UNITED STATES
                               SECURITIES AND EXCHANGE COMMISSION
                               Washington, D.C. 20549

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FORM 10-K

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[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

OR

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

FOR THE TRANSITION PERIOD FROM ___________ TO  _____________

Commission file number:  000-27163



KANA Software, Inc.

|Delaware                                                       | 77-0435679                             
|-------------------------------------------------------------- | ---------------------------------------
|(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number)

181 Constitution Drive
Menlo Park, California    94025

(650) 614 8300

Securities registered pursuant to Section 12(b) of the Act:None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value 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
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
[X]       No  [     ]Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes  [X]       No  [     ]Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
    Yes  
 ̈    No
x

As of June 30, 2003, the last business day of the Registrant's most recently completed
second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates
of the Registrant was approximately $70,803,934 based upon the closing sales price of the Common
Stock as reported on the Nasdaq Stock Market of $4.00. Shares of Common Stock held by officers,
directors, and holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be affiliates. The
determination of affiliate status is not necessarily a conclusive determination for other
purposes.

As of March 1, 2004, the Registrant had outstanding 28,748,007 shares of Common Stock.

Portions of the Registrant's Proxy Statement to be filed pursuant to Regulation 14A promulgated
by the Securities and Exchange Commission under the Securities Exchange Act of 1934, which is
anticipated to be filed within 120 days after the end of the Registrant's fiscal year ended
December 31, 2003, are incorporated by reference in Part III hereof.







KANA Software, Inc.
                               TABLE OF CONTENTS

ANNUAL REPORT ON FORM 10-K

                      For The Year Ended December 31, 2003



|Part I.    |                                                                                                                  | Page
|---------- | ---------------------------------------------------------------------------------------------------------------- | ----
|Item 1.    | Business                                                                                                         | 3   
|Item 2.    | Properties                                                                                                       | 10  
|Item 3.    | Legal Proceedings                                                                                                | 11  
|Item 4.    | Submission of Matters to a Vote of Security Holders                                                              | 12  
|Part II.   |                                                                                                                  |     
|Item 5.    | Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 12  
|Item 6.    | Selected Consolidated Financial Data                                                                             | 13  
|Item 7.    | Management's Discussion and Analysis of Financial Condition and Results of Operations                            | 15  
|Item 7a.   | Quantitative and Qualitative Disclosures About Market Risk                                                       | 49  
|Item 8.    | Financial Statements and Supplementary Data                                                                      | 50  
|Item 9.    | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             | 51  
|Item 9a.   | Controls and Procedures                                                                                          | 52  
|Part III.  |                                                                                                                  |     
|Item 10.   | Directors and Executive Officers of the Registrant                                                               | 52  
|Item 11.   | Executive Compensation                                                                                           | 55  
|Item 12.   | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                   | 55  
|Item 13.   | Certain Relationships and Related Transactions                                                                   | 55  
|Item 14.   | Principal Accountant Fees and Services                                                                           | 55  
|Part IV.   |                                                                                                                  |     
|Item 15.   | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                                  | 56  
|Signatures |                                                                                                                  | 87  

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PART I

The following discussion of our business and other parts of this
report contain forward-looking statements that are not historical facts but
rather are based on current expectations, estimates and projections about our
business and industry, and our beliefs and assumptions. Words such as
"anticipates," "expects," "intends,"
"plans," "believes," "seeks,"
"estimates" and variations of these words and similar expressions
identify forward-looking statements. These statements are not guarantees of
future performance and are subject to risks, uncertainties and other factors,
many of which are beyond our control, are difficult to predict and could cause
actual results to differ materially from those expressed or forecasted in the
forward-looking statements. These risks and uncertainties include, but are not
limited to, those described in "Risk Factors" and elsewhere in this
report. Forward-looking statements that we believed to be true at the time we
made them may ultimately prove to be incorrect or false. Readers are cautioned
not to place undue reliance on forward-looking statements, which reflect our
view only as of the date of this report. Except as required by law, we undertake
no obligation to update any forward-looking statement, whether as a result of
new information, future events or otherwise.

Item 1. Business

Overview

We are a leading provider of enterprise Customer Relationship Management
(eCRM) software solutions, primarily, knowledge-powered customer service
solutions that provide information to answer customer inquiries more
efficiently, accurately, and consistently. Our solutions intelligently apply
knowledge to the service resolution process, and use standards-based, modular
applications that promote cost-efficient, phased implementations of our software
by our customers and their implementation consultants. Our service, marketing
and commerce applications enable organizations to improve the quality and
efficiency of interactions with customers and partners across multiple
communication points, including web contact, web collaboration, email, and
telephone. Our customers include some of the largest businesses in the world,
and they use our products to help them to better service, market to, and
understand their customers and partners, while improving customer satisfaction
and decreasing operational costs.

KANA is headquartered in the Silicon Valley in Menlo Park, California, with
offices in Japan, Korea, and throughout the United States and Europe. Our
revenue is primarily derived from the sale of our software and related
maintenance and support of the software. To a lesser extent, we derive revenues
from training and consulting. Our products are generally installed by our
customers, using an integrator, such as IBM, Accenture, or Bearing Point. While
coordinating with integrators is an important part of our strategy (see "Our
Strategy" below), this often increases the overall project cost for our
customers, which could lengthen the sales process as well as subject potential
sales to additional factors not under our control. Further, in recent years we
have experienced a cautious purchasing environment in our market and a
lengthening in sales cycles. Consequently, we face difficulty predicting the
quarter in which sales to expected customers will occur, if at all, which
contributes to the uncertainty of our future operating results. Since a
significant portion of our license revenues is generated by a relatively small
number of transactions, we risk the likelihood that our revenues will be lower
than our expectations in any given quarter.

We were incorporated in July 1996 in California and reincorporated in
Delaware in September 1999. We had no significant operations until 1997.
References in this annual report on Form 10-K to "KANA,"
"we," "our," and "us" collectively refer to KANA
Software, Inc., and our predecessor, and our subsidiaries and their
predecessors. Our principal executive offices are located at 181 Constitution
Drive, Menlo Park, California 94025 and our telephone number is (650) 614-
8300. Our Internet website is located at http://www.kana.com. We make available
free of charge on our website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission.

Competition and Our Industry



The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. We currently face competition for our
products from solutions designed by our customers' in-house development teams
and by third party development efforts. We expect that these solutions will
continue to be a major source of competition for the foreseeable future. Our
primary competitors for eCRM platforms are larger, more established companies
such as Siebel Systems, Inc. and PeopleSoft, Inc., and to a lesser extent,
Oracle and SAP. We also face competition from Kanisa, Inc., InQuira, E.piphany,
Inc., Chordiant Software, Inc., Primus Knowledge Solutions, Amdocs, and
Pegasystems, Inc. with respect to several specific applications we offer. We may
face increased competition upon introduction of new products or upgrades from
competitors, especially knowledge-powered products.

We believe that the principal competitive factors affecting our industry
include having a significant base of referenceable customers, the breadth and
depth of a given solution, product quality and performance, customer service,
product scalability and reliability, product features, ability to implement
solutions, and perception of financial position. We believe that our products
currently compete favorably with respect to these factors, and, in particular,
that our Web-based architecture provides us with a competitive advantage because
it allows for greater product scalability and rapid implementation. However, we
may not be able to maintain our competitive position against current and
potential competitors, especially those with greater financial, marketing,
service, support, technical and other resources, and who may, for example, be
able to add features or functionality to their competing products more quickly
or decide to sell their products to their existing customer bases for other
products.

Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than we have.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. We may lose potential customers to competitors for various reasons,
including the ability or willingness of competitors to offer lower prices and
other incentives that we cannot match. It is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. We also expect that competition will increase as a result of industry
consolidations.

Our Strategy

Deliver world-class products that focus on customer service and
marketing. A significant percentage of an enterprise's cost of providing
service to its customers consists of resolving individual customer questions and
problems, or cases. These cases must be received, routed, tracked, and resolved
by customer service agents. While many enterprises possess technology capable of
routing and tracking cases, the actual resolution of customer issues is the
least automated, and therefore the most costly phase. Our product portfolio
addresses this largely underserved customer service resolution market. Our
knowledge-powered customer service solutions focus on automating the service
resolution process. The majority of our license revenues are for applications
that are used by our customers' agents, or directly by their customers,
empowering them with knowledge and information to solve their inquiries.

