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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For
the fiscal year ended: December 31, 2003



Commission
File Number: 0-26273



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PRIMUS KNOWLEDGE SOLUTIONS, INC.

(Exact name of Registrant as specified in its charter)



|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Washington                                                     |  | 91-1350484                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)



1601 Fifth Avenue,
Suite 1900

Seattle, WA 98101

(Address of principal executive offices, including zip code)



(206) 834-8100

(Registrants telephone number, including area code)



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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock $0.025 par
value per share



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



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



The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of the common stock on the last business day of the second fiscal quarter, June 30, 2003, as reported on Nasdaq National Market System was approximately $15.8 million. Shares of common stock held by each
executive officer and director and by each person who owned 5% or more of the outstanding common stock as of such date have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily
a conclusive determination for other purposes.



The number of
shares of the registrants common stock outstanding on March 18, 2004, was 23,676,884.



DOCUMENTS INCORPORATED BY REFERENCE



The information required by a portion of Item 10 and Items 11 and 12 of Part III of this report is incorporated by reference from the registrants definitive proxy statement, relating to the Annual Meeting of
Shareholders to be held in June 2004, which definitive proxy statement shall be filed not later than 120 days after the end of the fiscal year to which this report relates.

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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC.

FORM 10-K

TABLE OF CONTENTS



|     |  |                                                                                                |  |     
|---- |  | ---------------------------------------------------------------------------------------------- |  | ----
|Item |  |                                                                                                |  | Page
|     |  | PART I                                                                                         |  |     
|     |  |                                                                                               
|1.   |  | BUSINESS                                                                                       |  | 3   
|     |  |                                                                                               
|2.   |  | PROPERTIES                                                                                     |  | 28  
|     |  |                                                                                               
|3.   |  | LEGAL PROCEEDINGS                                                                              |  | 29  
|     |  |                                                                                               
|4.   |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                            |  | 29  
|     |  |                                                                                               
|     |  | PART II                                                                                        |  |     
|     |  |                                                                                               
|5.   |  | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                          |  | 30  
|     |  |                                                                                               
|6.   |  | SELECTED CONSOLIDATED FINANCIAL DATA                                                           |  | 31  
|     |  |                                                                                               
|7.   |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS          |  | 32  
|     |  |                                                                                               
|7A.  |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                     |  | 52  
|     |  |                                                                                               
|8.   |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                    |  | 53  
|     |  |                                                                                               
|9.   |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES          |  | 53  
|     |  |                                                                                               
|9A.  |  | CONTROLS AND PROCEDURES                                                                        |  | 53  
|     |  |                                                                                               
|     |  | PART III                                                                                       |  |     
|     |  |                                                                                               
|10.  |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                             |  | 54  
|     |  |                                                                                               
|11.  |  | EXECUTIVE COMPENSATION                                                                         |  | 58  
|     |  |                                                                                               
|12.  |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |  | 62  
|     |  |                                                                                               
|13.  |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                 |  | 64  
|     |  |                                                                                               
|14.  |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                         |  | 65  
|     |  |                                                                                               
|     |  | PART IV                                                                                        |  |     
|     |  |                                                                                               
|15.  |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                               |  | 67  



Primus®, Primus® eServer, Primus® eSupport, Primus® Enterprise Search, Primus® iView, Primus® Quick Resolve, and Primus® Visibility are trademarks, registered trademarks, or service marks of Primus.
This Annual Report on Form 10-K also contains trademarks and service marks of other companies, which are the property of their respective owners.



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PART I



This Annual Report on
Form 10-K (Form 10-K or Report) contains forward-looking statements. These statements relate to future events, plans or objectives or our future financial performance. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan, intend, anticipate, believe, estimate, predict, potential or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual
events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined in the Risks Associated with our Business and Future Operating Results contained in
Item 1 below. These factors may cause our actual results to differ materially from any forward-looking statement.



Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after
the date of this annual report to conform such statements to actual results or to changes in our expectations.



ITEM 1.    BUSINESS



Overview



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



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



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



Industry
Background



The emergence of the Web as a business medium
has made it imperative for companies across a variety of industries to extend the way they do business. Traditional call centers for customer service and support have been integrated with web enabled applications for self-service, and now include
multiple electronic communication channels for customers to choose from, including phone, email, self-service, chat, Instant Messaging (IM), Voice



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Over Internet Protocol (VOIP), Short Message Service (SMS), Multimedia Messaging Service (MMS). The fast-growing eService market has focused on enabling
companies to market their products, manage the sales process, transact sales, manage customer service, and interact and communicate with customers, partners and suppliers across any communication channel. Because of competitive pressures and
customer expectations, even the most traditional companies have found it difficult to ignore the need to implement an eService strategy.



The shift from traditional business practices to doing business on emerging communication channels has fundamentally changed the way that companies
interact with and think about their customers. Increasingly, companies are realizing that they must personalize each customer experience by providing products and support based on each customers needs and that exceed each customers
expectations. To accomplish these goals, businesses must communicate with customers via the media of the customers choice and deliver relevant information to customers. Companies realize that they must learn from each customer interaction, in
order to respond to customer inquiries in real-time and provide a consistent level of service 24 hours a day, seven days a week.



There are inherent challenges associated with interacting with customers in this new and dynamic business environment. Customers have higher expectations
for customer service and expect that service to be consistent regardless of the communication channel used to deliver the support. Companies must view their customers in an integrated way, providing visibility to each customers information
across their organizations. Customers are now active, informed participants in the business process and each customer interaction must be maximized to retain and increase sales to existing customers and improve customer satisfaction.



To compete in todays business environment, companies must maximize
their relationships with prospective and existing customers. This has led many companies to implement eService initiatives and software. eService software is designed to enable companies to interact with their customers and manage customer
information in a way that helps companies maximize the value of each customer interaction. Facilitating more efficient communications with customers can help to improve the level and quality of customer service and, in turn, increase customer
satisfaction and retention and cross-sell and up-sell opportunities.



Primus
Solutions



We offer complete knowledge solutions that
enable companies to deliver great service by finding, capturing and communicating information. Our products are used primarily for customer support by call centers and IT helpdesks and have been extended to support other business areas including
Human Resources, Sales and Marketing.



Our solutions are
predicated on the belief that the intellectual capital resident within a companys workforce and within its disparate corporate repositories, is its most valuable asset. We provide knowledge-enabling solutions that allow companies to
enhance customer relationships by managing and sharing the companys valuable internal knowledge and expertise with customers, partners and employees, across multiple communication channels and business processes. Our software helps address the
unique challenges faced by companies implementing a customer service and support strategy.



Primus software has the following key characteristics:



Intangible asset management.    Our software enables companies to capture, manage, and share a variety of knowledge, including requests for information, service, support, technical
information, and institutional knowledge gained from interactions with customers, partners and employees, across a multitude of communication channelsincluding the Webso that the entire enterprise can apply this knowledge to future
interactions.



Integration.    Our
software integrates with leading contact center and IT helpdesk solutions, including applications from Amdocs/Clarify, Kana, Onyx, Oracle, Peoplesoft, Remedy, SAP, Siebel and others. Integration



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with these types of applications enables companies to easily capture and access knowledge during the course of the customer interaction. Fast access to
current, relevant knowledge is key to achieving the verifiable return on investment (ROI) that buyers demand.



Scalable architecture.Our solutions scale from small to enterprise usage. Our customers have demonstrated the scalability
of our software in demanding, transaction heavy environments. For example, one company is leveraging our self service solution to answer over 1 million questions per month. In addition, companies have purchased our software to be used by thousands
of contact center employees, and hundreds of thousands of their customers and partners, on a global basis.



Rapid Return on Investment.Our software offers a significant, measurable return on investment. For example, a networking
software company reported a reduction of service escalations by 20% in six months; a manufacturing company reduced support escalations from level 2 support representatives to level 3 support representatives by 60% in three months. Our solutions can
be rapidly implemented and easily customized, thus allowing for minimal start-up time before companies experience the benefits of choosing Primus software. In addition, the extensive business functionality provided by our software allows companies
to realize more immediate benefits such as reduced support costs, enhanced customer satisfaction, and increased productivity. The extent of return on investment of Primus products is specific to each of our customers experience.



Primus Strategy



Establish and Maintain Leadership Position.    We intend to be the leader in providing
comprehensive problem resolution software solutions for the customer contact center, IT helpdesk, electronic communications and self-service portal markets. Our strategy includes delivering world class products that leverage industry standard Java
technologies, and web services, to easily integrate into existing systems, to address the market for self-service and assisted service.



Enhance our product suite.    We plan to enhance the capabilities of our product family by developing and licensing additional
products and technologies. We intend to focus on applications and technologies that extend the breadth of our eService solutions. We develop our products to operate in numerous enterprise environments including Java 2 Platform, Enterprise Edition
(J2EE), Microsoft Windows and NT and Sun Solaris Unix.



Target additional vertical markets.We are focused on targeting additional vertical markets to broaden the reach of our problem-resolution products. Initially, our sales and marketing efforts targeted large
enterprises in dynamic, technology-related industries that offer external customer support, such as software, hardware and telecommunications. We continue to focus on broadening our reach across multiple verticals, such as outsourced services
providers, manufacturing, aerospace, financial services, and government.



Build additional strategic relationships.    We intend to strengthen our market reach by further developing partner relationships with leading implementation consulting, systems integration,
and technology vendors. We believe that these strategic relationships will provide us with additional sales opportunities, further leverage our implementation resources, and broaden our current eService integration capabilities. Concurrently, we
intend to expand our indirect distribution channels to complement our direct sales force and pursue reseller opportunities.



Extend our solutions to other functional areas.We intend to continue to enhance the features of our solutions to provide
benefits to functional business areas other than customer support, such as Human Resources, Sales and Marketing. Primus applications are valuable to any organization that needs to help its employees or customers answer questions from disparate data
sources and store valuable knowledge for re-use by others within the organization.



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Products



Our software can be deployed as a suite, as individual modules, or as an integrated solution with other leading contact center and information technology
helpdesk applications, depending on the customers preference and/or the immediacy of their need.



License fees for our software vary with each application, but our products are typically licensed on a per-processor basis, per-user basis or based on the
number of user sessions authorized to use our software at any given time. Our typical license agreement provides the licensee a perpetual, nontransferable license to use our software.



The following summarizes the current products that comprise the Primus software suite:



Primus® eServer



Primus eServer enables organizations to dynamically create, capture, and share knowledge to enhance their customers
experiences and increase the effectiveness of their businesses. Primus eServer can be used in a variety of business environments, including customer service and support, field engineering, human resources, and sales and marketing, wherever a company
needs to make knowledge available to its employees or customers, particularly when there is a large volume of information relating to products or systems.



Primus eServer provides sophisticated search functionality and enables the capture and creation of knowledge during the course of an interaction with a
customer. Unlike text search engines that deliver large volumes of sometimes irrelevant answers or case-based systems thatdue to their designmay deliver too limited a response, Primus eServer delivers answers that are both useful and
manageable. We offer various intuitive and user-friendly interfaces to guide first level call center agents through a rapid problem resolution process or to provide full functionality to more experienced agents to access and create reusable
knowledge across the enterprise, including Primus®
eSupport, Primus® Quick Resolve and Primus® iView. Primus eServer can be used to support all phases
of the customer lifecycle, from new requests for information or service, to secondary customer interactions that leverage knowledge to proactively serve their customers. For example, knowing that a customer has experienced repetitive customer
service issues with a specific product, a company can proactively offer that customer a newly released product that will solve their service issues.



Primus® Enterprise Search



Primus Enterprise Search enables companies that want to leverage existing enterprise content, including websites, technical documentation and user manuals, to provide answers to questions from customers, employees,
and partners. Primus Enterprise Search can be configured to search across corporate repositories to provide a single access point for call center agents or as a portal for self-service. Users can quickly get relevant answers from more than 225 types
of files, including eServer knowledgebase solutions, Adobe PDF, Adobe Frame Maker, HTML, Microsoft Word, Microsoft PowerPoint, Microsoft Excel, and more. Primus Enterprise Search uses natural language processing (NLP) to analyze the meaning and
context of the customers question and provides specific answers from enterprise content. Used in conjunction with Primus eServer, customers can accelerate the creation of a knowledge base to more effectively share information across the
enterprise. Primus Enterprise Search also provides detailed reports to identify frequently requested documents, and information that needs to be updated or created within the organization.



Primus® Visibility



Primus® Visibility is a comprehensive electronic communication management solution designed to enhance employee productivity and correspondence quality in
customer and internal communications. Primus Visibility uses natural language processing to auto-classify electronic communications and apply rules or skills based



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routing to streamline the electronic communications process. Primus Visibility manages textual messaging channels including webforms, email, SMS, MMS and
other channels. The application is fully and simultaneous multi-lingual.



Product Architecture



Our products use a
multi-tiered architecture to meet the knowledge-enabled needs of businesses. We use industry-standard platforms, components, and communications interfaces to provide knowledge-enabling software that is designed to be reliable, maintainable and
scalable, and to provide high performance on a 24-hour basis. Our flexible architecture adapts to a range of needs, from a single desktop to enterprise systems that support thousands of users.



Primus eServer software runs on Microsoft Windows or Sun Solaris UNIX systems
in single- or multi-processor configurations. Our client software runs in a fully customizable interface accessed through a web browser. We currently support IBM DB-2, Microsoft SQL Server and Oracle databases.



Primus Enterprise Search software runs on J2EE and Windows systems in single-
or multi-processor configurations. Primus Enterprise Search complements the keyword search capabilities of these products with its ability to provide direct answers to natural language questions.



Primus Visibility is a J2EE application and runs on Windows, Sun Solaris, IBM
AIX and IBM Z/OS operating platforms. The product includes both Java and Web browser client user interfaces.



Customer Support and Professional Services



We believe that high-quality customer support and professional services are required for continued growth and increased sales of our products. We have made significant investments in our support and services
organization in the past and plan to continue to do so in the future.



Consulting.Our consulting teams work closely with our customers prior to product implementation to review a customers business objectives and information technology infrastructure in order to assist the
customer in determining Primus solutions that will best suit the customers needs. Thereafter, our consultants may install, integrate and implement our software in the users environment. In addition our consultants provide training to our
customers and third-party partners, including end-user training and advanced technical training regarding the implementation and administration of our products.



Application Hosting.    Primus offers application hosting services model is designed to help companies focus on their core
business by reducing initial capital or personnel costs associated while at the same time accelerating the deployment of any Primus software solution, with implementations in as little as two weeks. Our application hosting team installs and
maintains Primus applications at data centers provided by third party vendors to ensure security and system availability. Our application hosting model lets organizations enjoy the benefits of Primus software solutions quickly, without incurring
additional capital or personnel overhead costs.



Customer
Support.We recognize the importance of product support and quality service to the success of our customers by offering world wide technical product support to ensure quick response and resolution of their issues. Our
customers can contact our support engineers via telephone, fax, and email 7 days a week, 24 hours per day. The use of our eServer product by our support engineers facilitates the quick, accurate resolution of those issues. In addition, thru the
implementation and integration of our eSupport and Enterprise Search products we allow our customers direct, Web-based access to a robust and collective solution database for their self service needs.



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Customers



Initially, our sales efforts targeted large enterprises in dynamic, technology-related industries that offer external customer support. We have broadened
our sales focus to include additional vertical markets and enterprises of a wide variety of sizes that need to make knowledge available to their employees or customers, and particularly companies where there is a large volume of information relating
to products or systems. In addition to our traditional markets of technology and telecommunications, we touch vertical markets that include aerospace, financial services, manufacturing and retail. During 2003 we continued to grow our Global 2000
Customer base by adding many new customers including Altera Corporation, AT&T Wireless, Cap Gemini Ernst & Young, Foundry Networks, Genentech, Groupe Victoria, HSBC, Information Technology, Inc., Oce-USA, Orange, Primavera Systems, Red Hat,
Washington Mutual Bank, WebEx Communications and others.



Sales and
Marketing



We market and sell our products primarily
through a direct sales force. Our sales strategy is to pursue targeted accounts through a combination of our direct sales force and strategic relationships with third parties. Our field sales force, which includes both sales representatives and
sales engineers, is organized into regional teams, complemented by direct telesales based at our headquarters in Seattle. We have sales offices in the United States, the United Kingdom and France. Our international sales constituted 31%, 20% and 23%
of our 2003, 2002 and 2001 revenue, respectively.



Our
marketing department has a three-fold purpose: understanding the evolving needs of the marketplace and providing direction to the product development function, sustaining relationships with existing customers and industry analysts, and managing all
outbound communications with the marketplace to create awareness and generate interest in our products and services.



Our software is marketed, distributed and supported in Japan by Primus Knowledge Solutions, K.K. (Primus KK), a joint venture owned by Trans Cosmos, Inc.
and us. Our relationship with Primus KK is described in this Item under the subheading Joint Venture and Subsidiaries.



Product Development



Our product development team is responsible for designing, developing and releasing our products. The group is organized into five disciplines:
architecture, development, quality assurance, documentation and program management. Members from each of these disciplines, along with a product manager from our marketing department, form separate product teams that work closely with sales,
marketing, and professional services members, and with customers and prospects to better understand market needs and requirements.



When required, we also use third-party development firms to expand the capacity and technical expertise of our internal research and development teams and
in January of 2003 we engaged an offshore development team to accelerate our development efforts. Additionally, we sometimes license third-party technology that is incorporated into our products. We believe this approach significantly shortens our
time to market without compromising our competitive position or product quality. Therefore, we expect to continue to draw on third-party resources in the foreseeable future.



Our development efforts are essential for us to remain competitive. Costs related to research and development are among our
single greatest operating expenses. For a complete description of our development-related expenses, see Managements Discussion and Analysis of Financial Condition and Results of OperationsOperating Expenses.



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We have a software development methodology that we believe allows us to deliver products that satisfy
real business needs and meet commercial quality expectations. This methodology is based on the following key components:



| |  |  | specification and review of business and functional requirements
| | - |  | ----------------------------------------------------------------



| |  |  | quality assurance of code and documentation
| | - |  | -------------------------------------------



| |  |  | test of functions, components, systems, integration, performance, scaling, stress and internationalization
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | regression testing before beta or general availability releases
| | - |  | ---------------------------------------------------------------



| |  |  | trial deployments in an internal production environment prior to release
| | - |  | ------------------------------------------------------------------------



| |  |  | external beta releases
| | - |  | ----------------------



| |  |  | general availability release of English and localized products
| | - |  | --------------------------------------------------------------



Our goal is to implement quality assurance processes throughout the software development life cycle. We believe that strong emphasis placed on analysis
and design early in the project life cycle reduces the number and costs of defects that may be found in later stages.



Competition



The market for our products is rapidly evolving and increasingly competitive as current competitors expand their product offerings and new companies enter
the market. Our suite of products competes against various vendor software tools designed to address a specific element or elements of the complete set of eService processes, including e-mail management, support, knowledge management, and web-based
customer self-service and assisted service. We also face competition from in-house designed products and third-party custom development efforts.



In addition, competition may increase as a result of software industry consolidations and formations of alliances among industry participants or with
third parties. Some current and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other resources, and thus may be able to respond more quickly to new or changing opportunities,
technologies and customer requirements. Also, many current and potential competitors may have wider name recognition and more extensive customer bases. They might be able to undertake more extensive promotional activities, adopt more aggressive
pricing strategies, and offer purchasers more attractive terms. Some of the companies providing e-commerce, advanced natural language self service and traditional customer relationship management solutions that may compete with us include
Amdocs/Clarify, eGain, Inquira, iPhrase Technologies, Kana, Kanisa, Oracle, Peoplesoft, Right Now Technologies, ServiceWare, Siebel and Supportsoft.



The principal competitive factors in our industry include:



| |  |  | vendor and product reputation
| | - |  | -----------------------------



| |  |  | the availability of products on the Web and multiple operating platforms
| | - |  | ------------------------------------------------------------------------



| |  |  | measurable economic return on investment
| | - |  | ----------------------------------------



| |  |  | customer referenceability
| | - |  | -------------------------



| |  |  | product quality, performance and price
| | - |  | --------------------------------------



| |  |  | breadth of product functionality and features
| | - |  | ---------------------------------------------



| |  |  | product scalability
| | - |  | -------------------



| |  |  | product ease-of-use
| | - |  | -------------------



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| |  |  | the quality of customer support services, documentation and training
| | - |  | --------------------------------------------------------------------



| |  |  | the quality, speed and effectiveness of application development services
| | - |  | ------------------------------------------------------------------------



| |  |  | the effectiveness of sales and marketing efforts
| | - |  | ------------------------------------------------



| |  |  | product integration with other enterprise applications
| | - |  | ------------------------------------------------------



| |  |  | breadth of product application suite
| | - |  | ------------------------------------



As the market for customer service and support and knowledge management software matures, new and larger companies will enter the market, existing
competitors will form alliances and current and potential competitors could acquire, be acquired by or establish cooperative relationships with third parties. The resulting organizations could have greater technical, marketing and other resources
and improve their products to address the needs of our existing and potential users, thereby increasing their market share. Increased competition could result in pricing pressures, reduced margins or the failure of our products to achieve or
maintain market acceptance.



Although we believe that our
products and services currently compete favorably with respect to such factors, we cannot provide any assurance that we can maintain our competitive position against current and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical, and other resources.



Proprietary Information



Our success depends
in part on our ability to protect our proprietary rights. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and
protective contractual provisions such as those contained in license agreements with consultants, vendors and customers. We pursue the registration of certain of our trademarks and service marks in the United States and in certain other countries,
but we have not secured registration of all our marks.



Joint Venture and
Subsidiaries



Primus Knowledge Solutions, K.K.



Primus software is marketed, distributed and supported in
Japan by Primus Knowledge Solutions, K.K. (Primus KK), a joint venture in which we hold a 19.6% minority interest and hold 1 of 6 board of director positions. Trans Cosmos, Inc., one of Japans oldest and largest outsourced customer
service and information technology support solutions provider, holds the remaining 80.4% of Primus KK. Trans Cosmos currently holds approximately 8% of our common stock. Our distribution arrangements provide Primus KK with exclusive rights to the
Japanese and English versions of our Primus®
eServer and Primus® eSupport products in Japan, and
nonexclusive distribution rights for these products in Korea, China and Hong Kong. The distribution arrangement continues until terminated by mutual agreement or, if Primus KK has not completed the listing of its common stock on a recognized public
stock exchange by December 31, 2004 or if certain performance goals are not met, its expiration on March 31, 2006. In July 2002, January 2003, May 2003 and again in September 2003, we amended the distribution agreement with Primus KK, and they have
assumed a more significant role in product localization and support for the Japanese market. After the September 2003 amendment, our current royalty fee structure has guaranteed minimum payments from Primus KK of $125,000 per quarter through the
first quarter of 2004 provided certain professional services milestones are met. The amended distribution agreement provides for sublicense fees based on a percentage of net fees collected by Primus KK from its customers (subject to certain
minimums). The guaranteed minimum payments from Primus KK could result in an adjustment to the sublicense fee due each quarter, but such payments do not constitute an advance inventory purchase nor can such payments be credited or carried over from
one year to another. Guaranteed minimum royalty payments, to the extent they exceed sublicense fees due, are recognized in the period earned. As a result of the changing and uncertain



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business climate and operating results for Primus KK, we expect to negotiate further amendments to our distribution agreement. Our agreement with Primus KK
does not contain product return rights. Revenue recognized under the reseller agreement totals approximately $956,000, $1,394,000 and $3,134,000 in 2003, 2002 and 2001, respectively, and revenue deferred at December 31, 2003 and 2002 was
approximately $94,000 and $248,000, respectively, and accounts receivable at December 31, 2003 and 2002 were approximately $6,000 and $471,000, respectively. Primus KK is accounted for using the cost method, as management believes it does not have
significant influence over its operations, has not guaranteed any of its obligations and does not have any commitment or intent to provide any funding. The carrying value of Primus KK is zero at December 31, 2003 and 2002.



European Subsidiaries



Primus Knowledge Solutions (UK) Limited and Primus Knowledge Solutions
France are wholly-owned Primus subsidiaries conducting sales and marketing activities for Primus in Europe. Amacis Group Limited is a wholly-owned Primus subsidiary holding the technology assets arising from our subsidiary merger with Amacis Group
Limited on December 22, 2003. The assets, liabilities and results of operations of these subsidiaries are consolidated into our financial statements.



Broad Daylight, Inc.



Broad Daylight, Inc. is a wholly-owned Primus subsidiary holding the technology assets arising from our subsidiary merger with Broad Daylight, Inc.
entered into on September 3, 2003. This subsidiarys assets, liabilities and results of operations are consolidated into our financial statements.



AnswerLogic, Inc.



AnswerLogic, Inc. is a wholly-owned Primus subsidiary holding the technology assets arising from our subsidiary merger with AnswerLogic, Inc. on May 31,
2001. This subsidiarys assets, liabilities and results of operations are consolidated into our financial statements.



Imparto Software Corporation and 2order.com, Inc.



Imparto Software Corporation and 2order.com, Inc. are two inactive, wholly-owned subsidiaries which resulted from subsidiary mergers prior to 2001. The
assets, liabilities and results of operations of these inactive subsidiaries, if any, are consolidated into our financial statements.



We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities
nor do we have any commitment or intent to provide any funding to any such entity. As such, we are not exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.



Employees



As of December 31, 2003, we had 181 employees, including 39 European-based employees. These included 53 in sales and
marketing, 44 in client services and support, 61 in research and development and 23 in general and administration. None of our employees are represented by a labor union. We have not experienced any work stoppages, and we believe our relationship
with our employees is good. In addition, we occasionally supplement our workforce with consultants.



Competition for qualified personnel in our industry is intense. We believe that our future success will depend in part on our continued ability to hire,
train and retain qualified personnel.



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Acquisitions



Broad Daylight, Inc.



On August 12, 2003, we signed a definitive merger agreement and announced our intent to acquire 100% of the voting interest in Broad Daylight, Inc.
(Broad Daylight) an e-service software developer specializing in solutions for customer and employee self-service. The merger of Broad Daylight with a subsidiary of Primus closed on September 3, 2003. The combined offerings will leverage
natural language search and rules-based problem-solving technologies, and will provide a complete range of options for companies looking for assisted service and self-service solutions. Under the terms of the merger agreement, we purchased all of
the outstanding shares of Broad Daylight in exchange for 2,131,009 shares of Primus common stock valued at approximately $2,536,000, plus cash of approximately $140,000 and direct acquisition costs of approximately $198,000. The fair value of the
common stock issued on the acquisition was $1.19 per share, based on the average market price for a period before and after August 12, 2003.



The purchase price of approximately $2.9 million was allocated to the assets acquired and liabilities assumed based on their fair values at the
acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $3.3 million has been recorded as goodwill.



Amacis Group Limited



On December 22, 2003, we signed and consummated a share purchase agreement to acquire 100% of the voting interest in Amacis Group Limited, a corporation
organized under the Companies (Tables A to F) Regulations (Northern Ireland) (Amacis). Under the terms of the share purchase agreement, we purchased all of the outstanding shares of Amacis in exchange for 1,234,692 shares of Primus
common stock valued at approximately $7.4 million, assumed all employee stock options outstanding under an existing Amacis stock option plan, valued at approximately $1.1 million and incurred direct acquisition costs of approximately $364,000. The
fair value of our common stock issued as consideration in the acquisition was $6.00 per share, based on the average market price for a period before and after December 22, 2003.



The purchase price of approximately $8.9 million was allocated to the assets acquired and liabilities assumed based on their
fair values at the acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $8.4 million has been recorded as goodwill.



Restructurings



During 2001 and 2002, we executed restructuring plans to reduce headcount and infrastructure, and to eliminate excess leased
facilities. During the years ended December 31, 2001 and 2002, we recorded $2,530,000 and $1,227,000, respectively, in restructuring and other related charges. Restructuring charges for the year ended December 31, 2003 were $0.



The excess facilities and asset impairment charges recorded in 2001 and 2002
were the result of our decision to exit certain domestic and international facilities and were estimated based on our evaluation of then current market conditions relative to our existing excess facilities accrual. The estimated facilities costs are
based on current comparable rates for leases and subleases of a comparable term or termination fees. The asset impairment charges were primarily for leasehold improvements, computer equipment and related software, office equipment and furniture and
fixtures disposed of or removed from operations as a direct result of the restructuring plans. If estimates and/or assumptions change, the actual loss may differ from this estimate. Future cash outlays are anticipated through June 2004, unless we
are able to negotiate to exit the lease at an earlier date.



During March of 2004, we executed a further restructuring of our workforce to realize the efficiencies and synergies from our recent acquisitions and as a result will be recording restructuring charges of approximately $500,000 for
severance and benefits and associated costs due to an approximate 10% reduction in our worldwide



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workforce. Additionally, we anticipate consolidating our Santa Clara operations into other existing locations and expect to record an excess facility and/or
asset impairment charge in 2004.



As we continue to evaluate
our underlying cost structure to improve our operating results and better position ourselves for growth, we may incur further restructuring charges, including severance, benefits and related costs due to a reduction in workforce and/or charges for
excess facilities or assets disposed of or removed from operations as a direct result of a reduction in workforce.



Executive Officers



Information required by Item 10 of Form 10-K with respect to executive officers of Primus is set forth below. Our executive officers are appointed by our
Board of Directors. There are no family relationships among any our executive officers or directors.



Our executive officers as of March 18, 2004 are as follows:



|                    |  |     |  |                                                                            
|------------------- |  | --- |  | ---------------------------------------------------------------------------
|Name                |  | Age |  | Position                                                                   
|Michael A. Brochu   |  | 50  |  | President, Chief Executive Officer and Chairman of the Board               
|Ronald M. Stevens   |  | 40  |  | Chief Operating Officer, Chief Financial Officer and Treasurer             
|David M. Williamson |  | 40  |  | Executive Vice President of Business Affairs, General Counsel and Secretary



Michael A. Brochuhas served as our President, Chief Executive Officer and Chairman of the Board since November 1997. Mr. Brochu was President and Chief Operating Officer of Sierra On-Line, Inc., an interactive software publisher, from June 1994 until October
1997. Mr. Brochu received his B.B.A. in accounting and finance from the University of Texas at El Paso.



Ronald M. Stevenshas served as our Chief Operating Officer, Chief Financial Officer and Treasurer since October 2000. From August 1999 to
September 2000, Mr. Stevens served as Chief Financial Officer and then President and Chief Operating Officer of OnHealth Network Inc., a consumer healthcare Internet company, which was acquired by WebMD Corporation in September 2000. From May 1996
to August 1999, he served as General Manager and Senior Vice President of Sierra On-Line, Inc., an interactive software publisher. From May 1994 to May 1996, he served as Corporate and Divisional Controller of Sierra On-Line. Mr. Stevens received
his B.A. in accounting and business administration from Western Washington University.



David M. Williamson serves as our Executive Vice President of Business Affairs, General Counsel and Secretary. He joined Primus in November 2000. From April 1998 to October 2000 he was Senior Vice President of
Business Affairs at Sierra On-line, Inc., an interactive software company. Prior to April 1998, he was a partner in the Business Technology Group at the law firm of Perkins Coie LLP. Mr. Williamson received his B.A. in accounting from the University
of Denver and his J.D. from the University of California at Berkeley.



Available Information



We file annual,
quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 as amended (Exchange Act). You can inspect and copy our reports, proxy statements, and
other information filed with the SEC at the offices of the SECs Public Reference Rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Rooms.
The SEC maintains an Internet Web site at <http://www.sec.gov/> where you can obtain most of our SEC filings. In addition, you can inspect our reports, proxy materials and other information at the offices of the Nasdaq Stock Market at
1735 K Street NW, Washington D.C. 20006. We also make available free of charge on our website at <www.primus.com> our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to



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those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after they are filed electronically
with the SEC. You can also obtain copies of these reports by contacting Investor Relations at investor.relations@primus.com or by phone at 206.834.8100.



Risks and Uncertainties Associated with Our Business and Future Operating Results



Our future operating results may vary substantially from period to period. The price of our common stock will fluctuate
in the future, and an investment in our common stock is subject to a variety of risks, including but not limited to the specific risks identified below. The risks described below are not the only risks facing our company. Additional risks and
uncertainties not presently known to us, or that we currently deem immaterial, may impair our business operations. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in
this report and our other public filings. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected and the trading price of our common stock could decline.



We have a history of losses and may not be able to
generate sufficient revenues to support our business and require additional financing, failure to obtain such financing would affect our ability to maintain our operations and to grow our business, and the terms of any financing we obtain may impair
the rights of our existing stockholders.



In the future,
we may be required to seek additional financing to fund our operations or growth. Since we began operations, our revenue has not been sufficient to support our operations, and we have incurred operating losses in every quarter, except for the
quarters ended September 30, and December 31, 2003. As of December 31, 2003, our accumulated deficit was approximately $103 million. Our history of losses may cause some of our potential customers to question our viability and hamper our ability to
sell some of our products. Although we have restructured our operations to reduce operating expenses, we still may need to increase our revenue from existing levels and/or further reduce our operating expenses to achieve and/or maintain
profitability and positive cash flows from operations, and our revenue may decline, or fail to grow, in future periods. We expect an increase in operating expenses from our recent acquisitions of Broad Daylight and Amacis. Our expectations as to
whether we can achieve and/or maintain profitability on a quarterly or annual basis, revenue growth on an annual basis, positive cash flows from operations, and as to our future cash balances, are subject to a number of assumptions, including
assumptions regarding improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control. As a result, we may continue to experience losses, even if sales of our products and services grow.



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



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



Fluctuations in our operating results, particularly compared to the expectations of investors and analysts, could cause severe volatility in the price of
our common stock. Our revenue and operating results have fluctuated



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substantially from quarter to quarter and are likely to continue to do so in the future. Our quarterly revenue and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter particularly because of the length of our sales cycle, delays in customer buying decisions and variation in the size of individual license transactions from quarter to quarter. We believe that
period-to-period comparisons of our operating results may not be meaningful and you should not rely on these comparisons as an indication of our future performance. We will continue to base our decisions regarding operating expenses on anticipated
revenue trends. Therefore, to the extent our actual revenue falls short of our expectations, our operating results will suffer and our stock price will likely decline. If quarterly revenue or operating results fall below the expectations of
investors or analysts, the price of our common stock could decline substantially. Factors that might cause quarterly fluctuations in our operating results include the factors described under the other subheadings of this Risk Factors
section as well as:



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



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



| |  |  | budget and spending decisions by information technology and customer support departments of our customers
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | order deferrals in anticipation of new products or product enhancements introduced by our competitors or us
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | our ability to manage our expenses
| | - |  | ----------------------------------



| |  |  | the timing of new releases of our products
| | - |  | ------------------------------------------



| |  |  | changes in our pricing policies or those of our competitors
| | - |  | -----------------------------------------------------------



| |  |  | the timing of execution of large contracts that materially affect our operating results
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | uncertainty regarding the timing of delivery of our products
| | - |  | ------------------------------------------------------------



| |  |  | changes in the level of sales of professional services and hosting services as compared to product licenses
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | the mix of sales channels through which our products and services are sold
| | - |  | --------------------------------------------------------------------------



| |  |  | the mix of our domestic and international sales
| | - |  | -----------------------------------------------



| |  |  | costs related to the customization of our products
| | - |  | --------------------------------------------------



| |  |  | our ability to integrate successfully the operations of businesses that we may acquire
| | - |  | --------------------------------------------------------------------------------------



| |  |  | our ability to expand our operations, and the amount and timing of expenditures related to this expansion
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | decisions by customers and potential customers to delay purchasing of our products
| | - |  | ----------------------------------------------------------------------------------



| |  |  | a trend of continuing consolidation in our industry
| | - |  | ---------------------------------------------------



| |  |  | global economic and political conditions, as well as those specific to our customers or our industry
| | - |  | ----------------------------------------------------------------------------------------------------



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



Due to the protracted slowdown in the national and global economy from the year 2000, geopolitical uncertainties and uncertainties concerning the extent
or timing of any meaningful economic recovery, we believe that many existing and potential customers are carefully evaluating and reprioritizing their planned technology and Web-related investments and deferring purchasing decisions or electing to
purchase smaller initial implementations of software solutions. As a result, there is uncertainty with respect to our expected revenue, and any delays or reductions in business spending for information technology could have a material adverse effect
on our revenue, operating results and stock price.



