & Quist, LLC, Adams, Harkness & Hill, Inc.,
Sound-View Technology Group, Inc. (together, the
Underwriter Defendants) and certain current and
former officers and directors, including Andrew J. Frawley, John
G. OBrien, Jeffrey Horing, Ramanan Raghavendran, David G.
McFarlane, Michael D. McGonagle, Patrick A. McHugh, and N. Wayne
Townsend, have purportedly been named defendants in a class
action complaint filed on behalf of a class of purchasers of its
common stock during the period from December 9, 1998
through December 6, 2000. Xchange is currently reviewing
whether it has been formally served with this complaint, but it
purportedly alleges that documents filed in connection with the
Xchanges initial and follow-on public offerings (the
Offerings) were materially false and misleading
because they failed to disclose that (1) the Underwriter
Defendants solicited and received excessive and undisclosed
commissions from certain investors in exchange for which the
Underwriter Defendants allocated to those investors material
portions of the restricted stock issued in connection with the
Offerings, and (2) the Underwriter Defendants had entered
into agreements with customers whereby they agreed to allocate
Xchanges shares to those customers who agreed to purchase
additional shares in the after-market at pre-determined prices.
At this time, we are unable to ascertain the monetary damages
sought by the class. The action is pending in the United States
District Court for the Southern District of New York. We believe
these allegations are without merit and we intend to defend the
litigation vigorously.




Item 4.     Submission
of Matters to a Vote of Security Holders

There were no matters submitted to a vote of
security holders during the fourth quarter of 2001, however, the
Company had a Special Shareholder Meeting on February 27,
2002. Pursuant to this Special Meeting, the following matters
were approved by the shareholders: a proposal to give the Board
of Directors the authority to amend to the Companys
Certificate of Incorporation to either effect a reverse stock
split or increase the number of authorized but unissued shares
of common stock; a proposal to ratify an amendment to the 1998
Stock Incentive Plan to increase the number of shares authorized
for issuance thereunder; and a proposal to approve the issuance
of shares of common stock upon conversion of shares of
Series A Convertible Redeemable Preferred Stock. More
information about each of these matters can be found in the
Proxy Statement filed by the Company on January 25, 2002.




PART II




Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters

Market for
Common Stock

Xchanges common stock trades on the Nasdaq
National Market under the symbol EXAP. The high and low sales
prices for the Companys common stock for the eight
quarterly periods ended December 31, 2001 was as follows,
as adjusted for a 2 for 1 stock split on March 17, 2000 and
the 1 for 30 reverse stock split on March 18, 2002:

|                                      |  |           |       |            |  |   |        | 
|------------------------------------- |  | --------- | ----- | ---------- |  | - | ------ | 
|                                      |  | Low Sales |       | High Sales
|Fiscal 2001                           |  | Price     |       | Price     
|                                      |  |           |       |           
|4th quarter ending December 31, 2001  |  | $         | 5.40  |            |  | $ | 10.80  | 
|3rd quarter ending September 30, 2001 |  | $         | 3.90  |            |  | $ | 26.70  | 
|2nd quarter ending June 30, 2001      |  | $         | 31.50 |            |  | $ | 69.60  | 
|1st quarter ending March 31, 2001     |  | $         | 35.70 |            |  | $ | 120.00 | 

11



---



##### Table of Contents



|                                      |  |           |        |            |  |   |          | 
|------------------------------------- |  | --------- | ------ | ---------- |  | - | -------- | 
|                                      |  | Low Sales |        | High Sales
|Fiscal 2000                           |  | Price     |        | Price     
|                                      |  |           |        |           
|4th quarter ending December 31, 2000  |  | $         | 30.90  |            |  | $ | 181.80   | 
|3rd quarter ending September 30, 2000 |  | $         | 109.20 |            |  | $ | 1,218.90 | 
|2nd quarter ending June 30, 2000      |  | $         | 307.50 |            |  | $ | 1,683.90 | 
|1st quarter ending March 31, 2000     |  | $         | 731.40 |            |  | $ | 2,242.50 | 

Holders of
Record

As of December 31, 2001 there were 346
holders of record of the Xchanges common stock.

Dividends

Xchange has never declared or paid any cash
dividends on its capital stock. Future dividends, if any, will
be determined by the Board of Directors.

On January 28, 2000, Xchanges Board of
Directors approved a 2 for 1 stock split, to be effected in the
form of a stock dividend. On February 29, 2000,
Xchanges shareholders approved an increase in the
authorized shares of $.001 par value common stock to
150,000,000 shares giving the Company enough authorized
shares to effect the stock dividend. Accordingly, Xchange paid
the stock dividend on March 17, 2000 to all shareholders of
record on March 3, 2000. All share and per share amounts in
this Form 10-K have been adjusted to reflect the stock
split.

On March 11, 2002, Xchanges Board of
Directors approved a 1 for 30 reverse stock split of the
Companys common stock. The reverse split became effective
on March 18, 2002. As a result of the reverse split, each
30 issued and outstanding shares of common stock was exchanged
for one new share of common stock. The shares of common stock
underlying the Companys preferred stock and other
derivative securities were similarly adjusted. All share and per
share amount in this Form 10K have been adjusted to reflect
the reverse stock split.

12



---



##### Table of Contents






Item 6.     Selected
Consolidated Financial Data

The following historical selected consolidated
financial data of Xchange is qualified by reference to and
should be read in conjunction with the Consolidated Financial
Statements and Notes thereto included elsewhere herein. The
selected consolidated financial data set forth below as of
December 31, 2000 and 2001 and for each of the years ended
December 31, 1999, 2000 and 2001 are derived from the
audited financial statements of Xchange, which are included in
Item 8 of this Annual Report on Form 10-K. The
selected consolidated financial data as of December 31,
1997, 1998 and 1999 and for the years ended December 31,
1997, and 1998 are derived from the audited consolidated
financial statements of the Company, which are not included in
this Annual Report on Form 10-K. The data should be read in
conjunction with the Consolidated Financial Statements and the
Notes thereto and with Managements Discussion and Analysis
of Financial Condition and Results of Operations appearing
elsewhere in this Annual Report on Form 10-K.

|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |        |         |  
|----------------------------------------------- | ---------------------------------------------------------------------- | ------------------------------------- | ------ | ----- | ------ | ---- | ------ | ------ | ------ | ---- | ------ | ------ | ------ |  | -------- | ------ | ------- | - | -------- | ------ | ------- | -
|                                                |                                                                        |                                      
|                                                |                                                                        | Year Ended December 31,              
|                                                |                                                                        |                                      
|                                                |                                                                        | 1997                                  |        | 1998  |        | 1999 |        | 2000   |        | 2001
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |     
|                                                |                                                                        |                                      
|                                                |                                                                        | (in thousands, except per share data)
|Consolidated Statement of Operations
    Data:  |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|Revenues:                                       |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                | Software license fees                                                  |                                       | $      | 5,765 |        |      | $      | 14,357 |        |      | $      | 26,344 |        |  | $        | 38,070 |         |   | $        | 21,709 |        
|                                                | Services and maintenance                                               |                                       |        | 7,490 |        |      |        | 11,817 |        |      |        | 16,957 |        |  |          | 23,506 |         |   |          | 23,002 |        
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                |                                                                        | Total revenues                        |        |       | 13,255 |      |        |        | 26,174 |      |        |        | 43,301 |  |          |        | 61,576  |   |          |        | 44,711  |  
|                                                |                                                                        |                                      
|Cost of revenues:                               |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                |                                                                        |                                      
|                                                | Software license fees(1)                                               |                                       |        | 1,707 |        |      |        | 185    |        |      |        | 438    |        |  |          | 776    |         |   |          | 1,502  |        
|                                                | Services and maintenance                                               |                                       |        | 5,277 |        |      |        | 7,023  |        |      |        | 10,255 |        |  |          | 18,475 |         |   |          | 14,046 |        
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                |                                                                        | Total cost of revenues                |        |       | 6,984  |      |        |        | 7,208  |      |        |        | 10,693 |  |          |        | 19,251  |   |          |        | 15,548  |  
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|Gross profit                                    |                                                                        |                                       | 6,271  |       |        |      | 18,966 |        |        |      | 32,608 |        |        |  | 42,325   |        |         |   | 29,163   |       
|                                                |                                                                        |                                      
|Operating expenses:                             |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                | Sales and marketing(1)                                                 |                                       |        | 3,614 |        |      |        | 9,864  |        |      |        | 14,555 |        |  |          | 27,840 |         |   |          | 28,120 |        
|                                                | Research and development(1)                                            |                                       |        | 2,846 |        |      |        | 6,717  |        |      |        | 9,829  |        |  |          | 18,959 |         |   |          | 17,251 |        
|                                                | General and administrative                                             |                                       |        | 2,394 |        |      |        | 3,372  |        |      |        | 4,948  |        |  |          | 14,114 |         |   |          | 16,119 |        
|                                                | Cost of acquisition                                                    |                                       |        |      |        |      |        |       |        |      |        | 1,388  |        |  |          |       |         |   |          |       |        
|                                                | Amortization of goodwill and other intangibles                         |                                       |        |      |        |      |        |       |        |      |        |       |        |  |          | 22,331 |         |   |          | 16,566 |        
|                                                | Amortization of MicroStrategy assets                                   |                                       |        |      |        |      |        |       |        |      |        |       |        |  |          | 19,822 |         |   |          | 17,959 |        
|                                                | Impairment of MicroStrategy assets, goodwill and
    other intangibles |                                       |        |      |        |      |        |       |        |      |        |       |        |  |          | 76,604 |         |   |          | 56,176 |        
|                                                | Restructuring charges                                                  |                                       |        |      |        |      |        |       |        |      |        |       |        |  |          |       |         |   |          | 19,172 |        
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                |                                                                        | Total operating expenses              |        |       | 8,854  |      |        |        | 19,953 |      |        |        | 30,720 |  |          |        | 179,670 |   |          |        | 171,363 |  
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|Income (loss) from operations                   |                                                                        |                                       | (2,583 | )     |        |      | (987   | )      |        |      | 1,888  |        |        |  | (137,345 | )      |         |   | (142,200 | )     
|Interest Income (expense):                      |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|Interest income                                 |                                                                        |                                       | 24     |       |        |      | 104    |        |        |      | 1,430  |        |        |  | 1,109    |        |         |   | 191      |       
|Interest expense                                |                                                                        |                                       |       |       |        |      |       |        |        |      |       |        |        |  | (2,744   | )      |         |   | (8,610   | )     
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|                                                |                                                                        | Total interest income (expense), net  |        |       | 24     |      |        |        | 104    |      |        |        | 1,430  |  |          |        | (1,635  | ) |          |        | (8,419  | )
|Income (loss) before provision for income taxes |                                                                        |                                       | (2,559 | )     |        |      | (883   | )      |        |      | 3,318  |        |        |  | (138,980 | )      |         |   | (150,619 | )     
|Provision for income taxes                      |                                                                        |                                       |       |       |        |      | 111    |        |        |      | 2,220  |        |        |  | 9        |        |         |   | 38       |       
|                                                |                                                                        |                                       |        |       |        |      |        |        |        |      |        |        |        |  |          |        |         |   |          |       
|Net income (loss)                               |                                                                        |                                       | (2,559 | )     |        |      | (994   | )      |        |      | 1,098  |        |        |  | (138,989 | )      |         |   | (150,657 | )     

13



---



##### Table of Contents



|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|----------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ----- |  |  | - | -------- | - |  | - | -------- | -
|                                                                                    |  |                                      
|                                                                                    |  | Year Ended December 31,              
|                                                                                    |  |                                      
|                                                                                    |  | 1997                                  |        | 1998 |  | 1999 |        | 2000 |  | 2001
|                                                                                    |  |                                       |        |      |  |      |        |      |  |     
|                                                                                    |  |                                      
|                                                                                    |  | (in thousands, except per share data)
|Accretion of discount and dividends on preferred
    stock                          |  |                                       | (684   | )    |  |      | (180   | )    |  |      |      |  |  |   |         |   |  |   | (1,871   | )
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Net income (loss) applicable to common
    stockholders                             |  | $                                     | (3,243 | )    |  | $    | (1,174 | )    |  | $    | 1,098 |  |  | $ | (138,989 | ) |  | $ | (152,528 | )
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Basic net income (loss) per share applicable to
    common stockholders(2)(4)       |  | $                                     | (14.04 | )    |  | $    | (4.03  | )    |  | $    | 1.49  |  |  | $ | (145.22  | ) |  | $ | (136.90  | )
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Basic weighted average common shares
    outstanding(2)(4)                          |  |                                       | 231    |      |  |      | 291    |      |  |      | 737   |  |  |   | 957      |   |  |   | 1,114    |  
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Diluted net income (loss) per share applicable to
    common stockholders           |  | $                                     | (14.04 | )    |  | $    | (4.03  | )    |  | $    | 1.25  |  |  | $ | (145.22  | ) |  | $ | (136.90  | )
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Diluted weighted average common shares
    outstanding(2)                           |  |                                       | 231    |      |  |      | 291    |      |  |      | 881   |  |  |   | 957      |   |  |   | 1,114    |  
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Pro forma basic and diluted net loss per
    share(2)(3)(4)                         |  | $                                     | (6.60  | )    |  | $    | (1.80  | )    |  |      |       |  |  |   |          |   |  |   |          |  
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  
|Pro forma basic and diluted weighted average
    common shares outstanding(2)(3)(4) |  |                                       | 396    |      |  |      | 543    |      |  |      |       |  |  |   |          |   |  |   |          |  
|                                                                                    |  |                                       |        |      |  |      |        |      |  |      |       |  |  |   |          |   |  |   |          |  

|                                                  |  |                    |        |      |  |      |        |      |  |      |         |  |  |   |         |   |  |   |         |  
|------------------------------------------------- |  | ------------------ | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------- |  |  | - | ------- | - |  | - | ------- | -
|                                                  |  |                   
|                                                  |  | As of December 31,
|                                                  |  |                   
|                                                  |  | 1997               |        | 1998 |  | 1999 |        | 2000 |  | 2001
|                                                  |  |                    |        |      |  |      |        |      |  |     
|                                                  |  |                   
|                                                  |  | (in thousands)    
|Consolidated Balance Sheet Data:                  |  |                    |        |      |  |      |        |      |  |      |         |  |  |   |         |   |  |   |         |  
|Cash, cash equivalents, and marketable securities |  | $                  | 5,306  |      |  | $    | 20,671 |      |  | $    | 29,107  |  |  | $ | 8,617   |   |  | $ | 7,074   |  
|Working capital (deficit)                         |  |                    | 5,047  |      |  |      | 21,485 |      |  |      | 15,669  |  |  |   | (23,608 | ) |  |   | (16,190 | )
|Total assets                                      |  |                    | 11,475 |      |  |      | 31,986 |      |  |      | 115,065 |  |  |   | 162,307 |   |  |   | 43,238  |  
|Long-term debt, net of current portion            |  |                    | 237    |      |  |      | 145    |      |  |      | 16,653  |  |  |   | 3,056   |   |  |   | 3,165   |  
|Redeemable preferred stock                        |  |                    | 7,088  |      |  |      |       |      |  |      |        |  |  |   |        |   |  |   | 5,650   |  
|Stockholders equity (deficit)                    |  |                    | (683   | )    |  |      | 24,201 |      |  |      | 70,712  |  |  |   | 105,787 |   |  |   | 2,254   |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Cost of software license fees, sales and
    marketing expenses, and research and development expenses listed
    above are stated exclusively of amortization of the
    MicroStrategy assets and acquired technology, which is stated
    separately. See Note 5 of Notes to Consolidated Financial
    Statements.                                                                                                                                                                                                                                                                            
|   
|(2) | On January 28, 2000, Xchanges Board of
    Directors approved a 2 for 1 stock split in the form of a stock
    dividend. The dividend was paid on March 17, 2000 to all
    shareholders of record on March 3, 2000. Accordingly, all
    share and per share amounts have been adjusted to reflect the
    stock split. On March 11, 2002, Xchanges Board of
    Directors approved a 1 for 30 reverse stock split. The reverse
    split became effective on March 18, 2002. Accordingly, all
    share amounts have been adjusted to reflect the reverse stock
    split.                   
|   
|(3) | Gives effect, as of the issuance date, to the
    reclassification of Series A Preferred Stock to $3,269,000 of
    additional paid-in capital, the conversion of all outstanding
    shares of the Series B Convertible Preferred Stock, at a
    redemption value of $4,000,000, into 85,185 shares of
    common stock, and the conversion of all outstanding shares of
    Series C Convertible Preferred Stock, at $.001 par value
    per share, into 40,788 shares of common stock that occurred
    upon the closing of Xchanges initial public stock offering
    on December 14, 1998.
|   
|(4) | Computed on the basis described in Note 2(b)
    of Notes to Consolidated Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

14



---



##### Table of Contents






Item 7.     Managements
Discussion and Analysis of Financial Condition and Results Of
Operations

The following discussion should be read in
conjunction with the Consolidated Financial Statements and
related Notes thereto included elsewhere in this Annual report
on Form 10-K. This discussion contains forward-looking
statements that involve risks and uncertainties. Xchanges
actual results may differ materially from those anticipated in
these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth under Risk
Factors and elsewhere in this Annual Report on
Form 10-K.

Overview

Exchange Applications, Inc. and its subsidiaries
(Xchange or the Company), doing business
as Xchange, Inc., provides Customer Relationship Management
(CRM) solutions that help companies earn a greater
share of their customers business through relevant, personalized
customer communications. The Company provides an open-platform
CRM software and services solution that is designed to help
clients customize offers based on profile information,
synchronize offers across multiple customer channels in
real-time and track the responses. This solution is designed to
provide companies with opportunities to improve their
acquisition and retention of customers and to increase customer
relationship profitability. The Companys CRM solutions are
licensed for use at approximately 300 client sites in 33
countries, as well as the six leading U.S. marketing service
bureaus.

Corporate
Overview

The Company was incorporated in November 1996.
Prior to incorporation, the Company operated as a separate
division of two entities, Grant & Partners, Inc.
(GPI) and Grant & Partners Limited Partnership
(GPLP). The Companys activities during its
early stages of operation focused on the development of software
solutions to provide customer communications support to
businesses. In 1995, the Company began providing professional
services in the areas of marketing program design and execution
and data warehousing. In March 1997, the Company ceased
providing marketing program design services. The Companys
development efforts culminated in the introduction to market in
July 1996 of Xchange Campaign. Since this initial introduction
of Xchange Campaign, the Company has continued to focus
significant resources on the development of additional
functionality and features of the its original products as well
as the development and acquisition of additional solutions
within the Companys CRM solution set including Xchange
Real Time, Xchange eMessaging and Xchange Analytics. In October
2001 the Company announced Xchange 8, which is a bundling of the
Companys existing products, as part of a strategy to move
away from selling individual software components to selling an
integrated set of software solutions

The Company also has continued to expand its
marketing activities, build the Xchange identity, develop the
competencies of the professional services group, establish
international sales and distribution channels and develop its
general and administrative infrastructure.

In August 1999, the Company acquired eXstatic
Software, Inc. (formerly known as Gino Borland, Inc.)
(eXstatic) in a transaction accounted for as a
pooling of interest. eXstatic develops and markets software
products that enable businesses to plan, create and execute
highly personalized, permission-based email communications based
on customer profiles. In accordance with pooling of interests
accounting, the results of operations have been restated to
reflect the historical results of eXstatic on an as combined
basis. In March 2000, the Company acquired Knowledge Stream
Partners, Inc. (KSP) in a transaction accounted for
under the purchase method. KSP specializes in consulting and
software development for advanced data mining and online/offline
analytics. In June 2000, the Company acquired Customer
Analytics, Inc. (CA) in a transaction accounted for
under the purchase method. CA develops and markets campaign
management solutions focused on creating, executing, analyzing
and measuring customer communications at the local or branch
level.



| |                                                                       
| | ----------------------------------------------------------------------
| | Critical Accounting Policies and
	Significant Judgements and Estimates

Xchanges discussion and analysis of its
financial condition and results of operations are based on the
Companys consolidated financial statements which have been
prepared in accordance with accounting

15



---



##### Table of Contents



principles generally accepted in the United
States. The preparation of these financial statements requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the
reporting periods. On an ongoing basis, management evaluates its
estimates and judgements, including those related to revenue
recognition, bad debts, intangible assets, and income taxes.
Management bases its estimates on historical experience and on
various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for
making judgements about the timing and amounts of certain
transactions and carrying value of assets and liabilities that
are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.


The significant accounting policies that
management believes are most critical to aid in fully
understanding and evaluating our reported financial results
include the following:

Revenue Recognition

The Companys revenues are primarily
generated from the sale of perpetual licenses to its proprietary
Xchange 8 products and services. The Company generates its
services revenue from consulting and training services performed
for customers and from maintenance and support. As described
below, significant management judgements and estimates must be
made and used in connection with the revenue recognized in any
accounting period. Material differences may result in the amount
and timing of our revenue for any period if management made
different judgements or utilized different estimates.

The Company recognizes revenue based on the
provisions of Staff Accounting Bulletin 101, Revenue
Recognition in Financial Statements, Statement of Position,
(SOP), No. 97-2, Software Revenue Recognition, as
amended by SOP No. 98-4 and SOP No. 98-9, and the
provisions of SOP No. 81-1, Accounting for Performance
of Construction-Type and Certain Production-Type Contracts.The Company recognizes revenue from the sale of software
licenses when persuasive evidence of an arrangement exists, the
product has been delivered, the fees are fixed or determinable
and collection of the resulting receivable is reasonably
assured. The Company does not offer a right of return on its
products.

For all sales, the Company uses either a binding
purchase order or signed license agreement as evidence of an
arrangement. At the time of the transaction, the Company
assesses whether the fee associated with the transaction is
fixed or determinable based on the payment terms associated with
the transaction. If a significant portion of the fee is due
after our normal payment terms the Company accounts for the fee
as not being fixed or determinable. In these cases, the Company
recognizes revenue as the fees become due. Credit worthiness for
follow-on transactions is assessed through a review of the
transaction history with the customer. The Company does not
request collateral from its customers. If collection of a fee is
not reasonably assured, the Company defers the fee and
recognizes revenue at the time collection becomes reasonably
assured, which is generally upon receipt of cash.

Software license fee revenues are generated from
licensing the rights to the use of the Companys packaged
software products. Services and maintenance revenues are
generated from sales of maintenance, consulting, training and
hosting services performed for customers that license the
Companys products. The Company has concluded that
effective with the new generation of Xchange Analytics and
Xchange Real Time, certain of the implementation services
related to these products are essential to the customers
use of the packaged software products. Similarly, the
implementation services for the Companys Xchange EnAct
product is essential to the customers use of those
packaged software products. For sales of these products where
the Company is responsible for implementation, the Company
recognizes revenue for these arrangements following the
percentage-of-completion method over the implementation period.
Percentage of completion is measured by the percentage of
implementation hours incurred to date compared to estimated
total implementation hours. This method is used because
management has determined that expended hours to be the best
measure of progress on these engagements. In situations where
the Company is not responsible for implementation services, or
where the product configuration being delivered does not require
the implementation services deemed to be essential to the
customers use of the software, the Company recognizes
revenue on

16



---



##### Table of Contents



delivery of the packaged software if there is
persuasive evidence of an arrangement, collection is probable,
the fee is fixed or determinable and vendor-specific objective
evidence exists to allocate the total fees to all undelivered
elements of the arrangement.


Vendor-specific objective evidence is based on
the price charged when an element is sold separately or, in the
case of an element not yet sold separately, the price
established by authorized management, if it is probable that the
price, once established, will not change before market
introduction. Elements included in multiple-element arrangements
could consist of software products, maintenance, consulting and
training services.

Revenue from maintenance services is recognized
ratably over the term of the contract, typically one year.
Professional services revenue is primarily related to
implementation and consulting services performed on a
time-and-materials basis under separate service arrangements.
Revenues from professional service arrangements are recognized
on either a time and materials or percentage-of-completion basis
as the services are performed, provided that amounts due from
customers are fixed or determinable and deemed collectible by
management. In addition, the Company recognizes consulting
revenue for its application hosting service. The revenue is
recognized over the service delivery period based on either a
pre-determined monthly service fee or a usage based pricing
model.

In certain situations, the Company has entered
into transactions with third parties to acquire technology from
those entities at the same time that the Company sells its
technology to those same third parties. In those instances, the
Company applies Accounting Principles Board Opinion No. 29,
Accounting for Nonmonetary Transactions, and Emerging
Issues Task Force Issue (EITF) No. 86-29,
Nonmonetary Transactions: Magnitude of the Boot and the
Exceptions to the Use of Fair Value, to such transactions.

Revenues for maintenance and support are
recognized ratably over the term of the support period. Revenues
from consulting and training services are recognized as the
services are performed.

Accounts Receivable

Accounts receivable are reduced by an allowance
for amounts that may become uncollectible in the future. The
estimated allowance for uncollectible amounts is based primarily
on a specific analysis of accounts in the receivable portfolio
and historical write-off experience. While management believes
the allowance to be adequate, if the financial condition of the
Companys customers were to deteriorate, resulting in
impairment of their ability to make payments, additional
allowances may be required.

Goodwill and Intangibles

Purchase accounting requires extensive use of
accounting estimates and judgements to allocate the purchase
price to the fair market value of the assets purchased and
liabilities assumed. In recording the acquisition of KSP in
March 2000, and CA in June 2000, values were assigned to
intangible assets for assembled workforces, acquired technology
and existing customer bases. The value assigned to these assets
were based on independent third-party appraisals. The excess of
the purchase price over the fair value of assets acquired was
recorded as goodwill. The value of goodwill and intangibles
assets are amortized using the straight-line method over three
to five years based on management estimate of the assets
useful life.

Intangible assets are tested for impairment
whenever events or changes in circumstances indicate that the
carrying value for the asset may not be recoverable. In 2001,
the Company recorded impairment charges relative to its
investment in MicroStrategy technology and acquisition of CA. In
both instances the Company made the strategic decision to no
longer sell or support the products or assets underlying the
original acquisitions. As a result of these decisions,
management does not expect any material cash flows relative to
these intangible assets and accordingly has recorded impairment
charges for the entire unamortized balance at December 31,
2001. During the fourth quarter of 2001, in response to
continuing negative operating trends, the Company determined
that the remaining goodwill balance was impaired based upon a
third party indication of value of the Company as a whole. The
Company recorded an additional impairment of the carrying value
of such goodwill in the amount of $6.8 million.

17



---



##### Table of Contents



Accounting for Income Taxes

The preparation of consolidated financial
statements requires the Company to estimate income taxes in each
of the jurisdictions in which it operates, including those
outside the United States which may be subject to certain risks
that ordinarily would not be expected in the United States. The
income tax accounting process involves estimating actual current
exposure together with assessing temporary differences resulting
from differing treatment of items, such as deferred revenue, for
tax and accounting purposes. These differences result in the
recognition of deferred tax assets and liabilities. The Company
must then record a valuation allowance to reduce its deferred
tax assets and liabilities to the amount that is more likely
than not to be realized.

Significant management judgement is required in
determining the provision for income taxes, deferred tax assets
and liabilities and any valuation allowance recorded against
deferred tax assets. The Company has recorded a valuation
allowance of $65.2 million as of December 31, 2001,
due to uncertainties related to its ability to utilize some of
its deferred tax assets, primarily consisting of certain net
operating losses carried forward before they expire. The
valuation allowance is based on our estimates of taxable income
by jurisdiction in which the Company operates and the period
over which our deferred tax assets will be recoverable. In the
event that actual results differ from these estimates or the
Company adjusts these estimates in future periods the Company
may need to adjust its valuation allowance which could
materially impact its financial position and results of
operations.

Transactions
with MicroStrategy, Inc.

In December 1999, the Company entered into a
strategic alliance relationship with MicroStrategy, Inc.,
resulting in a series of transactions between the two companies.
The Company accounted for these transactions at the fair value
of the elements exchanged.

The Company agreed to pay MicroStrategy an
aggregate of $65 million in cash and the Companys
common stock over two years commencing in December 1999. In
return, the Company received the following:



| |   |                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | License for MicroStrategy applications valued at
    $30 million for the purpose of developing new products
    using MicroStrategy technology along with distribution rights to
    existing and newly developed MicroStrategy products on a
    royalty-free basis for 3 1/2 years;
|
| |  | A dedicated research and development workforce
    from MicroStrategy for a 3 1/2 year term valued at
    $30 million to develop new products using
    MicroStrategys technology; and                                                                                              
|
| |  | Prepaid co-marketing by MicroStrategy over
    18 months valued at $5 million.                                                                                                                                                                                                       

The Company capitalized the present value of the
$65 million payments, which totaled $62.0 million and
began amortized this amount to operations over the terms of the
underlying arrangements. Through December 31, 2001 the
Company has recorded total amortization charges of
$37.8 million against the MicroStrategy assets. In the
fourth quarter of 2001, as a result of decreased market demand
for MicroStrategy technology and MicroStrategys inability
to continue to support the product, the Company made the
strategic decision to discontinue the use of MicroStrategy
technology effective with the updated release of Xchange 8
in December, 2001. The Company recorded an impairment charge of
$24.2 million at December 31, 2001 to write-off the
remaining unamortized balance of the MicroStrategy assets. (See
Note 5 in the Companys Consolidated Financial
Statements)

Conversely, MicroStrategy also agreed to pay the
Company up to $10 million for the purchase of the following:



| |   |                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Royalty-free right to distribute in
    MicroStrategys Strategy.com ASP environment for 3 1/2
    years, the Companys Xchange eMessaging product to named
    affiliates of MicroStrategys Strategy.com web service.
    MicroStrategy agreed to pay $100,000 per named affiliate up to a
    cap of $8 million.

18



---



##### Table of Contents





| |   |                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Perpetual internal-use and development licenses
    to use the Companys Xchange Campaign and Xchange
    eMessaging products, along with the initial year of support and
    maintenance, valued at a total of $2.0 million.

MicroStrategy paid the Company the
$8.0 million for the Xchange eMessaging product
distribution over the 3 1/2 year term as MicroStrategy
designated named affiliates to its Strategy.com web service. The
Company recorded the license fee as MicroStrategy designated
named affiliates and the payments become due. The Company
determined that $100,000 was the fair valve of the Xchange
eMessaging product for purposes of revenue recognition based on
the published list price for that product and the appropriate
historical discount off list price for reseller contracts. The
Company is providing support to MicroStrategy under annual
maintenance contracts that are billed when MicroStrategy
designates affiliates. Revenues under these maintenance
contracts are recognized over the period of service. In December
1999, the Company recorded total revenue of $4.5 million
when MicroStratgey designated 45 named affiliates for the
Xchange eMessaging product through the Strategy.com web service.
The Company recorded the remaining $3.5 million of revenue
under this contract during 2000 when MicroStrategy designated an
additional 35 named affiliates to its Strategy.com web
service.

MicroStrategy paid the Company $2.0 million
for the internal-use and development licenses upon the delivery
and execution of the license agreements. The Company determined
the fair value of these licenses for revenue recognition
purposes based on historically established pricing for similar
third-party transactions. These products were delivered in
January 2000 at which point the product revenue was recognized
and the support and maintenance fees were deferred.

Restructuring
and other charges

In the second, third and fourth quarters of 2001,
the Company undertook corrective actions to better align costs
with its outlook on near term revenues and to preserve cash. As
a result of these actions, the Company recorded a charge of
$809,000 to cost of software license fees and a restructuring
charge of $19,172,000. The components of these charges were as
follows:

|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 
|--------------------------------------------- |  | -------------- | ----- | ------- |  | ------- | ----- | ----- |  | - | ----- |  |  | - | ------ | 
|                                              |  | Q2 2001        |       | Q3 2001 |  | Q4 2001 |       | Total
|                                              |  |                |       |         |  |         |       |      
|                                              |  |               
|                                              |  | (in thousands)
|Severance                                     |  | $              | 1,120 |         |  | $       | 1,119 |       |  | $ | 786   |  |  | $ | 3,025  | 
|Facilities related                            |  |                |      |         |  |         | 2,889 |       |  |   | 1,690 |  |  |   | 4,579  | 
|Property and equipment                        |  |                |      |         |  |         | 1,409 |       |  |   | 596   |  |  |   | 2,005  | 
|Asset impairment                              |  |                | 6,340 |         |  |         | 2,737 |       |  |   | 809   |  |  |   | 9,886  | 
|Others                                        |  |                |      |         |  |         | 250   |       |  |   | 236   |  |  |   | 486    | 
|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 
|Total restructuring and other unusual charges |  | $              | 7,460 |         |  | $       | 8,404 |       |  | $ | 4,117 |  |  | $ | 19,981 | 
|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 

Severance costs relate to the elimination of 226
managerial and staff positions worldwide, comprising
approximately 48% of the beginning of the year workforce in the
following areas: 52 in sales and marketing, 71 in research and
development, 63 in professional services and 40 in general and
administration. Facility related costs relate to the
consolidation and abandonment of excess facilities, net of
assumed sublease income. Property and equipment relate to
non-cash write-offs of excess computer equipment that has been
removed from operations as a result of employee reductions and
leasehold improvements on leased facilities that were abandoned
at various times in the latter half of 2001. Asset impairment
relates to the write-off of third-party acquired technology
which will not be realized based on the Companys decision
to no longer support an operating system platform, and the
write-off of obsolete third-party software originally acquired
to be sold as a component of Xchanges software solution
which will not be realized due to the Companys decision to
no longer offer certain product capabilities. Other costs relate
primarily to non-cancelable commitments for marketing activities
that will not take place as a result of the Companys cost
containment initiatives.