Partner with the world's leading system integrators. Our strategy is
to focus our efforts on the sale of software and maintenance, while leading
system integrators that have developed significant expertise with our
applications provide our customers with a wide range of implementation, systems
integration and consulting services. In the first quarter of 2003, we also began
using the expertise of these integrators to assist in developing our applications. This has
further increased their KANA product expertise, which benefits our customers who
can leverage our integrators' outstanding industry knowledge, and proven
integration success. In addition, these integrators employ larger sales forces
than we do, and we generally collaborate our efforts with them when selling our
respective software and services. As a result, our gross margins have improved
since 2001 when we adopted this strategy and reduced our sales force
professional services practice.

Deliver industry-specific applications. Certain industries, such as
banking, telecommunications and healthcare, have high volumes of customer
interactions, and providing consistent and accurate feedback to customers in
these industries has become increasingly difficult as our customers' products
and offerings have become increasingly complicated. We continue to expand our
portfolio of industry-specific applications to address the unique needs of
customers in these industries.

Hire and retain only the top performers. We maintain a continual
process of evaluation of our employees and believe in rewarding good performance
and only retain those with demonstrated ability.

Products

KANA iCARE is a comprehensive eCRM suite made up of modular applications
that provide Global 2000 organizations and other enterprises the ability to
provide more intelligent, effective interactions with customers, leading to
loyal and lasting customer relationships while reducing costs in the contact
center.

The KANA iCARE suite is a flexible and scalable, Web-architected solution,
integrated on a single platform that supports multiple customer communication
channels. KANA iCARE provides the critical link between contact centers and
marketing departments, allowing organizations to have effective, efficient
interactions with customers at all points of contact (including Web contact,
telephone and e-mail) and throughout the enterprise. KANA iCARE employs robust
analytic tools across its entire product family to allow companies to
continually analyze and improve their customer and partner relationships. These
features enable Global 2000 organizations and other enterprises to reduce the
cost of information access for their employees, customers and partners while
creating profitable customer relationships.

Our customers can deploy KANA's iCARE applications as a complete suite or as
separate applications Our iCARE applications include:

- KANA Contact Center

- KANA IQ

- KANA Response

- KANA ResponseIQ

- KANA Connect

- KANA Marketing

In addition, we have introduced solutions that optimize the delivery of
customer service for specific industries that face a high volume of complex
customer interactions. These industry solutions are:

- Agent IQ for Consumer Telecommunications

- Agent IQ for Retail Banking

- Customer IQ for Retail Banking

- Agent IQ for Branch Banking

Our applications are designed to easily integrate with other enterprise
software and legacy systems. They can be installed on systems running either
Unix or Microsoft Windows NT operating systems, and provides customers with
capabilities for personalization, customer profile management, inquiry
management, universal business rules, knowledge management and extranet
workflow. They can be linked with customers' legacy systems allowing customers
to design their systems to preserve previous investments. Our eCRM architecture
uses data modeling to make data located in external systems available in our
application without requiring the data to be moved or replicated. These
applications are built on a Web-architected platform incorporating our KANA eCRM
framework, which provides users with full access to our applications using a
standard Web browser and without requiring them to install additional software
on their individual computers.

Alliances

We partner with leading systems integrators that have developed
significant expertise with our Web-architected eCRM applications and are able to
provide customers with a wide range of consulting, implementation and systems
integration services. Our systems integrator partners are involved in nearly all
customer engagements, and in 2001 we significantly reduced the size of our
professional services team and narrowed the scope of our professional services
program to ensure that we do not compete with these key partners for
professional services engagements. We believe that the support of these systems
integrators for our products is increasingly important in influencing new
customers' decisions to license our products. Our systems integration partners
include Accenture, Bearing Point, HCL Technologies, BusinessEdge and IBM
Business Consulting Services. These integrators have been integral to KANA's
success in selling its products to large-organizations such as Advanced Micro
Devices, Blue Cross and Blue Shield of Minnesota, O2, Dell Computer Corp.,
Highmark, Sony Consumer Products, Sprint PCS, Yahoo! and many others.

Services and Support

Customer Support. Our customer support group uses KANA's own eCRM
applications to provide multi-channel global support for our customers and
partners, including phone and e-mail support and self-service solutions via the
KANA Customer and Partner support portal. As of December 31, 2003, we had 23
employees in our technical support department.

Consulting Services. Our worldwide consulting services group provides
business and technical expertise to support our alliance partners and customers.
Our consulting services group works closely with system integrators during
implementations to provide technical experience and functional subject matter
expertise of our products, to assist the integrators in providing our customers
with high-quality, successful, enterprise-wide implementations. As of December
31, 2003, we had 18 employees in our consulting services department.

Education Services. Our education services group has prepared a full
set of training programs and materials for our customers and partners, including
a comprehensive set of courses for end users, business consultants and
developers, which are available through instructor-led, Web-based and onsite
classes. As of December 31, 2003, we had 5 employees in our education services
department.

Each of our service groups provide up to date information to our customers
and partners through quarterly newsletters, as well as real time updates to our
customer and partner facing knowledge base.

Sales

Our sales strategy is to focus on Global 2000 companies through a
combination of strategic alliances and our direct sales force. We maintain
direct sales personnel across the United States and internationally throughout
Europe, Asia-Pacific and Canada. Our direct sales force complements our system
integrator and reseller alliances. As of December 31, 2003, 77 of our
employees were employed in sales and marketing activities.

Customers

Our customers range from Global 2000 companies to growing companies
pursuing an e-business strategy. The following is a list of customers that we
believe are representative of our overall customer base:

|Financial ServicesAetna
Ameritrade
Axa
Bank of America
Bank One
Capital One
Citizens Bank
Citigroup
E*Trade
GE Capital
JP Morgan Chase
Kookmin Bank
Principal Financial Group
Washington Mutual | Communications
AT&T
BellCanada
BellSouth
Bertelsmann
Cingular Wireless
Comcast
Disney
Hutchison 3G
02
SBC 
Sprint PCS
Telstra
Verizon                                                        
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Health Care
Abbott Laboratories
Anthem
Blue Cross Blue Shield Minnesota 
Bristol Myers Squibb 
Cigna
Highmark
Kaiser Permanente
Merck                                                           | Government/Education
City of Amsterdam
Open University
State of California
UK Inland Revenue                                                                                                 
|High Technology
Advanced Micro Devices
BEA Systems
Dell Computer Corp.
Earthlink 
eBay
EDS
Hewlett-Packard 
IBM
NEC
Siemens
Texas Instruments
Yahoo!                                            | Transportation/Hospitality
ANA
American Airlines
Best Western International
British Airways
Delta Airlines
Jet Blue Airways
KLM
Northwest Airlines
Priceline.com 
Travelocity
United Airlines
|Manufacturing/Consumer Goods
Canon
Daimler-Chrysler
Ford
Nissan
Royal Philips Electronics
Sara Lee
Sony Electronics, Inc.
Taylor Made
Xerox                                                     | Retail
1-800 Flowers
BarnesandNoble.com
Home Depot
QVC
Staples.com
Target
The Gap
Williams-Sonoma                                                                                            

One customer, IBM, accounted for 11% of our total revenues in 2002. No
customer accounted for 10% or more of our total revenues in 2003 or 2001. A
substantial portion of our license and service revenues in any given quarter has
been, and we expect will continue to be, generated from a limited number of
customers.

Research and Development

We believe that strong product development capabilities are essential to our
strategy of enhancing our core technology, developing additional applications
incorporating that technology and maintaining the competitiveness of our product
and service offerings. We have invested significant time and resources in
creating a structured process for undertaking all product development. In the
first quarter of 2003, we began implementing an outsourcing strategy, which
involves subcontracting a significant portion of our software programming,
quality assurance and technical documentation activities to Accenture, HCL, IBM
and Bearing Point with staffing in India and China. As of December 31, 2003, 40
of our employees were engaged in research and development activities.

Our success significantly depends on our ability to enhance our existing eCRM
solutions and to develop new services, functionality and technology that address
the increasingly sophisticated and varied needs of our prospective customers.
The challenges of developing new products and enhancements 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 existing and potential customers to choose a competitor's
products.

We spent $21.4 million, $25.9 million, and $35.6 million on research and
development in 2003, 2002, and 2001, respectively.

Intellectual Property

We rely upon a combination of patent, copyright, trade secret and trademark
laws, and contractual restrictions, such as confidentiality agreements and
licenses, to establish and protect our proprietary rights. We currently have
four issued U.S. patents, three of which expire in 2018 and one of which expires
in 2020,  and a number of U.S. patent applications pending. Our pending
applications, if allowed, in conjunction with our issued patents, would cover a
significant portion of the technology underlying our products and services. We
have also filed international patent applications corresponding to some of our
U.S. applications. In addition, we have several trademarks that are registered
or pending registration in the U.S. or abroad. Although we rely on patent,
copyright, trade secret and trademark law to protect our technology, we believe
that factors such as the technological and creative skills of our personnel, new
product developments, frequent product enhancements and reliable product
maintenance are more essential to establishing and maintaining a technology
leadership position. As a result, our technology is susceptible to the
development efforts of our competitors, who could independently develop
technology that is similar or superior to ours.

Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy or otherwise obtain and use our products or technology or to
develop products with the same functionality as our products. Policing
unauthorized use of our products is difficult. Also, the laws of other countries
in which we market our products may offer little or no effective protection of
our proprietary technology. Reverse engineering, unauthorized copying or other
misappropriation of our proprietary technology could enable third parties to
benefit from our technology without paying us for it, which would significantly
harm our business. In addition, some of our license agreements require us to
place the source code for our products into escrow. These agreements generally
provide that some parties will have a limited, non-exclusive right to use this
code if there is a bankruptcy proceeding instituted by or against us, we cease
to do business and have no successor, or we discontinue providing maintenance
and support.

Substantial litigation regarding intellectual property rights exists in our
industry. We expect that software in our industry may be increasingly subject to
third-party infringement claims as the number of competitors grows and the
functionality of products in different industry segments overlaps. Some of our
competitors in the market for customer communications software may have filed or
may intend to file patent applications covering aspects of their technology that
they may claim our technology infringes. Such competitors could make a claim of
infringement against us with respect to our products and technology. Third
parties may currently have, or may eventually be issued, patents upon which our
current or future products or technology infringe. Any of these third parties
might make a claim of infringement against us. See "Risk Factors-We may
become involved in litigation over proprietary rights, which could be costly and
time consuming."

Backlog

As of December 31, 2003 and 2002, we had $27.7 million and $29.8
million, respectively, in backlog which relates to firm orders, with $5.0
million and $6.3, respectively, not expected to be recognized within one year
due to either the timing of obligations in the underlying agreement or our
collectibility assessment. The substantial majority of these firm orders relate
to annual support contracts, and were invoiced and recorded as deferred revenue
as of December 31, 2003 and 2002.

Employees

As of December 31, 2003, we had 211 full-time employees, compared to 365
full-time employees as of December 31, 2002. Of the December 31, 2003 employees,
46 were in our services and support group, 77 were in sales and marketing, 40
were in research and development, and 48 were in finance, administration and
operations. In the first quarter of 2003, we began implementing an outsourcing
strategy, which involves subcontracting a significant portion of our software
programming, quality assurance and technical documentation activities to third-
party developers with staffing in India and China. As a result of transitioning
these activities, we reduced our research and development department by 88
employees during the year-ended December 31, 2003.

ITEM 2. PROPERTIES

Our corporate office is located in Menlo Park, California, where we lease
approximately 45,000 square feet under a lease that expires in April 2007. The
annual base rent for this lease totals approximately $1.0 million. We also lease
approximately 35,000 square feet of space in Manchester, New Hampshire. This
lease expires in April 2005, and we have an option to extend the lease for two
additional five-year terms. The annual base rent for the New Hampshire lease
totals approximately $568,000. We also lease approximately 12,000 square
feet of space in Framingham, Massachusetts at an annual base rent of
approximately $155,000. This lease expires in November 2007.

In addition, we lease smaller offices in several cities throughout the United
States, and internationally in Japan, Korea, and throughout Europe. The terms of
these leases renew semi-annually unless terminated. We believe that our office
space will be sufficient to meet our needs through at least the next 12
months.

We have a total of approximately 82,000 square feet of excess space available
for sublease or renegotiation. The excess space is located in Menlo Park,
California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining
lease commitment terms on these leases vary from seven to eight years. We are
seeking to sublease or renegotiate the obligations associated with the excess
space. We have $10.2 million in accrued restructuring costs as of December 31,
2003, which is our estimate, as of that date, of the exit costs of these excess
facilities. However, if we determine that any of these real estate markets
continues to deteriorate, additional adjustments to this accrual may be
required, which would result in additional restructuring costs in the period in
which such determination is made, which could harm our results of operations.
Likewise, if any of these real estate markets strengthen, and we are able to
sublease the properties earlier or at more favorable rates than projected, or if
we are otherwise able to negotiate early termination of obligations on favorable
terms, adjustments to the accrual may be required that would increase income in
the period in which such determination is made. As of December 31, 2003, our
estimate of accrued restructuring cost includes an assumption of receiving $8.2
million in sublease payments that are not yet under contractual arrangement, and
in most cases, a potential sublessor has not been identified. We have assumed
that the majority of these sublease payments will begin in 2005 through 2007,
and will continue through the end of the related lease.

ITEM 3. LEGAL PROCEEDINGS

In April 2001, Office Depot, Inc. filed a complaint against KANA in the
Circuit Court for the 15th District of the State of Florida claiming that KANA
breached its license agreement with Office Depot. Office Depot sought relief in
the form of a refund of license fees and maintenance fees paid to KANA,
attorneys' fees and costs. We settled this matter in November 2003, which
resulted in a payment by KANA of less than $50,000.

The underwriters for our initial public offering, Goldman Sachs & Co.,
Lehman Bros, Hambrecht & Quist LLC, Wit Soundview Capital Corp as well as
KANA and certain current and former officers of KANA were named as defendants in
federal securities class action lawsuits filed in the United States District
Court for the Southern District of New York. The cases allege violations of
various securities laws by more than 300 issuers of stock, including KANA, and
the underwriters for such issuers, on behalf of a class of plaintiffs who, in
the case of KANA, purchased KANA's stock between September 21, 1999 and December
6, 2000 in connection with our initial public offering. Specifically, the
complaints allege that the underwriter defendants engaged in a scheme concerning
sales of KANA's and other issuers' securities in the initial public offering and
in the aftermarket. In July 2003, we decided to join in a settlement negotiated
by representatives of a coalition of issuers named as defendants in this action
and their insurers. Although we believe that the plaintiffs' claims have no
merit, we have decided to accept the settlement proposal to avoid the cost and
distraction of continued litigation. Because the settlement will be funded
entirely by KANA's insurers, we do not believe that the settlement will have any
effect on our financial condition, results of operation or cash flows. The
proposed settlement agreement is subject to final approval by the court. Should
the court fail to approve the settlement agreement, we believe we have
meritorious defenses to these claims and would defend the action vigorously.

On April 16, 2002, Davox Corporation (now Concerto Software) filed an action
against KANA in the Superior Court, Middlesex, Commonwealth of Massachusetts,
asserting breach of contract, breach of implied covenant of good faith and fair
dealing, unjust enrichment, misrepresentation, and unfair trade practices, in
relation to an OEM Agreement between KANA and Davox under which Davox has paid a
total of approximately $1.6 million in fees. Davox seeks actual and punitive
damages in an amount to be determined at trial, and award of attorneys' fees.
This action is in its early stages and has been re-filed in the Circuit Court of
Cook County, Illinois. We believe we have meritorious defenses to these claims
and intend to defend the action vigorously.

Other third parties have from time to time claimed, and others may claim in
the future that we have infringed their past, current or future intellectual
property rights. We have in the past been forced to litigate such claims. These
claims, whether meritorious or not, could be time-consuming, result in costly
litigation, require expensive changes in our methods of doing business or could
require us to enter into costly royalty or licensing agreements, if available.
As a result, these claims could harm our business.

The ultimate outcome of any litigation is uncertain, and either unfavorable
or favorable outcomes could have a material negative impact on our results of
operations, consolidated balance sheet and cash flows, due to defense costs,
diversion of management resources and other factors.

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

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed on the Nasdaq Stock Market under the symbol
"KANA".

The following table sets forth the range of high and low closing sales prices
for each period indicated:



|               |  | High   |  | Low    | 
|-------------- |  | ------ |  | ------ | 
|Fiscal 2002    |  |        |  |        | 
|First Quarter  |  | $29.20 |  | $10.97 | 
|Second Quarter |  | 17.19  |  | 3.83   | 
|Third Quarter  |  | 4.12   |  | 0.75   | 
|Fourth Quarter |  | 3.48   |  | 0.59   | 
|Fiscal 2003    |  |        |  |        | 
|First Quarter  |  | 4.25   |  | 1.90   | 
|Second Quarter |  | 6.60   |  | 2.95   | 
|Third Quarter  |  | 5.09   |  | 2.65   | 
|Fourth Quarter |  | 4.93   |  | 2.63   | 

There were approximately 1,300 stockholders of record of our
common stock as of March 1, 2004. The actual number of stockholders is greater
than this number of record holders, and includes stockholders who are beneficial
owners, but whose shares are held in street name by brokers and other nominees.
This number of holders of record also does not include stockholders whose shares
may be held in trust by other entities. We estimate that the number of
beneficial owners of shares of our common stock as of March 1, 2004 was
approximately 50,000.

