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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



Form 10-Q



(Mark One)



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



For the quarterly period ended December 31, 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                                                       |  | 77-0466366                          
|(State or other jurisdiction of incorporation or organization) |  | (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 December 31, 2003
|Common Stock $0.001 par value |  | 3,691,180                       



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##### Table of Contents

eGAIN COMMUNICATIONS CORPORATION



TABLE OF CONTENTS



|         |  |                                                                                                               |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                               |  | Page
|         |  |                                                                                                              
|PART I.  |  | FINANCIAL INFORMATION                                                                                         |  | 1   
|         |  |                                                                                                              
|Item 1.  |  | Financial Statements                                                                                          |  | 1   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Balance Sheets at December 31, 2003 and June 30, 2003                                  |  | 1   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2003 and 2002 |  | 2   
|         |  |                                                                                                              
|         |  | Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2003 and 2002           |  | 3   
|         |  |                                                                                                              
|         |  | Notes to Condensed Consolidated Financial Statements                                                          |  | 4   
|         |  |                                                                                                              
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 13  
|         |  |                                                                                                              
|Item 3.  |  | Quantitative and Qualitative Disclosure About Market Risk                                                     |  | 35  
|         |  |                                                                                                              
|Item 4.  |  | Control and Procedures                                                                                        |  | 36  
|         |  |                                                                                                              
|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                                                           |  | 37  
|         |  |                                                                                                              
|Item 5.  |  | Other Information                                                                                             |  | 37  
|         |  |                                                                                                              
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                              |  | 38  
|         |  |                                                                                                              
|         |  | Signatures                                                                                                    |  | 39  





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##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------



eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS



(in thousands)



|                                                                                                                   |  |                  |          |   |              |   |          |  
|------------------------------------------------------------------------------------------------------------------ |  | ---------------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                   |  | December 31,2003 |          |   | June 30,2003 |  
|                                                                                                                   |  | (unaudited)      |          |   |              |  
|ASSETS                                                                                                             |  |                  |          |  
|                                                                                                                   |  |                 
|Current assets:                                                                                                    |  |                  |          |   |              |   |          |  
|Cash and cash equivalents                                                                                          |  | $                | 3,730    |   |              | $ | 4,407    |  
|Restricted cash                                                                                                    |  |                  | 315      |   |              |   | 791      |  
|Accounts receivable, net                                                                                           |  |                  | 2,328    |   |              |   | 3,270    |  
|Prepaid and other current assets                                                                                   |  |                  | 2,356    |   |              |   | 2,897    |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|Total current assets                                                                                               |  |                  | 8,729    |   |              |   | 11,365   |  
|Property and equipment, net                                                                                        |  |                  | 570      |   |              |   | 1,192    |  
|Goodwill, net                                                                                                      |  |                  | 4,880    |   |              |   | 4,880    |  
|Intangible assets, net                                                                                             |  |                  | 591      |   |              |   | 1,204    |  
|Other assets                                                                                                       |  |                  | 202      |   |              |   | 397      |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|                                                                                                                   |  | $                | 14,972   |   |              | $ | 19,038   |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                               |  |                  |          |   |              |   |          |  
|                                                                                                                   |  |                 
|Current liabilities:                                                                                               |  |                  |          |   |              |   |          |  
|Accounts payable                                                                                                   |  | $                | 1,209    |   |              | $ | 1,486    |  
|Accrued compensation                                                                                               |  |                  | 841      |   |              |   | 864      |  
|Accrued liabilities                                                                                                |  |                  | 1,266    |   |              |   | 1,918    |  
|Deferred revenue                                                                                                   |  |                  | 3,578    |   |              |   | 4,333    |  
|Current portion of accrued restructuring                                                                           |  |                  | 713      |   |              |   | 1,194    |  
|Current portion of bank borrowings                                                                                 |  |                  | 526      |   |              |   | 1,649    |  
|Current portion of notes payable                                                                                   |  |                  | 30       |   |              |   | 78       |  
|Current portion of capital lease obligations                                                                       |  |                  | 16       |   |              |   | 15       |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|Total current liabilities                                                                                          |  |                  | 8,179    |   |              |   | 11,537   |  
|                                                                                                                   |  |                 
|Related party notes payable                                                                                        |  |                  | 3,953    |   |              |   | 1,964    |  
|Capital lease obligations, net of current portion                                                                  |  |                  | 1        |   |              |   | 10       |  
|Accrued restructuring, net of current portion                                                                      |  |                  | 1,298    |   |              |   | 1,203    |  
|Other long term liabilities                                                                                        |  |                  | 246      |   |              |   | 243      |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|Total liabilities                                                                                                  |  |                  | 13,677   |   |              |   | 14,957   |  
|                                                                                                                   |  |                 
|Commitments                                                                                                        |  |                  |          |   |              |   |          |  
|                                                                                                                   |  |                 
|Stockholders equity:                                                                                              |  |                  |          |   |              |   |          |  
|Series A cumulative convertible preferred stock; Aggregate liquidation preference of $110,919 at December 31, 2003 |  |                  | 105,021  |   |              |   | 101,371  |  
|Common stock                                                                                                       |  |                  | 4        |   |              |   | 37       |  
|Additional paid-in capital                                                                                         |  |                  | 210,225  |   |              |   | 213,620  |  
|Notes receivable from stockholders                                                                                 |  |                  | (105     | ) |              |   | (102     | )
|Deferred stock compensation                                                                                        |  |                  |         |   |              |   | (38      | )
|Accumulated other comprehensive income (loss)                                                                      |  |                  | (266     | ) |              |   | (185     | )
|Accumulated deficit                                                                                                |  |                  | (313,584 | ) |              |   | (310,622 | )
|                                                                                                                   |  |                  |          |   |              |   |          |  
|Total shareholders equity                                                                                         |  |                  | 1,295    |   |              |   | 4,081    |  
|                                                                                                                   |  |                  |          |   |              |   |          |  
|                                                                                                                   |  | $                | 14,972   |   |              | $ | 19,038   |  
|                                                                                                                   |  |                  |          |   |              |   |          |  



