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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 March 31, 2004                                           
|  | 
|  |  | OR                                                                                      
|  | 
| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  | 
|  |  | For the transition period from                      to                                  



Commission File No.
0-30260



eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)



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



624 E. Evelyn
Avenue, Sunnyvale, CA

(Address of principal executive offices)



94086

(Zip Code)



(408) 212-3400

(Registrants telephone number, including area code)



N/A

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



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO ̈



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



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



|                              |  |                              
|----------------------------- |  | -----------------------------
|Class                         |  | Outstanding at March 31, 2004
|Common Stock $0.001 par value |  | 3,692,854                    



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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 March 31, 2004 and June 30, 2003                                   |  | 1   
|         |  |                                                                                                            
|         |  | Condensed Consolidated Statements of Operations for the Three and Nine Months Ended March 31, 2004 and 2003 |  | 2   
|         |  |                                                                                                            
|         |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2004 and 2003           |  | 3   
|         |  |                                                                                                            
|         |  | Notes to Condensed Consolidated Financial Statements                                                        |  | 4   
|         |  |                                                                                                            
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |  | 14  
|         |  |                                                                                                            
|Item 3.  |  | Quantitative and Qualitative Disclosure About Market Risk                                                   |  | 35  
|         |  |                                                                                                            
|Item 4.  |  | Control and Procedures                                                                                      |  | 35  
|         |  |                                                                                                            
|PART II. |  | OTHER INFORMATION                                                                                           |  | 36  
|         |  |                                                                                                            
|Item 1.  |  | Legal Proceedings                                                                                           |  | 36  
|         |  |                                                                                                            
|Item 2.  |  | Changes in Securities                                                                                       |  | 36  
|         |  |                                                                                                            
|Item 3.  |  | Defaults upon Senior Securities                                                                             |  | 36  
|         |  |                                                                                                            
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                         |  | 36  
|         |  |                                                                                                            
|Item 5.  |  | Other Information                                                                                           |  | 36  
|         |  |                                                                                                            
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                            |  | 37  
|         |  |                                                                                                            
|         |  | Signatures                                                                                                  |  | 38  
|         |  |                                                                                                            
|         |  | Certifications                                                                                              |  |     



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##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                                                |  |               |          |   |              |   |          |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                |  | March 31,2004 |          |   | June 30,2003 |  
|                                                                                                                |  | (unaudited)   |          |   |              |  
|ASSETS                                                                                                          |  |               |          |   |              |   |          |  
|Current assets:                                                                                                 |  |               |          |   |              |   |          |  
|Cash and cash equivalents                                                                                       |  | $             | 5,552    |   |              | $ | 4,407    |  
|Restricted cash                                                                                                 |  |               | 12       |   |              |   | 791      |  
|Accounts receivable, net                                                                                        |  |               | 3,393    |   |              |   | 3,270    |  
|Prepaid and other current assets                                                                                |  |               | 2,151    |   |              |   | 2,897    |  
|                                                                                                                |  |               |          |   |              |   |          |  
|Total current assets                                                                                            |  |               | 11,108   |   |              |   | 11,365   |  
|Property and equipment, net                                                                                     |  |               | 450      |   |              |   | 1,192    |  
|Goodwill, net                                                                                                   |  |               | 4,880    |   |              |   | 4,880    |  
|Intangible assets, net                                                                                          |  |               | 289      |   |              |   | 1,204    |  
|Other assets                                                                                                    |  |               | 206      |   |              |   | 397      |  
|                                                                                                                |  |               |          |   |              |   |          |  
|                                                                                                                |  | $             | 16,933   |   |              | $ | 19,038   |  
|                                                                                                                |  |               |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                            |  |               |          |   |              |   |          |  
|                                                                                                                |  |              
|Current liabilities:                                                                                            |  |               |          |   |              |   |          |  
|Accounts payable                                                                                                |  | $             | 1,172    |   |              | $ | 1,486    |  
|Accrued compensation                                                                                            |  |               | 871      |   |              |   | 864      |  
|Accrued liabilities                                                                                             |  |               | 1,491    |   |              |   | 1,918    |  
|Deferred revenue                                                                                                |  |               | 3,881    |   |              |   | 4,333    |  
|Current portion of accrued restructuring                                                                        |  |               | 183      |   |              |   | 1,194    |  
|Current portion of bank borrowings                                                                              |  |               | 821      |   |              |   | 1,649    |  
|Current portion of notes payable                                                                                |  |               |         |   |              |   | 78       |  
|Current portion of capital lease obligations                                                                    |  |               | 13       |   |              |   | 15       |  
|                                                                                                                |  |               |          |   |              |   |          |  
|Total current liabilities                                                                                       |  |               | 8,432    |   |              |   | 11,537   |  
|Related party notes payable                                                                                     |  |               | 6,376    |   |              |   | 1,964    |  
|Capital lease obligations, net of current portion                                                               |  |               |         |   |              |   | 10       |  
|Accrued restructuring, net of current portion                                                                   |  |               | 1,273    |   |              |   | 1,203    |  
|Other long term liabilities                                                                                     |  |               | 243      |   |              |   | 243      |  
|                                                                                                                |  |               |          |   |              |   |          |  
|Total liabilities                                                                                               |  |               | 16,324   |   |              |   | 14,957   |  
|Commitments                                                                                                     |  |               |          |   |              |   |          |  
|                                                                                                                |  |              
|Stockholders equity:                                                                                           |  |               |          |   |              |   |          |  
|Series A cumulative convertible preferred stock; Aggregate liquidation preference of $112,786 at March 31, 2004 |  |               | 106,888  |   |              |   | 101,371  |  
|Common stock                                                                                                    |  |               | 4        |   |              |   | 37       |  
|Additional paid-in capital                                                                                      |  |               | 208,584  |   |              |   | 213,620  |  
|Notes receivable from stockholders                                                                              |  |               | (92      | ) |              |   | (102     | )
|Deferred stock compensation                                                                                     |  |               |         |   |              |   | (38      | )
|Accumulated other comprehensive income (loss)                                                                   |  |               | (239     | ) |              |   | (185     | )
|Accumulated deficit                                                                                             |  |               | (314,536 | ) |              |   | (310,622 | )
|                                                                                                                |  |               |          |   |              |   |          |  
|Total shareholders equity                                                                                      |  |               | 609      |   |              |   | 4,081    |  
|                                                                                                                |  |               |          |   |              |   |          |  
|                                                                                                                |  | $             | 16,933   |   |              | $ | 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 March 31, |        |   | Nine Months Ended March 31, |  
|                                                                                      |  | 2004                         |        |   | 2003                        |   |        | 2004 |  |   | 2003   |  
|Revenue:                                                                              |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|License                                                                               |  | $                            | 1,271  |   |                             | $ | 983    |      |  | $ | 3,315  |   |  | $ | 4,619   |  
|Support and Services                                                                  |  |                              | 3,949  |   |                             |   | 4,240  |      |  |   | 11,568 |   |  |   | 12,098  |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Total revenue                                                                         |  |                              | 5,220  |   |                             |   | 5,223  |      |  |   | 14,883 |   |  |   | 16,717  |  
|Cost of license                                                                       |  |                              | 383    |   |                             |   | 443    |      |  |   | 1,281  |   |  |   | 1,329   |  
|Cost of support and services                                                          |  |                              | 1,686  |   |                             |   | 1,929  |      |  |   | 4,921  |   |  |   | 7,072   |  
|Cost of revenue  acquisition related                                                 |  |                              |       |   |                             |   | 227    |      |  |   |       |   |  |   | 827     |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Gross profit                                                                          |  |                              | 3,151  |   |                             |   | 2,624  |      |  |   | 8,681  |   |  |   | 7,489   |  
|Operating costs and expenses:                                                         |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Research and development                                                              |  |                              | 598    |   |                             |   | 1,381  |      |  |   | 2,323  |   |  |   | 4,695   |  
|Sales and marketing                                                                   |  |                              | 2,167  |   |                             |   | 1,840  |      |  |   | 6,303  |   |  |   | 7,538   |  
|General and administrative                                                            |  |                              | 822    |   |                             |   | 1,007  |      |  |   | 2,670  |   |  |   | 3,670   |  
|Amortization of other intangible assets                                               |  |                              | 302    |   |                             |   | 327    |      |  |   | 914    |   |  |   | 1,001   |  
|Amortization of deferred compensation                                                 |  |                              |       |   |                             |   | 31     |      |  |   |       |   |  |   | 136     |  
|Restructuring                                                                         |  |                              |       |   |                             |   | 512    |      |  |   | 167    |   |  |   | 274     |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Total operating costs and expenses                                                    |  |                              | 3,889  |   |                             |   | 5,098  |      |  |   | 12,377 |   |  |   | 17,314  |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Loss from operations                                                                  |  |                              | (738   | ) |                             |   | (2,474 | )    |  |   | (3,696 | ) |  |   | (9,825  | )
|Non-operating income (expense)                                                        |  |                              | (214   | ) |                             |   | 9      |      |  |   | (218   | ) |  |   | 205     |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                                              |  |                              | (952   | ) |                             |   | (2,465 | )    |  |   | (3,914 | ) |  |   | (9,620  | )
|Dividends on convertible preferred stock                                              |  |                              | (1,867 | ) |                             |   | (1,727 | )    |  |   | (5,517 | ) |  |   | (5,143  | )
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                            |  | $                            | (2,819 | ) |                             | $ | (4,192 | )    |  | $ | (9,431 | ) |  | $ | (14,763 | )
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Per Share information:                                                                |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per common share                                           |  | $                            | (0.76  | ) |                             | $ | (1.14  | )    |  | $ | (2.56  | ) |  | $ | (4.03   | )
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Weighted average shares used in computing basic and diluted net loss per common share |  |                              | 3,692  |   |                             |   | 3,665  |      |  |   | 3,685  |   |  |   | 3,663   |  
|                                                                                      |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  