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Our expenses are generally fixed and we will not be able to reduce these expenses quickly if we fail
to meet our revenue forecasts.



Most of our expenses, such
as employee compensation and occupancy expenses, are relatively fixed in the short term. Moreover, our budget is based, in part, on our expectations regarding future revenue levels. As a result, if total revenue for a particular quarter is below
expectations, we could not proportionately reduce operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on our expected operating results for that quarter.



Our continued NASDAQ SmallCap Market listing is not assured, which would
make the trading market for our stock more illiquid and could make it more difficult to raise capital.



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



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



Standards for accounting for
goodwill acquired in a business combination require recognition of goodwill as an asset but do not permit amortization of goodwill. Instead goodwill must be separately tested for impairment. As a result, our goodwill amortization charges ceased in
2002 and we recognized a $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of the adoption of this standard.



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



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



We may derive a significant portion of our
product license revenue in each quarter from a small number of relatively large orders. Our operating results for a particular fiscal quarter could be materially adversely affected if we are unable to complete one or more substantial license sales
forecasted for that quarter. Additionally, we also often offer volume-based pricing, which may affect operating margins.



Factors outside our control may cause the timing of our license revenue to vary from quarter-to-quarter, possibly adversely affecting our operating
results.



Applicable accounting policies may cause us to
report new license agreements as deferred revenue. We recognize revenue from a customer sale when persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve customization of the software, the license
fee is fixed or determinable and collection of the fee is probable. If an arrangement requires acceptance testing or software customization services from Primus, recognition of the associated license and service revenue would be delayed. The timing
of the commencement and completion of the these services is subject to factors that may be beyond



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our control, as this process may require access to the customers facilities and coordination with the customers personnel after delivery of the
software. In addition, customers could delay product implementations and integrations. Implementation and integration typically involves working with sophisticated software, computing and communications systems. If we experience difficulties with
implementation or integrations or do not meet project milestones in a timely manner, we could be obligated to devote more customer support, engineering and other resources to a particular project. Some customers may also require us to develop
customized features or capabilities. If new or existing customers have difficulty deploying our products or require significant amounts of our professional services support for customized features, our revenue recognition could be further delayed
and our costs could increase, causing increased variability in our operating results.



The high level of competition in our market has resulted in pricing pressures that may reduce our margins or may lead to the failure of our products to achieve market acceptance.



The market for our products is rapidly evolving, and becoming increasingly
competitive as current competitors expand their product offerings and new companies enter the market. Our suite of products competes against various vendor software tools designed to address a specific element or elements of the complete set of
eService processes, including e-mail management, support, knowledge management, and web-based customer self-service and assisted service. We also face competition from in-house designed products and third-party custom development efforts. The high
level of competition in our market has resulted in pricing pressures which, if such conditions continue or increase, could harm our results of operations.



In addition, competition may increase as a result of software industry consolidations and formations of alliances among industry participants or with
third parties. Some current and potential competitors have longer operating histories and significantly greater financial, technical, marketing, service, support and other resources, and thus may be able to respond more quickly to new or changing
opportunities, technologies and customer requirements. Also, many current and potential competitors have wider name recognition and more extensive customer bases that they could leverage. They might be able to undertake more extensive promotional
activities, adopt more aggressive pricing strategies, and offer purchasers more attractive products and/or more attractive terms. Some of the companies providing e-commerce, advanced natural language self service and traditional customer
relationship management solutions that may compete with us include Amdocs/Clarify, eGain, Inquira, iPhrase Technologies, Kana, Kanisa, Oracle, PeopleSoft, RightNow Technologies, ServiceWare, Siebel Systems and Supportsoft.



The principal competitive factors in our industry include:



| |  |  | vendor and product reputation
| | - |  | -----------------------------



| |  |  | product and services prices and fees
| | - |  | ------------------------------------



| |  |  | the availability of products on the Web and multiple operating platforms
| | - |  | ------------------------------------------------------------------------



| |  |  | measurable economic return on investment
| | - |  | ----------------------------------------



| |  |  | ability to use customers as references
| | - |  | --------------------------------------



| |  |  | product quality, performance and price
| | - |  | --------------------------------------



| |  |  | breadth of product functionality and features
| | - |  | ---------------------------------------------



| |  |  | product scalability
| | - |  | -------------------



| |  |  | vendor financial viability
| | - |  | --------------------------



| |  |  | product ease-of-use
| | - |  | -------------------



| |  |  | the quality of customer support services, documentation and training
| | - |  | --------------------------------------------------------------------



| |  |  | the quality, speed and effectiveness of application development services
| | - |  | ------------------------------------------------------------------------



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| |  |  | the effectiveness of sales and marketing efforts
| | - |  | ------------------------------------------------



| |  |  | product integration with other enterprise applications
| | - |  | ------------------------------------------------------



| |  |  | breadth of product application suite
| | - |  | ------------------------------------



As the market for eService and knowledge management software matures, it is possible that additional and possibly larger companies will enter the market,
existing competitors will form alliances or current and potential competitors could acquire, be acquired by or establish cooperative relationships with third parties. The resulting organizations could have greater technical, marketing and other
resources and improve their products to address the needs of our existing and potential users, thereby increasing their market share. Increased competition could result in pricing pressures, reduced margins or the failure of our products to achieve
or maintain market acceptance.



Seasonality may adversely
affect our quarterly operating results.



We expect to
experience seasonality in our revenue. To date, we believe that other factors, such as large orders and the timing of personnel changes in our sales staff, have impacted seasonality. Our customers purchase decisions are often affected by
fiscal budgetary factors and by efforts of our direct sales force to meet or exceed sales quotas.



We rely primarily on sales of only one product family.



Product license revenue and related service revenue from our Primus eServer and Primus eSupport related products accounted for approximately 86% of our
total revenue in 2003, and we expect these products to continue to account for a substantial portion of our revenue for 2004. For our business to succeed, the market for this software will have to grow substantially and we will have to achieve broad
market acceptance of our products. As a result, factors adversely affecting the demand for these products and our products in general, such as competition, pricing or technological change, could materially adversely affect our business, financial
condition, operating results and have a corresponding effect on our stock price. Our future financial performance will substantially depend on our ability to sell current versions of our entire suite of products and our ability to develop and sell
enhanced versions of our products.



We may not be able to
forecast revenue accurately because our products have a long and variable sales cycle.



To date, the typical sales cycles for our products have taken 3 to 12 months or more. The length of our sales cycles may cause license revenue and operating results to vary significantly from period to period. Our
sales cycles have required pre-purchase evaluation by a significant number of individuals in our customers organizations. Along with third parties that jointly market our software, we invest significant amounts of time and resources educating
and providing information to prospective customers regarding the use and benefits of our products. Many of our customers evaluate our software deliberately, depending on their specific technical capabilities, the size of the deployment, the
complexity of their network environment, and the quantity of hardware and the degree of hardware configuration necessary to deploy our products. In the event that the current national and global economy does not improve or worsens, or prospective
customers were to extend their purchasing cycles, the sales cycle for our products may become longer and we may require more time and resources to complete sales.



We depend on increased business from new customers, and if we fail to grow our customer base or generate repeat business,
our operating results could be harmed.



Our business model
generally depends on the sale of our products to new customers as well as on expanded use of our products within our existing customers organizations. If we fail to grow our customer base or



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generate repeat and expanded business from our current and future customers, our business and operating results will be seriously harmed. In some cases, our
customers initially make a limited purchase of our products and services for pilot programs. These customers may not purchase additional licenses to expand their use of our products. If these customers do not successfully develop and deploy initial
applications based on our products, they may choose not to purchase additional licenses.



In addition, as we introduce new versions of our products or new products, our current customers might not require the functionality of our new products and might not ultimately license these products. Because the
total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively affect our future services
revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could decline significantly. Further, some of our customers are telecom or information technology companies, which have been forced to
significantly reduce their operations in light of limited access to sources of financing and the current national and global economic slowdown. If customers are unable to pay for their current products or are unwilling to purchase additional
products, our revenue will decline and this will likely materially impact adversely our revenue, operating results and stock price.



Factors outside our control may make our products less useful.



The effectiveness of our software depends in part on widespread adoption and effective use of our software by an
enterprises personnel, partners, and customers and the value derived by each such usage. In addition, the effectiveness of our knowledge-enabled approach is somewhat dependent upon a current database. If customer-support personnel do not adopt
and effectively use our products, necessary solutions will not be added to the database, and the database may be inadequate. If an enterprise deploying our software fails to maintain a current database, the value of our software to our users may be
impaired. Successful deployment and broad acceptance of our products will depend in part on the quality of the users existing database of solutions, which is outside our control.



The loss of access to, or a problem with, third party databases could adversely affect our business.



Historically, we incorporated a database licensed from Versant into certain
of our products. Presently, our products support IBM DB-2, Microsoft SQL Server and Oracle databases. Because many of the products we have shipped historically rely on these databases, we continue to depend on these companies to support the
databases in a timely and effective manner.



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



If sales of new software licenses increased rapidly or if we were to sign an agreement for a particularly large or complex integration, our customer support and professional services personnel may be unable to meet
the demand for services. In that case, if we were unable to retain or hire highly trained consulting personnel or establish relationships with third-party systems-integrators and consultants to assist in the implementation of our products, we would
be unable to meet customer demands for integration and support services related to our products.



We may have potential contingent liabilities under service level agreements.



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





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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.



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



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



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



Our
workforce reductions and financial performance may adversely affect the morale and performance of our personnel and our ability to hire new personnel.



In connection with our effort to streamline operations, and reduce costs, we have engaged in several restructurings of our organization with
substantial reductions in our workforce. There have been and may continue to be substantial costs associated with this or other workforce reductions related to severance and other employee-related costs, and our restructuring plans may yield
unanticipated consequences, such as attrition beyond our planned reductions in workforce. As a result of these reductions, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities.



In addition, many of the employees who were terminated
possessed specific knowledge or expertise that may prove to be important to our operations. In that case, their absence may create significant difficulties. Personnel reductions may also subject us to the risk of litigation, which may adversely
impact our ability to conduct our operations and may cause us to incur significant expense.



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



Our reductions in work force since July of 2001 may affect employee morale and may create concern among existing
employees about job security, which may lead to increased turnover and reduce our ability to meet the needs of our current and future customers. As a result, we may need to hire to replace personnel lost due to



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attrition, or to accommodate growth in specific customer needs and/or acquire new skill sets. We may be unable to hire and/or retain the skilled personnel
necessary to develop and grow our business. Although a number of technology companies have recently implemented staff reductions, there remains substantial competition for experienced personnel, particularly in the greater Seattle area, where we are
headquartered, due to the limited number of people available with the necessary technical skills.



Because our stock price has suffered a significant decline since 2000, stock-based compensation, including options to purchase our common stock, may have
diminished effectiveness as employee hiring and retention devices. If employee turnover increases, our ability to provide client service and execute our strategy would be negatively affected. We may also face difficulties in hiring and retaining
qualified sales personnel to sell our products and services, which could impair our revenue growth.



We may be adversely affected if we lose key personnel.



Our success depends largely on the skills, experience and performance of some key members of our management and technical staff. If we lose one or more of
these key employees, our business, operating results and financial condition could be materially adversely affected. Much of our success also depends on Michael A. Brochu, our President and Chief Executive Officer. The loss of Mr. Brochus
services could harm our business.



We may face difficulties
in hiring and retaining qualified sales personnel to sell our products and services, which could impair our revenue growth.



Our ability to increase revenue in the future depends considerably upon our success in recruiting, training, managing and retaining direct sales
personnel and the success of the direct sales force. We might not be successful in these efforts. Our products and services require sophisticated sales backgrounds. There is a shortage of sales personnel with such qualifications and experience, and
competition for qualified personnel is intense in our industry. Our recent reductions in force may also impair our ability to recruit skilled sales personnel. Also, it may take a new salesperson a number of months to become a productive member of
our sales force. Our business will be harmed if we fail to hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than anticipated.



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



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



Integrating the operations associated with Broad Daylight and/or Amacis may be a challenging and expensive process that may
result in revenue disruption, loss of key employees, customer uncertainty, and other operational difficulties if not completed in a timely and efficient manner. We anticipate that for the foreseeable future, the operations associated with Amacis
will remain in Northern Ireland. The geographic separation could increase the operational risks associated with this acquisition. If we are not successful in addressing these risks or any other problems encountered in connection with these
acquisitions, our results of operations and business could be harmed.



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



In order to remain competitive, we may find it necessary or beneficial to acquire additional businesses, products and technologies. In the event that we
complete one or more acquisitions, we could be required to do one or more of the following:



| |  |  | issue equity securities, which would dilute current shareholders percentage ownership
| | - |  | --------------------------------------------------------------------------------------



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| |  |  | assume contingent, unrecorded and/or warranty liabilities
| | - |  | ---------------------------------------------------------



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



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



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



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



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



In order to obtain the benefits of any such acquisition, the acquired technology, products and services must operate together with our technology, products and services. We may be required to spend additional time or
money on integration, which would otherwise be spent on developing our products and services. If we do not integrate the technologies effectively or if management and technical staff spend too much time on integration issues, it could harm our
business, financial condition and results of operations, which may adversely affect our stock price. In addition, the success of any such acquisition may also depend on our ability to successfully integrate and manage the acquired operations and
retain or replace the key employees of the acquired business.



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



Potential losses from acquisitions may harm our business.



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



Our international operations are subject to additional risks.



Revenue from customers outside the United States was approximately $7,781,000, or 31% of our total revenue for the year ended December 31, 2003. This percentage may rise as a result of our acquisition of Amacis. We
currently customize our products for select foreign markets. In the future, we plan to develop additional localized versions of our products and localization of our products will create additional costs and would cause delays in new product
introductions. In addition, our international operations will continue to be subject to a number of other risks, including:



| |  |  | costs and complexity of customizing products for foreign countries
| | - |  | ------------------------------------------------------------------



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



| |  |  | compliance with multiple, conflicting and changing laws and regulations
| | - |  | -----------------------------------------------------------------------



| |  |  | longer sales cycles
| | - |  | -------------------



| |  |  | greater difficulty or delay in accounts receivable collection
| | - |  | -------------------------------------------------------------



| |  |  | import and export restrictions and tariffs
| | - |  | ------------------------------------------



| |  |  | difficulties in staffing and managing foreign operations
| | - |  | --------------------------------------------------------



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| |  |  | investing at appropriate levels in foreign operations to compete effectively
| | - |  | ----------------------------------------------------------------------------



| |  |  | political and economic instability
| | - |  | ----------------------------------



Our international operations also face foreign-currency-related risks. To date, substantially all of our revenue has been denominated in U.S. dollars, but
we believe that in the future, an increasing portion of our revenue may be denominated in foreign currencies, including the British Pound, Euro and Yen. Fluctuations in the value of foreign currencies may cause further volatility in our operating
results, reduce the accuracy of our financial forecasts and could have a material adverse effect on our business, operating results and financial condition.



Our failure to adapt to technology trends and evolving industry standards would hinder our competitiveness.



Our market is susceptible to rapid changes due to technology innovation,
evolving industry standards, and frequent new service and product introductions. New services and products based on new technologies or new industry standards expose us to risks of technical or product obsolescence. We will need to use leading
technologies effectively, continue to develop our technical expertise and enhance our existing products on a timely basis to compete successfully in this industry. We cannot be certain that we will be successful in using new technologies
effectively, developing new products or enhancing existing products on a timely basis or that any new technologies or enhancements used by us or offered to our customers will achieve market acceptance.



Our inability to continue integration of our products with other
third-party software could adversely affect market acceptance of our products.



Our ability to compete successfully also depends on the continued compatibility and interoperability of our products with products and systems sold by various third parties, including traditional eService software
sold by Amdocs/Clarify, BEA, Oracle, Peoplesoft, Remedy, Siebel and others. Currently, these vendors have open applications program interfaces, which facilitate our ability to integrate with their systems. These vendors have also been open to
licensing us rights to use their development tools to build integrations to their products. If any one of them should close their programs interface, fail to grant us necessary licenses or if they should acquire one of our competitors, our
ability to provide a close integration of our products could become more difficult and could delay or prevent our products integration with future systems.



Failure to successfully develop versions and updates of our products that run on the operating systems used by our
current and prospective customers could reduce our sales.



Many of our products run on the Microsoft Windows NT, Microsoft Windows 2000, Sun Solaris UNIX, Linux and various J2EE operating systems, and some require the use of third party software. Any change to our customers operating
systems could require us to modify our products and could cause us to delay product releases. In addition, any decline in the market acceptance of these operating systems we support may force us to ensure that all of our products and services are
compatible with other operating systems to meet the demands of our customers. If potential customers do not want to use the Microsoft, Sun Solaris or J2EE operating systems we support, we will need to develop more products that run on other
operating systems adopted by our customers. If we cannot successfully develop these products in response to customer demands, our business could be adversely impacted. The development of new products in response to these risks would require us to
commit a substantial investment of resources, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead potential customers to choose alternative products.



We rely on software licensed to us by third parties for features we
include in our solutions.



We incorporate software
licensed from third parties into our software products. As we develop enhanced versions of our software, some of the additional functionality and capabilities of our products may be a result of



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additional third party applications. A significant interruption in the availability of any of the licensed third-party software could adversely affect our
sales, unless and until we can replace this software with other software that performs similar functions. Because our solutions incorporate software developed and maintained by third parties, we depend on these third parties abilities to
deliver and support reliable products, enhance their current products, develop new products on a timely and cost-effective basis, and respond to emerging industry standards and other technological changes. If third-party software offered now or in
the future in conjunction with our solutions becomes obsolete or incompatible with future versions of our solutions, we may not be able to continue to offer some of the features we presently include in our solutions unless we can license alternative
software or develop the features ourselves.



Our stock price
has been volatile and could fluctuate in the future.



The market price of our common stock has been highly volatile and is subject to wide fluctuations. We expect our stock price to continue to fluctuate:



| |  |  | in response to quarterly variations in operating results
| | - |  | --------------------------------------------------------



| |  |  | in response to announcements of technological innovations or new products by us or our competitors
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | because of market conditions in the enterprise software industry
| | - |  | ----------------------------------------------------------------



| |  |  | in reaction to changes in financial estimates by securities analysts, and our failure to meet or exceed the expectations of analysts or investors
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in response to our announcements of significant acquisitions, strategic relationships or joint ventures
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | in response to sales of our common stock
| | - |  | ----------------------------------------



In the past, following periods of volatility in the market price of a particular companys securities, securities class action litigation has often
been brought against that company. We are currently subject to a securities related lawsuit (see Item 3, Legal Proceedings) and the volatility of our stock price could make us a target for additional suits. Securities class action
litigation could result in substantial costs and a diversion of our managements attention and resources. Volatility in our stock price could make it more difficult for us to raise capital or complete acquisitions on favorable terms.



Our efforts to protect our proprietary rights may be
inadequate.



Our success depends in part on our ability to
protect our proprietary rights. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions
such as those contained in license agreements with customers, consultants and vendors. We have not signed such agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and
obtain and use information that we regard as proprietary. Other parties may breach such confidentiality agreements and other protective contracts. We may not become aware of, or have adequate remedies in the event of, such breaches.



We pursue the registration of some of our trademarks and service marks in the
United States and in certain other countries, but we have not secured registration of all our marks. Significant portions of our marks include the word Primus. Other companies use Primus in their marks alone or in combination
with other words, and we cannot prevent all third-party uses of the word Primus. We license certain trademark rights to third parties. Such licensees may not abide by compliance and quality control guidelines with respect to such
trademark rights and may take actions that would adversely affect our trademarks.



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



If any of our products are found to violate third party
intellectual property or proprietary rights, we may be liable for damages and be required to reengineer our products or seek to obtain licenses from third parties, and such efforts may not be successful. We do not conduct comprehensive patent
searches to determine whether the technology used in our products infringes patents held by third parties. Product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications
pending, which are confidential when filed, with regard to potentially similar technologies. In addition, other companies have filed trademark applications for marks similar to the names of our products. Although we believe that our products do not
infringe the proprietary rights of any third parties, third parties could assert infringement claims against us in the future. The defense of any such claims would require us to incur substantial costs and would divert managements attention
and resources to defend against any claims relating to proprietary rights, which could materially and adversely affect our financial condition and operations. If a party succeeded in making such a claim we could be liable for substantial damages, as
well as injunctive or equitable relief that could effectively block our ability to sell our products and services. Any such outcome could have a material adverse effect on our business, financial condition, operating results and stock price. We do
not carry any insurance against intellectual property infringement claims. See Item 3. Legal Proceedings for a discussion of an outstanding claim of patent infringement.



Product liability claims by our customers could result in unexpected costs and damage to our reputation.



Our license agreements with customers generally contain provisions
designed to limit our exposure to potential product liability claims, such as disclaimers of warranties and limitations on liability for special, consequential and incidental damages. In addition, our license agreements generally cap the amounts
recoverable for damages to the amounts paid by the licensee to Primus for the product or services giving rise to the damages. However, these contractual limitations on liability may not be enforceable and we may be subject to claims based on errors
in our software or mistakes in performing our services including claims relating to damages to our customers internal systems. A product liability claim, whether or not successful, could harm our business by increasing our costs, damaging our
reputation and diverting managements attention and resources to defend any such claim, which could materially and adversely affect our financial condition, our results of operations and our stock price.



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



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



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



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



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



The occurrence of any of these or similar events
could damage our business, hurt our ability to distribute and/or host products and services and collect revenue, threaten the proprietary or confidential nature of our



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technology, harm our reputation, and expose us to litigation or liability. We may be required to expend significant capital or other resources to protect
against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks.



Security breaches or equipment failure could damage our reputation and deter customers from using our services.



We must protect our computer systems and networks from physical break-ins,
security breaches and other events such as electrical disruptions, equipment failure, and fire and water damage. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network,
which could adversely affect our ability to retain or attract customers, damage our reputation and subject us to litigation. We could be subject to denial of service, vandalism and other attacks on our computer systems by individuals with malicious
intentions. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage in certain circumstances may be
insufficient to cover losses that may result from such events.



Future taxation or regulation of the Web may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.



Local, state, federal and foreign regulators could adopt additional laws and regulations that impose additional costs
or other burdens on those companies that conduct business online. These laws and regulations could discourage web-based communications and customer self-service, which could reduce demand for our products and services.



The growth and development of the market for online services may prompt calls
for more stringent consumer protection laws or laws that may inhibit the use of Internet-based communications or the information contained in these communications. The adoption of any additional laws or regulations may decrease the expansion of the
Internet. The imposition of taxes or other charges would likewise deter the use of the Internet. A decline in the growth of the Internet, particularly as it relates to online communication and customer self-service, could decrease demand for our
products and services and increase our costs of doing business, or otherwise harm our business. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to the Internet and other online services could harm our growth and increase our costs, which could materially and adversely affect our financial condition, results of operations and our stock price.



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



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



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Certain of our facilities are located near known earthquake fault zones, and the occurrence of an
earthquake or other catastrophic disaster could cause damage to our facilities and equipment, which could require us to cease or curtail operations.



Our principal facilities are located in Seattle, Washington and are vulnerable to damage from earthquakes. We are also vulnerable to damage from other
types of disasters, including fire, floods, power loss, communications failures and similar events. If any disaster were to occur, our ability to operate our business at our principal facilities would be seriously, or potentially completely,
impaired. There are additional risks to our ability to maintain our hosting facilities for use of our applications over the Internet in a disaster. In addition, a disaster could cause significant delays in our development efforts. The insurance we
maintain may not be adequate to cover our losses resulting from disasters or other business interruptions. Accordingly, an earthquake or other disaster could materially and adversely harm our ability to conduct business.



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



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



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



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



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



Specific provisions of our articles of incorporation and
bylaws and Washington law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders.



Our articles of incorporation and bylaws establish a classified board of directors, eliminate the ability of shareholders to call special meetings,
eliminate cumulative voting for directors and establish procedures for advance notification of shareholder proposals. The presence of a classified board and the elimination of



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cumulative voting may make it more difficult for an acquirer to replace our board of directors. Further, the elimination of cumulative voting substantially
reduces the ability of minority shareholders to obtain representation on the board of directors.



Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further vote or action by our shareholders. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change of control of Primus and may
adversely affect the market price of the common stock and the voting and other rights of the holders of common stock.



Washington law imposes restrictions on some transactions between a corporation and significant shareholders. Chapter 23B.19 of the Washington Business
Corporation Act prohibits a target corporation, with some exceptions, from engaging in particular significant business transactions with an acquiring person, which is defined as a person or group of persons that beneficially owns 10% or more of the
voting securities of the target corporation, for a period of five years after the acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporations board of directors prior to the
acquisition. Prohibited transactions include, among other things:



| |  |  | a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from, the acquiring person
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | termination of 5% or more of the employees of the target corporation
| | - |  | --------------------------------------------------------------------



| |  |  | allowing the acquiring person to receive any disproportionate benefit as a shareholder
| | - |  | --------------------------------------------------------------------------------------



A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a
change in control of Primus. The foregoing provisions of our charter documents and Washington law could have the effect of making it more difficult or more expensive for a third party to acquire, or could discourage a third party from attempting to
acquire Primus. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.



You should not unduly rely on forward-looking statements because they are inherently uncertain.



You should not rely on forward-looking statements in this Report. This
document contains forward-looking statements that involve risks and uncertainties. We use words such as may, will, should, expects, plans, anticipates, believes,
estimates, predicts, potential, continue, or the negative of these terms or other comparable terminology to identify forward-looking statements. You should not place undue reliance on these
forward-looking statements, which apply only as of the date of this Report. The forward-looking statements contained in this Report are subject to the provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks described above and elsewhere in this Report and in our other reports and documents on file with
the U.S. Securities and Exchange Commission.



ITEM 2.    PROPERTIES



We lease principal administrative, engineering, manufacturing, marketing and sales facilities consisting of approximately 19,000 square feet in an office tower in Seattle, WA. The lease for this space extends to October 31, 2005. We
also lease other domestic sales and services offices in Santa Clara, CA, Beaver Creek, OH, Boston, MA, Clifton Park, NY, and Dallas, TX, as well as a location in Washington, DC primarily dedicated to engineering. The hub of our European Operations
is located in the United Kingdom with an additional sales office in Paris, France and a location in Northern Ireland primarily dedicated to engineering. We believe that our existing facilities are adequate to meet current requirements and that
additional or substitute space will be available as needed to accommodate any expansion of operations. Additional information with respect to office lease commitments is set forth under the caption Commitments and Contingencies in Note
10 of the Notes to Consolidated Financial Statements.



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ITEM 3.    LEGAL PROCEEDINGS



The Company, an officer, former officer and FleetBoston Robertson Stephens, Inc., J.P. Morgan Securities Inc., U.S. Bancorp Piper Jaffray Inc., CIBC World Markets, Dain Rauscher, Inc. and Salomon Smith Barney Holdings
Inc., the underwriters of our initial public offering, have been named as defendants in an action filed during December 2001 in the United States District Court for the Southern District of New York on behalf of persons who purchased Primus common
stock during the period from June 30, 1999 through December 6, 2000, which was issued pursuant to the June 30, 1999 registration statement and prospectus for the Companys initial public offering. This is one of a number of actions coordinated
for pretrial purposes. Plaintiffs in the coordinated proceeding have brought claims under the federal securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and
undisclosed activities concerning the allocation of shares in the IPOs of more than 300 companies during the period from late 1998 through 2000. Specifically, among other things, the plaintiffs allege that the prospectus pursuant to which
shares of Company common stock were sold in the Companys IPO contained certain false and misleading statements regarding the practices of the Companys underwriters with respect to their allocation of shares of common stock in the
Companys IPO to their customers and their receipt of commissions from those customers related to such allocations, and that such statements and omissions caused the Companys post-IPO stock price to be artificially inflated. The
individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. In June 2003 the plaintiffs in this action announced a proposed settlement with the issuer defendants and their insurance carriers. The
Company has elected to participate in the settlement, which generally provides that our insurance carrier is responsible for any payments other than legal fees we incurred before June 2003. On March 4, 2004, plaintiffs executive committee
advised the court that the negotiators for plaintiffs and issuers had agreed on the terms of the settlement. The court must still approve the settlement. If the settlement does not occur, and litigation against the Company continues, the Company
believes it has meritorious defenses and intends to defend the case vigorously. While we can not predict with certainty the outcome of the litigation or whether the settlement will be approved, we do not expect any material adverse impact to its
business from this matter.



In October 2003, we received notice
that ServiceWare, Inc. had filed a complaint against Primus in the United States District Court for the Western District of Pennsylvania, which alleges that aspects of our technology infringe one or more patents issued in 1998 alleged to be held by
the plaintiff. The complaint was served on us on January 28, 2004. We intend to vigorously defend against the allegations asserted in this complaint and we believe the plaintiffs claims are without merit. In February of 2004, we filed our
answer, denying all substantive claims, raising multiple affirmative defenses (including that the patents are invalid and unenforceable, that Primus products dont infringe the patents in any event and that these claims on 1998 patents are
barred by equitable estoppel and latches) and including a number of counterclaims. The results of any litigation matter are inherently uncertain. In the event of an adverse result in this action, or in any other litigation with third parties that
could arise in the future with respect to intellectual property rights relevant to our products or services, we could be required to pay substantial damages, including treble damages if we are held to have willfully infringed, to cease the use of
infringing products or services, to expend significant resources to develop non-infringing technology or to attempt to obtain licenses to the infringing technology on commercially reasonable terms, if at all. In addition, litigation frequently
involves substantial expenditures and can require significant management attention, even if the Company ultimately prevails. Accordingly, we cannot provide assurances that this action will not materially and adversely affect our business, our
results of operation or our stock price.



As of December 31,
2003, no amounts have been accrued as a liability associated with the aforementioned legal proceedings as the incurrence of a liability is not considered probable.



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



No matters were submitted to a vote of the security holders during our fourth quarter.



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PART II



ITEM 5.    MARKET FOR THE REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS



Market Price of Common Stock



Since our initial public offering on June 30, 1999, our common stock has traded on either the Nasdaq National or the Nasdaq Small Cap Market® under the symbol PKSI. The following table sets forth,
for the period indicated, the high and low sales closing prices for the common stock as reported on either the Nasdaq National or Small Cap Market. These quotations reflect inter-dealer prices and do not include retail markups, markdowns, or
commissions and may not necessarily represent actual transactions.



COMMON STOCK PRICE



|                                  |  |      |      |     |   |     
|--------------------------------- |  | ---- | ---- | --- | - | ----
|Period                            |  | High |      | Low
|January 1, 2002March 31, 2002    |  | $    | 2.50 |     | $ | 0.83
|April 1, 2002June 30, 2002       |  | $    | 2.58 |     | $ | 0.70
|July 1, 2002September 30, 2002   |  | $    | 0.86 |     | $ | 0.31
|October 1, 2002December 31, 2002 |  | $    | 0.62 |     | $ | 0.25
|January 1, 2003March 31, 2003    |  | $    | 0.95 |     | $ | 0.43
|April 1, 2003June 30, 2003       |  | $    | 1.45 |     | $ | 0.56
|July 1, 2003September 30, 2002   |  | $    | 1.80 |     | $ | 1.10
|October 1, 2003December 31, 2003 |  | $    | 6.29 |     | $ | 1.48



The closing sale price
of the common stock on December 31, 2003 was $6.29. On March 18, 2004 the closing price reported on the Nasdaq Small Cap Market System for the common stock was $4.22.



Holders of Common Stock



As of March 18, 2004, there were approximately 250 shareholders of record of our common stock and 23,676,884 shares of common stock outstanding.



Dividend Policy



We have never paid any cash dividends on our common stock and do not
anticipate paying dividends in the foreseeable future. We intend to retain any future earnings for use in our business. In addition, the terms of our current credit facility prohibits us from paying dividends without our lenders consent. See
Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources and Note 6, Financing Arrangements, to our attached Consolidated Financial Statements.