See accompanying
notes



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eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ----------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                      |  | Three Months Ended December 31, |        |   | Six Months Ended December 31, |  
|                                                                                      |  | 2003                            |        |   | 2002                          |   |        | 2003 |  |   | 2002   |  
|Revenue:                                                                              |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|License                                                                               |  |                                 | 1,254  |   |                               |   | 1,819  |      |  |   | 2,044  |   |  |   | 3,636   |  
|Support and Services                                                                  |  |                                 | 3,836  |   |                               |   | 4,004  |      |  |   | 7,619  |   |  |   | 7,858   |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Total revenue                                                                         |  |                                 | 5,090  |   |                               |   | 5,823  |      |  |   | 9,663  |   |  |   | 11,494  |  
|Cost of license                                                                       |  |                                 | 432    |   |                               |   | 432    |      |  |   | 865    |   |  |   | 865     |  
|Cost of support and services                                                          |  |                                 | 1,741  |   |                               |   | 2,181  |      |  |   | 3,268  |   |  |   | 5,164   |  
|Cost of revenue  acquisition related                                                 |  |                                 |       |   |                               |   | 300    |      |  |   |       |   |  |   | 600     |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Gross profit                                                                          |  |                                 | 2,917  |   |                               |   | 2,910  |      |  |   | 5,530  |   |  |   | 4,865   |  
|                                                                                      |  |                                 |        |  
|Operating costs and expenses:                                                         |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Research and development                                                              |  |                                 | 660    |   |                               |   | 1,381  |      |  |   | 1,725  |   |  |   | 3,314   |  
|Sales and marketing                                                                   |  |                                 | 2,011  |   |                               |   | 2,224  |      |  |   | 4,136  |   |  |   | 5,698   |  
|General and administrative                                                            |  |                                 | 939    |   |                               |   | 1,213  |      |  |   | 1,848  |   |  |   | 2,663   |  
|Amortization of other intangible assets                                               |  |                                 | 306    |   |                               |   | 337    |      |  |   | 612    |   |  |   | 674     |  
|Amortization of deferred compensation                                                 |  |                                 |       |   |                               |   | 39     |      |  |   |       |   |  |   | 105     |  
|Restructuring                                                                         |  |                                 | 46     |   |                               |   | (1,285 | )    |  |   | 167    |   |  |   | (238    | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Total operating costs and expenses                                                    |  |                                 | 3,962  |   |                               |   | 3,909  |      |  |   | 8,488  |   |  |   | 12,216  |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Loss from operations                                                                  |  |                                 | (1,045 | ) |                               |   | (999   | )    |  |   | (2,958 | ) |  |   | (7,351  | )
|Non-operating income (expense)                                                        |  |                                 | 155    |   |                               |   | 262    |      |  |   | (4     | ) |  |   | 196     |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                                              |  |                                 | (890   | ) |                               |   | (737   | )    |  |   | (2,962 | ) |  |   | (7,155  | )
|Dividends on convertible preferred stock                                              |  |                                 | (1,825 | ) |                               |   | (1,708 | )    |  |   | (3,650 | ) |  |   | (3,416  | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                            |  | $                               | (2,715 | ) |                               | $ | (2,445 | )    |  | $ | (6,612 | ) |  | $ | (10,571 | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|                                                                                      |  |                                 |        |  
|Per Share information:                                                                |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per common share                                           |  | $                               | (0.74  | ) |                               | $ | (0.67  | )    |  | $ | (1.80  | ) |  | $ | (2.89   | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Weighted average shares used in computing basic and diluted net loss per common share |  |                                 | 3,688  |   |                               |   | 3,663  |      |  |   | 3,682  |   |  |   | 3,662   |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  



See accompanying
notes



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eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                            |  |                               |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---- | - | ------ | -
|                                                                            |  | Six Months Ended December 31, |       
|                                                                            |  | 2003                          |        |   | 2002 |  
|Cash flows from operating activities:                                       |  |                               |        |   |      |   |        |  
|Net loss                                                                    |  | $                             | (2,962 | ) |      | $ | (7,155 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                               |        |   |      |   |        |  
|Depreciation                                                                |  |                               | 724    |   |      |   | 2,402  |  
|(Gain) / loss on disposal of fixed assets                                   |  |                               | (5     | ) |      |   | 31     |  
|Amortization of other intangible assets                                     |  |                               | 613    |   |      |   | 1,274  |  
|Amortization of deferred compensation                                       |  |                               |       |   |      |   | 105    |  
|Accrued interest and amortization of discount on related party notes        |  |                               | 184    |   |      |   |       |  
|Changes in operating assets and liabilities:                                |  |                               |        |   |      |   |        |  
|Restricted cash                                                             |  |                               | 476    |   |      |   | (1,371 | )
|Accounts receivable                                                         |  |                               | 942    |   |      |   | 939    |  
|Prepaid and other current assets                                            |  |                               | 541    |   |      |   | 936    |  
|Other assets                                                                |  |                               | 195    |   |      |   | 921    |  
|Accounts payable                                                            |  |                               | (277   | ) |      |   | (430   | )
|Accrued compensation                                                        |  |                               | (23    | ) |      |   | (1,407 | )
|Accrued liabilities                                                         |  |                               | (652   | ) |      |   | (332   | )
|Accrued restructuring                                                       |  |                               | (386   | ) |      |   | (2,473 | )
|Deferred revenue                                                            |  |                               | (755   | ) |      |   | 364    |  
|Other long term liabilities                                                 |  |                               | 3      |   |      |   | 46     |  
|Other                                                                       |  |                               |       |   |      |   | (3     | )
|                                                                            |  |                               |        |   |      |   |        |  
|Net cash (used in) operating activities                                     |  |                               | (1,382 | ) |      |   | (6,153 | )
|                                                                            |  |                              
|Cash flows from investing activities:                                       |  |                               |        |   |      |   |        |  
|Proceeds from sale of property and equipment                                |  |                               |       |   |      |   | 221    |  
|Purchases of property and equipment                                         |  |                               | (97    | ) |      |   | (37    | )
|                                                                            |  |                               |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                         |  |                               | (97    | ) |      |   | 184    |  
|                                                                            |  |                              
|Cash flows from financing activities:                                       |  |                               |        |   |      |   |        |  
|Payments on borrowings                                                      |  |                               | (1,947 | ) |      |   | (2,580 | )
|Payments on capital lease obligations                                       |  |                               | (8     | ) |      |   | (252   | )
|Proceeds from borrowings                                                    |  |                               | 776    |   |      |   | 1,567  |  
|Proceeds from borrowings from related party                                 |  |                               | 2,000  |   |      |   | 2,000  |  
|Net proceeds from issuance of common stock                                  |  |                               | 62     |   |      |   | 2      |  
|                                                                            |  |                               |        |   |      |   |        |  
|Net cash provided by financing activities                                   |  |                               | 883    |   |      |   | 737    |  
|Effect of exchange rate differences on cash                                 |  |                               | (81    | ) |      |   | (140   | )
|                                                                            |  |                               |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                   |  |                               | (677   | ) |      |   | (5,372 | )
|Cash and cash equivalents at beginning of period                            |  |                               | 4,407  |   |      |   | 9,892  |  
|                                                                            |  |                               |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                  |  | $                             | 3,730  |   |      | $ | 4,520  |  
|                                                                            |  |                               |        |   |      |   |        |  
|                                                                            |  |                              
|Supplemental cash flow disclosures:                                         |  |                               |        |   |      |   |        |  
|Cash paid for interest                                                      |  | $                             | 216    |   |      | $ | 163    |  