See accompanying notes



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eGAIN COMMUNICATIONS CORPORATION



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                            |  |                             |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                            |  | Nine Months Ended March 31, |       
|                                                                            |  | 2004                        |        |   | 2003 |  
|Cash flows from operating activities:                                       |  |                             |        |   |      |   |        |  
|Net loss                                                                    |  | $                           | (3,914 | ) |      | $ | (9,620 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                             |        |   |      |   |        |  
|Depreciation                                                                |  |                             | 937    |   |      |   | 3,274  |  
|(Gain) / loss on disposal of fixed assets                                   |  |                             | (9     | ) |      |   | 128    |  
|Amortization of other intangible assets                                     |  |                             | 914    |   |      |   | 1,828  |  
|Amortization of deferred compensation                                       |  |                             |       |   |      |   | 134    |  
|Accrued interest and amortization of discount on related party notes        |  |                             | 329    |   |      |   |       |  
|Changes in operating assets and liabilities:                                |  |                             |        |   |      |   |        |  
|Restricted cash                                                             |  |                             | 779    |   |      |   | (1,088 | )
|Accounts receivable                                                         |  |                             | (123   | ) |      |   | 1,612  |  
|Prepaid and other current assets                                            |  |                             | 746    |   |      |   | 1,235  |  
|Other assets                                                                |  |                             | 191    |   |      |   | 1,447  |  
|Accounts payable                                                            |  |                             | (314   | ) |      |   | (1,547 | )
|Accrued compensation                                                        |  |                             | 7      |   |      |   | (1,669 | )
|Accrued liabilities                                                         |  |                             | (427   | ) |      |   | 94     |  
|Accrued restructuring                                                       |  |                             | (941   | ) |      |   | (2,785 | )
|Deferred revenue                                                            |  |                             | (452   | ) |      |   | (109   | )
|Other long term liabilities                                                 |  |                             |       |   |      |   | 47     |  
|Other                                                                       |  |                             | 1      |   |      |   | (3     | )
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash (used in) operating activities                                     |  |                             | (2,276 | ) |      |   | (7,022 | )
|Cash flows from investing activities:                                       |  |                             |        |   |      |   |        |  
|Proceeds from sale of property and equipment                                |  |                             |       |   |      |   | 236    |  
|Purchases of property and equipment                                         |  |                             | (186   | ) |      |   | (71    | )
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                         |  |                             | (186   | ) |      |   | 165    |  
|Cash flows from financing activities:                                       |  |                             |        |   |      |   |        |  
|Payments on borrowings                                                      |  |                             | (2,503 | ) |      |   | (3,316 | )
|Payments on capital lease obligations                                       |  |                             | (12    | ) |      |   | (414   | )
|Proceeds from borrowings                                                    |  |                             | 1,597  |   |      |   | 2,067  |  
|Proceeds from borrowings from related party                                 |  |                             | 4,500  |   |      |   | 2,000  |  
|Net proceeds from issuance of common stock                                  |  |                             | 79     |   |      |   | 2      |  
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash provided by financing activities                                   |  |                             | 3,661  |   |      |   | 339    |  
|Effect of exchange rate differences on cash                                 |  |                             | (54    | ) |      |   | (140   | )
|                                                                            |  |                             |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                        |  |                             | 1,145  |   |      |   | (6,658 | )
|Cash and cash equivalents at beginning of period                            |  |                             | 4,407  |   |      |   | 9,892  |  
|                                                                            |  |                             |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                  |  | $                           | 5,552  |   |      | $ | 3,234  |  
|                                                                            |  |                             |        |   |      |   |        |  
|Supplemental cash flow disclosures:                                         |  |                             |        |   |      |   |        |  
|Cash paid for interest                                                      |  | $                           | 365    |   |      | $ | 251    |  



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
included 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 March 31, 2004, we have working capital of $2.7 million. We have not achieved profitability and may not be able to realize sufficient revenues to achieve or sustain profitability in the future.
Our working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular, that revenues maintain at the levels achieved in the quarter ended March 31, 2004 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 for the next 12 months but we may need to raise additional 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 stockholder value. These conditions raise 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.