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ITEM 6.    SELECTED CONDENSED CONSOLIDATED FINANCIAL DATA



The condensed consolidated statement of operations data and balance sheet data presented below were derived from our audited consolidated financial
statements. When you read this selected condensed consolidated financial data, it is important that you also read the historical consolidated financial statements and related notes included in this Form 10-K, as well as the section of this Form 10-K
related to Managements Discussion and Analysis of Financial Condition and Results of Operations. Historical results are not necessarily indicative of future results.



|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | - |  | ---- | ---------- | - |  | - | ---------- | -
|                                                                                                     |  | Fiscal Year Ended December 31,        |           
|                                                                                                     |  | 2003                                  |            |   | 2002 |   |            | 2001 |  |   | 2000       |   |  | 1999 |           
|                                                                                                     |  | (In thousands, except per share data) |           
|Condensed Consolidated Statement of Operations Data (1):                                             |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Revenue                                                                                              |  | $                                     | 25,051     |   |      | $ | 20,942     |      |  | $ | 27,550     |   |  | $    | 47,669     |   |  | $ | 27,318     |  
|Cost of revenue                                                                                      |  |                                       | 5,404      |   |      |   | 5,025      |      |  |   | 8,107      |   |  |      | 10,892     |   |  |   | 7,725      |  
|Sales and marketing                                                                                  |  |                                       | 10,434     |   |      |   | 11,519     |      |  |   | 19,812     |   |  |      | 27,653     |   |  |   | 19,180     |  
|Research and development                                                                             |  |                                       | 7,788      |   |      |   | 7,856      |      |  |   | 12,636     |   |  |      | 14,669     |   |  |   | 10,177     |  
|General and administrative                                                                           |  |                                       | 4,452      |   |      |   | 4,367      |      |  |   | 6,551      |   |  |      | 9,401      |   |  |   | 6,657      |  
|Amortization of goodwill                                                                             |  |                                       |           |   |      |   |           |      |  |   | 550        |   |  |      |           |   |  |   |           |  
|Restructuring charges                                                                                |  |                                       |           |   |      |   | 1,227      |      |  |   | 2,530      |   |  |      |           |   |  |   |           |  
|Merger related costs                                                                                 |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      | 505        |   |  |   | 1,520      |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Loss from operations                                                                                 |  |                                       | (3,027     | ) |      |   | (9,052     | )    |  |   | (22,636    | ) |  |      | (15,451    | ) |  |   | (17,941    | )
|Other income (expense), net                                                                          |  |                                       | 170        |   |      |   | 202        |      |  |   | 1,232      |   |  |      | 2,655      |   |  |   | 1,093      |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Loss before income taxes, extraordinary item and cumulative effect of change in accounting principle |  |                                       | (2,857     | ) |      |   | (8,850     | )    |  |   | (21,404    | ) |  |      | (12,796    | ) |  |   | (16,848    | )
|Income tax expense                                                                                   |  |                                       | 70         |   |      |   | 111        |      |  |   | 417        |   |  |      | 217        |   |  |   | 267        |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Loss before extraordinary item and cumulative effect of change in accounting principle               |  |                                       | (2,927     | ) |      |   | (8,961     | )    |  |   | (21,821    | ) |  |      | (13,013    | ) |  |   | (17,115    | )
|Extraordinary gain on disposal of assets                                                             |  |                                       |           |   |      |   |           |      |  |   | 566        |   |  |      |           |   |  |   |           |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Loss before cumulative effect of change in accounting principle                                      |  |                                       | (2,927     | ) |      |   | (8,961     | )    |  |   | (21,255    | ) |  |      | (13,013    | ) |  |   | (17,115    | )
|Cumulative effect of change in accounting principle (3)                                              |  |                                       |           |   |      |   | (2,281     | )    |  |   |           |   |  |      |           |   |  |   |           |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Net loss                                                                                             |  | $                                     | (2,927     | ) |      | $ | (11,242    | )    |  | $ | (21,255    | ) |  | $    | (13,013    | ) |  | $ | (17,115    | )
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Net loss available to common shareholders                                                            |  | $                                     | (2,927     | ) |      | $ | (11,242    | )    |  | $ | (21,255    | ) |  | $    | (13,056    | ) |  | $ | (18,234    | )
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Basic and diluted net loss per common share (2):                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Loss before extraordinary item                                                                       |  | $                                     | (0.15      | ) |      | $ | (0.47      | )    |  | $ | (1.18      | ) |  | $    | (0.74      | ) |  | $ | (1.81      | )
|Extraordinary gain on disposal of assets                                                             |  |                                       |           |   |      |   |           |      |  |   | 0.03       |   |  |      |           |   |  |   |           |  
|Cumulative effect of change in accounting principle                                                  |  |                                       |           |   |      |   | (0.12      | )    |  |   |           |   |  |      |           |   |  |   |           |  
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|                                                                                                     |  | $                                     | (0.15      | ) |      | $ | (0.59      | )    |  | $ | (1.15      | ) |  | $    | (0.74      | ) |  | $ | (1.81      | )
|                                                                                                     |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Shares used in computing basic and diluted net loss per common share                                 |  |                                       | 19,379,326 |   |      |   | 18,982,841 |      |  |   | 18,551,628 |   |  |      | 17,705,757 |   |  |   | 10,081,183 |  
|                                                                                                     | 
|                                                                                                     |  | December 31,                          |           
|                                                                                                     |  | 2003                                  |            |   | 2002 |   |            | 2001 |  |   | 2000       |   |  | 1999 |           
|                                                                                                     |  | (In thousands)                        |           
|Condensed Consolidated Balance Sheet Data (1):                                                       |  |                                       |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Cash, cash equivalents and short-term investments                                                    |  | $                                     | 12,154     |   |      | $ | 12,958     |      |  | $ | 18,499     |   |  | $    | 39,959     |   |  | $ | 54,657     |  
|Working capital                                                                                      |  |                                       | 2,980      |   |      |   | 7,604      |      |  |   | 14,288     |   |  |      | 34,398     |   |  |   | 44,538     |  
|Total assets                                                                                         |  |                                       | 35,663     |   |      |   | 21,260     |      |  |   | 33,294     |   |  |      | 56,938     |   |  |   | 67,406     |  
|Total current liabilities                                                                            |  |                                       | 15,650     |   |      |   | 10,402     |      |  |   | 11,263     |   |  |      | 17,091     |   |  |   | 19,591     |  
|Long-term debt, net of current portion                                                               |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   | 60         |  
|Redeemable convertible preferred stock                                                               |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   | 9,054      |  
|Shareholders equity (deficit)                                                                       |  |                                       | 20,013     |   |      |   | 10,858     |      |  |   | 22,031     |   |  |      | 39,847     |   |  |   | 38,701     |  

---

|(1) |  | Reflects restatement for pooling-of-interests business combinations in 2000 and 1999.
|--- |  | -------------------------------------------------------------------------------------

|(2) |  | For further discussion of loss per common share see Note 1 of Notes to Consolidated Financial Statements.
|--- |  | ---------------------------------------------------------------------------------------------------------

|(3) |  | For further discussion of the change in accounting principle see Note 1 of Notes to Consolidated Financial Statements.
|--- |  | ----------------------------------------------------------------------------------------------------------------------



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ITEM 7.    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Forward-Looking Statements



This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning Primus
performance and financial results. There are a variety of factors that could cause actual events or results to differ materially from those projected in the forward-looking statements, including, without limitation: our ability successfully
implement sales of our software solutions; competition, adoption and implementation of our software solutions by our customers; changes in general economic conditions, or other unforeseen developments in the industries in which we operate (See also
Item 1 Risks and Uncertainties Associated with Our Business and Future Operating Results). Accordingly, there can be no assurance that future activities or results will be as anticipated. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expects, plans, anticipates, believes, estimates, predicts, potential,
continue, or the negative of these terms or other comparable terminology.



Overview



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



To compete in todays business environment, companies
must maximize their relationships with prospective and existing customers. This has led many companies to implement eService initiatives and software. eService software is designed to enable companies to interact with their customers and manage
customer information in a way that helps companies maximize the value of each customer interaction. Facilitating more efficient communications with customers can help to improve the level and quality of customer service and, in turn, increase
customer satisfaction and retention and cross-sell and up-sell opportunities.



Our software suite consists of Primus eServer, Primus Enterprise Search and Primus Visibility. Product license revenue and related services from Primus eServer related products accounted for approximately 86% and 90%
of total revenue for the years ended December 31, 2003 and 2002, respectively. License fees for our software vary with each application, but our products are typically licensed on a per-processor basis, per-user basis or based on the number of users
authorized to access our software at any given time. Our typical license agreement provides the licensee a perpetual, nontransferable license to use our software. We deploy our solutions either in-house at the customers facility as installed
software or in a hosted environment operated and maintained by us. Customers using our hosted offerings can take advantage of our hosting expertise, thereby reducing the demands on their own information technology resources while receiving the full
benefit of secure and reliable access to our applications.



We
target mid- to large-sized organizations, and our products are used by contact centers, IT helpdesks, field service organizations, human resources organizations, marketing organizations, and eService businesses. Our customers include companies from
many verticals, including: High-tech, Telecommunications, Outsourced



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Services Providers, Financial Services, Manufacturing and Government. We develop our products and market and sell our software and services primarily through
a direct sales force and a minority owned Japanese entity. We have offices throughout the United States, and in the United Kingdom and France. Our principal executive offices are located at 1601 Fifth Avenue, Suite 1900, Seattle, WA 98101.



We market our software and services on a worldwide basis
primarily through our direct sales organization in the United States and Europe. Primus KK, a Japanese joint venture in which we hold a minority interest, has exclusive distribution rights to distribute our Primus eServer and Primus eSupport
products in Japan. Our international revenue constituted 31% and 20% of our total revenue for the years ended December 31, 2003 and 2002, respectively. We believe that international revenue, as a percentage of our total revenue, will continue to
fluctuate in the future. We have not guaranteed any obligations of our Japanese joint venture nor do we have any commitment or intent to provide any funding.



To help us execute our long-term growth strategy, we have invested heavily in product development and in building our sales, marketing, finance,
administrative and professional services organizations. We have incurred cumulative net losses since inception, and as of December 31, 2003, had an accumulated deficit of approximately $103 million. We anticipate that our operating expenses will
continue to be substantial for the foreseeable future as we continue to invest in product development and sales and marketing.



Factors adversely affecting the demand for our products and services, such as competition, pricing or technological change, could materially and adversely
affect our business, financial condition, operating results and stock price. Our future financial performance will substantially depend on our ability to sell current versions of our entire suite of products and our ability to develop and sell
enhanced versions of our products. We are subject to certain business risks that could affect future operations and financial performance. These risks include, but are not limited to, changing computing environments, rapid technological change,
development of new products, limited protection of proprietary technology, claims of intellectual property infringement and competitive products and pricing (See also Item 1. Risks and Uncertainties Associated with Our Business and Future
Operating Results).



Acquisitions



Acquisition of Broad Daylight, Inc.



On August 12, 2003, we signed a definitive merger agreement and announced
our intent to acquire 100% of the voting interest in Broad Daylight, Inc. (Broad Daylight) an e-service software developer specializing in solutions for customer and employee self-service. The merger of Broad Daylight with a subsidiary
of Primus closed on September 3, 2003. The combined offerings will leverage natural language search and rules-based problem-solving technologies, and will provide a complete range of options for companies looking for assisted service and
self-service solutions. Under the terms of the agreement, we purchased all of the outstanding shares of Broad Daylight in exchange for 2,131,009 shares of Primus common stock valued at approximately $2,536,000, plus cash of approximately $140,000
and direct acquisition costs of approximately $198,000. The fair value of the common stock issued for the acquisition was $1.19 per share, based on the average market price for a period before and after August 12, 2003.



The purchase price of approximately $2.9 million was allocated to the assets
acquired and liabilities assumed based on their fair values at the acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $3.3 million has been recorded as goodwill.



Acquisition of Amacis Group Limited



On December 22, 2003, we signed a share purchase agreement to acquire 100%
of the voting interest in Amacis Group Limited (Amacis), a leading provider of electronic commerce management solutions to global enterprises. The acquisition of Amacis will further extend our breadth and depth in the eService
marketplace by



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adding complementary email and wireless technologies to our customer service and support software solutions. The acquisition of Amaciss shares closed
on December 22, 2003. Under the terms of the agreement, we purchased all of the outstanding shares of Amacis in exchange for 1,234,692 shares of Primus common stock valued at approximately $7.4 million, and assumed all employee stock options
outstanding under an existing Amacis stock option plan (100% vested), valued at approximately $1.1 million and incurred direct acquisition costs of approximately $364,000. The fair value of the common stock issued by Primus upon the acquisition was
$6.00 per share, based on the average market price for a period before and after December 22, 2003.



The purchase price of approximately $8.9 million was allocated to the assets acquired and liabilities assumed based on their fair values at the
acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $8.4 million has been recorded as goodwill.



The following unaudited pro forma financial information presents the results of operations of Primus, Broad Daylight and
Amacis as if the acquisitions had occurred on January 1, 2003 and 2002 after giving effect to certain adjustments, primarily amortization of identifiable intangibles. The pro forma information does not purport to be indicative of what would have
occurred had the acquisitions been made as of those dates or of results that may occur in the future.



The unaudited pro forma financial information is as follows (in thousands, except per share data):



|                                                                                  |  |                         |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Year ended December 31, |        
|                                                                                  |  | 2003                    |         |   | 2002 |  
|Total revenues                                                                    |  | $                       | 27,624  |   |      | $ | 27,737  |  
|Loss before cumulative effect of change in accounting principle                   |  | $                       | (10,231 | ) |      | $ | (22,311 | )
|Net loss                                                                          |  | $                       | (10,231 | ) |      | $ | (24,592 | )
|Pro forma loss per share:                                                         |  |                         |         |   |      |   |         |  
|Loss before cumulative effect of change in accounting principlebasic and diluted |  | $                       | (0.45   | ) |      | $ | (1.00   | )
|Net lossbasic and diluted                                                        |  | $                       | (0.45   | ) |      | $ | (1.10   | )
|Weighted average shares outstanding                                               |  |                         | 22,624  |   |      |   | 22,349  |  



Restructurings



During 2001 and 2002, we executed restructuring plans to reduce headcount
and infrastructure, and to eliminate excess leased facilities. During the years ended December 31, 2001 and 2002, we recorded $2,530,000 and $1,227,000, respectively, in restructuring and other related charges. Restructuring charges for the year
ended December 31, 2003 were $0.



The excess facilities and
asset impairment charges recorded in 2001 and 2002 were the result of our decision to exit certain domestic and international facilities and were estimated based on our evaluation of then current market conditions relative to our existing excess
facilities accrual. The estimated facilities costs are based on current comparable rates for leases and subleases of a comparable term or termination fees. The asset impairment charges were primarily for leasehold improvements, computer equipment
and related software, office equipment and furniture and fixtures disposed of or removed from operations as a direct result of the restructuring plans. If estimates and/or assumptions change, the actual loss may differ from this estimate. Future
cash outlays are anticipated through June 2004, unless we are able to negotiate to exit the lease at an earlier date.



During March of 2004, we executed a further restructuring of our workforce to realize the efficiencies and synergies from our recent acquisitions and as a
result will be recording restructuring charges of approximately $500,000 for severance and benefits and associated costs due to an approximate 10% reduction in our worldwide workforce. Additionally, we anticipate consolidating our Santa Clara
operations into other existing locations and expect to record an excess facility and/or asset impairment charge in 2004.



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As we continue to evaluate our underlying cost structure to improve our operating results and better
position ourselves for growth, we may incur further restructuring charges, including severance, benefits and related costs due to a reduction in workforce and/or charges for excess facilities or assets disposed of or removed from operations as a
direct result of a reduction in workforce.



Significant Accounting Policies
and Estimates



Our discussion and analysis of our
financial condition and results of operations are based upon 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
consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



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



Restructuring



During 2001, 2002 and again in 2004, we recorded
significant write-offs and accruals in connection with our restructuring program under EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) and SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. These write-offs and accruals include estimates pertaining to employee separation costs and the settlements of contractual
obligations related to excess leased facilities and other contracts. Although we believe that we have made reasonable estimates of our restructuring costs in calculating these write-offs and accruals, the actual costs could differ from these
estimates.



In June 2002, the FASB issued SFAS, No. 146. This
Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF No. 94-3. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized at
fair value when the liability is incurred. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 in 2003 did not have a material effect on our financial
statements.



Revenue Recognition



We recognize revenue in accordance with accounting standards established for
software companies. These include Statement of Position No. 97-2, Software Revenue Recognition, as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements and Staff
Accounting Bulletin (SAB) No. 104 Revenue Recognition, which was issued in December 2003 and supercedes SAB No.101, Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement
exists, collection is probable, the fee is fixed or determinable and there is vendorspecific objective evidence (VSOE) to allocate the total fee to the elements of the arrangement.



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



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



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



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



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



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



From time to time we enter into distribution agreements with resellers that
typically provide for sublicense fees based on a percentage of list prices. Our distribution agreement with Primus KK, a related party, provided for sublicense fees based on a percentage of net fees collected by Primus KK from its customers, subject
to certain guaranteed minimum royalty payments. Sublicense fees are recognized upon delivery of software to Primus KK if pervasive evidence of an arrangement between the distributor and their customer exists, collection is probable, the fee is fixed
or determinable, and vendor-specific objective evidence exists for the undelivered elements. Guaranteed minimum royalty payments, to the extent they exceed sublicense fees due, are recognized in the period earned. Our agreements with our customers
and resellers, including Primus KK, do not contain product return rights.



Accounts Receivable



We
perform a quarterly analysis to determine the appropriate allowance for doubtful accounts. This analysis includes various analytical procedures and a review of factors, including specific individual balances selected from a cross-section of the
accounts that comprise total accounts receivable, our history of collections, as well as



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the overall economic environment. At December, 2003 and December 31, 2002, the allowance for doubtful accounts was $174,000 and $412,000, respectively.



Goodwill



SFAS No. 142, Goodwill and Other Intangible Assets, requires
that goodwill no longer be amortized to earnings, but instead be tested at least annually for impairment. The amortization of goodwill ceases upon the required adoption date of the Statement, which for us was January 1, 2002. At the date of
adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The implied fair value of goodwill was calculated based upon a comparison of the book value of the
Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002. Accordingly, we recognized a $2.3 million transitional impairment loss as the cumulative effect of a change in accounting
principle as a result of the adoption of SFAS No. 142.



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



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



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



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



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



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



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Results of Operations for the Years Ended December 31, 2003, 2002 and 2001



The following table sets forth, for the periods indicated, the percentage of
total revenue represented by each item reflected in our Consolidated Statements of Operations.



|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|---------------------------------------------------------------------------------------------------- |  | ---------------------------------- | -- |  | ---- | -- |  | ---- | --
|                                                                                                     |  | Fiscal Year Ended December 31,     |   
|                                                                                                     |  | 2003                               |    |  | 2002 |    |  | 2001 |   
|                                                                                                     |  | (As a percentage of total revenue) |   
|Revenue:                                                                                             |  |                                    |    |  |      |    |  |      |   
|License                                                                                              |  | 43                                 | %  |  | 39   | %  |  | 46   | % 
|Service                                                                                              |  | 57                                 |    |  | 61   |    |  | 54   |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Total revenue                                                                                        |  | 100                                |    |  | 100  |    |  | 100  |   
|Cost of revenue:                                                                                     |  |                                    |    |  |      |    |  |      |   
|License                                                                                              |  | 2                                  |    |  | 2    |    |  | 1    |   
|Service                                                                                              |  | 19                                 |    |  | 22   |    |  | 28   |   
|Amortization of purchased intangibles                                                                |  | 1                                  |    |  |     |    |  |     |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Total cost of revenue                                                                                |  | 22                                 |    |  | 24   |    |  | 29   |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Gross profit                                                                                         |  | 78                                 |    |  | 76   |    |  | 71   |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Operating expenses:                                                                                  |  |                                    |    |  |      |    |  |      |   
|Sales and marketing                                                                                  |  | 42                                 |    |  | 55   |    |  | 72   |   
|Research and development                                                                             |  | 31                                 |    |  | 37   |    |  | 46   |   
|General and administrative                                                                           |  | 18                                 |    |  | 21   |    |  | 24   |   
|Amortization of goodwill                                                                             |  |                                   |    |  |     |    |  | 2    |   
|Restructuring charges                                                                                |  |                                   |    |  | 6    |    |  | 9    |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Total operating expenses                                                                             |  | 91                                 |    |  | 119  |    |  | 153  |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Loss from operations                                                                                 |  | (12                                | )  |  | (43  | )  |  | (82  | ) 
|Other income, net                                                                                    |  | 1                                  |    |  | 1    |    |  | 4    |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Loss before income taxes, extraordinary item and cumulative effect of change in accounting principle |  | (11                                | )  |  | (42  | )  |  | (78  | ) 
|Income tax expense                                                                                   |  | 1                                  |    |  | 1    |    |  | 1    |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Loss before extraordinary item and cumulative effect of change in accounting principle               |  | (12                                | )  |  | (43  | )  |  | (79  | ) 
|Extraordinary gain on disposal of assets                                                             |  |                                   |    |  |     |    |  | 2    |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Loss before cumulative effect of change in accounting principle                                      |  | (12                                | )  |  | (43  | )  |  | (77  | ) 
|Cumulative effect of change in accounting principle                                                  |  |                                   |    |  | (11  | )  |  |     |   
|                                                                                                     |  |                                    |    |  |      |    |  |      |   
|Net loss                                                                                             |  | (12                                | )% |  | (54  | )% |  | (77  | )%
|                                                                                                     |  |                                    |    |  |      |    |  |      |   



Years ended December 31, 2003 and
2002



Revenue



Total revenue was $25.1 million and $20.9 million in 2003 and 2002,
respectively, representing an increase of $4.2 million, or 20%. During the twelve months ended December 31, 2003, revenue from two customers represented 29% of total revenue. During 2002, no single customer accounted for 10% or more of total
revenue. Related party sales to Primus KK were $956,000 and $1,394,000, respectively. International revenue was $7.8 million and $4.2 million in 2003 and 2002, respectively, representing an increase of $3.6 million, or 84%. We believe that
international revenue, as a percentage of our total revenue, will continue to fluctuate in the future.



License Revenue.    Total license revenue was $10.7 million and $8.1 million in 2003 and 2002, respectively, representing an
increase of $2.6 million, or 33%. During the second half of 2003, we acquired



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Broad Daylight, Inc. and Amacis Group Limited (the Acquired Companies) and our financial statements include the results of their operations since
the respective dates of acquisition. License revenue for 2003 includes sales of their products to new and existing customers of approximately $1.3 million. License revenue as a percentage of total revenue was 43% and 39% in 2003 and 2002,
respectively. Although we experienced an increase in the sales of our software in 2003 as compared to 2002, we continued to experience long and unpredictable sales cycles, making it difficult to predict when license sales may close. We believe
software license revenue increased in absolute dollars and as a percentage of total revenue primarily due to enterprise sales to two customers that represented approximately 49% of 2003 license revenue. The general economic and business conditions
have been extremely challenging during 2003 and 2002, and we expect them to continue to affect capital-spending initiatives of our targeted new and existing customer base. Additionally, our license revenues depend on the overall demand for customer
relationship management products and information technology helpdesk applications.



Service Revenue.    Total service revenue was $14.3 million and $12.9 million in 2003 and 2002, respectively, representing an increase of $1.4 million, or 11%, which was the result of an
increase in hosting and consulting fees of $2.1 million, partially offset by a decrease in maintenance and support contract revenue of $700,000 over the same period. During 2003, total service revenue contributed by the Acquired Companies was
approximately $400,000. Service revenue as a percentage of total revenue was 57% and 61% in 2003 and 2002, respectively. Hosting and consulting revenue was $3.7 million and $1.6 million in 2003 and 2002, respectively. The increase in consulting and
hosting fees is directly attributable to an increase in the types of hosting offerings and number of customers we are providing hosting services for, as well as consulting services for two customers who entered into enterprise license agreements
with us during 2003. Hosting and consulting revenue from these two customers was approximately 38% of total hosting and consulting revenue during 2003. Hosting services are typically provided under renewable contracts that range in length from one
to twelve months. There can be no assurances that customers will renew these agreements as they expire. Maintenance and support contract revenue was $10.6 million and $11.3 million in 2003 and 2002, respectively, representing a decrease of $700,000
or 6%. The decline in maintenance and support contract revenue is primarily due to a decline in the number of licenses on which maintenance was renewed, which is primarily the result of continued pricing pressures, customer consolidation and
downsizing, the termination of certain low margin maintenance and support contracts and decreases in software license revenue over the last few years. We expect the amount of and proportion of total service revenue to total revenue to fluctuate in
the future, depending primarily on the dollar amounts of software license revenue, maintenance and support contract revenue, hosting and consulting fees and our customers use of third-party consulting and implementation services providers and
the ongoing renewals of customer maintenance and support and hosting contracts.



Cost of Revenue



Total cost of revenue was
$5.4 million and $5.0 million in 2003 and 2002, respectively, representing an increase of $379,000, or 8%.



Cost of License Revenue.    Cost of license revenue consists primarily of media, product packaging and shipping, documentation
and other production costs, and third party royalties. Cost of license revenue was $461,000 and $328,000 in 2003 and 2002, respectively, representing an increase of $133,000, or 41%. Cost of license revenue as a percentage of license revenue was 4%
during 2003 and 2002. The increase in the cost of license revenue as an absolute dollar amount is primarily due to the significant increase in license revenue in 2003 and to a slight increase in the cost of third party software purchased and resold
during 2003. We anticipate that our cost of license revenue will vary in absolute dollars and as a percent of license revenue due to increases or decreases in the volume of software product sales, the sales mix and the costs of third party
technology resold or integrated with our solutions.



Cost of
Service Revenue.Cost of services revenue consists primarily of salaries, benefits and allocated overhead costs related to customer support, consulting, training and global services personnel, including the cost



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of service provided by third-party consultants engaged by Primus. Cost of service revenue was $4.9 and $4.7 million in 2003 and 2002, respectively,
representing an increase of $178,000 or 4%. Cost of service revenue as a percentage of service revenue was 34% and 37%, or a gross margin of 66% and 63%, during 2003 and 2002, respectively. The decrease in cost of service revenue as a percentage of
services revenue was primarily due to certain higher margin hosting contracts, higher utilization rates for our professional services staff and reductions in allocated overhead costs. The reductions in allocated overhead costs primarily related to
compensation related benefits, occupancy costs, and depreciation and amortization, partially offset by costs related to the Acquired Companies during 2003. Costs of service revenue related to the Acquired Companies were approximately $200,000, and
included payroll and related expenses of approximately $155,000. Cost of service revenue will vary depending on the mix of services that we provide between support and maintenance, hosting, training, implementation and integration services, as well
as staffing levels, overhead costs and customer needs. Gross profit margins are generally higher for post contract customer support and maintenance services, which include the delivery of software enhancements and upgrades, than for training,
implementation and integration services.



Operating Expenses



Overhead costs.    Allocated overhead costs
generally include compensation related benefits, facilities costs (occupancy, utilities, telephone, internet, postage and freight), depreciation and amortization related to property and equipment, general supplies and repair and maintenance costs,
and bank fees and charges. Allocated overhead costs are allocated to Cost of Service Revenue (customer support, consulting, training and global services personnel), Sales and Marketing expense, Research and Development expense and General and
Administrative expense based primarily upon headcount, and were approximately $4.9 million and $6.4 million for 2003 and 2002, a decrease of approximately $1.5 million, or 23%. This decrease is primarily due to reductions in compensation related
benefits of approximately $400,000, facilities costs (primarily occupancy) of approximately $450,000 and depreciation and amortization expense related to property and equipment of approximately $600,000, as well as smaller cost reductions in other
areas as a direct result of our continued close monitoring of our expenses and further implementation of our cost control initiatives. Total allocated overhead costs are as follows (in 000s):



|                               |  |                         |       |      |   |      
|------------------------------ |  | ----------------------- | ----- | ---- | - | -----
|                               |  | Year ended December 31,
|                               |  | 2003                    |       | 2002
|Cost of service revenue        |  | $                       | 1,069 |      | $ | 1,276
|Sales and marketing            |  |                         | 1,318 |      |   | 1,803
|Research and development       |  |                         | 1,717 |      |   | 2,349
|General and administrative     |  |                         | 761   |      |   | 991  
|                               |  |                         |       |      |   |      
|Total allocated overhead costs |  | $                       | 4,865 |      | $ | 6,419
|                               |  |                         |       |      |   |      



The decrease in
compensation related benefits expense is the direct result of favorable claims experience during 2003 under our self insured health benefits plan and our 2002 head count reductions. The reduction in occupancy costs during 2003 was due to a reduction
in the total square footage under lease in our Seattle, WA corporate headquarters. Effective December 31, 2002, we reduced our office space by approximately 14,400 square feet, from 33,300 square feet to 18,900 square feet. The net decrease in
depreciation and amortization expense related to property and equipment was primarily due to the aging of our property and equipment, and a larger portion of those assets becoming fully depreciated during the second half of 2002 or during 2003, as
well as an excess facility and asset impairment charge of approximately $636,000 incurred in the third quarter of 2002. The asset impairment charge was primarily for leasehold improvements, computer equipment and related software, office equipment
and furniture and fixtures disposed of or removed from operations as a direct result of our restructuring plans.



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Sales and Marketing.    Sales and marketing expenses consist primarily of
salaries, bonuses, commissions and benefits earned by sales and marketing personnel, allocated overhead costs, direct expenditures such as travel, communication and occupancy for direct sales offices and marketing expenditures related to direct
mail, online marketing, advertising, trade shows, public relations and new product launches. Sales and marketing expenses were approximately $10.4 million and $11.5 million for 2003 and 2002, respectively, representing a decrease of $1.1 million or
9%. This decrease is primarily the result of reductions in allocated overhead costs, travel and entertainment costs, recruiting expenses, and consulting and marketing expenditures (e.g. advertising, promotions, public relations, telemarketing,
tradeshows and events and collateral materials) as part of our continued close monitoring of our expenses and further implementation of our cost control initiatives. This decrease was partially offset by costs related to the Acquired Companies
during 2003 and increases in sales commissions and bonuses of approximately 33%, which were directly related to the 20% increase in total revenue and the signing of enterprise deals with two customers during 2003, which resulted in higher commission
rates for the effected personnel. Sales and marketing expenses related to the Acquired Companies were approximately $500,000, and included payroll and related expenses of approximately $410,000. Sales and marketing expenses as a percentage of total
revenue were 42% and 55% in 2003 and 2002, respectively. This decrease as a percentage of total revenue is primarily due to the decrease in total sales and marketing expenses during 2003, as well as the increase in total revenue from 2002 to 2003.
We believe that a significant sales and marketing effort is essential for us to maintain market position and further increase market acceptance of our products, and we anticipate that we will continue to invest significantly in sales and marketing
for the foreseeable future.



Research and
Development.    Research and development expenses include development costs associated with new products, enhancements and upgrades of existing products and quality control testing, and consist primarily of salaries,
benefits, and contractors fees for software engineers, program and product managers, technical writers, linguistic specialists and quality assurance personnel and allocated overhead costs. Research and development expenses were approximately
$7.8 million and $7.9 million in 2003 and 2002, respectively, representing a slight decrease of approximately $68,000 or 1%. The decrease was primarily due to reductions in allocated overhead costs, research and development headcount during 2003 and
2002, and our continued close monitoring of our expenses and further implementation of our cost control initiatives; offset by increases in research and development spending of approximately $1,234,000 related to our engagement of an offshore
development team in January of 2003 and costs related to the Acquired Companies during 2003. Research and development expenses related to the Acquired Companies were approximately $465,000, and included payroll and related expenses of approximately
$325,000. Research and development expenses as a percentage of total revenue were 31% and 37% for 2003 and 2002, respectively. This decrease as a percentage of total revenue is primarily due to the slight decrease in total research and development
spending in 2003 and the significant increase in total revenue from 2002 to 2003. We believe that a significant research and development investment is essential for us to maintain our market position, to continue to expand our knowledge application
software and to develop additional applications. When required, we also use third-party development firms to expand the capacity and technical expertise of our internal research and development teams and in January of 2003 we engaged an offshore
development team to accelerate our development efforts. Accordingly, we anticipate that we will continue to invest in product research and development for the foreseeable future, and we anticipate research and development costs as an absolute dollar
amount will fluctuate, depending primarily on the volume of future revenue, customer needs, staffing levels, overhead costs and our assessment of market demand.



General and Administrative.    General and administrative expenses consist primarily of salaries, benefits and related costs
for executive, finance, human resource, legal, administrative and information services personnel, occupancy costs, bad debt expense and costs associated with being a public company, including, but not limited to, annual and other public-reporting
costs, directors and officers liability insurance, investor-relations programs, professional-services fees and allocated overhead costs. General and administrative expenses were approximately $4.5 million and $4.4 million in 2003 and
2002, respectively, representing an increase of approximately $85,000 or 2%. This increase is primarily due to compensation expense of approximately $1.0 million as a result of the October 2003 purchase of certain outstanding stock options from Mr.
Brochu, president



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and chief executive officer of Primus, approximately $310,000 of expense related to a noncompete agreement entered into with Mr. Brochu in November of 2003
and costs related to the Acquired Companies during 2003; offset by reductions in allocated overhead costs and legal, accounting and administrative fees (Legal Fees). General and administrative expenses related to the Acquired Companies
were approximately $130,000, and included payroll and related expenses of approximately $115,000. Legal Fees decreased by approximately $960,000 during 2003, due primarily to Legal Fees being abnormally high in 2002 and to the release of an accrual
in 2003 that was recorded in 2002. Included in 2002 expenses was approximately $385,000 related to the April 2002 Mindfabric patent litigation settlement and accrued expenses of approximately $250,000 related to a then pending preference action in
connection with the bankruptcy of a former customer. During 2003, there were no Legal Fees related to the Mindfabric litigation, we favorably settled the pending preference action, which resulted in the release of the $250,000 accrual, and we
realized further, smaller savings on other legal matters when compared to 2002. General and administrative expenses as a percentage of total revenue were 18% in 2003 and 21% in 2002. The decrease of general and administrative expense as a percentage
of total revenue is primarily attributable to the increase in revenue during 2003. We believe that our general and administrative expenses will fluctuate in absolute dollars in future periods, depending primarily on the volume of future revenue,
staffing levels, overhead costs and corporate infrastructure requirements including insurance, professional services, bad debt expense, legal expense and other administrative costs.



Restructuring Charges.    There were no restructuring charges during the year ended December 31,
2003. In 2002 we incurred restructuring charges of approximately $1.2 million related to our decision to exit certain domestic and international facilities and reduce our workforce.



During March of 2004, we executed a further restructuring of our workforce to realize the efficiencies and synergies from
our recent acquisitions and as a result will be recording restructuring charges of approximately $500,000 for severance and benefits and associated costs due to an approximate 10% reduction in our worldwide workforce. Additionally, we anticipate
consolidating our Santa Clara operations into other existing locations and expect to record an excess facility and/or asset impairment charge in 2004.



As we continue to evaluate our underlying cost structure to improve our operating results and better position ourselves for growth, we may incur further
restructuring charges, including severance, benefits and related costs due to a reduction in workforce and charges for assets disposed of or removed from operations as a direct result of a reduction in workforce.



Other Income, Net.    Other income decreased
$32,000, or 16%, from $202,000 in 2002 to $170,000 in 2003. The decrease from period to period is primarily due to decreases in investment yields, partially offset by interest earned in 2003 related to financing terms provided to a customer. We
expect to continue to yield investment income on our average balance of combined cash and cash equivalents and short-term and long-term investments at an average rate that is approximately the same as that experienced in 2003, and we do not expect
to earn interest income in 2004 on the customer financing agreement as the balance financed was fully paid in December 2003.



Income Taxes.    We have not recorded income tax benefits related to our net operating losses in 2003 or 2002, as a result of
the uncertainties regarding the realization of such net operating losses. Income tax expense recorded in 2003 and 2002 primarily relates to our foreign operations, and in 2003, was reduced by the favorable settlement of a foreign tax related matter
which resulted in the release of a $200,000 accrual that had been recorded prior to 2001.



At December 31, 2003, the Company has US and foreign net operating loss carryforwards of approximately $163.9 and $10.4 million respectively. The Company also has research and development tax credit carryforwards of
$3.4 million. Under the provisions of Section 382 of the Internal Revenue Code, the Tax Reform Act of 1986 limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a
company. The Company may have experienced such ownership changes as a result of the



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various stock offerings, and the utilization of the carryforwards could be limited such that a portion of the net operating losses may never be utilizable.
The US net operating loss carryforwards increased during 2003 by $25.8 million due to the acquisition of Broad Daylight. However, these losses will be subject to limitation under the provisions of Section 382 discussed above. The foreign net
operating loss carryforwards increased by $11.2 million due to the acquisition of Amacis. Approximately $43.0 of the net operating loss carryforwards at December 31, 2003 result from deductions associated with the exercise of non-qualified employee
stock options, the realization of which would result in a credit to shareholders equity.