19



---



##### Table of Contents



At December 31, 2001 the Company had the
following restructuring accruals:

|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 
|---------------------- |  | -------------- | ------ | -------- |  | -------- | ------ | ----------------- |  | - | ----- |  |  | - | ----- | 
|                       |  |                |        |          |  |          |        | Restructuring    
|                       |  |                |        | Non-cash |  | Cash     |        | Accrual at       
|                       |  | Total Charges  |        | Charges  |  | Payments |        | December 31, 2001
|                       |  |                |        |          |  |          |        |                  
|                       |  |                |        |         
|                       |  | (in thousands) |        |         
|Severance              |  | $              | 3,025  |          |  | $        | 350    |                   |  | $ | 2,430 |  |  | $ | 245   | 
|Facilities related     |  |                | 4,579  |          |  |          |       |                   |  |   | 587   |  |  |   | 3,992 | 
|Property and equipment |  |                | 2,005  |          |  |          | 2,005  |                   |  |   |      |  |  |   |      | 
|Asset impairment       |  |                | 9,886  |          |  |          | 9,886  |                   |  |   |      |  |  |   |      | 
|Others                 |  |                | 486    |          |  |          |       |                   |  |   | 7     |  |  |   | 479   | 
|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 
|Total                  |  | $              | 19,981 |          |  | $        | 12,241 |                   |  | $ | 3,024 |  |  | $ | 4,716 | 
|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 

All terminations were completed by
December 31, 2001. The remaining severance costs will be
paid out in installment through April 30, 2002. Facility
costs will be paid out through 2005 based on the remaining lease
terms of the abandoned facilities. The Company anticipates
annualized cash savings of approximately $23 million as a
result of the severance, facilities related and other
restructuring actions, and annualized non-cash depreciation and
amortization expense savings of approximately $800,000.

Results of Operations

The following table sets forth, for the periods
indicated, the percentage of total revenues represented by
certain items from the Companys Consolidated Statements of
Operations

|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |       |       | 
|----------------------------- | ---------------------------------------------------------------------- | ------------------------ | ---- | ---- | ----- | ---- | ------ | ----- | ----- |  | ------ | ----- | ----- | 
|                              |                                                                        |                         
|                              |                                                                        | Year Ended December 31, 
|                              |                                                                        |                         
|                              |                                                                        | 1999                     |      | 2000 |       | 2001
|                              |                                                                        |                          |      |      |       |     
|Revenues:                     |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              | Software license fees                                                  |                          |      | 60.8 | %     |      |        | 61.8  | %     |  |        | 48.6  | %    
|                              | Services and maintenance                                               |                          |      | 39.2 |       |      |        | 38.2  |       |  |        | 51.4  |      
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              |                                                                        | Total revenues           |      |      | 100.0 |      |        |       | 100.0 |  |        |       | 100.0 | 
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|Cost of revenues:             |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              | Software license fees                                                  |                          |      | 1.0  |       |      |        | 1.3   |       |  |        | 3.4   |      
|                              | Services and maintenance                                               |                          |      | 23.7 |       |      |        | 30.0  |       |  |        | 31.4  |      
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              |                                                                        | Total cost of revenues   |      |      | 24.7  |      |        |       | 31.3  |  |        |       | 34.8  | 
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|Gross margin                  |                                                                        |                          | 75.3 |      |       |      | 68.7   |       |       |  | 65.2   |      
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|Operating expenses:           |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              | Sales and marketing                                                    |                          |      | 33.6 |       |      |        | 45.2  |       |  |        | 62.9  |      
|                              | Research and development                                               |                          |      | 22.7 |       |      |        | 30.8  |       |  |        | 38.6  |      
|                              | General and administrative                                             |                          |      | 11.4 |       |      |        | 22.9  |       |  |        | 36.1  |      
|                              | Cost of acquisition                                                    |                          |      | 3.2  |       |      |        |      |       |  |        |      |      
|                              | Amortization of goodwill and other intangibles                         |                          |      |     |       |      |        | 36.3  |       |  |        | 37.1  |      
|                              | Amortization of MicroStrategy assets                                   |                          |      |     |       |      |        | 32.2  |       |  |        | 40.2  |      
|                              | Impairment of MicroStrategy assets, goodwill and
    other intangibles |                          |      |     |       |      |        | 124.4 |       |  |        | 125.6 |      
|                              | Restructuring charge                                                   |                          |      |     |       |      |        |      |       |  |        | 42.9  |      
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|                              |                                                                        | Total operating expenses |      |      | 70.9  |      |        |       | 291.8 |  |        |       | 383.3 | 
|                              |                                                                        |                          |      |      |       |      |        |       |       |  |        |      
|Income (loss) from operations |                                                                        |                          | 4.4  |      |       |      | (223.0 | )     |       |  | (318.0 | )    

20



---



##### Table of Contents



|                                          |                  |                                      |     |      |     |      |        |      |      |   |        |       |       |  
|----------------------------------------- | ---------------- | ------------------------------------ | --- | ---- | --- | ---- | ------ | ---- | ---- | - | ------ | ----- | ----- | -
|                                          |                  |                                     
|                                          |                  | Year Ended December 31,             
|                                          |                  |                                     
|                                          |                  | 1999                                 |     | 2000 |     | 2001
|                                          |                  |                                      |     |      |     |     
|Interest income (expense), net:           |                  |                                      |     |      |     |      |        |      |      |   |        |      
|                                          | Interest income  |                                      |     | 3.3  |     |      |        | 1.8  |      |   |        | 0.4   |      
|                                          | Interest expense |                                      |     |     |     |      |        | (4.5 | )    |   |        | (19.3 | )    
|                                          |                  |                                      |     |      |     |      |        |      |      |   |        |      
|                                          |                  | Total interest income (expense), net |     |      | 3.3 |      |        |      | (2.6 | ) |        |       | (18.8 | )
|Income (loss) before provision for income |                  |                                      | 7.7 |      |     |      | (225.6 | )    |      |   | (336.9 | )    
|                                          |                  |                                      |     |      |     |      |        |      |      |   |        |      
|Provision for income taxes                |                  |                                      | 5.1 |      |     |      | (0.0   | )    |      |   | (0.1   | )    
|                                          |                  |                                      |     |      |     |      |        |      |      |   |        |      
|Net income (loss)                         |                  |                                      | 2.6 | %    |     |      | (225.6 | )%   |      |   | (337.0 | )%   
|                                          |                  |                                      |     |      |     |      |        |      |      |   |        |      

Years Ended
December 31, 1999, 2000 and 2001

Revenues

|                         |               |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |       |   
|------------------------ | ------------- | ------------- | ---- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- | ---- |  |  | ---- | ---- | - |  | ----- | ----- | --
|                         |               |               |      |      |  |      |      |                      
|                         |               |               |      |      |  |      |      | % increase (decrease)
|                         |               |               |      |      |  |      |      |                      
|                         |               | 1999          |      | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                         |               |               |      |      |  |      |      |                       |  |             
|                         |               |               |      |      |  |     
|                         |               | (in millions) |      |      |  |     
|Software license fees    |               | $             | 26.3 |      |  | $    | 38.1 |                       |  | $            | 21.7 |      |  |  | 44.9 | %    |   |  | (43.0 | )%   
|Services and maintenance |               |               | 17.0 |      |  |      | 23.5 |                       |  |              | 23.0 |      |  |  | 38.2 | %    |   |  | (2.1  | )%   
|                         |               |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |      
|                         | Total revenue |               | $    | 43.3 |  |      | $    | 61.6                  |  |              | $    | 44.7 |  |  |      | 42.3 | % |  |       | (27.4 | )%
|                         |               |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |      

Total revenues were $43.3 million,
$61.6 million and $44.7 million in 1999, 2000 and 2001
respectively, representing an increase of 42.3% from 1999 to
2000 and a decrease of 27.4% from 2000 to 2001. In 1999, the
Companys top five customers accounted for 37.7% of the
total revenues while the Companys three largest customers
accounted for 11.3%, 10.4% and 7.2%, respectively, of the
Companys total revenue. In 2000, the Companys top
five customers accounted for 26.9% of total revenues, while the
Companys three largest customers accounted 10.2%, 7.0% and
3.3% of total revenues. In 2001, the Companys top five
customers accounted for 41.9% of total revenues, while the top
three accounted for 25.8%, 4.5% and 4.4% of total revenue.

In 2000, software license fees increased 44.9%,
from $26.3 million in 1999 to $38.1 million in 2000.
This increase was due primarily to increased market awareness
and acceptance of the Companys original Campaign product
as well as incremental revenue generated by the addition of
three new products to the Xchange product suite. During 2000,
the Company added Xchange Analytics, Xchange EnAct and Xchange
Real time to its product offerings. In addition in 2000, the
Company was successful in the distribution of its eMessaging
product to value-added services providers as a component of
their overall managed service offering. This strategy generated
approximately $2.2 million in incremental revenue in 2000
versus 1999. In 2001, software license fees decreased 43.0% from
$38.1 million in 2000 to $21.7 million in 2001. The
decrease is attributed primarily to: (i) decrease in demand
for the Companys products, (ii) longer sales cycle,
and (iii) fewer sales resulting from a general market
slowdown for information technology spending.

In 2000, services and maintenance revenues
increased 38.2% from $17.0 million, or 39.2% of total revenues
in 1999 to $23.5 million, or 38.2% of total revenues, in
2000. The growth of services and maintenance revenue in 2000 was
directly attributable to $3.2 million in additional
services engagement revenue and $3.3 million in additional
maintenance fees from the Companys increased base of
customers. In 2001, services and maintenance revenues decreased
2.1% from $23.5 million, or 38.2% of total revenues in
2000, to $23.0 million, or 51.4% of total revenues, in
2001. The slight decrease is attributed to a decrease in service
engagement revenue of $3.7 million, offset by an increase
in eMessaging ASP services revenue of $1.8 million and an
increase in maintenance fees of $1.5 million. The decrease
in services engagement revenue is related partially to the
reduction in software license fees revenue, resulting in reduced
software implementation and integration services, and partially
to the Companys strategy of selling software licenses
through third-party resellers that perform the services work
historically performed by the Company. The increase in eMessaging

21



---



##### Table of Contents



ASP services revenue is attributable to the
addition of a significant new customer. Maintenance fees
increased as a result of increases in the Companys base of
software license customers in the first half of 2001. The
Company anticipates the mix of revenue between software license
fees and services and maintenance will shift to a higher
percentage of software license fees revenue in the future, as
the Company strengthens its relationship with third-party
software resellers, thereby reducing services engagement revenue
opportunities while maintenance revenue will grow at a slower
rate resulting from reduced new customer growth in the latter
half of 2001.


Cost
of Revenue

|                         |                        |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |       |   
|------------------------ | ---------------------- | ------------- | ---- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- | ---- |  |  | ---- | ---- | - |  | ----- | ----- | --
|                         |                        |               |      |      |  |      |      |                      
|                         |                        |               |      |      |  |      |      | % increase (decrease)
|                         |                        |               |      |      |  |      |      |                      
|                         |                        | 1999          |      | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                         |                        |               |      |      |  |      |      |                       |  |             
|                         |                        |               |      |      |  |     
|                         |                        | (in millions) |      |      |  |     
|Software license fees    |                        | $             | 0.4  |      |  | $    | 0.8  |                       |  | $            | 1.5  |      |  |  | 77.2 | %    |   |  | (93.6 | )%   
|Services and maintenance |                        |               | 10.3 |      |  |      | 18.5 |                       |  |              | 14.0 |      |  |  | 79.6 | %    |   |  | (24.3 | )%   
|                         |                        |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |      
|                         | Total cost of revenues |               | $    | 10.7 |  |      | $    | 19.3                  |  |              | $    | 15.5 |  |  |      | 80.4 | % |  |       | (19.7 | )%
|                         |                        |               |      |      |  |      |      |                       |  |              |      |      |  |  |      |      |   |  |       |      

Cost of software license fees is comprised of
royalty payments made to third parties for licensed intellectual
property included in Xchange software products, and costs
associated with software packaging and distribution. The cost of
software license fees increased in 2000 by $338,000 or 77.2%,
while the cost of software license fees increased as a
percentage of software license fees revenue from 1.7% in 1999 to
2.0% in 2000. The increase in both absolute dollars and
percentage of software license revenue is attributable to the
increase in software licenses fee revenues of 44.9% in 2000 as
well as an increase in the third-party royalty components of the
Xchange Analytics and Xchange Real Time software products
released to customers in 2000. The cost of software license fees
increased by $726,000 in 2001, an increase of 93.6% over 2000.
Included in the 2001 cost of software license fees was a
one-time, non-cash charge of $809,000 related to the write-off
of certain assets that are no longer expected to be realized
through the incorporation of the technology in future product
releases and service offerings due to a repriorization of the
Companys development efforts. Excluding the impact of this
unusual charge, 2001 cost of software license fees were
$693,000, or 3.2% of software license fees revenue, compared to
$776,000, or 2.0% of software license fees revenue in 2000. The
increase in the cost of software license fees as a percentage of
software license fees revenue is due to an increase in the
third-party royalties for components of the Xchange 8 product
suite. As the Company migrates from selling its software
components individually to selling them combined in the Xchange
8 product suite, it anticipates selling a larger number of
third-party software components and, therefore, the cost of
revenues as a percentage of software license fee revenue may
increase over current levels in the future.

Cost of service and maintenance consists
primarily of personnel, facilities and system costs incurred in
providing professional consulting services, training, hosted
software services for the Xchange eMessaging software product,
and customer support services. Cost of services and maintenance
as a percentage of total revenues was 23.7%, 30.0% and 31.4% in
1999, 2000 and 2001, respectively. Cost of services and
maintenance as a percentage of services and maintenance revenue
was 60.5%, 78.6% and 61.1% in 1999, 2000 and 2001, respectively.
During the first half of 2000 the Company made a conscious
decision to invest in the infrastructure and capacity of the
services organization in anticipation of the continued increase
in software transactions and the related services components.
The Company experienced an unanticipated slow down in the number
of software transactions completed in the second half of 2000
due to general market conditions and poor sales execution,
resulting in a decrease in the number services engagements and
revenue deliverables. These factors account for the increase in
the cost of services and maintenance in 2000 both in terms of
absolute dollars and as a percentage of revenue. The Company
took corrective actions beginning in the second quarter of 2001
to adjust its infrastructure costs downward to better match a
lower anticipated level of services and maintenance revenue.
These actions included reducing the headcount of billable
consultants, customer support staff and management from 146 at
December 31, 2000 to 48 at December 31, 2001, through
both employee severance and attrition, as well as rationalizing
facility and other infrastructure costs. As a result of

22



---



##### Table of Contents



these actions, the cost of services and
maintenance in 2001 decreased both in terms of absolute dollars
and as a percentage of services and maintenance revenue. The
Company believes that the cost reduction measures undertaken in
the later half of 2001, as well as an anticipated increase in
the contribution from higher margin maintenance revenue will
result in the cost of services and maintenance decreasing in
both absolute dollars and as a percentage of both total and
services and maintenance revenues in 2002.


Overall gross margin percentage decreased from
75.3% in 1999 to 68.7% in 2000 to 65.2% in 2001. The decrease in
2000 is attributed to the Companys decision to invest in
the infrastructure and capacity of the service organization
coupled with an unanticipated reduction in revenues due to the
general market slow-down and poor sales execution in the second
half of 2000. The decrease in 2001 is attributed primarily to a
higher contribution of lower margin services and maintenance
revenue to total revenue. As a result of its cost containment
initiatives and an anticipated improvement in the mix of total
revenue to include a higher percentage of license fee revenue
the Company anticipates gross margin percentage will improve in
2002.

Operating
Expenses

|                    |  |               |      |      |  |      |      |                       |  |              |      |  |  |  |      |   |  |  |     |  
|------------------- |  | ------------- | ---- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- |  |  |  | ---- | - |  |  | --- | -
|                    |  |               |      |      |  |      |      |                      
|                    |  |               |      |      |  |      |      | % increase (decrease)
|                    |  |               |      |      |  |      |      |                      
|                    |  | 1999          |      | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                    |  |               |      |      |  |      |      |                       |  |             
|                    |  |               |      |      |  |     
|                    |  | (in millions) |      |      |  |     
|Sales and marketing |  | $             | 14.6 |      |  | $    | 27.8 |                       |  | $            | 28.1 |  |  |  | 90.4 | % |  |  | 1.1 | %

Sales and marketing expenses consist primarily of
salaries for sales and marketing personnel, commissions and
promotional expenses. In 2000, sales and marketing expenses
increased by $13.2 million, or 90.4%, from
$14.6 million in 1999 to $27.8 million in 2000. The
increase was attributed to investments by the Company in
additional sales personnel and other promotional activities in
anticipation of continued sales growth in 2000. The number of
employees directly involved in the sales and marketing effort
increased from 55 at December 31, 1999 to 102 at
December 31, 2000. In 2001, sales and marketing expenses
increased only slightly, from $27.8 million in 2000 to
$28.1 million in 2001. While the Company continued to incur
sales and marketing related costs in the first and second
quarters of 2001 at approximately the same levels experienced in
2000, it began taking corrective actions late in the second
quarter of 2001 to adjust its infrastructure and other sales
related costs downward to better match lower anticipated levels
of revenue and sales opportunities which resulted from the
general market slow-down for information technology spending.
These actions included reducing the number of direct salesmen,
sales support and management personnel from 102 at
December 31, 2000 to 39 at December 31, 2001 through
employee severance and attrition, as well as rationalizing
facilities and other infrastructure costs and canceling a number
of significant marketing related promotional activities. As a
result of the Companys strategy of building stronger
relations with third-party software integrators to bolster its
distribution opportunities, and to the cost containment
activities begun in the later half of 2001, the Company
anticipates sales and marketing expenses decreasing both in
terms of absolute dollars and as a percentage of revenue in 2002.

|                         |  |               |     |      |  |      |      |                       |  |              |      |  |  |  |      |   |  |  |      |   
|------------------------ |  | ------------- | --- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- |  |  |  | ---- | - |  |  | ---- | --
|                         |  |               |     |      |  |      |      |                      
|                         |  |               |     |      |  |      |      | % increase (decrease)
|                         |  |               |     |      |  |      |      |                      
|                         |  | 1999          |     | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                         |  |               |     |      |  |      |      |                       |  |             
|                         |  |               |     |      |  |     
|                         |  | (in millions) |     |      |  |     
|Research and development |  | $             | 9.8 |      |  | $    | 19.0 |                       |  | $            | 17.3 |  |  |  | 93.9 | % |  |  | (8.9 | )%

Research and development expenses consist
primarily of employee salary and benefits, consultant costs, and
equipment and software maintenance costs associated with new
product development, enhancement of existing products and
quality assurance activities. In 2000, research and development
costs increased by $9.2 million, or 93.9%, from
$9.8 million in 1999 to $19.0 million in 2000. The
increase reflected the Companys investment in new Xchange
products, in particular the Xchange EnAct, Xchange Analytics and
Xchange Real Time products which were added to the
Companys product offerings in 2000. Total research and
development related headcount increased from 85 at
December 31, 1999 to 143 at December 31, 2000. In
2001, research and development costs decreased
$1.7 million, or 8.9%, from $19.0 million in 2000 to
$17.3 million in 2001. The reduction is related to
corrective actions the Company took beginning late in the second
quarter of 2001 to reprioritize its investment and commitment to
existing and new product offerings and features given its
reduced revenue base and need to conserve cash. These actions
included reducing

23



---



##### Table of Contents



research and development, engineering and
management personnel from 143 at December 31, 2000 to 63 at
December 31, 2001 through employee severance and attrition,
reducing the use of third-party consultants and rationalizing
facility and other infrastructure related costs. The Company
anticipates that as part of its reprioritization of product
development activities, research and development costs will
decrease both in terms of absolute dollars and as a percentage
of total revenue in 2002.


|                           |  |               |     |      |  |      |      |                       |  |              |      |  |  |  |       |   |  |  |      |  
|-------------------------- |  | ------------- | --- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- |  |  |  | ----- | - |  |  | ---- | -
|                           |  |               |     |      |  |      |      |                      
|                           |  |               |     |      |  |      |      | % increase (decrease)
|                           |  |               |     |      |  |      |      |                      
|                           |  | 1999          |     | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                           |  |               |     |      |  |      |      |                       |  |             
|                           |  |               |     |      |  |     
|                           |  | (in millions) |     |      |  |     
|General and administrative |  | $             | 4.9 |      |  | $    | 14.1 |                       |  | $            | 16.1 |  |  |  | 187.8 | % |  |  | 14.2 | %

General and administrative expenses consist
primarily of salaries and related costs, outside professional
fees, provision for uncollectible accounts receivable and
equipment and software depreciation costs associated with the
finance, legal, human resources, information systems, and
administrative functions of the Company. In 2000, general and
administrative expenses increased by $9.2 million, or
187.8%, from $4.9 million in 1999 to $14.1 million in
2000. The increase is attributed to an increase in general and
administrative headcount from 35 in December 31, 1999 to 76
at December 31, 2000. The Company began to increase its
administrative infrastructure in 2000 to accommodate an
approximate doubling of its employees and rapid increase in its
customer base. The Company also recorded $2.8 million in
charges associated with the write-off of specific bad debts,
provisions for future bad debts and return allowances, and
compensation expense associated with tax exposures on
international stock option expenses. In 2001, general and
administrative expense increased by $2.0 million, or 14.2%,
from $14.1 million in 2000 to $16.1 million in 2001.
The increase reflects the full year impact of increases in the
administrative infrastructure in the later part of 2000,
increases in legal and accounting fees associated with fund
raising activities, and provisions for bad debts of
approximately $2.4 million. Partially offsetting the
increases was the impact of corrective actions the Company took
beginning late in the second quarter of 2001 to reduce general
and administrative expense in line with the overall reduced
infrastructure needs of the Company and need to conserve case.
The actions included reducing general and administrative
headcount from 76 at December 31, 2000 to 25 at
December 31, 2001 through employee severance and attrition
and rationalizing facilities and other infrastructure costs. The
Company anticipates that as part of its cost containment actions
in the later part of 2001, general and administrative expense
will decrease both in terms of absolute dollars and as a
percentage of total revenue in 2002.

Cost
of acquisition

|                    |  |               |     |      |  |      |   |                       |  |              |   |  |  |  |      |    |  |  |     | 
|------------------- |  | ------------- | --- | ---- |  | ---- | - | --------------------- |  | ------------ | - |  |  |  | ---- | -- |  |  | --- | 
|                    |  |               |     |      |  |      |   |                      
|                    |  |               |     |      |  |      |   | % increase (decrease)
|                    |  |               |     |      |  |      |   |                      
|                    |  | 1999          |     | 2000 |  | 2001 |   | 1999 to 2000          |  | 2000 to 2001
|                    |  |               |     |      |  |      |   |                       |  |             
|                    |  |               |     |      |  |     
|                    |  | (in millions) |     |      |  |     
|Cost of acquisition |  | $             | 1.4 |      |  |      |  |                       |  |              |  |  |  |  | (100 | )% |  |  | n/a | 

On August 20, 1999, the Company acquired
eXstatic. Total costs associated with the acquisition of
$1.4 million included approximately $753,000 of non-cash
compensation charges associated with stock options, as well as
legal and accounting fees incurred by both organizations.

Impairment
of MicroStrategy investment, goodwill and other
intangibles

|                                                                           |  |               |   |      |  |      |      |                       |  |              |      |  |  |  |     |  |  |  |       |   
|-------------------------------------------------------------------------- |  | ------------- | - | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- |  |  |  | --- |  |  |  | ----- | --
|                                                                           |  |               |   |      |  |      |      |                      
|                                                                           |  |               |   |      |  |      |      | % increase (decrease)
|                                                                           |  |               |   |      |  |      |      |                      
|                                                                           |  | 1999          |   | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                                                                           |  |               |   |      |  |      |      |                       |  |             
|                                                                           |  |               |   |      |  |     
|                                                                           |  | (in millions) |   |      |  |     
|Impairment of MicroStrategy investment, goodwill
    and other intangibles |  |               |  |      |  | $    | 76.6 |                       |  | $            | 56.2 |  |  |  | n/a |  |  |  | (26.6 | )%

During the fourth quarter of 2000, the Company
recorded an impairment charge of $76.6 million related to
the goodwill recorded in connection with the acquisition of CA
based on its analysis of future discounted cash flows expected
to be generated from the CA business. In 2001, the Company took
an additional impairment charge of $24.9 related to goodwill and
other intangibles recorded in connection with the CA acquisition
resulting from the Companys further analysis of expected
cash flows and, ultimately, its decision to discontinue all
future sales activity and to sell the CA software technology to
Carreker Corporation. In

24



---



##### Table of Contents



2001, the Company took an impairment charge of
$6.8 million related to the goodwill recorded in connection with
the KSP acquisition based on a comparison of a third-party
indication of the fair value of the Company to the carrying
value of the Companys long-lived assets. The Company also
recorded a $24.5 million impairment charge in 2001 related
to the Companys MicroStrategy assets. See Notes 4 and
5 in the Companys Consolidated Financial Statements.


Interest
income (expense), net

|                               |  |               |     |      |  |      |      |                       |  |              |      |   |  |  |       |   |  |  |       |  
|------------------------------ |  | ------------- | --- | ---- |  | ---- | ---- | --------------------- |  | ------------ | ---- | - |  |  | ----- | - |  |  | ----- | -
|                               |  |               |     |      |  |      |      |                      
|                               |  |               |     |      |  |      |      | % increase (decrease)
|                               |  |               |     |      |  |      |      |                      
|                               |  | 1999          |     | 2000 |  | 2001 |      | 1999 to 2000          |  | 2000 to 2001
|                               |  |               |     |      |  |      |      |                       |  |             
|                               |  |               |     |      |  |     
|                               |  | (in millions) |     |      |  |     
|Interest income (expense), net |  | $             | 1.4 |      |  | $    | (1.6 | )                     |  | $            | (8.4 | ) |  |  | 214.3 | % |  |  | 414.9 | %

Interest income, net in 1999 related to interest
earned on proceeds from the Companys internal public
offering completed in December 1998 and its follow-on public
offering completed in June 1999. Interest expense, net in 2000
included $1.1 million of interest income more than offset
by $2.7 million in interest expense which was comprised of
$2.3 million in non-cash interest expense associated with
the MicroStrategy obligation, $248,000 in interest expense
associated with capital leases and $195,000 of interests on
notes issued in connection with the CA acquisition. Interest
expense, net in 2001 was comprised primarily of
$3.1 million in non-cash interest expense related to the
accretion of discounts on the convertible debentures,
$2.2 million in non-cash interest expense related to the
convertible debentures, $1.4 million in non-cash interest
expense related to the bridge notes and warrants issued to
Insight Capital Partners, $681,000 of non-cash interest expense
related to the MicroStrategy obligation, $252,000 of interest
expense related to the Companys bank line of credit,
$319,000 of interest expense related to the capital leases and
$375,000 of interest expense related to notes payable, offset by
$191,000 in interest income on excess cash balances.

Provision
for income taxes

|                           |  |               |     |      |  |      |   |                       |  |              |   |  |  |  |      |    |  |  |     | 
|-------------------------- |  | ------------- | --- | ---- |  | ---- | - | --------------------- |  | ------------ | - |  |  |  | ---- | -- |  |  | --- | 
|                           |  |               |     |      |  |      |   |                      
|                           |  |               |     |      |  |      |   | % increase (decrease)
|                           |  |               |     |      |  |      |   |                      
|                           |  | 1999          |     | 2000 |  | 2001 |   | 1999 to 2000          |  | 2000 to 2001
|                           |  |               |     |      |  |      |   |                       |  |             
|                           |  |               |     |      |  |     
|                           |  | (in millions) |     |      |  |     
|Provision for income taxes |  | $             | 2.2 |      |  |      |  |                       |  |              |  |  |  |  | (100 | )% |  |  | n/a | 

The Company recorded a provision for income taxes
for 1999 of $2.2 million or 67% of income before taxes. The
two primary reasons for the high effective tax rate were the
$1.4 million of non-tax deductible acquisition costs and
$405,000 dollars of non-tax deductible operating losses of
eXstatic prior to the August 20, 1999 acquisition date
included in the results of operations. Prior to its acquisition
eXstatic was structured as a sub-chapter S corporation
and, as such, the tax benefit of losses incurred through
August 20, 1999 reverted to eXstatics principals.
Because the acquisition was structured as non-taxable
transaction for the eXstatic shareholders, the Company does not
expect to realize any tax benefit from eXstatic losses incurred
prior to the acquisition.

The Company recorded a provision for income taxes
in 2000 and 2001 for minimum state and foreign income tax
requirements. However, no significant provision was recorded for
federal, state or foreign income taxes as the Company incurred
operating losses in those years. The Company has recorded a full
valuation allowance against the deferred tax asset generated as
a result of net-operating loss carry-forward incurred prior to
2001 because the Company believes it is more likely than not
that these assets will not be realized.