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.



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.



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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 obligations for us 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 typically 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.



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.



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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 March 31, 2004, there was no outstanding
balance of deferred stock compensation. We amortized $0 and $31,000 of deferred compensation in the quarters ended March 31, 2004 and March 31, 2003, respectively. The deferred compensation expense for the nine months ended March 31, 2004 was $0,
compared to $136,000 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 March 31, |        |   | Nine months ended March 31, |  
|                                                                                                 |  | 2004                         |        |   | 2003                        |   |        | 2004 |  |   | 2003   |  
|As Reported:                                                                                     |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                                       |  | $                            | (2,819 | ) |                             | $ | (4,192 | )    |  | $ | (9,431 | ) |  | $ | (14,763 | )
|Basic and diluted net loss per share                                                             |  |                              | (0.76  | ) |                             |   | (1.14  | )    |  |   | (2.56  | ) |  |   | (4.03   | )
|Add: Stock-based employee compensation expense included in reported net loss                     |  |                              |       |   |                             |   | 31     |      |  |   |       |   |  |   | 136     |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method |  |                              | (180   | ) |                             |   | (101   | )    |  |   | (366   | ) |  |   | (257    | )
|Pro Forma:                                                                                       |  |                              |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Net loss applicable to common stockholders                                                       |  | $                            | (2,895 | ) |                             | $ | (4,262 | )    |  | $ | (6,978 | ) |  | $ | (14,884 | )
|Basic and diluted net loss per share                                                             |  |                              | (0.78  | ) |                             |   | (1.16  | )    |  |   | (1.90  | ) |  |   | (4.06   | )



Note 4. Goodwill and Other
Intangible Assets



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



Effective July 1, 2002, we adopted SFAS No. 142 Goodwill and Other Intangible Assets and ceased amortization of goodwill and began reviewing
it annually (or more frequently if impairment indicators arise) for impairment. In addition, we evaluated our remaining purchased intangible assets to determine that all such assets have determinable lives. We operate under a single reporting unit
and accordingly, all of our goodwill is associated with the entire company. Prior to the adoption of SFAS No. 142, we amortized goodwill on a straight-line basis over 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 decline in revenue and reduced stock price, we performed goodwill impairment reviews for the first two quarters of fiscal year 2004 and found no impairment. We did not perform a
goodwill impairment review in the third fiscal quarter of 2004 as we did not identify any unfavorable indicators during the quarter.



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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. During the quarter ended March 31, 2004, 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):



|                                                              |  |               |         |  
|------------------------------------------------------------- |  | ------------- | ------- | -
|                                                              |  | March 31,2004 |        
|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):



|                              |  |                       |       |                         |   |        |                    |  |   |      
|----------------------------- |  | --------------------- | ----- | ----------------------- | - | ------ | ------------------ |  | - | -----
|                              |  | March 31, 2004       
|                              |  | Gross Carrying Amount |       | AccumulatedAmortization |   |        | Net CarryingAmount
|Acquired customer base        |  | $                     | 4,901 |                         | $ | (4,612 | )                  |  | $ | 289  
|Acquired developed technology |  |                       | 3,694 |                         |   | (3,694 | )                  |  |   |     
|                              |  |                       |       |                         |   |        |                    |  |   |      
|Total                         |  | $                     | 8,595 |                         | $ | (8,306 | )                  |  | $ | 289  
|                              |  |                       |       |                         |   |        |                    |  |   |      
|                              | 
|                              |  | 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 $302,000 during the quarter ended March 31, 2004. The remaining net carrying amount of $289,000 will be fully amortized by the end of fiscal 2004.



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.



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



|                                                                                      |  |                             |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | --------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                      |  | Three MonthsEnded March 31, |        |   | Nine Months Ended March 31, |  
|                                                                                      |  | 2004                        |        |   | 2003                        |   |        | 2004 |  |   | 2003   |  
|Net loss applicable to common stockholders                                            |  | $                           | (2,819 | ) |                             | $ | (4,192 | )    |  | $ | (9,431 | ) |  | $ | (14,763 | )
|Basic and diluted:                                                                    |  |                             |        |   |                             |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average shares outstanding                                                   |  |                             | 3,692  |   |                             |   | 3,665  |      |  |   | 3,685  |   |  |   | 3,666   |  
|Less weighted-average shares subject to repurchase                                    |  |                             |       |   |                             |   |       |      |  |   |       |   |  |   | (3      | )
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                             | 3,692  |   |                             |   | 3,664  |      |  |   | 3,685  |   |  |   | 3,663   |  
|Basic and diluted net loss per common share                                           |  | $                           | (0.76  | ) |                             | $ | (1.14  | )    |  | $ | (2.56  | ) |  | $ | (4.03   | )



Outstanding options
and warrants to purchase 1,233,291, and 812,837 shares of common stock at March 31, 2004 and 2003, respectively, and convertible preferred stock convertible into 1,983,047 and 1,855,339 shares of common stock at March 31, 2004 and 2003,
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 its 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 $925,000 and $2.5 million for the quarters ended March 31, 2004 and 2003, respectively. Comprehensive loss was $4.0 million and $9.8 million for the nine months ended March 31, 2004 and 2003, respectively.
Accumulated other comprehensive loss presented in the accompanying consolidated balance sheets at March 31, 2004 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.



