##### Table of Contents

---



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



Form 10-Q



(Mark One)



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



For the quarterly period ended September 30, 2003



OR



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



For the transition period from
 to



Commission File No. 0-30260



---



eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)



|Delaware (State or other jurisdiction of incorporation or organization) |  | 77-0466366 (I.R.S. Employer Identification No.)
|----------------------------------------------------------------------- |  | -----------------------------------------------



624 E. Evelyn
Avenue, Sunnyvale, CA

(Address of principal executive offices)



94086

(Zip Code)



(408) 212-3400

(Registrants telephone number, including area code)



N/A

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



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



YES  x                    NO ̈



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



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.



|Class                         |  | Outstanding at September 30, 2003
|----------------------------- |  | ---------------------------------
|Common Stock $0.001 par value |  | 3,680,954                        



---



---

##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



TABLE OF CONTENTS



|         |  |                                                                                                        |  | Page
|-------- |  | ------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                       
|PART I.  |  | FINANCIAL INFORMATION                                                                                  |  | 3   
|         |  |                                                                                                       
|Item 1.  |  | Financial Statements                                                                                   |  | 3   
|         |  |                                                                                                       
|         |  | Condensed Consolidated Balance Sheets at September 30, 2003 and June 30, 2003                          |  | 3   
|         |  |                                                                                                       
|         |  | Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2003 and 2002 |  | 4   
|         |  |                                                                                                       
|         |  | Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2003 and 2002 |  | 5   
|         |  |                                                                                                       
|         |  | Notes to Condensed Consolidated Financial Statements                                                   |  | 6   
|         |  |                                                                                                       
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                  |  | 15  
|         |  |                                                                                                       
|Item 3.  |  | Quantitative and Qualitative Disclosure About Market Risk                                              |  | 35  
|         |  |                                                                                                       
|Item 4.  |  | Control and Procedures                                                                                 |  | 35  
|         |  |                                                                                                       
|PART II. |  | OTHER INFORMATION                                                                                      |  | 37  
|         |  |                                                                                                       
|Item 1.  |  | Legal Proceedings                                                                                      |  | 37  
|         |  |                                                                                                       
|Item 2.  |  | Changes in Securities                                                                                  |  | 37  
|         |  |                                                                                                       
|Item 3.  |  | Defaults upon Senior Securities                                                                        |  | 37  
|         |  |                                                                                                       
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                    |  | 38  
|         |  |                                                                                                       
|Item 5.  |  | Other Information                                                                                      |  | 38  
|         |  |                                                                                                       
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                       |  | 38  
|         |  |                                                                                                       
|         |  | Signatures                                                                                             |  | 39  
|         |  |                                                                                                       
|         |  | Certifications                                                                                         |  |     





2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                                                   |  | September 30,2003 |          |   | June 30,2003 |  
|------------------------------------------------------------------------------------------------------------------ |  | ----------------- | -------- | - | ------------ | -
|ASSETS                                                                                                             |  | (unaudited)       |          |   |              |  
|Current assets:                                                                                                    |  |                   |          |   |              |  
|Cash and cash equivalents                                                                                          |  | $                 | 2,900    |   |              | $
|Restricted cash                                                                                                    |  |                   | 506      |   |              |  
|Accounts receivable, net                                                                                           |  |                   | 2,845    |   |              |  
|Prepaid and other current assets                                                                                   |  |                   | 2,562    |   |              |  
|                                                                                                                   |  |                   |          |   |              |  
|Total current assets                                                                                               |  |                   | 8,813    |   |              |  
|                                                                                                                   |  |                  
|Property and equipment, net                                                                                        |  |                   | 838      |   |              |  
|Goodwill, net                                                                                                      |  |                   | 4,880    |   |              |  
|Intangible assets, net                                                                                             |  |                   | 898      |   |              |  
|Other assets                                                                                                       |  |                   | 250      |   |              |  
|                                                                                                                   |  |                   |          |   |              |  
|                                                                                                                   |  | $                 | 15,679   |   |              | $
|                                                                                                                   |  |                   |          |   |              |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                               |  |                   |          |   |              |  
|Current liabilities:                                                                                               |  |                   |          |   |              |  
|Accounts payable                                                                                                   |  | $                 | 1,506    |   |              | $
|Accrued compensation                                                                                               |  |                   | 803      |   |              |  
|Accrued liabilities                                                                                                |  |                   | 1,541    |   |              |  
|Deferred revenue                                                                                                   |  |                   | 4,085    |   |              |  
|Current portion of accrued restructuring                                                                           |  |                   | 1,111    |   |              |  
|Current portion of bank borrowings                                                                                 |  |                   | 1,108    |   |              |  
|Current portion of notes payable                                                                                   |  |                   | 78       |   |              |  
|Current portion of capital lease obligations                                                                       |  |                   | 16       |   |              |  
|                                                                                                                   |  |                   |          |   |              |  
|Total current liabilities                                                                                          |  |                   | 10,248   |   |              |  
|                                                                                                                   |  |                  
|Related party notes payable                                                                                        |  |                   | 2,033    |   |              |  
|Capital lease obligations, net of current portion                                                                  |  |                   | 6        |   |              |  
|Accrued restructuring, net of current portion                                                                      |  |                   | 1,101    |   |              |  
|Other long term liabilities                                                                                        |  |                   | 244      |   |              |  
|                                                                                                                   |  |                   |          |   |              |  
|Total liabilities                                                                                                  |  |                   | 13,632   |   |              |  
|                                                                                                                   |  |                  
|Commitments                                                                                                        |  |                   |          |   |              |  
|                                                                                                                   |  |                  
|Stockholders equity:                                                                                              |  |                   |          |   |              |  
|Series A cumulative convertible preferred stock;Aggregate liquidation preference of $109,094 at September 30,
2003 |  |                   | 103,196  |   |              |  
|Common stock                                                                                                       |  |                   | 4        |   |              |  
|Additional paid-in capital                                                                                         |  |                   | 211,836  |   |              |  
|Notes receivable from stockholders                                                                                 |  |                   | (103     | ) |              |  
|Deferred stock compensation                                                                                        |  |                   |         |   |              |  
|Accumulated other comprehensive income (loss)                                                                      |  |                   | (192     | ) |              |  
|Accumulated deficit                                                                                                |  |                   | (312,694 | ) |              |  
|                                                                                                                   |  |                   |          |   |              |  
|Total shareholders equity                                                                                         |  |                   | 2,047    |   |              |  
|                                                                                                                   |  |                   |          |   |              |  
|                                                                                                                   |  | $                 | 15,679   |   |              | $
|                                                                                                                   |  |                   |          |   |              |  



See accompanying
notes



3



---

##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                      |  | Three Months Ended September 30, |       
|------------------------------------------------------------------------------------- |  | -------------------------------- | ------
|                                                                                      |  | 2003                             |       
|Revenue:                                                                              |  |                                  |       
|Hosting                                                                               |  | $                                | 732   
|License                                                                               |  |                                  | 790   
|Services                                                                              |  |                                  | 3,051 
|                                                                                      |  |                                  |       
|Total revenue                                                                         |  |                                  | 4,573 
|Cost of revenue  direct                                                              |  |                                  | 1,960 
|Cost of revenue  acquisition related                                                 |  |                                  |      
|                                                                                      |  |                                  |       
|Gross profit                                                                          |  |                                  | 2,613 
|Operating costs and expenses:                                                         |  |                                  |       
|Research and development                                                              |  |                                  | 1,065 
|Sales and marketing                                                                   |  |                                  | 2,125 
|General and administrative                                                            |  |                                  | 909   
|Amortization of other intangible assets                                               |  |                                  | 306   
|Amortization of deferred compensation                                                 |  |                                  |      
|Restructuring                                                                         |  |                                  | 121   
|                                                                                      |  |                                  |       
|Total operating costs and expenses                                                    |  |                                  | 4,526 
|                                                                                      |  |                                  |       
|Loss from operations                                                                  |  |                                  | (1,913
|Non-operating (expenses)                                                              |  |                                  | (159  
|                                                                                      |  |                                  |       
|Net loss                                                                              |  |                                  | (2,072
|Dividends on convertible preferred stock                                              |  |                                  | (1,825
|                                                                                      |  |                                  |       
|Net loss applicable to common stockholders                                            |  | $                                | (3,897
|                                                                                      |  |                                  |       
|Per Share information:                                                                |  |                                  |       
|Basic and diluted net loss per common share                                           |  | $                                | (1.06 
|                                                                                      |  |                                  |       
|Weighted average shares used in computing basic and diluted net loss per common share |  |                                  | 3,676 
|                                                                                      |  |                                  |       



See accompanying
notes



4



---

##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                            |  | Three Months Ended September 30, |       
|--------------------------------------------------------------------------- |  | -------------------------------- | ------
|                                                                            |  | 2003                             |       
|Cash flows from operating activities:                                       |  |                                  |       
|Net loss                                                                    |  | $                                | (2,072
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                  |       
|Depreciation                                                                |  |                                  | 412   
|Gain / (loss) on disposal of fixed assets                                   |  |                                  | 6     
|Amortization of other intangible assets                                     |  |                                  | 306   
|Amortization of deferred compensation                                       |  |                                  |      
|Accrued interest and amortization of discount on related party notes        |  |                                  | 69    
|Changes in operating assets and liabilities:                                |  |                                  |       
|Restricted cash                                                             |  |                                  | 285   
|Accounts receivable                                                         |  |                                  | 425   
|Prepaid and other current assets                                            |  |                                  | 335   
|Other assets                                                                |  |                                  | 147   
|Accounts payable                                                            |  |                                  | 20    
|Accrued compensation                                                        |  |                                  | (61   
|Accrued liabilities                                                         |  |                                  | (377  
|Accrued restructuring                                                       |  |                                  | (185  
|Deferred revenue                                                            |  |                                  | (248  
|Other long term liabilities                                                 |  |                                  | 1     
|Other                                                                       |  |                                  |      
|                                                                            |  |                                  |       
|Net cash (used in) operating activities                                     |  |                                  | (937  
|                                                                            |  |                                 
|Cash flows from investing activities:                                       |  |                                  |       
|Purchases of property and equipment                                         |  |                                  | (64   
|                                                                            |  |                                  |       
|Net cash (used in) investing activities                                     |  |                                  | (64   
|                                                                            |  |                                 
|Cash flows from financing activities:                                       |  |                                  |       
|Payments on borrowings                                                      |  |                                  | (1,077
|Payments on capital lease obligations                                       |  |                                  | (3    
|Proceeds from borrowings                                                    |  |                                  | 536   
|Net proceeds from issuance of common stock                                  |  |                                  | 45    
|                                                                            |  |                                  |       
|Net cash (used in) financing activities                                     |  |                                  | (499  
|Effect of exchange rate differences on cash                                 |  |                                  | (7    
|                                                                            |  |                                  |       
|Net decrease in cash and cash equivalents                                   |  |                                  | (1,507
|Cash and cash equivalents at beginning of period                            |  |                                  | 4,407 
|                                                                            |  |                                  |       
|Cash and cash equivalents at end of period                                  |  | $                                | 2,900 
|                                                                            |  |                                  |       
|                                                                            |  |                                 
|Supplemental cash flow disclosures:                                         |  |                                  |       
|Cash paid for interest                                                      |  | $                                | 84    



See accompanying
notes



5



---

##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note
1.  Organization, Nature of Business and Basis of Presentation



We are a leading provider of customer service and contact center software, used by global enterprises for over a decade. Twenty-four of the fifty largest global companies rely on us to transform their traditional call
centers into profit centers, and extend their competitive advantage through superior customer service. eGain Service 6, our software suite, available licensed or hosted, includes integrated, best-in-class applications for customer email management, live web
collaboration, virtual agent customer service, knowledge management, and web self-service. These robust applications are built on the eGain SMP, a scalable next-generation framework that includes end-to-end service process management, multi-channel, multi-site contact center management, a
flexible integration approach, and certified out-of-the-box integrations with leading call center and business systems.



We have prepared the condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission and
include the accounts of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.



The accompanying financial statements have been prepared on the basis that we will continue as a going concern. We have incurred significant operating
losses and negative cash flows since inception. As of September 30, 2003 we have a working capital deficit of $1.4 million. We have not achieved profitability and may not be able to realize sufficient revenues to achieve or sustain profitability in
the future. Our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular, that revenues increase beyond the levels achieved in the quarter ended September 30, 2003
and that customers continue to pay on a timely basis. We believe that existing capital resources will enable us to maintain current and planned operations in the short term, but in coming quarters it will be necessary for us to generate positive
cash flow or obtain additional financing. We may also need to raise capital due to unforeseen or unanticipated market conditions. Such financing may be difficult or impossible to obtain on terms acceptable to us and will almost certainly dilute
existing shareholders value. These conditions raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.