25



---



##### Table of Contents



Selected Quarterly Results of
Operations

The following tables present unaudited quarterly
consolidated statement of operations data for each quarter in
the eight quarters ended December 31, 2001, as well as such
data expressed as a percentage of the Companys total
revenues. This data has been derived from unaudited consolidated
financial statements that have been prepared on the same basis
as the audited consolidated financial statements and include all
adjustments (consisting only of normal recurring adjustments)
that the Company considers necessary for a fair presentation of
such information. The Company believes quarter-to-quarter
comparisons of its financial results should not be relied upon
as an indication of future performance, and operations results
may fluctuate from quarter to quarter in the future.

|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |        |        | 
|---------------------------------------------- | ---------------------------------------------------------------------- | ------------------------ | ------ | -------- | ------ | --------- | ------ | -------- | ------ | --------- | ------- | -------- | ------ | --------- | -------- | -------- | ------- | - | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ----- | ------ | - | ------- | ------ | ------ | 
|                                               |                                                                        |                         
|                                               |                                                                        | Quarter Ended           
|                                               |                                                                        |                         
|                                               |                                                                        | March 31,                |        | June 30, |        | Sept. 30, |        | Dec. 31, |        | March 31, |         | June 30, |        | Sept. 30, |          | Dec. 31,
|                                               |                                                                        | 2000                     |        | 2000     |        | 2000      |        | 2000     |        | 2001      |         | 2001     |        | 2001      |          | 2001    
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |         
|                                               |                                                                        |                         
|                                               |                                                                        | (in thousands)          
|Consolidated Statement of Operations
    Data: |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Revenues:                                      |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               | Software license fees                                                  |                          | $      | 10,262   |        |           | $      | 13,351   |        |           | $       | 5,940    |        |           | $        | 8,517    |         |   | $       | 9,045  |        |   | $       | 4,628  |        |   | $       | 3,623 |        |   | $       | 4,413  |       
|                                               | Services and maintenance                                               |                          |        | 4,900    |        |           |        | 6,287    |        |           |         | 6,549    |        |           |          | 5,770    |         |   |         | 6,715  |        |   |         | 6,179  |        |   |         | 5,485 |        |   |         | 4,623  |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               |                                                                        | Total revenues           |        |          | 15,162 |           |        |          | 19,638 |           |         |          | 12,489 |           |          |          | 14,287  |   |         |        | 15,760 |   |         |        | 10,807 |   |         |       | 9,108  |   |         |        | 9,036  | 
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |         
|Cost of revenues:                              |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |         
|                                               | Software license fees                                                  |                          |        | 141      |        |           |        | 221      |        |           |         | 164      |        |           |          | 250      |         |   |         | 203    |        |   |         | 298    |        |   |         | 47    |        |   |         | 953    |       
|                                               | Services and maintenance                                               |                          |        | 3,343    |        |           |        | 4,147    |        |           |         | 5,896    |        |           |          | 5,089    |         |   |         | 4,514  |        |   |         | 4,601  |        |   |         | 3,205 |        |   |         | 1,746  |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               |                                                                        | Total cost of revenues   |        |          | 3,484  |           |        |          | 4,368  |           |         |          | 6,060  |           |          |          | 5,339   |   |         |        | 4,717  |   |         |        | 4,899  |   |         |       | 3,252  |   |         |        | 2,699  | 
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Gross profit                                   |                                                                        |                          | 11,678 |          |        |           | 15,270 |          |        |           | 6,429   |          |        |           | 8,948    |          |         |   | 11,043  |        |        |   | 5,908   |        |        |   | 5,856   |       |        |   | 6,337   |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |         
|Operating expenses:                            |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |         
|                                               | Sales and marketing                                                    |                          |        | 4,841    |        |           |        | 6,188    |        |           |         | 7,424    |        |           |          | 9,387    |         |   |         | 10,280 |        |   |         | 9,448  |        |   |         | 5,301 |        |   |         | 3,091  |       
|                                               | Research and development                                               |                          |        | 3,212    |        |           |        | 4,576    |        |           |         | 5,885    |        |           |          | 5,286    |         |   |         | 6,221  |        |   |         | 5,155  |        |   |         | 3,262 |        |   |         | 2,614  |       
|                                               | General and administrative                                             |                          |        | 1,945    |        |           |        | 2,250    |        |           |         | 6,356    |        |           |          | 3,563    |         |   |         | 4,241  |        |   |         | 5,417  |        |   |         | 4,319 |        |   |         | 2,141  |       
|                                               | Amortization of goodwill and other intangibles                         |                          |        |         |        |           |        | 3,506    |        |           |         | 9,288    |        |           |          | 9,537    |         |   |         | 5,130  |        |   |         | 5,189  |        |   |         | 3,123 |        |   |         | 3,124  |       
|                                               | Amortization of MicroStrategy assets                                   |                          |        | 4,905    |        |           |        | 5,105    |        |           |         | 4,906    |        |           |          | 4,906    |         |   |         | 4,906  |        |   |         | 4,906  |        |   |         | 4,074 |        |   |         | 4,073  |       
|                                               | Impairment of MicroStrategy assets, goodwill and
    other intangibles |                          |        |         |        |           |        |         |        |           |         |         |        |           |          | 76,604   |         |   |         |       |        |   |         | 19,349 |        |   |         |      |        |   |         | 36,827 |       
|                                               | Restructuring charge                                                   |                          |        |         |        |           |        |         |        |           |         |         |        |           |          |         |         |   |         |       |        |   |         | 7,460  |        |   |         | 8,404 |        |   |         | 3,308  |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|                                               |                                                                        | Total operating expenses |        |          | 14,903 |           |        |          | 21,625 |           |         |          | 33,859 |           |          |          | 109,283 |   |         |        | 30,778 |   |         |        | 56,924 |   |         |       | 28,483 |   |         |        | 55,178 | 
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Income (loss) from operations                  |                                                                        |                          | (3,225 | )        |        |           | (6,355 | )        |        |           | (27,430 | )        |        |           | (100,335 | )        |         |   | (19,735 | )      |        |   | (51,016 | )      |        |   | (22,627 | )     |        |   | (48,841 | )     
|Interest income (expense), net                 |                                                                        |                          | (170   | )        |        |           | (303   | )        |        |           | (545    | )        |        |           | (617     | )        |         |   | (541    | )      |        |   | (1,671  | )      |        |   | (2,523  | )     |        |   | (3,684  | )     
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Income (loss) before provision for income tax  |                                                                        |                          | (3,395 | )        |        |           | (6,658 | )        |        |           | (27,975 | )        |        |           | (109,952 | )        |         |   | (20,276 | )      |        |   | (52,687 | )      |        |   | (25,150 | )     |        |   | (52,525 | )     
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Provision for income taxes                     |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           | 9        |          |         |   | 6       |        |        |   | 6       |        |        |   | 21      |       |        |   | 5       |       
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       
|Net income (loss)                              |                                                                        | $                        | (3,395 | )        |        | $         | (6,658 | )        |        | $         | (27,975 | )        |        | $         | (100,961 | )        |         | $ | (20,282 | )      |        | $ | (52,693 | )      |        | $ | (25,171 | )     |        | $ | (52,530 | )     
|                                               |                                                                        |                          |        |          |        |           |        |          |        |           |         |          |        |           |          |          |         |   |         |        |        |   |         |        |        |   |         |       |        |   |         |       

26



---



##### Table of Contents



|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |       |       | 
|--------------------------------------------- | ---------------------------------------------------------------------- | ------------------------ | ----- | -------- | ----- | --------- | ----- | -------- | ----- | --------- | ------ | -------- | ----- | --------- | ------ | -------- | ----- |  | ------ | ---- | ----- |  | ------ | ----- | ----- |  | ------ | ---- | ----- |  | ------ | ----- | ----- | 
|                                              |                                                                        |                         
|                                              |                                                                        | Quarter Ended           
|                                              |                                                                        |                         
|                                              |                                                                        | March 31,                |       | June 30, |       | Sept. 30, |       | Dec. 31, |       | March 31, |        | June 30, |       | Sept. 30, |        | Dec. 31,
|                                              |                                                                        | 2000                     |       | 2000     |       | 2000      |       | 2000     |       | 2001      |        | 2001     |       | 2001      |        | 2001    
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |         
|As a Percentage of Total Revenues:            |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|Revenues:                                     |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              | Software license fees                                                  |                          |       | 67.7     | %     |           |       | 68.0     | %     |           |        | 47.6     | %     |           |        | 59.6     | %     |  |        | 57.4 | %     |  |        | 42.8  | %     |  |        | 39.8 | %     |  |        | 48.8  | %    
|                                              | Services and maintenance                                               |                          |       | 32.3     |       |           |       | 32.0     |       |           |        | 52.4     |       |           |        | 40.4     |       |  |        | 42.6 |       |  |        | 57.2  |       |  |        | 60.2 |       |  |        | 51.2  |      
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              |                                                                        | Total revenues           |       |          | 100.0 |           |       |          | 100.0 |           |        |          | 100.0 |           |        |          | 100.0 |  |        |      | 100.0 |  |        |       | 100.0 |  |        |      | 100.0 |  |        |       | 100.0 | 
|Cost of revenues:                             |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              | Software license fees                                                  |                          |       | 1.0      |       |           |       | 1.1      |       |           |        | 1.3      |       |           |        | 1.8      |       |  |        | 1.3  |       |  |        | 2.8   |       |  |        | 0.5  |       |  |        | 10.5  |      
|                                              | Services and maintenance                                               |                          |       | 22.0     |       |           |       | 21.1     |       |           |        | 47.2     |       |           |        | 35.6     |       |  |        | 28.6 |       |  |        | 42.6  |       |  |        | 35.2 |       |  |        | 19.3  |      
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              |                                                                        | Total cost of revenues   |       |          | 23.0  |           |       |          | 22.2  |           |        |          | 48.5  |           |        |          | 37.4  |  |        |      | 29.9  |  |        |       | 45.3  |  |        |      | 35.7  |  |        |       | 29.9  | 
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|Gross margin                                  |                                                                        |                          | 77.0  |          |       |           | 77.8  |          |       |           | 51.5   |          |       |           | 62.6   |          |       |  | 70.1   |      |       |  | 54.7   |       |       |  | 64.3   |      |       |  | 70.1   |      
|Operating expenses:                           |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              | Sales and marketing                                                    |                          |       | 31.9     |       |           |       | 31.5     |       |           |        | 59.4     |       |           |        | 65.7     |       |  |        | 65.2 |       |  |        | 87.4  |       |  |        | 58.2 |       |  |        | 34.2  |      
|                                              | Research and development                                               |                          |       | 21.2     |       |           |       | 23.3     |       |           |        | 47.1     |       |           |        | 37.0     |       |  |        | 39.5 |       |  |        | 47.7  |       |  |        | 35.8 |       |  |        | 28.9  |      
|                                              | General and administrative                                             |                          |       | 12.8     |       |           |       | 11.4     |       |           |        | 50.9     |       |           |        | 24.9     |       |  |        | 26.9 |       |  |        | 50.1  |       |  |        | 47.4 |       |  |        | 23.7  |      
|                                              | Amortization of goodwill and other intangibles                         |                          |       |         |       |           |       | 17.9     |       |           |        | 74.4     |       |           |        | 66.8     |       |  |        | 32.6 |       |  |        | 48.0  |       |  |        | 34.3 |       |  |        | 34.6  |      
|                                              | Amortization of MicroStrategy assets                                   |                          |       | 32.4     |       |           |       | 26.0     |       |           |        | 39.3     |       |           |        | 34.3     |       |  |        | 31.1 |       |  |        | 45.4  |       |  |        | 44.7 |       |  |        | 45.1  |      
|                                              | Impairment of MicroStrategy assets, goodwill and
    other intangibles |                          |       |         |       |           |       |         |       |           |        |         |       |           |        | 536.2    |       |  |        |     |       |  |        | 179.0 |       |  |        |     |       |  |        | 407.6 |      
|                                              | Restructuring charge                                                   |                          |       |         |       |           |       |         |       |           |        |         |       |           |        |         |       |  |        |     |       |  |        | 69.0  |       |  |        | 92.3 |       |  |        | 36.6  |      
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|                                              |                                                                        | Total operating expenses |       |          | 98.3  |           |       |          | 110.1 |           |        |          | 271.1 |           |        |          | 764.9 |  |        |      | 195.3 |  |        |       | 526.7 |  |        |      | 312.7 |  |        |       | 610.6 | 
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|Income (loss) from operations                 |                                                                        |                          | (21.3 | )        |       |           | (32.3 | )        |       |           | (219.6 | )        |       |           | (702.3 | )        |       |  | (125.2 | )    |       |  | (472.1 | )     |       |  | (248.4 | )    |       |  | (540.5 | )    
|Interest income (expense), net                |                                                                        |                          | (1.1  | )        |       |           | (1.5  | )        |       |           | (4.4   | )        |       |           | (4.3   | )        |       |  | (3.4   | )    |       |  | (15.5  | )     |       |  | (27.7  | )    |       |  | (40.8  | )    
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|Income (loss) before provision for income tax |                                                                        |                          | (22.4 | )        |       |           | (33.9 | )        |       |           | (224.0 | )        |       |           | (706.6 | )        |       |  | (128.7 | )    |       |  | (487.5 | )     |       |  | (276.1 | )    |       |  | (581.3 | )    
|Provision for income taxes                    |                                                                        |                          |      |          |       |           |      |          |       |           |       |          |       |           | 0.1    |          |       |  | 0.0    |      |       |  | 0.1    |       |       |  | 0.2    |      |       |  | 0.1    |      
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      
|Net income (loss)                             |                                                                        |                          | (22.4 | )%       |       |           | (33.9 | )%       |       |           | (224.0 | )%       |       |           | (706.7 | )%       |       |  | (128.7 | )%   |       |  | (487.6 | )%    |       |  | (581.3 | )%   |       |  | (581.3 | )%   
|                                              |                                                                        |                          |       |          |       |           |       |          |       |           |        |          |       |           |        |          |       |  |        |      |       |  |        |       |       |  |        |      |       |  |        |      

Through June 30, 2000 the Companys
revenue had increased in every quarter for the previous ten
quarters as the Company continued to realize market acceptance
for its products, the continued growth of indirect channel
revenues, increases in sales resources and increases in
international revenues. In the third quarter of 2000 the Company
realized a significant decrease in total revenue resulting from
decrease in software license fee revenue due to poor sales
execution as well as the impact of contract accounting on some
transactions entered in the third quarter of 2000. The impact of
the decrease in software license revenue in the third quarter
had helped cause the reduced services and maintenance revenue in
the fourth quarter of 2000. While the Company experienced modest
increases in the total revenue in the fourth quarter of 2000 and
first quarter of 2001 due to an improvement in software license
fee revenue, the Company experienced a significant revenue
decrease in the second quarter of 2001 and subsequent declines
in the third and fourth quarters. The declines resulted from
fewer new software license deals and related services engagement
revenue due to: (i) delays in completing sales resulting
from the Companys efforts to reorganize its sales
and distributions strategy and personnel to effectively sell its
new Xchange 8 product and services suite, (ii) a longer
sales cycle, and (iii) a general market slow-down for
information technology spending. In the first, second, third and
fourth quarters of 2001 one customer, Carreker Corporation,
accounted for 25.2%, 36.3%, 16.8% of 23.3% of total revenues,
respectively, under an exclusive reseller arrangement. This
arrangement ended in December 2001 and the Company does not
anticipate any further revenue from this customer. While the
Company realized an increase in software license fee revenues in
the fourth quarter of 2001, there can be no assurances it will
continue to see positive quarterly growth.

27



---



##### Table of Contents



Cost of revenues as a percentage of revenue
generally increased during the period from the second quarter of
2000 to the second quarter of 2001 due to a shift in the mix of
revenue to a higher percentage of lower margin service and
maintenance revenue, and due to the Companys efforts to
expand its services infrastructure and capacity due to
anticipated revenue growth which did not materialize. Cost of
revenues as a percentage of total revenues improved in the third
and fourth quarters of 2001, as a result of corrective actions
taken to control costs in response to the short-term revenue
forecast. The Company anticipates that the total cost of revenue
will decrease both in terms of absolute dollars and as a
percentage of revenue in 2002 due to the full year impact of
cost saving initiatives and an improvement in the mix of revenue
to include a increased percentage of higher margin software
license fee revenue.

Operating expenses, exclusive of impairment and
restructuring changes, increased in virtually every quarter
presented through the first quarter of 2001, as the Company
consciously increased its personnel, facilities and other
infrastructure costs in anticipation of continued revenue
growth. Overall operating costs, excluding unusual charges,
decreased starting in the second quarter of 2001 as the impact
of corrective actions to reduce expenses and conserve cash began
to take effect.

The Companys quarterly and annual operation
results have varied significantly in the past and are expected
to do so in the future. Accordingly, the Company believes that
period-to-period comparisons of its results of operations are
not necessarily meaningful and should not be relied upon as
predictors of future performance. See Risk
Factors  Our quarterly operating results may
fluctuate significantly and you should not rely on them to
predict our future performance.

Liquidity and
Capital Resources

Since inception, the Company has financed
its operations primarily through the sale of equity
securities in private placements, the issuance of notes payable
to related parties, the issuance of convertible debentures and
the sales of common stock as part of its initial public stock
offering in December 1998 and its follow-on public stock
offering in June 1999. The Company has also utilized
$4.2 million of a $5 million secured credit from
Silicon Valley Bank (SVB). As of December 31,
2001 the Company had $7.0 million in cash and cash
equivalents.

The Company has sustained net losses and negative
cash flows from operations in 2000 and 2001. In addition, as of
December 31, 2001 the Company has a significant working
capital deficit, its bank line of credit matured on
April 25, 2002, and certain other notes payable are due in
June 2002. The Companys ability to meet its obligations in
the ordinary course of business and to continue as a going
concern is dependent on its ability to reduce net operating
expenses and refinance its existing obligations, or raise
additional financing through public or private equity financing
or other sources of financing to fund operations. There is no
assurance that the Company will be successful in its efforts to
raise additional capital, renegotiate its existing obligations
or to sufficiently reduce its operating expenses, all of which
may have a material adverse impact on the Companys
solvency. These factors raise substantial doubt about the
Companys ability to continue as a going concern. The
financial statements do not include any adjustments that might
result as the outcome of this uncertainty.

For the year ended December 31, 2001, net
cash used in operating activities was $32.4 million
resulting primarily from a loss of $35.0 million before
amortization expense and other non-cash charges, offset by a
decrease in working capital of $2.6 million.

Net cash used in investing activities in 2001 of
$480,000 was primarily the result of property and equipment
purchases of $2.3 million during the first quarter of 2001
related to the increase in headcount and investments in
infrastructure, partially offset by a tax refund of
$1.1 million related to the CA acquisition which was
accounted for as a adjustment to the KSP goodwill balance.

Net cash provided by financing activities of
$31.4 million consisted of $20.0 million in net
proceeds from the issuance of convertible debentures,
$4.6 million in net proceeds from the sale of Series A
Redeemable Convertible Preferred Stock, $6.9 million in net
proceeds from the issuance of notes payable to Insight,
$4.2 million in net borrowings under the Companys
credit facility, and $250,000 of proceeds from the sale of

28



---



##### Table of Contents



common stock under our Employee Stock Purchase
Plan. These contributions were offset by the repayment of
$2.1 million of capital lease obligations and
$2.5 million from the repayment of a note payable to former
investors of CA.


On April 16, 2001, the Company received an
undertaking letter (the Undertaking Letter) from
Insight Venture Associates IV, L.L.C. through four of its
affiliated funds (collectively Insight) under which
Insight agreed to provide additional financing to support the
Companys ongoing business operations (the Additional
Financing). In June 2001, the Company issued a 12% Bridge
Promissory Note (the June Note) to Insight for a
purchase price of $7,000,000. The June Note refinanced
previously issued notes to Insight as well as provided an
additional $2.5 million in funding. In July 2001, the
Company issued senior subordinated secured convertible
debentures (the July Debentures) to Insight in the
principal amount of $12.2 million. The July Debentures
refinanced the Companys obligations under the June Note
and provided an additional $5.0 million in funding. In
August 2001, the Company issued an additional $15.5 million
of senior subordinated secured convertible debentures to Insight
and several other investors (the August Debentures).
In connection with the closing of the sale of the August
Debentures, the terms of the July Debentures were modified to be
identical to the August Debentures. As of September 30,
2001, Insight had fulfilled its obligation under the terms of
the Undertaking Letter. Under Nasdaq Marketplace Rules 4350
(i) shareholder approval is normally required for
investments similar to the July Debentures and the August
Debentures. However, the Company requested from Nasdaq an
exception to this shareholder approval requirement pursuant to
Nasdaq Marketplace Rule 4350 (i) (2). Rule 4350 (i)
(2) provided that exceptions may be made upon application
to Nasdaq when: (A) the delay in securing shareholder
approval would seriously jeopardize the financial viability of
the enterprise; and (b) reliance by the company on this
exception is expressly approved by the Audit Committee or a
comparable body of the Board of Directors. The Company
obtained such exception to the shareholder approval requirements
from Nasdaq, citing its immediate need for funds.

In April 2001, the Company also received a
$5.0 million secured credit facility from SVB. Availability
under the credit facility is based on a percentage of
eligible receivables. Eligible receivables are all
U.S. dollar based trade receivables, excluding receivables over
90 days past due and receivables from companies in certain
Internet related industries. Eligible receivables have averaged
approximately 55%-75% of our total outstanding receivables. In
addition, the Company must maintain at least $2.0 million
in cash or excess borrowing capacity at all times. During 2001,
the Company received net proceeds of $4.2 million under the
line of credit. The credit facility expires on April 24,
2002. The Company is subject to certain operational and
financial covenants under the terms of the agreement. As of
December 31, 2001 the Company was in compliance with those
covenants.

On May 3, 2002 the Company secured two
credit facilities from SVB. The first replaces the
Companys previous secured credit facility with a $4
million revolving credit facility secured by all the
Companys assets. Availability under the line is based on
advances against the Companys accounts receivable in a
similar fashion as the previous secured credit line. The line
bears interest at the banks prime rate plus 2.5% points
and matures in one year. The second line is a $4 million credit
facility collateralized by a guarantee by Insight
(Guaranteed Line). The Guaranteed Line bears
interest at the banks prime rate plus 0.5% points and
matures in one year. In the event of a default on the Guaranteed
Line, Insight must purchase, and the Company must sell, notes
equal to the then outstanding principal and interest on the
collateralized line, the proceeds of which must be used to repay
SVB in full. See Note 19 in the Companys Consolidated
Financial Statements.

On May 2, 2002, the Company announced it had
received a preliminary offer from a group led by Insight to
acquire the Company. The offer is non-binding and subject to
customary conditions, including the execution of definitive
agreements. The Companys Board of Directors has formed a
Special Independent Committee to evaluate the offer.

The Company currently has sales offices in the
United Kingdom and Australia, in addition to the United States.
The Companys revenues from international operations have
been denominated in foreign currencies which historically have
been stable in relation to U.S. dollars. As a result, the gain
or loss from foreign

29



---



##### Table of Contents



currency transactions has not been material to
its operating results. As of December 31, 2001, the
materials assets and liabilities denominated in foreign
currencies include accounts receivable, accounts payable and
cash and cash equivalents. While it is anticipated that foreign
transactions will continue to be denominated in local
currencies, the Company expects to use hedging instruments to
offset potential currency exposures arising if its international
operations expand into less stable economic environments.
Inflation has not had a material impact on the Company financial
position or results from operations.


Recent
Accounting Pronouncements

In July 2001, the Financial Accounting Standards
Board (FASB) issued SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and other
Intangible Assets. Statement No. 141 requires that all
business combinations initiated after June 30, 2001, be
accounted for using the purchase method of accounting. Statement
No. 142 discusses how intangible assets that are acquired
should be accounted for in financial statements upon their
acquisition and also how goodwill and other intangible assets
should be accounted for after they have been initially
recognized in the financial statement. Beginning on
January 1, 2002, with the adoption of Statement
No. 142, goodwill and certain purchased intangibles
existing on June 30, 2001, will no longer be subject to
amortization over their estimated useful life. Rather goodwill
and certain purchased intangibles will be subject to an
assessment for impairment. The provisions of Statement
No. 142 are required to be applied starting with fiscal
years beginning after December 15, 2001. The Company does
not anticipate an impairment charge upon adoption.

In August 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. This statement supercedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of, and the
accounting and reporting provisions of Accounting Principals
Board (APB) Opinion No. 30, Reporting the
Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions. Under
this statement it is required that one accounting model be used
for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and it broadens the
presentation of discontinued operations to include more disposal
transactions. The provisions of this statement are effective for
financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal
years, with early adoption permitted. The Company is currently
evaluating the ultimate impact of this statement on its results
of operations or financial position until such time as its
provisions are applied.

30



---



##### Table of Contents






RISK FACTORS

Statements in this report concerning the
future results of operations, financial condition and business
of the Company are forward-looking statements as
defined in the Securities Act of 1933 and the Securities
Exchange Act of 1934. Investors are cautioned that information
contained in these forward-looking statements is inherently
uncertain, and that actual performance and results may differ
materially due to numerous risk factors. The following are all
the risk factors the Company believes are material:

We will require additional financing, which
may be difficult to obtain and may dilute our shareholders
ownership interest.

We will require additional capital to fund our
operations. We may seek additional funding through public or
private financings. Additional funding may not be available on
terms acceptable to us or at all. If we raise additional funds
by issuing equity securities, further dilution to our then
existing stockholders may result. In addition, the terms may
adversely affect the rights of our stockholders.

Our limited operating history makes
evaluating our business difficult.

We began commercial shipment of the initial
Xchange Campaign product (previously known as VALEX) in July
1996. We were not a separate company until November 1996.
Accordingly, we have only a limited operating history in order
to evaluate our business. The risks, expenses and difficulties
that an early-stage company like ours faces must be considered.
These risks include our ability to:



| |   |                                                               
| | - | --------------------------------------------------------------
| |  | successfully respond to competitive developments;             
|
| |  | continue to upgrade our products and service
	offerings; and  
|
| |  | continue to attract, retain and motivate
	qualified personnel.

Our quarterly operating results have
fluctuated significantly and you should not rely on them to
predict our future performance.

Our quarterly revenues, expenses and operating
results may vary significantly from quarter to quarter due to a
number of factors, including the continuous evolution of our
product offerings, the success or lack thereof we have in
selling the Xchange 8 product, the integration of new members of
our management team, the markets acceptance of our
products, the markets tendency or lack thereof to purchase
CRM software, and the general economic climate. Therefore,
period-to-period comparisons of results of operations should not
be relied on as an indication of future performance. Moreover,
our operating results may fall below market analysts
expectations in some future quarters. This could cause the
trading price of our common stock to decline.

We will be unable to increase our customer
base if new customers do not accept our solutions.

We currently derive most of our revenues from our
Xchange 8 product suite and services related to our CRM
solution. We anticipate that these sources will continue to
account for a majority of our revenues for the foreseeable
future. As a result, our business will suffer if the market does
not accept our solutions and our future enhancements of these
solutions. If demand for our solutions drops as a result of
competition, technological change or other factors, our business
could be substantially harmed.

The market for CRM applications is still emerging
and it may not continue to grow. Even if the market does grow,
businesses may not adopt our solutions. We have spent, and
intend to continue to spend, considerable resources educating
potential customers about customer optimization software and
services in general and about the features and functions of our
products and services in particular. However, our solutions may
not achieve any additional degree of market acceptance. If the
market for our solutions fails to grow or grows more slowly than
we currently anticipate, our business would be materially harmed.

31



---



##### Table of Contents



We depend on a few industries for most of
our sales, and we may not be successful in expanding beyond
those limited markets.

A substantial portion of our revenues has been
derived from sales to telecommunications companies and financial
institutions, including retail banks, credit card issuers and
mutual fund companies. We may not continue to be successful in
these markets. In addition, we may not be successful in
achieving significant market acceptance in other markets that we
target.

The loss of one of our largest customers
could cause our revenues to drop quickly and
unexpectedly.

In 1999, 2000 and 2001, our top five customers
accounted for 37.7%, 26.9% and 41.9% of total revenues,
respectively. We cannot be certain that our current customers
will continue to do business with us, that business from
existing customers will continue at the levels of previous
periods, or that we will be able to do a significant amount of
business with new customers. If we lose one of our customers,
our revenues could drop more quickly than we could reduce
expenses. This could substantially harm our financial results.

Our business will not grow if we do not
keep pace with rapidly changing technologies.

Because the market for our software products is
rapidly changing, our future success will depend upon our
ability to continue to enhance our current product line. We also
must develop and introduce new products that keep pace with
technological developments, satisfy increasingly sophisticated
customer requirements and achieve market acceptance. In
particular, our business could be harmed by any significant
errors or bugs in our software shipped to customers,
any delay by customers in making purchasing decisions in
anticipation of the general availability of new or enhanced
products, significant delays in the general availability of our
new products or releases, significant problems in the
installation or implementation of our new products or releases,
or customer dissatisfaction with our new products or releases.

Competition could reduce our market share
and harm our business.

Our competitors may be able to develop products
and services that are more attractive to businesses than our
products and services. Many of our competitors have longer
operating histories, significantly greater financial, technical,
marketing and other resources, greater name recognition and
larger customer bases. As a result, they may be able to adapt
more quickly to new or emerging technologies and changes in
customer requirements. They also may be able to devote greater
resources to the promotion and sale of their products and
services than we may. If these companies introduce products and
services that effectively competed with our products and
services, they could be in a position to charge lower prices or
to bundle their products and services with their other products
and services. This could give them a competitive advantage over
us.

In order to be successful in the future, we must
continue to respond promptly and effectively to the challenges
of technological change and competitors innovations. If we
cannot compete successfully with existing or new competitors, we
may have to reduce prices on our products, which could lead to
reduced profits. We could also lose market share, which would
materially and adversely affect our business.

Reductions in capital spending by our
existing and potential customers could reduce the demand for our
products.

Historically, corporations and other
organizations have tended to reduce or defer major capital
expenditures in response to slower economic growth or recession.
Market analysts have observed a significant reduction in the
growth of corporate spending on information technology projects
in response to the current economic slowdown. To the extent that
current economic uncertainty persists, some of the prospective
customers in our current sales pipeline could choose to postpone
or reduce orders for our products, or may delay implementing our
solutions within their organizations. In addition, existing
customers seeking to reduce capital expenditures may cancel or
postpone plans to expand use of our products in additional
operating divisions, or may defer plans to purchase additional
modules of our solutions. Any of the foregoing would have an
adverse impact on our revenues and our operating results,
particularly if the current period of volatility in the stock
market and the general economy were prolonged.

32



---



##### Table of Contents



If we do not successfully select and
maintain relationships with indirect distribution channels, our
sales could decline or could grow more slowly than
expected.

We expect to increase the amount of our products
that we distribute through various indirect channels. Currently
39% of our products are distributed through various indirect
channels. We expect to increase this to approximately 50%. Our
future performance will also depend, in part, on our ability to
attract organizations that will effectively market and support
our products, especially in markets in which we have not
previously distributed our products. Furthermore, we are unable
to predict the extent to which our distribution partners will be
successful in distributing our products. We rely on the
marketing and sales efforts of these organizations, many of
which also market and sell competitive products. None of our
agreements governing the re-seller or co-marketing relationships
with these organizations includes any commitments on the part of
these organizations to effect any minimum number of sales of our
products, or otherwise to provide us with business. The loss of
one or more of our relationships with these organizations could
have a material adverse effect on our business.

We have a limited ability to protect our
intellectual property rights and others could infringe on or
misappropriate our proprietary rights.

Our success and ability to compete are
substantially dependent on our internally developed technologies
and trademarks, which we protect through a combination of
copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions.

Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as
proprietary. Policing unauthorized use of our products is
difficult and, while we are unable to determine the extent to
which piracy of our software products exists, we expect software
piracy to be a problem. In addition, the laws of some foreign
countries do not protect our proprietary rights to the same
extent as the laws of the United States. Furthermore, our
competitors may independently develop technology similar to ours.

The number of intellectual property claims may
increase as the number of competing products grows and the
functionality of products in different industry segments
overlaps. Although we are not aware that any of our products
infringe upon the proprietary rights of third parties, there can
be no assurance that third parties will not claim infringement
by us with respect to current or future products. Any of these
claims, with or without merit, could be time consuming to
address, result in costly litigation, cause product shipment
delays or require us to enter into royalty or licensing
agreements. These royalty or licensing agreements, if required,
might not be available on terms acceptable to us or at all,
which could have a material adverse effect upon our business.

If we do not successfully grow our
international operations, our business may not increase as much
as necessary.

We have operations in a number of foreign
markets. We currently have customers in more than 33 countries.
We believe that we must expand our sales in international
markets in order for our business to grow as planned. If we are
unable to do so in a timely and effective manner, our growth in
international sales will be limited, and our business could be
materially adversely affected because it will not grow as
planned.

If we do not successfully manage our
international operations, our business may suffer.

As noted earlier, we believe that we must
continue to expand our sales in international markets in order
for our business to grow as planned. We have begun to translate
our products into different languages and character sets, which
may be more difficult or expensive to complete than expected.
Foreign markets may have longer selling cycles and different
product requirements than the United States and we may not be
able to successfully adapt our products and methods. In
addition, successful management of our international operations
will require continued compliance with a variety of foreign laws
and regulations, compliance with changes in regulatory
requirements, and efficient responses to changes in general
economic conditions of foreign markets.

33



---



##### Table of Contents



If we do not successfully manage our
international finances our business may suffer.

To operate successfully in foreign markets, we
must remain keenly aware of the vagaries of international
finance when operating our organization. In particular, items
which may affect the operation of our international finances may
include longer accounts-receivable payment cycles in certain
countries, a variety of different tax structures with which we
must comply, and a variety of selling cycles that come into play
depending on the market. We must continue to maintain an
awareness of these factors if we are to successfully operate in
multiple foreign markets.

Currency fluctuations and general economic
conditions in our foreign markets may impact our customers
spending and the value of money owed to us.

We have made substantial sales to international
customers in Australia, Canada, Denmark, Germany, the
Netherlands, Sweden, and the United Kingdom. As a result, we
have not adopted a policy of hedging foreign currency risks. If
economic conditions in our target markets decline, currencies
could fluctuate relative to the U.S. dollar, and our customers
could reduce their information technology spending.

Our officers, directors and principal
stockholders have substantial control over our voting stock and
have the ability to make decisions that could cause a negative
reaction in the marketplace causing our stock price to
fall.

As of January 2002, our current officers,
directors and principal stockholders held approximately
43 percent of our outstanding common stock and voting
common stock equivalents. Consequently, this group will be able
to exert some control over the outcome of all matters submitted
for stockholder action, including the election of members to our
Board of Directors and the approval of significant change in
control transactions, which may have the effect of delaying or
preventing a change in control. Representatives of the existing
stockholders constitute all six directors and will therefore
have significant influence in directing the actions of the Board
of Directors.

We are, and may in the future be, subject
to future product liability claims.

Xchange is currently a defendant in a routine
product liability case that is incidental to the normal course
of business. We believe that the outstanding claim lacks merit
and we are in the process of vigorously defending it. While our
license agreements with our customers typically contain
provisions designed to limit our exposure to potential product
liability claims, it is possible that these provisions may not
be effective under the laws of certain jurisdictions. At this
time, the total potential product-related liability for any
individual claim should not exceed the insurance deductible of
$250,000. Although we are fully insured for product-related
errors, a successful product liability claim brought against us
could have a material adverse effect on our business because it
may negatively affect our reputation in the industry and because
it may increase the expense of obtaining insurance in the
future. Moreover, defending these claims, regardless of merit,
could require the time and attention of key internal personnel.

Our common stock price is likely to be
volatile.

The market for securities of most high technology
companies, including our common stock, has been highly volatile.
It is likely that the market price of the common stock will
continue to fluctuate widely in the future. Factors that have
affected the trading price of our common stock in the past
include responses to quarterly variations in our results of
operations, the announcement of new products or product
enhancements by us or our competitors, technological innovation
by us or our competitors, general market conditions or market
conditions specific to particular industries, and changes in
earnings estimates by analysts.

We have adopted anti-takeover provisions
that could affect the market price of our common stock or our
ability to sell our business.