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



|                         |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|------------------------ |  | ---------------------------- | ----- | - | --------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                         |  | Three months ended March 31, |       |   | Nine months ended March 31, |  
|                         |  | 2004                         |       |   | 2003                        |   |        | 2004 |  |   | 2003   |  
|Total Revenue:           |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|North America            |  | $                            | 2,789 |   |                             | $ | 2,360  |      |  | $ | 7,732  |   |  | $ | 8,094  |  
|Europe                   |  |                              | 2,244 |   |                             |   | 2,660  |      |  |   | 6,700  |   |  |   | 7,713  |  
|Asia Pacific             |  |                              | 187   |   |                             |   | 203    |      |  |   | 451    |   |  |   | 910    |  
|                         |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|                         |  | $                            | 5,220 |   |                             | $ | 5,223  |      |  | $ | 14,883 |   |  | $ | 16,717 |  
|                         |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|Operating Income (Loss): |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|North America            |  | $                            | (524  | ) |                             | $ | (2,267 | )    |  | $ | (3,000 | ) |  | $ | (8,105 | )
|Europe                   |  |                              | 238   |   |                             |   | 340    |      |  |   | 780    |   |  |   | 260    |  
|Asia Pacific             |  |                              | 54    |   |                             |   | 46     |      |  |   | 70     |   |  |   | (230   | )
|India                    |  |                              | (506  | ) |                             |   | (593   | )    |  |   | (1,546 | ) |  |   | (1,750 | )
|                         |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  
|                         |  | $                            | (738  | ) |                             | $ | (2,474 | )    |  | $ | (3,696 | ) |  | $ | (9,825 | )
|                         |  |                              |       |   |                             |   |        |      |  |   |        |   |  |   |        |  



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



|              |  |           |        |          |   |       
|------------- |  | --------- | ------ | -------- | - | ------
|              |  | March 31, |        | June 30,
|              |  | 2004      |        | 2003    
|North America |  | $         | 7,692  |          | $ | 8,237 
|Europe        |  |           | 2,925  |          |   | 3,716 
|Asia Pacific  |  |           | 512    |          |   | 550   
|India         |  |           | 635    |          |   | 451   
|              |  |           |        |          |   |       
|              |  | $         | 11,764 |          | $ | 12,954
|              |  |           |        |          |   |       



During the three
months ended March 31, 2004 and 2003, no single customer accounted for more than 10% of our total revenue.



Note 8. Related Party Notes Payable



On March 31, 2004, we entered into a Note and Warrant Purchase Agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P.
(the lenders) pursuant to which the lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common stock in connection with such loan. The secured promissory notes have a
term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time subject to the prepayment penalties set forth in such notes. The warrants
allow the lenders to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price of $2.00. The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrants and the remaining
50% of the warrants become exercisable on the first anniversary of the issuance of the warrants. We recorded $2.28 million in related party notes payable and $223,000 of discount on the notes related to the relative value of the warrants issued in
the transaction that will be amortized to interest expense over the five year life of the notes. The fair value of these warrants 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 December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the 2002 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 2002 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



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amount loaned at an exercise price equal to 110% of the fair market value of our common stock (based on a five days
trailing closing price average at the time of each loan). The warrants issued in connection with the initial advance became fully exercisable on December 31, 2003. An initial advance of $2.0 million under the 2002 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 relative 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 warrants 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 2002 Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the 2002 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 2002 Purchase Agreement and 3) any additional warrants issued under the 2002
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 $1.8 million in related party notes payable
and $195,000 of discount on the notes related to the relative 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 warrants 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 March 31, 2004, the outstanding balance of related party notes payable
of $6.50 million was net of $531,000 of unamortized discount and included accrued interest of $407,000 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 was reduced by scheduled amortization payments on the term loan until the term loan was paid in full on February 27, 2004. 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 March 31,
2004, the outstanding balance under the AR Facility was $821,397, collateralized by $1,026,747 of receivables.



Note 10. Restructuring



During the quarter ended March 31, 2004, there was no restructuring charge recorded. The total payments of $555,000 for the quarter ended March 31, 2004, consisted of $14,000, $480,000 and $61,000 of expenses accrued in fiscal year 2003,
2002 and 2001, respectively.



In 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 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



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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, 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.



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



|                                       |  |               |  |             |     |                 |   |      |                    |  |   |   
|-------------------------------------- |  | ------------- |  | ----------- | --- | --------------- | - | ---- | ------------------ |  | - | --
|                                       |  | Cash/Non-cash |  | FY04Charges |     | AmountPaid/Used |   |      | Balance at03/31/04
|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 $222,000 was made for the excess facilities for the nine months ended March 31, 2004 and resulted in an unpaid balance of
$162,000.



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



|                                       |  |               |  |             |       |                 |   |        |                    |  |   |    
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------ |  | - | ---
|                                       |  | Cash/Non-cash |  | FY03Charges |       | AmountPaid/Used |   |        | Balance at03/31/04
|Excess facilities                      |  | Cash          |  | $           | 997   |                 | $ | (835   | )                  |  | $ | 162
|Employee severance                     |  | Cash          |  |             | 1,222 |                 |   | (1,222 | )                  |  |   |   
|Professional and miscellaneous charges |  | Cash          |  |             | 61    |                 |   | (61    | )                  |  |   |   
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |    
|Total restructuring charges            |  |               |  | $           | 2,280 |                 | $ | (2,118 | )                  |  | $ | 162
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |    



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 the $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 of 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



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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 nine months ended March 31, 2004, a payment of $673,000 was made for the excess facilities and resulted in an unpaid balance of $1.2 million. The unpaid balance is the
accrual of the potential contingent payments related to two lease settlements that are excluded from the calculation of contractual obligations of our operating leases. These contingent payments will be made in the event we make a distribution of
cash, stock or other consideration to our holders of our Series A Preferred with respect to the shares of Series A Preferred held by such Series A Preferred holders. If not sooner, this will occur on August 5, 2005.



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



|                                       |  |               |  |             |       |                 |   |        |                    |  |   |                    |   |  |   |      
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------ |  | - | ------------------ | - |  | - | -----
|                                       |  | Cash/Non-cash |  | FY02Charges |       | AmountPaid/Used |   |        | Adjustment In FY03 |  |   | Balance at03/31/04
|Excess facilities                      |  | Cash          |  | $           | 6,412 |                 | $ | (3,504 | )                  |  | $ | (1,660             | ) |  | $ | 1,248
|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 |                 | $ | (6,056 | )                  |  | $ | (1,660             | ) |  | $ | 1,248
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |                    |   |  |   |      



In fiscal 2001, we
recorded restructuring charges totaling $1.4 million. These charges primarily related to a reduction in our worldwide workforce of 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 nine months ended March 31, 2004, the total payment was $92,000, including $40,000 of professional expense and $52,000 settlement fee with terminated
employees. There was no unpaid balance as of March 31, 2004.