See accompanying
notes



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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. eGain Service 6, our software suite, available through licensed or hosted models, 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 December 31, 2003, we have working capital of $550,000. 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 maintain at the levels achieved in the quarter ended December 31, 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 shareholder
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 effected, 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.



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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.



Support and Service
revenues are primarily derived from hosting fees, consulting fees, maintenance agreements, and training. 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 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 81-1, 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 of whether to recognize revenue to resellers upon delivery or on a sell-through basis requires significant management judgment. This judgment can
materially impact the timing of revenue recognition.



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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 December 31, 2003, there was no outstanding balance of deferred stock compensation. We amortized $0 and $39,000 of deferred compensation in the
quarters ended December 31, 2003 and December 31, 2002, respectively. The deferred compensation expense for the six months ended December 31, 2003 was $0, compared to $105,000 in the same period last year.



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 December 31, |        |   | Six months ended December 31, |  
|                                                                                                 |  | 2003                            |        |   | 2002                          |   |        | 2003 |  |   | 2002   |  
|As Reported:                                                                                     |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                                       |  | $                               | (2,715 | ) |                               | $ | (2,445 | )    |  | $ | (6,612 | ) |  | $ | (10,571 | )
|Basic and diluted net loss per share                                                             |  |                                 | (0.74  | ) |                               |   | (0.67  | )    |  |   | (1.80  | ) |  |   | (2.89   | )
|                                                                                                 |  |                                 |        |  
|Add: Stock-based employee compensation expense included in reported net loss                     |  |                                 |       |   |                               |   | 39     |      |  |   |       |   |  |   | 105     |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method |  |                                 | (180   | ) |                               |   | (152   | )    |  |   | (366   | ) |  |   | (155    | )
|                                                                                                 |  |                                 |        |  
|Pro Forma:                                                                                       |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                                       |  | $                               | (2,895 | ) |                               | $ | (2,558 | )    |  | $ | (6,978 | ) |  | $ | (10,621 | )
|Basic and diluted net loss per share                                                             |  |                                 | (0.78  | ) |                               |   | (0.70  | )    |  |   | (1.90  | ) |  |   | (2.90   | )



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



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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.
The purchased intangible assets including customer base and acquired technology are being amortized over the assets useful lives, which range 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 reduced stock price during the quarter, we performed another goodwill impairment review as of December 31, 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 December 31, 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):



|                                                              |  |                  |         |  
|------------------------------------------------------------- |  | ---------------- | ------- | -
|                                                              |  | December 31,2003 |        
|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):



|                              |  |                       |       |                         |   |        |                    |  |   |    
|----------------------------- |  | --------------------- | ----- | ----------------------- | - | ------ | ------------------ |  | - | ---
|                              |  | December 31, 2003    
|                              |  | Gross Carrying Amount |       | AccumulatedAmortization |   |        | Net CarryingAmount
|Acquired customer base        |  | $                     | 4,901 |                         | $ | (4,310 | )                  |  | $ | 591
|Acquired developed technology |  |                       | 3,694 |                         |   | (3,694 | )                  |  |   |   
|                              |  |                       |       |                         |   |        |                    |  |   |    
|Total                         |  | $                     | 8,595 |                         | $ | (8,004 | )                  |  | $ | 591
|                              |  |                       |       |                         |   |        |                    |  |   |    



|                              |  |                       |       |                         |   |        |                    |  |   |      
|----------------------------- |  | --------------------- | ----- | ----------------------- | - | ------ | ------------------ |  | - | -----
|                              |  | June 30, 2003        
|                              |  | Gross Carrying Amount |       | AccumulatedAmortization |   |        | Net CarryingAmount
|Acquired customer base        |  | $                     | 4,901 |                         | $ | (3,697 | )                  |  | $ | 1,204
|Acquired developed technology |  |                       | 3,694 |                         |   | (3,694 | )                  |  |   |     
|                              |  |                       |       |                         |   |        |                    |  |   |      
|Total                         |  | $                     | 8,595 |                         | $ | (7,391 | )                  |  | $ | 1,204
|                              |  |                       |       |                         |   |        |                    |  |   |      



The amortization
expense on these intangible assets was $306,000 during the quarter ended December 31, 2003. The remaining net carrying amount of $591,000 will be fully amortized by the end of fiscal 2004.