Certain provisions of our amended and restated
certificate of incorporation and our by-laws could make it more
difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders. Included

34



---



##### Table of Contents



among these provisions are staggered terms for
the Board of Directors, thereby making it difficult for an
individual director to vote himself into a control position; the
Board of Directors authority to issue, at any time,
preferred stock that could have the effect of making the
financial condition of the Company less attractive in a hostile
takeover attempt; and the Board of Directors wide latitude
regarding tender offers, including its authorization to take
into account the non-economic factors of a transaction, such as
the potential impact on employees, customers, and/or the
communities in which we operate. In addition, certain provisions
of Delaware law, and our ability to issue options to purchase
common stock pursuant to our stock incentive plans may also have
the effect of discouraging, delaying or preventing a sale.


We are, and may in the future be, involved
in securities class action litigation.

Xchange and certain of our current or former
officers have been named defendants in two securities class
action lawsuits. The first lawsuit, filed on February 21,
2001, was filed on behalf of a purported class of purchasers of
our common stock during the period December 8, 1998 through
September 29, 2000. We were notified of the second lawsuit
via a press release issued on October 26, 2001. We have not
yet been formally served with the second lawsuit. Both of these
actions seek monetary damages for alleged violations of
securities laws; however, at this time, we are unable to
ascertain the total damages sought in either claim We believe
that we are fully insured for both of these claims, but
litigation is inherently uncertain and an adverse resolution of
the actions in an amount that exceeds our insurance coverage
would require us to recognize an unanticipated expense and to
make an unanticipated cash payment for the excess award.
Additionally, a successful claim brought against us could have a
material adverse effect on our business because it may
negatively affect our reputation in the industry and because it
may increase the expense of obtaining insurance in the future.
Moreover, defending these claims, regardless of merit, could
require the time and attention of key management personnel. For
further discussion of these lawsuits see Legal
Proceedings elsewhere in this filing.

We may have difficulty meeting Nasdaq
minimum listing requirements.

The Company received a letter on April 17, 2002
from the Nasdaq staff stating that the Company had failed to
file its annual report for the year ended December 31, 2001 in a
timely manner as required by Nasdaq Marketplace Rule 4310(c)(14)
and as a result its common stock was subject to delisting. At
the Companys request, a hearing will be held before a
Nasdaq Listing Qualification Panel to review the staffs
determination. On May 2, 2002, the Company received a letter
from the Nasdaq staff stating that the Company has not
maintained a minimum market value of $5 million as required by
Nasdaq Marketplace Rule 4450(e)(1), and that the Company had
until July 31, 2002 to regain compliance. There can be no
assurances that the Company will be successful in its pending
hearing or will be able to maintain the minimum market value, or
any other Nasdaq requirements, which may result in the delisting
of the Companys stock.

We may run out of capital in the near
future.

We require substantial amounts of capital to fund
our business operations. The rate at which our capital is
utilized is affected by the level of our fixed expenses
(including employee related, facility and infrastructure
expenses) and variable expenses. In 2000 and 2001, we
experienced negative cash flow from operations of
$18.5 million and $32.4 million, respectively, and at
December 31, 2001 have a working capital deficit of
$16.2 million. The Companys ability to meet its
obligations in the ordinary course of business and to continue
as a going concern is dependent on its ability to reduce net
operation expenses and refinance its existing obligations, or
raise additional financing through public or private equity
financing or other sources of financing to fund operations.
There is no assurance that the Company will be successful in its
efforts to raise addition capital, renegotiate its existing
obligations or to sufficiently reduce its operating expenses,
all of which may have a material adverse impact on the
Companys solvency.

The potential for future acquisitions may
divert the attention of key personnel.

We may continue to pursue acquisitions that
provide new technologies, products or service offerings. If any
future acquisitions present themselves as potential
opportunities, our financial results could suffer if the

35



---



##### Table of Contents



acquisition activity diverts the attention of
management or other key personnel from other business concerns
and/or from their ongoing responsibilities to manage the
business.


The potential for future acquisitions could
present the risk of entering new markets without experienced
personnel.

We may continue to pursue acquisitions that
provide new technologies, products or service offerings and may
include entrance into new markets that supplement or complement
our existing product base. If we were to enter into a market in
which we have no or limited prior experience, our financial
results could suffer if we are unable to retain the key,
experienced personnel of the acquired company.

Potential change in control due to changes
in the voting power of our common stock upon the exercise or
conversion of certain securities.

The Company had a Special Meeting of Shareholders
on February 27, 2002 at which the shareholders approved a
proposal to increase the authorized but unissued shares of
common stock, effected by either an increase to the authorized
but unissued shares of common stock or by implementing a reverse
stock split which would have the effect of increasing the
authorized but unissued shares of common stock, and a proposal
to allow the holders of the Series A Preferred Stock to
vote their full allotment of Preferred Stock shares. The passage
of these proposals could lead to a change in control of the
Company as it allows for the conversion or exercise, as the case
may be, of the July Debentures and the August Debentures and
warrants issued pursuant to the financing received by the
Company on August 29, 2001, and for the conversion of the
Series A Preferred Stock issued in January 2001. Assuming
the full conversion of the July Debentures and the August
Debentures, warrants, and Series A Preferred Stock, the
holders thereof would control approximately 79 percent of the
outstanding voting stock of the Company.




Item 7A.     Quantitative
and Qualitative Disclosure about Market Risk

The following discussion about the Companys
market risk disclosures involves forward-looking statements.
Actual results could differ materially from those projected in
the forward-looking statements. The Company is exposed to market
risk related to changes in interest rates and foreign currency
exchange rates. The Company does not use derivative financial
instruments for speculative or trading purposes.

Foreign Currency Exchange Risk.With sales and services offices in the
United States, United Kingdom, Australia and Singapore and a
global customer base, the Company faces exposure to adverse
movements in foreign currency exchange rates. These exposures
may change over time as business practices evolve and could have
a material adverse impact on the Companys financial
results. Historically the Companys primary exposure has
been nondollar-denominated operating expenses and sales by its
United Kingdom subsidiary. The introduction of the Euro as a
common currency for members of the European Monetary Union, of
which the United Kingdom is not a member, occurred in January
1999. To date, the Company has not seen any impact of the Euro
on foreign exchange exposure. The Company is prepared to hedge
against fluctuations in the British Sterling, Euro, or other
foreign currency if the exposure becomes material. As of
December 31, 2001 the Companys material
nondollar-denominated assets and liabilities primarily consisted
of cash, accounts receivable and accounts payable denominated in
British Sterling and Australian dollars.




Item 8.     Financial
Statements and Supplementary Data

The quarterly financial information required by
this Item 8 is included in Item 7 Managements
Discussion and Analysis of Financial Condition and Results of
Operations.

36



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES




INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                                                                  |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                                                                  |  | Page
|                                                                                                                                                  |  |     
|Report of Independent Public Accountants                                                                                                          |  |      | 38 | 
|Consolidated Balance Sheets as of
	December 31, 2000 and 2001                                                                                     |  |      | 39 | 
|Consolidated Statements of Operations for the
	Years Ended December 31, 1999, 2000 and 2001                                                       |  |      | 40 | 
|Consolidated Statements of Redeemable Convertible
	Preferred Stock and Stockholders Equity for the Years
	Ended December 31, 1999, 2000 and 2001 |  |      | 41 | 
|Consolidated Statements of Cash Flows for the
	Years Ended December 31, 1999, 2000 and 2001                                                       |  |      | 43 | 
|Notes to Consolidated Financial Statements                                                                                                        |  |      | 45 | 

37



---



##### Table of Contents






REPORT OF INDEPENDENT PUBLIC
ACCOUNTANTS

To the Board of Directors of 
 Exchange Applications, Inc. and subsidiaries:

We have audited the accompanying consolidated
balance sheets of Exchange Applications, Inc., a Delaware
corporation, and subsidiaries as of December 31, 2000 and
2001, and the related consolidated statements of operations,
redeemable convertible preferred stock and stockholders
equity and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial
position of Exchange Applications, Inc. and subsidiaries as of
December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States.

The accompanying financial statements have been
prepared assuming the Company will continue as a going concern.
As discussed in Note 1 to the financial statements, the
Company has sustained net losses and negative cash flows from
operations in 2000 and 2001 and has a significant working
capital deficit which raises substantial doubt about the
Companys ability to continue as a going concern.
Managements plans in regard to these matters are also
described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of
this uncertainty.



| |                        
| | -----------------------
| | /s/ ARTHUR ANDERSEN LLP
| |                        

Boston, Massachusetts

May 8, 2002


38



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES






CONSOLIDATED BALANCE SHEETS


(In thousands, except share amounts)


|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |        |        | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | -------- | ------ | ------- |  | -------- | ------ | ------ | 
|                                                                                                                                                           |                                                                                                                                  |                                           
|                                                                                                                                                           |                                                                                                                                  | December 31,                              
|                                                                                                                                                           |                                                                                                                                  |                                           
|                                                                                                                                                           |                                                                                                                                  | 2000                                       |          | 2001  
|                                                                                                                                                           |                                                                                                                                  |                                            |          |       
|ASSETS                                                                                                                                                    
|Current assets:                                                                                                                                            |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           | Cash and cash equivalents                                                                                                        |                                            | $        | 8,617  |         |  | $        | 7,074  |       
|                                                                                                                                                           | Accounts receivable, less allowance for doubtful
    accounts of $1,092 and $967 at December 31, 2000 and 2001,
    respectively |                                            |          | 16,969 |         |  |          | 7,031  |       
|                                                                                                                                                           | Prepaid expenses and other current assets                                                                                        |                                            |          | 4,270  |         |  |          | 1,874  |       
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           |                                                                                                                                  | Total current assets                       |          |        | 29,856  |  |          |        | 15,979 | 
|Property and equipment, net                                                                                                                                |                                                                                                                                  |                                            | 10,413   |        |         |  | 6,187    |       
|Non current assets from MicroStrategy
    Incorporated transaction (Note 5)                                                                                |                                                                                                                                  |                                            | 42,406   |        |         |  |         |       
|Goodwill                                                                                                                                                   |                                                                                                                                  |                                            | 44,980   |        |         |  | 20,407   |       
|Other intangible assets                                                                                                                                    |                                                                                                                                  |                                            | 24,753   |        |         |  | 375      |       
|Other assets                                                                                                                                               |                                                                                                                                  |                                            | 9,899    |        |         |  | 290      |       
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           |                                                                                                                                  | Total assets                               |          | $      | 162,307 |  |          | $      | 43,238 | 
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                          
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                                                                                  
|Current liabilities:                                                                                                                                       |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           | Accounts payable                                                                                                                 |                                            | $        | 5,717  |         |  | $        | 3,961  |       
|                                                                                                                                                           | Accrued expenses                                                                                                                 |                                            |          | 15,916 |         |  |          | 16,345 |       
|                                                                                                                                                           | Current portion of obligations under capital
    leases                                                                          |                                            |          | 1,987  |         |  |          | 1,232  |       
|                                                                                                                                                           | Current portion of MicroStrategy Incorporated
    obligation (Note 5)                                                            |                                            |          | 16,833 |         |  |          |       |       
|                                                                                                                                                           | Current portion of note payable to certain former
    shareholders of Customer Analytics (Note 10)                               |                                            |          | 2,875  |         |  |          | 2,487  |       
|                                                                                                                                                           | Note payable to Insight Venture Partners
    (Note 10)                                                                           |                                            |          | 1,500  |         |  |          |       |       
|                                                                                                                                                           | Line of credit (Note 10)                                                                                                         |                                            |          |       |         |  |          | 4,169  |       
|                                                                                                                                                           | Deferred revenue                                                                                                                 |                                            |          | 8,636  |         |  |          | 3,975  |       
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           |                                                                                                                                  | Total current liabilities                  |          |        | 53,464  |  |          |        | 32,169 | 
|Obligations under capital leases, net of current
    portion                                                                                               |                                                                                                                                  |                                            | 1,091    |        |         |  | 63       |       
|Note payable to certain former shareholders of
    Customer Analytics, net of current portion                                                              |                                                                                                                                  |                                            | 1,965    |        |         |  |         |       
|Convertible debentures                                                                                                                                     |                                                                                                                                  |                                            |         |        |         |  | 3,102    |       
|Series A redeemable convertible preferred
    stock                                                                                                        |                                                                                                                                  |                                            |         |        |         |  | 5,650    |       
|Commitments (Note 11)                                                                                                                                      |                                                                                                                                  |                                            |          |        |         |  |          |       
|Stockholders equity:                                                                                                                                      |                                                                                                                                  |                                            |          |        |         |  |          |       
|Preferred stock; $.001 par value 
    10,000,000 shares authorized, Zero shares outstanding at
    December 31, 2000 and 2001.                            |                                                                                                                                  |                                            |         |        |         |  |         |       
|Common stock, $.001 par value 
    5,000,000 shares authorized; 1,099,012 and
    1,152,892 shares issued at December 31, 2000 and 2001,
    respectively |                                                                                                                                  |                                            | 1        |        |         |  | 1        |       
|Additional paid-in capital                                                                                                                                 |                                                                                                                                  |                                            | 250,688  |        |         |  | 299,547  |       
|Accumulated deficit                                                                                                                                        |                                                                                                                                  |                                            | (144,502 | )      |         |  | (297,030 | )     
|Deferred compensation                                                                                                                                      |                                                                                                                                  |                                            | (204     | )      |         |  |         |       
|Other comprehensive income                                                                                                                                 |                                                                                                                                  |                                            | (196     | )      |         |  | (264     | )     
|Treasury stock, at cost; 12,219 shares at
    December 31, 2000 and 2001.                                                                                  |                                                                                                                                  |                                            |         |        |         |  |         |       
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           |                                                                                                                                  | Total stockholders equity                 |          |        | 105,787 |  |          |        | 2,254  | 
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       
|                                                                                                                                                           |                                                                                                                                  | Total liabilities and stockholders equity |          | $      | 162,307 |  |          | $      | 43,238 | 
|                                                                                                                                                           |                                                                                                                                  |                                            |          |        |         |  |          |       

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

39



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES




CONSOLIDATED STATEMENTS OF
OPERATIONS

(in thousands, except per share and share
amounts)

|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |           |         |  
|---------------------------------------------------------- | ------------------------------------------------------------------------- | ------------------------------------ | ------ | ------- | ------ | ---- | -------- | ------- | ------- | - | -------- | --------- | ------- | -
|                                                           |                                                                           |                                     
|                                                           |                                                                           | Years Ended December 31,            
|                                                           |                                                                           |                                     
|                                                           |                                                                           | 1999                                 |        | 2000    |        | 2001
|                                                           |                                                                           |                                      |        |         |        |     
|Revenues:                                                  |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Software license fees                                                     |                                      | $      | 26,344  |        |      | $        | 38,070  |         |   | $        | 21,709    |        
|                                                           | Services and maintenance                                                  |                                      |        | 16,957  |        |      |          | 23,506  |         |   |          | 23,002    |        
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           |                                                                           | Total revenues                       |        |         | 43,301 |      |          |         | 61,576  |   |          |           | 44,711  |  
|                                                           |                                                                           |                                     
|Cost of revenues:                                          |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Software license fees(1)                                                  |                                      |        | 438     |        |      |          | 776     |         |   |          | 1,502     |        
|                                                           | Services and maintenance                                                  |                                      |        | 10,255  |        |      |          | 18,475  |         |   |          | 14,046    |        
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           |                                                                           | Total cost of revenues               |        |         | 10,693 |      |          |         | 19,251  |   |          |           | 15,548  |  
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           |                                                                           |                                     
|Gross profit                                               |                                                                           |                                      | 32,608 |         |        |      | 42,325   |         |         |   | 29,163   |          
|                                                           |                                                                           |                                     
|Operating expenses:                                        |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Sales and marketing(1)                                                    |                                      |        | 14,555  |        |      |          | 27,840  |         |   |          | 28,120    |        
|                                                           | Research and development(1)                                               |                                      |        | 9,829   |        |      |          | 18,959  |         |   |          | 17,251    |        
|                                                           | General and administrative                                                |                                      |        | 4,948   |        |      |          | 14,114  |         |   |          | 16,119    |        
|                                                           | Cost of acquisition                                                       |                                      |        | 1,388   |        |      |          |        |         |   |          |          |        
|                                                           | Amortization of goodwill and other intangibles                            |                                      |        |        |        |      |          | 22,331  |         |   |          | 16,566    |        
|                                                           | Amortization of Microstrategy Incorporated assets                         |                                      |        |        |        |      |          | 19,822  |         |   |          | 17,959    |        
|                                                           | Impairment of MicroStrategy assets, goodwill and
    other intangibles    |                                      |        |        |        |      |          | 76,604  |         |   |          | 56,176    |        
|                                                           | Restructuring charge                                                      |                                      |        |        |        |      |          |        |         |   |          | 19,172    |        
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           |                                                                           | Total operating expenses             |        |         | 30,720 |      |          |         | 179,670 |   |          |           | 171,363 |  
|                                                           |                                                                           |                                     
|Income (loss) from operations                              |                                                                           |                                      | 1,888  |         |        |      | (137,345 | )       |         |   | (142,200 | )        
|Interest income (expense), net:                            |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Interest income                                                           |                                      |        | 1,440   |        |      |          | 1,109   |         |   |          | 191       |        
|                                                           | Interest expense                                                          |                                      |        | (10     | )      |      |          | (2,744  | )       |   |          | (8,610    | )      
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           |                                                                           | Total interest income (expense), net |        |         | 1,430  |      |          |         | (1,635  | ) |          |           | (8,419  | )
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|Income (loss) before provision for income
    taxes        |                                                                           |                                      | 3,318  |         |        |      | (138,980 | )       |         |   | (150,619 | )        
|Provision for income taxes                                 |                                                                           |                                      | 2,220  |         |        |      | 9        |         |         |   | 38       |          
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|Net income (loss)                                          |                                                                           |                                      | 1,098  |         |        |      | (138,989 | )       |         |   | (150,657 | )        
|Accretion of discount and dividends on preferred
    stock |                                                                           |                                      |       |         |        |      |         |         |         |   | 1,871    |          
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|Net income (loss) applicable to common
    stockholders    |                                                                           | $                                    | 1,098  |         |        | $    | (138,989 | )       |         | $ | (152,528 | )        
|Net income (loss) per share (Note 2(b)):                   |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Basic net income (loss) per share applicable
    to common stockholders   |                                      | $      | 1.49    |        |      | $        | (145.22 | )       |   | $        | (136.90   | )      
|                                                           | Basic weighted average common shares outstanding                          |                                      |        | 737,190 |        |      |          | 957,087 |         |   |          | 1,114,127 |        
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          
|                                                           | Diluted net income (loss) per share
    applicable to common stockholders |                                      | $      | 1.25    |        |      | $        | (145.22 | )       |   | $        | (136.90   | )      
|                                                           | Diluted weighted average common shares outstanding                        |                                      |        | 881,104 |        |      |          | 957,087 |         |   |          | 1,114,127 |        
|                                                           |                                                                           |                                      |        |         |        |      |          |         |         |   |          |          



---



|    |                                                                                                                                                                                                                                      
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Cost of software license fees, sales and
    marketing expenses, and research and development expenses are
    stated exclusive of amortization of assets and acquired
    technology from the MicroStrategy transaction. See Note 5.

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

40



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED


STOCK AND STOCKHOLDERS EQUITY


|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | --------- | ------------ |  | --------- | ------ | --------- |  | ------- | --------- |  |  | - | - |  |  | - | ------- | -
|                                                                                                                    |  |                                      |           |              |  |           |        |          
|                                                                                                                    |  | Series A                             |           |              |  |           |        |          
|                                                                                                                    |  | Redeemable Convertible               |           |              |  |          
|                                                                                                                    |  | Preferred Stock                      |           | Common Stock |  |          
|                                                                                                                    |  |                                      |           |              |  |          
|                                                                                                                    |  | Number of                            |           |              |  | Number of |        | $.001     |  | Paid-in
|                                                                                                                    |  | Shares                               |           | Amount       |  | Shares    |        | Par Value |  | Capital
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |        
|                                                                                                                    |  |                                     
|                                                                                                                    |  | (in thousands, except share amounts)
|Balance, December 31, 1998                                                                                          |  |                                      |          |              |  | $         |       |           |  |         | 697,710   |  |  | $ | 1 |  |  | $ | 31,698  |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Exercise of common stock options                                                                                    |  |                                      |          |              |  |           |       |           |  |         | 33,603    |  |  |   |  |  |  |   | 1,369   |  
|Compensation expense associated with stock options                                                                  |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | 753     |  
|Issuance of common stock in follow on public
    offering, net of offering costs                                    |  |                                      |          |              |  |           |       |           |  |         | 66,667    |  |  |   |  |  |  |   | 20,009  |  
|Conversion of convertible debt                                                                                      |  |                                      |          |              |  |           |       |           |  |         | 3,802     |  |  |   |  |  |  |   | 850     |  
|Cumulative translation adjustment                                                                                   |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Stock subscription to MicroStrategy, Incorporated                                                                   |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Tax benefit of stock options exercised                                                                              |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | 2,213   |  
|Unrealized gain on marketable securities                                                                            |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Net income                                                                                                          |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Comprehensive net loss for the year ended
    December 31, 1999                                                     |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Balance December 31, 1999                                                                                           |  |                                      |          |              |  | $         |       |           |  |         | 801,782   |  |  | $ | 1 |  |  | $ | 56,892  |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Exercise of common stock options                                                                                    |  |                                      |           |              |  |           |       |           |  |         | 65,652    |  |  |   |  |  |  |   | 5,617   |  
|Issuance of common stock under ESPP                                                                                 |  |                                      |          |              |  |           |       |           |  |         | 1,111     |  |  |   |  |  |  |   | 272     |  
|Compensation expense associated with stock options                                                                  |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | (101    | )
|Repayment of founders loan                                                                                         |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Issuance of common stock to Microstrategy, Inc.                                                                     |  |                                      |          |              |  |           |       |           |  |         | 54,351    |  |  |   |  |  |  |   | 37,500  |  
|Issuance of common stock in connection with
    acquisition of Knowledge Stream Partners, Inc.                      |  |                                      |          |              |  |           |       |           |  |         | 27,393    |  |  |   |  |  |  |   | 39,566  |  
|Issuance of common stock in connection with
    acquisition of Customer Analytics Inc.                              |  |                                      |          |              |  |           |       |           |  |         | 148,723   |  |  |   |  |  |  |   | 110,942 |  
|Unrealized gain on marketable securities                                                                            |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Cumulative translation adjustment                                                                                   |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Net loss                                                                                                            |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Comprehensive net loss for the year ended
    December 31, 2000                                                     |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Balance December 31, 2000                                                                                           |  |                                      |          |              |  | $         |       |           |  |         | 1,099,012 |  |  | $ | 1 |  |  | $ | 250,688 |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Issuance of Series A redeemable convertible
    preferred stock, net of offering costs of $637,811                  |  |                                      | 4,157,788 |              |  |           | 4,587  |           |  |         |          |  |  |   |  |  |  |   |        |  
|Conversion of note payable to Insight Venture
    Partners into Series A redeemable convertible preferred
    stock |  |                                      | 1,187,837 |              |  |           | 1,500  |           |  |         |          |  |  |   |  |  |  |   |        |  
|Beneficial conversion feature of Series A
    redeemable convertible preferred stock                                |  |                                      |          |              |  |           | (2,094 | )         |  |         |          |  |  |   |  |  |  |   | 2,094   |  
|Accretion of preferred stock dividends and
    amortization of original issuance discounts                          |  |                                      |          |              |  |           | 1,657  |           |  |         |          |  |  |   |  |  |  |   | 214     |  
|Issuance of shares to settle Microstrategy, Inc
    obligation                                                      |  |                                      |          |              |  |           |       |           |  |         | 32,073    |  |  |   |  |  |  |   | 17,512  |  
|Exercise of common stock options                                                                                    |  |                                      |          |              |  |           |       |           |  |         | 9,746     |  |  |   |  |  |  |   | 171     |  
|Issuance of common stock under ESPP                                                                                 |  |                                      |          |              |  |           |       |           |  |         | 12,061    |  |  |   |  |  |  |   | 251     |  
|Beneficial conversion feature of convertible
    debentures                                                         |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | 12,184  |  
|Issuance of warrants to Insight Venture Partners                                                                    |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | 16,389  |  
|Issuance of warrants to Silicon Valley Bank                                                                         |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | 153     |  
|Compensation expense associated with stock options                                                                  |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   | (109    | )
|Cumulative translation adjustment                                                                                   |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Net loss                                                                                                            |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|Comprehensive net loss for the year ended
    December 31, 2001                                                     |  |                                      |          |              |  |           |       |           |  |         |          |  |  |   |  |  |  |   |        |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  
|Balance December 31, 2001                                                                                           |  |                                      | 5,345,625 |              |  | $         | 5,650  |           |  |         | 1,152,892 |  |  | $ | 1 |  |  | $ | 299,547 |  
|                                                                                                                    |  |                                      |           |              |  |           |        |           |  |         |           |  |  |   |   |  |  |   |         |  

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

41



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES


CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED

STOCK AND STOCKHOLDERS
EQUITY  (Continued)


|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | -------- | -------- |  | ------------ | ---- | ------------- |  | ------------ | ---- | ----- |  | ------------- | ---- | - |  | - | ------- | - |  | - | -------- | - |  | - | -------- | -
|                                                                                                                    |  |                                      |          |          |  |              |      | Other         |  |              |      |       |  |              
|                                                                                                                    |  | Accumulated                          |          | Due from |  | Deferred     |      | Comprehensive |  | Stock        |      |       |  | Comprehensive
|                                                                                                                    |  | Deficit                              |          | Officer  |  | Compensation |      | Income        |  | Subscription |      | Total |  | Income (loss)
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |              
|                                                                                                                    |  |                                     
|                                                                                                                    |  | (in thousands, except share amounts)
|Balance, December 31, 1998                                                                                          |  | $                                    | (6,611   | )        |  | $            | (125 | )             |  | $            | (800 | )     |  | $             | 38   |   |  | $ |        |   |  | $ | 24,201   |   |  |   |          |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Exercise of common stock options                                                                                    |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 1,369    |   |  |   |          |  
|Compensation expense associated with stock options                                                                  |  |                                      |         |          |  |              |     |               |  |              | 283  |       |  |               |     |   |  |   |        |   |  |   | 1,036    |   |  |   |          |  
|Issuance of common stock in follow on public
    offering, net of offering costs                                    |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 20,009   |   |  |   |          |  
|Conversion of convertible debt                                                                                      |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 850      |   |  |   |          |  
|Cumulative translation adjustment                                                                                   |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               | 9    |   |  |   |        |   |  |   | 9        |   |  | $ | 9        |  
|Stock subscription to MicroStrategy, Inc.                                                                           |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   | 20,000  |   |  |   | 20,000   |   |  |   |          |  
|Tax benefit of stock options exercised                                                                              |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 2,213    |   |  |   |          |  
|Unrealized gain on marketable securities                                                                            |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               | (73  | ) |  |   |        |   |  |   | (73      | ) |  |   | (73      | )
|Net income                                                                                                          |  |                                      | 1,098    |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 1,098    |   |  |   | 1,098    |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Comprehensive net income for the year ended
    December 31, 1999                                                   |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   |         |   |  | $ | 1,034    |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Balance December 31, 1999                                                                                           |  | $                                    | (5,513   | )        |  | $            | (125 | )             |  | $            | (517 | )     |  | $             | (26  | ) |  | $ | 20,000  |   |  | $ | 70,712   |   |  |   |          |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Exercise of common stock options                                                                                    |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 5,617    |   |  |   |          |  
|Issuance of common stock under ESPP                                                                                 |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 272      |   |  |   |          |  
|Compensation expense associated with stock options                                                                  |  |                                      |         |          |  |              |     |               |  |              | 313  |       |  |               |     |   |  |   |        |   |  |   | 212      |   |  |   |          |  
|Repayment of founders loan                                                                                         |  |                                      |         |          |  |              | 125  |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 125      |   |  |   |          |  
|Issuance of common stock to Microstrategy, Inc.                                                                     |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   | (20,000 | ) |  |   | 17,500   |   |  |   |          |  
|Issuance of common stock in connection with
    acquisition of Knowledge Stream Partners, Inc                       |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 39,566   |   |  |   |          |  
|Issuance of common stock in connection with
    acquisition of Customer Analytics Inc.                              |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 110,942  |   |  |   |          |  
|Unrealized gain on Marketable securities                                                                            |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               | 65   |   |  |   |        |   |  |   | 65       |   |  |   | 65       |  
|Cumulative translation adjustment                                                                                   |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               | (235 | ) |  |   |        |   |  |   | (235     | ) |  |   | (235     | )
|Net loss                                                                                                            |  |                                      | (138,989 | )        |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | (138,989 | ) |  |   | (138,989 | )
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Comprehensive net loss for the year ended
    December 31, 2000                                                     |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   |         |   |  | $ | (139,159 | )
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Balance December 31, 2000                                                                                           |  | $                                    | (144,502 | )        |  | $            |     |               |  | $            | (204 | )     |  | $             | (196 | ) |  | $ |        |   |  | $ | 105,787  |   |  |   |          |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Issuance of Series A redeemable convertible
    preferred stock, net of offering costs of $637,811                  |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   |         |   |  |   |          |  
|Conversion of note payable to Insight Venture
    Partners into Series A redeemable convertible preferred
    stock |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   |         |   |  |   |          |  
|Beneficial conversion feature of Series A
    preferred stock                                                       |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 2,094    |   |  |   |          |  
|Accretion of preferred stock dividends and
    amortization of original issuance discounts                          |  |                                      | (1,871   | )        |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | (1,657   | ) |  |   |          |  
|Issuance of shares to settle Microstrategy, Inc
    obligation                                                      |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 17,512   |   |  |   |          |  
|Exercise of common stock options                                                                                    |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 171      |   |  |   |          |  
|Issuance of common stock under ESPP                                                                                 |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 251      |   |  |   |          |  
|Beneficial conversion feature of convertible
    debentures                                                         |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 12,184   |   |  |   |          |  
|Issuance of warrants to Insight Venture Partners                                                                    |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 16,389   |   |  |   |          |  
|Issuance of warrants to Silicon Valley Bank                                                                         |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | 153      |   |  |   |          |  
|Compensation expense associated with stock options                                                                  |  |                                      |         |          |  |              |     |               |  |              | 204  |       |  |               |     |   |  |   |        |   |  |   | 95       |   |  |   |          |  
|Cumulative translation adjustment                                                                                   |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               | (68  | ) |  |   |        |   |  |   | (68      | ) |  |   | (68      | )
|Net loss                                                                                                            |  |                                      | (150,657 | )        |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   | (150,657 | ) |  |   | (150,657 | )
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Comprehensive net loss for the year ended
    December 31, 2001                                                     |  |                                      |         |          |  |              |     |               |  |              |     |       |  |               |     |   |  |   |        |   |  |   |         |   |  | $ | (150,725 | )
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  
|Balance December 31, 2001                                                                                           |  | $                                    | (297,030 | )        |  | $            |     |               |  | $            |     |       |  | $             | (264 | ) |  |   |        |   |  | $ | 2,254    |   |  |   |          |  
|                                                                                                                    |  |                                      |          |          |  |              |      |               |  |              |      |       |  |               |      |   |  |   |         |   |  |   |          |   |  |   |          |  