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



|                                       |  |               |  |             |       |                 |   |        |                    |  |   |  
|-------------------------------------- |  | ------------- |  | ----------- | ----- | --------------- | - | ------ | ------------------ |  | - | -
|                                       |  | Cash/Non-cash |  | FY01Charges |       | AmountPaid/Used |   |        | Balance at03/31/04
|Excess facilities                      |  | Cash          |  | $           | 263   |                 | $ | (263   | )                  |  | $ | 
|Employee severance                     |  | Cash          |  |             | 917   |                 |   | (917   | )                  |  |   | 
|Professional and miscellaneous charges |  | Cash          |  |             | 263   |                 |   | (263   | )                  |  |   | 
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |  
|Total restructuring charges            |  |               |  | $           | 1,443 |                 | $ | (1,443 | )                  |  | $ | 
|                                       |  |               |  |             |       |                 |   |        |                    |  |   |  



Note 11. Other income and expense



During the quarter ended March 31, 2004, included in
non-operating income we recorded other income of $28,000 compared to $340,000 in the prior quarter. The total primarily consisted of a $15,000 insurance reimbursement for settlement of a lawsuit and a $19,000 refund for an overpayment of a capital
equipment lease.



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.



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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, and as of March 31, 2004, there was no reserve, however we cannot guarantee
that a warranty reserve will not become necessary in the future.



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 alleged 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 was settled and resolved with no cash payments and the execution of a cross-licensing agreement between the parties.



On February 26, 2003, Golden Gate Plaza, LLC filed a complaint for unlawful detainer against us. On December 23, 2003 we entered into a settlement
agreement (see Notes to Condensed Consolidated Financial Statements, Note 10: Restructuring) with the Plaintiff to resolve the case. A Request for Dismissal was entered by the court on January 12, 2004 and the settlement was later approved.



On February 12, 2004, we filed suit against Insight
Enterprises, Inc., the acquirer of Comark, Inc., a value-added reseller of our software, claiming inter alia breach of contract and failure to pay in connection with a sale of our software to one customer. The lawsuit seeks in excess of
$600,000 in damages.



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.



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



This report on Form 1O-Q and the documents incorporated herein by reference contain forward-looking statements that involve risks and uncertainties.
These statements may be identified by the use of the words such as anticipates, believes, continue, could, would, estimates, forecasts, expects,
intends, may, might, plans, potential, predicts, should, or will and similar expressions or the negative of those terms. The forward-looking statements
include, but are not limited to, risks stemming from strategic and operational choices in recent quarters, failure to improve our sales results and grow revenue, failure to compete successfully in the markets in which we do business, our continued
net losses since inception, our limited operating history, our equity structure and the significant risk of dilution, the adequacy of our capital resources and need for additional financing, liquidation preferences related to our preferred stock,
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



On March 31, 2004, we entered into a Note and Warrant Purchase Agreement with Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P.,
Oak Hill Capital Management Partners L.P., and FW Investors L.P. (the lenders) pursuant to which the lenders loaned to us $2.5 million evidenced by secured promissory notes and received warrants to purchase shares of our common stock in
connection with such loan. The secured promissory notes have a term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity of such notes. We have the option to prepay the notes at any time subject to the
prepayment penalties set forth in such notes. The warrants allow the lenders to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise price of $2.00. The warrants become exercisable as to 50% of the warrant shares
nine months after issuance of the warrants and the remaining 50% of the warrants become exercisable on the first anniversary of the issuance of the warrants. We recorded $2.28 million in related party notes payable and $223,000 of discount on the
notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the notes. The fair value of these warrants 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%.



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In February 2004, we were delisted from the Nasdaq SmallCap Market due to noncompliance with Marketplace
Rule 4310(c)(2)(B), which requires companies listed 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. Our common stock now trades in the over-the-counter market 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.



On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the 2002 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 2002 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 days trailing closing price average at the time of
each loan). The warrants issued in connection with the initial advance became fully exercisable on December 31, 2003. An initial advance of $2.0 million under the 2002 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 relative 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
warrants 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 2002 Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the 2002 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 2002 Purchase Agreement and 3) any additional warrants issued under the 2002 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 $1.8 million in related party notes payable and $195,000 of discount on the notes related
to the relative 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 warrants 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.



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



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



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



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



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



When licenses are sold together with consulting and implementation services, license fees are recognized upon shipment, provided that (1) the above criteria have been met, (2) payment of the license fees is not
dependent upon the performance of the consulting and implementation services, and (3) the services are not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and
services revenues are recognized in accordance with the provisions of SOP 81-1, 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
by 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.



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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 March 31, 2004 indicated no impairment was needed.



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



Restructuring



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



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:



|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   
|--------------------------------------- |  | --------------------- | -- |  | -------------------- | -- |  | ---- | -- |  | ---- | --
|                                        |  | ThreeMonths March 31, |    |  | NineMonths March 31, |   
|                                        |  | 2004                  |    |  | 2003                 |    |  | 2004 |    |  | 2003 |   
|Revenue:                                |  |                       |    |  |                      |    |  |      |    |  |      |   
|License                                 |  | 24                    | %  |  | 19                   | %  |  | 22   | %  |  | 28   | % 
|Support and Services                    |  | 76                    | %  |  | 81                   | %  |  | 78   | %  |  | 72   | % 
|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   
|Total revenue                           |  | 100                   | %  |  | 100                  | %  |  | 100  | %  |  | 100  | % 
|Cost of license                         |  | 8                     | %  |  | 8                    | %  |  | 9    | %  |  | 8    | % 
|Cost of support and services            |  | 32                    | %  |  | 37                   | %  |  | 33   | %  |  | 42   | % 
|Cost of revenueacquisition related     |  | 0                     | %  |  | 5                    | %  |  | 0    | %  |  | 5    | % 
|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   
|Gross profit                            |  | 60                    | %  |  | 50                   | %  |  | 58   | %  |  | 45   | % 
|Operating costs and expenses:           |  |                       |    |  |                      |    |  |      |    |  |      |   
|Research and development                |  | 11                    | %  |  | 26                   | %  |  | 16   | %  |  | 28   | % 
|Sales and marketing                     |  | 41                    | %  |  | 35                   | %  |  | 42   | %  |  | 45   | % 
|General and administrative              |  | 16                    | %  |  | 19                   | %  |  | 18   | %  |  | 22   | % 
|Amortization of other intangible assets |  | 6                     | %  |  | 6                    | %  |  | 6    | %  |  | 6    | % 
|Amortization of deferred compensation   |  | 0                     | %  |  | 1                    | %  |  | 0    | %  |  | 1    | % 
|Restructuring                           |  | 0                     | %  |  | 10                   | %  |  | 1    | %  |  | 2    | % 
|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   
|Total operating costs and expenses      |  | 74                    | %  |  | 97                   | %  |  | 83   | %  |  | 104  | % 
|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   
|Loss from operations                    |  | (14                   | %) |  | (47                  | %) |  | (25  | %) |  | (59  | %)
|                                        |  |                       |    |  |                      |    |  |      |    |  |      |   



Total revenue was $5.2
million in the quarter ended March 31, 2004 unchanged from the quarter ended March 31, 2003. Total revenue for the nine months ended March 31, 2004 decreased 11% to $14.9 million, compared to $16.7 million in the same period last year. This decrease
was primarily due to a decline in licensed customer orders in our international markets. During the quarters ended March 31, 2004 and 2003, no single customer accounted for more than 10% of total revenue.