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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 December 31, |        |   | Six Months Ended December 31, |  
|                                                                                      |  | 2003                            |        |   | 2002                          |   |        | 2003 |  |   | 2002   |  
|Net loss applicable to common stockholders                                            |  | $                               | (2,715 | ) |                               | $ | (2,445 | )    |  | $ | (6,612 | ) |  | $ | (10,571 | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted:                                                                    |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average shares outstanding                                                   |  |                                 | 3,688  |   |                               |   | 3,665  |      |  |   | 3,682  |   |  |   | 3,666   |  
|Less weighted-average shares subject to repurchase                                    |  |                                 | 0      |   |                               |   | (2     | )    |  |   | 0      |   |  |   | (4      | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                                 | 3,688  |   |                               |   | 3,663  |      |  |   | 3,682  |   |  |   | 3,662   |  
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per common share                                           |  | $                               | (0.74  | ) |                               | $ | (0.67  | )    |  | $ | (1.80  | ) |  | $ | (2.89   | )
|                                                                                      |  |                                 |        |   |                               |   |        |      |  |   |        |   |  |   |         |  



Outstanding options
and warrants to purchase 1,258,752, and 909,721 shares of common stock at December 31, 2003 and 2002, respectively, and convertible preferred stock convertible into 1,950,227 and 1,824,964 shares of common stock at December 31, 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 $964,000 and $766,000 for the quarters ended December 31, 2003 and 2002, respectively. Comprehensive loss was $3.0 million and $7.3 million for the six months ended December 31, 2003 and 2002, respectively.
Accumulated other comprehensive loss presented in the accompanying consolidated balance sheets at December 31, 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, namely, the development, license, implementation and support of our customer service infrastructure software solutions.



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



|                         |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|------------------------ |  | ------------------------------ | ------ | - | ---------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                         |  | Three months endedDecember 31, |        |   | Six months endedDecember 31, |  
|                         |  | 2003                           |        |   | 2002                         |   |        | 2003 |  |   | 2002   |  
|Total Revenue:           |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|North America            |  | $                              | 2,412  |   |                              | $ | 2,637  |      |  | $ | 4,943  |   |  | $ | 5,734  |  
|Europe                   |  |                                | 2,456  |   |                              |   | 2,688  |      |  |   | 4,456  |   |  |   | 5,053  |  
|Asia Pacific             |  |                                | 222    |   |                              |   | 498    |      |  |   | 264    |   |  |   | 707    |  
|India                    |  |                                |       |   |                              |   |       |      |  |   |       |   |  |   |       |  
|                         |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|                         |  | $                              | 5,090  |   |                              | $ | 5,823  |      |  | $ | 9,663  |   |  | $ | 11,494 |  
|                         |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|Operating Income (Loss): |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|North America            |  | $                              | (1,118 | ) |                              | $ | (1,045 | )    |  | $ | (2,476 | ) |  | $ | (5,838 | )
|Europe                   |  |                                | 492    |   |                              |   | 619    |      |  |   | 542    |   |  |   | (80    | )
|Asia Pacific             |  |                                | 86     |   |                              |   | 4      |      |  |   | 16     |   |  |   | (276   | )
|India                    |  |                                | (505   | ) |                              |   | (577   | )    |  |   | (1,040 | ) |  |   | (1,157 | )
|                         |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|                         |  | $                              | (1,045 | ) |                              | $ | (999   | )    |  | $ | (2,958 | ) |  | $ | (7,351 | )
|                         |  |                                |        |   |                              |   |        |      |  |   |        |   |  |   |        |  



In addition,
identifiable tangible assets corresponding to our geographic areas are as follows (in thousands):



|              |  |                  |       |              |   |       
|------------- |  | ---------------- | ----- | ------------ | - | ------
|              |  | December 31,2003 |       | June 30,2003
|North America |  | $                | 5,907 |              | $ | 8,237 
|Europe        |  |                  | 2,729 |              |   | 3,716 
|Asia Pacific  |  |                  | 392   |              |   | 550   
|India         |  |                  | 473   |              |   | 451   
|              |  |                  |       |              |   |       
|              |  | $                | 9,501 |              | $ | 12,954
|              |  |                  |       |              |   |       



During the three
months ended December 31, 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
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 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. In December 2003 we recorded an additional $1.80 million in related party notes payable and
$195,000 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.



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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 2.25%, and a dividend yield of 0%.



As of December 31, 2003, the outstanding balance of related party notes payable of $4.0 million was net of $327,000 of unamortized discount and included
accrued interest of $280,000 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 related to the term loan at December 31, 2003 was
$286,000. 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 term of the AR Facility 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 term of the AR Facility through September 30, 2003. On September 25,
2003, we entered into a modification agreement with SVB that extended the term of the AR Facility through December 31, 2003 and revised the interest to a rate of prime plus 3% or 7% per annum, whichever is greater. On December 19, 2003 we entered
into a modification agreement with SVB that extended the term of the AR Facility for an additional six months. As of December 31, 2003, the outstanding balance under the AR Facility was $240,000, collateralized by $300,000 of receivables.