In November 2002, we received stockholder approval for, and on August 20, 2003 affected, a reverse stock split of our common stock at a ratio of 1-for-10
(the reverse stock split). As a result of the reverse stock split, each outstanding share of common stock automatically converted into one-tenth of a share of common stock, with the par value of each share of common stock remaining at
one-tenth of a cent ($.001) per share. Accordingly, common stock share and per share amounts for all periods presented have been adjusted to reflect the impact of the reverse stock split.



Certain information and footnote disclosures, normally included in financial statements prepared in accordance with
generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of our financial position, results of operations and cash flows for the periods presented. These financial statements and notes should be read in conjunction with our audited consolidated financial
statements and notes thereto for the year ended June 30, 2003, included in our Annual Report on Form 10-K. The condensed consolidated balance sheet at June 30, 2003 has been derived from audited financial statements as of that date but does not
include all the information and footnotes required by generally accepted accounting principals for complete financial statements. The results of our operations for the interim periods presented are not necessarily indicative of results that may be
expected for any other interim period or for the full fiscal year ending June 30, 2004.



Certain prior year amounts in the consolidated financial statements have been reclassified to conform with the current year presentation.



6



---

##### Table of Contents

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 period. The estimates are based upon information available as of the date of the financial statements. Actual results could differ from those estimates.



Note 2.  Software Revenue Recognition



We recognize revenue in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97- 2), as
amended. Under SOP 97-2, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant eGain obligations remain, the fee is fixed or determinable, and collectibility is
probable. License revenue in multiple element contracts is recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence
of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the total fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference
between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. If sufficient vendor-specific objective evidence does not exist for undelivered elements in an
arrangement, all revenue from the arrangement is deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist for the undelivered elements or (b) all elements of the arrangement without
sufficient vendor-specific objective evidence have been delivered.



Revenue from hosting services is recognized ratably over the period of the agreement as services are provided. Hosting agreements are typically for a period of one year and automatically renew unless either party cancels the agreement.



Service revenue is primarily derived from consulting fees,
maintenance agreements, and training. Service revenue from consulting and training, billed on a time and materials basis, is recognized as performed. Service revenue on fixed price service arrangements is recognized upon completion of specific
contractual milestone events, or based on an estimated percentage of completion as work progresses. Maintenance agreements include the right to software updates on an if-and-when-available basis. The fair value of maintenance revenue, established by
annual maintenance renewals of existing customers, is deferred and recognized on a straight-line basis as service revenue over the life of the related agreement, which is typically one year.



In all cases, we assess whether the service element of the arrangement is
essential to the functionality of the other elements of the arrangement. In this determination, we focus on whether the services include significant alterations to the features and functionality of the software, whether the services involve the
building of complex interfaces, the timing of payments and the existence of milestones. In making this determination, we consider the following: (1) the relative fair value of the services compared to the software, (2) the amount of time and effort
subsequent to delivery of the software until the interfaces or other modifications are completed, (3) the degree of technical difficulty in building the interfaces or other modifications, and (4) any contractual cancellation, acceptance, or
termination provisions for failure to complete the interfaces. In those instances where we determine that the service elements are essential to the other elements of the arrangement, we account for the entire arrangement in accordance with
Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type Contracts, using the relevant guidance from SOP 97-2 and SOP 81-I, Accounting for Performance of Construction-Type and Certain Production-Type Contracts.



Revenue from sales to resellers are recognized either upon
delivery to the reseller or on a sell-through basis, depending on the facts and circumstances of the transaction, such as our understanding of the resellers use of our software, the resellers financial status and our past experience with
the particular reseller. Accordingly the decision whether to recognize revenue to resellers either upon delivery or on a sell-through basis requires significant management judgement. This judgement can materially impact the timing of revenue
recognition.



7



---

##### Table of Contents

Note 3.  Stock-Based Compensation



We account for our stock-based compensation arrangements with employees using the intrinsic-value method in accordance with
Accounting Principles Board 25, Accounting for Stock Issued to Employees. Deferred stock-based compensation is recorded on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options or
the purchase price for the shares of common stock.



Deferred
compensation is amortized on a graded vesting method over the vesting period of the individual grants. In addition, we record compensation expense in connection with grants of stock options to non-employees pursuant to Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). These grants are periodically revalued as they vest in accordance with SFAS 123 and EITF 96-18, Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.



As of September 30, 2003, there was no outstanding balance of deferred stock compensation. We amortized $0 and $66,000 of deferred compensation in the
quarters ended September 30, 2003 and September 30, 2002, respectively.



We have adopted the disclosure requirements of Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. Pro forma information regarding net income (loss) has been determined as
if we had accounted for our employee stock options under the fair value method prescribed by SFAS 123 (in thousands, except per share data):



|                                                                                                 |  | Three months ended September 30, |       
|------------------------------------------------------------------------------------------------ |  | -------------------------------- | ------
|                                                                                                 |  | 2003                             |       
|As Reported :                                                                                    |  |                                  |       
|Net loss applicable to common stockholders                                                       |  | $                                | (3,897
|Basic and diluted net loss per share                                                             |  |                                  | (1.06 
|                                                                                                 |  |                                 
|Add: Stock-based employee compensation expense included in reported net loss                     |  |                                  |      
|Deduct: Total stock-based employee compensation expense determined under fair value based method |  |                                  | (188  
|                                                                                                 |  |                                 
|Pro Forma:                                                                                       |  |                                  |       
|Net loss applicable to common stockholders                                                       |  | $                                | (4,085
|Basic and diluted net loss per share                                                             |  |                                  | (1.11 



Note 4.  Goodwill and
Other Intangible Assets



In June 2001, the FASB issued
SFAS 141 Business Combinations and SFAS 142 Goodwill and Other Intangible Assets. SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. SFAS 141
also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations and includes criteria that required intangible assets such as assembled workforce to be recognized as part
of goodwill. As of July 1, 2002, we reclassified $750,000 of assembled workforce from intangibles to goodwill.



Effective July 1, 2002, we adopted SFAS No. 142 Goodwill and Other Intangible Assets and ceased amortization of goodwill and began reviewing
it annually (or more frequently if impairment indicators arise) for impairment. In addition, we evaluated our remaining purchased intangible assets to determine that all such assets have determinable lives. We operate under a single reporting unit
and accordingly, all of our goodwill is associated with the entire company. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over



8



---

##### Table of Contents

its estimated useful life of three years. The purchased intangible assets including customer base and acquired technology
are being amortized over the assets useful life, which ranges from three to four years.



In connection with the transitional goodwill impairment evaluation provisions of SFAS 142, we performed our annual goodwill impairment review as of April 1, 2003 and found no impairment for fiscal year 2003. Due to
the decline in revenue and reduced stock price during the quarter, we performed another goodwill impairment review as of September 30, 2003 and found no impairment for the quarter.



As of July 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets (SFAS 144), we review long-lived assets, including property and equipment and intangible assets, for impairment whenever events or changes in business circumstances indicate that the
carrying amounts of the assets may not be fully recoverable. Under SFAS 144, an impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than
its carrying amount. Impairment, if any, is assessed using discounted cash flows. During the quarter ended September 30, 2003, we did not have any such impairments.



The following table provides a summary of the carrying amount of goodwill which includes amounts originally allocated to
assembled workforce upon adoption of SFAS 142 (in thousands):



|                                                              |  | September 30,2003 |        
|------------------------------------------------------------- |  | ----------------- | -------
|Gross carrying amount of goodwill                             |  | $                 | 86,664 
|Accumulated amortization of goodwill                          |  |                   | (81,784
|                                                              |  |                   |        
|Net carrying amount of goodwill including assembled workforce |  | $                 | 4,880  
|                                                              |  |                   |        



Purchased intangible
assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally 3 to 4 years. The following tables summarize the carrying amount of other intangible assets that
continue to be amortized and excludes amounts originally allocated to assembled workforce (in thousands):



|                              |  | September 30, 2003  
|----------------------------- |  | --------------------
|                              |  | Gross CarryingAmount
|Acquired customer base        |  | $                   
|Acquired developed technology |  |                     
|                              |  |                     
|Total                         |  | $                   
|                              |  |                     



|                              |  | June 30, 2003       
|----------------------------- |  | --------------------
|                              |  | Gross CarryingAmount
|Acquired customer base        |  | $                   
|Acquired developed technology |  |                     
|                              |  |                     
|Total                         |  | $                   
|                              |  |                     



The amortization
expense on these intangible assets was $306,000 during the quarter ended September 30, 2003. The remaining net carrying amount of $898,000 will be fully amortized in fiscal 2004.



9



---

##### Table of Contents

Note 5.  Net Loss Per Common Share



Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding.



The following table sets forth the calculation of basic and
diluted net loss per common share (in thousands, except per share data):



|                                                                                      |  | Three Months Ended September 30, |       
|------------------------------------------------------------------------------------- |  | -------------------------------- | ------
|                                                                                      |  | 2003                             |       
|Net loss applicable to common stockholders                                            |  | $                                | (3,897
|                                                                                      |  |                                  |       
|                                                                                      |  |                                 
|Basic and diluted:                                                                    |  |                                  |       
|Weighted-average shares outstanding                                                   |  |                                  | 3,676 
|Less weighted-average shares subject to repurchase                                    |  |                                  | 0     
|                                                                                      |  |                                  |       
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                                  | 3,676 
|                                                                                      |  |                                  |       
|Basic and diluted net loss per common share                                           |  | $                                | (1.06 
|                                                                                      |  |                                  |       



Outstanding options
and warrants to purchase 958,184, and 914,787 shares of common stock at September 30, 2003 and 2002, respectively, and convertible preferred stock convertible into 1,918,139 and 1,794,900 shares of common stock at September 30, 2003 and 2002,
respectively, were not included in the computation of diluted net loss per common share for the periods presented as a result of their anti-dilutive effect. Such securities could have a dilutive effect in future periods.



Note 6.  Comprehensive Loss



We report comprehensive loss and the components in accordance with Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). Under SFAS 130, comprehensive income includes all changes in equity during a period except those resulting from investments by or distributions to
owners. Total comprehensive loss was $2.1 million and $6.4 million for the quarters ended September 30, 2003 and 2002, respectively. Accumulated other comprehensive loss presented in the accompanying consolidated balance sheets at September 30, 2003
consists solely of accumulated foreign currency translation adjustments.



Note 7.  Segment Information



Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by our chief operating decision-makers to make decisions about resources to be allocated to the
segment and assess its performance. Our chief operating decision-makers, as defined under SFAS No. 131, are our executive management team. Our chief operating decision makers review financial information presented on a consolidated basis,
accompanied by separate information about operating results by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, we operate in one segment, the development, license, implementation and
support of our customer service infrastructure software solutions.



10



---

##### Table of Contents

Information relating to our geographic areas is as follows (in thousands):



|                                                                                                               |  | Three months ended September 30, |       
|-------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------
|                                                                                                               |  | 2003                             |       
|Total Revenue:                                                                                                 |  |                                  |       
|North America                                                                                                  |  | $                                | 2,530 
|Europe                                                                                                         |  |                                  | 2,000 
|Asia Pacific                                                                                                   |  |                                  | 43    
|India                                                                                                          |  |                                  |      
|                                                                                                               |  |                                  |       
|                                                                                                               |  | $                                | 4,573 
|                                                                                                               |  |                                  |       
|Operating Income (Loss):                                                                                       |  |                                  |       
|North America                                                                                                  |  | $                                | (1,358
|Europe                                                                                                         |  |                                  | 50    
|Asia Pacific                                                                                                   |  |                                  | (70   
|India                                                                                                          |  |                                  | (535  
|                                                                                                               |  |                                  |       
|                                                                                                               |  | $                                | (1,913
|                                                                                                               |  |                                  |       
|                                                                                                              
|In addition, identifiable tangible assets corresponding to our geographic areas are as follows (in thousands):
|                                                                                                               |  |                                 
|                                                                                                               |  | September 30,2003                |       
|North America                                                                                                  |  | $                                | 5,394 
|Europe                                                                                                         |  |                                  | 3,591 
|Asia Pacific                                                                                                   |  |                                  | 296   
|India                                                                                                          |  |                                  | 620   
|                                                                                                               |  |                                  |       
|                                                                                                               |  | $                                | 9,901 
|                                                                                                               |  |                                  |       



During the three
months ended September 30, 2003 and 2002, no single customer accounted for more than 10% of our total revenue.



Note 8.  Related Party Notes Payable



On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the Purchase Agreement) with Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy will make loans to us
evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of our common stock in connection with such loans (the Credit Facility). Each subordinated secured promissory note will have a
term of five years and will bear interest at an effective annual rate of 12% due and payable upon the maturity of such note. We have the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants
will allow Mr. Roy to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of our common stock (based on a five day trading average at the time of each loan). The
warrants become exerciseable as to 50% of the warrant shares nine months after issuance of the warrant and the remaining 50% of the warrant shares on the first anniversary of the issuance of the warrant. An initial advance of $2.0 million under the
Credit Facility occurred on December 31, 2002. We recorded $1.83 million in related party notes payable and $173,000 of discount on the notes related to the value of the warrants issued in the transaction that will be amortized to interest expense
over the five year life of the note. The fair value of these options was determined using the Black-Scholes valuation method with the following assumptions: an expected life of 3 years, an expected stock price volatility of .75, a risk free interest
rate of 2%, and a dividend yield of 0%. On October 31, 2003 we entered into an amendment to the Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the Purchase Agreement, even though we had
not met the milestones initially required for such further loan; 2) only the final milestone, as amended, remains applicable to the remaining $1.0 million available under the Purchase Agreement and 3) any additional warrants issued under the
Purchase Agreement, including the warrants issued in connection with the second loan, will vest fully on issuance and expire five years after issuance thereof.