License revenue increased 29% to $1.3 million in the quarter ended March 31,
2004 from $983,000 in the quarter ended March 31, 2004. This increase was primarily due to increased license customer orders of eGain Service 6 in North America. License revenue for the nine months ended March 31, 2004 decreased 28% to $3.3 million,
compared to $4.6 million in the same period last year. For the nine months ended March 31, 2004, license revenue from our international markets declined approximately 53% and increased approximately 13% for our North American customers. We believe
the decline in licensed customer orders in our international markets resulted from lengthened sales cycles caused by increased customer due diligence, while the increase in North America business was partially due to improved macroeconomic
conditions and the results of rebuilding the North America sales force that began in the second half of fiscal 2003. License revenue represented 24% and 19% of total revenue for the quarters ended March 31, 2004 and 2003, respectively.



Support and services revenue decreased 7% to $3.9 million in the quarter
ended March 31, 2004 from $4.2 million in the quarter ended March 31, 2003. Support and services for the nine months ended March 31, 2004 decreased 4% to $11.6 million, compared to $12.1 million in the same period last year. The decrease was due in
part from the decline in license revenues. Services and support revenue represented 76% and 81% of total revenue for the quarters ended March 31, 2004 and 2003, respectively.



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Operating Costs and Expenses Overview



Total operating costs and expenses decreased 24% to $3.9 million in the quarter ended March 31, 2004 from $5.1 million in
the quarter ended March 31, 2003. The decrease was primarily due to the reduction in restructuring and depreciation expenses. Total operating costs and expenses for the nine months ended March 31, 2004 decreased 29% to $12.4 million, compared to
$17.3 million in the same period last year. This reduction has been due primarily to the adoption of our ongoing expense management strategy, whereby we have reduced our worldwide workforce by 208 employees across all departments over the last 24
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 primarily includes the amortization of prepaid third-party software royalties and delivery costs for shipments to customers. Cost of license decreased 14% to $383,000 in the quarter ended March 31, 2004, compared to the quarter ended
March 31, 2004. Cost of license was $1.3 million for the nine months ended March 31, 2004 and 2003. The decrease was primarily due to the extension of one of the royalty agreements that resulted in a reduction in the amortization of prepaid
royalties. We expect this to continue to decline in future periods with the expiration or renewal of other 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 13% to $1.7 million in the quarter ended March 31, 2004 from $1.9
million in the quarter ended March 31, 2003. Cost of support and services for the nine months ended March 31, 2004 decreased 30% to $4.9 million, compared to $7.1 million in the same period last year. The 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 support and services 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 nine months ended March 31, 2003 were $227,000 and $827,000, 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 57% to $598,000 in the quarter ended March 31, 2004 from $1.4 million in the quarter ended March 31, 2003. Research and development expenses for the nine months ended March 31, 2004 decreased 51% to $2.3 million, compared to $4.7
million in the same period last year. The decrease was primarily due to the significant headcount reduction of 77 over the last 24 months, a decline in outside contractor



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services, the migration of 23 development resources to eGain India and an internal transfer of 7 employees. Our occupancy
costs and related overhead were also reduced due to the consolidation of excess facilities, the asset write-offs related to the reduction of work force and the closure of offices. Based upon current revenue expectations, we do not anticipate a
significant increase or decrease in research development in future periods.



Sales and Marketing



Sales and marketing
expenses primarily consist of compensation and benefits of our sales, marketing and business development personnel, advertising, trade show and other promotional costs and, to a lesser extent, occupancy costs and related overhead. Sales and
marketing expenses increased 18% to $2.2 million in the quarter ended March 31, 2004 from $1.8 million in the quarter ended March 31, 2003. This was primarily due to the increase in personnel related variable expenses and marketing spending. Sales
and marketing expenses for the nine months ended March 31, 2004 decreased 16% to $6.3 million, compared to $7.5 million in the same period last year. The nine months decrease was primarily due a reduction in 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 anticipate a slight increase 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 18% to $822,000 in the quarter ended March 31, 2004 from $1.0 million in the quarter ended March 31, 2003. The decrease was primarily due to the reduction in professional services fees related to the change in accounting firm,
reduced depreciation expense due to assets being fully depreciated and the discontinuance of certain software maintenance contracts. General and administrative expense for the nine months ended March 31, 2004 decreased 27% to $2.7 million, compared
to $3.7 million in the same period last year. The decrease was primarily due to a decline in headcount by 27 over the last 24 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 $302,000 during the quarter ended March 31, 2004 down from $327,000 during the quarter ended March 31, 2003. Amortization of other intangible assets for the nine
months ended March 31, 2004 decreased to $914,000, compared to $1.0 million in the same period last year. This decrease was primarily due to the acquired developed technology and customer base being fully amortized as of March 31, 2003 and February
29, 2004, respectively.



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 decline in revenue and
reduced stock price, we performed goodwill impairment reviews for the first two quarters of fiscal year 2004 and found no impairment. We did not perform a goodwill impairment review in the third fiscal quarter of 2004 as we did not identify any
unfavorable indicators during 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 nine months ended March 31, 2004,
we did not have any such losses.



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Valuation and Amortization of Stock-Based Compensation



Stock-based compensation is recorded in connection with grants of stock
options to employees on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options. Stock-based compensation is amortized on a graded vesting method over the vesting period of the
individual grants. In addition, we record compensation expense in connection with grants of stock options to non-employees pursuant to Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS 123). These grants are periodically revalued as they vest in accordance with SFAS 123 and EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services. We recorded amortization of deferred compensation of $0 and $31,000 in the quarters ended March 31, 2004 and 2003, respectively.



Restructuring Expense



Restructuring expenses was $0 for the quarter ended March 31, 2004 compared to $512,000 in the quarter ended March 31, 2003. Restructuring expense for the
nine months ended March 31, 2004 was $167,000, compared to $274,000 in the same period last year. Restructuring expense for the 9 months ended March 31, 2003 included a restructuring benefit of $1.3 million recorded in the quarter ended December
2002 related to a settlement to terminate a lease agreement of one of our facilities in North America. We do not anticipate a significant increase in restructuring expense in future periods.