Provision has not been made for U.S. or additional foreign taxes on undistributed earnings of the Companys foreign subsidiaries. These earnings of approximately $2.0 million, which are expected to be reinvested,
could become subject to additional tax if they were to be remitted as dividends, loaned to the Company, or if the Company should sell its stock in these subsidiaries.



Cumulative Effect of Change in Accounting Principle.    We recognized a $2.3 million transitional
impairment loss as the cumulative effect of a change in accounting principle as a result of the adoption of SFAS No. 142 on January 1, 2002. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires
that goodwill no longer be amortized to earnings, but instead be tested at least annually for impairment. The amortization of goodwill ceases upon the required adoption date of the Statement, which for us was January 1, 2002. At the date of
adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The implied fair value of goodwill was calculated based upon a comparison of the book value of the
Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002.



Years ended December 31, 2002 and 2001



Revenue



Total revenue was $20.9 million and $27.6 million in 2002 and 2001, respectively, representing a decrease of $6.6 million, or 24%. During 2002 and 2001, no single customer accounted for 10% or more of total revenue,
other than related party sales to Primus KK of $1,394,000 and $3,134,000, respectively. International revenue was $4.2 million and $6.4 million in 2002 and 2001, respectively, representing a decrease of $2.2 million, or 34%.



License Revenue.    Total license revenue was $8.1
million and $12.6 million in 2002 and 2001, respectively, representing a decrease of $4.5 million, or 36%. We experienced a decrease in the sales of our software in 2002 as compared to 2001. We believe the continued weakening of the global economy
in 2002 and the continued global slow down in information technology spending contributed to this decline. During 2002, the buying patterns of our potential customers caused a long sales cycle, making it difficult to predict when license sales would
close. License revenue as a percentage of total revenue was 39% and 46% in 2002 and 2001, respectively. Software license revenue decreased as a percentage of total revenue primarily due to the decrease in our software license revenue.



Service Revenue.    Total service revenue was
$12.9 million and $15.0 million in 2002 and 2001, respectively, representing a decrease of $2.1 million, or 14%, which was the result of a decrease in maintenance and support contract revenue of $1.3 million and a decrease in consulting fees of
$800,000 over the same period. Service revenue as a percentage of total revenue was 61% and 54% in 2002 and 2001, respectively. The increase in maintenance and support contract revenue as a percentage of total revenue is primarily due to the
significant decrease in license revenue. The decrease in maintenance and support contract revenue and consulting fees are by-products of continued pricing pressures, the termination of certain low margin maintenance and support contracts and the
declines in both license revenue and information technology spending experienced during 2002.



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Cost of Revenue



Total cost of revenue was $5.0 million and $8.1 million in 2002 and 2001, respectively, representing a decrease of $3.1 million, or 38%.



Cost of License Revenue.    Cost of license
revenue consists primarily of media, product packaging and shipping, documentation and other production costs, and third party royalties. Cost of license revenue was $328,000 and $373,000 in 2002 and 2001, respectively, representing a decrease of
$45,000, or 12%. Cost of license revenue as a percentage of license revenue was 4% and 3% during 2002 and 2001, respectively. The increase in the cost of license revenue as a percentage of license revenue is primarily due to the write off of certain
amounts under a prepaid royalty agreement during 2002. The decrease in the cost of license revenue as an absolute dollar amount is due to the significant decline in license revenue in 2002.



Cost of Service Revenue.Cost of services
revenue consists primarily of salaries, benefits and allocated overhead costs related to customer support, consulting, training and global services personnel, including the cost of service provided by third-party consultants engaged by Primus. Cost
of service revenue was $4.7 million and $7.7 million in 2002 and 2001, respectively, representing a decrease of $3.0 million, or 39%. Cost of service revenue as a percentage of service revenue was 37% and 52%, or a gross margin of 63% and 48%,
during 2002 and 2001, respectively. The decrease in cost of service revenue as a percentage of services revenue was primarily due to the higher utilization rates for our professional services staff, continued cost containment efforts, the cost
savings realized from workforce reductions made since the fourth quarter of 2001 within the professional services and customer support organizations and a reduction in allocated overhead costs. During 2002, our professional services and support
workforce decreased by 7 employees, or 18%. Cost of service revenue will vary depending on the mix of services that we provide between support and maintenance, training, implementation and integration services, as well as staffing levels, overhead
costs and customer needs. Gross profit margins are generally higher for post contract customer support and maintenance services, which include the delivery of software enhancements and upgrades, than for training, implementation and integration
services.



Operating Expenses



Overhead costs.    Allocated overhead costs
generally include compensation related benefits, facilities costs (occupancy, utilities, telephone, internet, postage and freight), depreciation and amortization related to property and equipment, general supplies and repair and maintenance costs,
and bank fees and charges. Allocated overhead costs are allocated to Cost of Service Revenue (customer support, consulting, training and global services personnel), Sales and Marketing expense, Research and Development expense and General and
Administrative expense based primarily upon headcount, and were approximately $6.4 million and $7.8 million for 2002 and 2001, a decrease of approximately $1.4 million, or 18%. This decrease is primarily due to reductions in facilities costs
(primarily occupancy) of approximately $1.0 million, depreciation and amortization expense related to property and equipment of approximately $275,000, telephone and internet expense of approximately $250,000; partially offset by an increase in
compensation related benefits of approximately $125,000. Total allocated overhead costs are as follows (in 000s):



|                               |  |                         |       |      |   |      
|------------------------------ |  | ----------------------- | ----- | ---- | - | -----
|                               |  | Year ended December 31,
|                               |  | 2002                    |       | 2001
|Cost of service revenue        |  | $                       | 1,276 |      | $ | 1,515
|Sales and marketing            |  |                         | 1,803 |      |   | 2,244
|Research and development       |  |                         | 2,349 |      |   | 2,906
|General and administrative     |  |                         | 991   |      |   | 1,151
|                               |  |                         |       |      |   |      
|Total allocated overhead costs |  | $                       | 6,419 |      | $ | 7,816
|                               |  |                         |       |      |   |      



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The reduction in occupancy costs during 2002 was due to a reduction in the total square footage under
lease in our Seattle, WA corporate headquarters, a restructuring and reduction of our leased space at our Slough, United Kingdom facility (UK facility), and the closure of our Atlanta, GA facility as part of our fourth quarter 2001
restructuring. Effective January 1, 2002, we reduced our Seattle, WA office space by approximately 17,700 square feet, from 51,000 square feet to 33,300 square feet, resulting in savings of approximately $550,000. During the second half of 2001, we
restructured our UK facility lease, and then in the third quarter of 2002, as part of our restructuring, we reduced the amount of space under lease at that facility by approximately 75%. This reduced our 2002 occupancy costs for our UK facility by
approximately $200,000, as compared to 2001. During the third quarter of 2001 we discontinued funding product development for 2order, and during the fourth quarter of 2001 we closed 2orders office in Atlanta, GA, resulting in 2002 savings of
approximately $250,000. The decrease in telephone and internet expense was primarily the result of a renegotiation of rates for certain of our corporate phone and international phone lines, as well as the reductions in head count in 2001 and 2002.
The net decrease in depreciation and amortization expense related to property and equipment was primarily due to the aging of our property and equipment, and a significant portion of those assets becoming fully depreciated during the second half of
2002, as well as excess facility and asset impairment charges of approximately $2.0 million incurred during 2001 and 2002. The asset impairment charges were primarily for leasehold improvements, computer equipment and related software, office
equipment and furniture and fixtures disposed of or removed from operations as a direct result of our restructuring plans. The increase in compensation related benefits expense is the direct result of unfavorable claims experience during 2002 under
our self insured health benefits plan.



Sales and
Marketing.    Sales and marketing expenses consist primarily of salaries, bonuses, commissions and benefits earned by sales and marketing personnel, direct expenditures such as travel, communication and occupancy for direct
sales offices and marketing expenditures related to direct mail, online marketing, advertising, trade shows, public relations and new product launches and allocated overhead costs. Sales and marketing expenses were approximately $11.5 million and
$19.8 million for 2002 and 2001, respectively, representing a decrease of $8.3 million or 42%. This decrease is primarily the result of the reduction in total fixed and variable (bonuses and commissions) employee related costs due to the reduction
in sales and marketing headcount since July of 2001, as well as reductions in allocated overhead costs, travel and entertainment costs, recruiting expenses, and consulting and marketing expenditures (e.g. advertising, public relations, tradeshows
and collateral materials) as part of our overall cost containment efforts. During 2002, our sales and marketing workforce decreased by 16 employees, or 25%. Sales and marketing expenses as a percentage of total revenue were 55% and 72% in 2002 and
2001, respectively. This decrease as a percentage of total revenue is primarily due to the substantial decrease in total sales and marketing expenses during 2002, as well as the significant decrease in total revenue from 2001 to 2002.



Research and Development.    Research and
development expenses include development costs associated with new products, enhancements and upgrades of existing products and quality control testing, and consist primarily of salaries, benefits, and contractors fees for software engineers,
program and product managers, technical writers, linguistic specialists and quality assurance personnel, and allocated overhead costs. Research and development expenses were approximately $7.9 million and $12.6 million in 2002 and 2001,
respectively, representing a decrease of approximately $4.8 million or 38%. The decrease was primarily due to reductions in allocated overhead costs, the discontinuance of funding for 2order during the third quarter of 2001, reductions in research
and development headcount since July of 2001 and our continued cost containment efforts, partially offset by increases in research and development headcount related to our May 31, 2001 acquisition of AnswerLogic. During 2002, our research and
development workforce decreased by 24 employees, or 34%. Research and development expenses as a percentage of total revenue were 37% and 46% for 2002 and 2001, respectively. This decrease as a percentage of total revenue is primarily due to the
substantial decrease in total research and development spending in 2002 and the significant decrease in total revenue from 2001 to 2002. When required, we also use third-party development firms to expand the capacity and technical expertise of our
internal research and development teams.



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##### Table of Contents

General and Administrative.    General and administrative expenses consist
primarily of salaries, benefits and related costs for executive, finance, human resource, legal, administrative and information services personnel, occupancy costs, bad debt expense and costs associated with being a public company, including, but
not limited to, annual and other public-reporting costs, directors and officers liability insurance, investor-relations programs and professional-services fees, and allocated overhead costs. General and administrative expenses were
approximately $4.4 million and $6.6 million in 2002 and 2001, respectively, representing a decrease of approximately $2.2 million or 33%. This decrease is primarily due to reductions in the fixed and variable components of total compensation related
expenses in the second half of 2001 and 2002, as well as reductions in allocated overhead costs, consulting fees, recruiting expenses and bad debt expenses, partially offset by increases in legal expenses. Included in 2002 expenses was approximately
$385,000 related to the April 2002 Mindfabric patent litigation settlement and accrued expenses of approximately $250,000 related to a then pending preference action in connection with the bankruptcy of a former customer. During 2002, our general
and administrative workforce decreased by 5 employees, or 20%. The decrease in absolute dollars incurred for general and administrative expenses for 2002 reflects the continued impact of the overall cost containment measures taken by us during the
last eighteen months. General and administrative expenses as a percentage of total revenue were 21% in 2002 and 24% in 2001. The decrease of general and administrative expense as a percentage of total revenue is primarily attributable to the
substantial decrease in general and administrative expenses during 2002, as well as a significant decrease in revenue during the same period.



Goodwill Amortization.    Amortization of goodwill was $0 in 2002 and $550,000 in 2001. The goodwill amortization expense is a
result of the acquisition of AnswerLogic, which was completed in May 2001 and accounted for under the purchase method of accounting. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires that
goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceased upon the required adoption date of the Statement, which for us was January 1, 2002. At the date of adoption, we had unamortized
goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The implied fair value of goodwill was calculated based upon a comparison of the book value of the Company to its fair value.
Fair value was determined based upon the market capitalization of the Company as of January 1, 2002. Accordingly, we recognized a $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of
the adoption of SFAS No. 142.



Restructuring
Charges.    In 2002 we incurred restructuring charges of approximately $1.2 million. During the first quarter of 2002, we executed a restructuring of our workforce and as a result recorded restructuring charges of
approximately $435,000 for severance, benefits and associated costs due to a 12% reduction in our worldwide workforce. Exclusive of attrition, we reduced our research and development workforce by ten employees, or 14%, our sales and marketing
workforce by seven employees, or 11%, our professional services and support workforce by four employees, or 10%, and our general and administrative workforce by three employees, or 13%, for a total workforce reduction of 24 people, or 12% of our
employee base at March 2002.



During the third quarter of 2002,
we executed a further restructuring plan and as a result incurred charges of approximately $827,000 related to our decision to exit certain domestic and international facilities and reduce our workforce. Excess facilities charges and related asset
impairments for the three months ended September 30, 2002 were estimated at $671,000 based on our evaluation of current market conditions relative to our existing excess facilities accrual. The estimated facility costs are based on current
comparable rates for leases and subleases of a comparable term or termination fees. The asset impairment charges are primarily for leasehold improvements, computer equipment and related software, office equipment and furniture and fixtures disposed
of or removed from operations as a direct result of the restructuring plan. If other estimates and/or assumptions change, the actual loss may exceed this estimate. Future cash outlays are anticipated through December 2003 unless the Company is able
to negotiate to exit the lease at an earlier date. Employee separation costs, which include severance, benefits and associated costs of $156,000, relates to approximately ten employees terminated during the third quarter of 2002. The ten employees
were primarily in marketing and research and development departments. At December 31, 2002, unpaid restructuring charges consisted of excess facilities costs of $526,000, which is net of estimated future sublease receipts of $52,000.



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##### Table of Contents

During the fourth quarter of 2001, we executed a restructuring plan and as a result incurred
restructuring charges of approximately $2.5 million related to the reductions in our workforce and costs associated with certain excess leased facilities and asset impairments. Included in the charge was approximately $800,000 for assets disposed of
or removed from operations as a direct result of its restructuring plan, which consisted primarily of leasehold improvements, computer equipment and related software, office equipment, and furniture and fixtures. Also included in the charge was
approximately $1.1 million for severance, benefits and related costs due to the reduction in workforce. We reduced our workforce by 72 people, or 26% of our employee base in October 2001, and all functional areas were affected by the reductions. The
remaining $600,000 of the charge was due to our decision to exit and reduce excess facilities. A portion of the charge was based on the estimated period to sublease the excess space and the current estimated lease rental rates for leases in the
respective market.



Other Income,
Net.    Other income decreased $1.0 million, or 84%, from $1.2 million in 2001 to $200,000 in 2002. The decrease from period to period is primarily due to fluctuations in the average combined cash, cash equivalents and
short-term investment balances as well as declining investment yields.



Income Taxes.    We have not recorded income tax benefits related to the net operating losses in 2002 or 2001, as a result of the uncertainties regarding the realization of the tax benefits from such losses.
Income tax expense recorded in 2002 and 2001 primarily relates to our foreign operations.



Cumulative Effect of Change in Accounting Principle.    We recognized a $2.3 million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of
the adoption of SFAS No. 142 on January 1, 2002. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill no longer be amortized to earnings, but instead be tested at least annually
for impairment. The amortization of goodwill ceases upon the required adoption date of the Statement, which for us was January 1, 2002. At the date of adoption, we had unamortized goodwill of approximately $2.3 million, and the implied fair value of
the goodwill as of the date of adoption was zero. The implied fair value of goodwill was calculated based upon a comparison of the book value of the Company to its fair value. Fair value was determined based upon the market capitalization of the
Company as of January 1, 2002.



Extraordinary
Item.    Extraordinary gain on the disposal of assets was $566,000 for the year ended December 31, 2001. This gain was recorded in connection with the September 2001 sale of certain intellectual property and assets of our
wholly owned subsidiary, 2order, which was acquired through a business combination in January 2000 and accounted for using the pooling-of-interests method of accounting.



47



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##### Table of Contents

Quarterly Results of Operations



The following table presents our unaudited quarterly results of operations for 2003 and 2002. You should read the following
table in conjunction with our consolidated financial statements and the notes related thereto. We have prepared this unaudited condensed information on a basis consistent with the audited consolidated financial statements. This table includes all
adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. You should not draw any conclusions about our future results
from our quarterly results of operations.



|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------------------------- |  | ------------------------- | ----- | - | -------------- | - | ----- | ------------- |  | - | -------------- | - |  | ------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | -------------- | - |  | - | ------ | - |  | - | ------ | -
|                                                                                          |  | Three Months Ended        |      
|                                                                                          |  | Dec. 31, 2003             |       |   | Sept. 30, 2003 |   |       | June 30, 2003 |  |   | March 31, 2003 |   |  | Dec. 31, 2002 |        |   | Sept. 30, 2002 |   |        | June 30, 2002 |  |   | March 31, 2002 |  
|                                                                                          |  | (In thousands, unaudited) |      
|Condensed Consolidated Statement of Operations Data:                                      |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Revenue:                                                                                  |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|License                                                                                   |  | $                         | 4,674 |   |                | $ | 3,215 |               |  | $ | 466            |   |  | $             | 2,375  |   |                | $ | 1,582  |               |  | $ | 2,945          |   |  | $ | 1,108  |   |  | $ | 2,457  |  
|Service                                                                                   |  |                           | 4,113 |   |                |   | 3,844 |               |  |   | 3,251          |   |  |               | 3,113  |   |                |   | 2,981  |               |  |   | 3,167          |   |  |   | 3,132  |   |  |   | 3,570  |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Total revenue                                                                             |  |                           | 8,787 |   |                |   | 7,059 |               |  |   | 3,717          |   |  |               | 5,488  |   |                |   | 4,563  |               |  |   | 6,112          |   |  |   | 4,240  |   |  |   | 6,027  |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Cost of revenue:                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|License                                                                                   |  |                           | 171   |   |                |   | 136   |               |  |   | 57             |   |  |               | 97     |   |                |   | 64     |               |  |   | 147            |   |  |   | 44     |   |  |   | 73     |  
|Service                                                                                   |  |                           | 1,340 |   |                |   | 1,154 |               |  |   | 1,242          |   |  |               | 1,139  |   |                |   | 1,110  |               |  |   | 1,144          |   |  |   | 1,148  |   |  |   | 1,295  |  
|Amortization of purchased intangibles                                                     |  |                           | 54    |   |                |   | 14    |               |  |   |               |   |  |               |       |   |                |   |       |               |  |   |               |   |  |   |       |   |  |   |       |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Total cost of revenue                                                                     |  |                           | 1,565 |   |                |   | 1,304 |               |  |   | 1,299          |   |  |               | 1,236  |   |                |   | 1,174  |               |  |   | 1,291          |   |  |   | 1,192  |   |  |   | 1,368  |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Gross profit                                                                              |  |                           | 7,222 |   |                |   | 5,755 |               |  |   | 2,418          |   |  |               | 4,252  |   |                |   | 3,389  |               |  |   | 4,821          |   |  |   | 3,048  |   |  |   | 4,659  |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Operating expenses:                                                                       |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Sales and marketing                                                                       |  |                           | 2,659 |   |                |   | 2,650 |               |  |   | 2,527          |   |  |               | 2,598  |   |                |   | 2,629  |               |  |   | 2,898          |   |  |   | 2,925  |   |  |   | 3,067  |  
|Research and development                                                                  |  |                           | 2,164 |   |                |   | 1,934 |               |  |   | 1,874          |   |  |               | 1,816  |   |                |   | 1,582  |               |  |   | 1,790          |   |  |   | 2,099  |   |  |   | 2,385  |  
|General and administrative                                                                |  |                           | 1,881 |   |                |   | 896   |               |  |   | 702            |   |  |               | 973    |   |                |   | 889    |               |  |   | 843            |   |  |   | 1,282  |   |  |   | 1,353  |  
|Restructuring charges                                                                     |  |                           |      |   |                |   |      |               |  |   |               |   |  |               |       |   |                |   | (35    | )             |  |   | 827            |   |  |   |       |   |  |   | 435    |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Total operating expenses                                                                  |  |                           | 6,704 |   |                |   | 5,480 |               |  |   | 5,103          |   |  |               | 5,387  |   |                |   | 5,065  |               |  |   | 6,358          |   |  |   | 6,306  |   |  |   | 7,240  |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Income (loss) from operations                                                             |  |                           | 518   |   |                |   | 275   |               |  |   | (2,685         | ) |  |               | (1,135 | ) |                |   | (1,676 | )             |  |   | (1,537         | ) |  |   | (3,258 | ) |  |   | (2,581 | )
|Other income (expense), net                                                               |  |                           | (28   | ) |                |   | 131   |               |  |   | 12             |   |  |               | 55     |   |                |   | 14     |               |  |   | (15            | ) |  |   | 93     |   |  |   | 110    |  
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Income (loss) before income taxes and cumulative effect of change in accounting principle |  |                           | 490   |   |                |   | 406   |               |  |   | (2,673         | ) |  |               | (1,080 | ) |                |   | (1,662 | )             |  |   | (1,552         | ) |  |   | (3,165 | ) |  |   | (2,471 | )
|Income tax benefit (expense)                                                              |  |                           | 38    |   |                |   | (27   | )             |  |   | (31            | ) |  |               | (50    | ) |                |   | (17    | )             |  |   | (24            | ) |  |   |       |   |  |   | (70    | )
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Income (loss) before cumulative effect of change in accounting principle                  |  |                           | 528   |   |                |   | 379   |               |  |   | (2,704         | ) |  |               | (1,130 | ) |                |   | (1,679 | )             |  |   | (1,576         | ) |  |   | (3,165 | ) |  |   | (2,541 | )
|Cumulative effect of change in accounting principle                                       |  |                           |      |   |                |   |      |               |  |   |               |   |  |               |       |   |                |   |       |               |  |   |               |   |  |   |       |   |  |   | (2,281 | )
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  
|Net income (loss)                                                                         |  | $                         | 528   |   |                | $ | 379   |               |  | $ | (2,704         | ) |  | $             | (1,130 | ) |                | $ | (1,679 | )             |  | $ | (1,576         | ) |  | $ | (3,165 | ) |  | $ | (4,822 | )
|                                                                                          |  |                           |       |   |                |   |       |               |  |   |                |   |  |               |        |   |                |   |        |               |  |   |                |   |  |   |        |   |  |   |        |  



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##### Table of Contents

The following table sets forth unaudited condensed consolidated quarterly results of operations as a
percentage of revenue for 2003 and 2002.



|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|----------------------------------------------------------------------------------------- |  | ------------------ | - |  | -------------- | - |  | ------------- | -- |  | -------------- | -- |  | ------------- | -- |  | -------------- | -- |  | ------------- | -- |  | -------------- | --
|                                                                                          |  | Three Months Ended |  
|                                                                                          |  | Dec. 31, 2003      |   |  | Sept. 30, 2003 |   |  | June 30, 2003 |    |  | March 31, 2003 |    |  | Dec. 31, 2002 |    |  | Sept. 30, 2002 |    |  | June 30, 2002 |    |  | March 31, 2002 |   
|                                                                                          |  | (Unaudited)        |  
|Condensed Consolidated Statement of Operations Data:                                      |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Revenue:                                                                                  |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|License                                                                                   |  | 53.2               | % |  | 45.5           | % |  | 12.5          | %  |  | 43.3           | %  |  | 34.7          | %  |  | 48.2           | %  |  | 26.1          | %  |  | 40.8           | % 
|Service                                                                                   |  | 46.8               |   |  | 54.5           |   |  | 87.5          |    |  | 56.7           |    |  | 65.3          |    |  | 51.8           |    |  | 73.9          |    |  | 59.2           |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Total revenue                                                                             |  | 100.0              |   |  | 100.0          |   |  | 100.0         |    |  | 100.0          |    |  | 100.0         |    |  | 100.0          |    |  | 100.0         |    |  | 100.0          |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Cost of revenue:                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|License                                                                                   |  | 2.0                |   |  | 2.0            |   |  | 1.5           |    |  | 1.8            |    |  | 1.4           |    |  | 2.4            |    |  | 1.0           |    |  | 1.2            |   
|Service                                                                                   |  | 15.2               |   |  | 16.5           |   |  | 33.4          |    |  | 20.7           |    |  | 24.3          |    |  | 18.7           |    |  | 27.1          |    |  | 21.5           |   
|Amortization of purchased intangibles                                                     |  | 0.6                |   |  |               |   |  |              |    |  |               |    |  |              |    |  |               |    |  |              |    |  |               |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Total cost of revenue                                                                     |  | 17.8               |   |  | 18.5           |   |  | 34.9          |    |  | 22.5           |    |  | 25.7          |    |  | 21.1           |    |  | 28.1          |    |  | 22.7           |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Gross profit                                                                              |  | 82.2               |   |  | 81.5           |   |  | 65.0          |    |  | 77.5           |    |  | 74.3          |    |  | 78.9           |    |  | 71.9          |    |  | 77.3           |   
|Operating expenses:                                                                       |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Sales and marketing                                                                       |  | 30.3               |   |  | 37.5           |   |  | 68.0          |    |  | 47.4           |    |  | 57.6          |    |  | 47.4           |    |  | 69.0          |    |  | 50.9           |   
|Research and development                                                                  |  | 24.6               |   |  | 27.4           |   |  | 50.4          |    |  | 33.1           |    |  | 34.7          |    |  | 29.3           |    |  | 49.5          |    |  | 39.6           |   
|General and administrative                                                                |  | 21.4               |   |  | 12.7           |   |  | 18.9          |    |  | 17.7           |    |  | 19.5          |    |  | 13.8           |    |  | 30.2          |    |  | 22.4           |   
|Restructuring charges                                                                     |  |                   |   |  |               |   |  |              |    |  |               |    |  | (0.8          | )  |  | 13.5           |    |  |              |    |  | 7.2            |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Total operating expenses                                                                  |  | 76.3               |   |  | 77.6           |   |  | 137.3         |    |  | 98.2           |    |  | 111.0         |    |  | 104.0          |    |  | 148.7         |    |  | 120.1          |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Income (loss) from operations                                                             |  | 5.9                |   |  | 3.9            |   |  | (72.3         | )  |  | (20.7          | )  |  | (36.7         | )  |  | (25.1          | )  |  | (76.8         | )  |  | (42.8          | ) 
|Other income (expense), net                                                               |  | (0.3               | ) |  | 1.9            |   |  | 0.3           |    |  | 1.0            |    |  | 0.3           |    |  | (0.3           | )  |  | 2.2           |    |  | 1.8            |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Income (loss) before income taxes and cumulative effect of change in accounting principle |  | 5.6                |   |  | 5.8            |   |  | (71.9         | )  |  | (19.7          | )  |  | (36.4         | )  |  | (25.4          | )  |  | (74.6         | )  |  | (41.0          | ) 
|Income tax benefit (expense)                                                              |  | 0.4                |   |  | (0.4           | ) |  | (0.8          | )  |  | (0.9           | )  |  | 0.4           |    |  | 0.4            |    |  |              |    |  | 1.2            |   
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Income (loss) before cumulative effect of change in accounting principle                  |  | 6.0                |   |  | 5.4            |   |  | (72.7         | )  |  | (20.6          | )  |  | (36.8         | )  |  | (25.8          | )  |  | (74.6         | )  |  | (42.2          | ) 
|Cumulative effect of change in accounting principle                                       |  |                   |   |  |               |   |  |              |    |  |               |    |  |              |    |  |               |    |  |              |    |  | (37.8          | ) 
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   
|Net income (loss)                                                                         |  | 6.0                | % |  | 5.4            | % |  | (72.7         | )% |  | (20.6          | )% |  | (36.8         | )% |  | (25.8          | )% |  | (74.6         | )% |  | (80.0          | )%
|                                                                                          |  |                    |   |  |                |   |  |               |    |  |                |    |  |               |    |  |                |    |  |               |    |  |                |   



The trends discussed
in the preceding annual comparisons of operating results generally apply to the comparison of operating results for the four quarters in each of the 12-month periods ended December 31, 2003 and 2002. The first quarter of 2002 included the cumulative
effect of a change in accounting principle and the first and third quarter of 2002 included restructuring charges. During the third and fourth quarter of 2003, we achieved quarterly profitability, due primarily to a significant increase in total
revenue, partially related to acquisitions made during those quarters and to enterprise sales made to two customers during the second half of 2003, as well as our continued close monitoring of costs. Our quarterly operating results have varied
widely in the past, and we expect that they will continue to fluctuate in the future as a result of a number of factors, many of which are outside our control.



Liquidity and Capital Resources



Prior to our initial public offering, we had primarily financed our operations through the private sale of our equity securities. To a lesser extent, we
have financed our operations through equipment financing and traditional lending arrangements. In July 1999, we completed our initial public offering in which we received approximately $46.2 million in cash, net of underwriting discounts,
commissions, and other offering costs.



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As of December 31, 2003, we had cash, cash equivalents and short-term investments of $12.2 million,
representing a decrease of $800,000 from December 31, 2002. As of December 31, 2003, our working capital was $3.0 million compared to $7.6 million at December 31, 2002.



Our operating activities resulted in net cash outflows of $1.3 million and $5.3 million in 2003 and 2002, respectively. In
2003, adjustments to the $2.9 million net loss to reconcile to cash used in operating activities include $1.3 million for the increase in compensation-related accruals and accounts receivable and decrease in accounts payable and accrued liabilities.
This is offset by approximately $2.9 million for the decrease in prepaid expenses and other current assets and other assets, the increase in compensation-related accounts and deferred revenue, $1.7 million in depreciation and amortization, a
$849,000 charge for compensation expense related to an option purchase and non-compete agreement with our CEO. Cash used in operations/cash provided by operations is dependent upon our ability to achieve positive earnings and the timing of our
payments and collections and we expect that it will fluctuate from period to period.



Investing activities provided cash of $532,000 and $3.7 million in 2003 and 2002, respectively. Investing activities for this period consisted primarily of approximately $1.4 million in proceeds from the maturity of
short-term investments and $117,000 of cash acquired in acquisitions offset by the purchase of short-term investments of $395,000, and of property and equipment of $586,000.



Financing activities provided cash of $911,000 and $66,000 in 2003 and 2002, respectively, through proceeds from the
issuance of common stock.



Our principal source of liquidity at
December 31, 2003 was our cash and cash equivalents. We also have a line of credit totaling $3.0 million, which is secured by substantially all of our assets, bears interest at the banks prime rate plus 1% (5.0%) as of December 31, 2003) and
expires in March 2005. There were no borrowings outstanding as of December 31, 2003 under this line of credit. As of December 31, 2003 and March 2004, we were in compliance with our financial covenants in connection with the line of credit. If we
are unable to maintain compliance in the future, this $3.0 million line of credit may not be available in its entirety.



In connection with the December 2003 acquisition of Amacis, we assumed Amaciss outstanding obligation of approximately $395,000 under a credit
facility with a bank. The facility is payable in month installments of approximately $9,000, including interest at a rate of the banks rate plus 2% (5.75% as of December 31, 2003), due June 2008. Due to the purchase of all of Amaciss
common shares by us, the facility is payable upon demand. We anticipate repaying this obligation in its entirety during 2004. The loan is denominated in British pounds sterling.



We currently anticipate that we will continue to experience fluctuations in results of operations for the foreseeable future
as we:



| |  |  | enter new markets for our products and services, including through potential acquisitions of complementary businesses, technology or other assets
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | increase or decrease research and development spending
| | - |  | ------------------------------------------------------



| |  |  | increase or decrease sales and marketing activities
| | - |  | ---------------------------------------------------



| |  |  | develop new distribution channels
| | - |  | ---------------------------------



| |  |  | improve our operational and financial systems
| | - |  | ---------------------------------------------



| |  |  | broaden our professional services capabilities
| | - |  | ----------------------------------------------



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



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



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We continue to focus on maximizing the performance of our core business and controlling costs to respond
to the economic environment and will continue to evaluate our underlying cost structure to improve our operating results and better position ourselves for growth. As such, we may incur further restructuring charges, including severance, benefits and
related costs due to a reduction in workforce and/or charges for assets disposed of or removed from operations as a direct result of a reduction in workforce.



In the near-term, we believe our costs and operating expenses, excluding restructuring-related charges, will track to a level that is close to our
expected revenue while allowing us to continue to invest in accordance with our strategic priorities. However, we may be unable to achieve these expense levels without adversely affecting our business and results of operations. We may continue to
experience losses and negative cash flows in the near term, even if sales of our products and services grow.



While we will continue to implement cost containment efforts across our business, our operating expenses, will consume a material amount of our cash
resources. We believe that the total amount of our cash and cash equivalents along with our commercial credit facilities, will be sufficient to meet our anticipated cash needs for working capital or other purposes for at least the next twelve
months. Thereafter, depending on the development of our business, we will likely require additional funds to support our working capital requirements, unanticipated expenses, opportunities for acquisitions or other business initiatives we encounter
and we may seek to raise such additional working capital through public or private equity or debt financing (including debt convertible into equity) or from other sources. We may not be able to obtain adequate or favorable financing at that time.
Our history of declining market valuation and volatility in our stock price could make it difficult for us to raise capital on favorable terms. Any financing we obtain may dilute or otherwise impair our current shareholders ownership interest
in the Company.



We lease office space under operating leases
with various expiration dates through 2006. In January 2003, we engaged an offshore development team to accelerate our development efforts. Our commitment under this agreement is to incur up to approximately $125,000 per month for development work
through January 2005. During the year ended December 31, 2003, we incurred development expenses of approximately $1,234,000 related to this agreement. We have no material long-term commitments or obligations other than those under these
agreements.Future contractual obligations and future leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2003 are as follows (in 000s):



|     |  |                  |        |                               |   |       |  |   |      
|---- |  | ---------------- | ------ | ----------------------------- | - | ----- |  | - | -----
|     |  | Operating Leases |        | Other Contractual Obligations |   | Total
|2004 |  | $                | 909    |                               | $ | 1,500 |  | $ | 2,409
|2005 |  |                  | 804    |                               |   | 125   |  |   | 929  
|2006 |  |                  | 21     |                               |   |      |  |   | 21   
|     |  |                  |        |                               |   |       |  |   |      
|     |  |                  | $1,734 |                               | $ | 1,625 |  | $ | 3,359
|     |  |                  |        |                               |   |       |  |   |      



Rent expense was
approximately $1,300,000 (net of sublease rental income of $55,000), $2.2 million (net of sublease rental income of $356,000), and $2.8 million (net of sublease rental income of $177,000) for 2003, 2002 and 2001, respectively.



We do not have any relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide any funding to any such entity. As such, we are not materially exposed to any market, credit, liquidity or financing risk
that could arise if we had engaged in such relationships.



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Recently Issued Accounting Statements



In December 2003, SFAS Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest
Entities, was issued. This Interpretation addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. We will be required to apply FIN 46R to variable interests in Variable Interest Entities (VIEs) created after
December 31, 2003. For variable interest in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the
assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. We are evaluating
the impact of applying FIN 46R to existing VIEs in which we have variable interest and have not yet completed this analysis. At this time, the adoption of FIN 46R is not expected to have a material effect on our financial statements.



ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We are exposed to the impact of interest rate changes and related change in the market values of our investments and foreign currency exchange risk.