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

42



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                                |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |          |        |         |  
|--------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------- | ------------------------------------------------------- | ------- | ------ | ------- | - | -------- | ------ | ------- | - | -------- | ------ | ------- | -
|                                                                                                                |                                                                                   |                                          
|                                                                                                                |                                                                                   | Years Ended December 31,                 
|                                                                                                                |                                                                                   |                                          
|                                                                                                                |                                                                                   | 1999                                      |                                                         | 2000    |        | 2001   
|                                                                                                                |                                                                                   |                                           |                                                         |         |        |        
|                                                                                                                |                                                                                   |                                          
|                                                                                                                |                                                                                   | (in thousands)                           
|Cash flows from operating activities:                                                                           |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                | Net income (loss)                                                                 |                                           | $                                                       | 1,098   |        |         | $ | (138,989 | )      |         | $ | (150,657 | )     
|Adjustments to reconcile net income (loss) to net
    cash provided (used in) provided by operating activities: |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                | Non cash interest related to notes payable to
    Customer Analytics shareholders |                                           |                                                         |        |        |         |   | 58       |        |         |   | 108      |       
|                                                                                                                | Non-cash interest related to Microstrategy
    Obligation                         |                                           |                                                         |        |        |         |   | 2,301    |        |         |   | 681      |       
|                                                                                                                | Non-cash interest related to Insight bridge notes
    and warrants                |                                           |                                                         |        |        |         |   |         |        |         |   | 1,823    |       
|                                                                                                                | Non-cash interest related to convertible
    debentures                           |                                           |                                                         |        |        |         |   |         |        |         |   | 5,243    |       
|                                                                                                                | Non-cash interest related to warrants issued to
    Silicon Valley Bank           |                                           |                                                         |        |        |         |   |         |        |         |   | 93       |       
|                                                                                                                | Amortization of goodwill and other intangibles                                    |                                           |                                                         |        |        |         |   | 22,331   |        |         |   | 16,566   |       
|                                                                                                                | Amortization of MicroStrategy Inc. assets                                         |                                           |                                                         |        |        |         |   | 19,822   |        |         |   | 17,959   |       
|                                                                                                                | Impairment of MicroStrategy Inc. assets, goodwill
    and other intangible assets |                                           |                                                         |        |        |         |   | 76,604   |        |         |   | 56,176   |       
|                                                                                                                | Non-cash restructuring charges                                                    |                                           |                                                         |        |        |         |   |         |        |         |   | 12,241   |       
|                                                                                                                | Depreciation and other amortization                                               |                                           |                                                         | 1,600   |        |         |   | 3,716    |        |         |   | 4,698    |       
|                                                                                                                | Compensation expense associated with stock options                                |                                           |                                                         | 1,036   |        |         |   | 212      |        |         |   | 95       |       
|                                                                                                                | Changes in operating assets and liabilities, net
    of acquisitions:             |                                           |                                                         |         |        |         |   |          |        |         |   |          |       
|                                                                                                                |                                                                                   | Accounts receivable                       |                                                         |         | (3,678 | )       |   |          | 4,381  |         |   |          | 9,938  |        
|                                                                                                                |                                                                                   | Prepaid expenses and other current assets |                                                         |         | (2,130 | )       |   |          | (1,328 | )       |   |          | 810    |        
|                                                                                                                |                                                                                   | Accounts payable                          |                                                         |         | 850    |         |   |          | 1,161  |         |   |          | (1,806 | )      
|                                                                                                                |                                                                                   | Accrued expenses                          |                                                         |         | (1,032 | )       |   |          | (3,875 | )       |   |          | (1,725 | )      
|                                                                                                                |                                                                                   | Deferred revenue                          |                                                         |         | 5,101  |         |   |          | (4,866 | )       |   |          | (4,661 | )      
|                                                                                                                |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                |                                                                                   |                                           | Net cash provided by (used in) operating
    activities |         |        | 2,845   |   |          |        | (18,472 | ) |          |        | (32,418 | )
|                                                                                                                |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|Cash flows from investing activities:                                                                           |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                | Cash acquired                                                                     |                                           |                                                         |        |        |         |   | 72       |        |         |   |         |       
|                                                                                                                | Purchase and sale of marketable securities                                        |                                           |                                                         | (3,864  | )      |         |   | 19,524   |        |         |   |         |       
|                                                                                                                | Purchases of property and equipment                                               |                                           |                                                         | (3,595  | )      |         |   | (4,803   | )      |         |   | (2,310   | )     
|                                                                                                                | Proceeds from the sale of property, equipment and
    improvements                |                                           |                                                         |        |        |         |   |         |        |         |   | 118      |       
|                                                                                                                | MicroStrategy Incorporated cash payment                                           |                                           |                                                         | (10,000 | )      |         |   |         |        |         |   |         |       
|                                                                                                                | (Increase) decrease in other assets                                               |                                           |                                                         | 13      |        |         |   | (8,763   | )      |         |   | 1,713    |       
|                                                                                                                |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                |                                                                                   |                                           | Net cash provided by (used in) investing
    activities |         |        | (17,446 | ) |          |        | 6,030   |   |          |        | (479    | )
|                                                                                                                |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|Cash flows from financing activities:                                                                           |                                                                                   |                                           |                                                         |         |        |         |   |          |        |         |   |         
|                                                                                                                | Repayments under capital leases                                                   |                                           |                                                         | (380    | )      |         |   | (898     | )      |         |   | (2,105   | )     
|                                                                                                                | Repayments of note payable to Customer Analytics
    shareholders                 |                                           |                                                         |         |        |         |   |         |        |         |   | (2,460   | )     
|                                                                                                                | Due from officer                                                                  |                                           |                                                         |        |        |         |   | 125      |        |         |   |         |       
|                                                                                                                | Proceeds from note payable to Insight Venture
    Partners                        |                                           |                                                         |        |        |         |   | 1,500    |        |         |   | 6,866    |       
|                                                                                                                | Exercise of common stock options                                                  |                                           |                                                         | 1,369   |        |         |   | 5,617    |        |         |   | 171      |       
|                                                                                                                | Issuance of common stock under ESPP                                               |                                           |                                                         |        |        |         |   | 272      |        |         |   | 251      |       
|                                                                                                                | Issuance of convertible debt                                                      |                                           |                                                         | 850     |        |         |   |         |        |         |   | 19,943   |       
|                                                                                                                | Proceeds for Series A redeemable convertible
    preferred stock                  |                                           |                                                         |        |        |         |   |         |        |         |   | 4,587    |       
|                                                                                                                | Proceeds from line of credit                                                      |                                           |                                                         |        |        |         |   |         |        |         |   | 4,169    |       
|                                                                                                                | Tax benefit from exercise of common stock options                                 |                                           |                                                         | 2,213   |        |         |   |         |        |         |   |         |       

43



---



##### Table of Contents



|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |        |        | 
|------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------- | ------ | ------ | ------ | ---- | ------ | -------- | ----- | - | ------ | ------ | ------ | 
|                                                                         |                                                                                                                                   |                                          
|                                                                         |                                                                                                                                   | Years Ended December 31,                 
|                                                                         |                                                                                                                                   |                                          
|                                                                         |                                                                                                                                   | 1999                                      |        | 2000   |        | 2001
|                                                                         |                                                                                                                                   |                                           |        |        |        |     
|                                                                         |                                                                                                                                   |                                          
|                                                                         |                                                                                                                                   | (in thousands)                           
|                                                                         | Issuance of common stock in follow-on public
	offering, net of offering costs                                                     |                                           |        | 20,009 |        |      |        |         |       |   |        |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         |                                                                                                                                   | Net cash provided by financing activities |        |        | 24,061 |      |        |          | 6,616 |   |        |        | 31,422 | 
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Effect of exchange rate changes on cash and cash
	equivalents            |                                                                                                                                   |                                           | 8      |        |        |      | (235   | )        |       |   | (68    | )     
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Net increase (decrease) in cash and cash
	equivalents                    |                                                                                                                                   |                                           | 9,468  |        |        |      | (6,061 | )        |       |   | (1,543 | )     
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Cash and cash equivalents, beginning of year                             |                                                                                                                                   |                                           | 5,210  |        |        |      | 14,678 |          |       |   | 8,617  |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Cash and cash equivalents, end of year                                   |                                                                                                                                   | $                                         | 14,678 |        |        | $    | 8,617  |          |       | $ | 7,074  |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Supplemental disclosure of cash flow information:                        |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Cash paid for interest                                                                                                            |                                           | $      | 13     |        |      | $      | 153      |       |   | $      | 576    |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Cash paid for income taxes                                                                                                        |                                           | $      | 104    |        |      | $      | 239      |       |   | $      | 16     |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|Supplemental disclosure of non-cash financing and
	investing activities: |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Equipment acquired under capital lease                                                                                            |                                           | $      |       |        |      | $      | 3,000    |       |   | $      | 322    |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Accretion of dividends on Series A
	redeemable convertible preferred stock                                                        |                                           | $      |       |        |      | $      |         |       |   | $      | 917    |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Accretion of discount on issuance of
	Series A redeemable convertible preferred stock                                             |                                           | $      |       |        |      | $      |         |       |   | $      | 954    |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Conversion of Insight note payable into
	Series A redeemable convertible preferred stock                                          |                                           |        |       |        |      |        |         |       |   | $      | 1,500  |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Conversion of Insight notes payable into
	convertible debentures                                                                  |                                           |        |       |        |      |        |         |       |   | $      | 7,000  |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Issuance of common stock related to stock
	subscription and to settle obligation to MicroStrategy, Inc. and
	related interest     |                                           | $      |       |        |      | $      | 37,500   |       |   | $      | 17,512 |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Conversion of convertible debt to common stock                                                                                    |                                           | $      | 850    |        |      | $      |         |       |   | $      |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Technology rights acquired for MicroStrategy Inc.
	obligation                                                                     |                                           | $      | 32,030 |        |      | $      |         |       |   | $      |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Technology rights acquired for subscription stock                                                                                 |                                           | $      | 20,000 |        |      | $      |         |       |   | $      |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | In connection with the acquisition of Knowledge
	Stream Partners on March 31, 2000, the following non-cash
	transaction occurred: |                                           |        |        |        |      |        |          |       |   |        |        |       
|                                                                         | Fair value of assets acquired, net of cash
	acquired                                                                              |                                           | $      |       |        |      | $      | 43,205   |       |   | $      |       |       
|                                                                         | Issuance of common stock and stock options                                                                                        |                                           |        |       |        |      |        | (39,896  | )     |   |        |       |       
|                                                                         | Acquisition costs                                                                                                                 |                                           |        |       |        |      |        | (430     | )     |   |        |       |       
|                                                                         | Cash acquired                                                                                                                     |                                           |        |       |        |      |        | 49       |       |   |        |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Liabilities assumed related to acquisitions                                                                                       |                                           | $      |       |        |      | $      | 2,928    |       |   | $      |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | In connection with the acquisition of Customer
	Analytics, Inc. on June 30, 2000, the following non-cash
	transaction occurred:   |                                           |        |        |        |      |        |          |       |   |        |        |       
|                                                                         | Fair value of assets acquired, net of cash
	acquired                                                                              |                                           | $      |       |        |      | $      | 139,295  |       |   | $      |       |       
|                                                                         | Issuance of common stock and stock options                                                                                        |                                           |        |       |        |      |        | (110,942 | )     |   |        |       |       
|                                                                         | Acquisitions costs                                                                                                                |                                           |        |       |        |      |        | (2,819   | )     |   |        |       |       
|                                                                         | Cash acquired                                                                                                                     |                                           |        |       |        |      |        | 23       |       |   |        |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       
|                                                                         | Liabilities assumed related to acquisition                                                                                        |                                           | $      |       |        |      | $      | 25,557   |       |   | $      |       |       
|                                                                         |                                                                                                                                   |                                           |        |        |        |      |        |          |       |   |        |       

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

44



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND
SUBSIDIARIES






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(1) Background and Basis of
Presentation

Exchange Applications, Inc. and its subsidiaries
(Xchange or the Company), doing business as
Xchange Inc., provides Customer Relationship Management
(CRM) solutions that help companies earn a greater
share of their customers business through relevant,
personalized customer communications. Xchange provides an
open-platform CRM software and services solution that enables
clients to customize offers based on profile information,
synchronize offers across all customer channels in real-time and
track the responses. This solution provides companies with the
opportunity to improve their acquisition and retention of
customers and increase customer relationship profitability.

On August 20, 1999, the Company acquired
eXstatic Software, Inc. (formerly known as Gino Borland, Inc.)
(eXstatic) a company that develops and markets
software solutions that enable businesses to plan, create and
execute highly personalized, permission-based email
communications based on customer profiles. This merger has been
accounted for as a pooling of interests and, accordingly, the
historical results of operations have been restated to reflect
the results of eXstatic on a combined basis (See Note 3).

The Company has sustained net losses and negative
cash flows from operations in 2000 and 2001. In addition, as of
December 31, 2001 the Company has a significant working
capital deficit, its bank line of credit matures on
April 25, 2002, and certain other notes payable are due in
June 2002. (Current development are discussed in Note 19 
Subsequent Events.) The Companys ability to meet its
obligations in the ordinary course of business and to continue
as a going concern is dependent on its ability to reduce net
operating expenses and refinance its existing obligations, or
raise additional financing through public or private equity
financing or other sources of financing to fund operations.
There is no assurance that the Company will be successful in its
efforts to raise additional capital, renegotiate its existing
obligations or to sufficiently reduce its operating expenses,
all of which may have a material adverse impact on the
Companys solvency. These factors raise substantial doubt
about the Companys ability to continue as a going concern.
The financial statements do not include any adjustments that
might result as the outcome of this uncertainty.

(2) Significant Accounting
Policies

The accompanying consolidated financial
statements reflect the application of certain significant
accounting policies as described in this note and elsewhere in
the accompanying consolidated financial statements and notes.

(a) Principles
of Consolidation

The accompanying consolidated financial
statements include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany balances have
been eliminated in consolidation.

(b) Net
Income (Loss) Per Share

The Company computes earnings per share in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 128, Earnings per Share.
Basic net income (loss) per common share for the years
ended December 31, 1999, 2000 and 2001 is calculated by
dividing the net loss applicable to common stockholders by the
weighted average number of vested common shares outstanding.

For the year ended December 31, 1999,
diluted net income per common share is calculated by dividing
the net income applicable to common stockholders by the weighted
average number of vested common shares outstanding and the
dilutive effect of potential common shares, consisting of
outstanding stock options and unvested common shares, as
determined using the treasury stock method in accordance with
SFAS No. 128.

45



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table reconciles the weighted
average common shares outstanding to the shares used in the
computation of basic and diluted weighted average common shares
outstanding:

|                                                                         |  |                         |         |      |  |      |         |  |  |  |           | 
|------------------------------------------------------------------------ |  | ----------------------- | ------- | ---- |  | ---- | ------- |  |  |  | --------- | 
|                                                                         |  |                        
|                                                                         |  | Year Ended December 31,
|                                                                         |  |                        
|                                                                         |  | 1999                    |         | 2000 |  | 2001
|                                                                         |  |                         |         |      |  |     
|Weighted average common shares outstanding                               |  |                         | 738,154 |      |  |      | 957,087 |  |  |  | 1,114,129 | 
|Less: weighted average unvested common shares
    outstanding            |  |                         | 965     |      |  |      |        |  |  |  |          | 
|                                                                         |  |                         |         |      |  |      |         |  |  |  |           | 
|Basic weighted average common shares outstanding                         |  |                         | 737,189 |      |  |      | 957,087 |  |  |  | 1,114,129 | 
|Potential common shares from stock options and
    unvested common stock |  |                         | 143,915 |      |  |      |        |  |  |  |          | 
|                                                                         |  |                         |         |      |  |      |         |  |  |  |           | 
|Diluted weighted average common shares outstanding                       |  |                         | 881,104 |      |  |      | 957,087 |  |  |  | 1,114,129 | 
|                                                                         |  |                         |         |      |  |      |         |  |  |  |           | 
|Pro forma:                                                               |  |                         |         |      |  |      |         |  |  |  |           | 

Diluted weighted average shares outstanding at
December 31, 2000 and 2001 exclude the potential common
shares from stock options, unvested common stock and convertible
preferred stock, because to include such shares would have been
antidilutive. As of December 31, 2000 and 2001, 149,889 and
5,700,693 potential common shares were outstanding, respectively.

(c) Cash
Equivalents and Marketable Securities

Cash equivalents are short-term, highly liquid
investments with original maturity dates of three months or
less. Cash equivalents are carried at amortized cost, which
approximates fair market value. The Company accounts for
marketable securities in accordance with SFAS No. 115,
Accounting for Certain Investments in Debt and Equity
Securities. The Companys short-term and long-term
marketable securities are classified as available-for-sale and
are recorded at fair value with any unrealized gain or loss
recorded as an element of stockholders equity. As of
December 31, 2000 and December 31, 2001, the Company
had no marketable securities and no unrealized gains (losses).

(d) Long-Lived
Assets

In accordance with the provisions of SFAS
No. 121, Accounting for Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of, the Company
evaluates the realizability of its long-lived assets
periodically based on projected future cash flows. As of
December 31, 2000 and 2001, the Companys long-lived
assets consisted of technology acquired from third parties,
goodwill and other intangible assets from acquisitions, and
fixed assets. In December 2000, the Company determined that a
reduction in the carrying value of certain intangible assets
related to the Customer Analytics (CA) acquisition
was required and the assets were written down accordingly. In
2001, the Company determined that the CA acquisition intangible
assets were further impaired necessitating a further write-down
and that an impairment charge was required on the intangible
assets related to the Knowledge Stream Partners acquisition (see
Note 4). The Company also determined that a reduction in
the carrying value of the Companys investment in
MicroStrategy assets was required and the asset was write-down
accordingly (see Note 5). As of December 31, 1999,
2000 and 2001, the Company determined that no other material
adjustments to the carrying value of its long-lived assets was
required.

(e) Software
Development Costs

The Companys software products are highly
technical and require a significant engineering and development
effort. Cost incurred in the development of computer software to
be sold have been expensed as research and development costs in
the accompanying consolidated statement of operations, in
accordance with SFAS No. 86, Accounting for the Costs of
Computer Software To Be Sold, Leased or Otherwise Marketed.

46



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Costs incurred subsequent to the attainment of
technological feasibility are insignificant and accordingly have
been charged to research and development expense.

(f) Income
Taxes

The Company accounts for income taxes in
accordance with the provisions of SFAS No. 109,
Accounting for Income Taxes. This statement requires the
Company to recognize a current tax liability or asset for
current taxes payable or refundable and to record a deferred tax
asset or liability for the estimated future tax effects of
temporary differences and carryforwards to the extent they are
realizable. A deferred tax provision or benefit results from the
net change in deferred tax assets and liabilities during the
year. A deferred tax valuation allowance is required if it is
more likely than not that all or a portion of the
recorded deferred tax assets will not be realized.

(g) Financial
Instruments

Financial instruments consist principally of cash
equivalents, accounts receivable, accounts payable, notes
payable, obligations due to MicroStrategy and convertible
debentures. With the exception of the convertible debentures,
the estimated fair value of these financial instruments
approximates their carrying value. Management estimates the fair
market value of the convertible debentures to be
$23.5 million at December 31, 2001 based on the market
value of the underlying common shares and warrants on an
as-converted basis. (See Note 10(b)(iv)).

(h) Off-Balance
Sheet and Concentration of Credit Risk

The Company has no significant off-balance-sheet
risk such as significant foreign exchange contracts, option
contracts or other foreign hedging arrangements. Financial
instruments that potentially subject the Company to
concentrations of credit risk are principally cash equivalents
and accounts receivable. Concentration of credit risk with
respect to accounts receivable is limited to certain customers
to whom the Company makes substantial sales. The Company
performs periodic credit evaluations of its customers and has
recorded allowances for estimated losses.

(i) Foreign
Currency

The functional currencies of the Companys
wholly owned subsidiaries in the United Kingdom and Australia
are the local currencies. The financial statements of the
subsidiaries are translated to U.S. dollars using period-end
exchange rates for assets and liabilities and average exchange
rates during the corresponding period for revenues, cost of
revenues and expenses. Translation gains and losses are deferred
and accumulated as a component of stockholders equity. Net
gains and losses resulting from foreign exchange transactions
are included in the consolidated statements of operations and
were not significant during the periods presented.

(j) Revenue
Recognition

The Company recognizes revenue based on the
provisions of Staff Accounting Bulletin (SAB) 101,
Revenue Recognition in Financial Statements, Statement of
Position, (SOP), No. 97-2, Software Revenue
Recognition, as amended by SOP No. 98-4 and SOP
No. 98-9, and the provisions of SOP No. 81-1,
Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.

Software license fee revenues are generated from
licensing the rights to the use of the Companys packaged
software products. Services and maintenance revenues are
generated from sales of maintenance, consulting, training and
hosting services performed for customers that license the
Companys products. The Company has concluded that
effective with the new generation of Xchange Analytics and
Xchange Real Time, certain of the implementation services
related to these products are essential to the customers
use of

47



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the packaged software products. Similarly, the
implementation services for the Companys Xchange EnAct
product is essential to the customers use of those
packaged software products. For sales of these products where
the Company is responsible for implementation, the Company
recognizes revenue for these arrangements following the
percentage-of-completion method over the implementation period.
Percentage of completion is measured by the percentage of
implementation hours incurred to date compared to estimated
total implementation hours. This method is used because
management has determined expended hours to be the best measure
of progress on these engagements. In situations where the
Company is not responsible for implementation services, or where
the product configuration being delivered does not require the
implementation services deemed to be essential to the
customers use of the software, the Company recognizes
revenue on delivery of the packaged software if there is
persuasive evidence of an arrangement, collection is probable,
the fee is fixed or determinable and vendor-specific objective
evidence exists to allocate the total fees to all undelivered
elements of the arrangement.

Vendor-specific objective evidence is based on
the price charged when an element is sold separately or, in the
case of an element not yet sold separately, the price
established by authorized management, if it is probable that the
price, once established, will not change before market
introduction. Elements included in multiple-element arrangements
could consist of software products, maintenance, consulting and
training services.

Revenue from maintenance services is recognized
ratably over the term of the contract, typically one year.
Professional services revenue is primarily related to
implementation and consulting services performed on a
time-and-materials basis under separate service arrangements.
Revenues from professional service arrangements are recognized
on either a time and materials or percentage-of-completion basis
as the services are performed, provided that amounts due from
customers are fixed or determinable and deemed collectible by
management. In addition, the Company recognizes consulting
revenue for its application hosting service. The revenue is
recognized over the service delivery period based on either a
pre-determined monthly service fee or a usage based pricing
model.

In certain situations, the Company has entered
into transactions with third parties to acquire technology from
those entities at the same time that the Company sells its
technology to those same third parties. In those instances, the
Company applied Accounting Principles Board Opinion No. 29,
Accounting for Nonmonetary Transactions, and Emerging
Issues Task Force Issue (EITF) No. 86-29,
Nonmonetary Transactions: Magnitude of the Boot and the
Exceptions to the Use of Fair Value, to such transactions.

(k) Accounting
for Stock-Based Compensation

The Company follows SFAS No. 123,
Accounting for Stock-Based Compensation, in accounting
for stock-based grants.As permitted by SFAS
No. 123, the Company accounts for employee stock options in
accordance with APB No. 25, Accounting for Stock Issued
to Employees, and has included the pro forma disclosures
required by SFAS No. 123 for all periods presented.

(l) New
Accounting Standards

In July 2001, the Financial Accounting Standards
Board (FASB) issued SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. Statement No. 141 requires that all
business combinations initiated after June 30, 2001, be
accounted for using the purchase method of accounting.
SFAS 142 discusses how intangible assets that are acquired
should be accounted for in financial statements after they have
been initially recognized in the financial statements. Beginning
on January 1, 2002, with the adoption of SFAS 142,
goodwill and certain purchased intangibles existing on
June 30, 2001, will no longer be subject to amortization
over their estimated useful life. Rather goodwill and certain
purchased intangibles will be subject to an assessment for
impairment. The provisions of SFAS 142 are required to be

48



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

applied starting with fiscal years beginning
after December 15, 2001. The Company does not anticipate an
impairment charge upon adoption.

In August 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. This statement supercedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30,
Reporting the Results of Operations  Reporting the
Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. Under this statement, it is required that one
accounting model be used for long-lived assets to be disposed of
by sales, whether previously held and used or newly acquired,
and it broadens the presentation of discontinued operations to
include more disposal transactions. The provisions of this
statement are effective for financial statements issued for
fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years, with early adoption
permitted. The Company is evaluating the impact of this
statement on its results of operations or financial position.

(n) Use
of Estimates

The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues
and expenses during the reporting periods. Actual results could
differ from those estimates.

(o) Comprehensive
Income (Loss)

Comprehensive income is defined as the change in
equity of a business enterprise during a period from
transactions and other events and circumstances and non-owner
sources, including foreign currency translation adjustments and
unrealized gains (losses) on marketable securities. For the
years ended December 31, 1999, 2000 and 2001, the
difference between other comprehensive income (loss) and
net income (loss) was ($64,000), ($170,000) and ($68,000),
respectively.

(p) Reclassifications

Certain items in the prior-year financial
statements have been reclassified to conform to the current-year
presentation.

(3) Acquisitions

(a) Acquisition
of eXstatic Software, Inc.

On August 20, 1999, the Company acquired
eXstatic, a company that develops and markets software solutions
that enable businesses to plan, create and execute highly
personalized, permission-based email communications based on
customer profiles. The Company exchanged 40,486 shares of its
common stock for all the outstanding shares of eXstatic common
stock, and exchanged options to purchase 9,261 shares of the
Companys common stock for all the outstanding options of
eXstatic. This acquisition has been accounted for as a pooling
of interests, and, accordingly, the historical results of
operations have been restated to reflect the results of eXstatic
on a combined basis for all periods presented.

49



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table presents a reconciliation of
net revenues and net income (loss) previously reported by
the Company to those incorporated in the accompanying
consolidated financial statements (in thousands):

|                           |                       |               |        |        |  
|-------------------------- | --------------------- | ------------- | ------ | ------ | -
|                           |                       | For the Six  
|                           |                       | Months Ended 
|                           |                       | June 30, 1999
|                           |                       |              
|                           |                       | (unaudited)  
|Net revenues               |                       |               |        |       
|                           | Exchange Applications |               | $      | 18,365 |  
|                           | eXstatic Software     |               |        | 358    |  
|                           |                       |               |        |       
|Combined net revenues      |                       | $             | 18,723 |       
|                           |                       |               |        |       
|Net income (loss)          |                       |               |        |       
|                           | Exchange Applications |               | $      | 1,214  |  
|                           | eXstatic Software     |               |        | (408   | )
|                           |                       |               |        |       
|Combined net income (loss) |                       | $             | 806    |       
|                           |                       |               |        |       

(b) Acquisition
of Knowledge Stream Partners, Inc.

On March 31, 2000, the Company acquired
Knowledge Stream Partners, Inc. (KSP), a Company
that specializes in consulting and software development for
advanced data mining and online/offline analytics. The Company
exchanged 27,393 shares of its common stock for all the
outstanding shares of common stock of KSP. In addition, the
Company assumed all of the outstanding employee stock options of
KSP, which converted into options to acquire 4,495 shares of the
Companys common stock. As of the date of the consummation
of the acquisition, the common stock issued by the Company and
the converted stock options had a market value of $39,896,000
based on a per share value of $1,587.60. The aggregate purchase
price of $43,254,000 consisted of the following (in thousands):

|                               |  |        |        | 
|------------------------------ |  | ------ | ------ | 
|Description                    |  | Amount
|                               |  |       
|Liabilities assumed            |  | $      | 2,928  | 
|Acquisition costs              |  |        | 430    | 
|Common stock and stock options |  |        | 39,896 | 
|                               |  |        |        | 
|Total purchase price           |  | $      | 43,254 | 
|                               |  |        |        | 

The purchase price was allocated based upon the
fair value of the identified assets acquired. These allocations
represent the fair values determined by an independent
appraisal. The allocation has resulted in acquired goodwill of
$41,869,000, which is being amortized on a straight-line basis
over a five-year period. The Company has also allocated $900,000
to the assembled work force acquired from KSP as determined by
the independent appraisal, which is being amortized on a
straight-line basis over a three-year period. The purchase price
was allocated to the acquired assets as follows (in thousands):

|                       |  |        |        | 
|---------------------- |  | ------ | ------ | 
|Description            |  | Amount
|                       |  |       
|Current assets         |  | $      | 233    | 
|Property and equipment |  |        | 252    | 
|Assembled workforce    |  |        | 900    | 
|Goodwill               |  |        | 41,869 | 
|                       |  |        |        | 
|                       |  | $      | 43,254 | 
|                       |  |        |        | 

50



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(c) Acquisition
of Customer Analytics, Inc.

In June 2000, the Company acquired Customer
Analytics, Inc. (CA), a company that specializes in
the development and licensing of marketing campaign management
solutions targeted at the local branch level. The Company
exchanged 148,723 shares of its common stock for all the
outstanding shares of common stock of CA; 25,387 of these shares
issued were placed into escrow as security for indemnification
obligations pursuant to the merger agreement. In addition, the
Company assumed all of the outstanding employee stock options of
CA, which converted into options to acquire 23,826 shares
of the Companys common stock. As of the date of the
consummation of the acquisition, the common stock issued by the
Company and the issued stock options had a market value of
$110,942,000 based on a per share value of $666.00. The
aggregate purchase price of $139,318,000 consisted of the
following (in thousands):

|                               |  |        |         | 
|------------------------------ |  | ------ | ------- | 
|Description                    |  | Amount
|                               |  |       
|Liabilities assumed            |  | $      | 25,557  | 
|Acquisition costs              |  |        | 2,819   | 
|Common stock and stock options |  |        | 110,942 | 
|                               |  |        |         | 
|Total purchase price           |  | $      | 139,318 | 
|                               |  |        |         | 

Included in acquisition cost was severance for
employees of CA who were terminated in connection with the
acquisition totaling $2,326,000. The Company paid $1,599,000 and
$641,000 of the severance owed to employees during the years
ended December 31, 2000 and 2001, respectively. The
remaining severance payment will be paid to employees in
installments through June 2002. The purchase price was allocated
based upon the fair value of the identified assets acquired.
These allocations represent the fair values determined by an
independent appraisal. The allocation has resulted in acquired
goodwill of $96,449,000, which is being amortized on a
straight-line basis over a five-year period The Company has also
allocated $3,700,000 to the assembled work force, $8,000,000 to
the customer base and $17,750,000 to purchased technology and
technological know-how acquired from CA as determined by the
independent appraisal, which are being amortized on a
straight-line basis over a three-year period. The purchase price
has been allocated to the acquired assets as follows (in
thousands):

|                       |  |        |         | 
|---------------------- |  | ------ | ------- | 
|Description            |  | Amount
|                       |  |       
|Current assets         |  | $      | 11,919  | 
|Property and equipment |  |        | 1,500   | 
|Assembled workforce    |  |        | 3,700   | 
|Acquired technology    |  |        | 17,750  | 
|Customer base          |  |        | 8,000   | 
|Goodwill               |  |        | 96,449  | 
|                       |  |        |         | 
|Total purchase price   |  | $      | 139,318 | 
|                       |  |        |         | 

See Note 4 for further discussion related to
the acquired intangibles.

(d) Pro
forma Financial Information

The following unaudited proforma financial
information presents the combined results of operations of CA
and KSP as if the acquisitions had occurred on January 1,
1999. The pro forma data are presented for illustrative purposes
only and are not necessarily indicative of the combined
financial position or results of operations for future periods
or the results that actually would have occurred had KSP and CA
been a combined company during the specified periods.

51



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following unaudited proforma information
presents a summary of consolidated results of operations as if
the acquisition had occurred on January 1, 1999:

|                                                                 |  |                           |         |      |  |   |           |  
|---------------------------------------------------------------- |  | ------------------------- | ------- | ---- |  | - | --------- | -
|                                                                 |  |                          
|                                                                 |  | Twelve Months Ended      
|                                                                 |  |                          
|                                                                 |  | 1999                      |         | 2000
|                                                                 |  |                           |         |     
|                                                                 |  |                          
|                                                                 |  | (in thousands, except per
|                                                                 |  | share data)              
|Revenues                                                         |  | $                         | 64,512  |      |  | $ | 75,326    |  
|Net Loss                                                         |  |                           | (47,236 | )    |  |   | (161,678  | )
|Basic and diluted net loss per share                             |  |                           | (51.60  | )    |  |   | (143.40   | )
|Basic and diluted weighted average common shares
    outstanding |  |                           | 913,305 |      |  |   | 1,127,347 |  

(4) Intangible Assets and
Goodwill

Intangible assets and goodwill related to the KSP
acquisition consisted of the following at December 31, 2001
(in thousands):

|                    |  |                |         |                |  |              |        |            |  |         |        |  |  |   |       |  |  |   |        | 
|------------------- |  | -------------- | ------- | -------------- |  | ------------ | ------ | ---------- |  | ------- | ------ |  |  | - | ----- |  |  | - | ------ | 
|                    |  |                |         |                |  | Accumulated  |        | Impairment |  |        
|                    |  | Estimated Life |         | Original Value |  | Amortization |        | Charge     |  | Balance
|                    |  |                |         |                |  |              |        |            |  |        
|                    |  |                |         |               
|                    |  | (in thousands) |         |               
|Goodwill            |  |                | 5 years |                |  | $            | 41,869 |            |  | $       | 14,669 |  |  | $ | 6,793 |  |  | $ | 20,407 | 
|Assembled workforce |  |                | 3 years |                |  |              | 900    |            |  |         | 525    |  |  |   |      |  |  |   | 375    | 
|                    |  |                |         |                |  |              |        |            |  |         |        |  |  |   |       |  |  |   |        | 
|                    |  |                |         |                |  | $            | 42,769 |            |  | $       | 15,194 |  |  | $ | 6,793 |  |  | $ | 20,782 | 
|                    |  |                |         |                |  |              |        |            |  |         |        |  |  |   |       |  |  |   |        | 

The Company recorded goodwill and other
intangible assets of $124.8 million in connection with the CA
acquisition. The Company amortized goodwill and other
intangibles related to the acquisition of CA using a
straight-line method over periods ranging from three to five
years. Amortization expense related to the CA intangible assets
totaled $ 15.9 million in 2000 and $7.4 million in
2001. During the fourth quarter of 2000, the Company determined
that an impairment in the carrying value of the assets related
to the CA acquisition had occurred and reduced the carrying
value of assets related to CA to the fair value based on the
discounted future cash flows. As a result, the Company recorded
an impairment of goodwill of $76.6 million in 2000. In
2001, the Company determined that further impairment to the
carrying value had occurred as the Company made the strategic
decision to no longer sell or support the software products
underlying the original CA acquisition. During 2001, the Company
licensed and ultimately sold the software technology which was
underlying the CA acquisition to Carreker Corporation. As a
result, the Company recorded impairment charges of
$24.9 million in 2001 to write-off the remaining
unamortized balance of the CA goodwill and intangible assets.