Non-operating Income (expense)



Non-operating expense was $214,000 in the quarter ended March 31, 2004,
compared to non-operating income of $9,000 in the quarter ended March 31, 2003. The expense in the quarter ended March 31, 2004 primarily consisted of the interest expense for the related party notes payable and foreign exchange transaction loss.
Non-operating expense for the nine months ended March 31, 2004 was $218,000, compared to non-operating income of $205,000 in the same period last year. The non-operating income of $205,000 in the nine months ended March 31, 2003 included a gain
related to a real estate settlement of $360,000. The non-operating expense in the nine months ended March 31, 2004 primarily consisted of interest expense of 365,000 and tax expense of $69,000 which was partially offset by the 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.



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 $2.3 million in the nine months ended March 31, 2004 from $7.0 million in the nine months ended March 31, 2003.



As of March 31, 2004, we have working capital of $2.7 million, compared to a negative working capital of $1.4 million at September 30, 2003. 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 March 31, 2004 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 for the next 12 months but we may need to raise additional 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 stockholders 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 March 31, 2004 the accretion of the convertible preferred
shares totaled $1.9 million. The cumulative accretion through March 31, 2004 totals $24.3 million.



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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 was reduced by scheduled amortization payments on the term loan until the term loan was paid in full on February 27, 2004. 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 March 31, 2004, the outstanding balance under the AR Facility was $821,397, collateralized by $1,026,747 of receivables.



On December 24, 2002, we entered into a Note and Warrant Purchase Agreement (the 2002 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 2002 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 days trailing closing price average at the time of each loan). The warrants issued in connection with the initial advance became fully exercisable on December 31, 2003. An initial advance of $2.0 million under the 2002 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 relative 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 warrants 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 2002 Purchase Agreement with Mr. Roy, pursuant to which: 1) Mr. Roy provided an additional $2.0 million loan under the 2002 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 2002 Purchase Agreement and 3) any additional warrants issued under
the 2002 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 $1.8 million in related party notes
payable and $195,000 of discount on the notes related to the relative 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 warrants 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 March 31, 2004, we entered into a Note and Warrant Purchase Agreement with
Ashutosh Roy, our Chief Executive Officer, Oak Hill Capital Partners L.P., Oak Hill Capital Management Partners L.P., and FW Investors L.P. (the lenders) pursuant to which the lenders loaned to us $2.5 million evidenced by secured
promissory notes and received warrants to purchase shares of our common stock in connection with such loan. The secured promissory notes have a term of five years and bear interest at an effective annual rate of 12% due and payable upon the maturity
of such notes. We have the option to prepay the notes at any time subject to the prepayment penalties set forth in such notes. The warrants allow the lenders to purchase a number of shares of up to 25% of the aggregate amount loaned at an exercise
price of $2.00. The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrants and the remaining 50% of the warrants become exercisable on the first anniversary of the issuance of the warrants. We recorded
$2.28 million in related party notes payable and $223,000 of discount on the notes related to the relative value of the warrants issued in the transaction that will be amortized to interest expense over the five year life of the notes. The fair
value of these warrants 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%.



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On March 31, 2004, cash and cash equivalents were $5.6 million, compared to $4.4 million at June 30,
2003. As of March 31, 2004 we had working capital of $2.7 million, compared to negative working capital of $172,000 as of June 30, 2003. In addition to the $5.6 million in cash and cash equivalents, we had $12,000 and $1.1 million in restricted cash
as of March 31, 2004 and 2003, respectively.



Net cash used in
operating activities was $2.3 million and $7.0 million in the nine months ended March 31, 2004 and 2003, 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 $186,000 in the nine months ended March 31,
2004 and net cash provided from investing was $165,000 in the nine month ended March 31, 2003. Cash used in investing activities was primarily due to equipment purchases. Cash provided from investing in the nine months ended March 31, 2003 was
related to a settlement from a previous purchase of property and equipment.



Net cash provided from financing activities was $3.7 million and $339,000 in the nine months ended March 31, 2004 and 2003, respectively. Cash provided from financing activities was primarily due to the proceeds from
the related party notes, bank borrowings and the issuance of common stock, partially offset by the payments on bank borrowings and capital leases, accrued interest and amortization of discount on related party notes.



The following table summarizes eGains contractual obligations as of
March 31, 2004 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             |  | $                   | 4     |      | $ | 9    |  | $    |    |      | $ |           |  | $     |      |  | $ |      |  | $ | 13    
|Operating leases           |  |                     | 243   |      |   | 885  |  |      | 840 |      |   | 746        |  |       | 760   |  |   | 745   |  |   | 4,219 
|Bank borrowings            |  |                     | 821   |      |   |     |  |      |    |      |   |           |  |       |      |  |   |      |  |   | 821   
|Related Party Note Payable |  |                     |      |      |   |     |  |      |    |      |   |           |  |       | 2,000 |  |   | 4,500 |  |   | 6,500 
|                           |  |                     |       |      |   |      |  |      |     |      |   |            |  |       |       |  |   |       |  |   |       
|Total                      |  |                     | 1,068 |      |   | 894  |  |      | 840 |      |   | 746        |  |       | 2,760 |  |   | 5,245 |  |   | 11,553
|                           |  |                     |       |      |   |      |  |      |     |      |   |            |  |       |       |  |   |       |  |   |       



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 $952,000 during
the quarter ended March 31, 2004. As of March 31, 2004, we had an accumulated deficit of approximately $314.5 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.



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 in the
past experienced significant turnover of our North America sales force. Expansion and growth of our business is very much dependant on our ability to develop a productive North America sales force. If we do not effectively develop and train our
sales force, and see successful results from such sales force in light of our investment of resources, we may not be able to achieve profitability, our results from operations will suffer 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 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.



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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 our 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, leaves little room for error in the forecasting and achievement of revenue goals.



While we have achieved significant cost savings through such measures, we will be unable to quickly reverse the course of
such actions and the initial costs associated with such restructuring may be lost if the infrastructure changes do not enhance 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 our company, properly serve
customers or successfully achieve sales goals. Finally, a failure to meet our 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.



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



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



* demand for our software and budget and spending decisions by
information technology departments of our customers;



*
seasonal trends in technology purchases;



* 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;



* litigation relating to our intellectual proprietary rights; and



* budget, purchasing and payment cycles, timing and revenue recognition of customer contracts and potential customer contracts.



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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.



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 $2.3 million in the nine months ended March 31, 2004 from $7.0 million in the nine months ended March 31,
2003.



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 for the next 12 months but we may need to raise additional 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 stockholders.



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 an aggregate of 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 March 31, 2004 the Series A shares would be convertible into 2.0
million additional shares of common stock. We currently have only 3.7 million shares of common stock issued and outstanding.