We have not paid any cash dividends on our capital stock. We currently intend
to retain any earnings to fund the development and growth of our business and,
therefore, do not anticipate paying any cash dividends in the foreseeable
future. In addition, our existing credit facilities prohibit the payment of cash
or stock dividends on our capital stock without the lender's prior written
consent.

Recent Unregistered Sales of Securities

The following table provides information about our unregistered sales of KANA
securities since January 1, 2003.

|Marketing agreement          | Marketing partner                                       | December 10, 2003 | Warrant to Purchase Common Stock | 230,000 | $1,150,000* 
|---------------------------- | ------------------------------------------------------- | ----------------- | -------------------------------- | ------- | ------------
|Acquisition of Hipbone, Inc. | Certain employees and security holders of
Hipbone, Inc. | February 10, 2004 | Common Stock                     | 262,500 | $1,231,125**

___________

*	The aggregate consideration represents the aggregate exercise price of
the warrant, and assumes the purchaser exercises the warrant in full, using cash
to pay the exercise price. This warrant has not yet been exercised.

**	The aggregate consideration represents the closing share price of KANA
commons stock on the date of issuance multiplied by the number of shares
issued.

All sales were made in reliance on Section 4(2) of the Securities Act and/or
Regulation D promulgated under the Securities Act. The securities were sold to a
limited number of people with no general solicitation or advertising. The
purchasers had access to all relevant information necessary to evaluate the
investment and who represented to the issuer that the shares were being acquired
for investment.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the consolidated financial statements
and the related notes included elsewhere in this annual report on Form 10-K, and
other information we have filed with the Securities and Exchange Commission
(SEC).

The consolidated statement of operations data for each of the years in the
five year period ended December 31, 2003, and the consolidated balance sheet
data at December 31, 2003, 2002, 2001, 2000, and 1999 are derived from our
audited consolidated financial statements. The diluted net loss per share
computation excludes shares of common stock issuable upon exercise or conversion
of other securities, including outstanding options to purchase common stock and
common stock subject to repurchase rights, because their effect would be
antidilutive. See Note 1 of "Notes to the Consolidated Financial
Statements" included in Item 15 of this annual report for a detailed
explanation of the determination of the shares used to compute basic and diluted
net loss per share. Historical results are not necessarily indicative of results
to be expected for any future period. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

`Year Ended December 31,
                                                     ----------------------------------------------------------
                                                       2003        2002        2001         2000        1999
                                                     ---------  ----------  -----------  -----------  ---------
                                                              (in thousands, except per share amounts)
Consolidated Statement of Operations Data:
Revenues:
 License........................................... $  26,228  $   41,530  $    37,963  $    75,360  $  10,536
 Service...........................................    34,778      37,560       52,632       42,595      2,966
                                                     ---------  ----------  -----------  -----------  ---------
 Total revenues....................................    61,006      79,090       90,595      117,955     13,502
                                                     ---------  ----------  -----------  -----------  ---------
Cost of revenues:
 License...........................................     3,125       3,402        2,536        2,856        271
 Service...........................................     9,702      29,250       51,799       56,082      6,383
                                                     ---------  ----------  -----------  -----------  ---------
Total cost of revenues.............................    12,827      32,652       54,335       58,938      6,654
                                                     ---------  ----------  -----------  -----------  ---------
Gross profit.......................................    48,179      46,438       36,260       59,017      6,848
                                                     ---------  ----------  -----------  -----------  ---------
Operating expenses:
 Sales and marketing...............................    29,189      37,423       69,635       88,186     21,199
 Research and development..........................    21,437      25,933       35,558       42,724     12,854
 General and administrative........................     9,073      13,053       21,215       18,945      5,018
 Amortization of stock-based compensation..........     5,870      16,620       15,880       14,715     80,476
 Amortization of goodwill and
  identifiable intangibles.........................     1,453       4,800      127,660      873,022         --
 Merger and transition related costs...............        --          --       13,443        6,564      5,635
 Restructuring costs...............................     1,704      (5,086)      89,047           --         --
 In process research and development...............        --          --           --        6,900         --
 Goodwill impairment...............................        --      55,000      603,446    2,084,841         --
                                                     ---------  ----------  -----------  -----------  ---------
 Total operating expenses..........................    68,726     147,743      975,884    3,135,897    125,182
                                                     ---------  ----------  -----------  -----------  ---------
Operating loss.....................................   (20,547)   (101,305)    (939,624)  (3,076,880)  (118,334)
Impairment of investment...........................      (500)         --       (1,000)          --         --
Other income (expense), net........................       186         913        1,521        4,834       (744)
Income tax expense.................................      (318)         --           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
Loss from continuing operations....................   (21,179) $ (100,392) $  (939,103) $(3,072,046) $(119,078)
Discontinued operation:
 Income (loss) from operations of discontinued oper        --          --         (125)       1,173        335
 Gain (loss) on disposal, including provision of $1.1
  million for operating losses during phase-out per        --         381       (3,667)          --         --
Cumulative effect of accounting change related
  to the elimination of negative goodwill..........        --       3,901           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
         Net loss.................................. $ (21,179)    (96,110)    (942,895)  (3,070,873)  (118,743)
                                                     =========  ==========  ===========  ===========  =========
Basic and diluted net loss per share:
  Loss from continuing operations ................. $   (0.88) $    (4.48) $    (68.33) $   (395.83) $  (46.21)
  Income (loss) from discontinued operation........        --        0.02        (0.28)        0.15       0.13
  Gain on elimination of negative goodwill.........        --        0.17           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
  Net loss ........................................ $   (0.88) $    (4.29) $    (68.61) $   (395.68) $  (46.08)
                                                     =========  ==========  ===========  ===========  =========
Shares used in computing basic and
  diluted net loss per share amounts...............    24,031      22,403       13,743        7,761      2,577
                                                     =========  ==========  ===========  ===========  =========


                                                                           December 31,
                                                     ----------------------------------------------------------
                                                       2003        2002        2001         2000        1999
                                                     ---------  ----------  -----------  -----------  ---------
                                                                           (in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and
  short-term investments........................... $  32,956  $   32,498  $    40,130  $    76,499  $  53,217
Working capital (deficit)..........................     4,168      (4,533)     (13,697)      52,753     38,591
Total assets.......................................    69,878      80,550      160,672      980,124     70,229
Total long-term debt...............................        --          --          108          148        412
Total stockholders' equity......................... $  21,532  $   21,952  $    66,839  $   899,452  $  48,500`

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

Special Note Regarding Forward Looking Statements

The following discussion of our financial condition and results of
operations and other parts of this report contain forward looking statements
that are not historical facts but rather are based on current expectations,
estimates and projections about our business and industry, and our beliefs and
assumptions. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks,"
"estimates" and variations of these words and similar expressions
identify forward looking statements. These statements are not guarantees of
future performance and are subject to risks, uncertainties and other factors,
many of which are beyond our control, are difficult to predict and could cause
actual results to differ materially from those expressed or forecasted in the
forward looking statements. These risks and uncertainties include, but are not
limited to, those described in "Risk Factors" and elsewhere in this
report. Forward looking statements that we believed to be true at the time we
made them may ultimately prove to be incorrect or false. Readers are cautioned
not to place undue reliance on forward-looking statements, which reflect our
view only as of the date of this report. Except as required by law, we undertake
no obligation to update any forward looking statement, whether as a result of
new information, future events or otherwise.

OVERVIEW



We are a leading provider of Customer Relationship Management (CRM)
software solutions, specifically, customer service and marketing solutions. Our
applications enable organizations to improve the quality and efficiency of
interactions with customers and partners across multiple communication points,
including web contact, web collaboration, email, and telephone.  As a result,
our target market is large enterprises with a high volume of customer
interactions, such as banks, telecommunications companies, high-tech
manufacturers, healthcare organizations, and government agencies.

To a large degree, we rely on our relationships with leading system
integrators who co-develop, recommend, and install our software. This provides
leverage in the selling phase, and also allows us to realize higher gross
margins by selling primarily software licenses and support, which typically have
higher margins than consulting and implementation services. However, since our
applications are generally installed by our customers using a system integrator,
these services generally increase the cost of the project substantially,
subjecting their purchase to more levels of required approval and scrutiny of
projected cost savings in their customer service and marketing departments.
Consequently, we face difficulty predicting the quarter in which sales to
expected customers will occur, if at all, which contributes to the uncertainty
of our future operating results. Moreover, to the extent that significant sales
occur earlier or later than anticipated, revenues for subsequent quarters may be
lower or higher, respectively, than expected.