During the fourth quarter of 2001, in response to
continuing negative operating trends, the Company determined
that the remaining goodwill balance was impaired based upon a
third party indication of value of the Company as a whole. The
Company recorded an additional impairment of the carrying value
of such goodwill in the amount of $6.8 million.

In connection with the Companys adoption of
SFAS 141 on January 1, 2002 the unamortized balance of the
assembled workforce will be classified as goodwill. The carrying
value of goodwill will not be amortized beginning on
January 1, 2002, but will be subject to annual impairment
testing. The Company does not anticipate an impairment charge
upon adoption.

(5) Transactions with MicroStrategy,
Inc.

In December 1999, the Company entered into a
strategic alliance relationship with MicroStrategy, Inc.
(MicroStrategy), resulting in a series of
transactions between the two companies. MicroStrategys
products help businesses analyze customer data in order to
create intelligent marketing campaigns. The Company

52



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

accounted for these transactions as monetary
exchanges and recorded them at the fair value of the elements
exchanged.

The Company agreed to pay MicroStrategy an
aggregate of $65 million in cash and the Companys
common stock over two years commencing in December 1999. In
return, the Company received the following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Technology
    licenses The Company
    received licenses for MicroStrategys products for the
    purpose of developing new products using MicroStrategy
    technology along with distribution rights to the MicroStrategy
    applications incorporated as part of an CRM solution on a
    royalty-free basis for 42 months. The total consideration
    for these licenses was $30 million and consisted of a cash
    payment of $10 million in December 1999 and a stock
    subscription for $20 million, which was settled by the
    Company in January 2000 through the issuance of
    27,491 shares of the Companys common stock.
|
| | Research and development
    workforce The Company
    received the services of a dedicated research and development
    workforce from MicroStrategy for a 3 1/2 year term to
    develop new products using MicroStrategys technology.                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | Prepaid co-marketing
    services The Company
    received $5 million in co-marketing services from
    MicroStrategy in the form of joint advertising and promotion
    support over a period of 18 months.                                                                                                                                                                                                                                                                                                                                                                                                                                   

The total consideration for the research and
development workforce and the prepaid co-marketing costs was
$35 million and was payable in either cash or the
Companys common stock, at the Companys option, on a
quarterly basis over two years beginning in June 2000. Under the
terms of the agreement, the per share price used to calculate
the number of shares issued to settle any quarterly payment made
in stock is limited to a high and low stock price of $979.80 and
$587.70, respectively. The Company issued 26,860 and
32,073 shares of common stock in 2000 and 2001,
respectively, in full settlement of the obligation plus all
accrued interest.

The Company capitalized as a non current asset
the present value of the future payment obligations to
MicroStrategy, totaling $62.0 million, and amortized this
asset to operations over the terms of the underlying
arrangements, which is approximately 18 to 42 months. The
following represent is the components of the amortization of the
MicroStrategy assets in 2000 and 2001:

|                                           |  |                       |        |      |  |   |        | 
|------------------------------------------ |  | --------------------- | ------ | ---- |  | - | ------ | 
|                                           |  |                      
|                                           |  | For the Twelve Months
|                                           |  | Ended December 31,   
|                                           |  |                      
|                                           |  | 2000                  |        | 2001
|                                           |  |                       |        |     
|                                           |  |                      
|                                           |  | (in thousands)       
|Technology licenses                        |  | $                     | 8,342  |      |  | $ | 8,147  | 
|Research and development workforce         |  |                       | 8,147  |      |  |   | 8,147  | 
|Prepaid co-marketing service               |  |                       | 3,333  |      |  |   | 1,665  | 
|                                           |  |                       |        |      |  |   |        | 
|Total amortization of MicroStrategy assets |  | $                     | 19,822 |      |  | $ | 17,959 | 
|                                           |  |                       |        |      |  |   |        | 

In the fourth quarter of 2001, as a result of
decreased market demand for MicroStrategy technology and
MicroStrategys inability to continue to support the
product, the Company made the strategic decision to discontinue
the use of MicroStrategy technology effective with the updated
release of Xchange 8 in December, 2001. The Company
recorded an impairment charge of $24.5 million at
December 21, 2001 to write-off the remaining unamortized
balance of the MicroStrategy asset.

Also in December 1999, MicroStrategy entered into
a valued added reseller agreement and a software license
agreement with the Company whereby they will receive the
following licenses from the Company:



| |                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Royalty-Free Distribution
    License MicroStrategy
    received a royalty-free right to distribute in their
    Strategy.com ASP environment for 3 1/2 years the
    Companys Xchange eMessaging product to named affiliates of
    MicroStrategys Strategy.com web service. MicroStrategy
    agreed to pay $100,000 per named affiliate up to a cap of $8.0
    million.

53



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Internal-use and development
    licenses MicroStrategy
    received perpetual internal-use and development licenses to use
    the Companys products, along with the initial year of
    support and maintenance, valued at a total of $2.0 million.

MicroStrategy paid the Company the
$8.0 million for the Xchange eMessaging product
distribution over the 3 1/2 year term as MicroStrategy
designated named affiliates to its Strategy.com web service. The
Company recorded the license fee as MicroStrategy designated
named affiliates and the payments become due. The Company
determined that $100,000 was the fair value of the Xchange
eMessaging product for purposes of revenue recognition based on
the published list price for that product and the appropriate
historical discount off list price for reseller contracts. The
Company is providing support to MicroStrategy under annual
maintenance contracts that are billed when MicroStrategy
designates affiliates. Revenues under these maintenance
contracts are recognized over the period of service. In December
1999, the Company recorded total revenue of $4.5 million
when MicroStrategy designated 45 named affiliates for the
Xchange eMessaging product through the Strategy.com web service.
The Company recorded the remaining $3.5 million of revenue
under this contract during 2000 when MicroStrategy designated
and paid for additional named affiliates to its Strategy.com web
service.

MicroStrategy paid the Company the
$2.0 million for the internal-use and development licenses
upon the delivery and execution of the license agreements. The
Company determined the fair value of these licenses for revenue
recognition purposes based on historically established pricing
for similar third-party transactions. These products were
delivered in January 2000, at which point the product revenue
was recognized and the support and maintenance fees were
deferred.

(6) Property and Equipment

Property and equipment are stated at cost, net of
accumulated depreciation and amortization. The Company provides
for depreciation and amortization using the straight-line method
to allocate the cost of property and equipment over their
estimated useful lives. Property and equipment, at cost, and
their estimated useful lives are as follows:

|                                |  |             |                   |                |  |      |        |  |  |   |        | 
|------------------------------- |  | ----------- | ----------------- | -------------- |  | ---- | ------ |  |  | - | ------ | 
|                                |  |             |                   |               
|                                |  |             |                   | December 31,  
|                                |  | Estimated   |                   |               
|                                |  | Useful Life |                   | 2000           |  | 2001
|                                |  |             |                   |                |  |     
|                                |  |             |                   |               
|                                |  |             |                   | (in thousands)
|Computers and equipment         |  |             | 4 years           |                |  | $    | 9,135  |  |  | $ | 6,210  | 
|Furniture and fixtures          |  |             | 10 years          |                |  |      | 2,023  |  |  |   | 1,532  | 
|Purchased software              |  |             | 3 years           |                |  |      | 4,000  |  |  |   | 3,803  | 
|Leasehold improvements          |  |             | Life of the lease |                |  |      | 1,581  |  |  |   | 1,303  | 
|                                |  |             |                   |                |  |      |        |  |  |   |        | 
|                                |  |             |                   |                |  |      | 16,739 |  |  |   | 12,848 | 
|Less  Accumulated depreciation |  |             |                   |                |  |      | 6,326  |  |  |   | 6,661  | 
|                                |  |             |                   |                |  |      |        |  |  |   |        | 
|                                |  |             |                   |                |  | $    | 10,413 |  |  | $ | 6,187  | 
|                                |  |             |                   |                |  |      |        |  |  |   |        | 

Depreciation expense for the years ended
December 31, 1999, 2000 and 2001 was approximately
$1,600,000, $3,716,000 and $4,698,000 respectively.

54



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(7) Accrued Expenses

Accrued expenses at December 31, 2000 and
2001 consisted of the following:

|                          |  |                |        |      |  |   |        | 
|------------------------- |  | -------------- | ------ | ---- |  | - | ------ | 
|                          |  |               
|                          |  | December 31,  
|                          |  |               
|                          |  | 2000           |        | 2001
|                          |  |                |        |     
|                          |  |               
|                          |  | (in thousands)
|Payroll and related costs |  | $              | 5,719  |      |  | $ | 2,577  | 
|Accrued tax liabilities   |  |                | 3,171  |      |  |   | 3,612  | 
|Restructuring accrual     |  |                |       |      |  |   | 4,716  | 
|Accrued interest          |  |                | 201    |      |  |   | 2,428  | 
|Accrued insurance         |  |                | 195    |      |  |   | 1,142  | 
|Other                     |  |                | 6,630  |      |  |   | 1,870  | 
|                          |  |                |        |      |  |   |        | 
|                          |  | $              | 15,916 |      |  | $ | 16,345 | 
|                          |  |                |        |      |  |   |        | 

(8) Income Taxes

For financial reporting purposes, income
(loss) before taxes includes the following components:

|                     |               |                |       |       |  |      |          |          |   |   |          |          |  
|-------------------- | ------------- | -------------- | ----- | ----- |  | ---- | -------- | -------- | - | - | -------- | -------- | -
|                     |               | 1999           |       | 2000  |  | 2001
|                     |               |                |       |       |  |     
|                     |               |               
|                     |               | (in thousands)
|Pretax income/(loss) |               |                |       |       |  |      |          |          |   |   |          |         
|                     | United States |                | $     | 2,833 |  |      | $        | (132,603 | ) |   | $        | (145,801 | )
|                     | Foreign       |                |       | 485   |  |      |          | (6,377   | ) |   |          | (4,818   | )
|                     |               |                |       |       |  |      |          |          |   |   |          |         
|                     |               | $              | 3,318 |       |  | $    | (138,980 | )        |   | $ | (150,619 | )       
|                     |               |                |       |       |  |      |          |          |   |   |          |         

The components of the provision for income taxes
for the each of the three years in the period ended
December 31, 2001 are as follows:

|         |         |                |       |       |       |      |   |   |   |  |    |    |    | 
|-------- | ------- | -------------- | ----- | ----- | ----- | ---- | - | - | - |  | -- | -- | -- | 
|         |         | 1999           |       | 2000  |       | 2001
|         |         |                |       |       |       |     
|         |         |               
|         |         | (in thousands)
|Current  |         |                |       |       |       |      |   |   |   |  |    |   
|         | Federal |                | $     | 1,754 |       |      | $ |  |   |  | $  |   |   
|         | State   |                |       | 310   |       |      |   |  |   |  |    | 12 |   
|         | Foreign |                |       | 152   |       |      |   | 9 |   |  |    | 26 |   
|         |         |                |       |       |       |      |   |   |   |  |    |   
|         |         |                | 2,216 |       |       |      | 9 |   |   |  | 38 |   
|         |         |                |       |       |       |      |   |   |   |  |    |   
|Deferred |         |                |       |       |       |      |   |   |   |  |    |   
|         | Federal |                |       |      |       |      |   |  |   |  |    |   |   
|         | State   |                |       |      |       |      |   |  |   |  |    |   |   
|         | Foreign |                |       |      |       |      |   |  |   |  |    |   |   
|         |         |                |       |       |       |      |   |   |   |  |    |   
|         |         |                |      |       |       |      |  |   |   |  |   |   
|         |         |                |       |       |       |      |   |   |   |  |    |   
|         |         | Total          |       | $     | 2,216 |      |   | $ | 9 |  |    | $  | 38 | 
|         |         |                |       |       |       |      |   |   |   |  |    |   

For the year ended December 31, 1999, the
Companys tax liability was reduced as a result of a tax
benefit related to disqualifying dispositions from stock option
exercises of approximately $2.2 million which was recorded
as an increase in additional paid-in capital. For the years
ended December 31, 2000 and 2001, a similar tax benefit was
not recorded due to either the absence of disqualifying
dispositions or due to the uncertainty related to the future
realizability of the net operating loss carryforwards generated.

55



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The approximate tax effects of temporary
differences that give rise to significant portions of the
Companys deferred tax assets are as follows:

|                                    |                        |                |         |      |  |   |         |   | 
|----------------------------------- | ---------------------- | -------------- | ------- | ---- |  | - | ------- | - | 
|                                    |                        |               
|                                    |                        | December 31,  
|                                    |                        |               
|                                    |                        | 2000           |         | 2001
|                                    |                        |                |         |     
|                                    |                        |               
|                                    |                        | (in thousands)
|Nondeductible expenses and reserves |                        | $              | 5,031   |      |  | $ | 5,790   |  
|Net operating losses acquired       |                        |                | 6,583   |      |  |   | 6,122   |  
|Net operating loss carryforwards    |                        |                | 14,920  |      |  |   | 53,322  |  
|                                    |                        |                |         |      |  |   |         |  
|Deferred Tax Asset                  |                        |                | 26,534  |      |  |   | 65,234  |  
|                                    |                        |                |         |      |  |   |         |  
|Valuation allowance                 |                        |                | (26,534 | )    |  |   | (65,234 | )
|                                    |                        |                |         |      |  |   |         |  
|                                    | Net deferred tax asset |                | $       |     |  |   | $       |  | 
|                                    |                        |                |         |      |  |   |         |  

The Company has established a valuation allowance
against its deferred tax asset to the extent that it cannot
conclusively demonstrate that these assets more likely
than not will be realized. In evaluating the realizability
of these deferred tax assets, the Company has considered the
following factors: (1) its short operating history,
(2) the volatility of the industry in which it operates,
and (3) the operating losses incurred to date. The Company
believes that given the significance of this evidence, a full
valuation reserve against its deferred tax assets is required as
of December 31, 2000 and 2001. During the year ended
December 31, 2000, deferred tax assets totaling $8,620,000
were acquired and fully reserved due to the uncertainty of the
realization of the assets.

The Tax Reform Act of 1986 contains provisions
that may limit the amount of net operating loss and credit
carryforwards that the Company may utilize in any one year in
the event of certain cumulative changes in ownership over a
three-year period in excess of 50%, as defined. While a formal
study has not been performed, the Company believes it has
experienced a change in ownership in excess of 50%. The
businesses it acquired during the year ended December 31, 2000
also experienced ownership changes in excess of 50%. The Company
does not believe that ownership changes of the acquired entities
will significantly impact the Companys ability to utilize
the net operating loss carryforwards from those entities.
However, depending when the Companys ownership changes are
deemed to have occurred, the ability to utilize non-acquired net
operating loss carryforwards may be subject to material
limitations. A formal study would need to be performed to
determine the limitation amounts.

As of December 31, 2001, the Company had net
operating loss carryforwards of approximately $153 million
to reduce future income taxes, if any. Of this amount,
approximately $142.1 million expire through 2021 and
$11.0 million can be carried forward indefinitely. The net
operating loss carryforwards are subject to review and possible
adjustment by the Internal Revenue Service and tax authorities
within foreign jurisdictions.

56



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A reconciliation of the federal statutory rate to
the Companys effective tax rate for each of the three
years in the period ended December 31, 2001 is as follows:

|                                           |                                           |                    |    |      |    |      |     |    |   |   |     |    |   |  
|------------------------------------------ | ----------------------------------------- | ------------------ | -- | ---- | -- | ---- | --- | -- | - | - | --- | -- | - | -
|                                           |                                           | 1999               |    | 2000 |    | 2001
|                                           |                                           |                    |    |      |    |     
|Provision at federal statutory rate        |                                           |                    | 34 | %    |    |      | (34 | )% |   |   | (34 | )%
|Increase (decrease) in tax resulting from: |                                           |                    |    |      |    |      |     |    |   |   |     |   
|                                           | State income tax, net of federal benefits |                    |    | 6    |    |      |     | (3 | ) |   |     | (3 | )
|                                           | Foreign income taxes                      |                    |    |     |    |      |     |   |   |   |     | (1 | )
|                                           | eXstatic pre-acquisition losses           |                    |    | 7    |    |      |     |   |   |   |     |   |  
|                                           | eXstatic acquisition expense              |                    |    | 16   |    |      |     |   |   |   |     |   |  
|                                           | Non-deductible goodwill                   |                    |    |     |    |      |     | 27 |   |   |     | 12 |  
|                                           | Non-deductible amortization               |                    |    |      |    |      |     |    |   |   |     | 5  |  
|                                           | Change in valuation allowance             |                    |    | 7    |    |      |     | 10 |   |   |     | 21 |  
|                                           | Other, net                                |                    |    | (3   | )  |      |     |   |   |   |     |   |  
|                                           |                                           |                    |    |      |    |      |     |    |   |   |     |   
|                                           |                                           | Effective tax rate |    |      | 67 | %    |     |    |  | % |     |    |  | %
|                                           |                                           |                    |    |      |    |      |     |    |   |   |     |   

(9) Restructuring and Other
Charges

In the second, third and fourth quarters of 2001,
the Company undertook corrective actions to better align costs
with its outlook on near term revenues and to preserve cash. As
a result of these actions, the Company recorded a charge of
$809,000 to cost of software license fees and a restructuring
charge of $19,172,000. The components of these charges were as
follows:

|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 
|--------------------------------------------- |  | -------------- | ----- | ------- |  | ------- | ----- | ----- |  | - | ----- |  |  | - | ------ | 
|                                              |  | Q2 2001        |       | Q3 2001 |  | Q4 2001 |       | Total
|                                              |  |                |       |         |  |         |       |      
|                                              |  |               
|                                              |  | (in thousands)
|Severance                                     |  | $              | 1,120 |         |  | $       | 1,119 |       |  | $ | 786   |  |  | $ | 3,025  | 
|Facilities related                            |  |                |      |         |  |         | 2,889 |       |  |   | 1,690 |  |  |   | 4,579  | 
|Property and equipment                        |  |                |      |         |  |         | 1,409 |       |  |   | 596   |  |  |   | 2,005  | 
|Asset impairment                              |  |                | 6,340 |         |  |         | 2,737 |       |  |   | 809   |  |  |   | 9,886  | 
|Others                                        |  |                |      |         |  |         | 250   |       |  |   | 236   |  |  |   | 486    | 
|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 
|Total restructuring and other unusual charges |  | $              | 7,460 |         |  | $       | 8,404 |       |  | $ | 4,117 |  |  | $ | 19,981 | 
|                                              |  |                |       |         |  |         |       |       |  |   |       |  |  |   |        | 

Severance costs relate to the elimination of 226
managerial and staff positions worldwide, comprising
approximately 48% of the beginning of the year workforce in the
following areas: 52 in sales and marketing, 71 in research and
development, 63 in professional services and 40 in general and
administration. Facility related costs relate to the
consolidation and abandonment of excess facilities, net of
assumed sublease income. Property and equipment relate to
non-cash write-offs of excess computer equipment that has been
removed from operations as a result of employee reductions and
leasehold improvements on leased facilities that were abandoned
at various times in the latter half of 2001. Asset impairment
relates to the write-off of third-party acquired technology
which will not be realized based on the Companys decision
to no longer support an operating system platform, and the
write-off of obsolete third-party software originally acquired
to be sold as a component of Xchanges software solution
which will not be realized due to the Companys decision to
no longer offer certain product capabilities. Other costs relate
primarily to non-cancelable commitments for marketing activities
that will not take place as a result of the Companys cost
containment initiatives.

57



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

At December 31, 2002 the Company had the
following restructuring accruals:

|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 
|---------------------- |  | -------------- | ------ | -------- |  | -------- | ------ | ----------------- |  | - | ----- |  |  | - | ----- | 
|                       |  |                |        |          |  |          |        | Restructuring    
|                       |  | Total          |        | Non-Cash |  | Cash     |        | Accrual at       
|                       |  | Charges        |        | Charges  |  | Payments |        | December 31, 2001
|                       |  |                |        |          |  |          |        |                  
|                       |  |               
|                       |  | (in thousands)
|Severance              |  | $              | 3,025  |          |  | $        | 350    |                   |  | $ | 2,430 |  |  | $ | 245   | 
|Facilities related     |  |                | 4,579  |          |  |          |       |                   |  |   | 587   |  |  |   | 3,992 | 
|Property and equipment |  |                | 2,005  |          |  |          | 2,005  |                   |  |   |      |  |  |   |      | 
|Asset impairment       |  |                | 9,886  |          |  |          | 9,886  |                   |  |   |      |  |  |   |      | 
|Others                 |  |                | 486    |          |  |          |       |                   |  |   | 7     |  |  |   | 479   | 
|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 
|Total                  |  | $              | 19,981 |          |  | $        | 12,241 |                   |  | $ | 3,024 |  |  | $ | 4,716 | 
|                       |  |                |        |          |  |          |        |                   |  |   |       |  |  |   |       | 

All terminations were completed by
December 31, 2001. The remaining severance costs will be
paid out in installment through April 30, 2002. Facility
costs will be paid out through 2005 based on the remaining lease
terms of the abandoned facilities.

(10) Indebtedness

(a) Notes
Payable to former CA Shareholders

In connection with the acquisition of CA, the
Company entered into subordinated note agreements with certain
former shareholders of CA in the amount of $5,000,000. The notes
bear interest at 5% per annum. $2,875,000 of the notes are due
on December 31, 2000 and $2,125,000 are due on June 1,
2002 or upon the sale of the Companys common stock with
net proceeds of at least $75,000,000 or the closing of a senior
debt facility with a commercial lender with a borrowing capacity
of at least $20,000,000. The Company has discounted the
long-term portion of the notes due in June 2002 at a rate
of 10%. In January 2001, the Company repaid $2,460,000 of
the notes outstanding plus all accrued interest.

(b) Transactions
with Insight Venture Partners

(i) Note
Payable to Insight Venture Partners

On December 15, 2000, Insight Venture
Associates IV, L.L.C. through four of its affiliated funds
(collectively, Insight) entered into a note purchase
agreement with the Company that provided for the issuance by the
Company of up to $4,000,000 of convertible promissory notes (the
December 2000 Notes). The December 2000
Notes accrued interest at 9% per annum, matured on
January 10, 2001 and were automatically convertible into
the next round of the Companys equity financing. On
January 10, 2001, the aggregate outstanding principal
amount of the December 2000 Notes ($1,500,000) was converted
into shares of the Companys Series A Preferred Stock
(See Note 12).

(ii) February
and March Securities Purchase Agreements

Pursuant to a Securities Purchase Agreement dated
February 20, 2001, the Company issued a 9% Bridge
Promissory Note (the February Note) and a warrant to
purchase up to 3,629 shares of the Companys common
stock (the February Warrant) to Insight for an
aggregate purchase price of $3.0 million. The February
Warrant is exercisable at any time after April 30, 2001 and
on or prior to February 15, 2011 at an exercise price of
$82.662 per share. Approximately $113,000 of the proceeds of the
February Note were allocated to the value of the February
Warrant which was recorded in additional paid-in capital. The
resulting discount was amortized to interest expense over the
period from issuance to maturity on April 30, 2001.

Pursuant to a Securities Purchase Agreement dated
March 28, 2001, the Company issued a 10% Bridge Promissory
Note (the March Note) and a warrant to purchase up
to 9,804 shares of the Companys

58



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

common stock (the March Warrant) to
Insight for an aggregate purchase price of $1.5 million.
The March Warrant is exercisable at any time after
June 2001 and on or prior to March 28, 2011 at an
exercise price of $45.90 per share. Approximately $145,000 of
the proceeds of the March Note was allocated to the value of the
March Warrant which was recorded in additional paid-in capital.
The resulting discount was amortized to interest expense over
the period from issuance to maturity on June 28, 2001.

(iii) Undertaking
Letter

On April 16, 2001, the Company received an
undertaking letter (the Undertaking Letter) from
Insight. Under the terms of the Undertaking Letter, Insight
agreed to refinance the February Note and the March Note with an
new note that matured on January 15, 2002 and to provide up
to $13.5 million of additional financing through
December 31, 2001 or the consummation of the Sale of
the Corporation, as defined in the Companys
Series A Redeemable Convertible Preferred Stock documents.
In accordance with the terms of the Undertaking Letter, the
additional financing would be available at any time provided
that the Company has used its best efforts to obtain financing
from other investors and has not been successful in obtaining
such financing.

In connection with the Undertaking Letter, the
Company issued a warrant (the April Warrant) to
purchase a minimum of 27,273 and up to 50,636 shares of the
Companys common stock to Insight at a per share exercise
price equal to the lowest closing price per share of the
Companys common stock from April 16, 2001 until
(a) the date of first exercise (b) the earliest of:
(i) December 31, 2001, (ii) the date that
Insights obligations, if any, with respect to the
Undertaking Letter, terminates due to notification from the
Company to that effect, and (iii) the date of the
consummation of a Sale of the Corporation as defined
in the Companys Series A Redeemable Convertible
Preferred Stock documents. Under the terms of the Undertaking
Letter, additional vesting of warrants in excess of the 27,273
minimum is accreted daily based on the number of days lapsed
from the date of the Undertaking Letter. The Company has
recorded deferred financing charges of $1.3 million
representing the value of the original issuance of
27,273 warrants. This charge is being amortized to interest
expense over the term of the Undertaking Letter. Additional
financing charges related to the vesting of warrants in excess
of the minimum share value are valued at their fair market value
on the date the warrants become vested and are recorded to
interest expense during the period in which the warrants become
vested. During 2001, the Company recorded $877,000 in non-cash
interest expense related to the April Warrant. Upon the
execution of the July Securities Purchase Agreement, the
remaining balance of the deferred financing charges were netted
against the carrying value of the debt. In connection with the
August Securities Purchase Agreement the number of warrant
shares issuable under the April Warrant was fixed at 39,311 as
of August 29, 2001 with a per share exercise price of $9.90
per share (see Note 10(b)(iv)).

(iv) June 2001
Securities Purchase Agreement

Pursuant to a Securities Purchase Agreement dated
June 1, 2001 (the June Securities Purchase
Agreement), the Company issued a 12% Bridge Promissory
Note (the June Note) for a purchase price of
$7,000,000 to Insight. The June Note refinanced the February
Note and March Note as contemplated in an Undertaking Letter
from Insight (see Note 10(b)(iii)) and provided
$2.5 million of additional financing. The original maturity
of the June Note was January 15, 2002. In connection with
the June Securities Purchase Agreement, the Company issued a
warrant to purchase 45,456 shares of the Companys common
stock (the June Warrant) at a per share exercise
price equal to the lowest market price for the period commencing
on February 20, 2001 and ending on the earlier of:
(i) the exercise date of the June Warrant, (ii) the
date all principal and interest on the June Note is repaid, and
(iii) the date on which all of the Companys
obligations under the June Note are terminated due to a
conversion of the June Note pursuant to its terms. Approximately
$1,145,000 of the proceeds were allocated to the value of the
June Warrant and was recorded in additional paid-in capital
based on the fair value of the warrant. The resulting discount
was being amortized to interest expense over the period from
issuance to the maturity date of the June Note. During 2001 the

59



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Company recognized $291,000 in interest expense,
respectively, associated with the June Warrant. Pursuant to a
Securities Purchase Agreement dated July 26, 2001 (the
July Securities Purchase Agreement), the June Note
was refinanced with a new security. In addition, pursuant to a
Securities Purchase Agreement dated August 29, 2001 (the
August Securities Purchase Agreement), the June
Warrant was cancelled. (see Note 10(b)(iv))

(v) Issuance
of Convertible Debentures

Pursuant to the July Securities Purchase
Agreement, the Company issued convertible debentures in the
amount of $12.2 million (the July Debentures).
The July Debentures refinanced the June Note including all
accrued and unpaid interest and provided an additional
investment of $5.0 million. The July Debentures bear
interest at 12% and mature on January 10, 2005.

Pursuant to the August Securities Purchase
Agreement the following transactions occurred:



| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company issued $15.5 million of new
    convertible debentures to certain investors including Insight
    (the August Debentures).                   
|
| |  | The terms of the July Debentures were amended to
    be identical to the terms of the August Debentures.                                                   
|
| |  | The June Warrant was canceled.                                                                                                                             
|
| |  | The number of shares issuable under the April
    Warrant was fixed at 39,311 as of August 29, 2001 with a
    per share exercise price of $9.90 per share.

The August Debentures bear interest at 12% per
annum through August 29, 2003 and 15% per annum for the
period commencing on August 29, 2003 through their maturity
date on January 10, 2005. The holders of the August
Debentures have the option to require prepayment of the
outstanding obligations in an amount equal to the aggregate
principal amount multiplied by a factor of 103% plus all accrued
and unpaid interest upon the occurrence of: (i) an event of
default, as defined in the August Security Purchase Agreement,
(ii) a Liquidity Event, as defined in the
August Securities Purchase Agreement, or
(iii) January 10, 2004. The August Debentures are
convertible at the option of the holder into the number of
shares equal to the product of the unpaid principal multiplied
by a factor of 103% plus any accrued and unpaid interest divided
by the conversion price, currently $9.5490 per share (subject to
adjustment as defined in the August Securities Purchase
Agreement).

Warrants to purchase 1,439,941 shares of
common stock (the August Warrant) were issued to the
holders of the August Debentures. The August Warrant has an
exercise price of $9.5490 per share and expires on
August 29, 2011. The August Warrant became exercisable on
March 11, 2002, upon approval by the Companys
shareholders to increase the authorized shares.

The entire proceeds of the July Debentures and
the August Debentures (collectively Convertible
Debentures), net of all financing and transaction costs,
were allocated to the beneficial conversion feature, in the
amount of $12.2 million, and to the value of the warrants
issued, in the amount of $13.3 million. These allocations
are recorded as reductions to the carrying value of the
Convertible Debentures and as contributions to additional
paid-in capital. The resulting discount on the Convertible
Debentures will be accreted up through interest expense over the
maturity period of the Convertible Debentures. The Company
accreted $3.1 million of the discount to interest expense
in 2001.

(c) Bank
Line of Credit

In April 2001, the Company entered into a
$5.0 million secured credit facility with SVB. Availability
under the credit facility is based on a percentage of the
Companys eligible receivables as defined in the credit
facility documentation. Borrowings under the credit facility
bear interest at the banks prime rate (4.75% at

60



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

December 31, 2001) plus 2.5% points. The
credit facility matures on April 25, 2002. Under the terms
of the credit facility documentation, the Company must maintain
at least $2.0 million of excess availability or cash and
investments at all times. In connection with the line of credit,
the Company issued a warrant to purchase 2,336 shares of
the Companys common stock with a per share exercise price
of $64.20. The warrant expires in April 24, 2008. The
Company has valued the warrant at $132,000, which is being
amortized to interest expense over the remaining term of credit
facility documentation. At June 30, 2001, the Company was
out of compliance with certain financial covenants of the line
of credit. In July 2001, certain terms of the credit
facility were modified pursuant to which the bank agreed to
waive the Companys non compliance with certain financial
covenants provided that Company receive $5 million of
additional funding from the sale of equity securities or
subordinated debt on or before July 31, 2001 and
$2.5 million of additional funding from the sale of equity
securities or subordinated debt on or before September 30,
2001. In July and August 2001, the Company received
$5.0 million and $15.5 million, respectively, from the
sale of the Convertible Debentures (see Note 10.b.iv). In
connection with the loan modification, the Company issued an
additional warrant to the bank to purchase 1,667 shares of
the Companys common stock with a per share exercise price
of $15.30. The warrant expires on July 24, 2008. The
Company has valued the warrant at $20,900, which is being
amortized to interest expense over the remaining term of the
agreement. During 2001, the Company recorded $93,000 of interest
expense related to the amortization of the value of the
banks warrants. At December 31, 2001, the Company was
in compliance with all financial covenants.

(11) Commitments

The Company leases certain facilities, equipment,
and technology under noncancellable operating and capital lease
agreements. The leases expire at various dates through 2005. The
Company has letters of credit outstanding with a bank for
collateral on its leased facilities and certain equipment. Total
rent expense, net of sublease rental income, under these
agreements was approximately $1,646,000, $3,105,000 and
$3,789,000 for the years ended December 31, 1999, 2000 and
2001, respectively. For the year ended December 31, 2001,
sublease rent income was $392,000.