11



---

##### Table of Contents

As of September 30, 2003, the outstanding balance of related party notes payable of $2.0 million was net
of $147,000 of unamortized discount and included accrued interest of $180,000 at an annual rate of 12%.



Note 9.  Bank Borrowings



On September 20, 2002, we entered into a new accounts receivable purchase agreement (the AR Facility) with Silicon Valley Bank (SVB), which replaced the existing revolving line of credit. The
AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly administrative fee. As part of this agreement, the existing term loan and
equipment loan with SVB were combined into one term loan facility in the amount of $2.6 million, which was secured by establishing a restricted certificate of deposit. This amount will be reduced as scheduled amortization payments on the term loan
are made. The remaining balance at September 30, 2003 was $572,000. There are no financial or operational covenant requirements under this agreement. On March 25, 2003, we entered into a modification agreement with SVB which extended the termination
of the AR Facility for an additional 90 days through June 30, 2003 and revised the sale amount of qualified receivables from $5.0 million to $1.9 million. On June 25, 2003, we entered into a new modification agreement for the AR Facility with SVB
that extended the termination of the AR Facility for an additional 90 days through September 30, 2003. As of September 30, 2003, the outstanding balance under the AR Facility was $536,000, collateralized by $670,000 of receivables. On September 25,
2003, we entered into a modification agreement with SVB that extended the termination of the AR Facility for an additional 90 days through December 31, 2003 and revised the interest to a rate of prime plus 3% or 7% per annum, whichever is greater.



Total borrowings under the SVB Credit Facilities were $1.1
million at September 30, 2003, which consisted of the following (in thousands):



|                             |  | Amount |       | Maturity Date |                   | Interest Rate
|---------------------------- |  | ------ | ----- | ------------- | ----------------- | -------------
|Accounts Receivable Facility |  | $      | 536   |               | December 31, 2003 |              
|Term loan                    |  |        | 572   |               | February 29, 2004 |              
|                             |  |        |       |               |                   |              
|                             |  | $      | 1,108 |               |                   |              
|                             |  |        |       |               |                   |              



Note 10.  Restructuring



During the quarter ended September 30, 2003, we incurred
and paid a restructuring charge of $121,000 which consisted of $80,000 in employee severance payments and $41,000 in liquidation cost related to the French subsidiary.



Total payments of $306,000 in the quarter included $121,000, $91,000, $86,000 and $8,000 of expenses accrued in fiscal year
2004, 2003, 2002 and 2001, respectively.



Details of
restructuring charges incurred in fiscal 2004 are as follows (in thousands):



|                                       |  | Cash/Non-cash |  | FY04Charges |     | AmountPaid/Used |   |      | Balance at09/30/03
|-------------------------------------- |  | ------------- |  | ----------- | --- | --------------- | - | ---- | ------------------
|Employee severance                     |  | Cash          |  | $           | 80  |                 | $ | (80  | )                 
|Professional and miscellaneous charges |  | Cash          |  |             | 41  |                 |   | (41  | )                 
|                                       |  |               |  |             |     |                 |   |      |                   
|Total restructuring charges            |  |               |  | $           | 121 |                 | $ | (121 | )                 
|                                       |  |               |  |             |     |                 |   |      |                   



12



---

##### Table of Contents

During fiscal year 2003, we recorded a net restructuring charge of $620,000. This amount consisted of
$2.3 million of new restructuring expenses partially offset by a reversal of $1.7 million, previously recorded as restructuring expense in fiscal 2002, related to a settlement on the termination of a lease agreement for one of our excess facilities
in North America. The $2.3 million of expenses included $772,000 related to the closure of local offices in Holland, France, Germany, Australia and Singapore, $225,000 for additional consolidation of excess facilities in North America, $1.2 million
in employee severance payments and $61,000 in professional services and miscellaneous charges related to the restructuring.



The total payments of $3.3 million in fiscal year 2003 consisted of $1.9 million, $1.4 million and $40,000 of expenses accrued in fiscal year 2003, 2002
and 2001, respectively. The $1.9 million included $1.3 million employee severance payments, professional services and miscellaneous charges related to the restructuring, as well as $613,000 for excess facilities in worldwide recorded in fiscal year
2003. An additional payment of $91,000 was made for the excess facilities during the quarter ended September 30, 2003 and resulted in an unpaid balance of $293,000.



Details of restructuring charges incurred in fiscal 2003 are as follows (in thousands):



|                                       |  | Cash/Non-cash |  | FY03Charges |       | AmountPaid/Used |   |        | Balance at09/30/03
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------
|Excess facilities                      |  | Cash          |  | $           | 997   |                 | $ | (704   | )                 
|Employee severance                     |  | Cash          |  |             | 1,222 |                 |   | (1,222 | )                 
|Professional and miscellaneous charges |  | Cash          |  |             | 61    |                 |   | (61    | )                 
|                                       |  |               |  |             |       |                 |   |        |                   
|Total restructuring charges            |  |               |  | $           | 2,280 |                 | $ | (1,987 | )                 
|                                       |  |               |  |             |       |                 |   |        |                   



During fiscal year
2002, we recorded restructuring charges totaling $9.0 million pursuant to a plan approved by the required level of management necessary to execute its components. These charges were primarily related to $6.4 million consolidation of our facilities
in North America, $1.3 million in write-offs of leasehold improvement and $15,000 in professional services and miscellaneous charges associated with the exited facilities. In addition, we recorded a total severance charge of $1.2 million that was
primarily due to the reduction in worldwide workforce by 190 employees across all departments. Total payments of $4.0 million in fiscal year 2002, consisted of $1.5 million for excess facilities in North America, $1.3 million in write-offs of
leasehold improvement, and $1.2 million in employee severance, professional services and miscellaneous charges. In fiscal year 2003, an additional payment of $1.4 million was made for the excess facilities. During the quarter ended September 30,
2003, a payment of $86,000 was made for the excess facilities and resulted in an unpaid balance of $1.8 million.



Details of the restructuring charges cumulatively incurred in fiscal 2002 are as follows (in thousands):



|                                       |  | Cash/Non-cash |  | FY02Charges |       | AmountPaid/Used |   |        | Adjustment In FY03 |  |   | Balance at09/30/03
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------ |  | - | ------------------
|Excess facilities                      |  | Cash          |  | $           | 6,412 |                 | $ | (2,917 | )                  |  | $ | (1,660            
|Leasehold improvement write-offs       |  | Non-cash      |  |             | 1,315 |                 |   | (1,315 | )                  |  |   |                  
|Employee severance                     |  | Cash          |  |             | 1,222 |                 |   | (1,222 | )                  |  |   |                  
|Professional and miscellaneous charges |  | Cash          |  |             | 15    |                 |   | (15    | )                  |  |   |                  
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |                   
|Total restructuring charges            |  |               |  | $           | 8,964 |                 | $ | (5,469 | )                  |  | $ | (1,660            
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |                   



In fiscal 2001, we
recorded restructuring charges totaling $1.4 million. These charges primarily related to a reduction in our worldwide workforce by 141 employees across all departments and office closures in North America pursuant to the adoption of our expense
management strategy. The total charges were primarily comprised



13



---

##### Table of Contents

of $917,000 related to severance costs, $263,000 related to office closure costs and $263,000 related to professional services and miscellaneous charges
associated with the employee terminations. Total payments of $1.4 million were made through fiscal year 2003. During the quarter ended September 30, 2003, we paid $8,000 of professional expense and the unpaid balance was reduced to $84,000.



Details of the restructuring charges cumulatively incurred in
fiscal 2001 are as follows (in thousands):



|                                       |  | Cash/Non-cash |  | FY01Charges |       | AmountPaid/Used |   |        | Balance at09/30/03
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------
|Excess facilities                      |  | Cash          |  | $           | 263   |                 | $ | (263   | )                 
|Employee severance                     |  | Cash          |  |             | 917   |                 |   | (917   | )                 
|Professional and miscellaneous charges |  | Cash          |  |             | 263   |                 |   | (179   | )                 
|                                       |  |               |  |             |       |                 |   |        |                   
|Total restructuring charges            |  |               |  | $           | 1,443 |                 | $ | (1,359 | )                 
|                                       |  |               |  |             |       |                 |   |        |                   



Note 11.  Warranties



We generally warrant that the program portion of our
software will perform substantially in accordance with certain specifications for a period of 90 days. Our liability for a breach of this warranty is either a return of the license fee or providing a fix, patch, work-around or replacement of the
software.



We also provide standard warranties against and
indemnification for the potential infringement of third party intellectual property rights to our customers relating to the use of our products, as well as indemnification agreements with certain officers and employees under which we may be required
to indemnify such persons for liabilities arising out of their duties to us. The terms of such obligations vary. Generally, the maximum obligation is the amount permitted by law.



Historically, costs related to these guarantees have not been significant, however we cannot guarantee that a warranty
reserve will not become necessary in the future.



Note 12.  New
Accounting Pronouncements



In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150 establishes how an issuer classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted this
statement on July 1, 2003 and the adoption did not have a material impact on our financial position or results of operations.



Note 13.  Litigation



Beginning on October 25, 2001, a number of securities class action complaints were filed against us, and certain of our then officers and directors and
underwriters connected with our initial public offering of common stock in the U.S. District Court for the Southern District of New York (consolidated into In re Initial Public Offering Sec. Litig.). The complaints allege generally that the
Prospectus under which such securities were sold contained false and misleading statements with respect to discounts and excess commissions received by the underwriters as well as allegations of laddering whereby underwriters required
their customers to purchase additional shares in the aftermarket in exchange for an allocation of IPO shares. The complaints sought an unspecified amount in damages on behalf of persons who purchased the common stock between September 23, 1999 and
December 6, 2000. Similar complaints were filed against 55 underwriters and more than 300 other companies and other individuals. The over 1,000 complaints were consolidated into a single action. We recently reached an agreement with the plaintiffs
to resolve the cases as to our liability and that of our officers and directors. The settlement involved no monetary



14



---

##### Table of Contents

payment by us or our officers and directors and no admission of liability. The Court has not yet approved the settlement.



In March 2002, we were named as defendant in a Wisconsin state court action
alleging breach of contract/ warranty, fraudulent misrepresentation and related claims arising from a software license agreement between Metavante Corp. and Inference Corporation, an acquired wholly owned subsidiary. On October 8, 2003 we entered
into a settlement agreement with the Plaintiff to resolve the case and a Stipulation and Order for Dismissal was entered by the court on October 16, 2003.



On December 13, 2002, Mindfabric, Inc. filed an action for patent infringement against us. The suit alleges that eGain eService enterprise software
infringes later filed patents related to Mindfabrics computer-based learning and natural language processing patents. We believe the allegations contained in this suit to be wholly without merit and intend to defend this claim vigorously. We
do not expect its prosecution to have a material impact on our results of operations. However, even if claims such as these are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert management attention and other
resources.



On February 26, 2003, Golden Gate Plaza, LLC filed
a complaint for unlawful detainer against us. Golden Gate Plaza, LLCs unlawful detainer complaints seek contract damages for unpaid rent and associated costs under a commercial lease. The allegations contained in the suit related to property
leased by Inference. We deny the allegations in the complaint and allege that Golden Gate Plaza, LLCs damages, if any, are subject to off-set by way of mitigation. We intend to defend the claim vigorously and do not expect it to have a
material impact on our results of operations.



With the
exception of these matters, we are not a party to any other material pending legal proceedings, nor is our property the subject of any material pending legal proceeding, except routine legal proceedings arising in the ordinary course of our business
and incidental to our business, none of which are expected to have a material adverse impact, as taken individually or in the aggregate, upon our business, financial position or results of operations.



However, even if these claims are not meritorious, the ultimate outcome of
any litigation is uncertain, and it could divert managements attention, and impact other resources.