We have grown rapidly through acquisitions until recent years. These
acquisitions provided us with much of the core technology used in our
applications. In more recent years, we have substantially reduced the scale of
our operations as we began leveraging the service and development capabilities
of system integrators, and have acted to reduce costs and focus our product
offerings.

In the past three years, we have experienced a cautious purchasing
environment in our industry. We feel that this is largely a reaction to the
uncertain economy, which had a disproportionate effect on information technology
spending. While general economic conditions began to stabilize and improve in
the second half of 2003, we believe that our market continued to exhibit
cautiousness and uncertainty and that as a result, many enterprises continued to
be reluctant to invest in large CRM applications. Since 1997 we have incurred
substantial costs to develop our products and to recruit, train and compensate
personnel for our engineering, sales, marketing, client services and
administration departments. As a result, we have incurred substantial losses
since inception. For the twelve months ended December 31, 2003, we recorded a
net loss of $21.2 million. As of December 31, 2003, we had an accumulated
deficit of $4.3 billion, which includes approximately $2.7 billion related to
goodwill impairment charges. We expect to decrease our operating losses in 2004
as a result of our personnel and facility cost reductions throughout 2003. We
expect our cash and cash equivalents and short-term investments on hand will be
sufficient to meet our working capital and capital expenditures needs for the
next 12 months.

In June 2001, we completed a merger with Broadbase Software. This transaction
was accounted for using the purchase method of accounting. The purchase price
approximated $101.4 million.

In November 2003, we announced the completion of an underwritten public
offering of 4,080,000 shares of our common stock at a price to the public of
$3.00 per share. We offered the common stock under our shelf registration
statement. In addition to the 4,080,000 shares sold in the public offering, the
underwriter exercised, in full, an option to purchase a maximum of 612,000
additional shares to cover over-allotments of shares. The proceeds from the
offering, net of expenses, were approximately $13.1 million.

As of December 31, 2003, we had 211 full-time employees, which represents a
decrease from 365 employees at December 31, 2002. Over half of the decrease
during 2003 was related to our elimination of 88 research and development
positions in connection with our subcontracting a significant portion of our
software programming, quality assurance and technical documentation activities
to third-party development partners with staffing in India and China.

On February 10, 2004, we completed the acquisition of Hipbone, Inc., a
leading provider of online customer interaction solutions. This transaction will
be accounted for using the purchase method of accounting. The purchase price is
expected to approximate $1.0 million. As a result of this acquisition, we
now offer Hipbone's Web collaboration, chat, co-browsing and file-sharing
capabilities.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The 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 our reported
assets, liabilities, revenues and expenses, and our related disclosure of
contingent assets and liabilities. We continually evaluate our estimates,
including those related to revenue recognition, collectibility of receivables,
goodwill and intangible assets, contract loss reserve, income taxes, and
restructuring. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances. This
forms the basis of 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.

We believe the following critical accounting policies and the related
judgments and estimates significantly affect the preparation of our consolidated
financial statements:

Revenue Recognition.  Revenue recognition rules for software companies
are complex, and various judgments affect the recognition of revenues. The
amount and timing of our revenue is difficult to predict, and any shortfall in
revenue or delay in recognizing revenue could cause our operating results to
vary significantly from quarter to quarter and could result in future operating
losses.

License revenue is recognized when there is persuasive evidence of an
arrangement, delivery to the customer has occurred, provided the arrangement
does not require significant customization or modification of the software, the
fee is fixed or determinable, and collectibility is reasonably assured.

In software arrangements that include rights to multiple software products
and/or services, we allocate the total arrangement fee using the residual
method, under which revenue is allocated to undelivered elements based on
vendor-specific objective evidence of fair value of such undelivered elements
with the residual amounts of revenue being allocated to the delivered elements.
Elements included in multiple element arrangements primarily consist of software
products, maintenance (which includes customer support services and unspecified
upgrades), or consulting services. Vendor-specific objective evidence for
software products and consulting services is based on the price charged when an
element is sold separately or, in the case of an element not yet sold
separately, the price established by authorized management if it is probable
that the price, once established, will not change before market introduction.
Vendor-specific objective evidence for maintenance is generally based on stated
contractual renewal rates. Evaluating whether sufficient and appropriate vendor-
specific objective evidence exists to use in allocating revenue to undelivered
elements, and the interpretation of such evidence to determine the fair value of
undelivered elements is subject to judgment and estimates that affect when and
to what extent we may recognize revenues from a given contractual arrangement.

Probability of collection is based upon assessment of the customer's
financial condition through review of their current financial statements or
publicly-available credit reports. For sales to existing customers, prior
payment history is also considered in assessing probability of collection. We
exercise significant judgment in deciding whether collectibility is reasonably
assured, and such judgments may materially affect the timing of our revenues and
our results of operations.

Revenues from support are primarily for the purpose of providing
global support for our customers and partners, including phone and e-mail
support and self-service solutions, as well as product maintenance updates and unspecified upgrades.
Support revenues are recognized ratably over the term of the
contract, typically one year.

Consulting revenues in 2002 and 2003 were generated primarily by providing
specific subject matter expertise as opposed to overall project management and
were performed on a time-and-materials basis. In September 2001, we shifted our
strategy to have our customers use third-party systems integrators for their
implementation of our software. Some consulting engagements prior to September
2001 included implementation and project management and some such engagements
were provided on a fixed-fee basis, under separate service arrangements.
Implementation or project management services performed under fixed-fee
arrangements were generally recognized on a percentage-of-completion basis. We
have not entered into any new fixed-fee implementation services since September
2001. For any arrangement in which customer acceptance was not assured or an
ability to reliably estimate costs was not possible, we used the completed
contract method, whereby revenues and related costs were deferred until all
contractual obligations were met, and acceptance, if required by the contract,
was received. Revenues from training services are recognized as services are
performed.

Collectibility of Receivables. In order to recognize revenue from a
transaction, collectibility must be determined by management to be reasonably
assured. If collectibility is not determined to be reasonably assured, amounts
billed to customers are recorded as deferred revenue. For sales to existing
customers, prior payment history is a factor in assessing probability of
collection.

We make judgments as to our ability to collect outstanding receivables and
provide allowances for receivables that may not be collectible. A considerable
amount of judgment is required to assess the ultimate realization of
receivables. In assessing collectibility, we consider the age of the receivable,
our historical collection experience, current economic trends, and the current
credit-worthiness of each customer. In the future, additional provisions for
doubtful accounts may be needed and the future results of operations could be
materially affected.

Reserve for Loss Contract. For professional services arrangements
involving a fixed fee, we assess whether a loss reserve is necessary, estimate
the total expected costs of providing services necessary to complete the
contract and compare these costs to the fees expected to be received under the
contract. For example, we were party to a contract with a customer that provided
for fixed fee payments in exchange for services upon meeting certain milestone
criteria. Based on the analysis we performed in the fourth quarter of 2000, we
expected the costs to complete the project to exceed the associated fees, and
accordingly we recorded a loss reserve of $1.4 million in the quarter ended
December 31, 2000. As a result of our restructuring in the third quarter of
2001, substantially all of the remaining professional services required under
the contract were being provided by a third party, and we recorded an additional
loss reserve of $6.1 million based upon an analysis of costs to complete these
services. In the second quarter of 2002, we began discussions with the customer
regarding the timing and scope of the project deliverables, which led to an
amendment in August 2002 to the original contract. Based on the amendment and
associated negotiations with a third-party integrator that had been providing
implementation services to the customer, we recorded a charge of approximately
$15.6 million to cost of services revenue in the second quarter of 2002 and in
accordance with the terms of the amendment were relieved from providing any
further implementation services under the contract. The amendment required that
we transfer $6.9 million to an escrow account (which included $5.8 million
previously reported as restricted cash) to compensate any third-party integrator
for the continued implementation of the customer's system. The charge also
included $8.5 million of fees that we had paid the third-party integrator prior
to the amendment. During the second quarter of 2002, we received a scheduled
payment of $4.0 million associated with the original agreement that we reported
as deferred revenue. The $4.0 million is being recognized as revenue as we
fulfill our support and training obligations. As of December 31, 2003, we have
recognized $1.5 million of the $4.0 million as revenue, and $2.5 million remains
in deferred revenue, of which $1.6 million relates to support and will be
recognized evenly through the first quarter of 2006. The remaining $0.9 million
relates to training and will be recognized as we perform training obligations,
but not later than the third quarter of 2005 when the training credits
expire.