Interest Rate Risk.    We typically
invest our excess cash in high quality corporate and municipal debt instruments. As a result, our related investment portfolio is exposed to the impact of short-term changes in interest rates. Investments in both fixed rate and floating rate
interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted by a rise in interest rates, while floating rate securities may produce less income than expected if
interest rates fall. As a result, changes in interest rates may cause us to suffer losses in principal if forced to sell securities that have declined in market value or may cause our future investment income to fall short of expectations. Our
investment portfolio is designated as available-for-sale, and accordingly is presented at fair value in the consolidated balance sheet.



We protect and preserve our invested funds with investment policies and procedures that limit default, market and reinvestment risk. We have not utilized
derivative financial instruments in our investment portfolio.



During the year ended December 31, 2003, decreases in interest rates on the fair market value of our cash and cash equivalents caused an insignificant increase in our net loss. We believe that the impact on the fair market value of
our securities and our operating results for 2004 from a hypothetical 10% increase or decrease in interest rates would be insignificant.



Foreign Currency Exchange Risk.    We develop products in the United States and the United Kingdom and sell them in North
America, Europe, and, through Primus KK, Asia. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We have three foreign
subsidiariesPrimus Knowledge Solutions (UK) Limited, Amacis Group Limited (UK) and Primus Knowledge Solutions Francewhose expenses are incurred in their local currency. As exchange rates vary, their expenses, when translated, may vary
from expectations and adversely impact overall expected results. Our operating results have not been significantly affected by exchange rate fluctuations in 2002 and 2003. If, during 2004, the U.S. dollar uniformly increases or decreases in strength
by 10% relative to the currency of our foreign sales subsidiaries, our operating results for 2004 would likely not be significantly affected.



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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



The Consolidated Financial Statements and Supplementary Data of the Company are listed under Part IV, Item 15, of this Form 10-K.



ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



Not applicable.



ITEM 9A.    CONTROLS AND PROCEDURES



Evaluation of disclosure controls and procedures.Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, the Companys principal executive
officer and principal financial officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective to
ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules
and forms.



Changes in internal
controls.There were no significant changes in the Companys internal control over financial reporting identified in managements evaluation during the fourth quarter of fiscal 2003 that have materially affected
or are reasonably likely to materially affect the Companys internal control over financial reporting.



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PART III



ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



In accordance with our Second Restated Bylaws, as amended, our Board of Directors is composed of seven directors, divided into three classes that are
staggered such that the shareholders elect approximately one-third of the directors each year. At present our Board consists of six directors with one vacancy, resulting from the resignation of Janice Peters on November 3, 2003. To date, no
replacement director has been nominated. The bylaws provide that at the next annual meeting, the term of office of the remaining Class 1 director, Promod Haque, expires. Every director elected to the Board will serve for a term of three years or
until such time as his or her successor is elected and qualified. If a director resigns from the Board before the expiration of his or her term, however, the director elected or appointed to fill the resulting vacancy may be designated to a class
such that he or she initially must be elected to a shorter term.



Our executive officers and directors as of March 18, 2004 are as follows:



|                    |  |     |  |                                                                            
|------------------- |  | --- |  | ---------------------------------------------------------------------------
|Name                |  | Age |  | Position                                                                   
|Michael A. Brochu   |  | 50  |  | President, Chief Executive Officer and Chairman of the Board               
|Ronald M. Stevens   |  | 40  |  | Chief Operating Officer, Chief Financial Officer and Treasurer             
|David M. Williamson |  | 40  |  | Executive Vice President of Business Affairs, General Counsel and Secretary
|Antonio M. Audino   |  | 45  |  | Director                                                                   
|Promod Haque        |  | 55  |  | Director                                                                   
|Yasuki Matsumoto    |  | 50  |  | Director                                                                   
|John A. Moga        |  | 66  |  | Director                                                                   
|Daniel C. Regis     |  | 64  |  | Director                                                                   



Michael A. Brochuhas served as our President, Chief Executive Officer and Chairman of the Board since November 1997. Mr. Brochu was President and Chief Operating Officer of Sierra On-Line, Inc., an interactive software publisher, from June 1994 until October
1997. Mr. Brochu received his B.B.A. in accounting and finance from the University of Texas at El Paso.



Ronald M. Stevenshas served as our Chief Operating Officer, Chief Financial Officer and Treasurer since October 2000. From August 1999 to
September 2000, Mr. Stevens served as Chief Financial Officer and then President and Chief Operating Officer of OnHealth Network Inc., a consumer healthcare Internet company, which was acquired by WebMD Corporation in September 2000. From May 1996
to August 1999, he served as General Manager and Senior Vice President of Sierra On-Line, Inc., an interactive software publisher. From May 1994 to May 1996, he served as Corporate and Divisional Controller of Sierra On-Line. Mr. Stevens received
his B.A. in accounting and business administration from Western Washington University.



David M. Williamson serves as our Executive Vice President of Business Affairs, General Counsel and Secretary. He joined Primus in November 2000. From April 1998 to October 2000 he was Senior Vice President of
Business Affairs at Sierra On-line, Inc., an interactive software company. Prior to April 1998, he was a partner in the Business Technology Group at the law firm of Perkins Coie LLP. Mr. Williamson received his B.A. in accounting from the University
of Denver and his J.D. from the University of California at Berkeley.



Antonio M. Audino has served as one of our directors since April 1995. Since September 1996, Mr. Audino has been founder and managing director of Voyager Capital, a venture capital firm. Mr. Audino holds a B.S. B.A. from Creighton
University. Mr. Audinos term as a member of the Board of Directors expires at the Annual Meeting of Shareholders to be held in 2005.



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Promod Haque has served as one of our directors since February 1996. Mr. Haque has been employed
in various capacities by Norwest Venture Partners, a venture capital firm, since November 1990. Mr. Haque is currently Managing Partner of Norwest Venture Partners VII and Norwest Venture Partners VIII and General Partner of Norwest Venture Partners
VI, Norwest Equity Partners V and Norwest Equity Partners IV. Mr. Haque is a member of the board of directors of Extreme Networks, Inc., Redback Networks, Inc., and SPSS, Inc. Mr. Haque holds an M.S. and a Ph.D. in electrical engineering and an M.M.
from Northwestern University and a B.S. in electrical engineering from the University of New Delhi, India. Mr. Haque has been nominated for election at the 2004 Meeting to serve a three-year term on the Board of Directors ending at the Annual
Meeting of Shareholders to be held in 2007.



Yasuki
Matsumoto has served as one of our directors since October 1994. Since March 1997, Mr. Matsumoto has been the President and Chief Executive Officer of Trans Cosmos USA, Inc., an information technology venture capital investment firm. Trans
Cosmos USA, Inc. is a wholly owned subsidiary of Trans Cosmos, Inc. Entities affiliated with Trans Cosmos, Inc. own approximately 8.2% of our outstanding common stock. Mr. Matsumoto holds an M.S. in computer engineering from Portland State
University. Mr. Matsumotos term as a member of the Board of Directors expires at the Annual Meeting of Shareholders to be held in 2005.



John A. Moga presently develops new business for Hitachi Consulting, a subsidiary of Hitachi Data Systems. From July 1999 until July 2002, he was a
consultant to Andersens Northwest practice. Prior to that, he was the Managing Partner for Andersen in the Northwest for thirteen years. Mr. Moga holds a Bachelor of Science degree from Seattle University. Mr. Mogas term as a member of
the Board of Directors expires at the Annual Meeting of Shareholders to be held in 2006.



Daniel C Regis has served as one of our directors since April 2003, having been appointed by the Board to fill Fredric Harmans former directorship position. Mr. Regis presently serves as a Managing
Director of Digital Partners, a mid-sized venture capital fund specializing in Northwest emerging technology companies. From 1996 to 1999, he was with Kirlan Venture Capital Inc. where he served as Managing Partner of venture funds with a similar
focus. Prior to 1996, Mr. Regis was the Managing Partner of Price Waterhouse LLP in Seattle and previously for the Northwest and Portland. Mr. Regis is a member of the board of directors of Cray, Inc. Mr. Regis holds a Bachelor of Commercial Science
from Seattle University with a major in accounting and a minor in philosophy. Mr. Regiss term as a member of the Board of Directors expires at the Annual Meeting of Shareholders to be held in 2006.



In February 2003, Fredric W. Harman, whose term as a director was to expire
as of the Companys 2003 annual shareholders meeting, resigned from the Companys board of directors. His board seat was replaced by Daniel C. Regis, who was elected at the 2003 Annual Meeting of Shareholders.



Director Compensation



Members of our Board of Directors did not receive any fee for their services as directors in 2002. Commencing with the
second quarter of 2003, directors (other than Mr. Brochu) received a quarterly retainer fee of $3,000. Any board meetings attended in excess of four (4) per year results in an additional $500 fee per additional meeting attended. Committee members
receive a fee of $500 per committee meeting attended, with the chair of the Audit Committee receiving a $1,000 fee per committee meeting attended. Directors are eligible to participate in our 1999 Stock Incentive Compensation Plan, which was adopted
by our Board of Directors and our shareholders in April 1999. New directors generally receive an initial stock option grant of 50,000 shares and all continuing, non-employee directors receive an annual grant of 12,500 option shares. As new directors
in 2003, Mr. Regis and Mr. Moga each received an initial grant of 50,000 shares. Each of the continuing directors, excluding Mr. Brochu, received a grant of 12,500 shares in 2003.



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Board Independence and Corporate Governance



With the exception of Michael Brochu, who serves as our President and Chief Executive Officer, all of our other current
directors are independent as defined by NASDAQ. The independent directors regularly have the opportunity to meet without Mr. Brochu in attendance. No family relationship exists among any of our directors or executive officers. No
arrangement or understanding exists between any director or executive officer and any other person pursuant to which any director was selected as a director or executive officer of Primus. Primus does not have a specific policy regarding director
attendance at the annual shareholder meeting; however, all directors are encouraged to attend if available. Mr. Brochu was present at last years annual meeting.



Committees of the Board and Meetings



During the last fiscal year there were ten meetings of the Board of Directors. Antonio Audino, Michael Brochu, Promod Haque, Fredric Harman (who resigned
in February 2003), Daniel Regis (who joined the Board in April 2003), John Moga (who joined the Board in June 2003) and Janice Peters (who resigned in November 2003) each attended at least 75% of all board and committee meetings of which they were a
member. Yasuki Matsumoto attended 70% of all board meetings. John Connors, whose term on the Board expired on June 18, 2003, did not attend any board or committee meetings in 2003.



The Board of Directors has an Audit Committee, a Compensation Committee and a Nominating Committee. The current charters of
the Audit and Nominating Committees are available on the Primus internet site, www.primus.com/company/corporategovernance/. Also posted at that site is a description of the process for shareholders to send communications to the Board.



The purpose of the Audit Committee is to oversee Primuss accounting and
financial reporting processes and the audits of its financial statements. The Audit Committee is directly responsible for, among other things, the appointment, compensation, retention and oversight of Primuss independent auditor.



The Audit Committee is currently composed of Daniel Regis, Promod Haque
and John Moga. Fredric Harman, who resigned in February 2003, and John Connors, whose term expired in June 2003, were members of the Audit Committee until their service on the Board ended during 2003. All of the members of the Audit Committee during
the past fiscal year were, and all of the current members are, independent in accordance with applicable rules promulgated by the Securities and Exchange Commission (the SEC) and NASDAQ listing standards. Each former and current member
is able to read and understand fundamental financial statements, including Primuss balance sheet, income statement and cash flow statement. The Board of Directors has determined that Mr. Regis is an audit committee financial expert
as defined in Section 401(h) of Regulation S-K promulgated by the SEC under the Exchange Act. During the last fiscal year, there were four meetings of the Audit Committee.



The Compensation Committee, currently composed of Antonio Audino and Promod Haque (who replaced Janice Peters after her
resignation from the Board of Directors on November 3, 2003), reviews and approves the compensation and benefits for our executive officers and makes recommendations to the Board of Directors regarding compensation and benefits matters. Each of the
Compensation Committee members is independent in accordance with applicable NASDAQ listing standards. During the last fiscal year, there were three meetings of the Compensation Committee.



The Nominating Committee was established on January 30, 2004. The Nominating Committee, currently composed of Antonio
Audino, Promod Haque and John Moga, identifies and recommends individuals to be presented to the Companys shareholders for election or re-election to the Companys Board. All the members of the Nominating Committee are independent in
accordance with applicable NASDAQ listing standards.



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Director Nominations and Qualifications



In addition to considering Director candidates recommended by Nominating Committee members, other Board members and Primus
management, the Nominating Committee will consider candidates recommended by Primus shareholders. The Board will not, however, generally consider self-nominations by shareholders.



A Primus shareholder who wishes to recommend a prospective nominee for the Board must notify the Companys Corporate
Secretary or any member of the Nominating Committee (through correspondence in care of the Corporate Secretary at the Companys headquarters) in writing with relevant supporting material including confirmation that the nominee consents to being
a nominee to the Board. Any shareholder recommended nominee must be available to complete a director questionnaire (including such information regarding the nominated person that would be required in a proxy statement filed pursuant to the
SECs proxy rules if the person had been nominated for election by the Board of Directors), meet with the Nominating Committee and provide other relevant background information requested by the Nominating Committee, such as information
regarding the shareholder making the nomination, including name, address, and number of shares of Primus that are beneficially owned by the shareholder, a representation that the shareholder is entitled to vote at the meeting at which directors will
be elected, and that the shareholder intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice and a description of any arrangements or understandings between the shareholder and such nominee
and any other persons (including their names), pursuant to which the nomination is made.



Any shareholder recommendation must be made at least 120 days prior to the annual meeting of shareholders and must meet the timing and other requirements of the Primus bylaws in order to bring such business before an
annual shareholder meeting, as well as any legal and regulatory requirements that must be met in order to have a shareholder proposal included in Primuss proxy statement.



The Chairman of the Board, other directors and executive officers may also recommend director nominees to the Nominating
Committee. The committee will evaluate nominees recommended by shareholders against the same criteria that it uses to evaluate other nominees. These criteria include the candidates general understanding of finance, enterprise software and
services sales and marketing and other disciplines relevant to the success of an enterprise software company in todays business environment; understanding of Primuss business, and educational and professional experience, as well as other
factors that are listed in the Nominating Committee charter, which is posted on the Companys internet site, www.primus.com/company/corporategovernance/. The committee has not in the past retained any third party to assist it in identifying
candidates.



Compensation Committee Interlocks and Insider Participation



During the fiscal year ended December 31, 2003, Messrs.
Antonio Audino, Promod Haque, Fredric Harman (a director until February 2003) and Janice Peters (a director through November 3, 2003) served on the Compensation Committee of our Board of Directors. None of our executive officers serves as a member
of a compensation committee or board of directors of any entity that has an executive officer serving as a member of our Compensation Committee or Board of Directors.



Code of Ethics



Primus has adopted a Code of Ethics that applies to all its employees, including the Companys Chief Executive Officer and Chief Financial Officer.
The Code of Ethics is posted on Primus Internet site at www.primus.com/company/corporategovernance/. Primus intends to satisfy the disclosure requirements under Item 10 of Form 8-K regarding any amendment to or waiver of the Code with respect
to Primuss Chief Executive Officer and Chief Financial Officer, and persons performing similar functions, by posting such information on its Internet site.



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Section 16(a) Beneficial Ownership Reporting Compliance



The federal securities laws require the Companys directors and
executive officers, and persons who own more than ten percent (10%) of the Companys common stock, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of any securities of the
Company.



To the Companys knowledge, based solely on a
review of the copies of such reports furnished to the Company and written representations that no other reports were required, the Company believes that during the year ended December 31, 2003, its officers, directors and greater-than-10%
stockholders complied with all Section 16(a) filing requirements.



ITEM 11.    EXECUTIVE COMPENSATION



Compensation Summary



The following table
lists all compensation earned during the years ended December 31, 2003, December 31, 2002 and December 31, 2001 by our executive officers at December 31, 2003 (named executive officers).



Summary Compensation Table



|                                                                                      |  |                     |     |                             |        |                       |       |     |                             |  |                       |  |   |             |    
|------------------------------------------------------------------------------------- |  | ------------------- | --- | --------------------------- | ------ | --------------------- | ----- | --- | --------------------------- |  | --------------------- |  | - | ----------- | ---
|                                                                                      |  | Annual Compensation |     | Long-TermCompensationAwards |        |                       |      
|Name and Principal Position                                                           |  | Year                |     |                             | Salary |                       | Bonus |     | SecuritiesUnderlyingOptions |  | All OtherCompensation | 
|Michael A. Brochu President and Chief Executive Officer                               |  | 200320022001        |     |                             | $$$    | 303,333290,000290,000 |       | $$$ | 0014,500                    |  | 01,200,000200,000     |  | $ | 1,307,968 | (1)
|                                                                                      |  |                     |     |                             |       
|Ronald M. Stevens Chief Financial Officer, Executive Vice President and Treasurer     |  | 200320022001        |     |                             | $$$    | 191,667175,000175,000 |       | $$$ | 008,750                     |  | 0300,00080,000        |  |   |          |    
|                                                                                      |  |                     |     |                             |       
|David M. Williamson Executive Vice President, General Counsel and Corporate Secretary |  | 2003                | (2) |                             | $      | 191,667               |       | $   | 0                           |  | 0                     |  |   |            |    

---

|(1) |  | Other Compensation for Mr. Brochu consists of $997,968 in consideration of the Companys purchase of 1,239,165 of Mr. Brochus outstanding stock options, which constituted
all of his options with an exercise price over $0.86 per share and $310,000 in consideration of a three year non-competition and non-solicitation agreement from Mr. Brochu. Each of these transactions is discussed in more detail in Item 13, under the
heading Certain Relationships and Related Transactions.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Mr. Williamson was named an Executive Officer in 2003.
|--- |  | ------------------------------------------------------



Option Grants in Fiscal 2003



There were no options granted during the year ended
December 31, 2003 to the named executive officers.



58



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##### Table of Contents

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values



The following table provides information regarding options exercised during
2003 and held as of December 31, 2003 by each of the named executive officers.



|                    |  |                                                          |  |                                                                |         |             |         |               |         |                |   |                  |  |   |          
|------------------- |  | -------------------------------------------------------- |  | -------------------------------------------------------------- | ------- | ----------- | ------- | ------------- | ------- | -------------- | - | ---------------- |  | - | ---------
|                    |  | Total Number ofUnexercised Options atFiscal Year-End (#) |  | Value of UnexercisedIn-the-Money OptionsAt Fiscal Year-End ($)
|Name                |  | SharesAcquiredon Exercise                                |  | ValueRealized                                                  |         | Exercisable |         | Unexercisable |         | Exercisable(1) |   | Unexercisable(1)
|Michael A. Brochu   |  | 50,000                                                   |  | $                                                              | 169,500 |             | 716,666 |               | 433,334 |                | $ | 3,791,163        |  | $ | 2,292,337
|Ronald M. Stevens   |  | 125,000                                                  |  |                                                                | 418,100 |             | 216,040 |               | 163,960 |                |   | 531,718          |  |   | 656,032  
|David M. Williamson |  | 122,000                                                  |  |                                                                | 403,805 |             | 134,422 |               | 118,578 |                |   | 116,293          |  |   | 429,077  

---

|(1) |  | For the fiscal year ended December 31, 2003. The average of the high and low trades of Primus common stock on that date as reported on the Nasdaq Small Cap Market was $6.15
per share.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Change in Control Arrangements



Primus has entered into an agreement with each of Michael A. Brochu, Ronald
M. Stevens and David M. Williamson that provides for certain compensation arrangements upon and following a change of control of the Company. The agreements expire one year following a change of control. A change of control occurs under the
agreements when



| |  |  | Primus completes a merger, consolidation or share exchange after which its prior shareholders own less than a majority of the surviving corporation;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Primus sells substantially all of its assets not in the ordinary course of business; or
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | one person or entity acquires a majority of Primus outstanding shares.
| | - |  | -----------------------------------------------------------------------



Immediately upon a change of control, 50% of the unvested options of each executive become exercisable. Our 1995 and 1999 stock option plans also
provide for vesting of all unvested options in certain circumstances involving a merger, sale or liquidation of Primus.



If one of our executives is terminated by us without cause or terminates his or her employment due to a substantial change in his position or
responsibilities during the year following a change of control, he will be entitled to his accrued annual base salary, bonus and commissions through the date of termination plus severance pay equal to one-half of annual base salary. Further, all of
his outstanding options will become immediately exercisable. To the extent the employee regularly receives commissions as part of his compensation, we will also pay commissions to the terminated employee for sales to his former accounts that occur
during the six months following termination.



Compensation Committee Report
on Executive Compensation



Our executive compensation
program is administered by the Compensation Committee (the Committee), which is comprised of two non-employee directors. Our executive compensation policy is designed to:



| |  |  | assist us in attracting and retaining key executives critical to the Companys success;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | align the interests of the executives with the interests of our shareholders;
| | - |  | -----------------------------------------------------------------------------



| |  |  | reflect our overall performance; and
| | - |  | ------------------------------------



| |  |  | reward executives individually.
| | - |  | -------------------------------



Executive compensation consists of three major components: base salary, bonuses and stock option grants.



59



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##### Table of Contents

Base Salary.    The base salary of the chief executive officer is set at an
amount the Committee believes is competitive with the salaries paid to executives of other high-growth companies in the software industry located within the local area. The Committee relies on surveys and on knowledge of local pay practices as
reported in financial periodicals or otherwise accessible to the Committee. Additionally, a review of the chief executive officers performance and a general review of the Companys financial and stock price performance are considered. The
base salary for executive officers is reviewed annually. The chief executive officers base salary was held constant at $290,000 for 2001 and 2002 and was raised to $310,000 in May of 2003.



Bonus.    Under a bonus plan established in
February 1999, Primus executives may be eligible for annual and/or quarterly bonuses. Each executives potential bonus is set as a percentage of his base salary; bonuses for 2003 were generally considered based 100% on the Companys
results of operations and profitability over the year. No bonus payments were awarded during 2003.



Stock Option Grants.    Primus provides its executives with long-term incentives through the 1999 Stock Incentive Compensation
Plan and the 1999 Amended and Restated Non-Officer Employee Stock Compensation Plan (the 1999 Plans). The objective of the 1999 Plans is to enhance long-term profitability and shareholder value. The Compensation Committee of the Board
determines the number and terms of options granted to Primus chief executive officer and other executive officers. The Committee relies upon surveys and general familiarity with the number and proportion of shares available for grant pursuant
to stock options in similar companies to determine appropriate grant level. To encourage stock retention, all options are granted as incentive stock options to the maximum extent possible under the Internal Revenue Code. Options are typically
granted at the then-current market price and generally have a four-year vesting period to encourage key employees to continue their employment with Primus. The January 2002 option grants to employees and officers had a three-year vesting period. No
option grants were made to executive officers in 2003.



Section
162(m) of the Internal Revenue Code limits the tax deductibility by a corporation of compensation in excess of $1 million paid to the chief executive officer and any other of its four most highly compensated executive officers. However, compensation
which qualifies as performance-based is excluded from the $1 million limit. Although Primuss stock option plans are designed to qualify as performance-based compensation that is fully deductible by Primus for income tax purposes,
certain of the payments made to our Chief Executive Officer described in the section entitled Certain Relationships and Related Transactions may be deemed not to be performance based. To the extent that they exceed the $1 million limit,
it is possible that such payments would not be deductible by Primus.



The Committee believes that our compensation policies have been successful in attracting and retaining qualified employees and in linking compensation directly to corporate performance relative to our goals. The Committee will continue to
monitor the compensation levels potentially payable under Primuss other compensation programs, but intends to retain the flexibility necessary to provide total compensation in line with competitive practice, Primuss compensation
philosophy, and Primuss best interests.



Compensation Committee



Antonio M. Audino

Promod Haque



60



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##### Table of Contents

Performance Graph



The following graph shows a comparison of cumulative total shareholder return for Primus, the NASDAQ Stock Market-U.S. Index and S&P 500 Application
Software Index. The graph shows the value of $100 invested on July 1, 1999 in our common stock, the NASDAQ Stock Market-U.S. Index and the S&P 500 Application Software Index. Stock price performance shown below is historical and not necessarily
indicative of future price performances.



LOGO



Comparison of Cumulative Total
Return Primus Knowledge Solutions, Inc., the Nasdaq Stock Market-U.S and the S&P 500 Application Software Index.



|                             |  |              |     |               |   |      
|---------------------------- |  | ------------ | --- | ------------- | - | -----
|                             |  | July 1, 1999 |     | Dec. 31, 2003
|Primus                       |  | $            | 100 |               | $ | 44.93
|NASDAQ Stock Market-U.S.     |  | $            | 100 |               | $ | 74.30
|S&P 500 Application Software |  | $            | 100 |               | $ | 54.99



61



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##### Table of Contents

Equity Compensation Plan Information



The following table sets forth information regarding our common stock that may be issued upon the exercise of options,
warrants and other rights granted to employees, consultants or directors under all of our existing equity compensation plans as of December 31, 2003.



|                                                           |  |                                                                                         |     |  |                                                                         |      |                                                                                          |           |    
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------- | --- |  | ----------------------------------------------------------------------- | ---- | ---------------------------------------------------------------------------------------- | --------- | ---
|Plan category                                              |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights |     |  | Weighted-averageexercise price ofoutstandingoptions, warrantsand rights |      | Number of securitiesremaining availablefor future issuanceunder equitycompensation plans |          
|Equity compensation plans approved by security holders     |  | 2,496,040                                                                               |     |  | $                                                                       | 5.41 |                                                                                          | 1,447,733 | (1)
|Equity compensation plans not approved by security holders |  | 3,279,244                                                                               | (2) |  | $                                                                       | 6.14 |                                                                                          | 627,511   |    
|Total                                                      |  | 5,775,284                                                                               |     |  | $                                                                       | 5.84 |                                                                                          | 2,075,244 |    

---

|(1) |  | Under the terms of the Primus 1999 Stock Incentive Compensation Plan, the maximum number of shares issuable pursuant to the plan is automatically increased each January 1 by 666,666
shares.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Includes 383 option shares under the 1996 Option Plan assumed by the Company in its acquisition in 1999 of Imparto Software, Inc.; 265,327 option shares under the Amacis Group
Limited 2003 Enterprise Management Incentive Scheme assumed by the Company in its acquisitions in December 2003 of Amacis Group Limited; and 11,921 warrants issued prior to 1998, which were assumed in connection with the Companys acquisition
of 2Order.com, Inc, in 2000.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Equity Compensation Plans Not
Approved By Security Holders.



The Board adopted the 1999
Nonofficer Employee Stock Compensation Plan (the 1999 Plan) to enable the grant of nonqualified stock options to employees, consultants, agents, advisors and independent contractors of the Company. The 1999 Plan has not been approved by
the Companys shareholders. The Compensation Committee of the Board is the administrator of the 1999 Plan, and as such determines all matters relating to options granted under the 1999 Plan, including the selection of the recipients, the size
of the grants and the conditions to vesting and exercisability. The Compensation Committee has delegated authority to make grants under the 1999 Plan to certain officers of the Company, subject to specified limitations on the size and terms of such
grants. Up to thirty percent of the option pool under the 1999 Plan may be granted to officers and directors of the Company. A maximum of 4,200,000 shares of Common Stock have been reserved for issuance under the 1999 Plan.



ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



The following table provides information with respect to the beneficial ownership of shares of common stock as of March 1, 2004 by



| |  |  | each person or group that we know owns more than 5% of our common stock
| | - |  | -----------------------------------------------------------------------



| |  |  | each of the named executive officers
| | - |  | ------------------------------------



| |  |  | each of our incumbent directors
| | - |  | -------------------------------



| |  |  | all of our incumbent directors and executive officers as a group
| | - |  | ----------------------------------------------------------------



62



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##### Table of Contents

Beneficial ownership is determined in accordance with rules of the Securities and Exchange Commission and
includes shares over which the indicated beneficial owner exercises voting and/or investment power. Shares of our common stock subject to options exercisable as of March 1, 2004 or within 60 days of that date are deemed outstanding for computing the
percentage ownership of the person holding the options but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated, we believe the beneficial owners of the common stock listed below, based
on information furnished by them, have sole voting and investment power with respect to the number of shares listed opposite their names.



|                                               |  |                                          |  |                                       |  
|---------------------------------------------- |  | ---------------------------------------- |  | ------------------------------------- | -
|Name of Beneficial Owner(1)                    |  | Amount and Nature ofBeneficial Ownership |  | Percentage of commonstock Outstanding |  
|Principal Shareholders                         |  |                                          |  |                                       |  
|WM Advisors, Inc.                              |  | 3,294,800                                |  | 13.9                                  | %
|Entities affiliated with Trans Cosmos, Inc.(2) |  | 1,935,285                                |  | 8.2                                   | %
|Norwest Equity Partners, V                     |  | 1,441,166                                |  | 6.1                                   | %



|                                                          |  |                          |  |            |  |           |  |                                         |  
|--------------------------------------------------------- |  | ------------------------ |  | ---------- |  | --------- |  | --------------------------------------- | -
|Name of Beneficial Owner(1)                               |  | Shares BeneficiallyOwned |  | Options(3) |  | Total     |  | Percentage ofcommon stockOutstanding(4) |  
|Directors                                                 |  |                          |  |            |  |           |  |                                         |  
|Yasuki Matsumoto (5)                                      |  | 1,995,891                |  | 56,613     |  | 2,052,504 |  | 8.5                                     | %
|Promod Haque (6)                                          |  | 1,441,166                |  | 54,947     |  | 1,496,113 |  | 6.0                                     | %
|Michael A. Brochu (7)                                     |  | 9,000                    |  | 800,000    |  | 809,000   |  | 3.2                                     | %
|Antonio M. Audino                                         |  | 99,721                   |  | 89,322     |  | 189,043   |  | *                                       |  
|Daniel C. Regis                                           |  | 0                        |  | 12,500     |  | 12,500    |  | *                                       |  
|John A. Moga                                              |  | 0                        |  | 0          |  | 0         |  | *                                       |  
|                                                          |  |                          |  |           
|Executive Officers                                        |  |                          |  |            |  |           |  |                                         |  
|Ronald M. Stevens                                         |  | 1,000                    |  | 216,456    |  | 216,456   |  | *                                       |  
|David M. Williamson                                       |  | 0                        |  | 156,227    |  | 156,227   |  | *                                       |  
|Directors and executive officers as a group ([8] persons) |  | 3,546,778                |  | 1,386,065  |  | 4,932,843 |  | 19.7                                    | %

---

|* |  | Less than 1%.
|- |  | -------------



|(1) |  | The address of WM Advisors, Inc. is 1201 Third Avenue, 22nd Floor, Seattle, WA 98101. The address of Trans Cosmos, Inc. and Mr. Matsumoto is 777-108th Avenue, N.E., Suite 2300,
Bellevue, WA 98004. The address of Norwest Equity Partners V, L.P. and Mr. Haque is Suite 800, 525 University Avenue, Palo Alto, CA 94301. The address of Mr. Audino is Voyager Capital, 719 Second Avenue, Suite 1400, Seattle, WA 98104. The address of
Messrs. Regis, Moga, Brochu, Stevens and Williamson is c/o Primus Knowledge Solutions, Inc., 1601 Fifth Avenue, Suite 1900, Seattle, WA 98101.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Represents the following: (a) 199,999 shares owned by Trans Cosmos, Inc.; (b) 802,957 shares owned by Trans Cosmos USA, Inc; (c) 857,329 shares owned by U.S. Information Technology
Financing, L.P.; and (d) 75,000 shares held directly by Primus KK. Trans Cosmos USA, Inc. is a wholly owned subsidiary of Trans Cosmos, Inc. U.S. Information Technology Financing, L.P. is a limited partnership whose sole general partner is Trans
Cosmos USA, Inc. Yasuki Matsumoto, a director of Primus, is the President and CEO of Trans Cosmos USA, Inc.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | Includes all options exercisable within sixty days of March 1, 2004.
|--- |  | --------------------------------------------------------------------



|(4) |  | Calculated pursuant to Rule 13d-3 of the Securities Exchange Act of 1934.
|--- |  | -------------------------------------------------------------------------



|(5) |  | Represents the following: (a) 199,999 shares owned by Trans Cosmos, Inc.; (b) 802,957 shares owned by Trans Cosmos USA, Inc.; (c) 857,329 shares owned by U.S. Information Technology
Financing, L.P.; (d) 75,000 shares held directly by Primus KK; and (e) 60,606 shares owned by Mr. Matsumotos spouse. Trans Cosmos USA, Inc. is a wholly owned subsidiary of Trans Cosmos, Inc. U.S. Information Technology Financing, L.P. is
a limited partnership whose sole general partner is Trans Cosmos USA, Inc. Yasuki Matsumoto, a director of Primus, is the President and CEO of Trans Cosmos USA, Inc.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(6) |  | Represents 1,441,166 shares owned by Norwest Equity Partners V, L.P. Mr. Haque is a Partner in Norwest Venture Partners, an affiliate of Norwest Equity Partners V, L.P. Mr. Haque
disclaims beneficial ownership of the shares held by Norwest Equity Partners, V, L.P. except to the extent of his pecuniary interest arising from his interest in Norwest Venture Partners.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) |  | Represents the following: (a) 8,000 shares held directly by Mr. Brochu; and (b) 1,000 shares held by Mr. Brochus minor child. Mr. Brochu disclaims beneficial ownership of
1,000 shares held in the name of his minor child.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



In April 2001, the Companys Board of Directors approved an unsecured loan to Michael A. Brochu, the Companys President and Chief Executive
Officer, for $750,000 bearing interest at 4.9%. The maturity date of the loan was April 16, 2007 with principal and accrued interest payments due annually starting on April 16, 2005. This note was subject to full forgiveness in the event of Mr.
Brochus termination of employment without cause or for good reason following a change of control. Mr. Brochu prepaid the loan and all accrued interest in 2003.



On October 31, 2003, the Company entered into an agreement with Michael Brochu, President and Chief Executive Officer, to
purchase all of his outstanding stock options with an exercise price above $0.86, or 1,239,165 stock options, which reduces the net dilution from stock options to the Companys shareholders. Mr. Brochu elected to apply the proceeds, after
required tax withholdings of approximately $264,000, from this option disposition to his outstanding $750,000 loan from the Company. As a result of this transaction, the outstanding principal balance on the loan was reduced to approximately
$114,000. Mr. Brochu did not retain any net proceeds from the transaction.



The Companys Board of Directors, with Mr. Brochu abstaining from discussions and voting, approved of the above described transaction and established the total purchase price, using the Black-Scholes option
pricing model, of $997,968. The Company purchased from Mr. Brochu 547,999 stock options (granted on November 4, 1997) with an exercise price of $3.00, 78,666 stock options (granted on February 4, 1999) with an exercise price of $8.25, 150,000 stock
options (granted on August 13, 1999) with an exercise price of approximately $20.41, 150,000 stock options (granted on February 2, 2000) with an exercise price of approximately $74.03, 37,500 stock options (granted on May 17, 2000) with an exercise
price of approximately $38.66, 75,000 stock options (granted on October 12, 2000) with an exercise price of approximately $5.31, and 200,000 stock options (granted on May 16, 2001) with an exercise price of approximately $3.49.