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



This report on Form 1O-Q and the documents incorporated herein by reference contain forward-looking statements that involve risks and uncertainties.
These statements may be identified by the use of the words such as anticipates, believes, continue, could, would, estimates, forecasts, expects,
intends, may, might, plans, potential, predicts, should, or will and similar expressions or the negative of those terms. The forward-looking statements
include, but are not limited to, risks stemming from strategic and operational choices in recent quarters, failure to improve our sales results and grow revenue, failure to compete successfully in the markets in which we do business, our continued
net losses since inception, our limited operating history, our equity structure and the significant risk of dilution, the adequacy of our capital resources and need for additional financing, liquidation preferences related to our preferred stock our
ability to maintain listing on the Nasdaq SmallCap Stock Market, continued lengthy and delayed sales cycles, the development of our strategic relationships and third party distribution channels, broad economic and political instability around the
world affecting the market for our goods and services, the continued need for customer service and contact center software solutions and the continued acceptance of our Web-native architecture, our ability to respond to rapid technological change
and competitive challenges, the effects of cost reductions on our workforce and ability to service customers, risks from our substantial international operations, adverse results in pending litigation, legal and regulatory uncertainties and other
risks related to protection of our intellectual property assets and the operational integrity and maintenance of our systems. Our actual results could differ materially from those discussed in statements relating to our future plans, product
releases, objectives, expectations and intentions, and other assumptions underlying or relating to any of these statements. Factors that could contribute to such differences include those discussed in Factors That May Affect Future
Results and elsewhere in this document. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or understanding to release publicly any updates



15



---

##### Table of Contents

or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.



Overview



We are a leading provider of
customer service and contact center software, used by global enterprises for over a decade. Twenty-four of the fifty largest global companies rely on us to transform their traditional call centers into profit centers, and extend their competitive
advantage through superior customer service. eGain Service 6, our software suite, available licensed or hosted, includes integrated, best-in-class applications for customer email management, live web collaboration, virtual agent customer service, knowledge management, and web
self-service. These robust applications are built on the eGain Service Management Platform (eGain SMP), a scalable next-generation framework that includes end-to-end service process management, multi-channel, multi-site contact center management, a flexible integration approach, and
certified out-of-the-box integrations with leading call center and business systems.



Recent Developments



In November 2003, we
received a notice from Nasdaq that we are not in compliance with Marketplace Rule 4310(c)(2)(B), which requires companies listed on the Nasdaq SmallCap Market to have a minimum of $2,500,000 in stockholders equity or $35,000,000 market value
of listed securities or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years. In the notice, Nasdaq indicated that it is reviewing our eligibility for
continued listing on The Nasdaq SmallCap Market and that we are required to submit a plan to achieve and sustain such compliance on or before November 21, 2003.



In November 2002, we received stockholder approval for, and on August 20, 2003 affected, a reverse stock split of our common stock at a ratio of
1-for-10 (the reverse stock split). As a result of the reverse stock split, each outstanding share of common stock automatically converted into one-tenth of a share of common stock, with the par value of each share of common stock
remaining at one-tenth of a cent ($0.01) per share. Accordingly, common stock share and per share amounts for all periods presented have been adjusted to reflect the impact of the reverse stock split. The reverse split of our common stock brought us
into compliance with the Nasdaq SmallCap Market bid price requirement. See further discussion on this matter under Additional Factors that May Affect Future Results.



On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the Purchase Agreement) with
Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy will make loans to us evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of our common stock in connection with such loans
(the Credit Facility). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the terms of such note. We have the option to prepay each note
at any time subject to the prepayment penalties set forth in such note. The warrants will allow Mr. Roy to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of our
common stock (based on a five day trading average at the time of each loan). The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrant and the remaining 50% of the warrant shares on the first
anniversary of the issuance of the warrant. An initial loan of $2.0 million under the Credit Facility occurred on December 31, 2002. On October 31, 2003 we entered into an amendment to the Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr.
Roy provided an additional $2.0 million loan under the Purchase Agreement, even though we had not met the milestones initially required for such further loan; 2) only the final milestone, as amended, remains applicable to the remaining $1.0 million
available under the Purchase Agreement and 3) any additional warrants issued under the Purchase Agreement, including the warrants issued in connection with the second loan, will vest fully on issuance and expire five years after issuance thereof.



Critical Accounting Policies and Estimates



Managements Discussion and Analysis of Financial Condition and Results
of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to



16



---

##### Table of Contents

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 amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, valuation allowances
and accrued liabilities, long-lived assets and restructuring. Management bases its estimates and judgments 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 judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



Revenue Recognition



We derive revenues from three sources, hosting fees, license fees and
services. Services include software maintenance and support, training and system implementation consulting. Maintenance and support consists of technical support and software upgrades and enhancements. Significant management judgments and estimates
are made and used to determine the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if different conditions were to prevail.



We apply the provisions of Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended by SOP 98-9 Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions to all transactions involving the sale of software products.



We recognize license revenue when persuasive evidence of an arrangement
exists, the product has been delivered, no significant obligations remain, the fee is fixed or determinable, and collection of the resulting receivable is probable. In software arrangements that include rights to multiple software products and/or
services, we use the residual method under which revenue is allocated to the undelivered elements based on vendor specific objective evidence of the fair value of such undelivered elements. The residual amount of revenue is allocated to the
delivered elements and recognized as revenue. Such undelivered elements in these arrangements typically consist of services.



We recognize hosting services revenue ratably over the period of the applicable agreement as services are provided. Hosting agreements are typically for a
period of one year and automatically renew unless either party cancels the agreement.



We use signed software license and services agreements and order forms as evidence of an arrangement for sales of software, hosting, maintenance and support. We use signed engagement letters to evidence an arrangement
for system implementation consulting and training.



Software is
delivered to customers electronically or on a CD-ROM. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. Our standard payment terms are generally less than 90 days. In instances where
payments are subject to extended payment terms, revenue is deferred until payments become due. We assess collectability based on a number of factors, including the customers past payment history and its current creditworthiness. If we
determine that collection of a fee is not reasonably assured, we defer the revenue and recognize it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is
recognized upon the earlier of customer acceptance or the expiration of the acceptance period.



When licenses are sold together with consulting and implementation services, license fees are recognized upon shipment, provided that (1) the above criteria have been met, (2) payment of the license fees is not
dependent upon the performance of the consulting and implementation services, and (3) the services are not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and
services revenues are recognized in accordance with the provisions of SOP 81-I, Accounting for Performance of Construction Type and Certain Production Type Contracts. When reliable estimates are available for the costs and efforts
necessary to complete the implementation services, we account for the arrangements under the percentage of completion method pursuant to SOP 81-I. When such estimates are not available, the completed contract method is utilized.



17



---

##### Table of Contents

The majority of our consulting and implementation services and accompanying agreements qualify for
separate accounting. We use vendor-specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element.
Our consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. For a fixed-fee contract, we recognize revenue upon completion of specific contractual milestones or using the percentage of
completion method. For time-and-materials contracts, we recognize revenue as services are performed.



Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Training revenue is
recognized when training is provided.



Revenue from sales to
resellers is recognized either upon delivery to the reseller or on a sell-through basis. depending on the facts and circumstances of the transaction, such as our understanding of the resellers use of our software, the resellers financial
status and our past experience with the particular reseller. Accordingly the decision whether to recognize revenue to resellers either upon delivery or on a sell-through basis requires significant management judgment. This judgment can materially
impact the timing of revenue recognition.



Valuation of
Long-Lived Assets



Effective July 1, 2002, we adopted SFAS
No. 142 and ceased amortization of goodwill and began reviewing it annually (or more frequently if impairment indicators arise) for impairment. In addition, we evaluated our remaining purchased intangible assets to determine that all such assets
have determinable lives. We operate under a single reporting unit and accordingly, all of our goodwill is associated with the entire company. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over its estimated
useful life of three years.



In connection with the
transitional goodwill impairment evaluation provisions of SFAS 142, we performed a goodwill impairment review as of July 1, 2002 and found no impairment. We also performed our annual goodwill impairment review as of April 1, 2003 and found no
impairment. The impairment review as of September 30, 2003 indicated no impairment was needed.



As of July 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), we review long-lived
assets, including property and equipment and intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable. Under SFAS 144, an impairment loss
would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Impairment, if any, is assessed using discounted cash flows. Significant
management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and, should different conditions prevail or judgments be made, material write-downs of net intangible
assets and/or goodwill could occur. In addition, our depreciation and amortization policies reflect judgments on the estimated useful lives of assets.



Restructuring



We have taken restructuring charges related to excess facilities and have established reserves at the low end of the range of estimable cost (as required
by accounting standards) against outstanding commitments for leased properties that we have abandoned. These reserves are based upon our estimate of triggering events, such as the time required to sublease the property and the amount of sublease
income that might be generated from the date of abandonment and the expiration of the lease. These estimates are reviewed based on changes in these triggering events. Adjustments to the restructuring charge will be made in future periods, if
necessary, should different conditions prevail from those anticipated in our original estimate.



18



---

##### Table of Contents

Allowance for Doubtful Accounts



We maintain an allowance for doubtful accounts to reserve for potential uncollectable trade receivables. We review our trade
receivables by aging category to identify specific customers with known disputes or collectability issues. We exercise judgment when determining the adequacy of these reserves as we evaluate historical bad debt trends, general economic conditions in
the U.S. and internationally, and changes in customer financial conditions. If we made different judgments or utilized different estimates, material differences may result in additional reserves for trade receivables, which would be reflected by
charges in general and administrative expenses for any period presented.



Results of Operations



The following table
sets forth the results of operations for the periods presented expressed as a percentage of total revenue:



|                                        |  | Three Months September 30, |   
|--------------------------------------- |  | -------------------------- | --
|                                        |  | 2003                       |   
|Revenue:                                |  |                            |   
|Hosting                                 |  | 16                         | % 
|License                                 |  | 17                         | % 
|Services                                |  | 67                         | % 
|                                        |  |                            |   
|Total revenue                           |  | 100                        | % 
|Cost of revenue  direct                |  | 43                         | % 
|Cost of revenue  acquisition related   |  | 0                          | % 
|                                        |  |                            |   
|Gross profit                            |  | 57                         | % 
|                                        |  |                           
|Operating costs and expenses:           |  |                            |   
|Research and development                |  | 23                         | % 
|Sales and marketing                     |  | 46                         | % 
|General and administrative              |  | 20                         | % 
|Amortization of other intangible assets |  | 7                          | % 
|Amortization of deferred compensation   |  | 0                          | % 
|Restructuring                           |  | 3                          | % 
|                                        |  |                            |   
|Total operating costs and expenses      |  | 99                         | % 
|                                        |  |                            |   
|Loss from operations                    |  | (42                        | %)
|                                        |  |                            |   



Total revenue
decreased 19% to $4.6 million in the quarter ended September 30, 2003 from $5.7 million in the quarter ended September 30, 2002. We believe the decrease was primarily due to a decline in licensed customer orders worldwide resulting from lengthened
sales cycles and the uncertain macro-economic environment. During the quarters ended September 30, 2003 and 2002, no single customer accounted for more than 10% of total revenue.



Hosting revenue decreased 30% to $732,000 for the quarter ended September 30, 2003 from $1.0 million in the quarter ended
September 30, 2002. The decrease was primarily due to the termination of existing hosted customer contracts during the quarter ended September 30, 2003. The number of new hosted customer contracts increased in the quarter ended September 30, 2003
and therefore we do not expect hosting revenues to decline significantly in future quarters. Hosting revenue represented 16% and 18% of total revenue for the quarters ended September 30, 2003 and 2002, respectively.



License revenue decreased 57% to $790,000 in the quarter ended September 30,
2003 from $1.8 million in the quarter ended September 30, 2002. The decrease was primarily due to the continued weak economy that resulted in a decline in customer orders as well as lengthened sales cycles worldwide. License revenue represented 17%
and 32% of total revenue for the quarters ended September 30, 2003 and 2002, respectively.



19



---

##### Table of Contents

Services revenue increased 9% to $3.1 million in the quarter ended September 30, 2003 from $2.8 million
in the quarter ended September 30, 2002. The increase was due in part from existing customers upgrading and expanding their use of our products. Services revenue represented 67% and 50% of total revenue for the quarters ended September 30, 2003 and
2002, respectively.



Operating Costs and Expenses Overview



Total operating costs and expenses decreased 46% to $4.5 million in the
quarter ended September 30, 2003 from $8.3 million in the quarter ended September 30, 2002. This reduction has been due primarily to the adoption our ongoing expense management strategy, whereby we have reduced our worldwide workforce by 170
employees across all departments over the last 15 months and reduced our direct operating presence in several international countries.



In the short term, based upon our current revenue expectations, we anticipate total operating costs and expenses will remain relatively constant in
absolute dollars. If our revenue for a particular quarter is below expectations, we may be unable to proportionately reduce our operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on our
expected operating results for that quarter. For this reason, period-to-period comparisons of our operating results may not be a good indication of our future performance.



Cost of Revenue  Direct



Cost of revenue  direct includes personnel costs for our hosting services, consulting services and customer support. It also includes depreciation
of capital equipment used in our hosted network, cost of third-party software royalties and lease costs paid to remote co-location centers. Cost of revenue-direct decreased 43% to $2.0 million in the quarter ended September 30, 2003 from $3.4
million in the quarter ended September 30, 2002. The significant decrease was primarily due to the reduction in worldwide workforce, a decline in outside contractor services and co-location lease costs as well as the migration of resources to eGain
India. Our occupancy costs and related overhead were also reduced due to the consolidation of excess facilities, the asset write-offs related to the reduction of workforce and the closure of offices. Based upon current revenue expectations, we do
not anticipate a significant increase or decrease in cost of revenue  direct in future periods.