Accounting for Internal-Use Software. Internal-use software costs,
including fees paid to third parties to implement the software, are capitalized
beginning when we have determined various factors are present, including among
others, that technology exists to achieve the performance requirements, we have
made a decision as to whether we will purchase the software or develop it
internally and we have authorized funding for the project. Capitalization of
software costs ceases when the software implementation is substantially complete
and is ready for its intended use, and the capitalized costs are amortized over
the software's estimated useful life (generally five years) using the straight-
line method. As of December 31, 2003, we had $11.1 million of capitalized costs
of internal use software, net of $4.0 million accumulated depreciation.

When events or circumstances indicate the carrying value of internal use
software might not be recoverable, we assess the recoverability of these assets
by determining whether the amortization of the asset balance over its remaining
life can be recovered through undiscounted future operating cash flows. The
amount of impairment, if any, is recognized to the extent that the carrying
value exceeds the projected discounted future operating cash flows and is
recognized as a write down of the asset. In addition, if it is no longer
probable that computer software being developed will be placed in service, the
asset will be adjusted to the lower of its carrying value or fair value, if any,
less direct selling costs. Any such adjustment would result in an expense in the
period recorded, which could have a material adverse effect on our consolidated
statement of operations. Based on our assessment as of December 31, 2003, we
determined that no such impairment of internal-use software existed.

Restructuring. During 2001, we recorded significant liabilities in
connection with our restructuring program. These reserves included estimates
pertaining to contractual obligations related to excess leased facilities. We
have a total of approximately 82,000 square feet of excess space available for
sublease or renegotiation. Locations of the excess space include Menlo Park,
California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining
lease commitment terms on these leases vary from seven to eight years. We are
seeking to sublease or renegotiate the obligations associated with the excess
space. We had $10.2 million in accrued restructuring costs as of December 31,
2003, which is our estimate, as of that date, of the exit costs of these excess
facilities. We have worked with real estate brokers in each of the markets where
the properties are located to help us estimate the amount of the accrual. This
process involves significant judgments regarding these markets. If we determine
that any of these real estate markets continues to deteriorate, additional
adjustments to this accrual may be required, which would result in additional
restructuring expenses in the period in which such determination is made.
Likewise, if any of these real estate markets strengthen, and we are able to
sublease the properties earlier or at more favorable rates than projected, or if
we are otherwise able to negotiate early termination of obligations on favorable
terms, adjustments to the accrual may be required that would increase income in
the period in which such determination is made. As of December 31, 2003, our
estimate of accrued restructuring cost includes an assumption of receiving $8.2
million in sublease payments that are not yet under contractual arrangement, and
in most cases, a potential subleasor has not been identified. We have assumed
that the majority of these sublease payments will begin in 2005 through 2007 and
continue through the end of the related leases.

Goodwill and Intangible Assets. Consideration paid in connection with
acquisitions is required to be allocated to the acquired assets, including
identifiable intangible assets, and liabilities acquired.  Acquired assets and
liabilities are recorded based on our estimate of fair value, which requires
significant judgment with respect to future cash flows and discount rates. For
intangible assets other than goodwill, we are required to estimate the useful
life of the asset and recognize its cost as an expense over the useful life. We
use the straight-line method to expense long-lived assets, which results in an
equal amount of expense being recorded in each period. Amortization of goodwill
ceased as of January 1, 2002 upon our adoption of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. Instead, we
are now required to test goodwill for impairment under certain circumstances and
write down goodwill when it is impaired. We have determined that our
consolidated results comprise one reporting unit for the purpose of impairment
testing through December 31, 2003.

We regularly evaluate all potential indicators of impairment of goodwill and
intangible assets. Our judgments regarding the existence of impairment
indicators are based on market conditions, operational performance of our
acquired businesses and identification of reporting units. Future events could
cause us to conclude that impairment indicators exist and that goodwill and
other intangible assets associated with our acquired businesses are
impaired.

Under the transition provisions of SFAS No. 142, there was no goodwill
impairment at January 1, 2002 based upon our analysis completed at that time.
However, during the quarter ended June 30, 2002, circumstances developed that
indicated goodwill was likely impaired. The circumstances that lead to the
impairment included the revision of estimates of our revenues and net loss for
the second quarter of 2002 and subsequent quarters, based upon preliminary
revenue results late in the second quarter of 2002 and the reduction of
estimated revenue and cash flows. As a result, we announced preliminary second
quarter 2002 results on July 2, 2002. Following this announcement, the decline
in the trading price of our common stock reduced KANA's market capitalization,
and we performed an impairment analysis as of June 30, 2002. This analysis
resulted in a $55.0 million impairment expense to reduce goodwill. The
circumstances that led to the impairment included the lower-than-previously-
expected revenues and net loss for the second quarter of 2002 and the revision
of estimates of our revenues and net loss for subsequent quarters, based upon
financial results for the second quarter of 2002 and the reduction of estimated
cash flows in future quarters. We used a combination of discounted cash flows
and relevant market data, including our market capitalization during the period
following the announcement of preliminary results for the second quarter of
2002, to calculate an estimated fair value and the resulting goodwill
impairment. The estimated fair value was compared to the corresponding carrying
value of goodwill at June 30, 2002, which resulted in a reduction of goodwill as
of June 30, 2002 by $55.0 million. During the three months ended June 30, 2003
we performed our annual test for goodwill impairment as required by Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). We currently operate in one reportable segment, which is also the
only reporting unit for the purposes of SFAS 142. We completed our evaluation
and concluded that goodwill was not impaired as the fair value of our Company
exceeded its carrying value, including goodwill. The remaining amount of
goodwill as of December 31, 2003 was $7.4 million. Any further impairment loss
could have a material adverse impact on our financial condition and results of
operations.

We continue to assess whether any potential indicators of impairment of
goodwill have occurred and have determined that no such indicators have arisen
since June 30, 2003. Any further impairment loss could have a material adverse
impact on our financial condition and results of operations.

Income Taxes. We estimate our income taxes in each of the
jurisdictions in which we operate as part of the process of preparing our
consolidated financial statements. This process involves us estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as net operating loss
carryforwards, and stock-based compensation, for tax and accounting purposes.
These differences result in deferred tax assets and liabilities. We then assess
the likelihood that our net deferred tax assets will be recovered from future
taxable income and to the extent we believe that recovery is not likely, we
establish a valuation allowance. We concluded that a full valuation allowance
was required for all periods presented. While we have considered future taxable
income in assessing the need for the valuation allowance, in the event we were
to determine that we would be able to realize our deferred tax assets in the
future in excess of its net recorded amount, an adjustment to the deferred tax
asset would be made, increasing our income in the period in which such
determination was made. Pursuant to the Internal Revenue Code, the amounts of
and benefits from net operating loss carryforwards may be impaired or limited in
certain circumstances. Events which cause limitations in the amount of net
operating losses that we may utilize include, but are not limited to, a
cumulative change of more than 50% ownership of the company, as defined, over a
three year period. The portion of the net operating loss and tax credit
carryforwards subject to potential expiration has not been included in deferred
tax assets.

Contingencies and Litigation. We are subject to lawsuits and other
claims and proceedings. We assess the likelihood of any adverse judgments or
outcomes to these matters as well as ranges of probable losses. A determination
of the amount of loss contingency required, if any, for these matters are made
after careful analysis of each individual matter. The required loss
contingencies may change in the future as the facts and circumstances of each
matter changes.



RESULTS OF OPERATIONS

The following table sets forth selected data for the periods presented.
Percentages are expressed as a percentage of total revenues.



`Years Ended December 31,
                                 -----------------------------------------------
                                       2003             2002            2001
                                 --------------   -------------   --------------
Revenues:
 License....................... $ 26,228    43 % $ 41,530   53 % $ 37,963    42 %
 Service.......................   34,778    57     37,560   47     52,632    58
                                 -------- -----   -------- ----   -------- -----
   Total revenues..............   61,006   100     79,090  100     90,595   100

Cost of revenues:
 License.......................    3,125     5      3,402    4      2,536     3
 Service.......................    9,702    16     29,250   37     51,799    57
                                 -------- -----   -------- ----   -------- -----
   Total cost of revenues......   12,827    21     32,652   41     54,335    60
                                 -------- -----   -------- ----   -------- -----
Gross profit...................   48,179    79     46,438   59     36,260    40

Operating expenses:
 Sales and marketing...........   29,189    48     37,423   47     69,635    77
 Research and development......   21,437    35     25,933   33     35,558    39
 General and administrative....    9,073    15 %   13,053   17 %   21,215    23 %`



Comparison of the Years Ended December 31, 2003 and 2002

Revenues

Total revenues decreased by 23% to $61.0 million for the year ended
December 31, 2003 from $79.1 million for the year ended December 31, 2002,
primarily as a result of fewer license deals in 2003 than in 2002, as well as a
31% decrease in the average sales price per license deal over $100,000 realized
during 2003 compared to 2002. We believe the decrease in 2003 is due to a
multitude of factors including competitive pricing pressures and the continuing
slow down in the information technology spending environment.