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 certain terms and conditions of the redemption of the preferred stock prior to August 8, 2005. Regardless of the timing or success of any such resolution, the result of
any such conversion would nonetheless also cause significant dilution to the holders of the common stock. We can make no assurances as to when the renegotiation of certain terms of our Series A shares will occur, if at all.



Our preferred stock carries a substantial liquidation preference



In the event of our liquidation, dissolution or winding up, 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



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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 us, 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, consideration, available to our common stock holders.



Our common stock
has been delisted and thus the price and liquidity of our common stock has been affected and our ability to obtain future equity financing may be further impaired



In February 2004, we were delisted from the Nasdaq SmallCap Market due to noncompliance with Marketplace Rule 4310(c)(2)(B),
which requires companies listed 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.



Our common
stock now trades in the over-the-counter market 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 OTC Bulletin Board is generally considered less efficient than the Nasdaq SmallCap Market. Consequently, selling our common stock is likely 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.



Our listing on the OTC Bulletin Board, or further declines in
our stock price, may greatly impair our ability to raise additional necessary capital through equity or debt financing, and significantly increase the dilution to our current stockholders caused by any issuance of equity in financing or other
transactions. The price at which we would issue shares in such transactions is generally based on the market price of our common stock and a decline in the stock price could result in our need to issue a greater number of shares to raise a given
amount of funding.



In addition, as our common stock is not
listed on a principal national exchange, we are 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, general weakness
in the global securities markets, recessionary corporate spending levels and the protracted slump



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in technology spending specifically, has caused our average sales cycle to further increase and, in some cases, has
prevented deals from closing that we believed were likely to close. Consequently, we may miss our revenue forecasts and may incur expenses that are not offset by corresponding revenue.



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



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



We may experience a 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



Spending on technology solutions by corporations and government enterprises has been markedly slow to rebound and the industry continues to be mired in an
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 a 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



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will seek to have their eService applications hosted by us. If any of these assumptions is incorrect, our business will
be seriously harmed and our stock price will decline.



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



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



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



To streamline operations and better align
operating costs and expenses with revenue trends, we have restructured our organization several times in recent years. The result has been substantial reductions in our workforce over time and reductions in our employees salaries numerous
times since the quarter ended December 31, 2001. Such reductions in workforce and salary levels may continue to affect 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. In particular, increased levels of attrition in the Indian workforce on which we
deeply rely for research and development and where we have moved significant resources in recent years would have significant effects on the company and its 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.



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Our international operations involve various risks



We derived 47% of our revenues from international sales in the quarter ended March 31, 2004 compared to 55% in the quarter
ended March 31, 2003. 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 have a significant impact on our product development, customer support or 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.



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, our customers 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.



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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 issues associated with our initial public offering of common stock, breach of contract, and litigation associated with the termination of employees.



From time to time, parties have also asserted or threatened, and may continue to do so, infringement claims. Because the
contents of patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products. In particular, intellectual property litigation is expensive and
time-consuming and could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all, in the event of a
successful claim of infringement. Our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.



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



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



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



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



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software defects that affect our new or current services or enhancements until after they are deployed. It is possible
that, despite testing by us, defects may occur in the software and we can give no assurance that our products and services will not experience such defects in the future. Furthermore, our customers generally use our products together with products
from other companies. As a result, when problems occur in the integration or network, it may be difficult to identify the source of the problem. Even when our products do not cause these problems, these problems may cause us to incur significant
warranty and repair costs, divert the attention of our engineering personnel from product development efforts and cause significant customer relations problems. These defects or problems could result in damage to our reputation, lost sales, product
liability claims, delays in or loss of market acceptance of our products, product returns and unexpected expenses, and diversion of resources to remedy errors.



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



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



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



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



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



| |  |  | the thinly traded nature of our stock on the OTC Bulletin Board;
| | - |  | ----------------------------------------------------------------



| |  |  | concerns related to liquidity of our stock, 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 stock 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 our stock price precipitously drops in the future, we may become involved in this type of
litigation. Litigation of this kind, or involving intellectual property rights, is often expensive and diverts managements attention and resources, which could continue to harm our business and operating results.



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



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



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



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



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



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



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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 our growth or decrease demand for our services or increase our cost of doing business



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



In addition, the applicability of laws and regulations directly applicable to the businesses of our customers, particularly customers in the fields of financial services, will continue to 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 the application of existing laws to our business could burden our company and those with which we do business. Further, the adoption of additional laws and regulations
could limit the growth of our business and that of our business partners and customers. Any decreased generalized demand for our services, or the loss of or decrease, in business, by a key partner due to regulation or the expense of compliance with
any regulation, could either increase the costs associated with our business or affect revenue, either of which could harm our financial condition or operating results.



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



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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.



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 alleged 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 was settled and resolved with no cash payments and the
execution of a cross-licensing agreement between the parties.



On February 26, 2003, Golden Gate Plaza, LLC filed a complaint for unlawful detainer against us. On December 23, 2003 we entered into a settlement agreement (see Notes to Condensed Consolidated Financial Statements, Note 10: Restructuring)
with the Plaintiff to resolve the case. A Request for Dismissal was entered by the court on January 12, 2004 and the settlement was later approved.



On February 12, 2004, we filed suit against Insight Enterprises, Inc., the acquirer of Comark, Inc., a value-added reseller of our software, claiming
inter alia breach of contract and failure to pay in connection with a sale of our software to one customer. The lawsuit seeks in excess of $600,000 in damages.



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                                                                                                                                         
|    |  |                                                                                    
|    |  | 31.1                                                                                |  | Rule 13a-15d(e)/15d-15(e) Certification of Chief Executive Officer.                                                                                             
|    |  |                                                                                    
|    |  | 31.2                                                                                |  | Rule 13a-15d(e)/15d-15(e) 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 three reports on Form 8-K for the quarter ended March 31, 2004 as follows:
|    |  |                                                                                    
|    |  | Date                                                                                |  | Item Reported on                                                                                                                                                
|    |  |                                                                                    
|    |  | May 6, 2004                                                                         |  | Press release filed announcing quarter ended May 6, 2004 results of operations and financial condition.                                                         
|    |  |                                                                                    
|    |  | March 25, 2004                                                                      |  | Change in Registrants certified accountants effective as of March 31, 2004                                                                                     
|    |  |                                                                                    
|    |  | March 31, 2004                                                                      |  | Completion of financing in which Registrant entered in to Note and Warrant Purchase Agreement with certain purchasers dated as of March 31, 2004                



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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: May 14, 2004 |  |  |  | eGAIN COMMUNICATIONS CORPORATION
|                    |  |  |  |                                 
|                    |  |  |  |                                  |  | By |  | /s/ Eric N. Smit                                                                                             
|                    |  |  |  |                                  |  |    |  | Eric N. Smit Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)



38