Cost of Revenue  Acquisition Related



Cost of revenue  acquisition related decreased 100% to $0 in the quarter ended September 30, 2003 from $300,000 in the quarter ended September 30, 2002. These amounts consisted of amortization of developed
technology and customer base resulting from the business combinations in fiscal 2000. The acquired developed technology was fully amortized as of March 31, 2003. We do not anticipate any cost of revenue  acquisition related in future periods.



Research and Development



Research and development expenses primarily consist of compensation and
benefits of engineering, product management and quality assurance personnel and, to a lesser extent, occupancy costs and related overhead. Research and development expenses decreased 45% to $1.1 million in the quarter ended September 30, 2003 from
$1.9 million in the quarter ended September 30, 2002. The decrease was primarily due to the significant headcount reduction, a decline in outside contractor services and the migration of development resources to eGain India. Our occupancy costs and
related overhead were also reduced due to the consolidation of excess facilities, the asset write-offs related to the reduction of work force and the closure of offices. Based upon current revenue expectations, we do not anticipate a significant
increase or decrease in research development in future periods.



Sales and
Marketing



Sales and marketing expenses primarily consist
of compensation and benefits of our sales, marketing and business development personnel, advertising, trade show and other promotional costs and, to a lesser extent,



20



---

##### Table of Contents

occupancy costs and related overhead. Sales and marketing expenses decreased 39% to $2.1 million in the quarter ended September 30, 2003 from $3.5 million in
the quarter ended September 30, 2002. The decrease was primarily due to a decline in headcount through planned workforce reductions to reflect a tough market and internal reorganization and a decrease in spending on advertising and marketing
programs. Our occupancy costs and related overhead were also reduced due to the consolidation of excess facilities, the asset write-offs related to the reduction of work force and the closure of offices. Based upon current revenue expectations, we
do not anticipate a significant increase or decrease in sales and marketing in future periods.



General and Administrative



General and administrative expenses primarily consist of compensation and benefits for our finance, human resources, administrative and legal services personnel, fees for outside professional services, provision for doubtful accounts and,
to a lesser extent, occupancy costs and related overhead. General and administrative expenses decreased 37% to $909,000 in the quarter ended September 30, 2003 from $1.5 million in the quarter ended September 30, 2002. The decrease was primarily due
to a decline in headcount through increased efficiencies and migration of certain accounting and human resource functions to India and a decline in outside professional services. Our occupancy costs and related overhead were also reduced due to the
consolidation of excess facilities, the asset write-offs related to the reduction of work force and the closure of offices. Based upon current revenue expectations, we do not anticipate a significant increase or decrease in general and
administrative expenses in future periods.



Amortization of Other Intangible
Assets



Amortization of other intangibles decreased 9% to
approximately $306,000 during the quarter ended September 30, 2003 from $337,000 during the quarter ended September 30, 2002. This decrease was primarily due to the discontinuance of amortization of acquired developed technology intangible which was
fully amortized as of March 31, 2003.



Impairment of Long Lived Assets



In connection with the transitional goodwill impairment
evaluation provisions of SFAS 142, we performed a goodwill impairment review as of July 1, 2002 and found no impairment. We performed our annual goodwill impairment review as of April 1, 2003 and found no impairment. The impairment review as of
September 30, 2003 indicated no impairment was needed.



As of
July 1, 2002, in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), we review long-lived assets, including property and
equipment and intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amounts of the assets may not be fully recoverable. Under SFAS 144, an impairment loss would be recognized when estimated
undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Impairment, if any, is assessed using discounted cash flows. During fiscal 2003, we did not have any such
losses.



Valuation and Amortization of Stock-Based Compensation



Stock-based compensation is recorded in connection with
grants of stock options to employees on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options. Stock-based compensation is amortized on a graded vesting method over the vesting
period of the individual grants. In addition, we record compensation expense in connection with grants of stock options to non-employees pursuant to Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123). These grants are periodically revalued as they vest in accordance with SFAS 123 and EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. We recorded amortization of deferred compensation of $0 and $66,000 in the quarters ended September 30, 2003 and 2002, respectively.



21



---

##### Table of Contents

Restructuring Expense



Restructuring expenses decreased 88% to $121,000 for the quarter ended September 30, 2003 from $1.0 million for the quarter ended September 30, 2002. The
expenses consisted of severance costs and liquidation costs associated with the closure of the French office. The $1.0 million for the quarter ended September 30, 2002 consisted of $713,000 in severance payments associated with planned headcount
reductions and $296,000 for the closure of local offices in Holland and France.



Non-operating Income (expense)



Non-operating
expense increased 141% to $159,000 during the quarter ended September 30, 2003 from $66,000 during the quarter ended September 30, 2002.



Liquidity and Capital Resources



In response to declining revenues we have repeatedly taken actions to reduce expense rates. As a result of these actions net cash used in operations
decreased to $937,000 during quarter ended September 30, 2003 from $6.3 million during quarter ended September 30, 2002.



Our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors in particular that
revenues increase beyond the levels achieved in the quarter ended September 30, 2003 and that customers continue to pay on a timely basis. We believe that existing capital resources will enable us to maintain current and planned operations in the
short term, but in coming quarters it will be necessary for us to generate positive cash flow or obtain additional financing. We may also need to raise capital due to unforeseen or unanticipated market conditions. Such financing may be difficult or
impossible to obtain on terms acceptable to us and will almost certainly dilute existing shareholders value.



On August 8, 2000, we raised and received net proceeds of $82.6 million through the issuance of shares of convertible preferred stock and warrants to
purchase approximately 383,000 shares of common stock in a private placement. The convertible preferred stock liquidation value accretes at a rate of 6.75% per annum. During fiscal years 2001 and 2002, the accretion on the convertible preferred
shares totaled $5.4 million and $6.5 million, respectively. At fiscal year end 2003, the accretion equaled $6.9 million.



On September 20, 2002, we entered into a new accounts receivable purchase agreement (the AR Facility) with Silicon Valley Bank
(SVB), which replaced the existing revolving line of credit. The AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly
administrative fee. As part of this agreement, the existing term loan and equipment loan with SVB were combined into one term loan facility in the amount of $2.6 million, which was secured by establishing a restricted certificate of deposit. This
amount will be reduced as scheduled amortization payments on the term loan are made. The remaining outstanding balance at September 30, 2003 was $572,000. There are no financial or operational covenant requirements under this agreement. On March 25,
2003, we entered into a modification agreement with SVB which extended the termination of the AR Facility for an additional 90 days through June 30, 2003 and revised the sale amount of qualified receivables from $5.0 million to $1.9 million. On June
25, 2003, we entered into a new modification agreement for the AR Facility with SVB that extended the termination of the AR Facility for an additional 90 days through September 30, 2003. As of September 30, 2003, the outstanding balance under the AR
Facility was $536,000, collateralized by $670,000 of receivables. On September 25, 2003, we entered into a modification agreement with SVB that extended the termination of the AR Facility for an additional 90 days through December 31, 2003 and
revised the interest to a rate of prime plus 3% or 7% per annum, whichever is greater.



On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the Purchase Agreement) with Ashutosh Roy, our Chief Executive Officer, pursuant to which Mr. Roy will make loans to us
evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of our common stock in connection with such loans (the Credit Facility). Each subordinated secured promissory note will have a
term of five years and will bear interest at an effective annual rate of 12% due and payable upon the term of such note. We have the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants will
allow Mr. Roy to purchase a number of shares up to 25% of the aggregate amount loaned at



22



---

##### Table of Contents

an exercise price equal to 110% of the fair market value of our common stock (based on a five day trailing trading average at the time of each loan). The
warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrant and the remaining 50% of the warrant shares on the first anniversary of the issuance of the warrant. An initial loan of $2.0 million under the
Credit Facility occurred on December 31, 2002. On October 31, 2003 we entered into an amendment to the Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the Purchase Agreement, even though
we had not met the milestones initially required for such further loan; 2) only the final milestone, as amended, remains applicable to the remaining $1.0 million available under the Purchase Agreement and 3) any additional warrants issued under the
Purchase Agreement, including the warrants issued in connection with the second loan, will vest fully on issuance and expire five years after issuance thereof.



On September 30, 2003, cash and cash equivalents were $2.9 million, compared to $4.4 million at June 30, 2003. As of September 30, 2003 we had a
negative working capital of $1.4 million, compared to negative working capital of $172,000 as of June 30, 2003. In addition to the $2.9 million in cash and cash equivalents, we had $506,000 in restricted cash as of September 30, 2003.



Net cash used in operating activities was $937,000 and $6.3 million during
the quarters ended September 30, 2003 and 2002, respectively. Cash used in operating activities was primarily the result of net loss, partially offset by non-cash charges.



Net cash used in investing was $64,000 and $33,000 during the quarters ended September 30, 2003 and 2002, respectively. Cash
used in investing activities was primarily due to equipment purchases.



Net cash used in financing activities was $499,000 and $610,000 during the quarters ended September 30, 2003 and 2002, respectively. Cash used in financing activities was primarily due to the payments on borrowings and capital leases,
accrued interest and amortization of discount on related party notes, partially offset by proceeds from borrowings and the issuance of common stock.



The following table summarizes our contractual obligations at September 30, 2003 and the effect such obligations are expected to have on its liquidity and
cash flow in future periods (in thousands):



|                           |  | Year Ended June 30, |       |      |   |      
|-------------------------- |  | ------------------- | ----- | ---- | - | -----
|                           |  | 2004                |       | 2005 |   | 2006 
|Capital leases             |  | $                   | 16    |      | $ | 6    
|Operating leases           |  |                     | 1,592 |      |   | 1,478
|Bank borrowings            |  |                     | 1,108 |      |   |     
|Related Party Note Payable |  |                     |      |      |   |     
|                           |  |                     |       |      |   |      
|Total                      |  |                     | 2,716 |      |   | 1,484
|                           |  |                     |       |      |   |      



23



---

##### Table of Contents

Additional Factors That May Affect Future Results



We face a variety of risks stemming from strategic and operational decisions we have made
in recent quarters



In recent quarters we have made a
series of key decisions relating to cost reduction, debt accrual and operational structure. Such decisions have posed challenges to and will continue to affect the infrastructure, debt and equity structure and the operations of the company. If such
decisions have unanticipated consequences, they may have a material adverse effect on the financial condition and future results of operations. We have significantly cut the cost structure through reductions in force and the movement of certain key
business functions to operations in India. We have also reduced our work force overall by 42% since fiscal year ended 2002. In addition, in excess of 50% of all employees and the majority of all software development is now done in India with an
Indian workforce. As a result, our cash position, although sustainable to fund operations in the short term and despite significant restructuring of overhead, leaves little room for error in the forecasting and achievement of revenue goals.



While we have achieved significant cost savings through such
measures, we will be unable to quickly reverse the course of such actions and the initial costs associated with such restructuring may be lost if the infrastructure changes do not prove advantageous to our results. In addition, the continued and
aggressive restructuring over time has reduced our personnel and resources to minimal levels where the margin of operational error is very low. To the extent we have made poor decisions about the cutting of certain resources, such loss of assets may
contribute to an inability to effectively operate as a public company, properly serve customers or successfully achieve sales goals. Finally, a failure to meet top line revenue forecasts despite such cost cutting measures, will leave us with
insufficient resources to fund growth initiatives and accordingly our results and future financial condition will likely suffer.



We have a history of losses and expect continuing losses and may never achieve profitability



We incurred a net loss of $2.1 million during the quarter ended September 30, 2003. As of September 30, 2003, we had an
accumulated deficit of approximately $312.7 million. We do not know when or if we will become profitable in the foreseeable future. However, we must continue to spend resources on maintaining and strengthening our business, and this may, in the near
term, have a continued negative effect on our operating results and our financial condition. If we continue to incur net losses in future periods, we may not be able to retain employees, or fund investments in capital equipment, sales and marketing
programs, and research and development to successfully compete against our competitors. We also expect to continue to spend financial and other resources at reduced levels on developing and introducing product and service offerings. Accordingly, if
our revenue declines despite such investments, our business and operating results could suffer. We also may never obtain sufficient revenues to exceed our cost structure and achieve profitability. If we do not become profitable within the timeframe
expected by financial analysts or investors, the market price of our common stock may further decline. Even if we achieve profitability, we may be unable to sustain or increase profitability in the future. This may also, in turn, cause the price of
our common stock to demonstrate volatility and/or continue to decline.



We
may need additional capital, and raising such additional capital may be difficult or impossible and will likely significantly dilute existing stockholders



In response to declining revenues over the last two fiscal years we have repeatedly taken actions to reduce expense rates. As a result of these actions
net cash used in operations decreased to $937,000 for the quarter ended September 30, 2003 from $6.3 million for the quarter ended September 30, 2002.