License revenues include licensing fees only, and exclude associated
maintenance and consulting revenue. The majority of our licenses to customers
are perpetual and recognized upon shipment, provided that all revenue
recognition criteria are met as discussed in "Revenue Recognition"
under "Critical Accounting Policies" above.

License revenues decreased by 37% to $26.2 million for the year ended
December 31, 2003 from $41.5 million for 2002. This decrease in license revenue
was primarily due to a decrease in the average selling price of license deals,
as well as a decrease in the number of license deals closed during the year. The
decrease in the average selling price of license deals was primarily experienced
in the middle of the year. We expect our average selling price to fluctuate
in future quarters given the relatively low number of new deals that comprise
the majority of our license revenue recognized per quarter. As an example, the
average quarterly selling price of license deals exceeding $100,000 varied from
a low of approximately $320,000 in the second quarter of 2003 to a high of
approximately $740,000 in the fourth quarter of 2003. In addition, we expect
that license deals closed in any particular quarter will continue to constitute
a significant percentage of the license revenues recognized in that quarter.

Our license revenue decreased as a percentage of total revenue due to the
reduction in the average selling price of license deals and the
number of license deals closed in 2003 as discussed above. We expect license
revenues to increase moderately in absolute dollars in 2004 from 2003, primarily
due to our expectations of an increase in the average selling price,
particularly from the second and third quarters of 2003 since those quarters had
relatively few large deals. However, the market for our products is
unpredictable and intensely competitive, and the economic environment over the
last few years has had an effect on corporate purchasing which has impacted
sales of our products.

Our service revenues consist of either support revenues or professional
services. Support revenues relate to providing customer support and product
maintenance, product updates and unsepcified upgrades to our customers. Professional services revenues
relate to providing consulting, training and, to a lesser extent, implementation
services to our customers. Service revenues decreased by 7% to $34.8 million for
the year ended December 31, 2003 from $37.6 million for 2003. The decrease in
service revenues was primarily in professional services, due to our customers'
increased use of independent third party integrators for implementation services
in 2003. Support revenues were relatively consistent with 2002, at $30.6 million
in 2003 versus $30.8 million in 2002. The reduction in the sales of new licenses
in 2003 affected service revenues less than license revenues because the
majority of our service revenues relate to ongoing support
contracts with existing customers. We expect that service revenues in 2004 will
be fairly consistent with 2003 in absolute dollars as we continue to focus on
license sales and using third-party integrators for implementation services.

Revenues from international sales were $17.2 million, or 28% of total
revenues, in the year ended December 31, 2003 and $25.5 million, or 32% or total
revenues, in the year ended December 31, 2002. The decrease in international
sales in 2003 is primarily as a result of large sales through our integration
partner in the United Kingdom in 2002 that did not recur to the same extent in
2003. Our international revenues were derived from sales in Europe, Canada, Asia
Pacific and Latin America.

During 2003 we experienced an increase in sales to companies in the
telecommunications and financial services sector, representing approximately 41%
and 30%, respectively, of our revenues in 2003 compared to approximately 27% and
10%, respectively, in 2002. We also experienced a decrease in sales to companies
in the high technology sector, representing approximately 5% of our revenues in
2003 compared to approximately 23% in 2002. We expect the concentration of sales
to the telecommunications and financial services sectors to decrease slightly in
2004, offset by relative increases in sales in various other sectors in
2004.

Cost of Revenues

Total cost of revenues decreased by 61% to $12.8 million for the year ended
December 31, 2003 from $32.7 million for the year ended December 31, 2002.

Cost of license revenues consists of third party software royalties, and to a leser extent,
costs of product packaging, documentation, and production and delivery costs for
shipments to customers. Cost of license revenues as a percentage of license
revenue for 2003 was 12% compared to 8% in 2002. The increase was due to royalty
costs associated with a relatively higher proportion of non-revenue-related
shipments, such as upgrades and updates during 2003. We expect that our cost of
license revenue as a percentage of sales in 2004 will decrease slightly from
2003 due to renegotiations of our royalty agreements in late 2003, which allow
for royalties based on a percentage of revenue for large deals as opposed to a
fixed amount per licensed seat.

Cost of service revenues consists primarily of salaries and related expenses
for our customer support, consulting, and training services organizations.
Cost of service revenues decreased to 28% of service revenues, or $9.7
million, for 2003 compared to 78%, or $29.3 million, for the prior year. Cost of
service revenues in 2002 included approximately $15.6 million, or 42% of service
revenues, related to a loss contract with a customer, as discussed in
"Reserve for Loss Contract" under "Critical Accounting
Policies" above. The improvement in service margins in 2003 was also due to
the change in service revenues mix throughout 2002 following a shift in our
strategy in September 2001 to have customers use independent third party
integrators to provide implementation services, rather than purchase those
services from us. As a result, support revenues comprised a larger percentage of
service revenues during the entire year of 2003, which yielded better margins
than professional services revenues since the ratio of customers-to-personnel is
significantly higher for customer support. Support revenues comprised $30.6
million, or 50% of total revenues in 2003, compared to $30.8 million, or 39% in
2002. We anticipate that our cost of service revenues will remain relatively
constant in dollars, and as a percentage of service revenue, in 2004 compared to
2003.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist
primarily of compensation and related costs for sales and marketing personnel
and promotional expenditures, including public relations, advertising, trade
shows and marketing materials. Sales and marketing expenses decreased by 22% to
$29.2 million for the year ended December 31, 2003 from $37.4 million for the
year ended December 31, 2002. This decrease was primarily attributable to
reductions in sales and marketing personnel during 2003 by 27%, from 106
positions as of December 31, 2002 to 77 positions at December 31, 2003, which
resulted in approximately $4.2 million in savings in salaries and related
benefits. In addition, commission expense in 2003 was $2.3 million lower than in
2002 due to decreases in license revenues in 2003 discussed above.  We also
spent $2.2 million less in marketing programs in 2003 than in 2002. We
anticipate that sales and marketing expenses in 2004 will be fairly consistent
with 2003 in absolute dollars, and will fluctuate as a percentage of revenues
depending on the timing and amount of revenues.

Research and Development. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses decreased by 17% to
$21.4 million for the year ended December 31, 2003 from $25.9 million for the
year ended December 31, 2002. This decrease was attributable primarily to the
reduction of personnel during 2003 by 69%, from 128 as of December 31, 2002 to
40 at December 31, 2003 and resulted in savings of approximately $8.5 million in
compensation, benefits, and allocated facility and operations costs. These
reductions in personnel were offset by approximately $6.0 million in fees
associated with our outsourcing strategy begun in the first quarter of 2003,
which involves subcontracting a significant portion of our software programming,
quality assurance and technical documentation activities to development partners
with staffing in India and China. Likewise, expense for contractors in the
United States decreased by $0.8 million in 2003 compared to 2002. We also
realized savings in depreciation expense charged to research and development of
$0.9 million in 2003 compared to 2002 due to assets placed in service in 2000
becoming fully depreciated in 2003. We anticipate that research and development
expenses will be slightly lower in absolute dollars in 2004 than in 2003,
particularly in the first and second quarters of 2004 compared to the same
periods in 2003, and will fluctuate as a percentage of revenues depending on the
timing and amount of revenues. The anticipated reduction in research and
development expense in these periods is due to the fact that we had not yet
completed our transition to outsourcing in the first half of 2003 and thus
incurred duplicative costs during that period.

General and Administrative. General and administrative expenses
consist primarily of compensation and related costs for finance, legal, human
resources, corporate governance, and bad debt expense. Information technology
and facilities costs are allocated among all operating departments. General and
administrative expenses decreased by 30% to $9.1 million for the year ended
December 31, 2003 from $13.1 million for the year ended December 31, 2002. This
decrease was attributable to the 23% reduction in general and administrative
personnel during 2003, from 30 finance, legal and human resources-related
positions at December 31, 2002 to 23 such positions at December 31, 2003, as
well as $2.0 million in net reductions to bad debt expense in 2003. We
anticipate that general and administrative costs will be slightly lower in
absolute dollars in 2004 compared to 2003, and will fluctuate as a percentage of
revenues depending on the timing and amount of revenues.