At December 31, 2001, the minimum lease
commitments for all leased facilities and equipment with an
initial or remaining term in excess of one year are as follows:

|                                        |                        |                |       |         |  |   |       |       | 
|--------------------------------------- | ---------------------- | -------------- | ----- | ------- |  | - | ----- | ----- | 
|                                        |                        | Operating      |       | Capital
|For the Year Ending December 31,        |                        | Leases         |       | Leases 
|                                        |                        |                |       |        
|                                        |                        |               
|                                        |                        | (in thousands)
|2002                                    |                        | $              | 2,845 |         |  | $ | 1,302 |      
|2003                                    |                        |                | 2,809 |         |  |   | 62    |      
|2004                                    |                        |                | 1,501 |         |  |   | 6     |      
|2005                                    |                        |                | 41    |         |  |   | 6     |      
|2006                                    |                        |                |      |         |  |   | 3     |      
|Thereafter                              |                        |                |      |         |  |   |      |      
|                                        |                        |                |       |         |  |   |       |      
|                                        | Total minimum payments |                | $     | 7,196   |  |   |       | 1,379 | 
|                                        |                        |                |       |         |  |   |       |      
|Amount representing interest            |                        |                |       |         |  |   | 84    |      
|                                        |                        |                |       |         |  |   |       |      
|Present value of minimum lease payments |                        |                |       |         |  | $ | 1,295 |      
|                                        |                        |                |       |         |  |   |       |      

Included in the total minimum payments for
operating leases is approximately $4,306,000 related to
abandoned real estate which was accrued as a liability as part
of the Companys restructuring charges in 2001. See
Note 9.

61



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

From time to time, we are involved in litigation
relating to claims arising out of our operations in the normal
course of business. As of the date of this filing, it is
managements opinion that we are not a party to any legal
proceedings which, if decided adversely to Xchange, would have a
material adverse effect on our results of operations or
financial position.

Xchange and certain of our current and former
officers (the Xchange Defendants) and its certified
public accountants, Arthur Andersen, LLP, have been named
defendants in a consolidated class action lawsuit originally
filed on February 21, 2001 and subsequently filed as a
Consolidated Amended Class Action Complaint on August 2,
2001, filed on behalf of a purported class of purchasers of our
common stock during the period from December 9, 1998
through September 29, 2000. The Amended Class Action
Complaint alleges that we made false or misleading statements
that inflated our common stock price during the class period.
The relief sought is damages on behalf of the class; however, at
this time, we are unable to ascertain the monetary damages
sought by the class. Through our attorneys, we have filed a
Motion to Dismiss the Amended Class Action Complaint on
October 3, 2001. The action is pending in the United States
District Court for the District of Massachusetts. We believe
these allegations are without merit and we intend to defend the
litigation vigorously.

Xchange, along with BT Alex Brown, Inc.,
Hambrecht & Quist, LLC, Adams, Harkness &
Hill, Inc., Sound-View Technology Group, Inc. (together, the
Underwriter Defendants) and certain current and
former officers and directors, including Andrew J. Frawley, John
G. OBrien, Jeffrey Horing, Ramanan Raghavendran, David G.
McFarlane, Michael D. McGonagle, Patrick A. McHugh, and
N. Wayne Townsend, have purportedly been named defendants
in a class action complaint filed on behalf of a class of
purchasers of its common stock during the period from
December 9, 1998 through December 6, 2000. Xchange is
currently reviewing whether it has been formally served with
this complaint, but it purportedly alleges that documents filed
in connection with the Xchanges initial and follow-on
public offerings (the Offerings) were materially
false and misleading because they failed to disclose that
(1) the Underwriter Defendants solicited and received
excessive and undisclosed commissions from certain investors in
exchange for which the Underwriter Defendants allocated to those
investors material portions of the restricted stock issued in
connection with the Offerings, and (2) the Underwriter
Defendants had entered into agreements with customers whereby
they agreed to allocate Xchanges shares to those customers
who agreed to purchase additional shares in the after-market at
pre-determined prices. At this time, we are unable to ascertain
the monetary damages sought by the class. The action is pending
in the United States District Court for the Southern District of
New York. We believe these allegations are without merit and we
intend to defend the litigation vigorously.

(12) Preferred Stock

At incorporation on November 7, 1996, the
Company authorized 10,000,000 shares of $.001 par value
Preferred Stock for future issuance in one or more series.

On March 18, 1997, the Company converted all
of its previously outstanding shares of Preferred Stock into
1,725,000 shares of common stock. The Company then amended
its certificate of incorporation to reduce the number of
authorized shares of its $.001 par value preferred stock to
5,455,556 shares, of which 2,900,000 shares were
designated as Series A Preferred Stock and
2,555,556 shares were designated Series B Preferred
Stock. The 2,900,000 shares of Series A Preferred
Stock were issued upon the conversion of $2,405,000 of notes
payable to related parties. The 2,555,556 shares of
Series B Preferred Stock were sold to venture capital
investors at a price of $1.565 per share, with net proceeds to
the Company of $3,888,000.

Each outstanding share of Series A Preferred
Stock accrued a cumulative annual dividend of 8.25%. The Company
has provided for Series A Preferred Stock cumulative
dividends by accreting charges against the accumulated deficit
with corresponding increases to the carrying value of the
Series A Preferred Stock. Such increases aggregated
approximately $189,000 and $180,000 for the years ended
December 31, 1997 and 1998, respectively.

62



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company loaned $125,000 to an officer for the
purchase of approximately 38,000 shares of Series B
Preferred Stock from another stockholder. The loan is evidenced
by a note that bears interest at the prime rate and is secured
by the 38,000 shares of Series B Preferred Stock the
officer purchased. The Company accounted for this loan as a
stock subscription receivable classified as Due from Officer in
the accompanying consolidated statements of stockholders
equity as of December 31, 1999. In October 2000, the
loan, plus all accrued interest, was repaid to the Company.

On December 4, 1997, the Company authorized
an additional 1,223,954 shares of $.001 par value Preferred
Stock and designated these shares as Series C Convertible
Preferred Stock (the Series C Preferred Stock).
The 1,223,954 shares of the Series C Preferred Stock
were sold to venture capital investors at a price of $3.268 per
share, with net proceeds to the Company of $3,987,000.

On December 14, 1998, the Company completed
an initial public offering that satisfied the conditions of a
Qualified Offering as defined by the Preferred Stock agreements.
Accordingly, Series A Preferred Stock was reclassified to
$3,269,000 of additional paid-in capital and the Series B
Preferred Stock, at a redemption value of $4,000,000, was
converted into 85,185 shares of common stock. In addition,
the Series C Preferred Stock was converted to
40,798 shares of common stock upon completion of the
initial public offering.

In January 2001, the Company designated
5,330,000 shares of its authorized Preferred Stock, $.001
par value, as Series A Convertible Redeemable Preferred
Stock (the Series A Convertible Preferred
Stock). The Company issued 5,325,645 shares at a purchase
price of $1.2628 per share resulting in gross proceeds of
$6.7 million including the conversion of a
$1.5 million note payable to Insight. Each share of
Series A Convertible Preferred Stock accrues cumulative
dividends at a rate of 10% per annum. The holders of the
Series A Convertible Preferred Stock may require the
Company to redeem outstanding shares at any time after
January 10, 2004 for an amount equal to a 3% premium over
the purchase price per share and all accrued and unpaid
dividends. Each share of Series A Preferred Stock is
convertible into the number of shares of the Companys
common stock equal to the initial purchase price plus all
accrued and unpaid dividends divided by the conversion price
(currently $9.9679); however absent approval by a majority of
the Companys shareholders, the Series A Convertible
Preferred Stock is convertible into a maximum of
216,293 shares of the Companys common stock. The
conversion price is subject to adjustment for certain dilutive
events, as defined in the Series A Convertible Preferred
Stock documents. The holders of the Series A Convertible
Preferred Stock are entitled to vote on all matters together
with the common stock holders as one class. The holders of the
Series A Convertible Preferred Stock are entitled to the
number of votes equal to the number of shares of common stock
into which the Series A Convertible Preferred Stock are
then convertible.

In connection with the issuance of the
Series A Convertible Preferred Stock, the Company has
recorded a $2.1 million beneficial conversion feature of
the Series A Convertible Preferred Stock as a reduction to
the carrying value of the Series A Convertible Preferred
Stock and as a contribution of capital to additional paid-in
capital. The resulting discount on the Series A Convertible
Preferred Stock will be accreted over the period from issuance
to the first redemption date of the Series A Convertible
Preferred Stock. During the year ended December 31, 2001,
the Company recorded accretion of dividends of $917,000 from the
Series A Convertible Preferred Stock. In addition, the
Company recorded $954,000 accretion of the discount on the
Series A Convertible Preferred Stock in 2001.

(13) Stockholders Equity

(a) Common
Stock

At incorporation, the Company authorized 333,333
shares of $0.001 par value common stock. In March 1997, December
1997 and July 1998, the Company amended its certificate of
incorporation to increase the number of authorized shares of
$.001 par value common stock to a total of 1,000,000 shares. On
February 29,

63



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2000 the Companys shareholders approved an
increase in the authorized shares of $.001 par value common
stock to a total of 5,000,000 shares.

On January 28, 2000, the Companys
Board of Directors approved a 2 for 1 stock split, to be
effected in the form of a stock dividend. On March 17,
2000, the Company paid the stock dividend to all shareholders of
record on March 3, 2000. All share and per share amounts in
the accompanying financial statements have been adjusted to
reflect the stock split.

On March 11, 2002, Xchanges Board of
Directors approved a 1 for 30 reverse stock split of the
Companys common stock. The reverse split became effective
on March 18, 2002. As a result of the reverse split, each
30 issued and outstanding shares of common stock was exchanged
for one new share of common stock. All share and per share
amount in these financial statements have been adjusted to
reflect the reverse stock split.

(b) Restricted
Common Stock

At incorporation, the Company issued 165,625
shares of common stock to the Companys founders and
employees at $.001 per share, the fair market value as
determined by the Board of Directors at the time of issuance.

In connection with the issuance of common stock,
the Company and two of its founders signed a Founder Restricted
Stock Agreement (the Founder Agreement). These
shares vested 50% immediately with the balance vesting ratably
on an annual basis through January 1, 1999.

As provided in the Founder Agreement, if the
employment of the founders is terminated, the Company has the
option (the Company Option) to purchase their
unvested stock. This Company Option shall be exercisable by the
Company at a price equal to the lesser of the issue price or the
fair market value of the stock as determined by the Board of
Directors. In March 1997, one of the founders terminated
employment, resulting in the Companys repurchase of 5,558
unvested common shares at $0.001 per share.

In addition, on November 15, 1996, the
Company and all of its employees holding common stock, excluding
the two founders, signed restricted stock agreements (the
Restricted Stock Agreements) providing for shares
issued from the 1996 Stock Incentive Plan to vest retroactively,
25% on the respective employees date of hire with an
additional 25% on each anniversary thereafter.

According to the Restricted Stock Agreements, if
an employee ceases to provide services to the Company either as
a consultant or employee prior to the third anniversary of the
date of hire, the Company has the right to repurchase the
unvested stock from the employee at the price paid by the
employee. Since inception, the Company has repurchased an
additional 6,661 shares of unvested common stock at $0.001 per
share from other terminated employees. As of December 31,
2001, all outstanding shares of restricted common stock were
fully vested.

(14) Stock Options

(a) 1996
Stock Option Plan

In November 1996, the Company adopted the 1996
Stock Incentive Plan (the 1996 Plan), pursuant to
which 208,331 shares of the Companys common stock were
reserved for issuance. The 1996 Plan provides for the grant of
incentive stock options, nonqualified stock options and
restricted common stock to officers, employees and directors who
are also employees of the Company. Non-employee directors and
outside consultants to the Company are eligible to receive
nonqualified options and restricted common stock only.

The 1996 Plan is administered by the Board of
Directors, which determines the fair market value and the
purchase price for such options. Options generally vest over a
four-year period and expire 10 years from the

64



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

date of grant. Restricted common stock awards
entitle recipients to purchase shares of the Companys
common stock subject to restrictions concerning the sale,
transfer and other disposition of the shares issued until such
shares are vested. The shares subject to options that expire or
are not exercised for other reasons, or any restricted common
stock that is repurchased by the Company will be available for
future grant under the 1996 Plan. In addition, the 1996 Plan
provides for the granting of time accelerated incentive stock
options.

(b) 1998
Stock Option Plan

In July 1998, the Company adopted the 1998 Stock
Option Plan (the 1998 Plan), pursuant to which
180,000 additional shares of the Companys common stock
were reserved for future issuance. In June 2000, the number of
shares authorized for issuance under the 1998 Plan was increased
from 180,000 to 313,333 and an additional 133,333 shares of the
Companys common stock was reserved for the issuance of
stock options in connection with the 1998 Plan. In February
2002, the number of shares authorized for issuance under the
1998 Plan was increased from 313,333 to 1,580,000. The 1998 Plan
provides for the grant of incentive stock options and
nonqualified stock options to officers and employees of the
Company. The 1998 Plan is administered by the Board of
Directors, which determines the fair market value and the
purchase price for such options. Options generally vest over a
four-year period and expire 10 years from the date of grant. The
shares subject to options that expire or are not exercised for
other reasons will be available for future grant under the 1998
Plan. In addition, the 1998 Plan provides for the granting of
time accelerated incentive stock options.

(c) 1998
Directors Stock Option Plan

In July 1998, the Company adopted the 1998 Board
of Directors Plan (the 1998 Directors Plan),
pursuant to which 6,667 shares of the Companys common
stock were reserved for future issuance under the plan. The 1998
Directors Plan provides for the grant of nonqualified stock
options and restricted common stock to non-employee directors of
the Company. The 1998 Directors Plan is administered by the
Board of Directors, which determines the fair market value and
the purchase price for such options. Options generally vest over
a four-year period and expire 10 years from the date of
grant. The shares subject to options that expire or are not
exercised for other reasons will be available for future grant
under the 1998 Directors Plan.

(d) Summary
of Option Activity

Stock option activity for the years ended
December 31, 1999, 2000 and 2001 is as follows:

|                               |           |           |         |                 |   |                  |      |       |  |   |   |   |        |          |  |   |        |        | 
|------------------------------ | --------- | --------- | ------- | --------------- | - | ---------------- | ---- | ----- |  | - | - | - | ------ | -------- |  | - | ------ | ------ | 
|                               |           |           |         |                 |   |                 
|                               |           | Number of |         | Range of        |   | Weighted Average
|                               |           | Shares    |         | Exercise Prices |   | Exercise Price  
|                               |           |           |         |                 |   |                 
|                               |           |           |         |                 |   |                  |      |       |  |  
|Outstanding, December 31, 1998 |           |           | 168,566 |                 |   | $                | 9.75 |       |  |  |   | $ | 165.00 |          |  | $ | 60.60  |       
|                               |           |           |         |                 |   |                  |      |       |  |  
|                               | Granted   |           |         | 88,123          |   |                  |      | 12.90 |  |   |  |   |        | 525.00   |  |   |        | 325.80 | 
|                               | Exercised |           |         | (33,603         | ) |                  |      | 9.75  |  |   |  |   |        | 447.30   |  |   |        | 36.60  | 
|                               | Canceled  |           |         | (18,609         | ) |                  |      | 9.75  |  |   |  |   |        | 525.00   |  |   |        | 180.00 | 
|                               |           |           |         |                 |   |                  |      |       |  |  
|Outstanding, December 31, 1999 |           |           | 204,476 |                 |   | $                | 9.75 |       |  |  |   | $ | 525.00 |          |  | $ | 168.00 |       
|                               |           |           |         |                 |   |                  |      |       |  |  
|                               | Granted   |           |         | 172,457         |   |                  |      | 38.70 |  |   |  |   |        | 1,432.50 |  |   |        | 924.90 | 
|                               | Exercised |           |         | (65,652         | ) |                  |      | 9.75  |  |   |  |   |        | 731.40   |  |   |        | 85.50  | 
|                               | Canceled  |           |         | (172,024        | ) |                  |      | 9.75  |  |   |  |   |        | 1,432.50 |  |   |        | 862.20 | 
|                               |           |           |         |                 |   |                  |      |       |  |  

65



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                               |           |           |         |                 |   |                  |      |      |  |   |   |   |          |          |  |   |        |        | 
|------------------------------ | --------- | --------- | ------- | --------------- | - | ---------------- | ---- | ---- |  | - | - | - | -------- | -------- |  | - | ------ | ------ | 
|                               |           |           |         |                 |   |                 
|                               |           | Number of |         | Range of        |   | Weighted Average
|                               |           | Shares    |         | Exercise Prices |   | Exercise Price  
|                               |           |           |         |                 |   |                 
|                               |           |           |         |                 |   |                  |      |      |  |  
|Outstanding, December 31, 2000 |           |           | 139,257 |                 |   | $                | 9.75 |      |  |  |   | $ | 1,432.50 |          |  | $ | 297.91 |       
|                               |           |           |         |                 |   |                  |      |      |  |  
|                               | Granted   |           |         | 304,149         |   |                  |      | 6.60 |  |   |  |   |          | 64.20    |  |   |        | 25.00  | 
|                               | Exercised |           |         | (9,746          | ) |                  |      | 9.75 |  |   |  |   |          | 60.00    |  |   |        | 17.55  | 
|                               | Canceled  |           |         | (149,995        | ) |                  |      | 9.75 |  |   |  |   |          | 1,432.50 |  |   |        | 214.80 | 
|                               |           |           |         |                 |   |                  |      |      |  |  
|Outstanding, December 31, 2001 |           |           | 283,665 |                 |   |                  | 6.60 |      |  |  |   |   | 1,432.50 |          |  |   | 60.50  |       
|                               |           |           |         |                 |   |                  |      |      |  |  
|Exercisable, December 31, 2001 |           |           | 60,095  |                 |   | $                | 6.60 |      |  |  |   | $ | 1,432.50 |          |  | $ | 136.43 |       
|                               |           |           |         |                 |   |                  |      |      |  |  
|Exercisable, December 31, 2000 |           |           | 42,824  |                 |   | $                | 9.75 |      |  |  |   | $ | 1,432.50 |          |  | $ | 195.00 |       
|                               |           |           |         |                 |   |                  |      |      |  |  
|Exercisable, December 31, 1999 |           |           | 66,433  |                 |   | $                | 9.75 |      |  |  |   | $ | 447.30   |          |  | $ | 69.90  |       
|                               |           |           |         |                 |   |                  |      |      |  |  

|                |        |                |  |                  |  |                     |          |                     |  |                  |         |  |  |  |     |  |  |   |          |  |  |  |        |  |  |   |          | 
|--------------- | ------ | -------------- |  | ---------------- |  | ------------------- | -------- | ------------------- |  | ---------------- | ------- |  |  |  | --- |  |  | - | -------- |  |  |  | ------ |  |  | - | -------- | 
|                |        |                |  |                  |  |                     |          |                    
|                |        |                |  |                  |  | Options Outstanding |          | Options Exercisable
|                |        |                |  |                 
|Range of        |        | Outstanding as |  | Weighted Average |  | Weighted-Average    |          | Exercisable as      |  | Weighted Average
|Exercise Prices |        | of 12/31/01    |  | Remaining Life   |  | Exercise Price      |          | of 12/31/01         |  | Exercise Price  
|                |        |                |  |                  |  |                     |          |                     |  |                 
|$               | 0.00   |                |  |                 |  | $                   | 9.90     |                     |  |                  | 94,232  |  |  |  | 9.3 |  |  | $ | 7.01     |  |  |  | 3,647  |  |  | $ | 9.75     | 
|$               | 9.91   |                |  |                 |  | $                   | 19.80    |                     |  |                  | 80,417  |  |  |  | 9.3 |  |  |   | 15.94    |  |  |  | 1,282  |  |  |   | 12.97    | 
|$               | 19.81  |                |  |                 |  | $                   | 30.00    |                     |  |                  | 970     |  |  |  | 1.7 |  |  |   | 20.25    |  |  |  | 970    |  |  |   | 20.25    | 
|$               | 30.01  |                |  |                 |  | $                   | 45.00    |                     |  |                  | 63,306  |  |  |  | 8.9 |  |  |   | 36.63    |  |  |  | 25,610 |  |  |   | 36.02    | 
|$               | 45.01  |                |  |                 |  | $                   | 75.30    |                     |  |                  | 6,621   |  |  |  | 4.1 |  |  |   | 57.74    |  |  |  | 5,490  |  |  |   | 56.48    | 
|$               | 75.31  |                |  |                 |  | $                   | 150.00   |                     |  |                  | 12,255  |  |  |  | 5.9 |  |  |   | 142.93   |  |  |  | 9,417  |  |  |   | 142.60   | 
|$               | 150.01 |                |  |                 |  | $                   | 300.00   |                     |  |                  | 14,230  |  |  |  | 5.9 |  |  |   | 270.01   |  |  |  | 7,847  |  |  |   | 269.03   | 
|$               | 300.01 |                |  |                 |  | $                   | 600.00   |                     |  |                  | 7,526   |  |  |  | 6.3 |  |  |   | 403.80   |  |  |  | 3,823  |  |  |   | 410.92   | 
|$               | 600.01 |                |  |                 |  | $                   | 900.00   |                     |  |                  | 1,879   |  |  |  | 5.2 |  |  |   | 635.14   |  |  |  | 1,047  |  |  |   | 639.57   | 
|$               | 900.01 |                |  |                 |  | $                   | 1,440.00 |                     |  |                  | 2,229   |  |  |  | 5.1 |  |  |   | 1,198.93 |  |  |  | 962    |  |  |   | 1,246.94 | 
|                |        |                |  |                  |  |                     |          |                     |  |                  |         |  |  |  |     |  |  |   |          |  |  |  |        |  |  |   |          | 
|                |        |                |  |                  |  |                     |          |                     |  |                  | 283,665 |  |  |  | 8.6 |  |  | $ | 60.50    |  |  |  | 60,095 |  |  | $ | 136.43   | 
|                |        |                |  |                  |  |                     |          |                     |  |                  |         |  |  |  |     |  |  |   |          |  |  |  |        |  |  |   |          | 

In connection with the acquisitions of eXstatic,
KSP, and CA, the Company assumed the existing stock option plans
of the acquired companies. No additional stock options may be
granted under these plans. The historical stock option activity
of eXstatic, which was accounted for under the pooling of
interest method, has been reflected in the Companys
historical stock option activity above. In connection with the
acquisitions of KSP and CA, the Company assumed 4,495 and 23,826
outstanding stock options, respectively, which have been
included in the stock option activity above as granted in the
year ended December 31, 2000.

In connection with certain stock option grants in
1997 and 1998, the Company has recorded a total of $1,101,000 of
deferred compensation expense, which is being amortized and
charged to operations over the four-year vesting period of the
related options. Total option-related compensation expense
pertaining to these grants was $258,000, $212,000 and $95,000
for the years ended December 31, 1999, 2000 and 2001,
respectively.

On November 10, 1998, the Company amended
the terms of all Stock Option Agreements granted between
May 1, 1998 and September 30, 1998, whereby the
exercise prices on options to purchase 21,273 shares of common
stock were reduced to $150.00 per share.

In December 2000, the Company offered employees
the opportunity to participate in a program, pursuant to which
each employee could elect to replace certain outstanding options
with new options on a one-for-one basis. The new options will be
granted six months and one day following the cancellation date
of the existing

66



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

stock options with an exercise price equal to the
fair value of the Companys common stock as of the close of
business on the day of the new grant. A total of 107,301 stock
options were cancelled in December 2000 in connection with this
program and 71,300 shares were reissued in June 2001.

As of December 31, 2001, the Company had
14,276, 27,949 and 4,500 shares available for future issuance
under the 1996 Stock Option Plan, 1998 Stock Option Plan and the
Directors Stock Option Plan, respectively.

(e) Pro
Forma Stock-Based Compensation

The Company has computed the pro forma
disclosures required under SFAS No. 123 for options granted
during 1999, 2000 and 2001 using the Black-Scholes option
pricing model prescribed by SFAS No. 123. The weighted
average assumptions used were as follows:

|                                                                       |  |                         |           |      |  |      |           |   |  |  |           |  
|---------------------------------------------------------------------- |  | ----------------------- | --------- | ---- |  | ---- | --------- | - |  |  | --------- | -
|                                                                       |  |                        
|                                                                       |  | Year Ended December 31,
|                                                                       |  |                        
|                                                                       |  | 1999                    |           | 2000 |  | 2001
|                                                                       |  |                         |           |      |  |     
|Risk-free interest rate                                                |  |                         | 5.54      | %    |  |      | 6.15      | % |  |  | 4.32      | %
|Expected dividend yield                                                |  |                         |          |      |  |      |          |   |  |  |          |  
|Expected lives                                                         |  |                         | 4 years   |      |  |      | 4 years   |   |  |  | 4 years   |  
|Expected volatility                                                    |  |                         | 75.5      | %    |  |      | 94.1      | % |  |  | 176.9     | %
|Weighted average grant date fair value                                 |  |                         | $2.60     |      |  |      | $23.18    |   |  |  | $23.28    |  
|Weighted average remaining contractual life of
    options outstanding |  |                         | 7.9 years |      |  |      | 6.8 years |   |  |  | 8.6 years |  

Had compensation expense for the Companys
stock option plans been determined consistent with SFAS
No. 123, net loss and net loss per share would have been
approximately as follows:

|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |          |  
|----------- | ------------------------------------------------------- | ------------------------------------- | - | ------ | - | ---- | - | -------- | - |  | - | -------- | -
|            |                                                         |                                      
|            |                                                         | Year Ended December 31,              
|            |                                                         |                                      
|            |                                                         | 1999                                  |   | 2000   |   | 2001
|            |                                                         |                                       |   |        |   |     
|            |                                                         |                                      
|            |                                                         | (in thousands, except per share data)
|As reported |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|            | Net income (loss) applicable to common
    Stockholders |                                       | $ | 1,098  |   |      | $ | (138,989 | ) |  | $ | (152,528 | )
|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|            | Basic net income (loss) per share                       |                                       | $ | 1.50   |   |      | $ | (145.22  | ) |  | $ | (136.90  | )
|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|            | Diluted net income (loss) per share                     |                                       | $ | 1.20   |   |      | $ | (145.22  | ) |  | $ | (136.90  | )
|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|Pro forma   |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|            | Net loss applicable to common stockholders              |                                       | $ | (5,069 | ) |      | $ | (152,374 | ) |  | $ | (187,241 | )
|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |         
|            | Base and diluted net (loss) per share                   |                                       | $ | (6.60  | ) |      | $ | (159.30  | ) |  | $ | (168.06  | )
|            |                                                         |                                       |   |        |   |      |   |          |   |  |   |         

(15) Employee Stock Purchase
Plan

In July 1998, the Company adopted an Employee
Stock Purchase Plan (the ESPP),whereby employees, at
their option, can purchase shares of Company common stock. This
is done through a payroll deduction at the lower of 85% of the
fair market value on the first day of the ESPP offering period
or the end of each six-month period. The ESPP expires at the
earlier of December 31, 2008 or the date on which all
shares available for issuance have been sold. The Company had
reserved 13,333 shares of common stock for issuance under the
ESPP. In June 2001, the number of shares reserved for issuance
under the ESPP was increased from 13,333 to 33,333. Through
December 31, 2001 employees have purchased 13,651 shares
through the ESPP and 19,682 shares are available for future
purchases.

67



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(16) Employee Benefit Plan

The Company has a qualified 401(k) savings plan
(the 401(k) Plan) covering all of the Companys
eligible full-time employees. Under this plan, participants may
elect to defer a portion of their compensation, subject to
certain IRS limitations. The Company does not provide employer
matching contributions under the 401(k) Plan.

(17) Segment and Enterprise Wide
Reporting

The Company has adopted SFAS No. 131
Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 131 requires certain financial
and supplementary information to be disclosed on an annual and
interim basis of each reportable segment of an enterprise. SFAS
No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major
customers. Operating segments are defined as components of an
enterprise about which separate discrete financial information
is evaluated regularly by the chief operating decision maker or
decision making group, in deciding how to allocate resources and
assess performance. Unless impracticable, companies are required
to restate prior period information upon adoption. To date, the
Company has viewed its operations and managed its business as
principally one segment. As a result, the financial information
disclosed herein, materially represents all of the financial
information related to the Companys principal operating
segment.

Revenues by geography (based on customer
location) as a percentage of total revenues are as follows:

|               |  |              |     |      |  |      |     |   |  |  |     |  
|-------------- |  | ------------ | --- | ---- |  | ---- | --- | - |  |  | --- | -
|               |  |             
|               |  | Years Ended 
|               |  | December 31,
|               |  |             
|               |  | 1999         |     | 2000 |  | 2001
|               |  |              |     |      |  |     
|United States  |  |              | 77  | %    |  |      | 68  | % |  |  | 74  | %
|Australia      |  |              |    |      |  |      | 12  |   |  |  | 8   |  
|United Kingdom |  |              | 8   |      |  |      | 6   |   |  |  | 6   |  
|Canada         |  |              | 2   |      |  |      | 0   |   |  |  | 2   |  
|Germany        |  |              | 1   |      |  |      | 2   |   |  |  | 3   |  
|Japan          |  |              | 3   |      |  |      | 1   |   |  |  | 1   |  
|Other          |  |              | 9   |      |  |      | 11  |   |  |  | 6   |  
|               |  |              |     |      |  |      |     |   |  |  |     |  
|               |  |              | 100 | %    |  |      | 100 | % |  |  | 100 | %
|               |  |              |     |      |  |      |     |   |  |  |     |  

The Company established a foreign subsidiary in
the United Kingdom in July 1997, Australia in April 1998 and
Japan in 2000. Operations in various geographic areas, since the
inception of those entities, are summarized as follows:

|                             |                   |        |   |         |  |                |   |       |  |              |   |              |  |  |   |   |  |  |   |        |   |  |   |        | 
|---------------------------- | ----------------- | ------ | - | ------- |  | -------------- | - | ----- |  | ------------ | - | ------------ |  |  | - | - |  |  | - | ------ | - |  | - | ------ | 
|                             |                   | United |   | United  |  |                |   |       |  |              |   |             
|                             |                   | States |   | Kingdom |  | Australia      |   | Japan |  | Eliminations |   | Consolidated
|                             |                   |        |   |         |  |                |   |       |  |              |   |             
|                             |                   |        |   |         |  |                |   |       |  |             
|                             |                   |        |   |         |  | (in thousands) |   |       |  |             
|Year Ended December 31, 1999 |                   |        |   |         |  |                |   |       |  |              |   |              |  |  |   |   |  |  |   |        |   |  |   |       
|                             | Total revenues    |        | $ | 37,268  |  |                | $ | 7,592 |  |              | $ | 2,402        |  |  | $ |  |  |  | $ | (3,962 | ) |  | $ | 43,301 | 
|                             |                   |        |   |         |  |                |   |       |  |              |   |              |  |  |   |   |  |  |   |        |   |  |   |       
|                             | Net income        |        | $ | 612     |  |                | $ | $380  |  |              | $ | 106          |  |  | $ |  |  |  | $ |       |   |  | $ | 1,098  | 
|                             |                   |        |   |         |  |                |   |       |  |              |   |              |  |  |   |   |  |  |   |        |   |  |   |       
|                             | Long-lived assets |        | $ | 4,193   |  |                | $ | 398   |  |              | $ | 45           |  |  | $ |  |  |  | $ |       |   |  | $ | 4,636  | 
|                             |                   |        |   |         |  |                |   |       |  |              |   |              |  |  |   |   |  |  |   |        |   |  |   |       

68



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |          |  
|---------------------------- | ----------------- | ------ | - | -------- | - | -------------- | - | ------ | - | ------------ | - | ------------ | - |  | - | ---- | - |  | - | ------ | - |  | - | -------- | -
|                             |                   | United |   | United   |   |                |   |        |   |              |   |             
|                             |                   | States |   | Kingdom  |   | Australia      |   | Japan  |   | Eliminations |   | Consolidated
|                             |                   |        |   |          |   |                |   |        |   |              |   |             
|                             |                   |        |   |          |   |                |   |        |   |             
|                             |                   |        |   |          |   | (in thousands) |   |        |   |             
|Year Ended December 31, 2000 |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Total revenues    |        | $ | 54,249   |   |                | $ | 7,785  |   |              | $ | 2,798        |   |  | $ |     |   |  | $ | (3,257 | ) |  | $ | 61,575   |  
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Net loss          |        | $ | (130,030 | ) |                | $ | (4,885 | ) |              | $ | (621         | ) |  | $ | (196 | ) |  | $ | (3,257 | ) |  | $ | (138,989 | )
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Long-lived assets |        | $ | 19,406   |   |                | $ | 671    |   |              | $ | 234          |   |  | $ | 1    |   |  | $ |       |   |  | $ | 20,312   |  
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|Year Ended December 31, 2001 |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Total revenues    |        | $ | 34,031   |   |                | $ | 6,470  |   |              | $ | 4,210        |   |  | $ |     |   |  | $ |       |   |  | $ | 44,711   |  
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Net loss          |        | $ | (145,814 | ) |                | $ | (4,315 | ) |              | $ | (120         | ) |  | $ | (408 | ) |  | $ |       |   |  | $ | (150,657 | )
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         
|                             | Long-lived assets |        | $ | 5,867    |   |                | $ | 424    |   |              | $ | 186          |   |  | $ |     |   |  | $ |       |   |  | $ | 6,477    |  
|                             |                   |        |   |          |   |                |   |        |   |              |   |              |   |  |   |      |   |  |   |        |   |  |   |         

The following table summarizes the number of
customers that individually comprise greater than 10% of total
revenue and/or total accounts receivable and their aggregate
percentage of the Companys total revenues and accounts
receivable.

|                  |  |           |   |                     |  |           |    |               |  |  |   |  |  |  |    |  
|----------------- |  | --------- | - | ------------------- |  | --------- | -- | ------------- |  |  | - |  |  |  | -- | -
|                  |  |           |   |                    
|                  |  | Revenue   |   | Accounts Receivable
|                  |  |           |   |                    
|                  |  |           |   | Percent of          |  |           |    | Percent of   
|                  |  | Number of |   | Total               |  | Number of |    | Total Account
|                  |  | Customers |   | Revenue             |  | Customers |    | Receivables  
|                  |  |           |   |                     |  |           |    |              
|December 31, 1999 |  |           | 2 |                     |  |           | 22 | %             |  |  | 1 |  |  |  | 12 | %
|December 31, 2000 |  |           | 1 |                     |  |           | 10 | %             |  |  |  |  |  |  |   |  
|December 31, 2001 |  |           | 1 |                     |  |           | 26 | %             |  |  | 2 |  |  |  | 37 | %

(18) Allowance for Doubtful
Accounts

A summary of the allowance for doubtful accounts
is as follows:

|                             |                                 |                |     |      |   |      |       |     |  |   |       |        |  
|---------------------------- | ------------------------------- | -------------- | --- | ---- | - | ---- | ----- | --- |  | - | ----- | ------ | -
|                             |                                 |               
|                             |                                 | December 31,  
|                             |                                 |               
|                             |                                 | 1999           |     | 2000 |   | 2001
|                             |                                 |                |     |      |   |     
|                             |                                 |               
|                             |                                 | (in thousands)
|Balance, beginning of period |                                 | $              | 317 |      |   | $    | 375   |     |  | $ | 1,092 |       
|                             | Provision for doubtful accounts |                |     | 231  |   |      |       | 717 |  |   |       | 2,430  |  
|                             | Write-offs                      |                |     | (173 | ) |      |       |    |  |   |       | (2,555 | )
|                             |                                 |                |     |      |   |      |       |     |  |   |       |       
|Balance, end of period       |                                 | $              | 375 |      |   | $    | 1,092 |     |  | $ | 967   |       
|                             |                                 |                |     |      |   |      |       |     |  |   |       |       

(19) Subsequent Events

Additional Financing

On May 2, 2002 the Company secured two credit
facilities with SVB.