Our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors in particular that
revenue levels remain stable and that customers continue to pay on a timely basis. We believe that any further significant reductions in expenses would be difficult to achieve given current operating levels. We believe that existing capital
resources will enable us to maintain current and planned operations in the short term, but in coming quarters it will be necessary for us to generate positive cash flow or obtain addition financing. We may also need to raise capital due to
unforeseen or unanticipated market conditions. Such financing may be difficult or impossible to obtain on terms acceptable to us and will almost certainly dilute existing shareholders.



24



---

##### Table of Contents

If we fail to improve the effectiveness and expand our sales and marketing activities and results, we may be unable to
grow our business, negatively impacting our operating results and financial condition



We have experienced significant turnover of our North America sales force. Expansion and growth of our business is very much dependant on our ability to integrate and develop our North America sales force. If we do
not effectively develop and train our sales force, and see results and success rates of such sales force in light of our investments of resources, we may not be able to achieve profitability and our common stock price could decline. Due to the
complexity of our eService platform and related products and services, we must utilize highly trained sales personnel to educate prospective customers regarding the use and benefits of our products and services as well as provide effective customer
support. Because we have experienced turnover in our sales force and have fewer resources than many of our competitors, our sales and marketing organization may not be able to successfully compete with those of our competitors. Our competitors often
may have sizeable sales forces and the ability to more frequently call on target customers and develop closer relationships with senior management and technical personnel who decide on the deployment of certain technology solutions.



We must compete successfully in our market segment



The market for customer service and contact center software is intensely
competitive. Other than product development, there are no substantial barriers to entry in this market, and established or new entities may enter this market in the near future. While home-grown software developed by enterprises represents indirect
competition, we also compete directly with packaged application software vendors in the customer service arena, including Avaya, Inc., Epiphany, Inc., Firepond, Inc., Genesys Telecommunications (a wholly-owned subsidiary of Alcatel), Kana Software,
Inc., Primus Knowledge Solutions, Inc., RightNow Technologies, Inc., Serviceware, and Talisma Corp. In addition, we face actual or potential competition from larger software companies such as Siebel Systems, Inc., PeopleSoft, Inc., Oracle
Corporation, SAP Inc. and similar companies may attempt to sell customer service software to their installed base.



We believe competition will continue to be fierce and increase as current competitors increase the sophistication of their offerings and as new
participants enter the market. Many of our current and potential competitors have longer operating histories, larger customer bases, broader brand recognition, and significantly greater financial, marketing and other resources. With more established
and better-financed competitors, these companies may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies, and make more attractive offers to businesses to induce them to use their products or services.



Further, any delays in the general market acceptance of our
applications would likely harm our competitive position by allowing our competitors additional time to improve their product and service offerings, and also provide time for new competitors to develop applications and solicit prospective customers
within our target markets. Increased competition could result in pricing pressures, reduced operating margins and loss of market share.



Due to our limited operating history and the emerging market for our products and services, revenue and operating expenses are unpredictable and may fluctuate which
may harm our operating results and financial condition



Due to the emerging nature of the multi-channel contact center market and other factors, revenue and operating results may fluctuate from quarter to quarter. Our revenues in some past quarters fell and could continue to fall short of
expectations if we experience delays or cancellations of even a small number of orders. It is possible that our operating results in some quarters will be below the expectations of financial analysts or investors. In this event, the market price of
our common stock is also likely to decline.



A number of
factors are likely to cause fluctuations in our operating results, including, but not limited to, the following:



| |  | demand for our software and budget and spending decisions by information technology departments of our customers;
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | seasonal trends in technology purchases;
| | - | ----------------------------------------



25



---

##### Table of Contents

| |  | the announcement or introduction of new or enhanced products and services by us or by our competitors and other competitive pressure from new and existing market participants;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to attract and retain customers and maintain customer satisfaction;
| | - | -------------------------------------------------------------------------------



| |  | litigation relating to our proprietary rights; and
| | - | --------------------------------------------------



| |  | budget, purchasing and payment cycles, timing and revenue recognition of customer contracts and potential customer contracts.
| | - | -----------------------------------------------------------------------------------------------------------------------------



In addition, we base our expense levels in part on expectations regarding
future revenue levels. In the short term, expenses, such as employee compensation and rent, are relatively fixed. If revenue for a particular quarter is below expectations, we may be unable to proportionately reduce our operating expenses for that
quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on expected operating results for that quarter. Moreover, we believe that any further significant reductions in expenses would be difficult to achieve given current
operating levels. For this reason, period-to-period comparisons of our operating results may also not be a good indication of our future performance.



The conversion of our preferred shares and the exercise of the related warrants would result in very significant number of additional shares being issued, which could
result in a decline in the market price of our common stock



On August 8, 2000, we issued 35.11 shares of non-voting Series A Cumulative Convertible Preferred Stock (Series A), $100,000 stated value per share, and 849.89 shares of non-voting Series B Cumulative Convertible Preferred Stock
(Series B), $100,000 stated value per share in a private placement to certain investors. The Series B shares automatically converted into Series A shares upon stockholder approval on November 20, 2000 at the annual stockholders meeting.
In addition, investors received warrants to purchase 383,000 shares of our common stock with a current warrant exercise price of $56.875 per share. The Series A shares have a liquidation preference of $100,000 per share, or an aggregate liquidation
preference of $88.5 million, which increases on a daily basis at an annual rate of 6.75% from August 8, 2000, compounded on a semi-annual basis (the Liquidation Value). The Series A shares are convertible into common stock (including all
amounts accreted from August 8, 2000) at a conversion price of $56.875 per share. At recent stock prices, such Liquidation Value preference would mean very substantial dilution to the holders of our common stock. By way of illustration, as of
September 30, 2003, the current conversion price of $56.875 per share, the Series A shares would be convertible into 1.9 million additional shares of common stock on the market, while we currently have only 3.7 million shares of common stock issued
and outstanding excluding warrants and options.



To the extent
the preferred shares are converted into common stock (including all amounts accreted from August 8, 2000), a very significant number of shares of common stock may be sold into the market, which could decrease the price of our common stock. If not
sooner converted, on August 8, 2005 we must either, at our option, (i) redeem each outstanding share of Series A, at a redemption price equal to the Liquidation Value plus any declared but unpaid dividends or (ii) convert the Series A shares into
common stock at a price per share equal to 95% of the average closing bid price per share of the common stock on the 20 consecutive trading days immediately prior to the redemption date. We hope to renegotiate some the terms and conditions of the
redemption of the preferred stock prior to August 8, 2005. Regardless of the timing or availability of any such resolution, the result would nonetheless also likely be significant dilution to the holders of the common stock. Finally, we can make no
assurances as to when such resolution of the redemption issue would occur, if at all.



Our preferred stock carries a substantial liquidation preference



In the event of a liquidation, dissolution or winding up of eGain, the holders of Series A shares would be entitled to receive, prior to distribution of any proceeds to holders of common stock, proceeds equal to the
greater of (i) $88.5 million (plus increases in such liquidation preference at an annual rate of 6.75% from August 8, 2000) or (ii) the amount the holders of the Series A shares would have received had they converted their shares into common stock
immediately prior to such liquidation, dissolution or winding up. If we enter into a transaction pursuant to



26



---

##### Table of Contents

which we sell or transfer all or substantially all of our assets or we enter into a merger with another company, then at the option of the holder of Series A
shares, (A) each share of Series A may be converted into convertible equity securities of the entity acquiring eGain or (B) each Series A share may convert into shares of common stock based on the Liquidation Value, calculated as of the later of (x)
the closing date of such transaction or (y) August 8, 2003. In the event that we entered into a merger or sale in which the total value of the transaction would be less than the Liquidation Value, a buyer would unlikely be willing to assume the
liquidation preferences and other obligations represented by the Series A shares. Consequently, based on our current capital structure, we anticipate that a transaction resulting in such a sale would result in substantially all of the proceeds of
such transaction being distributed to the holders of the our Series A shares with little, if any remuneration, available to common stock holders.



We may be unable to maintain our Nasdaq listing and the price and liquidity of our common stock and our ability to obtain future equity financing may be further
impaired if we cannot do so



In November 2003, we received
a notice from Nasdaq that we are not in compliance with Marketplace Rule 4310(c)(2)(B), which requires companies listed on the Nasdaq SmallCap Market to have a minimum of $2,500,000 in stockholders equity or $35,000,000 market value of listed
securities or $500,000 of net income from continuing operations for the most recently completed fiscal year or two of the three most recently completed fiscal years. In the notice, Nasdaq indicated that it is reviewing our eligibility for continued
listing on The Nasdaq SmallCap Market and that we are required to submit a plan to achieve and sustain such compliance on or before November 21, 2003. We can offer no assurance that any plan to achieve or sustain compliance will meet with
Nasdaqs approval nor that it will be ultimately successful in achieving continued compliance.



The various markets operated by The Nasdaq Stock Market have quantitative maintenance criteria for continued listing of common stock on their exchanges.
On November 5, 2002, the listing of our common stock was transferred to the Nasdaq SmallCap Market from the Nasdaq National Market. We must now satisfy a number of requirements to maintain our listing on the Nasdaq SmallCap Market, including
maintaining a minimum bid price for our common stock of $1.00 per share required for 30 consecutive trading days. On August 19, 2003, we effected a one-for-ten reverse stock split of all outstanding common stock. While the reverse split of our
common stock brought us into compliance with the Nasdaq SmallCap Market bid price requirement, we can offer no assurance that our common stock will continue to meet the minimum bid price requirement or that we will meet the other requirements for
the continued listing of our common stock on the Nasdaq SmallCap Market.



If a delisting from the Nasdaq SmallCap Market were to occur, shares of our common stock would likely trade in the over-the-counter market in the so-called pink sheets maintained by Pink Sheets LLC, or on
the OTC Bulletin Board owned by The Nasdaq Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq National Market or the Nasdaq SmallCap Market. The pink sheets and the OTC
Bulletin Board are generally considered less efficient than the Nasdaq SmallCap Market. Consequently, selling our common stock would be more difficult because of diminished liquidity in smaller quantities of shares likely be bought and sold,
transactions could be delayed, and securities analysts and news media coverage of us may be further reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of common stock.



Such delisting from the Nasdaq SmallCap Market, or further declines in our
stock price, could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and significantly increase the ownership dilution to stockholders caused by any issuance of equity in financing or other
transactions. The price at which we would issue shares in such transactions is generally based on the market price of our common stock and a decline in the stock price could result in our need to issue a greater number of shares to raise a given
amount of funding or acquire a given dollar value of goods or services.



In addition, if our common stock is not listed on the Nasdaq SmallCap Market, we may become subject to Rule 15g-9 under the Securities and Exchange Act of 1934, as amended. That rule imposes additional sales practice requirements on
broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser
and have received the purchasers written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of holders to sell their shares of our common
stock in the secondary market. Moreover, investors may be less interested in purchasing low-priced securities because the brokerage commissions, as a percentage of the total



27



---

##### Table of Contents

transaction value, tend to be higher for such securities, and some investment funds will not invest in low-priced securities (other than those which focus on
small-capitalization companies or low-priced securities).



Our lengthy sales
cycles and the difficulty in predicting timing of sales or delays may impair our operating results



The long sales cycle for our products may cause license revenue and operating results to vary significantly from period to period. Our sales cycle for our
products can be six months or more and varies substantially from customer to customer. Because we sell complex and deeply integrated solutions, it can take many months of customer education to secure sales. While our potential customers are
evaluating our products before, if ever, executing definitive agreements, we may incur substantial expenses and spend significant management effort in connection with the potential customer. Our multi-product offering and the increasingly complex
needs of our customers contribute to a longer and unpredictable sales cycle. Consequently, we often face difficulty predicting the quarter in which expected sales will actually occur. This contributes to the uncertainty and fluctuations in our
future operating results. In particular the economic slowdown in North America and globally has caused and may continue to cause potential customers to delay or cancel major information technology purchasing decisions. In addition, weakness in the
global securities markets, recessionary corporate spending levels and the protracted slump in technology spending specifically, has caused our average sales cycle to further increase and, in some cases, has prevented deals from closing that we
believed were likely to close. Consequently, we may miss our revenue forecasts and may incur expenses that are not offset by corresponding revenue.



Our failure to expand strategic and third-party distribution channels would impede our revenue growth



To grow our revenue base, we need to increase the number of our distribution
partners, including software vendors and resellers. Our existing or future distribution partners may choose to devote greater resources to marketing and supporting the products of our competitors that could also harm our financial condition or
results of operations. Our failure to expand third-party distribution channels would impede our future revenue growth. Similarly, to increase our revenue and implementation capabilities, we must continue to develop and expand relationships with
systems integrators. We sometimes rely on systems integrators to recommend our products to their customers and to install and support our products for their customers. We likewise depend on broad market acceptance by these systems integrators of our
product and service offerings. Our agreements generally do not prohibit competitive offerings and systems integrators may develop, market or recommend software applications that compete with our products. Moreover, if these firms fail to implement
our products successfully for their customers, we may not have the resources to implement our products on the schedule required by their customers. To the extent we devote resources to these relationships and the partnerships do not proceed as
anticipated or provide revenue or other results as anticipated our business may be harmed. Once partnerships are forged, there can be no guarantee that such relationships will be renewed in the future or available on acceptable terms. If we lose
strategic third party relationships, fail to renew or develop new relationships or fail to fully exploit revenue opportunities within such relationships, our results of operations and future growth may suffer.