Total borrowings under the SVB Credit Facilities were $526,000
at December 31, 2003, which consisted of the following (in thousands):



|                             |  |        |     |               |                   |               |                                                           
|---------------------------- |  | ------ | --- | ------------- | ----------------- | ------------- | ----------------------------------------------------------
|                             |  | Amount |     | Maturity Date |                   | Interest Rate
|Accounts Receivable Facility |  | $      | 240 |               | June 30, 2004     |               | 7% or Prime + 3.0% whichever is greater + 0.5% monthly fee
|Term loan                    |  |        | 286 |               | February 29, 2004 |               | Prime                                                     
|                             |  |        |     |               |                   |               |                                                           
|                             |  | $      | 526 |               |                   |               |                                                           
|                             |  |        |     |               |                   |               |                                                           



Note 10. Restructuring



During the quarter ended December 31, 2003, we entered
into a settlement agreement to terminate a lease agreement for one of our excess facilities in Novato, CA. In connection with this settlement agreement we recorded an additional restructuring charge of $46,000 to increase the restructuring accrual
for this facility to $703,000. Under this agreement, we agreed to pay up to $1.5 million (the Settlement Amount) to the landlord. Of this obligation, $456,000 was paid in January 2004. The remaining balance will be paid in the event we
make a distribution of cash, stock, or other consideration to holders of our 6.75% Series A Cumulative Convertible Preferred Stock (the Series A Preferred) with respect to the shares of Series A Preferred held by such Series A Preferred
holders. In such event, the landlord would receive a payment equal to the lesser of (i) $1.0 million or (ii) the amount payable to a holder of shares of Series A Preferred with an aggregate stated value of $1.0 million. As of December 31, 2003 we
have accrued $247,000 of the total potential $1.0 million contingent payment based on our current estimate of the future payout under the lease settlement.



The total payments of $247,000 for the quarter ended December 31, 2003, consisted of $70,000, $107,000 and $70,000 of expenses accrued in fiscal year
2003, 2002 and 2001, respectively.



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.



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



|                                       |  |                 |  |              |     |                  |   |      |                     |  |   |   
|-------------------------------------- |  | --------------- |  | ------------ | --- | ---------------- | - | ---- | ------------------- |  | - | --
|                                       |  | Cash/Non - cash |  | FY04 Charges |     | Amount Paid/Used |   |      | Balance at 12/31/03
|Excess facilities                      |  | Cash            |  | $            | 46  |                  | $ |     |                     |  | $ | 46
|Employee severance                     |  | Cash            |  |              | 80  |                  |   | (80  | )                   |  |   |  
|Professional and miscellaneous charges |  | Cash            |  |              | 41  |                  |   | (41  | )                   |  |   |  
|                                       |  |                 |  |              |     |                  |   |      |                     |  |   |   
|Total restructuring charges            |  |                 |  | $            | 167 |                  | $ | (121 | )                   |  | $ | 46
|                                       |  |                 |  |              |     |                  |   |      |                     |  |   |   



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 of a dispute with respect to the termination of a facility lease agreement for 628 E. Evelyn Avenue, Sunnyvale, CA. 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 for employee severance payments, professional services and miscellaneous charges related
to the restructuring, as well as $613,000 for excess worldwide facilities recorded in fiscal year 2003. The payment of $161,000 was made for the excess facilities for the six months ended December 31, 2003 and resulted in an unpaid balance of
$223,000.



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



|                                       |  |                 |  |              |       |                  |   |        |                    |  |   |    
|-------------------------------------- |  | --------------- |  | ------------ | ----- | ---------------- | - | ------ | ------------------ |  | - | ---
|                                       |  | Cash/Non - cash |  | FY03 Charges |       | Amount Paid/Used |   |        | Balance at12/31/03
|Excess facilities                      |  | Cash            |  | $            | 997   |                  | $ | (774   | )                  |  | $ | 223
|Employee severance                     |  | Cash            |  |              | 1,222 |                  |   | (1,222 | )                  |  |   |   
|Professional and miscellaneous charges |  | Cash            |  |              | 61    |                  |   | (61    | )                  |  |   |   
|                                       |  |                 |  |              |       |                  |   |        |                    |  |   |    
|Total restructuring charges            |  |                 |  | $            | 2,280 |                  | $ | (2,057 | )                  |  | $ | 223
|                                       |  |                 |  |              |       |                  |   |        |                    |  |   |    



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 six months ended December 31,
2003, a payment of $193,000 was made for the excess facilities and resulted in an unpaid balance of $1.7 million.



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



|                                       |  |                |  |              |       |                  |   |        |                    |  |   |                     |   |  |   |      
|-------------------------------------- |  | -------------- |  | ------------ | ----- | ---------------- | - | ------ | ------------------ |  | - | ------------------- | - |  | - | -----
|                                       |  | Cash/Non- cash |  | FY02 Charges |       | Amount Paid/Used |   |        | Adjustment In FY03 |  |   | Balance at 12/31/03
|Excess facilities                      |  | Cash           |  | $            | 6,412 |                  | $ | (3,024 | )                  |  | $ | (1,660              | ) |  | $ | 1,728
|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 |                  | $ | (5,576 | )                  |  | $ | (1,660              | ) |  | $ | 1,728
|                                       |  |                |  |              |       |                  |   |        |                    |  |   |                     |   |  |   |      



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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 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 six months ended December 31, 2003, the total payment was $78,000, including $26,000 of professional expense and $52,000 settlement fee with terminated employees. The unpaid balance was reduced to $14,000.



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



|                                       |  |                |  |              |       |                  |   |        |                     |  |   |   
|-------------------------------------- |  | -------------- |  | ------------ | ----- | ---------------- | - | ------ | ------------------- |  | - | --
|                                       |  | Cash/Non- cash |  | FY01 Charges |       | Amount Paid/Used |   |        | Balance at 12/31/03
|Excess facilities                      |  | Cash           |  | $            | 263   |                  | $ | (263   | )                   |  | $ |  
|Employee severance                     |  | Cash           |  |              | 917   |                  |   | (917   | )                   |  |   |  
|Professional and miscellaneous charges |  | Cash           |  |              | 263   |                  |   | (249   | )                   |  |   | 14
|                                       |  |                |  |              |       |                  |   |        |                     |  |   |   
|Total restructuring charges            |  |                |  | $            | 1,443 |                  | $ | (1,429 | )                   |  | $ | 14
|                                       |  |                |  |              |       |                  |   |        |                     |  |   |   



Note 11. Other income



During the quarter ended December 31, 2003, we recorded
benefits of $340,000 from the reversal of an outstanding liability related to an internal use license agreement and $48,000 from the reduction of the buyout amount for one of our capital equipment leases which was partially offsest by interest
expense.