The total purchase price under the above described transaction are reflected
as compensation expense and included in general and administrative expenses in our consolidated financial statements for the period ending December 31, 2003. The net proceeds were first applied against accrued interest due the Company of
approximately $98,000 and the remainder reduced Mr. Brochus outstanding loan principal balance by approximately $636,000.



On November 13, 2003, the Company entered into a noncompetition and nonsolicitation agreement with Michael Brochu. The Companys Board of Directors,
consistent with their desire to ensure that Mr. Brochus incentives support the long term growth of the company in the best interests of all shareholders and with Mr. Brochu abstaining from discussions and voting, approved of the transaction
and established consideration to Mr. Brochu in exchange for this agreement of one times his annual base salary, or $310,000. The noncompetition and nonsolicitation agreement is effective from November 13, 2003 through three years from the end date
of Mr. Brochus employment for any reason. Mr. Brochu elected to apply approximately $114,000 of the proceeds, after required tax withholdings of approximately $82,000, to his outstanding loan from the Company. As a result of this prepayment,
the loan was fully paid by December 31, 2003. The payment under this agreement is reflected as compensation expense and included in general and administrative expense in our consolidated financial statements for the period ending December 31, 2003.



64



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Our software is marketed, distributed and supported in Japan by Primus Knowledge Solutions, K.K.
(Primus KK), a joint venture in which we hold a 19.6% minority interest and hold 1 of 6 board of director positions. Trans Cosmos, Inc., one of Japans oldest and largest outsourced customer service and information technology
support solutions provider, holds the remaining 80.4% of Primus KK. Trans Cosmos currently holds approximately 8% of our common stock. Our distribution arrangements provide Primus KK with exclusive rights to the Japanese and English versions of our
Primus® eServer and Primus® eSupport products in Japan, and nonexclusive
distribution rights for these products in Korea, China and Hong Kong. The distribution arrangement continues until terminated by mutual agreement or, if Primus KK has not completed the listing of its common stock on a recognized public stock
exchange by December 31, 2004 or if certain performance goals are not met, its expiration on March 31, 2006. In July 2002, January 2003, May 2003 and again in September 2003, we amended the distribution agreement with Primus KK, and they have
assumed a more significant role in product localization and support for the Japanese market. After the September 2003 amendment, our current royalty fee structure has guaranteed minimum payments from Primus KK of $125,000 per quarter, through the
first quarter of 2004 provided certain professional services milestones are met. The amended distribution agreement provides for sublicense fees based on a percentage of net fees collected by Primus KK from its customers (subject to certain
minimums). The guaranteed minimum payments from Primus KK could result in an adjustment to the sublicense fee due each quarter, but such payments do not constitute an advance inventory purchase nor can such payments be credited or carried over from
one year to another. Guaranteed minimum royalty payments, to the extent they exceed sublicense fees due, are recognized in the period earned. As a result of the changing and uncertain business climate and operating results for Primus KK, we expect
to negotiate further amendments to our distribution agreement. Our agreement with Primus KK does not contain product return rights. Revenue recognized under the reseller agreement totals approximately $956,000, $1,394,000 and $3,134,000 in 2003,
2002 and 2001, respectively, and revenue deferred at December 31, 2003 and 2002 was approximately $94,000 and $248,000, respectively, and accounts receivable at December 31, 2003 and 2002 were approximately $6,000 and $471,000, respectively. Primus
KK is accounted for using the cost method, as management believes it does not have significant influence over its operations, has not guaranteed any of its obligations and does not have any commitment or intent to provide any funding. The carrying
value of Primus KK is zero at December 31, 2003 and 2002.



ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES



The Audit Committee of the Board has selected KPMG LLP to serve as independent public accountants. Representatives from KPMG LLP are expected to be
present at the Annual Meeting and will have an opportunity to make a statement and to respond to appropriate questions from shareholders.



The following table presents fees for professional services rendered by KPMG LLP to the Company.



|                             |  |      |         |      |   |        
|---------------------------- |  | ---- | ------- | ---- | - | -------
|                             |  | 2003 |         | 2002
|Audit fees                   |  | $    | 428,803 |      | $ | 115,000
|Audit related fees(1)        |  |      | 0       |      |   | 10,500 
|                             |  |      |         |      |   |        
|Audit and audit related fees |  |      | 428,803 |      |   | 125,500
|Tax fees(2)                  |  |      | 38,500  |      |   | 43,183 
|All other fees               |  |      | 0       |      |   | 0      
|                             |  |      |         |      |   |        
|Total fees                   |  | $    | 467,303 |      | $ | 168,683
|                             |  |      |         |      |   |        

---

|(1) |  | Audit related fees consisted principally of fees for consultations in connection with accounting and reporting matters in 2002.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Tax fees consisted of fees for tax consultation and tax compliance services.
|--- |  | ----------------------------------------------------------------------------



The Audit Committee has considered and concluded that the provision of non-audit services, principally tax compliance services, is compatible with
maintaining the independence of KPMG LLP.



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Effective May 6, 2003, we were required to obtain pre-approval by our Audit Committee for all audit and
permissible non-audit related fees incurred with our independent auditors. Fiscal 2003 was a transition year for this new requirement. All new projects authorized after the effective date of this requirement were approved in advance by the Audit
Committee. We did not receive pre-approval by the Audit Committee for non-audit related fees during fiscal 2002. The Audit Committee has adopted pre-approval policies and procedures, available on the Primus Internet site,
www.primus.com/company/corporategovernance/.



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PART IV



ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



(a)(1)  Financial Statements



|   |  |                                                                                                                                                    
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|1. |  | Report of KPMG LLP dated February 10 2004, except as to Notes 10 and 16, which are as of March 18, 2004. (See Page F-2 hereof).                    
|   | 
|2. |  | Consolidated Balance Sheets as of December 31, 2003 and 2002. (See Page F-3 hereof).                                                               
|   | 
|3. |  | Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001. (See Page F-4 hereof).                                 
|   | 
|4. |  | Consolidated Statements of Shareholders Equity and Comprehensive Loss for the years ended December 31, 2003, 2002 and 2001. (See Page F-5 hereof).
|   | 
|5. |  | Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001. (See Page F-6 hereof).                                 
|   | 
|6. |  | Notes to Consolidated Financial Statements. (See pages F-7 through F-30 hereof).                                                                   



(a)(2)  Financial Statement Schedules



|             |  |                                  
|------------ |  | ---------------------------------
|Schedule No. |  | Description                      
|Schedule II  |  | Valuation and Qualifying Accounts



Other schedules are
not provided because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.



(a)(3)  Exhibits



(a)    Exhibits.  The following is a complete list of Exhibits filed as part of this Form 10-K.



|           |  |                                                                                                                                                                                                                                                                                                     
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Description                                                                                                                                                                                                                                                                                         
|2.1        |  | Agreement and Plan of Merger, dated December 12, 1999, among the registrant, San Antonio Acquisition, Inc. and Imparto Software Corporation.(3)                                                                                                                                                     
|           | 
|2.2        |  | Agreement and Plan of Merger, dated as of January 8, 2000, by and among the registrant, Austin Acquisition, Inc. and 2order.com, Inc.(4)                                                                                                                                                            
|           | 
|2.3        |  | Agreement and Plan of Reorganization, dated May 21, 2001, by and among the registrant, AL Acquisition, Inc. and AnswerLogic, Inc.(6)                                                                                                                                                                
|           | 
|2.4        |  | Agreement and Plan of Reorganization, dated September 3, 2003, by and among the registrant, Broad Daylight, Inc. and Q Merger Corp.(9)                                                                                                                                                              
|           | 
|2.5        |  | Share Purchase Agreement, dated December 22, 2003, by and among the registrant, Amacis Group Limited and each shareholder of Amacis Group Limited.(10)                                                                                                                                              
|           | 
|3.1        |  | Fourth Amended and Restated Articles of Incorporation of the registrant.(1)                                                                                                                                                                                                                         
|           | 
|3.2        |  | Second Amended and Restated Bylaws of the registrant.(1)                                                                                                                                                                                                                                            
|           | 
|4.1        |  | Registration Rights Agreement, dated July 22, 1998, as amended, by and among the registrant, Trans Cosmos, USA, Inc., Trans Cosmos, Inc., Encompass Group, Inc., Oak Investment Partners VI
L.P., Oak VI Affiliates Fund, L.P., Norwest Equity Partners, V, Piper Jaffray, Inc., and Snowden L.P.(1)
|           | 
|4.2        |  | Third Amendment to Registration Rights Agreement, dated December 12, 1999 by and among the registrant, Trans Cosmos USA Inc., Trans Cosmos, Inc., Encompass Group, Inc., Oak Investment
Partners VI L.P., Oak VI Affiliates Fund, L.P. and Norwest Equity Partners, V.(2)                           
|           | 
|4.3        |  | Registration Rights Agreement, dated January 21, 2000, by and among the registrant and the Investors listed on Schedule A thereto.(2)                                                                                                                                                               



67



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|           |  |                                                                                                                                                                          
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Description                                                                                                                                                              
|           | 
|10.1       |  | Joint Venture Agreement, dated November 16, 1995, by and between the registrant and Trans Cosmos, Inc.(1)                                                                
|           | 
|10.2       |  | First Amendment to Joint Venture Agreement, dated September 26, 1997, by and among the registrant, Trans Cosmos, Inc., and Best Career Company.(1)                       
|           | 
|10.3       |  | Exclusive Distribution License Agreement, dated September 26, 1997, by and between the registrant and Trans Cosmos, Inc.(1)                                              
|           | 
|10.4       |  | First Right of Refusal, dated September 26, 1997, by and between the registrant and Primus K.K.(1)                                                                       
|           | 
|10.5       |  | Software Marketing and Distribution Agreement, dated March 31, 1998, by and between the registrant and Primus Knowledge Solutions K.K.(1)                                
|           | 
|10.6       |  | Amended and Restated Value Added Reseller License Agreement, dated December 31, 1997, by and between the registrant and Versant Object Technology Corporation.(1)        
|           | 
|10.7       |  | Form of Change of Control Agreement entered into by the registrant, Michael A. Brochu, Ronald Stevens, David Williamson, David Ridout, Leif Larsen and Tom Montgomery.(1)
|           | 
|10.8       |  | Employee Stock Option and Restricted Stock Award Plan, as adopted by registrants board of directors on November 29, 1993.(1)                                            
|           | 
|10.9       |  | Non-Employee Director Stock Option Plan, as adopted by registrants board of directors on November 1, 1994.(1)                                                           
|           | 
|10.10      |  | 1995 Stock Incentive Compensation Plan, as amended and restated on March 12, 1996 and amended on February 10, 1998.(1)                                                   
|           | 
|10.11      |  | 1999 Stock Incentive Compensation Plan.(1)                                                                                                                               
|           | 
|10.12      |  | 1999 Employee Stock Purchase Plan.(1)                                                                                                                                    
|           | 
|10.13      |  | Office Lease Agreement, dated July 25, 1995, by and between the registrant and Westlake Center Associates Limited Partnership.(1)                                        
|           | 
|10.14      |  | Lease Amendment 1, dated February 1, 1999, by and between the registrant and Westlake Center Associates Limited Partnership.(1)                                          
|           | 
|10.15      |  | Services Agreement, dated February 13, 1998, by and between the registrant and Encompass Globalization, Inc.(1)                                                          
|           | 
|10.16      |  | Amended and Restated Software Marketing and Distribution Agreement, dated March 31, 2000, by and between registrant and Primus Knowledge Solutions KK.(1)                
|           | 
|10.17      |  | Lease Amendment II, dated February 11, 2000, by and between the registrant and Westlake Center Associates Limited Partnership.(3)                                        
|           | 
|10.18      |  | Lease Amendment III, dated May 31, 2000, by and between the registrant and Westlake Center Associates Limited Partnership.(4)                                            
|           | 
|10.19      |  | Second Amendment to Joint Venture Agreement, dated July 24, 2000, by and between the registrant and Trans Cosmos, Inc.(5)                                                
|           | 
|10.20      |  | Third Amendment to Joint Venture Agreement, dated August 9, 2001, by and between the registrant and Trans Cosmos, Inc.(7)                                                
|           | 
|10.21      |  | Fourth Amendment to Joint Venture Agreement, dated November 7, 2001, by and between the registrant and Trans Cosmos, Inc.(7)                                             
|           | 
|10.22      |  | Addendum One to Amended and Restated Distribution Agreement, dated November 7, 2001, by and between registrant and Primus Knowledge Solutions, KK.(7)                    



68



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##### Table of Contents

|           |  |                                                                                                                                                                                                                                                  
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNo. |  | Description                                                                                                                                                                                                                                      
|10.23      |  | Lease Amendment IV, dated December 13, 2001, by and between the registrant and Westlake Center Associates Limited Partnership.(7)                                                                                                                
|           | 
|10.24      |  | Addendum Two to Amended and Restated Distribution Agreement, dated July 10, 2002, by and between registrant and Primus Knowledge Solutions, KK.(8)                                                                                               
|           | 
|10.25      |  | Lease Amendment V, dated November 26, 2002, by and between the registrant and Westlake Center Associates Limited Partnership.(9)                                                                                                                 
|           | 
|10.26      |  | Addendum Three to Amended and Restated Distribution Agreement, dated January 1, 2003, by and between registrant and Primus Knowledge Solutions, KK.(9)                                                                                           
|           | 
|10.27      |  | Addendum Four to Amended and Restated Distribution Agreement, dated March 31, 2003, by and between registrant and Primus Knowledge Solutions, KK.(12)                                                                                            
|           | 
|10.28      |  | Addendum Five to Amended and Restated Distribution Agreement dated September 30, 2003, by and between registrant and Primus Knowledge Solutions, KK.(12)                                                                                         
|           | 
|10.29      |  | Agreement by and between registrant and Michael A. Brochu, dated October 31, 2003.                                                                                                                                                               
|           | 
|10.30      |  | Key Employee Non-Competition and Non-Solicitation Agreement, by and between registrant and Michael A. Brochu, dated November 13, 2003.                                                                                                           
|           | 
|10.31      |  | Amacis Group Limited 2003 Enterprise Management Incentive Scheme.(13)                                                                                                                                                                            
|           | 
|21.1       |  | Subsidiaries of the registrant.                                                                                                                                                                                                                  
|           | 
|23.1       |  | Consent of KPMG LLP.                                                                                                                                                                                                                             
|           | 
|31.1       |  | Certification of Michael A. Brochu, President and Chief Executive Officer of Primus Knowledge Solutions, Inc., pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of
1934, as amended.                                  
|           | 
|31.2       |  | Certification of Ronald M. Stevens, Chief Operating Officer, Chief Financial Officer and Treasurer of Primus Knowledge Solutions, Inc., pursuant to Rules 13a-14(a) and 15d-14(a) under the
Securities Exchange Act of 1934, as amended.         
|           | 
|32.1       |  | Certification of Michael A. Brochu, President and Chief Executive Officer of Primus Knowledge Solutions, Inc., Pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.                         
|           | 
|32.2       |  | Certification of Ronald M. Stevens, Chief Operating Officer, Chief Financial Officer and Treasurer of Primus Knowledge Solutions, Inc., pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.

---

|(1) |  | Incorporated by reference herein to our Registration Statement on Form S-1 and all amendments thereto filed with the Securities and Exchange Commission on April 30, 1999
(Registration No. 333-77477).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference herein to our Form 10-K filed with the Securities and Exchange Commission on March 23, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on May 11, 2000.
|--- |  | --------------------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on August 14, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on November 13, 2000.
|--- |  | -------------------------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference herein to the Form 8-K filed with the Securities and Exchange Commission on June 15, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------

|(7) |  | Incorporated by reference herein to our Form 10-K filed with the Securities and Exchange Commission on March 20, 2002.
|--- |  | ----------------------------------------------------------------------------------------------------------------------

|(8) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on November 7, 2002.
|--- |  | ------------------------------------------------------------------------------------------------------------------------

|(9) |  | Incorporated by reference herein to our Form 10-K filed with the Securities and Exchange Commission on March 27, 2003.
|--- |  | ----------------------------------------------------------------------------------------------------------------------



69



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##### Table of Contents

|(10) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on August 14, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------

|(11) |  | Incorporated by reference herein to our Form 8-K filed with the Securities and Exchange Commission on December 24, 2003.
|---- |  | ------------------------------------------------------------------------------------------------------------------------

|(12) |  | Incorporated by reference herein to our Form 10-Q filed with the Securities and Exchange Commission on November 14, 2003.
|---- |  | -------------------------------------------------------------------------------------------------------------------------

|(13) |  | Incorporated by reference herein to our Form S-8 filed with the Securities and Exchange Commission on January 13, 2004.
|---- |  | -----------------------------------------------------------------------------------------------------------------------



(b)  Reports on Form 8-K for the Quarter ended December 31,
2003.



Form 8-K filed December 24, 2003 disclosing the
Companys acquisition of Amacis Group Limited.



Form 8-K/A
filed November 17, 2003 amending the Companys previous disclosure of its acquisition of Broad Daylight, Inc.



Form 8-K filed November 4, 2003 disclosing the purchase by the Company of certain of the CEOs stock options.



Form 8-K furnished on October 28, 2003 disclosing the Companys
financial results for the third quarter ended September 30, 2003.



70



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##### Table of Contents

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.



|               |  |  |  |                                  |  |                                                             
|-------------- |  |  |  | -------------------------------- |  | ------------------------------------------------------------
|               |  |  |  | PRIMUS KNOWLEDGE SOLUTIONS, INC.
|               |  |  | 
|March 26, 2004 |  |  |  | By:                              |  | /s/    MICHAEL A.
BROCHU                                    
|Date           |  |  |  |                                  |  | Michael A. Brochu                                           
|               |  |  |  |                                  |  | President, Chief Executive Officer and Chairman of the Board
|               |  |  | 
|               |  |  |  |                                  |  |                                                             



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



|                                          |  |                                                                                                             |  |                   
|----------------------------------------- |  | ----------------------------------------------------------------------------------------------------------- |  | ------------------
|Signature                                 |  | Title                                                                                                       |  | Date              
|                                          |  |                                                                                                            
|/s/    MICHAEL A.
BROCHUMichael A.
Brochu |  | President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)                  |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    RONALD M.
STEVENSRonald M.
Stevens |  | Chief Operating Officer, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    JOHN
MOGAJohn Moga                 |  | Director                                                                                                    |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    ANTONIO M.
AUDINOAntonio M.
Audino |  | Director                                                                                                    |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    PROMOD
HAQUEPromod Haque           |  | Director                                                                                                    |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    YASUKI
MATSUMOTOYasuki
Matsumoto   |  | Director                                                                                                    |  | March 26, 2004Date
|                                          |  |                                                                                                            
|/s/    DANIEL
REGISDaniel Regis           |  | Director                                                                                                    |  | March 26, 2004Date





71



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC.



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                            |  |     
|--------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                            |  | Page
|                                                                                                                            | 
|Independent Auditors Report                                                                                                |  | F-2 
|                                                                                                                            | 
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                                |  | F-3 
|                                                                                                                            | 
|Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001                                  |  | F-4 
|                                                                                                                            | 
|Consolidated Statements of Shareholders Equity and Comprehensive Loss for the Years Ended December 31, 2003, 2002 and 2001 |  | F-5 
|                                                                                                                            | 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001                                  |  | F-6 
|                                                                                                                            | 
|Notes to Consolidated Financial Statements                                                                                  |  | F-7 
|                                                                                                                            | 
|Schedule II Valuation and Qualifying Accounts                                                                               |  | S-1 



F-1



---

##### Table of Contents

INDEPENDENT AUDITORS REPORT



The Shareholders and Board of Directors

Primus Knowledge Solutions, Inc.:



We have audited the consolidated financial statements of Primus Knowledge
Solutions, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based
on our audits.



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



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Primus
Knowledge Solutions, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as whole presents fairly, in all material respects,
the information set forth therein.



As discussed in Note 1 to
the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets as of January 1, 2002.



KPMG LLP



Seattle, Washington

February 10, 2004, except as to Notes 10 and 16, which are as of March 18, 2004



F-2



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------- | -------- | - | ---- | - | ------- | -
|                                                                                                                                                                 |  | December 31,                                       |         
|                                                                                                                                                                 |  | 2003                                               |          |   | 2002 |  
|                                                                                                                                                                 |  | (In thousands, except share and per share amounts) |         
|A S S E T S                                                                                                                                                      |  |                                                    |          |   |      |  
|Current assets:                                                                                                                                                  |  |                                                    |          |   |      |   |         |  
|Cash, cash equivalents and short-term investments                                                                                                                |  | $                                                  | 12,154   |   |      | $ | 12,958  |  
|Accounts receivable, net of allowance for doubtful accounts of $174 and $412 at December 31, 2003 and 2002, respectively                                         |  |                                                    | 5,475    |   |      |   | 4,201   |  
|Prepaid expenses and other current assets                                                                                                                        |  |                                                    | 1,001    |   |      |   | 847     |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Total current assets                                                                                                                                             |  |                                                    | 18,630   |   |      |   | 18,006  |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Property and equipment, net                                                                                                                                      |  |                                                    | 1,415    |   |      |   | 2,268   |  
|Goodwill                                                                                                                                                         |  |                                                    | 11,785   |   |      |   |        |  
|Other intangible assets, net of accumulated amortization of $68                                                                                                  |  |                                                    | 3,608    |   |      |   |        |  
|Note receivable from related party                                                                                                                               |  |                                                    |         |   |      |   | 750     |  
|Other assets                                                                                                                                                     |  |                                                    | 225      |   |      |   | 236     |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Total assets                                                                                                                                                     |  | $                                                  | 35,663   |   |      | $ | 21,260  |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|L I A B I L I T I E S    A N D    S H A R E H O L D E R S
    E Q U I T Y                                                                                       |  |                                                    |          |   |      |  
|Current liabilities:                                                                                                                                             |  |                                                    |          |   |      |   |         |  
|Accounts payable                                                                                                                                                 |  | $                                                  | 2,555    |   |      | $ | 953     |  
|Accrued and other liabilities                                                                                                                                    |  |                                                    | 2,170    |   |      |   | 2,295   |  
|Compensation-related accruals                                                                                                                                    |  |                                                    | 1,733    |   |      |   | 926     |  
|Obligations due under credit facility                                                                                                                            |  |                                                    | 395      |   |      |   |        |  
|Deferred revenue, including related-party amounts of $94 and $248 at December 31, 2003 and 2002, respectively                                                    |  |                                                    | 8,797    |   |      |   | 6,228   |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Total current liabilities                                                                                                                                        |  |                                                    | 15,650   |   |      |   | 10,402  |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Commitments and contingencies                                                                                                                                    |  |                                                    |          |   |      |   |         |  
|Shareholders equity:                                                                                                                                            |  |                                                    |          |   |      |   |         |  
|Common stock, $.025 par value; authorized 50,000,000 shares; issued and outstanding 23,257,082 and 19,053,821 shares at December 31, 2003 and
2002, respectively |  |                                                    | 581      |   |      |   | 476     |  
|Additional paid-in capital                                                                                                                                       |  |                                                    | 122,051  |   |      |   | 110,187 |  
|Accumulated other comprehensive income                                                                                                                           |  |                                                    | 188      |   |      |   | 75      |  
|Accumulated deficit                                                                                                                                              |  |                                                    | (102,807 | ) |      |   | (99,880 | )
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Total shareholders equity                                                                                                                                       |  |                                                    | 20,013   |   |      |   | 10,858  |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                       |  | $                                                  | 35,663   |   |      | $ | 21,260  |  
|                                                                                                                                                                 |  |                                                    |          |   |      |   |         |  



See accompanying notes
to consolidated financial statements



F-3



---

##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|---------------------------------------------------------------------------------------------------- |  | -------------------------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                                     |  | Years Ended December 31,                           |           
|                                                                                                     |  | 2003                                               |            |   | 2002 |   |            | 2001 | 
|                                                                                                     |  | (In thousands, except share and per share amounts) |           
|Revenue:                                                                                             |  |                                                    |            |   |      |   |            |      |  |   |            |  
|License:                                                                                             |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Third party                                                                                          |  | $                                                  | 10,152     |   |      | $ | 7,371      |      |  | $ | 10,417     |  
|Related partyPrimus KK                                                                              |  |                                                    | 578        |   |      |   | 721        |      |  |   | 2,152      |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|                                                                                                     |  |                                                    | 10,730     |   |      |   | 8,092      |      |  |   | 12,569     |  
|Service:                                                                                             |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Third party                                                                                          |  |                                                    | 13,943     |   |      |   | 12,177     |      |  |   | 13,999     |  
|Related partyPrimus KK                                                                              |  |                                                    | 378        |   |      |   | 673        |      |  |   | 982        |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|                                                                                                     |  |                                                    | 14,321     |   |      |   | 12,850     |      |  |   | 14,981     |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Total revenue                                                                                        |  |                                                    | 25,051     |   |      |   | 20,942     |      |  |   | 27,550     |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Cost of revenue:                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|License                                                                                              |  |                                                    | 461        |   |      |   | 328        |      |  |   | 373        |  
|Service                                                                                              |  |                                                    | 4,875      |   |      |   | 4,697      |      |  |   | 7,734      |  
|Amortization of purchased intangibles                                                                |  |                                                    | 68         |   |      |   |           |      |  |   |           |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Total cost of revenue                                                                                |  |                                                    | 5,404      |   |      |   | 5,025      |      |  |   | 8,107      |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Gross profit                                                                                         |  |                                                    | 19,647     |   |      |   | 15,917     |      |  |   | 19,443     |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Operating expenses:                                                                                  |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Sales and marketing                                                                                  |  |                                                    | 10,434     |   |      |   | 11,519     |      |  |   | 19,812     |  
|Research and development                                                                             |  |                                                    | 7,788      |   |      |   | 7,856      |      |  |   | 12,636     |  
|General and administrative                                                                           |  |                                                    | 4,452      |   |      |   | 4,367      |      |  |   | 6,551      |  
|Amortization of goodwill                                                                             |  |                                                    |           |   |      |   |           |      |  |   | 550        |  
|Restructuring charges                                                                                |  |                                                    |           |   |      |   | 1,227      |      |  |   | 2,530      |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                                                             |  |                                                    | 22,674     |   |      |   | 24,969     |      |  |   | 42,079     |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Loss from operations                                                                                 |  |                                                    | (3,027     | ) |      |   | (9,052     | )    |  |   | (22,636    | )
|Interest income                                                                                      |  |                                                    | 146        |   |      |   | 234        |      |  |   | 1,389      |  
|Other income (expense), net                                                                          |  |                                                    | 24         |   |      |   | (32        | )    |  |   | (157       | )
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Loss before income taxes, extraordinary item and cumulative effect of change in accounting principle |  |                                                    | (2,857     | ) |      |   | (8,850     | )    |  |   | (21,404    | )
|Income tax expense                                                                                   |  |                                                    | (70        | ) |      |   | (111       | )    |  |   | (417       | )
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Loss before extraordinary item and cumulative effect of change in accounting principle               |  |                                                    | (2,927     | ) |      |   | (8,961     | )    |  |   | (21,821    | )
|Extraordinary gain on disposal of assets                                                             |  |                                                    |           |   |      |   |           |      |  |   | 566        |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Loss before cumulative effect of change in accounting principle                                      |  |                                                    | (2,927     | ) |      |   | (8,961     | )    |  |   | (21,255    | )
|Cumulative effect of change in accounting principle                                                  |  |                                                    |           |   |      |   | (2,281     | )    |  |   |           |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Net loss                                                                                             |  | $                                                  | (2,927     | ) |      | $ | (11,242    | )    |  | $ | (21,255    | )
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Basic and diluted per share amounts:                                                                 |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Loss before extraordinary item and cumulative effect of change in accounting principle               |  | $                                                  | (0.15      | ) |      | $ | (0.47      | )    |  | $ | (1.18      | )
|Extraordinary gain on disposal of assets                                                             |  |                                                    |           |   |      |   |           |      |  |   | .03        |  
|Cumulative effect of change in accounting principle                                                  |  |                                                    |           |   |      |   | (0.12      | )    |  |   |           |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Net loss                                                                                             |  | $                                                  | (0.15      | ) |      | $ | (0.59      | )    |  | $ | (1.15      | )
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Weighted average shares used in:                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  
|Computing basic and diluted per share amounts                                                        |  |                                                    | 19,379,326 |   |      |   | 18,982,841 |      |  |   | 18,551,628 |  
|                                                                                                     |  |                                                    |            |   |      |   |            |      |  |   |            |  



See accompanying notes
to consolidated financial statements.



F-4



---

##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSS



|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|---------------------------------------------------------- |  | ------------------------------------ | - |  | ------------------------- | --- | - | -------------------------------- | - | ------- | ------------------------------------------- |  | - | ------------------- | - |  | ------------------------- | --- | - |  | - | -------- | - |  | - | ------- | -
|                                                           |  | Common stock                         |   |  | Additionalpaid-in Capital |     |   | Deferredstock-based compensation |   |         | Accumulatedothercomprehensive income (loss) |  |   | Accumulated deficit |   |  | Totalshareholders equity |    
|                                                           |  | Shares                               |   |  | Parvalue                  |     |   |                                  |   |         |                                            
|                                                           |  | (In thousands, except share amounts) |  
|Balance at December 31, 2000                               |  | 18,045,376                           |   |  | $                         | 452 |   |                                  | $ | 106,876 |                                             |  | $ | (54                 | ) |  | $                         | (44 | ) |  | $ | (67,383  | ) |  | $ | 39,847  |  
|Stock issued in acquisition of AnswerLogic                 |  | 750,000                              |   |  |                           | 19  |   |                                  |   | 2,936   |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 2,955   |  
|Exercise of stock options                                  |  | 56,960                               |   |  |                           | 1   |   |                                  |   | 163     |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 164     |  
|Stock issued for employee stock purchase plan              |  | 93,177                               |   |  |                           | 2   |   |                                  |   | 236     |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 238     |  
|Deferred stock-based compensation                          |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   | 21                  |   |  |                           |    |   |  |   |         |   |  |   | 21      |  
|Forfeiture of non-vested deferred stock based compensation |  |                                     |   |  |                           |    |   |                                  |   | (33     | )                                           |  |   | 33                  |   |  |                           |    |   |  |   |         |   |  |   |        |  
|Comprehensive loss:                                        |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Foreign currency translation loss                          |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | (14 | ) |  |   |         |   |  |   |        |  
|Unrealized gain on securities available for sale           |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | 75  |   |  |   |         |   |  |   |        |  
|Net loss                                                   |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           |    |   |  |   | (21,255  | ) |  |   |        |  
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                   |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | 61  |   |  |   | (21,255  | ) |  |   | (21,194 | )
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Balance at December 31, 2001                               |  | 18,945,513                           |   |  |                           | 474 |   |                                  |   | 110,178 |                                             |  |   |                    |   |  |                           | 17  |   |  |   | (88,638  | ) |  |   | 22,031  |  
|Exercise of stock options                                  |  | 3,571                                |   |  |                           |    |   |                                  |   | 3       |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 3       |  
|Stock issued for employee stock purchase plan              |  | 142,237                              |   |  |                           | 3   |   |                                  |   | 80      |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 83      |  
|Cancellation of escrowed AnswerLogic shares                |  | (37,500                              | ) |  |                           | (1  | ) |                                  |   | (74     | )                                           |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | (75     | )
|Comprehensive loss:                                        |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Foreign currency translation gain                          |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | 112 |   |  |   |         |   |  |   |        |  
|Unrealized loss on securities available for sale           |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | (54 | ) |  |   |         |   |  |   |        |  
|Net loss                                                   |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           |    |   |  |   | (11,242  | ) |  |   |         |  
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                   |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           | 58  |   |  |   | (11,242  | ) |  |   | (11,184 | )
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Balance at December 31, 2002                               |  | 19,053,821                           |   |  |                           | 476 |   |                                  |   | 110,187 |                                             |  |   |                    |   |  |                           | 75  |   |  |   | (99,880  | ) |  |   | 10,858  |  
|Exercise of stock options                                  |  | 728,921                              |   |  |                           | 18  |   |                                  |   | 848     |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 866     |  
|Stock issued for employee stock purchase plan              |  | 108,639                              |   |  |                           | 3   |   |                                  |   | 42      |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 45      |  
|Stock issued in acquisition of Broad Daylight              |  | 2,131,009                            |   |  |                           | 53  |   |                                  |   | 2,483   |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 2,536   |  
|Stock issued in acquisition of Amacis                      |  | 1,234,692                            |   |  |                           | 31  |   |                                  |   | 7,377   |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 7,408   |  
|Assumption of Amacis stock option plan                     |  |                                     |   |  |                           |    |   |                                  |   | 1,114   |                                             |  |   |                    |   |  |                           |    |   |  |   |         |   |  |   | 1,114   |  
|Comprehensive loss:                                        |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Foreign currency translation gain                          |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | 117 |   |  |   |         |   |  |   |        |  
|Unrealized loss on securities available for sale           |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           | (4  | ) |  |   |         |   |  |   |        |  
|Net loss                                                   |  |                                     |   |  |                           |    |   |                                  |   |        |                                             |  |   |                    |   |  |                           |    |   |  |   | (2,927   | ) |  |   |        |  
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                   |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           | 113 |   |  |   | (2,927   | ) |  |   | (2,814  | )
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  
|Balance at December 31, 2003                               |  | 23,257,082                           |   |  | $                         | 581 |   |                                  | $ | 122,051 |                                             |  | $ |                    |   |  | $                         | 188 |   |  | $ | (102,807 | ) |  | $ | 20,013  |  
|                                                           |  |                                      |   |  |                           |     |   |                                  |   |         |                                             |  |   |                     |   |  |                           |     |   |  |   |          |   |  |   |         |  





See accompanying notes to consolidated financial statements.