We may experience a decrease in market demand due to the slowed economy, which has been
further stymied by the concerns of terrorism, war and social and political instability in the regions in which we do business



Worldwide economic growth, particularly in the United States, has slowed significantly, and many analysts believe the global economy is experiencing a
protracted recession or deceleration in spending from which recovery has been slow. In addition, the terrorist attacks in the United States and Europe and turmoil and war in the Middle East, Asia and elsewhere has increased the uncertainty in the
United States, the European Union and Asian economies and may further add to the prolonged decline in the United States business environment. The war on terrorism, along with the effects of the terrorist attack and other similar events, the war in
Iraq, military activities in Afghanistan, and hostilities between India and Pakistan, could contribute further to the slowdown of the already slumping market demand for goods and services, including digital communications software and services. If
the economy continues to decline as a result of the recent economic, political and social turmoil, or if there are further terrorist attacks in the United States and Europe, or as a result of the war in the Middle East and Asia, particularly India,
we may experience further decreases in the demand for our products and services, which may harm our operating results.



28



---

##### Table of Contents

We depend on broad market acceptance of our applications and of our business model



We depend on the widespread acceptance and use of our applications as an
effective solution for businesses seeking to manage high volumes of customer communication over the Internet while providing improved customer service. While we believe the potential to be very large, we cannot accurately estimate the size or growth
rate of the potential market for such product and service offerings generally, and we do not know whether our products and services in particular will achieve broad market acceptance. The market for eService software is new and rapidly evolving, and
concerns over the security and reliability of online transactions, the privacy of users and quality of service or other issues may inhibit the growth of the Internet and commercial online services. If the market for our applications fails to grow or
grows more slowly than we currently anticipate, our business will be seriously harmed.



Furthermore, our business model is premised on business assumptions that are still evolving. Historically, customer service has been conducted primarily in person or over the telephone. Our business model assumes that
both customers and companies will increasingly elect to communicate via the Internet (assisted and unassisted online service), as well as demanding integration of the online channels into the traditional telephone-based call center. Our business
model also assumes that many companies recognize the benefits of a hosted delivery model and will seek to have their eService applications hosted by us. If any of these assumptions is incorrect, our business will be seriously harmed and our stock
price will decline.



We may not be able to respond to the rapid
technological change of the customer service and contact center industry



The eService industry is characterized by rapid technological change, changes in customer requirements and preferences, and the emergence of new industry standards and practices that could render our existing
services, proprietary technology and systems obsolete. We must continually develop or introduce and improve the performance, features and reliability of our products and services, particularly in response to competitive offerings. Our success
depends, in part, on our ability to enhance our existing services and to develop new services, functionality and technology that address the increasingly sophisticated and varied needs of prospective customers. If we do not properly identify the
feature preferences of prospective customers, or if we fail to deliver product features that meet the standards of these customers, our ability to market our service and compete successfully and to increase revenues could be impaired. The
development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. We may not be able to keep pace with the latest technological
developments. We may also be unable to use new technologies effectively or adapt services to customer requirements or emerging Industry standards or regulatory or legal requirements. More generally, if we cannot adapt or respond in a cost-effective
and timely manner to changing industry standards, market conditions or customer requirements, our business and operating results will suffer.



Cost reduction initiatives may adversely affect the morale and performance of our personnel, which could affect our ability to retain high performers



To streamline operations and better align operating costs and expenses
with revenue trends, we have restructured our organization several times in recent years. The result has been substantial reductions in our workforce over time. To reduce operating expenses, we have also reduced our employees salaries numerous
times since the quarter ended December 31, 2001. Reductions in workforce and salary levels may continue to reduce employee morale, create concern among existing employees about job security, and contribute to distractions that drain productivity.
These issues may also lead to attrition beyond our planned workforce reductions and reduce our ability to meet the needs of our current and future customers. In addition, many of the employees who were terminated may have possessed specific
knowledge or expertise and their absence may create significant difficulties. This personnel reduction may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us to incur
significant expense. In addition, the workforce reductions previously completed have increased our dependence on our remaining employees and senior management. Any attrition beyond our planned workforce reductions could reduce our ability to develop
new products and services, provide acceptable levels of customer service and meet the needs of our current and future customers and harm our results of operations.



29



---

##### Table of Contents

Our success will also depend in large part on the skills, experience and performance of highly motivated
senior management, engineering, sales, marketing and other key personnel. The loss of the services of any of our senior management or other key personnel, including our Chief Executive Officer and co-founder, Ashutosh Roy, could harm our business.
In addition, in recent quarters, we also entered into a creditor relationship with Mr. Roy as he made a loan to us from his personal funds. To the extent a departure by Mr. Roy might affect our ability to further draw down on the loan facility
created for that purpose, such failure could have a materially adverse effect on our financial condition.



Our international operations involve various risks



We derived 45% of our revenues from international sales in the quarter ended September 30, 2003 unchanged from the quarter ended September 30, 2002. Including those discussed above, our international sales operations
are subject to a number of specific risks, such as:



| |  | foreign currency fluctuations and imposition of exchange controls;
| | - | ------------------------------------------------------------------



| |  | expenses associated with complying with differing technology standards and language translation issues;
| | - | -------------------------------------------------------------------------------------------------------



| |  | difficulty and costs in staffing and managing our international operations;
| | - | ---------------------------------------------------------------------------



| |  | difficulties in collecting accounts receivable and longer collection periods;
| | - | -----------------------------------------------------------------------------



| |  | various trade restrictions and tax consequences; and
| | - | ----------------------------------------------------



| |  | reduced intellectual property protections in some countries.
| | - | ------------------------------------------------------------



In addition, we intend to continue to expand and move our operations into international environments and to spend significant amounts of resources to do
so. Through eGain India, we also currently have a significant number of employees representing in excess of 50% of our total workforce located in India, more than a half employed in research and development. Although the movement of certain
operations internationally was principally motivated by cost cutting, the continued management of these remote operations will require significant management attention and financial resources that could adversely affect our operating performance.
Our reliance on our workforce in India makes us particularly susceptible to disruptions in the business environment in that region. In particular, sophisticated telecommunications links, high speed data communications with other eGain offices and
customers, and overall consistency and stability of our business infrastructure are vital to our day to day operations, and any impairment of such infrastructure will cause our financial condition and results to suffer. The maintenance of stable
political relations between both the United States and the European Union, and India are also of great importance to our operations.



Any of these risks could in particular have a significant impact on one or more of the following business functions: product development, customer support
and professional services. To the extent the costs of maintaining these operations abroad do not exceed the expense of establishing and maintaining such activities, our operating results and financial condition will suffer.



Difficulties in implementing our products could harm our revenues and margins



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



30



---

##### Table of Contents

Our reserves may be insufficient to cover receivables we are unable to collect



We assume a certain level of credit risk with our customers in order to do
business. Conditions affecting any of our customers could cause them to become unable or unwilling to pay us in a timely manner, or at all, for products or services we have already provided them. For example, if the current economic conditions
continue to decline, they may experience financial difficulties and be unable to pay their bills. In the past, we have experienced collection delays from certain customers, and we cannot predict whether we will continue to experience similar or more
severe delays in the future. Although we have established reserves to cover losses due to delays or inability to pay, there can be no assurance that such reserves will be sufficient to cover our losses. If losses due to delays or inability to pay
are greater than our reserves, it could harm our business, operating results and financial condition.



Pending litigation and infringement claims could be costly to defend and distract our management team



We may be involved in legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of
the intellectual property or proprietary rights of third parties, employment claims and other commercial contract disputes. Third parties may also infringe or misappropriate our copyrights, trademarks and other proprietary rights for which we may be
required to file suit to protect or mediate our rights. In the past we have had lawsuit brought or threatened against us in a variety of contexts including but not limited to claims related to our stock price, issues associated with our initial
public offering of common stock, and litigation associated with the termination of employees. Parties have also asserted or threatened, and may continue to do so, infringement claims against us including those referenced in the section of this
document entitled Legal Proceedings. Because the contents of patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products. In
particular, intellectual property litigation is expensive and time-consuming and could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be
available on acceptable terms, if at all, in the event of a successful claim of infringement. Our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.



Where appropriate, we intend to vigorously defend all claims. However, any
actual or threatened claims, even if not meritorious or material, could result in the expenditure of significant financial and managerial resources. The continued defense of these claims and other types of lawsuits could result in and could divert
managements attention away from running our business. Negative developments in lawsuits could cause our stock price to decline as well. In addition, required amounts to be paid in settlement of any claims, and the legal fees and other costs
associated with such settlement cannot be estimated and could, individually or in the aggregate, materially harm our financial condition.



We rely on trademark, copyright, trade secret laws, contractual restrictions and patent rights to protect our intellectual property and proprietary rights and if these
rights are impaired our ability to generate revenue will be harmed



We regard our patents, copyrights, service marks, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark and copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers and partners to protect our proprietary rights. We have numerous registered trademarks and trademark applications pending in the United States and internationally, as well as common law trademark rights. In
addition, we own several patents in the area of case-based reasoning, and have patents pending relating to various technologies. We will seek additional trademark and patent protection in the future. We do not know if our trademark and patent
applications will be granted, or whether they will provide the protection eGain desires, or whether they will subsequently be challenged or Invalidated. It is difficult to monitor unauthorized use of technology, particularly in foreign countries,
where the laws may not protect our proprietary rights as fully as in the United States. Furthermore, our competitors may independently develop technology similar to our technology.



Despite our efforts to protect our proprietary rights through confidentiality and license agreements, unauthorized parties
may attempt to copy or otherwise obtain and use our products or technology. These precautions may not prevent misappropriation or infringement of our intellectual property. In addition, we routinely require employees, customers, and potential
business partners to enter into confidentiality and nondisclosure agreements



31



---

##### Table of Contents

before we will disclose any sensitive aspects of our products, technology, or business plans. In addition, we require employees to agree to surrender any
proprietary information, inventions or other intellectual property they generate or come to possess while employed by us. In addition, some of our license agreements with certain customers and partners require us to place the source code for our
products into escrow. These agreements typically provide that some party will have a limited, non-exclusive right to access and use this code as authorized by the license agreement if there is a bankruptcy proceeding instituted by or against us, or
if we materially breach a contractual commitment to provide support and maintenance to the party.



Unknown software defects could disrupt our products and services and problems arising from our vendors products or services could disrupt operations, which could harm our business and reputation



Our product and service offerings depend on complex
software, both internally developed and licensed from third parties. Complex software often contains defects or errors in translation or integration, particularly when first introduced or when new versions are released or localized for international
markets. We may not discover software defects that affect our new or current services or enhancements until after they are deployed. It is possible that, despite testing by us, defects may occur in the software and we can give no assurance that our
products and services will not experience such defects in the future. Furthermore, our customers generally use our products together with products from other companies. As a result, when problems occur in the integration or network, it may be
difficult to identify the source of the problem. Even when our products do not cause these problems, these problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from product
development efforts and cause significant customer relations problems. These defects or problems could result in damage to our reputation, lost sales, product liability claims, delays in or loss of market acceptance of our products, product returns
and unexpected expenses, and diversion of resources to remedy errors.



We
may need to license third-party technologies and may be unable to do so



To the extent we need to license third-party technologies, we may be unable to do so on commercially reasonable terms or at all. In addition, we may fail to successfully integrate any licensed technology into our
products or services. Third-party licenses may expose us to increased risks, including risks associated with the integration of new technology, the diversion of resources from the development of our own proprietary technology, and our inability to
generate revenue from new technology sufficient to offset associated acquisition and maintenance costs. Our inability to obtain and successfully integrate any of these licenses could delay product and service development until equivalent technology
can be identified, licensed and integrated. This in turn would harm our business and operating results.



Our stock price has demonstrated volatility and overall declines since being listed on the public market and continued market conditions may cause further declines or fluctuations



The price at which our common stock trades has been and will likely continue
to be highly volatile and show wide fluctuations and substantial declines due to factors such as the following:



| |  | our capital structure, in particular the presence and terms of the preferred stock liquidation preferences and redemption rights;
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | the prospect of a delisting order from the Nasdaq SmallCap Market and concerns related to liquidity, financial condition or cash balances;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | actual or anticipated fluctuations in our operating results, our ability to meet announced or anticipated profitability goals and changes in or failure to meet securities
analysts expectations;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | announcements of technological innovations and/or the introduction of new services by us or our competitors;
| | - | ------------------------------------------------------------------------------------------------------------



| |  | developments with respect to intellectual property rights and litigation, regulatory scrutiny and new legislation;
| | - | ------------------------------------------------------------------------------------------------------------------



32



---

##### Table of Contents

| |  | conditions and trends in the Internet and other technology industries; and
| | - | --------------------------------------------------------------------------



| |  | general market and economic conditions.
| | - | ---------------------------------------



Furthermore, the stock market has in recent quarters experienced significant price and volume fluctuations that have affected the market prices for the
common stocks of technology companies, particularly Internet companies, regardless of the specific operating performance of the affected company. These broad market fluctuations may cause the market price of our common stock to increase and decline.