Note 12. 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
generally warrant that our professional services will meet agreed specifications and expectations with a remedy of reperformance of such services until conforming.



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.



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Note 13. 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 14. 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 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.



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.



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. On December 23, 2003 we entered into a settlement agreement with the Plaintiff to resolve the case and a Request for Dismissal was entered by the court on January 12, 2004.



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



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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 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. eGain Service 6, our software suite, available through licensed or hosted models, 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 were 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 was reviewing our eligibility for continued listing on The Nasdaq SmallCap Market and that we were required to submit a plan to achieve and sustain such compliance
on or before November 21, 2003. We submitted our preliminary plan as required and it was rejected. We then requested and received a hearing on the matter. On January 22, 2004 a hearing was held before the Listing Qualifications Panel to review our
plans to regain and maintain compliance. We have not received any indication of a determination by the Panel and await results of the hearing.



In November 2002, we received stockholder approval for, and on August 20, 2003 effected, 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 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 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



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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. In December 2003 we recorded an additional $1.80 million in related
party notes payable and $179,000 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 2.25%, and a dividend yield of 0%.



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
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 two sources: license fees and support and services. Support and services includes hosting, 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.



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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 81-1, 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 81-1. When such estimates are not available, the completed contract method is utilized.



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 of whether to
recognize revenue to resellers 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 December 31, 2003 indicated no impairment was needed.



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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.



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.



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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 December 31, |    |  | Six Months December 31, |   
|                                        |  | 2003                      |    |  | 2002                    |    |  | 2003 |    |  | 2002 |   
|Revenue:                                |  |                           |    |  |                         |    |  |      |    |  |      |   
|License                                 |  | 25                        | %  |  | 31                      | %  |  | 21   | %  |  | 32   | % 
|Support and Services                    |  | 75                        | %  |  | 69                      | %  |  | 79   | %  |  | 68   | % 
|                                        |  |                           |    |  |                         |    |  |      |    |  |      |   
|Total revenue                           |  | 100                       | %  |  | 100                     | %  |  | 100  | %  |  | 100  | % 
|Cost of license                         |  | 9                         | %  |  | 7                       | %  |  | 9    | %  |  | 7    | % 
|Cost of support and services            |  | 34                        | %  |  | 38                      | %  |  | 34   | %  |  | 45   | % 
|Cost of revenue  acquisition related   |  | 0                         | %  |  | 5                       | %  |  | 0    | %  |  | 5    | % 
|                                        |  |                           |    |  |                         |    |  |      |    |  |      |   
|Gross profit                            |  | 57                        | %  |  | 50                      | %  |  | 57   | %  |  | 43   | % 
|Operating costs and expenses:           |  |                           |    |  |                         |    |  |      |    |  |      |   
|Research and development                |  | 13                        | %  |  | 24                      | %  |  | 18   | %  |  | 29   | % 
|Sales and marketing                     |  | 40                        | %  |  | 38                      | %  |  | 43   | %  |  | 50   | % 
|General and administrative              |  | 18                        | %  |  | 21                      | %  |  | 19   | %  |  | 23   | % 
|Amortization of other intangible assets |  | 6                         | %  |  | 6                       | %  |  | 6    | %  |  | 6    | % 
|Amortization of deferred compensation   |  | 0                         | %  |  | 1                       | %  |  | 0    | %  |  | 1    | % 
|Restructuring                           |  | 1                         | %  |  | (22                     | %) |  | 2    | %  |  | (2   | %)
|                                        |  |                           |    |  |                         |    |  |      |    |  |      |   
|Total operating costs and expenses      |  | 78                        | %  |  | 68                      | %  |  | 88   | %  |  | 107  | % 
|                                        |  |                           |    |  |                         |    |  |      |    |  |      |   
|Loss from operations                    |  | (21                       | %) |  | (18                     | %) |  | (31  | %) |  | (64  | %)
|                                        |  |                           |    |  |                         |    |  |      |    |  |      |   



Total revenue
decreased 13% to $5.1 million in the quarter ended December 31, 2003 from $5.8 million in the quarter ended December 31, 2002. Total revenue for the six months ended December 31, 2003 decreased 16% to $9.7 million, compared to $11.5 million in the
same period last year. We believe the decrease was primarily due to a decline in licensed customer orders in our International markets. During the quarters ended December 31, 2003 and 2002, no single customer accounted for more than 10% of total
revenue.



License revenue decreased 31% to $1.3 million in the
quarter ended December 31, 2003 from $1.8 million in the quarter ended December 31, 2002. License revenue for the six months ended December 31, 2003 decreased 44% to $2.0 million, compared to $3.6 million in the same period last year. We believe the
decline in licensed customer orders in our international markets resulted from lengthened sales cycles caused by increased customer due diligence. License revenue represented 25% and 31% of total revenue for the quarters ended December 31, 2003 and
2002, respectively.



Support and services revenue decreased 4%
to $3.8 million in the quarter ended December 31, 2003 from $4.0 million in the quarter ended December 31, 2002. Support and services for the six months ended December 31, 2003 decreased 3% to $7.6 million, compared to $7.9 million in the same
period last year. The decrease was due in part from the decline in License revenues. Services and support revenue represented 75% and 69% of total revenue for the quarters ended December 31, 2003 and 2002, respectively.