F-5



---

##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBISIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                          |  | Years Ended December 31, |       
|                                                                                                                          |  | 2003                     |        |   | 2002 |   |         | 2001 | 
|                                                                                                                          |  | (In thousands)           |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                     |  |                          |        |   |      |   |         |      |  |   |         |  
|Net loss                                                                                                                  |  | $                        | (2,927 | ) |      | $ | (11,242 | )    |  | $ | (21,255 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                               |  |                          |        |   |      |   |         |      |  |   |         |  
|Compensation expense related to note repayment in conjunction with option purchase and non-compete agreement              |  |                          | 849    |   |      |   |        |      |  |   |        |  
|Extraordinary gain on disposal of assets                                                                                  |  |                          |       |   |      |   |        |      |  |   | (566    | )
|Loss on disposal of assets                                                                                                |  |                          |       |   |      |   | 313     |      |  |   | 790     |  
|Cumulative effect of change in accounting principle                                                                       |  |                          |       |   |      |   | 2,281   |      |  |   |        |  
|Option and warrant expense                                                                                                |  |                          |       |   |      |   |        |      |  |   | 21      |  
|Depreciation and amortization                                                                                             |  |                          | 1,716  |   |      |   | 2,196   |      |  |   | 3,039   |  
|Changes in assets and liabilities, net of effects from purchase of businesses:                                            |  |                          |        |   |      |   |         |      |  |   |         |  
|Accounts receivable                                                                                                       |  |                          | (712   | ) |      |   | 1,709   |      |  |   | 4,903   |  
|Prepaid expenses and other current assets                                                                                 |  |                          | 74     |   |      |   | 448     |      |  |   | (229    | )
|Other assets                                                                                                              |  |                          | 33     |   |      |   | 11      |      |  |   | 76      |  
|Accounts payable and accrued liabilities                                                                                  |  |                          | (549   | ) |      |   | (321    | )    |  |   | (3,887  | )
|Compensation-related accruals                                                                                             |  |                          | 120    |   |      |   | (497    | )    |  |   | (2,079  | )
|Deferred revenue                                                                                                          |  |                          | 116    |   |      |   | (204    | )    |  |   | (1,119  | )
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                                                                     |  |                          | (1,280 | ) |      |   | (5,306  | )    |  |   | (20,306 | )
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                                     |  |                          |        |   |      |   |         |      |  |   |         |  
|Purchases of short-term investments                                                                                       |  |                          | (394   | ) |      |   |        |      |  |   | (11,260 | )
|Proceeds from maturities of short-term investments                                                                        |  |                          | 1,395  |   |      |   | 4,000   |      |  |   | 35,641  |  
|Proceeds from sale of assets                                                                                              |  |                          |       |   |      |   |        |      |  |   | 695     |  
|Purchases of property and equipment                                                                                       |  |                          | (586   | ) |      |   | (299    | )    |  |   | (1,495  | )
|Issuance of note receivable from related party                                                                            |  |                          |       |   |      |   |        |      |  |   | (750    | )
|Cash acquired in business acquisitions, net of cash paid                                                                  |  |                          | 117    |   |      |   |        |      |  |   | 237     |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Net cash provided by investing activities                                                                                 |  |                          | 532    |   |      |   | 3,701   |      |  |   | 23,068  |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                                     |  |                          |        |   |      |   |         |      |  |   |         |  
|Repayments of long-term debt and obligations under credit facility                                                        |  |                          |       |   |      |   |        |      |  |   | (781    | )
|Proceeds from exercise of stock options and warrants and purchases of common stock under the employee stock purchase plan |  |                          | 911    |   |      |   | 86      |      |  |   | 402     |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities                                                                       |  |                          | 911    |   |      |   | 86      |      |  |   | (379    | )
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Effect of exchange rate changes on cash                                                                                   |  |                          | 43     |   |      |   | 97      |      |  |   | 485     |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                                                      |  |                          | 206    |   |      |   | (1,422  | )    |  |   | 2,868   |  
|Cash and cash equivalents at beginning of year                                                                            |  |                          | 11,948 |   |      |   | 13,370  |      |  |   | 10,502  |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                                                                  |  | $                        | 12,154 |   |      | $ | 11,948  |      |  | $ | 13,370  |  
|                                                                                                                          |  |                          |        |   |      |   |         |      |  |   |         |  
|Supplemental disclosure of cash flow information:                                                                         |  |                          |        |   |      |   |         |      |  |   |         |  
|Cash paid during the year for interest                                                                                    |  | $                        | 10     |   |      | $ | 12      |      |  | $ | 55      |  
|Cash paid during the year for income taxes                                                                                |  |                          | 201    |   |      |   | 265     |      |  |   | 380     |  
|NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                                              |  |                          |        |   |      |   |         |      |  |   |         |  
|Shares issued for the acquisition of Amacis Group Limited                                                                 |  |                          | 8,522  |   |      |   |         |      |  |   |         |  
|Assets and liabilities assumed in acquisition:                                                                            |  |                          |        |   |      |   |         |      |  |   |         |  
|Current assets                                                                                                            |  |                          | 574    |   |      |   |         |      |  |   |         |  
|Property and equipment                                                                                                    |  |                          | 93     |   |      |   |         |      |  |   |         |  
|Goodwill                                                                                                                  |  |                          | 8,439  |   |      |   |         |      |  |   |         |  
|Other intangible assets                                                                                                   |  |                          | 3,100  |   |      |   |         |      |  |   |         |  
|Accounts payable, accrued liabilities and deferred revenue                                                                |  |                          | 3,229  |   |      |   |         |      |  |   |         |  
|Compensation-related accruals                                                                                             |  |                          | 236    |   |      |   |         |      |  |   |         |  
|Note payable to bank                                                                                                      |  |                          | 390    |   |      |   |         |      |  |   |         |  
|Shares issued for the acquisition of Broad Daylight, Inc.                                                                 |  |                          | 2,536  |   |      |   |         |      |  |   |         |  
|Assets and liabilities assumed in acquisition:                                                                            |  |                          |        |   |      |   |         |      |  |   |         |  
|Current assets                                                                                                            |  |                          | 314    |   |      |   |         |      |  |   |         |  
|Property and equipment                                                                                                    |  |                          | 113    |   |      |   |         |      |  |   |         |  
|Goodwill                                                                                                                  |  |                          | 3,346  |   |      |   |         |      |  |   |         |  
|Other intangible assets                                                                                                   |  |                          | 576    |   |      |   |         |      |  |   |         |  
|Other assets                                                                                                              |  |                          | 14     |   |      |   |         |      |  |   |         |  
|Accounts payable, accrued liabilities and deferred revenue                                                                |  |                          | 1,380  |   |      |   |         |      |  |   |         |  
|Compensation-related accruals                                                                                             |  |                          | 393    |   |      |   |         |      |  |   |         |  
|Cancellation of escrowed shares issued for acquisition of AnswerLogic Inc.                                                |  |                          |        |   |      |   | 75      |      |  |   |         |  
|Accretion on redeemable convertible preferred stock                                                                       |  |                          |        |   |      |   |         |      |  |   |         |  
|Shares issued for acquisition of AnswerLogic, Inc.                                                                        |  |                          |        |   |      |   |         |      |  |   | 2,955   |  
|Assets and liabilities assumed in acquisition:                                                                            |  |                          |        |   |      |   |         |      |  |   |         |  
|Current assets                                                                                                            |  |                          |        |   |      |   |         |      |  |   | 144     |  
|Property and equipment                                                                                                    |  |                          |        |   |      |   |         |      |  |   | 1,300   |  
|Goodwill                                                                                                                  |  |                          |        |   |      |   |         |      |  |   | 2,831   |  
|Accounts payable and accrued liabilities                                                                                  |  |                          |        |   |      |   |         |      |  |   | 490     |  
|Compensation-related accruals                                                                                             |  |                          |        |   |      |   |         |      |  |   | 287     |  
|Obligations under credit facility                                                                                         |  |                          |        |   |      |   |         |      |  |   | 781     |  



See accompanying notes
to consolidated financial statements.



F-6



---

##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Note 1.    Description of Business and Summary of Significant Accounting Policies



Description of Business and Basis of Presentation



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



License fees for the Companys software vary with each application, but the Companys products are typically licensed on a per-processor
basis, per-user basis or based on the number of users authorized to access our software at any given time. The Companys typical license agreement provides the licensee a perpetual, nontransferable license to use its software.



Product license revenue and related services from the Companys Primus
eServer and Primus eSupport related products accounted for approximately 86% of total revenue for the year ended December 31, 2003, and 90% or more of total revenue for each of the years ended December 31, 2002 and 2001. Although the Company expects
the percentage of total revenue derived from these products to continue to decline in 2004 due to the Company recent acquisitions, the Company still expects these products to continue to account for a substantial portion or the Companys
revenue for 2004.



The Company is subject to certain business
risks that could affect future operations and financial performance. These risks include, but are not limited to, changing computing environments, rapid technological change, development of new products, limited protection of proprietary technology,
claims of intellectual property infringement and competitive products and pricing.



The consolidated financial statements include the accounts of Primus and its wholly owned subsidiaries, including its foreign subsidiaries, Primus Knowledge Solutions (UK) Limited, Amacis Group Limited, a UK company,
and Primus Knowledge Solutions France. All significant intercompany balances and transactions have been eliminated in consolidation.



Cash, Cash Equivalents and Short-term Investments



For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with maturity at purchase of
three months or less to be cash equivalents. At December 31, 2003 and 2002, the Companys cash equivalents consisted primarily of money market funds.



The Company considers all short-term investments as available-for-sale. Accordingly, these investments are carried at fair value and unrealized holding
gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities are
determined on a specific identification basis.



F-7



---

##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



A decline in the market value of any available-for-sale security below cost that is deemed to be
other than temporary results in a reduction in its carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Premiums and discounts are amortized or accreted over the life of the
related security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.



Cash, cash equivalents and short-term investments consist of the following:



|                                                        |  |              |        |      |   |       
|------------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                        |  | December 31,
|                                                        |  | 2003         |        | 2002
|                                                        |  | (In 000s)  
|Cash and cash equivalents                               |  | $            | 12,154 |      | $ | 11,948
|Short-term investments                                  |  |              |       |      |   | 1,010 
|                                                        |  |              |        |      |   |       
|Total cash, cash equivalents and short-term investments |  | $            | 12,154 |      | $ | 12,958
|                                                        |  |              |        |      |   |       



Accounts Receivable



Accounts receivable are recorded at the invoiced amount
and do not bear interest. The allowance for doubtful accounts is the Companys best estimate of the amount of probable credit losses in the Companys existing accounts receivable. The Company performs a periodic analysis to determine the
appropriate allowance for doubtful accounts. This analysis includes various analytical procedures and a review of factors, including specific individual balances selected from a cross-section of the accounts that comprise total accounts receivable,
individual review of past due balances over 90 days and greater than a specified amount, the Companys history of collections, as well as the overall economic environment. Account balances are charged off against the allowance after the
potential for recovery is considered remote. The Company does not have any off balance sheet credit exposure related to its customers.



Property and Equipment



Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated on the
straight-line method over the estimated useful lives of the assets (two to seven years) or over the lease term, if shorter for leasehold improvements.



Goodwill



The changes in the carrying amount of goodwill for the years ended December 31, 2003 and 2002 are as follows (in 000s):



|                                |  |   |        |  
|------------------------------- |  | - | ------ | -
|Balance as of January 1, 2002   |  | $ | 2,281  |  
|Impairment loss                 |  |   | (2,281 | )
|                                |  |   |        |  
|Balance as of December 31, 2002 |  |   |       |  
|Acquisition of Broad Daylight   |  |   | 3,346  |  
|Acquisition of Amacis           |  |   | 8,439  |  
|                                |  |   |        |  
|Balance as of December 31, 2003 |  | $ | 11,785 |  
|                                |  |   |        |  



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



Goodwill represents the excess of costs over fair value of assets of businesses acquired. Primus
adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002. Goodwill and intangible assets acquired in a purchase business combination and determined
to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.



The amortization of goodwill ceased upon the required adoption date of the
Statement, which for us was January 1, 2002. At the date of adoption, the Company had unamortized goodwill of approximately $2.3 million, and the implied fair value of the goodwill as of the date of adoption was zero. The implied fair value of
goodwill was calculated based upon a comparison of the book value of the Company to its fair value. Fair value was determined based upon the market capitalization of the Company as of January 1, 2002. Accordingly, the Company recognized a $2.3
million transitional impairment loss as the cumulative effect of a change in accounting principle as a result of the adoption of SFAS No. 142.



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



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



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



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



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



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



In the fourth quarter of 2003, the Company performed an analysis as described
above, in connection with its annual impairment test required under SFAS No. 142. The Companys 2003 annual impairment analysis did not require the Company to recognize an impairment loss.



In 2001, prior to the adoption of SFAS No. 142, goodwill, which was related
to the May 2001 acquisition of AnswerLogic, Inc., was amortized on a straight line basis over its estimated economic life of three years, and assessed for recoverability by determining whether the amortization of the goodwill balance over its
remaining life could be recovered through undiscounted future operating cash flows of the acquired operation.





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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



Net loss and loss per share for the year ended December 31, 2001, adjusted to exclude goodwill
amortization expense are as follows (in thousands, except per share data):



|                                                                              |  |                             |         |  
|----------------------------------------------------------------------------- |  | --------------------------- | ------- | -
|                                                                              |  | Year EndedDecember 31, 2001 |        
|Net loss:                                                                     |  |                             |         |  
|Reported loss before extraordinary item                                       |  | $                           | (21,821 | )
|Goodwill amortization                                                         |  |                             | 550     |  
|                                                                              |  |                             |         |  
|Adjusted loss before extraordinary item                                       |  |                             | (21,271 | )
|                                                                              |  |                             |         |  
|Extraordinary item                                                            |  |                             | 566     |  
|                                                                              |  |                             |         |  
|Adjusted net loss                                                             |  | $                           | (20,705 | )
|                                                                              |  |                             |         |  
|Basic and diluted loss:                                                       |  |                             |         |  
|Reported basic and diluted loss per share before extraordinary item per share |  | $                           | (1.18   | )
|Goodwill amortization                                                         |  |                             | 0.03    |  
|                                                                              |  |                             |         |  
|Adjusted basic and diluted loss before extraordinary item per share           |  |                             | (1.15   | )
|                                                                              |  |                             |         |  
|Extraordinary item                                                            |  |                             | 0.03    |  
|                                                                              |  |                             |         |  
|Adjusted net loss                                                             |  | $                           | (1.12   | )
|                                                                              |  |                             |         |  



Investment in
Primus Knowledge Solutions, K.K.



In December 1995, Primus
invested $50,000 for a 50% interest in Primus Knowledge Solutions, KK (Primus KK), a Japanese distributor, with Trans Cosmos, Inc., a Japanese company (TCI), a significant shareholder of the Company. Primus accounted for its investment using the
equity method and wrote down its investment to zero in March 1997 as a result of recognizing the Companys portion of the investees losses to date. In September 1997, Primus and TCI renegotiated their agreement, reducing Primus
ownership to 14.3%. In August 2000, the arrangement was further amended and the Companys ownership percentage in Primus KK was increased to 19.6%. Primus KK is accounted for using the cost method, as management believes it does not have
significant influence over the operations of Primus KK, has not guaranteed any of its obligations and does not have any commitment or intent to provide any funding. The carrying value of the Companys investment in Primus KK is zero at December
31, 2003 and 2002.



Fair Value of Financial Instruments



At December 31, 2003 and 2002, the recorded amounts of
cash and cash equivalents, short-term investments, accounts receivable and payable, prepaid expenses and other current assets, note receivable from related party, notes payable to bank, accrued and other liabilities and compensation-related accruals
reflected in the financial statements approximate fair value based on their liquidity or their short-term nature. The fair value of the Companys investment in Primus KK is not readily determinable.



Impairment of Long-Lived Assets



Long lived assets, such as property, plant, and equipment, and purchased
intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a
disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.



Revenue Recognition



The Company recognizes revenue in accordance with accounting standards established for software companies. These include Statement of Position No. 97-2,
Software Revenue Recognition, as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements and Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, which
was issued in December 2003 and supercedes SAB No. 101, Revenue Recognition in Financial Statements. Revenue is recognized when persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable and
there is vendorspecific objective evidence (VSOE) to allocate the total fee to the elements of the arrangement.



VSOE is typically based on the price charged when an element is sold separately, or, in the case of an element not yet sold separately, the price
established by authorized management, if it is probable that the price, once established, will not change before market introduction. In multiple element arrangements in which VSOE exists only for undelivered elements, the fair value of the
undelivered elements are deferred and the residual arrangement fee is assigned to the delivered elements. If evidence of fair value for any of the undelivered elements does not exist, all revenue from the arrangement is deferred until such time that
evidence of fair value does exist or until all elements of the arrangement are delivered.



Revenue from software license arrangements is recognized upon the delivery of the software, provided all of the other revenue recognition requirements of Statement of Position No. 97-2 have been met.



If a customer requires an acceptance period, revenue is recognized upon the
earlier of customer acceptance or the expiration of the acceptance period. Revenue for license arrangements with payment terms extending beyond 120 days is recognized periodically as payments become due, provided all other conditions for revenue
recognition are met.



Service revenue consists of maintenance
and support fees and consulting, training and hosting fees. Maintenance and support and ongoing hosting fees are recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation and
integration services performed on a time-and-materials basis under separate service arrangements related to the use of our software products. Revenue from consulting and training services is recognized as services are performed. If a transaction
includes both license and service elements, license fees are recognized separately upon delivery of the software, provided services do not include significant customization or modification of the base product, and the licenses are not subject to
acceptance criteria.



From time to time the Company enters into
distribution agreements with resellers that typically provide for sublicense fees based on a percentage of list prices. The Companys distribution agreement with Primus KK, a related party, provided for sublicense fees based on a percentage of
net fees collected by Primus KK from its customers, subject to certain guaranteed minimum royalty payments. Sublicense fees are recognized upon delivery of software to Primus KK if pervasive evidence of an arrangement between the distributor and
their



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



customer exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists for the undelivered elements.
Guaranteed minimum royalty payments, to the extent they exceed sublicense fees due, are recognized in the period earned. The Companys agreements with its customers and resellers, including Primus KK, do not contain product return rights.



Cost of Revenue



Cost of license revenue consists primarily of media, product packaging and
shipping, documentation and other production costs, and third party royalties. Cost of services and maintenance revenue consist primarily of salaries, benefits and allocated overhead costs related to customer support, consulting, training and global
services personnel, including the cost of services provided by third-party consultants engaged by Primus.



Software Development Costs



Software development costs are expensed as incurred until technological feasibility of the underlying software product is achieved. After technological
feasibility is established, software development costs are capitalized. Capitalized costs are then amortized on a straight-line basis over the estimated product life, or based on the ratio of current revenue to total projected product revenue,
whichever is greater. To date, technological feasibility and general availability of such software have occurred simultaneously and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not
capitalized any software development costs.



Advertising



Advertising costs are expensed as incurred. Advertising
expense is included in sales and marketing expenses and was approximately $170,000, $287,000 and $670,000 during the years ended December 31, 2003, 2002, and 2001, respectively.



Income Taxes



Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized.



Concentration of Credit Risk and Major Customers



Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of accounts
receivable. The Companys customer base is dispersed across different geographic areas throughout North America, Europe, and Japan and consists of companies in a variety of industries. During 2003, revenue from enterprise sales to two customers
represented approximately 29% of total revenue. No single customer accounted for 10% or more of total revenue in 2002 or 2001. At December 31, 2003, accounts receivable included amounts due from Primus KK of approximately $6,000 and amounts due from
another customer of approximately $1.4 million, or approximately 25% of gross accounts receivable. At December 31,



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



2002, no single customer accounted for 10% or more of accounts receivable. The Company does not require collateral or other security to support credit sales,
but provides an allowance for doubtful accounts based on historical experience and specifically identified risks.



A note receivable from a related party in the amount of $750,000 existed at December 31, 2002 and was repaid during 2003 (see Note 5 Note Receivable
from Related Party).



The Company is also subject to
risks related to its significant balances of cash and cash equivalents. The Companys portfolio, however, is diversified and consists primarily of highly rated money market funds and short-term investment-grade securities.



Foreign Currency



The functional currency of the Companys foreign subsidiaries is the
local currency in the country in which the subsidiaries are located. Assets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rate in effect on the balance sheet date. Revenue and expenses are
translated at the average rates of exchange prevailing during the year. The net gain or loss resulting from translation is shown as foreign currency translation adjustment within accumulated other comprehensive income (loss) as a component of
stockholders equity. Gains and losses on foreign currency transactions are included in the consolidated statement of operations. There were no significant foreign currency transaction gains or losses in 2003, 2002 or 2001.



Stock-Based Compensation



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



|                                                                                                            |  |                                      |        |      |   |        |  |   |        |  
|----------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ------ |  | - | ------ | -
|                                                                                                            |  | Year Ended December 31,              |       
|                                                                                                            |  | 2003                                 |        | 2002 |   | 2001   | 
|                                                                                                            |  | (In thousands, except per sharedata) |       
|Net loss, as reported                                                                                       |  | $                                    | 2,927  |      | $ | 11,242 |  | $ | 21,255 |  
|Deduct stock-based employee compensation expense included in reported net loss                              |  |                                      |       |      |   |       |  |   | (21    | )
|Add total stock-based employee compensation expense determined under fair value-based method for all awards |  |                                      | 9,768  |      |   | 13,753 |  |   | 20,861 |  
|                                                                                                            |  |                                      |        |      |   |        |  |   |        |  
|Pro forma net loss                                                                                          |  | $                                    | 12,695 |      | $ | 24,995 |  | $ | 42,095 |  
|Basic and diluted net loss per share:                                                                       |  |                                      |        |      |   |        |  |   |        |  
|As reported                                                                                                 |  | $                                    | 0.15   |      | $ | 0.59   |  | $ | 1.15   |  
|SFAS No. 123 pro forma                                                                                      |  | $                                    | 0.66   |      | $ | 1.32   |  | $ | 2.27   |  



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



Loss Per Common Share



In accordance with SFAS No. 128, Earnings Per Share, the Company has reported both basic and diluted net loss
per common share for each period presented. Basic net loss per common share is computed on the basis of the weighted-average number of common shares outstanding for the year. Diluted net loss per common share is computed on the basis of the
weighted-average number of common shares plus dilutive potential common shares outstanding. Dilutive potential common shares are calculated under the treasury stock method. Securities that could potentially dilute basic income per share consist of
outstanding stock options and warrants. As the Company had a net loss applicable to common shareholders in each of the periods presented, basic and diluted net loss per common share are the same. Dilutive potential securities outstanding were not
included in the computation of diluted net loss per common share, because to do so would have been anti-dilutive. Dilutive potential securities for the years ended December 31, 2003, 2002 and 2001 included options and warrants to purchase
approximately 5,775,000, 6,937,000, and 5,103,000 common shares, respectively.



Other Comprehensive Loss



Comprehensive loss consists of net loss, foreign currency translation adjustments and net unrealized gains (losses) from securities available-for-sale and is presented in the accompanying statements of shareholders equity and
comprehensive loss.



Use of Estimates



The preparation of the consolidated financial statements requires management
of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include, but may not be limited to, the carrying amount of property and equipment, intangibles and goodwill; valuation allowances for
receivables, prepaid expenses and other current assets and deferred income tax assets; and assets and obligations related to employee benefits.. Actual results could differ from those estimates.



Contingencies



Liabilities for loss contingencies arising from claims, assessments,
litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.



Recently Issued Accounting Standards



In December 2003, SFAS Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest
Entities, (FIN 46R) was issued. This Interpretation addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the
entity. FIN 46R replaces SFAS Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. The Company will be required to apply FIN 46R to variable interests in Variable Interest Entities (VIEs)
created after December 31, 2003. For variable interest in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated under FIN 46R that were created before January 1,
2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized
as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1.    Description of Business and Summary of
Significant Accounting Policies (Continued)



at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The Company is evaluating the impact
of applying FIN 46R to existing VIEs in which it has variable interest and has not yet completed this analysis. At this time, the adoption of FIN 46R is not expected to have a material effect on the Companys financial statements.



Note 2.    Acquisitions, Other Intangible Assets and Goodwill



Acquisition of Broad Daylight, Inc.



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



The purchase price of approximately $2.9 million was allocated to the assets acquired and liabilities assumed based on their
fair values at the acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $3.3 million has been recorded as goodwill, which is not deductible for tax purposes.



A summary of the components of the estimated purchase price for the
acquisition is as follows (in thousands, except per share data):



|                            |  |   |      
|--------------------------- |  | - | -----
|Primus common shares issued |  |   | 2,131
|Per common share value      |  | $ | 1.19 
|                            |  |   |      
|                            |  | $ | 2,536
|Plus:                       |  |   |      
|Cash                        |  |   | 140  
|Estimated acquisition costs |  |   | 198  
|                            |  |   |      
|Total                       |  | $ | 2,874
|                            |  |   |      



The following
represents the allocation of the purchase price to the assets and liabilities of Broad Daylight and may not be indicative of the final allocation of purchase price consideration. The excess of the purchase price over the fair value of net
identifiable assets acquired is reflected as goodwill (in thousands):



|                                  |  |   |        |  
|--------------------------------- |  | - | ------ | -
|Current assets                    |  | $ | 400    |  
|Furniture and equipment           |  |   | 113    |  
|Other assets                      |  |   | 14     |  
|Goodwill                          |  |   | 3,346  |  
|Other acquired intangible assets: |  |   |        |  
|Acquired technology               |  |   | 450    |  
|Customer relationships            |  |   | 70     |  
|Tradenames                        |  |   | 56     |  
|Liabilities                       |  |   | (1,575 | )
|                                  |  |   |        |  
|Total                             |  | $ | 2,874  |  
|                                  |  |   |        |  



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 2.    Acquisitions, Other Intangible Assets
and Goodwill (Continued)



Acquired technology has a weighted average estimated useful life of five years, customer
relationships have a weighted average estimated useful life of 30 months and tradenames have a weighted average estimated useful life of sixteen months.



Acquisition of Amacis Group Limited



On December 22, 2003, the Company signed a share purchase agreement to acquire 100% of the voting interest in Amacis Group Limited (Amacis), a
United Kingdom company. The acquisition of Amaciss shares closed on December 22, 2003. Under the terms of the agreement, the Company purchased all of the outstanding shares of Amacis for 1,234,692 shares of Primus common stock valued at
approximately $7.4 million, and assumed all employee stock options outstanding under an existing Amacis stock option plan (100% vested), valued at approximately $1.1 million and incurred direct acquisition costs of approximately $364,000. The fair
value of the common stock issued by Primus upon the acquisition was $6.00 per share, based on the average market price for a period before and after December 22, 2003. The results of Amaciss operations are included in the Companys
consolidated financial statements since the closing date of the acquisition, December 22, 2003.



The purchase price of approximately $8.9 million was allocated to the assets acquired and liabilities assumed based on their fair values at the
acquisition date. The excess of the purchase price over the fair value of the net identifiable assets acquired of approximately $8.4 million has been recorded as goodwill, which is not deductible for tax purposes.



A summary of the components of the estimated purchase price for the
acquisition is as follows (in thousands, except per share data):



|                            |  |   |       |    
|--------------------------- |  | - | ----- | ---
|Primus common shares issued |  |   | 1,235 |    
|Per common share value      |  | $ | 6.00  |    
|                            |  |   |       |    
|                            |  | $ | 7,408 |    
|Plus:                       |  |   |       |    
|Stock options assumed       |  |   | 1,114 | (1)
|Estimated acquisition costs |  |   | 364   |    
|                            |  |   |       |    
|Total                       |  | $ | 8,886 |    
|                            |  |   |       |    

---

|(1) |  | Stock options assumed were valued using the Black Scholes Valuation Model.
|--- |  | --------------------------------------------------------------------------



The following represents the allocation of the purchase price to the assets and liabilities of Amacis and may not be indicative of the final allocation of
purchase price consideration. The excess of the purchase price over the fair value of net identifiable assets acquired is reflected as goodwill (in thousands):



|                                  |  |   |        |     
|--------------------------------- |  | - | ------ | ----
|Current assets                    |  | $ | 745    |     
|Furniture and equipment           |  |   | 93     |     
|Goodwill                          |  |   | 8,439  |     
|Other acquired intangible assets: |  |   |        |     
|Acquired technology               |  |   | 2,800  |     
|PCS contracts                     |  |   | 240    |     
|Hosting contract                  |  |   | 60     |     
|Liabilities                       |  |   | (3,491 | )(2)
|                                  |  |   |        |     
|Total                             |  | $ | 8,886  |     
|                                  |  |   |        |     

---

|(2) |  | Amaciss liabilities were adjusted to reflect the fair value of facility lease obligations and deferred revenue obligations.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 2.    Acquisitions, Other Intangible Assets
and Goodwill (Continued)



Acquired technology has a weighted average estimated useful life of seven years, post contract
support (PCS) contracts have a weighted average estimated useful life of approximately 57 months and hosting contracts have a weighted average estimated useful life of four months.



The following pro forma financial information presents the results of operations of Primus, Broad Daylight and Amacis as if
the acquisitions had occurred on January 1, 2003 and 2002 after giving effect to certain adjustments, primarily amortization of identifiable intangibles. The pro forma information does not purport to be indicative of what would have occurred had the
acquisitions been made as of those dates or of results that may occur in the future.



The pro forma financial information is as follows (in thousands, except per share data):



|                                                                |  |                         |         |   |      |   |         |  
|--------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                                                |  | Year ended December 31, |        
|                                                                |  | 2003                    |         |   | 2002 |  
|Total revenues                                                  |  | $                       | 27,624  |   |      | $ | 27,737  |  
|Loss before cumulative effect of change in accounting principle |  | $                       | (10,231 | ) |      | $ | (22,311 | )
|Net loss                                                        |  | $                       | (10,231 | ) |      | $ | (24,592 | )
|Basic and diluted pro forma loss per share:                     |  |                         |         |   |      |   |         |  
|Loss before cumulative effect of change in accounting principle |  | $                       | (0.45   | ) |      | $ | (1.00   | )
|Net loss                                                        |  | $                       | (0.45   | ) |      | $ | (1.10   | )
|Weighted average shares outstanding                             |  |                         | 22,624  |   |      |   | 22,349  |  



Other Intangible
Assets



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



|                        |  |                   |      
|----------------------- |  | ----------------- | -----
|                        |  | December 31, 2003
|Acquired technology     |  | $                 | 3,250
|Maintenance contracts   |  |                   | 240  
|Customer relationships  |  |                   | 70   
|Hosting contracts       |  |                   | 60   
|Trade names             |  |                   | 56   
|                        |  |                   |      
|Other intangible assets |  | $                 | 3,676
|                        |  |                   |      



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 2.    Acquisitions, Other Intangible Assets
and Goodwill (Continued)



Other intangible assets related to the Amacis acquisition totaled $3.1 million and are amortized over
their estimated useful life ranging from four to 60 months for certain maintenance and hosting contracts and seven years for acquired technology. Intangible assets recorded in connection with the acquisition of Broad Daylight totaled $576,000 and
are amortized over their estimated useful lives ranging from 16 months to three years. Amortization expense for the year ended December 31, 2003 was approximately $68,000. Based on identified intangible assets recorded as of December 31, 2003, and
assuming no subsequent impairment of the underlying assets, the annual amortization expense is expected to be as follows (in thousands):



|      |  |   |      
|----- |  | - | -----
|2004  |  | $ | 664  
|2005  |  |   | 566  
|2006  |  |   | 543  
|2007  |  |   | 538  
|2008  |  |   | 507  
|2009  |  |   | 400  
|2010  |  |   | 390  
|      |  |   |      
|Total |  | $ | 3,608
|      |  |   |      



Note
3.    Restructuring Charges



Restructuring charges for the year ended December 31, 2003 were $0. During 2002 and 2001, the Company executed restructuring plans to reduce headcount and infrastructure, and to eliminate excess leased facilities, and recorded $1,227,000
and $2,530,000, respectively, in restructuring and other related charges.



The components of the 2001 charges and a rollforward of the related liability included within accrued and other liabilities follows (in 000s):



|                                        |  |                             |   |                                           |   |                               |  |   |                             |   |  |   |    
|--------------------------------------- |  | --------------------------- | - | ----------------------------------------- | - | ----------------------------- |  | - | --------------------------- | - |  | - | ---
|                                        |  | Balance atDecember 31, 2000 |   | Charge for theyear endedDecember 31, 2001 |   | Net CashPayments &Impairments |  |   | Balance atDecember 31, 2001
|Excess facilities and asset impairments |  | $                           |  |                                           | $ | 1,375                         |  | $ | (775                        | ) |  | $ | 600
|Employee separation costs               |  |                             |  |                                           |   | 1,145                         |  |   | (1,145                      | ) |  |   |   
|Other                                   |  |                             |  |                                           |   | 10                            |  |   |                            |   |  |   | 10 
|                                        |  |                             |   |                                           |   |                               |  |   |                             |   |  |   |    
|Total                                   |  | $                           |  |                                           | $ | 2,530                         |  | $ | (1,920                      | ) |  | $ | 610
|                                        |  |                             |   |                                           |   |                               |  |   |                             |   |  |   |    



The components of the
2002 charges and a rollforward of the related liability included within accrued and other liabilities follows (in 000s):



|                                        |  |                             |     |                                           |   |                               |  |   |                             |   |  |   |    
|--------------------------------------- |  | --------------------------- | --- | ----------------------------------------- | - | ----------------------------- |  | - | --------------------------- | - |  | - | ---
|                                        |  | Balance atDecember 31, 2001 |     | Charge for theyear endedDecember 31, 2002 |   | Net CashPayments &Impairments |  |   | Balance atDecember 31, 2002
|Excess facilities and asset impairments |  | $                           | 600 |                                           | $ | 636                           |  | $ | (710                        | ) |  | $ | 526
|Employee separation costs               |  |                             |    |                                           |   | 581                           |  |   | (581                        | ) |  |   |   
|Other                                   |  |                             | 10  |                                           |   | 10                            |  |   | (20                         | ) |  |   |   
|                                        |  |                             |     |                                           |   |                               |  |   |                             |   |  |   |    
|Total                                   |  | $                           | 610 |                                           | $ | 1,227                         |  | $ | (1,311                      | ) |  | $ | 526
|                                        |  |                             |     |                                           |   |                               |  |   |                             |   |  |   |    



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 3.    Restructuring Charges (Continued)



The rollforward of the 2003 restructuring liability included within accrued and other liabilities
follows (in 000s):



|                                        |  |                             |     |                               |   |      |                             |  |   |   
|--------------------------------------- |  | --------------------------- | --- | ----------------------------- | - | ---- | --------------------------- |  | - | --
|                                        |  | Balance atDecember 31, 2002 |     | Net CashPayments &Impairments |   |      | Balance atDecember 31, 2003
|Excess facilities and asset impairments |  | $                           | 526 |                               | $ | (499 | )                           |  | $ | 27
|                                        |  |                             |     |                               |   |      |                             |  |   |   



The excess facilities
and asset impairment charges recorded in 2001 and 2002 were the result of the Companys decision to exit certain domestic and international facilities and were estimated based on its evaluation of then current market conditions relative to its
existing excess facilities accrual. The estimated facilities costs are based on current comparable rates for leases and subleases of a comparable term or termination fees. The asset impairment charges were primarily for leasehold improvements,
computer equipment and related software, office equipment and furniture and fixtures disposed of or removed from operations as a direct result of the restructuring plans. If estimates and/or assumptions change, the actual loss may differ from this
estimate. Future cash outlays are anticipated through June 2004, unless we are able to negotiate to exit the lease at an earlier date.



Note 4.    Property and Equipment



Property and equipment, net consists of the following:



|                                               |  |                |        |   |      |   |        |  
|---------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                               |  | December 31,   |       
|                                               |  | 2003           |        |   | 2002 |  
|                                               |  | (In thousands) |       
|Computer equipment                             |  | $              | 4,948  |   |      | $ | 4,268  |  
|Furniture, fixtures, and equipment             |  |                | 1,452  |   |      |   | 1,406  |  
|Software                                       |  |                | 2,457  |   |      |   | 2,420  |  
|Leasehold improvements                         |  |                | 301    |   |      |   | 301    |  
|                                               |  |                |        |   |      |   |        |  
|                                               |  |                | 9,158  |   |      |   | 8,395  |  
|Less accumulated depreciation and amortization |  |                | (7,743 | ) |      |   | (6,127 | )
|                                               |  |                |        |   |      |   |        |  
|                                               |  | $              | 1,415  |   |      | $ | 2,268  |  
|                                               |  |                |        |   |      |   |        |  



Depreciation and
amortization expense was approximately $1,648,000, $2,196,000 and $2,489,000 for the years ended December 31, 2003, 2002 and 2001, respectively.