The first replaces the Companys existing
secured credit facility with a $4 million revolving credit
facility secured by all the Companys assets
(Receivables Line). Availability under the
Receivables Line is based on advances against the Companys
trade receivables. The Receivables Line bears interest at the
banks prime rate plus 2.5% points, and matures on May 2,
2003.

69



---



##### Table of Contents



EXCHANGE APPLICATIONS, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The second line is a $4 million credit facility
collateralized by a guarantee by Insight (Guaranteed
Line). The Guaranteed Line bears interest at the
banks prime rate plus 0.5% points and matures on May 2,
2003. In consideration for SVB issuing the Guaranteed Line, the
Company agreed to reprice 4,003 warrants previously issued to
$1.38 per share. In the event of a default by the Company on the
Guaranteed Line, the Company must sell, and Insight must buy,
notes (Insight Notes) equal to the then outstanding
principal and unpaid interest balance of the Guaranteed Line,
the proceeds of which must be used to repay SVB in full. The
Insight Notes will bear interest at a rate of 2% per month and
mature 30 days after issuance. In the event the Company defaults
on the repayment of the Insight Notes, interest will increase by
1% point per month until the Insight Notes are repaid.

In consideration for Insight guaranteeing the
Guaranteed Line, the Company granted Insight a Contingent Value
Right (CVR). Under the terms of the CVR agreement,
Insight may request the Company redeem the CVR for a cash
payment based on the occurrence of a Trigger Event.
Trigger Events include: a) the sale of the Company;
b) the Company achieving trailing 12 month consolidated
revenues in excess of $50 million, or c) the Company
achieving trailing 12 month consolidated earnings before
interest, taxes, depreciation and amortization expense of $10
million. The value of the CVR will be $3.0 million, except in
the event b) above, in which case the CVR will be the greater
$3.5 million or 7% of consolidated revenues, subject to a $10
million cap.

Offer from Investor Group

On May 2, 2002, the Company announced it had
received a preliminary offer from a group led by Insight to
acquire the Company. The offer is non-binding and subject to
customary conditions, including the execution of definitive
agreements. The Companys Board of Directors has formed a
Special Independent Committee to evaluate the offer.

70



---



##### Table of Contents



Item 9.     Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure

None




PART III




Item 10.     Directors
and Executive Officers of the Registrant

The information required by this item is
incorporated herein by reference to the section entitled
Election of Directors and Section 16(a)
Beneficial Ownership Reporting Compliance included in the
Companys Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10, 2002, which will be
filed with the Securities and Exchange Commission within
120 days after the end of the Companys fiscal year to
which this Annual Report on Form 10-K relates. Certain
information concerning the registrants executive officers
is included under the caption Executive Officers of the
Registrant on page 8 following Part I,
Item 1 of this report.




Item 11.     Executive
Compensation

The information required by this item is
incorporated herein by reference to the section entitled
Executive Compensation included in the
Companys Proxy Statement for the Annual Meeting of
Stockholders to be held on June 10, 2002, which will be
filed with the Securities and Exchange Commission within
120 days after the end of the Companys fiscal year to
which this Annual Report on Form 10-K relates.




Item 12.     Security
Ownership of Certain Beneficial Owners and
Management

The information required by this item is
incorporated herein by reference to the section titled
Voting Securities included in the Companys
Proxy Statement for the Annual Meeting of Stockholders to be
held on June 10, 2002, which will be filed with the
Securities and Exchange Commission within 120 days after
the end of the Companys fiscal year to which this Annual
Report on Form 10-K relates.




Item 13.     Certain
Relationships and Related Transactions

The information required by this item is
incorporated herein by reference to the section
Compensation Committee Interlocks, Insider Participation
and Certain Transactions included in the Companys
Proxy Statement for the Annual Meeting of Stockholders to be
held on June 10, 2002, which will be filed with the
Securities and Exchange Commission within 120 days after
the end of the Companys fiscal year to which this Annual
Report on Form 10-K relates.




PART IV




Item
14.     Exhibits and Financial
Statement Schedules

(a)(1) Financial Statements.

Financial statements are shown in the Index on
page 37 of this report.

(a)(2) Schedules.

All schedules have been omitted because either
they are not required, are not applicable or the information is
otherwise set forth in the Consolidated Financial Statements and
notes thereto.

71



---



##### Table of Contents



(a)(3) Exhibits.The
following is a list of exhibits filed herewith or incorporated
by reference herein:

|         |    |     |  |                                                                                                                                                                                                                                                                                       
|-------- | -- | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |    
|         |    |    
|         | 3  | .1* |  | Form of Amended and Restated Certificate of
    Incorporation of the Registrant (filed as Exhibit 3.1 to
    the Companys Registration Statement on Form S-1,
    dated July 22, 1998, File No.333-59613)                                                                            
|         | 3  | .2* |  | Form of Amended and Restated By-laws of the
    Registrant (filed as Exhibit 3.2 to the Companys
    Registration Statement on Form S-1, dated July 22,
    1998, File No. 333-59613)                                                                                                
|         | 4  | .1* |  | Specimen Certificate for Shares of the
    Registrants Common Stock, $.001 par value (filed as
    Exhibit 4.1 to Pre-Effective No. 3 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                          
|         | 4  | .2* |  | Amended and Restated Registration Rights
    Agreement dated December 4, 1997 (filed as
    Exhibit 10.14 to the Companys Registration Statement
    on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                                       
|         | 4  | .3* |  | Certificate of Designation of Series A
    Preferred Stock of Exchange, dated as of January 10, 2001.
    (Incorporated by reference to the Companys Form 8-K,
    dated January 10, 2001, filed with the Commission on
    January 24, 2001)                                        
|         | 4  | .4* |  | Registration Rights Agreement by and among
    Exchange and the purchasers of the Series A Preferred
    Stock, dated as of January 10, 2001. (Incorporated by
    reference to the Companys Form 8-K, dated
    January 10, 2001, filed with the Commission on
    January 24, 2001)
|         | 4  | .5* |  | Form of Amended and Restated Registration Rights
    Agreement, dated as of February 20, 2001, by and among the
    Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)           
|         | 4  | .6* |  | Form of Second Amended and Restated Registration
    Right Agreement, dated as of March 28, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)        
|         | 4  | .7* |  | Form of Third Amended and Restated Registration
    Rights Agreement, dated as of June 1, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated June 1, 2001 filed with
    the Commission on June 11, 2001)                
|         | 4  | .8* |  | Form of Fourth Amended and Restated Registration
    Right Agreement, dated as of July 26, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated July 26, 2001 filed
    with the Commission on August 10, 2001)            
|         | 4  | .9* |  | Form of Fifth Amended and Restated Registration
    Right Agreement, dated as of August 29, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated August 29, 2001 filed
    with the Commission on September 12, 2001)      
|         | 10 | .1* |  | Form of 1998 Stock Incentive Plan, with related
    forms of stock option agreements (filed as Exhibit 10.1 to
    Pre-Effective Amendment No. 1 to the Companys
    Registration Statement on Form S-1, dated November 13,
    1998, File No. 333-59613)                            
|         | 10 | .2* |  | Form of 1996 Stock Incentive Plan, as amended,
    with related forms of stock option agreements and form of
    restricted stock agreement (filed as Exhibit 10.2 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)              
|         | 10 | .3* |  | Form of 1998 Director Stock Option Plan, with
    related form of stock option agreement (filed as
    Exhibit 10.3 to the Companys Registration Statement
    on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                             
|         | 10 | .4* |  | Form of 1998 Employee Stock Purchase Plan (filed
    as Exhibit 10.4 to the Companys Registration
    Statement on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                                                                            
|         | 10 | .5* |  | 401(k) Plan (filed as Exhibit 10.5 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                                                                              
|         | 10 | .6* |  | Stock Purchase and Waiver Agreement, dated
    December 4, 1997 (filed as Exhibit 10.11 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                         
|         | 10 | .7* |  | Amended and Restated Stockholders Agreement dated
    December 4, 1997 (filed as Exhibit 10.13 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                  

72



---



##### Table of Contents



|         |    |      |  |                                                                                                                                                                                                                                                                                                                        
|-------- | -- | ---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |     
|         |    |     
|         | 10 | .8*  |  | Letter Agreement, dated December 22, 1997,
    between the Registrant and Fleet National Bank, as amended, and
    the related Promissory Note (filed as Exhibit 10.15 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                           
|         | 10 | .9*  |  | Office lease for 89 South Street, Boston,
    Massachusetts (filed as Exhibit 10.17 to the Companys
    Registration Statement on Form S-1, dated July 22,
    1998, File No. 333-59613)                                                                                                                              
|         | 10 | .10* |  | Payment and Registration Rights Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                      
|         | 10 | .11* |  | Software Development and OEM Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                         
|         | 10 | .12* |  | Value Added Reseller Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                                 
|         | 10 | .13* |  | Exchange Agreement relating to stock options,
    dated December 1, 2000 (filed as Exhibit 10.18 to the
    Companys Annual Report on Form 10-K, dated
    April 16, 2001, File No. 000-24679)                                                                                                                        
|         | 10 | .14* |  | Form of Undertaking Letter, dated April 16,
    2001, between the Company and Insight (filed as
    Exhibit 10.18 to the Companys Annual Report on
    Form 10-K, dated April 16, 2001, File
    No. 000-24679)                                                                                                       
|         | 10 | .15* |  | Securities Purchase Agreement, dated as of
    January 10, 2001, by and among Exchange and the purchasers
    of the Series A Preferred Stock, includes all Schedules
    thereto. (Incorporated by reference to the Companys
    Form 8-K, dated January 10, 2001, filed with the
    Commission on January 24, 2001)
|         | 10 | .16* |  | Form of Securities Purchase Agreement, dated as
    of February 20, 2001, by and among the Company and Insight.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)                                                                 
|         | 10 | .17* |  | Form of Warrant issued by the Company to Insight,
    dated February 20, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)                                                                                                      
|         | 10 | .18* |  | Form of Securities Purchase Agreement, dated as
    of March 28, 2001, by and among the Company and InSight.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)                                                                    
|         | 10 | .19* |  | Form of Warrant issued by the Company to Insight,
    dated March 28, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)                                                                                                         
|         | 10 | .20* |  | Form of Warrant, dated April 16, 2001,
    issued to Insight by the Company (filed as Exhibit 10.18 to
    the Companys Annual Report on Form 10-K, dated
    April 16, 2001, File No. 000-24679)                                                                                                                     
|         | 10 | .21* |  | Form of Securities Purchase Agreement, dated as
    of June 1, 2001, by and among the Company and InSight.
    (Incorporated by reference to the Companys Form 8-K,
    dated June 1, 2001 filed with the Commission on
    June 11, 2001)                                                                            
|         | 10 | .22* |  | Form of Warrant issued by the Company to Insight,
    dated June 1, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated June 1, 2001 filed with
    the Commission on June 11, 2001)                                                                                                                 
|         | 10 | .23* |  | Form of Securities Purchase Agreement, dated as
    of July 26, 2001, by and among the Company, eXstatic and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with the
    Commission on August 10, 2001)                                                              
|         | 10 | .24* |  | Form of 12% Senior Subordinated Convertible
    Debenture issued by the Company to Insight, dated July 26,
    2001. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with the
    Commission on August 10, 2001)                                                                   
|         | 10 | .25* |  | Form of 12% Senior Secured Convertible Debenture
    issued by the Company to the Purchasers, dated August 29,
    2001. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2002)                                                          

73



---



##### Table of Contents



|         |    |      |  |                                                                                                                                                                                                                                                                                                        
|-------- | -- | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |     
|         |    |     
|         | 10 | .26* |  | Form of Warrant, dated August 29, 2001,
    issued by the Company to the Purchasers (Incorporated by
    reference to the Companys Form 8-K, dated
    August 29, 2001 filed with the Commission on
    September 12, 2002.)                                                                          
|         | 10 | .27* |  | Form of Securities Purchase Agreement, dated as
    of August 29, 2001, by and between the Company and the
    Purchasers. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2001)                                        
|         | 10 | .28  |  | Amendment No. 1 to warrants to purchase Stock,
    dated May 2, 2002, between the Company and Silicon Valley
    Bank (SVB)                                                                                                                                                                          
|         | 10 | .29  |  | Form of Employment Agreement dated
    August 27, 2001 between the Company and Andrew J.
    Frawley.                                                                                                                                                                                                  
|         | 10 | .30  |  | Form of Employment Agreement dated July 26,
    2001 between the Company and J. Christopher Wagner.                                                                                                                                                                                                    
|         | 10 | .31  |  | Form of Software Marketing Agreement, dated
    May 29, 1997, by and between the Company and Acxiom
    Corporation.                                                                                                                                                                                   
|         | 21 | .1   |  | Subsidiaries of Registrant                                                                                                                                                                                                                                                                             
|         | 23 | .1   |  | Consent of Arthur Andersen LLP, Independent
    Public Accountants                                                                                                                                                                                                                                     
|         | 99 | .1*  |  | Form of 9% Bridge Promissory Note in the
    aggregate principal amount of up to $3,000,000 issued by the
    Company to Insight, dated as of February 20, 2001.
    (Incorporated by reference to the Companys Form 8-K, dated
    February 20, 2001 filed with the Commission on
    April 12, 2001)
|         | 99 | .2*  |  | Form of 10% Bridge Promissory Note in the
    aggregate principal amount of up to $1,500,000 issued by the
    Company to Insight, dated as of March 28, 2001.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)  
|         | 99 | .3*  |  | Form of Loan and Security Agreement with SVB
    dated as of April 25, 2001. (Incorporated by reference to
    the Companys Form 10-Q, dated May 15, 2001 filed
    with the Commission on May 15, 2001)                                                                                              
|         | 99 | .4*  |  | Form of 12% Bridge Promissory Note in the
    aggregate principal amount of up to $7,000,000 issued by the
    Company to Insight, dated as of June 1, 2001. (Incorporated
    by reference to the Companys Form 8-K, dated
    June 1, 2001 filed with the Commission on June 11,
    2001)          
|         | 99 | .5*  |  | Form of Security Agreement, dated as of
    July 26, 2001, by and among the Company, eXstatic and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with 30 the
    Commission on August 10, 2001)                                                      
|         | 99 | .6*  |  | Form of Undertaking Letter, dated April 16,
    2001 between Exchange and Insight. (Filed as Exhibit 10.19
    to the Companys Annual Report on Form 10-K, dated
    April 16, 2001)                                                                                                                  
|         | 99 | .7*  |  | Form of Loan Modification Agreement between
    Silicon Valley Bank (SVB) and Exchange Applications,
    Inc. and eXstatic Software, Inc. (Filed as Exhibit 99.21 to
    the Companys Quarterly Report on Form 10-Q, dated
    August 14, 2001)                                                     
|         | 99 | .8*  |  | Letter Agreement dated August 29, 2001
    between the Company and Insight. (Incorporated by reference to
    the Companys Form 8-K, dated August 29, 2001
    filed with the Commission on September 12, 2001)                                                                                       
|         | 99 | .9*  |  | Amendment No. 1 to the Security Agreement,
    dated as of August 29, 2001, between the Company and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2001)                                                  
|         | 99 | .10  |  | Letter to Commission pursuant to Temporary
    Note 3T, dated May 6, 2002.                                                                                                                                                                                                                             
|         | 99 | .11  |  | Form of Amended and Restated Loan and Securities
    Agreement, dated May 3, 2002, between the Company and SVB.                                                                                                                                                                                        
|         | 99 | .12  |  | Form of Accounts Receivable Financing Agreement,
    dated May 3, 2002, between the Company and SVB.                                                                                                                                                                                                   
|         | 99 | .13  |  | Form of Security Agreement, dated May 3, 2002,
    between the Company and Insight.                                                                                                                                                                                                                    
|         | 99 | .14  |  | Form of Senior Secured Note, dated May 3, 2002
    between the Company and Insight.                                                                                                                                                                                                                    
|         | 99 | .15  |  | Form of Contingent Value Right, dated May 3,
    2002, between the Company and Insight.                                                                                                                                                                                                                

74



---



##### Table of Contents



|         |    |     |  |                                                                                               
|-------- | -- | --- |  | ----------------------------------------------------------------------------------------------
|Exhibits |    |    
|         |    |    
|         | 99 | .16 |  | Form of Securities Purchase Agreement, dated May
    3, 2002, between the Company and Insight.



---



|  |                          
|- | -------------------------
|* | Incorporated by reference

(b) Current Reports on
Form 8-K:

The Company filed a Form 8-K on
November 26, 2001 as an Item 5 for the cancellation of
its Special Shareholder Meeting that was scheduled to be held on
December 10, 2001.

75



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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, in the City of Boston,
Commonwealth of Massachusetts, on this 14th day of May,
2002.



| |                            
| | ---------------------------
| | EXCHANGE APPLICATIONS, INC.



| |    |                          
| | -- | -------------------------
| | By | /s/ J. CHRISTOPHER WAGNER

| |                                          
| | -----------------------------------------
| |                                          
| | J. Christopher Wagner                    
| | Chief Executive Officer and
    President

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons in the capacities and on the dates indicated:

|                                               |  |                                                                                                             |  |             
|---------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | ------------
|Signature                                      |  | Title                                                                                                       |  | Date        
|                                               |  |                                                                                                             |  |             
|                                               |  |                                                                                                             |  |             
|/s/ J. CHRISTOPHER WAGNERJ. Christopher Wagner |  | President, Chief Executive Officer and Director
    (Principal Executive, Financial and Accounting Officer) |  | May 14, 2002
|/s/ ANDREW J. FRAWLEY* Andrew J. Frawley       |  | Chairman of the Board                                                                                       |  | May 14, 2002
|                                              
|/s/ STEVEN PERKINS*Steven Perkins              |  | Director                                                                                                    |  | May 14, 2002
|                                              
|/s/ RAMANAN RAGHAVENDRAN*Ramanan Raghavendran  |  | Director                                                                                                    |  | May 14, 2002
|                                              
|/s/ DEVEN PAREKH*Deven Parekh                  |  | Director                                                                                                    |  | May 14, 2002

76



---



##### Table of Contents



EXHIBIT INDEX

|         |    |     |  |                                                                                                                                                                                                                                                                                       
|-------- | -- | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |    
|         |    |    
|         | 3  | .1* |  | Form of Amended and Restated Certificate of
    Incorporation of the Registrant (filed as Exhibit 3.1 to
    the Companys Registration Statement on Form S-1,
    dated July 22, 1998, File No.333-59613)                                                                            
|         | 3  | .2* |  | Form of Amended and Restated By-laws of the
    Registrant (filed as Exhibit 3.2 to the Companys
    Registration Statement on Form S-1, dated July 22,
    1998, File No. 333-59613)                                                                                                
|         | 4  | .1* |  | Specimen Certificate for Shares of the
    Registrants Common Stock, $.001 par value (filed as
    Exhibit 4.1 to Pre-Effective No. 3 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                          
|         | 4  | .2* |  | Amended and Restated Registration Rights
    Agreement dated December 4, 1997 (filed as
    Exhibit 10.14 to the Companys Registration Statement
    on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                                       
|         | 4  | .3* |  | Certificate of Designation of Series A
    Preferred Stock of Exchange, dated as of January 10, 2001.
    (Incorporated by reference to the Companys Form 8-K,
    dated January 10, 2001, filed with the Commission on
    January 24, 2001)                                        
|         | 4  | .4* |  | Registration Rights Agreement by and among
    Exchange and the purchasers of the Series A Preferred
    Stock, dated as of January 10, 2001. (Incorporated by
    reference to the Companys Form 8-K, dated
    January 10, 2001, filed with the Commission on
    January 24, 2001)
|         | 4  | .5* |  | Form of Amended and Restated Registration Rights
    Agreement, dated as of February 20, 2001, by and among the
    Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)           
|         | 4  | .6* |  | Form of Second Amended and Restated Registration
    Right Agreement, dated as of March 28, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)        
|         | 4  | .7* |  | Form of Third Amended and Restated Registration
    Rights Agreement, dated as of June 1, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated June 1, 2001 filed with
    the Commission on June 11, 2001)                
|         | 4  | .8* |  | Form of Fourth Amended and Restated Registration
    Right Agreement, dated as of July 26, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated July 26, 2001 filed
    with the Commission on August 10, 2001)            
|         | 4  | .9* |  | Form of Fifth Amended and Restated Registration
    Right Agreement, dated as of August 29, 2001, by and among
    the Company and Insight. (Incorporated by reference to the
    Companys Form 8-K, dated August 29, 2001 filed
    with the Commission on September 12, 2001)      
|         | 10 | .1* |  | Form of 1998 Stock Incentive Plan, with related
    forms of stock option agreements (filed as Exhibit 10.1 to
    Pre-Effective Amendment No. 1 to the Companys
    Registration Statement on Form S-1, dated November 13,
    1998, File No. 333-59613)                            
|         | 10 | .2* |  | Form of 1996 Stock Incentive Plan, as amended,
    with related forms of stock option agreements and form of
    restricted stock agreement (filed as Exhibit 10.2 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)              
|         | 10 | .3* |  | Form of 1998 Director Stock Option Plan, with
    related form of stock option agreement (filed as
    Exhibit 10.3 to the Companys Registration Statement
    on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                             
|         | 10 | .4* |  | Form of 1998 Employee Stock Purchase Plan (filed
    as Exhibit 10.4 to the Companys Registration
    Statement on Form S-1, dated July 22, 1998, File
    No. 333-59613)                                                                                                            
|         | 10 | .5* |  | 401(k) Plan (filed as Exhibit 10.5 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                                                                              
|         | 10 | .6* |  | Stock Purchase and Waiver Agreement, dated
    December 4, 1997 (filed as Exhibit 10.11 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                         
|         | 10 | .7* |  | Amended and Restated Stockholders Agreement dated
    December 4, 1997 (filed as Exhibit 10.13 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                                                                  



---



##### Table of Contents



|         |    |      |  |                                                                                                                                                                                                                                                                                                                        
|-------- | -- | ---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |     
|         |    |     
|         | 10 | .8*  |  | Letter Agreement, dated December 22, 1997,
    between the Registrant and Fleet National Bank, as amended, and
    the related Promissory Note (filed as Exhibit 10.15 to the
    Companys Registration Statement on Form S-1, dated
    July 22, 1998, File No. 333-59613)                                           
|         | 10 | .9*  |  | Office lease for 89 South Street, Boston,
    Massachusetts (filed as Exhibit 10.17 to the Companys
    Registration Statement on Form S-1, dated July 22,
    1998, File No. 333-59613)                                                                                                                              
|         | 10 | .10* |  | Payment and Registration Rights Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                      
|         | 10 | .11* |  | Software Development and OEM Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                         
|         | 10 | .12* |  | Value Added Reseller Agreement, dated
    December 28, 1999, between the Registrant and
    MicroStrategy, Inc. (filed as Exhibit 10.20 to the
    Companys Annual Report on Form 10-K, dated
    March 30, 2000, File No. 000-24679)                                                                                 
|         | 10 | .13* |  | Exchange Agreement relating to stock options,
    dated December 1, 2000 (filed as Exhibit 10.18 to the
    Companys Annual Report on Form 10-K, dated
    April 16, 2001, File No. 000-24679)                                                                                                                        
|         | 10 | .14* |  | Form of Undertaking Letter, dated April 16,
    2001, between the Company and Insight (filed as
    Exhibit 10.18 to the Companys Annual Report on
    Form 10-K, dated April 16, 2001, File
    No. 000-24679)                                                                                                       
|         | 10 | .15* |  | Securities Purchase Agreement, dated as of
    January 10, 2001, by and among Exchange and the purchasers
    of the Series A Preferred Stock, includes all Schedules
    thereto. (Incorporated by reference to the Companys
    Form 8-K, dated January 10, 2001, filed with the
    Commission on January 24, 2001)
|         | 10 | .16* |  | Form of Securities Purchase Agreement, dated as
    of February 20, 2001, by and among the Company and Insight.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)                                                                 
|         | 10 | .17* |  | Form of Warrant issued by the Company to Insight,
    dated February 20, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)                                                                                                      
|         | 10 | .18* |  | Form of Securities Purchase Agreement, dated as
    of March 28, 2001, by and among the Company and InSight.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)                                                                    
|         | 10 | .19* |  | Form of Warrant issued by the Company to Insight,
    dated March 28, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated February 20, 2001 filed
    with the Commission on April 12, 2001)                                                                                                         
|         | 10 | .20* |  | Form of Warrant, dated April 16, 2001,
    issued to Insight by the Company (filed as Exhibit 10.18 to
    the Companys Annual Report on Form 10-K, dated
    April 16, 2001, File No. 000-24679)                                                                                                                     
|         | 10 | .21* |  | Form of Securities Purchase Agreement, dated as
    of June 1, 2001, by and among the Company and InSight.
    (Incorporated by reference to the Companys Form 8-K,
    dated June 1, 2001 filed with the Commission on
    June 11, 2001)                                                                            
|         | 10 | .22* |  | Form of Warrant issued by the Company to Insight,
    dated June 1, 2001. (Incorporated by reference to the
    Companys Form 8-K, dated June 1, 2001 filed with
    the Commission on June 11, 2001)                                                                                                                 
|         | 10 | .23* |  | Form of Securities Purchase Agreement, dated as
    of July 26, 2001, by and among the Company, eXstatic and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with the
    Commission on August 10, 2001)                                                              
|         | 10 | .24* |  | Form of 12% Senior Subordinated Convertible
    Debenture issued by the Company to Insight, dated July 26,
    2001. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with the
    Commission on August 10, 2001)                                                                   
|         | 10 | .25* |  | Form of 12% Senior Secured Convertible Debenture
    issued by the Company to the Purchasers, dated August 29,
    2001. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2002)                                                          



---



##### Table of Contents



|         |    |      |  |                                                                                                                                                                                                                                                                                                        
|-------- | -- | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |    |     
|         |    |     
|         | 10 | .26* |  | Form of Warrant, dated August 29, 2001,
    issued by the Company to the Purchasers (Incorporated by
    reference to the Companys Form 8-K, dated
    August 29, 2001 filed with the Commission on
    September 12, 2002.)                                                                          
|         | 10 | .27* |  | Form of Securities Purchase Agreement, dated as
    of August 29, 2001, by and between the Company and the
    Purchasers. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2001)                                        
|         | 10 | .28  |  | Amendment No. 1 to warrants to purchase Stock,
    dated May 2, 2002, between the Company and Silicon Valley
    Bank (SVB)                                                                                                                                                                          
|         | 10 | .29  |  | Form of Employment Agreement dated
    August 27, 2001 between the Company and Andrew J.
    Frawley.                                                                                                                                                                                                  
|         | 10 | .30  |  | Form of Employment Agreement dated July 26,
    2001 between the Company and J. Christopher Wagner.                                                                                                                                                                                                    
|         | 10 | .31  |  | Form of Software Marketing Agreement, dated
    May 29, 1997, by and between the Company and Acxiom
    Corporation.                                                                                                                                                                                   
|         | 21 | .1   |  | Subsidiaries of Registrant                                                                                                                                                                                                                                                                             
|         | 23 | .1   |  | Consent of Arthur Andersen LLP, Independent
    Public Accountants                                                                                                                                                                                                                                     
|         | 99 | .1*  |  | Form of 9% Bridge Promissory Note in the
    aggregate principal amount of up to $3,000,000 issued by the
    Company to Insight, dated as of February 20, 2001.
    (Incorporated by reference to the Companys Form 8-K, dated
    February 20, 2001 filed with the Commission on
    April 12, 2001)
|         | 99 | .2*  |  | Form of 10% Bridge Promissory Note in the
    aggregate principal amount of up to $1,500,000 issued by the
    Company to Insight, dated as of March 28, 2001.
    (Incorporated by reference to the Companys Form 8-K,
    dated February 20, 2001 filed with the Commission on
    April 12, 2001)  
|         | 99 | .3*  |  | Form of Loan and Security Agreement with SVB
    dated as of April 25, 2001. (Incorporated by reference to
    the Companys Form 10-Q, dated May 15, 2001 filed
    with the Commission on May 15, 2001)                                                                                              
|         | 99 | .4*  |  | Form of 12% Bridge Promissory Note in the
    aggregate principal amount of up to $7,000,000 issued by the
    Company to Insight, dated as of June 1, 2001. (Incorporated
    by reference to the Companys Form 8-K, dated
    June 1, 2001 filed with the Commission on June 11,
    2001)          
|         | 99 | .5*  |  | Form of Security Agreement, dated as of
    July 26, 2001, by and among the Company, eXstatic and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated July 26, 2001 filed with 30 the
    Commission on August 10, 2001)                                                      
|         | 99 | .6*  |  | Form of Undertaking Letter, dated April 16,
    2001 between Exchange and Insight. (Filed as Exhibit 10.19
    to the Companys Annual Report on Form 10-K, dated
    April 16, 2001)                                                                                                                  
|         | 99 | .7*  |  | Form of Loan Modification Agreement between
    Silicon Valley Bank (SVB) and Exchange Applications,
    Inc. and eXstatic Software, Inc. (Filed as Exhibit 99.21 to
    the Companys Quarterly Report on Form 10-Q, dated
    August 14, 2001)                                                     
|         | 99 | .8*  |  | Letter Agreement dated August 29, 2001
    between the Company and Insight. (Incorporated by reference to
    the Companys Form 8-K, dated August 29, 2001
    filed with the Commission on September 12, 2001)                                                                                       
|         | 99 | .9*  |  | Amendment No. 1 to the Security Agreement,
    dated as of August 29, 2001, between the Company and
    Insight. (Incorporated by reference to the Companys
    Form 8-K, dated August 29, 2001 filed with the
    Commission on September 12, 2001)                                                  
|         | 99 | .10  |  | Letter to Commission pursuant to Temporary
    Note 3T, dated May 6, 2002.                                                                                                                                                                                                                             
|         | 99 | .11  |  | Form of Amended and Restated Loan and Securities
    Agreement, dated May 3, 2002, between the Company and SVB.                                                                                                                                                                                        
|         | 99 | .12  |  | Form of Accounts Receivable Financing Agreement,
    dated May 3, 2002, between the Company and SVB.                                                                                                                                                                                                   
|         | 99 | .13  |  | Form of Security Agreement, dated May 3, 2002,
    between the Company and Insight.                                                                                                                                                                                                                    
|         | 99 | .14  |  | Form of Senior Secured Note, dated May 3, 2002
    between the Company and Insight.                                                                                                                                                                                                                    



---



##### Table of Contents



|         |    |     |  |                                                                                               
|-------- | -- | --- |  | ----------------------------------------------------------------------------------------------
|Exhibits |    |    
|         |    |    
|         | 99 | .15 |  | Form of Contingent Value Right, dated May 3,
    2002, between the Company and Insight.       
|         | 99 | .16 |  | Form of Securities Purchase Agreement, dated May
    3, 2002, between the Company and Insight.



---



|  |                          
|- | -------------------------
|* | Incorporated by reference