Operating Costs and Expenses Overview



Total operating costs and expenses increased 1% to $4.0 million in the
quarter ended December 31, 2003 from $3.9 million in the quarter ended December 31, 2002. Total operating costs and expenses for the six months ended December 31, 2003 decreased 31% to $8.5 million, compared to $12.2 million in the same period last
year. Included in the quarter ended December 31, 2002 number is a restructuring benefit of $1.3 million that was primarily due to the termination of one of our facility leases in North America. In addition, there was a



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$1.2 million reduction in ongoing operating costs in the quarter ended December 31, 2003, when compared to the same period last year. This reduction has been
due primarily to the adoption our ongoing expense management strategy, whereby we have reduced our worldwide workforce by 176 employees across all departments over the last 18 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 reduce our operating expenses proportionately 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 License



Cost of license includes primarily the amortizing of a fixed amount of
third-party software royalties and delivery costs for shipments to customers. Cost of license was $432,000 in the quarter ended December 31, 2003, unchanged from the quarter ended December 31, 2002. Cost of license was a $865,000 for the six months
ended December 31, 2003 and 2002. We expect this to decline in future periods with the expiration or renewal of certain third party royalty agreements.



Cost of Support and Services



Cost of support and services 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 support for the third-party software and lease costs paid to remote co-location centers. Cost of support and services decreased 20% to $1.7 million in the quarter ended December 31, 2003 from
$2.2 million in the quarter ended December 31, 2002. Cost of support and services for the six months ended December 31, 2003 decreased 37% to $3.3 million, compared to $5.2 million in the same period last year. 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



The acquired developed technology was fully amortized as
of March 31, 2003. Cost of revenue  acquisition related for the three and six months ended December 31, 2002 were $300,000 and $600,000, respectively. These amounts consisted of amortization of developed technology resulting from the business
combinations in fiscal 2000. 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 52% to $660,000 in the quarter ended December 31, 2003 from $1.4 million in the quarter ended December 31, 2002. Research and development expenses
for the six months ended December 31, 2003 decreased 48% to $1.7 million, compared to $3.3 million in the same period last year. The decrease was primarily due to the significant headcount reduction by 73 over the last 18 months, a decline in
outside contractor services, the migration of 23 development resources to eGain India and an internal transfer of 7 resources. 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.



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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, occupancy costs and related overhead. Sales and marketing expenses decreased 10% to $2.0 million in the quarter ended December 31, 2003 from $2.2 million in the quarter ended December 31,
2002. Sales and marketing expenses for the six months ended December 31, 2003 decreased 27% to $4.1 million, compared to $5.7 million in the same period last year. The decrease was primarily due a reduction is sales related commissions in line with
the decline in license revenue. Our occupancy costs and related overhead were also reduced due to the consolidation of excess facilities. 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 23% to $939,000 in the quarter ended December 31, 2003 from $1.2 million in the quarter ended December 31, 2002. General and administrative expense for the six months ended December 31, 2003 decreased 31% to $1.8 million, compared
to $2.7 million in the same period last year. The decrease was primarily due to a decline in headcount by 23 over the last 18 months 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. 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 was approximately $306,000 during the quarter ended December 31, 2003 down from $337,000 during the quarter ended December 31, 2002. Amortization of other intangible assets for the
six months ended December 31, 2003 decreased to $612,000, compared to $674,000 in the same period last year. This decrease was primarily due to the acquired developed technology being 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 an initial 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. Due to the reduced stock price
during the quarter, we performed another goodwill impairment review as of December 31, 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 fiscal 2003 and the six months ended December 31, 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.



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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 $39,000 in the quarters ended December 31, 2003 and 2002, respectively.



Restructuring Expense



Restructuring expenses was $46,000 for the quarter ended December 31, 2003 compared to a restructuring benefit of $1.3
million for the quarter ended December 31, 2002. Restructuring expense for the six months ended December 31, 2003 was $167,000, compared to a net total of restructuring benefit of $238,000 in the same period last year. The benefit in the quarter
ended December 2002 consisted primarily of a settlement to terminate a lease agreement of one of our facilities in North America. The expense in the quarter ended December 31, 2003 was primarily related to a settlement to terminate a lease agreement
of one of our facilities in North America.



Non-operating Income (expense)



Non-operating income decreased 41% to $155,000 in the
quarter ended December 31, 2003 from $262,000 in the quarter ended December 31, 2002. Non-operating expense for the six months ended December 31, 2003 was $4,000, compared to non-operating income of $196,000 in the same period last year. The
non-operating income of $262,000 in the same period last year included a gain related to a real estate settlement of $360,000. The non-operating income in the quarter ended December 31, 2003 primarily consisted of benefits of $340,000 from the
reversal of an outstanding liability related to an internal use license agreement and $48,000 from the reduction of the buyout amount for one of our capital equipment leases which was partially offset by interest expense.



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 $1.4 million in the six months ended December 31, 2003 from $6.2 million in the six months ended December 31, 2002.



As of December 31, 2003, we have working capital of $550,000. 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 maintain at the levels achieved in the quarter ended December 31, 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 the quarter ended December 31, the accretion of the convertible preferred shares totaled $1.8 million. The cumulative accretion through December 31, 2003 totals $22.4 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 balance at December 31, 2003 was $286,000. 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 term of the AR Facility through June 30, 2003 and revised the sale amount of qualified receivables from $5.0 million
to $1.9 million. On



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June 25, 2003, we entered into a new modification agreement for the AR Facility with SVB that extended the term of the AR Facility through September 30,
2003. On September 25, 2003, we entered into a modification agreement with SVB that extended the term of the AR Facility through December 31, 2003 and revised the interest to a rate of prime plus 3% or 7% per annum, whichever is greater. On December
19, 2003 we entered into a modification agreement with SVB that extended the term of the AR Facility for an additional six months. As of December 31, 2003, the outstanding balance under the AR Facility was $240,000, collateralized by $300,000 of
receivables.



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 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 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. In December 2003 we recorded an additional $1.80 million in related party notes payable and $179,000 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 2.25%, and a dividend yield of 0%.



On December 31, 2003, cash and cash equivalents were $3.7 million, compared to $4.4 million at June 30, 2003. As of December 31, 2003 we had working
capital of $550,000, compared to negative working capital of $172,000 as of June 30, 2003. In addition to the $3.7 million in cash and cash equivalents, we had $315,000 and $1.4 million in restricted cash as of December 31, 2003 and 2002,
respectively.