Note 5.    Note Receivable from Related Party



In April 2001, the Companys Board of Directors approved an unsecured loan to Michael A. Brochu, the Companys President and Chief Executive
Officer, for $750,000 bearing interest at 4.9%. The maturity date of the loan was April 16, 2007 with principal and accrued interest payments due annually starting on April 16, 2005. This note was subject to full forgiveness in the event of Mr.
Brochus termination of employment without cause or for good reason following a change of control.



On October 31, 2003, the Company entered into an agreement with Michael Brochu, President and Chief Executive Officer, to purchase all of his outstanding
stock options with an exercise price above $0.86, or 1,239,165 stock options, which reduces the net dilution from stock options to the Companys shareholders. Mr.



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 5.    Note Receivable from Related Party
(Continued)



Brochu elected to apply the proceeds, after required tax withholdings of approximately $264,000, from this option disposition to his outstanding $750,000
loan from the Company. As a result of this transaction, the outstanding principal balance on the loan was reduced to approximately $114,000. Mr. Brochu did not retain any net proceeds from the transaction.



The Companys Board of Directors, with Mr. Brochu abstaining from
discussions and voting, approved of the above described transaction and, using the Black-Scholes option pricing model, established the total purchase price of $997,968. The Company purchased from Mr. Brochu 547,999 stock options (granted on November
4, 1997) with an exercise price of $3.00, 78,666 stock options (granted on February 4, 1999) with an exercise price of $8.25, 150,000 stock options (granted on August 13, 1999) with an exercise price of approximately $20.41, 150,000 stock options
(granted on February 2, 2000) with an exercise price of approximately $74.03, 37,500 stock options (granted on May 17, 2000) with an exercise price of approximately $38.66, 75,000 stock options (granted on October 12, 2000) with an exercise price of
approximately $5.31, and 200,000 stock options (granted on May 16, 2001) with an exercise price of approximately $3.49.



The total purchase price of $997,968 under the above described transaction are reflected as compensation expense and included in general and
administrative expenses in our consolidated financial statements for the period ending December 31, 2003. The net proceeds were first applied against accrued interest due the Company of approximately $98,000 and the remainder reduced Mr.
Brochus outstanding loan principal balance by approximately $636,000.



On November 13, 2003, the Company entered into a noncompetition and nonsolicitation agreement with Michael Brochu. The Companys Board of Directors, consistent with their desire to ensure that Mr. Brochus
incentives support the long term growth of the Company in the best interests of all shareholders and with Mr. Brochu abstaining from discussions and voting, approved of the transaction and established consideration to Mr. Brochu in exchange for this
agreement of one times his annual base salary, or $310,000. The noncompetition and nonsolicitation agreement is effective from November 13, 2003 through three years from the end date of Mr. Brochus employment for any reason. Mr. Brochu elected
to apply approximately $114,000 of the proceeds, after required tax withholdings of approximately $82,000, to his outstanding loan from the Company. As a result of this prepayment, the not receivable from Mr. Brochu was fully paid by December 31,
2003. The payment of $310,000 under this agreement is reflected as compensation expense and included in general and administrative expense in our consolidated financial statements for the period ended December 31, 2003.



Note 6.    Financing Arrangements



As of December 31, 2003, the Company had a $3 million line of credit
available, which matures in March 2005 and bears interest at a rate of prime plus 1.0% (5.00% at December 31, 2003). The Company had no borrowings outstanding under the line of credit or outstanding letters of credit at December 31, 2003. All assets
of the Company secure the arrangement. The agreement includes certain financial covenants including those requiring the Company to maintain minimum levels of working capital and tangible net worth, which the Company was in compliance with at
December 31, 2003. The Company had no long-term debt at December 31, 2003 or 2002.



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 6.    Financing Arrangements (Continued)



In connection with the December 2003 acquisition of Amacis, Primus assumed Amaciss outstanding
obligation of approximately $395,000 under a credit facility with a bank. The facility is payable in month installments of approximately $9,000, including interest at a rate of the banks rate plus 2% (5.75% at December 31, 2003), due June
2008. Due to the purchase of all of Amaciss common shares by Primus, the facility is payable upon demand and the Company expects the obligation to be repaid in full during 2004. The loan is denominated in British pounds.



Note 7.    Income Taxes



The components of loss before income taxes, extraordinary item and
cumulative effect of change in accounting principle are as follows:



|                         |  |                         |        |   |      |   |        |      |  |   |         |  
|------------------------ |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------- | -
|                         |  | Year Ended December 31, |       
|                         |  | 2003                    |        |   | 2002 |   |        | 2001 | 
|                         |  | (In thousands)          |       
|U.S. operations          |  | $                       | (3,643 | ) |      | $ | (8,956 | )    |  | $ | (21,896 | )
|International operations |  |                         | 785    |   |      |   | 106    |      |  |   | 492     |  
|                         |  |                         |        |   |      |   |        |      |  |   |         |  
|                         |  | $                       | (2,857 | ) |      | $ | (8,850 | )    |  | $ | (21,404 | )
|                         |  |                         |        |   |      |   |        |      |  |   |         |  



The components of
income tax expense are as follows:



|                   |  |                         |    |      |   |      |  |   |    
|------------------ |  | ----------------------- | -- | ---- | - | ---- |  | - | ---
|                   |  | Year Ended December 31,
|                   |  | 2003                    |    | 2002 |   | 2001
|                   |  | (In thousands)         
|Current:           |  |                         |    |      |   |      |  |   |    
|Federal            |  | $                       |   |      | $ |     |  | $ |   
|Foreign taxes      |  |                         | 70 |      |   | 111  |  |   | 417
|                   |  |                         |    |      |   |      |  |   |    
|Income tax expense |  | $                       | 70 |      | $ | 111  |  | $ | 417
|                   |  |                         |    |      |   |      |  |   |    



Income tax expense
(benefit) differed from the amounts computed by applying the U.S. federal income tax rate of 35% to loss before income taxes, extraordinary item and cumulative effect of change in accounting principle as a result of the following:



|                                                        |  |                         |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                        |  | Year Ended December 31, |       
|                                                        |  | 2003                    |        |   | 2002 |   |        | 2001 | 
|                                                        |  | (In thousands)          |       
|Income tax benefit at U.S. statutory rate of 35%        |  | $                       | (1,000 | ) |      | $ | (3,098 | )    |  | $ | (7,491 | )
|Non-deductible expenses, including merger related costs |  |                         | 37     |   |      |   | 27     |      |  |   | 288    |  
|U.S. tax on unremitted foreign earnings                 |  |                         | 399    |   |      |   |       |      |  |   |       |  
|Change in valuation allowance                           |  |                         | 704    |   |      |   | 3,450  |      |  |   | 8,050  |  
|Research and development credit                         |  |                         | (98    | ) |      |   | (310   | )    |  |   | (583   | )
|Foreign taxes                                           |  |                         | 28     |   |      |   | 42     |      |  |   | 153    |  
|                                                        |  |                         |        |   |      |   |        |      |  |   |        |  
|Income tax expense                                      |  | $                       | 70     |   |      | $ | 111    |      |  | $ | 417    |  
|                                                        |  |                         |        |   |      |   |        |      |  |   |        |  



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 7.    Income Taxes (Continued)



The tax effects of temporary differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities are presented below:



|                                          |  |                |         |   |      |   |         |  
|----------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                          |  | December 31,   |        
|                                          |  | 2003           |         |   | 2002 |  
|                                          |  | (In thousands) |        
|Deferred tax assets:                      |  |                |         |   |      |   |         |  
|U.S. net operating loss carryforwards     |  | $              | 57,369  |   |      | $ | 47,259  |  
|Foreign net operating loss carryforwards  |  |                | 3,118   |   |      |   |        |  
|Research and development tax credits      |  |                | 3,444   |   |      |   | 2,778   |  
|Deferred revenue                          |  |                | 2,355   |   |      |   | 1,987   |  
|Accrued expenses not currently deductible |  |                | 924     |   |      |   | 798     |  
|Other                                     |  |                | 873     |   |      |   | 873     |  
|                                          |  |                |         |   |      |   |         |  
|Total deferred tax assets                 |  |                | 68,083  |   |      |   | 53,695  |  
|Valuation allowance                       |  |                | (66,951 | ) |      |   | (53,695 | )
|                                          |  |                |         |   |      |   |         |  
|Net deferred tax assets                   |  | $              | 1,132   |   |      | $ |        |  
|                                          |  |                |         |   |      |   |         |  
|Deferred tax liabilities:                 |  |                |         |   |      |   |         |  
|Intangible assets                         |  |                | 202     |   |      |   |        |  
|Foreign intangible assets                 |  |                | 930     |   |      |   |        |  
|                                          |  |                |         |   |      |   |         |  
|Total deferred tax liabilities            |  |                | 1,132   |   |      |   |        |  
|                                          |  |                |         |   |      |   |         |  



Due to the
Companys history of net operating losses, the Company has established a valuation allowance equal to its deferred tax assets. The valuation allowance increased approximately $13.3 million, $8.9 million and $10.6 million during 2003, 2002 and
2001, respectively. At such time as it is determined that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced.



At December 31, 2003, the Company has US and foreign net operating loss carryforwards of approximately $163.9 and $10.4
million respectively. The Company also has research and development tax credit carryforwards of $3.4 million. Under the provisions of Section 382 of the Internal Revenue Code, the Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock ownership of a company. The Company may have experienced such ownership changes as a result of the various stock offerings, and the utilization of the carryforwards could be
limited such that a portion of the net operating losses may never be utilizable. The US net operating loss carryforwards increased during 2003 by $25.8 million due to the acquisition of Broad Daylight. However, these losses will be subject to
limitation under the provisions of Section 382 discussed above. The foreign net operating loss carryforwards increased by $11.2 million due to the acquisition of Amacis. Approximately $43.0 of the net operating loss carryforwards at December
31, 2003 result from deductions associated with the exercise of non-qualified employee stock options, the realization of which would result in a credit to shareholders equity.



Provision has not been made for U.S. or additional foreign taxes on undistributed earnings of the Companys foreign
subsidiaries. These earnings of approximately $2.0 million, which are expected to be reinvested, could become subject to additional tax if they were to be remitted as dividends, loaned to the Company, or if the Company should sell its stock in these
subsidiaries.



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 8.    Shareholders Equity



Common Stock



In May 2001, in connection with the acquisition of AnswerLogic, 750,000 shares of Primus common stock were issued in
exchange for all of the outstanding equity securities and certain outstanding convertible subordinated promissory notes of AnswerLogic.



In September 2003, in connection with the acquisition of Broad Daylight, 2,131,009 shares of Primus Common Stock, plus cash of approximately $140,000 were
exchange for all of the outstanding equity securities of Broad Daylight.



In December of 2003, in connection with the acquisition of Amacis, 1,234,692 shares of Primus Common Stock were issued in exchange for all of the outstanding equity securities of Amacis.



Stock Options



The Companys fixed stock option plans include the Employee Stock
Option and Restricted Stock Award Plan, the Nonemployee Director Stock Option Plan, the 1995 Stock Incentive Compensation Plan, the 1999 Stock Incentive Compensation Plan (1999 SIC Plan), and the 1999 Nonofficer Employee Stock Compensation Plan
(1999 NESC Plan). The use of the 1995 Stock Incentive Compensation Plan for grants of new awards terminated in 1999. In connection with the mergers with Imparto in December 1999, 2order in January 2000 and Amacis in December 2003, the Company
assumed outstanding options to purchase common stock originally issued under Impartos, 2orders and Amaciss stock option plans (Acquired Options). All of the Acquired Options have been adjusted to give effect to the conversion under
the terms of the Agreement and Plan of Merger with Imparto, the Agreement and Plan of Merger with 2order and the Share Purchase Agreement with Amacis. No additional options will be granted under the Imparto, 2order or Amacis stock option plans. The
Companys stock option plans, as well as the assumed stock option plans, are hereby collectively referred to as the Option Plans. The Option Plans provide for the granting of incentive stock options to employees and nonqualified
stock options to employees, directors, and consultants. Other than the January 2, 2002 option grant, which options vest ratably over 36 months, options granted under the Option Plans typically vest over four years and remain exercisable for a period
not to exceed ten years. Options assumed under the Amacis Plan were fully vested at the date of acquisition. The number of shares available for issuance under the terms of the 1999 SIC Plan automatically increase by 666,666 shares each January 1.
There were no additional shares made available under the Option Plans during 2003. At December 31, 2003, there were 2,075,244 shares available for grant, consisting of 1,447,733 under the 1999 SIC Plan and 627,511 under the 1999 NESC Plan.



On October 31, 2003, the Company entered into an agreement
with Michael Brochu, President and Chief Executive Officer, to purchase all of his outstanding stock options with an exercise price above $0.86, or 1,239,165 stock options. Mr. Brochu elected to apply the proceeds, after required tax withholdings of
approximately $264,000, from this option disposition to his outstanding $750,000 loan from the Company (see Note 5,Note Receivable From Related Party). Mr. Brochu did not retain any net proceeds from the transaction.



The Companys Board of Directors, with Mr. Brochu abstaining from
discussions and voting, approved of the transaction and, using the Black-Scholes option pricing model, established the total purchase price of $997,968. The Company purchased from Mr. Brochu 547,999 stock options (granted on November 4, 1997) with
an exercise price of $3.00, 78,666 stock options (granted on February 4, 1999) with an exercise price of $8.25, 150,000 stock options (granted on August 13, 1999) with an exercise price of approximately $20.41, 150,000 stock options (granted on
February 2, 2000) with an exercise price of approximately $74.03, 37,500 stock options (granted on May 17, 2000) with an exercise price of approximately $38.66, 75,000 stock options (granted on October 12, 2000) with an exercise price of
approximately $5.31, and 200,000 stock options (granted on May 16,



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 8.    Shareholders Equity (Continued)



2001) with an exercise price of approximately $3.49. The purchased options were subsequently cancelled by the Company and are no longer available for grant.



A summary of the Companys stock option activity for the
years ended December 31 follows:



|                                      |  |                          |   |  |                     |   |  |                                |      
|------------------------------------- |  | ------------------------ | - |  | ------------------- | - |  | ------------------------------ | -----
|                                      |  |                          |   |  | Outstanding Options
|                                      |  | SharesAvailableFor Grant |   |  | Number ofShares     |   |  | Weighted-AverageExercisePrices
|Balance at December 31, 2000          |  | 1,527,144                |   |  | 5,042,188           |   |  |                                | 23.67
|Additional shares authorized          |  | 1,866,666                |   |  |                    |   |  |                                |     
|Options grantedprice equal to market |  | (2,566,761               | ) |  | 2,566,761           |   |  |                                | 3.75 
|Options forfeited                     |  | 2,428,723                |   |  | (2,461,316          | ) |  |                                | 20.28
|Options expired                       |  | (125,000                 | ) |  |                    |   |  |                                |     
|Options exercised                     |  |                         |   |  | (56,960             | ) |  |                                | 2.89 
|                                      |  |                          |   |  |                     |   |  |                                |      
|Balance at December 31, 2001          |  | 3,130,772                |   |  | 5,090,673           |   |  |                                | 15.49
|Additional shares authorized          |  | 666,666                  |   |  |                    |   |  |                                |     
|Options grantedprice equal to market |  | (3,805,200               | ) |  | 3,805,200           |   |  |                                | 0.91 
|Options forfeited                     |  | 1,956,895                |   |  | (1,966,735          | ) |  |                                | 13.45
|Options exercised                     |  |                         |   |  | (3,571              | ) |  |                                | 0.86 
|                                      |  |                          |   |  |                     |   |  |                                |      
|Balance at December 31, 2002          |  | 1,949,133                |   |  | 6,925,567           |   |  |                                | 8.07 
|Additional shares authorized          |  | 666,666                  |   |  |                    |   |  |                                |     
|Options grantedprice equal to market |  | (1,351,000               | ) |  | 1,351,000           |   |  |                                | 3.59 
|Options assumed                       |  |                         |   |  | 265,327             |   |  |                                | 2.04 
|Options forfeited                     |  | 810,445                  |   |  | (810,445            | ) |  |                                | 25.68
|Options purchased and cancelled       |  |                         |   |  | (1,239,165          | ) |  |                                | 4.80 
|Options exercised                     |  |                         |   |  | (728,921            | ) |  |                                | 1.19 
|                                      |  |                          |   |  |                     |   |  |                                |      
|Balance at December 31, 2003          |  | 2,075,244                |   |  | 5,763,363           |   |  | $                              | 5.84 
|                                      |  |                          |   |  |                     |   |  |                                |      



Total exercisable
options and their weighted average exercise price at December 31, 2003, 2002 and 2001 were 2,961,084, 3,239,870 and 2,052,905 shares and $8.50, $11.33 and $18.74, respectively. Additional information regarding options outstanding and options
exercisable at December 31, 2003 for selected exercise price ranges follows:



|                         |  |                  |  |                                         |  |                               |        |                  |           |                               |   |       
|------------------------ |  | ---------------- |  | --------------------------------------- |  | ----------------------------- | ------ | ---------------- | --------- | ----------------------------- | - | ------
|                         |  |                  |  | Outstanding                             |  | Exercisable                  
|Range of Exercise Prices |  | Number ofOptions |  | Weighted-AverageContractualLife (Years) |  | Weighted-AverageExercisePrice |        | Number ofOptions |           | Weighted-AverageExercisePrice
|$    0.44  $    0.83    |  | 120,859          |  | 9.05                                    |  | $                             | 0.67   |                  | 14,680    |                               | $ | 0.50  
|0.86        0.86        |  | 2,135,567        |  | 8.00                                    |  |                               | 0.86   |                  | 1,157,971 |                               |   | 0.86  
|0.91        1.87        |  | 679,274          |  | 9.52                                    |  |                               | 1.34   |                  | 53,429    |                               |   | 1.82  
|1.92        3.10        |  | 732,177          |  | 6.86                                    |  |                               | 2.66   |                  | 580,757   |                               |   | 2.57  
|3.34        5.32        |  | 669,211          |  | 7.28                                    |  |                               | 4.04   |                  | 445,716   |                               |   | 4.11  
|5.50        6.22        |  | 253,974          |  | 6.72                                    |  |                               | 5.12   |                  | 202,010   |                               |   | 5.82  
|6.25        6.47        |  | 616,600          |  | 9.89                                    |  |                               | 6.46   |                  | 12,832    |                               |   | 6.25  
|7.03    109.47          |  | 502,842          |  | 6.37                                    |  |                               | 27.53  |                  | 441,228   |                               |   | 28.72 
|119.75    131.63        |  | 52,859           |  | 6.19                                    |  |                               | 129.81 |                  | 52,461    |                               |   | 129.89
|                         |  |                  |  |                                         |  |                               |        |                  |           |                               |   |       
|$    0.44  $131.63      |  | 5,763,363        |  | 7.96                                    |  |                               | 5.84   |                  | 2,961,084 |                               |   | 8.50  
|                         |  |                  |  |                                         |  |                               |        |                  |           |                               |   |       



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 8.    Shareholders Equity (Continued)



Employee Stock Purchase Plan



In April 1999, the Company adopted the Employee Stock Purchase Plan (ESPP). Under the terms of the ESPP, the Company is
authorized to issue up to an initial 600,000 shares of common stock, plus annual increases as defined by the plan document. The annual increase in authorized shares for the plan during 2003 was 200,000 shares. The Company issued 108,639, 142,237 and
93,177 shares for employee stock purchases in 2003, 2002 and 2001, respectively. The ESPP enables employees to purchase shares of the Companys common stock at a discounted price through after-tax payroll deductions. Shares are offered to
employees in 24-month offering periods that include four consecutive six-month purchase periods. Eligible employees elect to have deducted from 1% to 10% of their base compensation up to $25,000 per year, and can purchase no more than 1,000 shares
per purchase period. The amounts deducted can be used to purchase the Companys common stock at the lesser of 85% of the fair value on the first day of the 24-month offering period or 85% of the fair value on last day of the purchase period
(purchase date). At December 31, 2003, 917,386 shares remained available for purchase under the plan.



Warrants



A summary of the Companys warrant activity for the years ended December 31 follows:



|                             |  |                      |  |                               
|---------------------------- |  | -------------------- |  | ------------------------------
|                             |  | Outstanding Warrants
|                             |  | NumberOf Shares      |  | Weighted-AverageExercisePrices
|Balance at December 31, 2001 |  | 11,921               |  | 12.88                         
|                             |  |                      |  |                               
|Balance at December 31, 2002 |  | 11,921               |  | 12.88                         
|                             |  |                      |  |                               
|Balance at December 31, 2003 |  | 11,921               |  | 12.88                         
|                             |  |                      |  |                               



All warrants were
assumed in connection with the Imparto and 2order acquisitions in 1999 and 2000, respectively, and are exercisable as of December 31, 2003 and expire between 2006 to 2008.



Stock-Based Compensation



In 1999, the Company issued certain fixed options to employees under the Option Plans with an exercise price less than the fair value of the underlying
common stock on the date of grant. The Company also issued certain options and warrants to purchase common stock to non-employees in connection with financing arrangements and consulting agreements in 1999 and prior years. The value of these awards
was recognized as either compensation or interest expense over the underlying awards service periods. The Company did not recognize any compensation expense for stock based compensation awards in 2003 or 2002, and recognized approximately
$21,000 in 2001 related to these options and warrants.



Pro
forma information regarding net loss and net loss per share required by SFAS No. 123 has been determined as if the Company had accounted for its employee stock options and stock purchase plan under the fair market value method. The fair value of
options and stock purchase rights was estimated at the date of grant using the Black-Scholes option pricing model. The fair value of options granted under the Option Plans was estimated using the following weighted-average assumptions: risk-free
interest rates of .95%% to 3.25% in 2003, 2.53% to 3.03% in 2002, and 4.39% in 2001; expected option lives of three months to five years in 2003, four to



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 8.    Shareholders Equity (Continued)



five years in 2002 and five years in 2001; dividend yield rate of 0% in 2003, 2002 and 2001; and volatility of 104.6% in 2003, 119.83% in 2002 and 109.73% in
2001. The fair value of stock purchase rights under the ESPP was estimated using the following weighted-average assumptions:



|                              |  |                 |  |                 |  |                
|----------------------------- |  | --------------- |  | --------------- |  | ---------------
|                              |  | 2003            |  | 2002            |  | 2001           
|Stock prices                  |  | $0.45           |  | $0.44  $0.68   |  | $4.33  $5.81  
|Exercise prices               |  | $0.39           |  | $0.37  $0.57   |  | $3.68  $4.94  
|Risk free year interest rates |  | 0.98%  1.32%   |  | 1.27%  2.99%   |  | 1.82%  4.08%  
|Expected life                 |  | 6 mo.   2 yrs. |  | 6 mo.  2 yrs.  |  | 6 mo.  2 yrs. 
|Dividend yield rate           |  | 0%              |  | 0%              |  | 0%             
|Expected volatility           |  | 114.8%  129.5% |  | 105.1%  133.0% |  | 107.6%  169.1%



The weighted-average
fair value of options granted during the year are as follows:



|             |  |                         |      |      |   |      |  |   |     
|------------ |  | ----------------------- | ---- | ---- | - | ---- |  | - | ----
|             |  | Year Ended December 31,
|             |  | 2003                    |      | 2002 |   | 2001
|Option plans |  | $                       | 2.74 |      | $ | 0.72 |  | $ | 3.07
|ESPP         |  | $                       | 0.30 |      | $ | 0.40 |  | $ | 4.03



Note
9.    Employee Benefit Plan



The
Company maintains a defined contribution retirement plan for eligible employees under the provisions of Internal Revenue Code Section 401(k). Participants may defer up to a portion of their annual compensation on a pretax basis, subject to maximum
limits on contributions. Contributions by the Company are at the discretion of the Board of Directors. No discretionary contributions have been made by the Company to date.



Note 10.    Commitments and Contingencies



The Company has entered into various agreements that allow for incorporation of licensed technology into its products. The
Company incurs royalty fees under these agreements that are based on a predetermined fee per license sold. Royalty costs incurred under these agreements are recognized over the periods that the related revenue is recognized and is included in cost
of revenue. These amounts totaled approximately, $200,000, $189,000 and $202,000 for the years ended December 31, 2003, 2002, and 2001, respectively.



In January 2003, the Company engaged an offshore development team to accelerate its development efforts. The Companys commitment under this
agreement is to incur up to approximately $125,000 per month for development work through January 2005. During the year ended December 31, 2003, the Company incurred software development expenses of approximately $1,234,000 related to this
agreement. The Company has no material long-term commitments or obligations other than those under these agreements.



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 10.    Commitments and Contingencies
(Continued)



The Company leases office space under operating leases with various expiration dates through 2006.
Future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2003 are as follows:



|     |  |                  |       |                              |   |       |  |   |      
|---- |  | ---------------- | ----- | ---------------------------- | - | ----- |  | - | -----
|     |  | Operating Leases |       | Other ContractualObligations |   | Total
|2004 |  | $                | 909   |                              | $ | 1,500 |  | $ | 2,409
|2005 |  |                  | 804   |                              |   | 125   |  |   | 929  
|2006 |  |                  | 21    |                              |   |      |  |   | 21   
|     |  |                  |       |                              |   |       |  |   |      
|     |  | $                | 1,734 |                              | $ | 1,625 |  | $ | 3,359
|     |  |                  |       |                              |   |       |  |   |      



Rent expense was
approximately $1,300,000 (net of sublease rental income of $55,000), $1,800,000 (net of sublease rental income of $356,000) and $2,800,000 (net of sublease rental income of $177,000) for 2003, 2002 and 2001, respectively.



Legal Proceedings



The Company, an officer, former officer and FleetBoston Robertson Stephens,
Inc., J.P. Morgan Securities Inc., U.S. Bancorp Piper Jaffray Inc., CIBC World Markets, Dain Rauscher, Inc. and Salomon Smith Barney Holdings Inc., the underwriters of our initial public offering, have been named as defendants in an action filed
during December 2001 in the United States District Court for the Southern District of New York on behalf of persons who purchased Primus common stock during the period from June 30, 1999 through December 6, 2000, which was issued pursuant to the
June 30, 1999 registration statement and prospectus for the Companys initial public offering. This is one of a number of actions coordinated for pretrial purposes. Plaintiffs in the coordinated proceeding have brought claims under the federal
securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities concerning the allocation of shares in the IPOs of more than 300 companies
during the period from late 1998 through 2000. Specifically, among other things, the plaintiffs allege that the prospectus pursuant to which shares of Company common stock were sold in the Companys IPO contained certain false and misleading
statements regarding the practices of the Companys underwriters with respect to their allocation of shares of common stock in the Companys IPO to their customers and their receipt of commissions from those customers related to such
allocations, and that such statements and omissions caused the Companys post-IPO stock price to be artificially inflated. The individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. In June
2003 the plaintiffs in this action announced a proposed settlement with the issuer defendants and their insurance carriers. The Company has elected to participate in the settlement, which generally provides that the Companys insurance carrier
is responsible for any payments other than legal fees it incurred before June 2003. On March 4, 2004, plaintiffs executive committee advised the court that the negotiators for plaintiffs and issuers had agreed on the terms of the settlement.
The court must still approve the settlement. If the settlement does not occur, and litigation against the Company continues, the Company believes it has meritorious defenses and intends to defend the case vigorously. While the Company can not
predict with certainty the outcome of the litigation or whether the settlement will be approved, the Company does not expect any material adverse impact to its business from this matter.



In October 2003, the Company received notice that ServiceWare, Inc. had filed a complaint against Primus in the United
States District Court for the Western District of Pennsylvania, which alleges that aspects of the Companys technology infringe one or more patents issued in 1998 alleged to be held by the plaintiff. The complaint was served on the Company on
January 28, 2004. In February of 2004, the Company filed its answer,



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 10.    Commitments and Contingencies
(Continued)



denying all substantive claims, raising multiple affirmative defenses (including that the patents are invalid and unenforceable, that Primus products
dont infringe the patents in any event and that these claims on 1998 patents are barred by equitable estoppel and latches) and including a number of counterclaims. The Company intends to vigorously defend against the allegations asserted in
this complaint and the Company believes the plaintiffs claims are without merit.



From time to time the Company is, and expects to continue to be, subject to legal proceedings and claims in the ordinary course of its business, including employment claims, contract-related claims and claims of
alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, including those described above, even if not meritorious, could force the Company to spend significant financial and managerial resources.
The Company is not aware of any legal proceedings or claims that the Company believes will have, individually or taken together, a material adverse effect on the Companys business, prospects, financial condition or results of operations.
However, the Company may incur substantial expenses in defending against third party claims. In the event of a determination adverse to the Company, the Company may incur substantial monetary liability, and/or be required to change its business
practices. Either of these could have a material adverse effect on the Companys financial position and results of operations.



As of December 31, 2003, no amounts have been accrued as a liability associated with the aforementioned legal proceedings as the incurrence of a liability
is not considered probable.



Note 11.    Related Party
Transactions



In 1997, Primus Knowledge Solutions, K.K.
(Primus KK), a distributor whose majority shareholder is also a significant shareholder of the Company, became a reseller of certain of the Companys products and a provider of support services in Japan The distribution arrangement with Primus
KK continues until terminated by mutual agreement or, if Primus KK has not completed the listing of its common stock on a recognized public stock exchange by December 31, 2004 or if certain performance goals are not met, its expiration on March 31,
2006. In July 2002, January 2003, May 2003 and again in September 2003, the Company amended the distribution agreement with Primus KK, and Primus KK has assumed a more significant role in product localization and support for the Japanese market.
After the September 2003 amendment, the current royalty fee structure has guaranteed minimum payments from Primus KK of $125,000 per quarter through the first quarter of 2004 provided certain professional services milestones are met. The amended
distribution agreement provides for sublicense fees based on a percentage of net fees collected by Primus KK from its customers (subject to certain minimums). The guaranteed minimum payments from Primus KK could result in an adjustment to the
sublicense fee due each quarter, but such payments do not constitute an advance inventory purchase nor can such payments be credited or carried over from one year to another. Guaranteed minimum royalty payments, to the extent they exceed sublicense
fees due, are recognized in the period earned. As a result of the changing and uncertain business climate and operating results for Primus KK, the Company expects to negotiate further amendments to its distribution agreement. The Companys
agreement with Primus KK does not contain product return rights. The Company recognized revenue from sublicense fees and guaranteed minimum payments of $956,000, $1,394,000 and $3,134,000 in 2003, 2002 and 2001, respectively, and revenue deferred at
December 31, 2003 and 2002 was approximately $94,000 and $248,000, respectively, and accounts receivable at December 31, 2003 and 2002 were approximately $6,000 and $471,000.



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 12.    Extraordinary Item



In September 2001, the Company recognized an extraordinary gain of $566,000
on the sale of certain assets and intellectual property of its wholly-owned subsidiary, 2order, for cash of $685,000. 2order was acquired in January 2000 through a business combination accounted for using the pooling-of-interests method of
accounting. The disposal of the 2order assets was not contemplated at the time of the pooling transaction. The decision to dispose of these assets was made in the ordinary course of business based on the change in the Companys marketing
strategy, the poor operating results of 2orders product lines and the significant funding burden on the Company to continue supporting 2order.



Note 13.    Business Segment Information



The Company operates primarily in one business segment and is principally engaged in the design, development, marketing, sale and support of Primus® eServer, Primus® eSupport, Primus® Enterprise Search, Primus® iView, Primus® Quick Resolve, and Primus® Visibility software products. Substantially all revenue results from the licensing of the Companys software products and related consulting,
hosting and customer support (maintenance) services. The Companys chief operating decision-maker reviews financial information presented on a consolidated basis, accompanied by disaggregated revenue information.



The majority of the Companys revenue is derived from customers in the
United States of America. The Companys international sales are principally in Europe and Japan. The following geographic information for revenue is presented for years ended December 31, 2003, 2002 and 2001:



|              |  |                         |        |      |   |        |  |   |       
|------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|              |  | Year Ended December 31,
|              |  | 2003                    |        | 2002 |   | 2001  
|              |  | (In thousands)         
|United States |  | $                       | 17,270 |      | $ | 16,713 |  | $ | 21,151
|Europe        |  |                         | 6,825  |      |   | 2,835  |  |   | 3,265 
|Japan         |  |                         | 956    |      |   | 1,394  |  |   | 3,134 
|              |  |                         |        |      |   |        |  |   |       
|Total revenue |  | $                       | 25,051 |      | $ | 20,942 |  | $ | 27,550
|              |  |                         |        |      |   |        |  |   |       



Note
14.    Guarantees



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



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##### Table of Contents

PRIMUS KNOWLEDGE SOLUTIONS, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 15.    Liquidity



The Companys operations have historically been financed through issuances of common and preferred stock. For the year
ended December 31, 2003, the Company incurred a net loss of approximately $2.9 million and used cash in operating activities of approximately $1.3 million. At December 31, 2003, the Company has working capital (current assets minus current
liabilities, excluding deferred revenue) of approximately $11.8 million. Management of the Company believes it has sufficient resources to continue as a going concern through at least December 31, 2004. Management plans to fund the growth of the
Company by generating sufficient revenue from customer contracts; if they are unable to do so, management would seek to further reduce operating costs in an attempt to provide positive cash flows from operations. There can be no assurance that the
Company will be able to generate sufficient revenue from customer contracts, or further reduce costs sufficiently, to provide positive cash flows from operations. If the Company is not able to generate positive cash flows from operations, the
Company will need to consider alternative financing sources. Alternative financing sources may not be available when and if needed by the Company or on favorable terms.



Note 16.    Subsequent Event



During March of 2004, the Company executed a further restructuring of their workforce to realize the efficiencies and
synergies from our recent acquisitions and as a result will be recording restructuring charges of approximately $500,000 for severance and benefits and associated costs due to an approximate 10% reduction in our worldwide workforce. Additionally,
the Company anticipates consolidating its Santa Clara operations into other existing locations and expects to record an excess facility and/or asset impairment charge in the first half of 2004.



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##### Table of Contents

SCHEDULE II



PRIMUS KNOWLEDGE
SOLUTIONS, INC. AND SUBSIDIARIES



VALUATION AND
QUALIFYING ACCOUNTS



YEARS ENDED DECEMBER 31, 2003, 2002
AND 2001



|                                |  |                              |  |                               |   |  |            |   |  |                       
|------------------------------- |  | ---------------------------- |  | ----------------------------- | - |  | ---------- | - |  | ----------------------
|Allowance For Doubtful Accounts |  | Balance at Beginning of Year |  | Charged (Credited) to Expense |   |  | Write-offs |   |  | Balance at End of Year
|                                |  | (In thousands)              
|Year ended December 31, 2003    |  | 412                          |  | (25                           | ) |  | (213       | ) |  | 174                   
|Year ended December 31, 2002    |  | 1,524                        |  | (140                          | ) |  | (972       | ) |  | 412                   
|Year ended December 31, 2001    |  | 950                          |  | 852                           |   |  | (278       | ) |  | 1,524                 



S-1