In addition, in past periods of volatility in the market price
of a particular companys securities, securities class action litigation has been brought against that company following such declines. To the extent the stock precipitously drops in the future, we may become involved in this type of litigation
in the future. Litigation of this kind, or in the form of intellectual property rights litigation, is often expensive and diverts managements attention and resources, which could continue to harm our business and operating results.



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



Our customers have in the past experienced some interruptions with the eGain-hosted operations. We believe that these interruptions will continue to occur
from time to time. These interruptions could be due to hardware and operating system failures. As a result, our business will suffer if we experience frequent or long system interruptions that result in the unavailability or reduced performance of
our hosted operations or reduce our ability to provide remote management services. We expect to experience occasional temporary capacity constraints due to sharply increased traffic or other Internet wide disruptions, which may cause unanticipated
system disruptions, slower response times, impaired quality, and degradation in levels of customer service. If this were to continue to happen, our business and reputation could be seriously harmed.



The recent growth in the use of the Internet has caused frequent
interruptions and delays in accessing the Internet and transmitting data over the Internet. Interruptions also occur due to systems burdens brought on by unsolicited bulk email or Spam, malicious service attacks and hacking into
operating systems, viruses, worms and Trojan horses, the proliferation of which may be beyond our control and may seriously impact ours and our customers businesses.



Because we provide Internet-based eService software, interruptions or delays in Internet transmissions will harm our
customers ability to receive and respond to online interactions. Therefore, our market depends on improvements being made to the entire Internet infrastructure to alleviate overloading and congestion.



Our success largely depends on the efficient and uninterrupted operation of
our computer and communications hardware and network systems. Most of our computer and communications systems are located in Sunnyvale, California. Due to our locations, our systems and operations are vulnerable to damage or interruption from fire,
earthquake, power loss, telecommunications failure and similar events.



We have entered into service agreements with some of our customers that require minimum performance standards, including standards regarding the availability and response time of our remote management services. If we fail to meet these
standards, our customers could terminate their relationships with us, and we could be subject to contractual refunds and services credits to customers. Any unplanned interruption of services may harm our ability to attract and retain customers.



We may be liable for activities of customers or others using our hosted
operations



As a provider of customer service and contact
center software for the Internet, we face potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the actions of our customers, and their customers, or others using our solutions or
communicating through our networks. This liability could result from the nature and content of the communications transmitted by customers through the hosted operations. We do not and cannot screen all of the communications generated by our
customers, and we could be exposed to liability with respect to this content. Furthermore, some foreign governments, including Germany and



33



---

##### Table of Contents

China, have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the United
States. In some instances criminal liability may arise in connection with the content of Internet transmissions.



Although we carry general liability and umbrella liability insurance, our insurance may not cover claims of these types or may not be adequate to
indemnify us for all liability that may be imposed. There is a risk that a single claim or multiple claims, if successfully asserted against us, could exceed the total of our coverage limits. There also is a risk that a single claim or multiple
claims asserted against us may not qualify for coverage under our insurance policies as a result of coverage exclusions that are contained within these policies. Should either of these risks occur, capital contributed by our stockholders might need
to be used to settle claims. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage could harm our reputation and business and operating results, or could result in the imposition
of criminal penalties.



If our system security is breached, our business and
reputation could suffer and we may face liability associated with disclosure of sensitive customer information



A fundamental requirement for online communications and transactions is the secure transmission of confidential information over public networks. Third
parties may attempt to breach our security or that of our customers. We may be liable to our customers for any breach in our security and any breach could harm our business and reputation. Although we have implemented network security measures, our
servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays, or loss of data. We may be required to expend significant capital and other resources to license
encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach. Since our applications frequently manage sensitive and personally identifiable customer information, and we may
also be subject to claims associated with invasion of privacy or inappropriate disclosure, use or loss of this information and fraud and identity theft crimes associated with such use or loss. Any imposition of liability, particularly liability that
is not covered by insurance or is in excess of insurance coverage, could harm our reputation and our business and operating results.



The regulatory environment for and certain legal uncertainties in the operation of our business and our customers business could impair the growth of the
Internet decreasing demand for our services or Increasing our cost of doing business



Few laws currently apply directly to activity on the Internet and related services for businesses operating commercial online service. However new laws are frequently proposed and other laws made applicable to
Internet communications every year both in the U.S. and internationally. In particular, in the operation of our business we face risks associated with privacy, confidentiality of user data and communications, consumer protection and pricing,
taxation, content, copyright, trade secrets, trademarks, antitrust, defamation and other legal issues. In particular, legal concerns with respect to communication of confidential data have affected our financial services and health care customers
due to newly enacted federal legislation. The growth of the industry and the proliferation of ecommerce services may prompt further legislative attention to our industry and thus invite more regulatory control of our business. Further, the growth
and development of the market for commercial online transactions may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies engaged in ecommerce. Moreover, the applicability to the Internet of
existing laws in various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve.



In addition, the applicability of laws and regulations directly applicable to the businesses of our customers, particularly
customers in the fields of financial services, will continue to affect us. The security of information about our customers end-users continues to be an area where a variety of laws and regulations with respect to privacy and confidentiality
are enacted. As our customers implement the protections and prohibitions with respect to the transmission of end-user data, our customers will look to us to assist them in remaining in compliance with this evolving area of regulation. In particular
the Gramm-Leach-Blilely Act contains restrictions with respect to the use and protection of banking records for end-users whose information may pass through our system.



34



---

##### Table of Contents

The imposition of more stringent protections and/or new regulations and application of laws to our
business could burden our company and those with which we do business. Further, the adoption of additional laws and regulations could limit the growth of our business and that of our business partners and customers. Any decreased generalized demand
for our services or the loss of, or decrease, in business by a key partner due to regulation or the expense of compliance with any regulation, could either increase the costs associated with our business or affect revenue, either of which could harm
our financial condition or operating results.



Finally, we face
increased regulatory scrutiny and potential criminal liability for our executives associated with various accounting and corporate governance rules promulgated under the Sarbanes-Oxley Act of 2002. We have reviewed and will continue to monitor all
of our accounting policies and practices, legal disclosure and corporate governance policies under the new legislation, including those related to relationships with our Independent accountants, enhanced financial disclosures, internal controls,
board and board committee practices, corporate responsibility and loan practices, and intend to fully comply with such laws. Nevertheless, such increased scrutiny and penalties involve risks to both eGain and our executive officers and directors in
monitoring and insuring compliance. A failure to properly navigate the legal disclosure environment and implement and enforce appropriate policies and procedures, if needed, could harm our business and prospects.



We may engage in future acquisitions or investments that could dilute our existing
stockholders, cause us to incur significant expenses or harm our business



We may review acquisition or investment prospects that might complement our current business or enhance our technological capabilities. Integrating any newly acquired businesses or their technologies or products may
be expensive and time-consuming. To finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings. Additional funds may not be available on terms that are favorable to us, if at all, and, in the
case of equity financings, may result in dilution to our existing stockholders. We may not be able to operate acquired businesses profitably or otherwise implement our growth strategy successfully. If we are unable to integrate newly acquired
entities or technologies effectively, our operating results could suffer. Future acquisitions by us could also result in large and immediate write-offs, the conversion of the our preferred stock into common stock, incurrence of debt and contingent
liabilities, or amortization of expenses related to goodwill and other intangibles, any of which could harm our operating results.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We develop products in the United States and India and sell these products internationally. Generally, sales are made in local currency. As a result, our
financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. To date, the effect of changes in foreign currency exchange rates on revenues and operating expenses
has not been material. We do not currently use derivative instruments to hedge against foreign exchange risk.



Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. Our investments consist primarily of
commercial paper and money market funds, which in 2003, had an annual average rate of 1.05%, and have maturities of three months or less. We do not consider our cash equivalents to be subject to interest rate risk due to the short maturities.



ITEM 4. CONTROLS AND PROCEDURES



(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures, as such term is defined in Rule 13a-14(c) under the Securities Exchange Act of 1934 (the Exchange
Act), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the
objectives of the disclosure controls and procedures are



35



---

##### Table of Contents

met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that
any design will succeed in achieving its stated goals under all potential future conditions.



Based on their evaluation as of a date within 90 days prior to the filing date of this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the
limitations noted above, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during
the period in which this Quarterly Report on Form 10-Q was being prepared.



(b) Changes in internal controls. There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date
of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



36



---

##### Table of Contents

Part II.    OTHER INFORMATION



Item 1. Legal Proceedings



Beginning on October 25, 2001, a number of securities class action complaints were filed against us, and certain of our then officers and directors and underwriters connected with our initial public offering of common stock in the U.S.
District Court for the Southern District of New York (consolidated into In re Initial Public Offering Sec. Litig.). The complaints allege generally that the Prospectus under which such securities were sold contained false and misleading
statements with respect to discounts and excess commissions received by the underwriters as well as allegations of laddering whereby underwriters required their customers to purchase additional shares in the aftermarket in exchange for
an allocation of IPO shares. The complaints sought an unspecified amount in damages on behalf of persons who purchased the common stock between September 23, 1999 and December 6, 2000. Similar complaints were filed against 55 underwriters and more
than 300 other companies and other individuals. The over 1,000 complaints were consolidated into a single action. We recently reached an agreement with the plaintiffs to resolve the cases as to our liability and that of our officers and directors.
The settlement involved no monetary payment by us or our officers and directors and no admission of liability. The Court has not yet approved the settlement.



In March 2002, we were named as defendant in a Wisconsin state court action alleging breach of contract/ warranty, fraudulent misrepresentation and
related claims arising from a software license agreement between Metavante Corp. and Inference Corporation, an acquired wholly owned subsidiary. On October 8, 2003 we entered into a settlement agreement with the Plaintiff to resolve the case and a
Stipulation and Order for Dismissal was entered by the court on October 16, 2003.



On December 13, 2002, Mindfabric, Inc. filed an action for patent infringement against us. The suit alleges that eGain eService enterprise software infringes later filed patents related to Mindfabrics
computer-based learning and natural language processing patents. We believe the allegations contained in this suit to be wholly without merit and intend to defend this claim vigorously. We do not expect its prosecution to have a material impact on
our results of operations. However, even if claims such as these are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert management attention and other resources.



On February 26, 2003, Golden Gate Plaza, LLC filed a complaint for unlawful
detainer against us. Golden Gate Plaza, LLCs unlawful detainer complaints seek contract damages for unpaid rent and associated costs under a commercial lease. The allegations contained in the suit related to property leased by Inference. We
deny the allegations in the complaint and allege that Golden Gate Plaza, LLCs damages, if any, are subject to off-set by way of mitigation. We intend to defend the claim vigorously and do not expect it to have a material impact on our results
of operations.



With the exception of these matters, we are not
a party to any other material pending legal proceedings, nor is our property the subject of any material pending legal proceeding, except routine legal proceedings arising in the ordinary course of our business and incidental to our business, none
of which are expected to have a material adverse impact, as taken individually or in the aggregate, upon our business, financial position or results of operations.



However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could divert
managements attention, and impact other resources.



Item 2. Changes in Securities



None.



Item 3. Defaults upon Senior Securities



None.



37



---

##### Table of Contents

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



None.



Item 5. Other Information



None.



Item 6. Exhibits and Reports on Form 8-K



|    |  |             
|--- |  | ------------
|(a) |  | Exhibits No.
|    |  |             
|    |  | 10.27       
|    |  |             
|    |  | 10.28       
|    |  |             
|    |  | 31.1        
|    |  |             
|    |  | 31.2        
|    |  |             
|    |  | 32.1        
|    |  |             
|    |  | 32.2        



(b)     Reports on
Form 8-K



We filed one report on Form 8-K for the quarter
ended September 30, 2003 as follows:



|Date             |  | Item Reported on                                                                                              
|---------------- |  | --------------------------------------------------------------------------------------------------------------
|November 6, 2003 |  | Press release filed announcing quarter ended September 30, 2003 results of operations and financial condition.



38



---

##### Table of Contents

SIGNATURES



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



|Dated: November 14, 2003 |  |  |  | eGAIN COMMUNICATIONS CORPORATION
|------------------------ |  |  |  | --------------------------------
|                         |  |  |  |                                 
|                         |  |  |  |                                 
|                         |  |  |  |                                 
|                         |  |  |  |                                 



39