Net cash used in operating activities was $1.4
million and $6.2 million in the six months ended December 31, 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 $97,000 in the six months ended December 31,
2003 and net cash provided from investing was $184,000 in the six month ended December 31, 2002. Cash used in investing activities was primarily due to equipment purchases. Cash provided from investing in the six months ended December 31, 2002 was
related to a settlement from a previous purchase of property and equipment.



Net cash provided from financing activities was $883,000 and $737,000 in the six months ended December 31, 2003 and 2002, respectively. Cash provided from financing activities was primarily due to the proceeds from
the related party notes, borrowings and the issuance of common stock, partially offset by the payments on borrowings and capital leases, accrued interest and amortization of discount on related party notes.



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The following table summarizes eGains contractual obligations as of December 31, 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 |  | 2007 |     | 2008 |   | Thereafter |  | Total
|Capital leases             |  | $                   | 16    |      | $ | 1    |  | $    |    |      | $ |           |  | $     |      |  | $ |      |  | $ | 17   
|Lease settlements          |  |                     | 456   |      |   |     |  |      |    |      |   |           |  |       |      |  |   |      |  |   | 456  
|Operating leases           |  |                     | 461   |      |   | 885  |  |      | 840 |      |   | 746        |  |       | 760   |  |   | 745   |  |   | 4,437
|Bank borrowings            |  |                     | 526   |      |   |     |  |      |    |      |   |           |  |       |      |  |   |      |  |   | 526  
|Related Party Note Payable |  |                     |      |      |   |     |  |      |    |      |   |           |  |       | 2,000 |  |   | 2,000 |  |   | 4,000
|Total                      |  |                     | 1,459 |      |   | 886  |  |      | 840 |      |   | 746        |  |       | 2,760 |  |   | 2,745 |  |   | 9,436



The table excludes
potential contingent payments of $2.0 million related to two lease settlements. These contingent payments will be paid in the event we make a distribution of cash, stock or other consideration to holders of our Series A Preferred with respect to the
shares of Series A Preferred held by such Series A Preferred holders. In such event, each of the two landlords would receive a payment equal to the lesser of (i) $1.0 million or (ii) the amount payable to a holder of shares of Series A Preferred
with an aggregate stated value of $1.0 million.



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Additional Factors That May Affect Future Results



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



We incurred a net loss of $890,000 during
the quarter ended December 31, 2003. As of December 31, 2003, we had an accumulated deficit of approximately $313.6 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 $1.4 million in the six months ended December 31, 2003 from $6.2 million in the six months ended
December 31, 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 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.



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



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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.



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 develop and get results from 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, our results from operations and our common stock price will likely further 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., 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 who may attempt to sell customer
service software to their installed base.



We believe
competition will continue to be fierce and increase as current competitors enhance 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 roll out or 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 similar 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



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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;
| | - | ----------------------------------------



| |  | 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 a 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
December 31, 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



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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 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 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 was reviewing our eligibility for continued
listing on The Nasdaq SmallCap Market. We were required to submit a plan by November 21, 2003 to indicate our plans for achieving compliance, we did so and such preliminary plan was rejected. We then requested and received a hearing on the matter.
On January 22, 2004 a hearing was held before the Listing Qualifications Panel to review our detailed plans to regain and maintain compliance. We have not received any indication of a determination by the Panel and await results of the hearing.



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 being 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



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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
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.



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We may experience a further decrease in market demand due to the slowed economy, which has also 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 particular, spending on technology solutions by corporations and government enterprises has been markedly slow to rebound and the industry continues to be mired
in a protracted economic slump. 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.



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 relatively 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.



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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.



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 53% of our revenues from international sales in the quarter ended December 31, 2003 unchanged from the quarter ended December 31, 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 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 benefit of maintaining these operations abroad does not exceed the expense of establishing and maintaining such activities, our operating results and financial condition will suffer.



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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.



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 lawsuits 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.



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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 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;
| | - | ---------------------------------------------------------------------------------------------------------------------------------



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| |  | 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;
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | 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. 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



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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 service 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 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



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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 effect 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.



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 effect 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 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.



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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 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.



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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 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.



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.



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. On December 23, 2003 we entered into a settlement agreement with the Plaintiff to resolve the case and a Request for Dismissal was entered by
the court on January 12, 2004.



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.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



None.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------



None.



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|Item 6. | Reports on Form 8-K Exhibits and Reports on Form 8-K
|------- | ----------------------------------------------------



(a)



|             |  |                                                                                                                                                                 
|------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits No. |  | Description of Exhibits                                                                                                                                         
|             | 
|10.29        |  | Accounts Receivable Purchase Modification Agreement between eGain and Silicon Valley Bank, December 19, 2003.                                                   
|             | 
|31.1         |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.                                                                                              
|             | 
|31.2         |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.                                                                                              
|             | 
|32.1         |  | Certification pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of Ashutosh Roy, Chief Executive Officer.
|             | 
|32.2         |  | Certification pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 of Eric Smit, Chief Financial Officer.   



|(b) | Reports on Form 8-K
|--- | -------------------



We filed one report on Form 8-K for the quarter ended December 31, 2003 as follows:



|                 |  |                                                                                                              
|---------------- |  | -------------------------------------------------------------------------------------------------------------
|Date             |  | Item Reported on                                                                                             
|                 | 
|February 3, 2003 |  | Press release filed announcing quarter ended December 31, 2003 results of operations and financial condition.



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##### 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: February 13, 2004 |  |  |  | eGAIN COMMUNICATIONS CORPORATION
|                         |  |  |  |                                 
|                         |  |  |  |                                  |  | By |  | /s/ Eric N. Smit                                                                                             
|                         |  |  |  |                                  |  |    |  |                                                                                                              
|                         |  |  |  |                                  |  |    |  | Eric N. Smit Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)



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