Amortization of Stock-Based Compensation. In connection with certain
stock option grants to employees, and warrants issued to non-employees, we
recorded unearned stock-based compensation charges. These charges represent the
total difference between the exercise prices of stock options and the deemed
fair value of the underlying common stock for accounting purposes on the date
these stock options were granted. Amortization of stock-based compensation was
$5.9 million and $16.6 million for the years ended December 31, 2003 and 2002,
respectively. In 2003, there were no options granted with an exercise price
below the fair value of the option shares on the date of grant. We reversed $1.1
million of stock-based compensation associated with expenses related to unvested
options granted previously that were cancelled during 2003 in connection with employee
terminations. In 2002, options granted with an exercise price below the fair
value of the option shares on the date of grant resulted in a charge of
$138,000. We reversed $1.8 million of stock-based compensation associated with
expenses related to unvested options granted previously that were cancelled during 2002.

In connection with the merger with Broadbase, we recorded unearned stock-
based compensation totaling approximately $15.5 million during the year ended
December 31, 2001. These amounts are included as a component of stockholders'
equity and are being amortized on an accelerated basis by charges to operations
over the vesting period of the options.

In September 2000, we issued to Accenture 40,000 shares of common stock and a
warrant to purchase up to 72,500 shares of our common stock at an exercise price
of $371.25 per share pursuant to a stock and warrant purchase agreement in
connection with our global strategic alliance. The shares of the common stock
issued were fully vested, and we recorded a deferred stock-based compensation
charge of approximately $14.8 million which was amortized through December 31,
2003, consistent with the term of the related original alliance agreement. As of
December 31, 2003, 33,997 shares of common stock subject to the warrant were
fully vested and 38,503 had been forfeited. The vested portion of the warrant
was valued using the Black-Scholes model resulting in charges totaling $2.0
million of which $1.0 million was immediately expensed in the fourth quarter of
2000 and $1.0 million is being amortized over the term of the related alliance
agreement. The warrants are exercisable through December 30, 2005. In September
2001, we issued to Accenture a fully-vested warrant to purchase up to 150,000
shares of common stock at an exercise price of $3.33 per share pursuant to a
warrant purchase agreement in connection with our original global strategic
alliance. The warrant was valued using the Black-Scholes model resulting in a
charge of approximately $946,000 which was amortized through December 31, 2003,
coincident with the term of the original related alliance agreement. Accenture
exercised this additional warrant in March 2002.

In September 2001, we issued to a customer a warrant to purchase up to 5,000
shares of common stock at an exercise price of $7.50 per share pursuant to a
warrant purchase agreement. The warrant will become fully vested in September
2006 and has a provision for acceleration of vesting by 1,250 shares annually
over four years if the customer meets certain marketing criteria. As of December
31, 2003, no such marketing criteria has been met. The warrant was valued using
the Black-Scholes model, resulting in a deferred stock-based compensation charge
of approximately $29,000, which is being amortized over the four-year term of
the agreement.

In November 2001, we issued to two investment funds warrants to purchase up
to 386,118 shares of our common stock at an exercise price of $10.00 per share
in connection with a proposed financing which was to have been completed in
February 2002 upon attaining stockholder approval. These warrants were initially
exercisable for an aggregate of 193,059 shares. The exercisable warrants were
valued using the Black-Scholes model resulting in a charge of approximately $1.0
million to deferred stock-based compensation. On February 1, 2002, our
stockholders voted against the proposed financing, which resulted in us
terminating the share purchase agreement and caused the warrants to become
exercisable with respect to all 386,118 shares. The warrants were exercisable
for two years from the date the share purchase agreement was terminated. The
warrants expired unexercised. Using the Black-Scholes model, the warrants issued
in November 2001 that were initially exercisable were re-valued as of February
1, 2002, and the warrants that became exercisable on February 1, 2002 were
valued as of such date, resulting in a charge totaling approximately $4.7
million which was reflected as amortization of stock-based compensation in the
first quarter of 2002.

In November 2002, we issued to our landlords warrants to purchase up to
200,000 shares of common stock at $1.61 per share in connection with an
amendment to our existing facility lease. The warrants were valued using the
Black-Scholes model which resulted in a charge of approximately $137,000 which
was accounted for as a reduction to our restructuring liability in the fourth
quarter of 2002. The warrant was exercised in November 2003.

In December 2003, we issued to a customer warrants to purchase up to 230,000
fully vested shares of common stock at $5.00 per share in connection with a
marketing agreement. The warrants were valued at approximately $459,000, using
the Black-Scholes model. This amount was accounted for as a reduction of revenue
in the fourth quarter of 2003.

As of December 31, 2003, a total of approximately $1.5
million of unearned deferred stock-based compensation remained to be amortized.
We anticipate stock-based compensation expense to approximate from $1.0 to $1.4
million in 2004, and the remainder in 2005. The amortization of stock-based
compensation for 2003 and 2002, by operating expense, is detailed as follows (in
thousands):

`Year Ended December 31
                                  -----------------------
                                     2003         2002
                                  -----------  ----------
Cost of service................. $       430  $      883
Sales and marketing.............       2,300       4,697
Research and development........       2,149       4,384
General and administrative......         991       6,656
                                  -----------  ----------
 Total.......................... $     5,870  $   16,620
                                  ===========  ==========`

Amortization of Identifiable Intangibles. The amortization of
identifiable intangible assets recorded in the current and prior year relates to
$14.4 million of purchased technology recorded as an intangible asset in
connection with the merger with Silknet in April 2000. The amortization of these
assets concluded in April 2003. Amortization during totaled $1.5 million and
$4.8 million for the years ended December 31, 2003 and 2002, respectively.

Restructuring Costs. During the fourth quarter of 2003, we recorded
$1.7 million in restructuring costs related to a change in evaluation of real
estate market conditions in the United Kingdom, and changes in sublease
estimates based on communication from current and potential subtenants in the
United States. For the year ended December 31, 2002, we recorded approximately
$5.1 million in restructuring cost savings related to an amendment to a facility
lease, our evaluation of real estate market conditions relating to this and
other excess leased facilities, and discussions with our other landlords.

The following table summarizes our restructuring expenses, payments, and
liabilities at and for the years ended December 31, 2003 and 2002 (in
thousands):

`Fixed Asset
                                           Severance     Facilities     Disposals       Totals
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2000..... $        --   $         --   $         --  $         --
                                          -----------   ------------   ------------  ------------
Restructuring charge....................      24,426         38,168         26,453        89,047
Non-cash reduction of restructuring.....      (1,858)            --        (26,453)      (28,311)
Payments made...........................     (21,655)       (10,750)            --       (32,405)
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2001.....         913         27,418             --        28,331
                                          -----------   ------------   ------------  ------------
Non-cash reduction of restructuring.....          --         (5,086)            --        (5,086)
Payments made...........................        (696)       (12,415)            --       (13,111)
Sublease payments received..............          --            814             --           814
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2002.....         217         10,731             --        10,948
                                          -----------   ------------   ------------  ------------
Restructuring charge....................          --          1,704             --         1,704
Payments made...........................         (33)        (2,773)            --        (2,806)
Sublease payments received..............          --            348             --           348
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2003..... $       184   $     10,010   $         --  $     10,194
                                          ===========   ============   ============  ============`

We expect payments relating to restructuring liabilities to approximate $3.3
million in 2004, net of contractual sublease payments, with the remainder being
paid fairly evenly from 2005 until 2011.

During 2003 and 2002, we did not incur any restructuring costs related to
personnel. During 2003 and 2002, we realized personnel-related costs savings
associated with reductions in headcount as a result of our restructuring in
2001, of approximately $36.1 million in each year. Cost savings in 2003 relating
to facilities reductions from our restructuring in 2001 included $348,000 in
sublease payments received and $2.1 million in reduced rent obligations relating
to an amendment in 2002 to a facility lease. Cost savings in 2002 relating to
facilities reductions from our restructuring in 2001 included $814,000 in
sublease payments received and $340,000 in reduced rent obligations relating to
the lease amendment in 2002. Reductions in rent obligations related to this
amendment ranged from approximately $2.1 million in 2003, increasing to
approximately $2.8 million in 2010. To the extent we are able to sublease excess
facilities sooner than anticipated, or for greater dollar amounts than assumed,
we will experience further cost reductions. Likewise, to the extent that our
sublease expectations are not met, we may experience adjustments to our
restructuring reserve in future periods that may have a material adverse effect
on our financial statements.

Goodwill Impairment.  On January 1, 2002, we adopted Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets("SFAS 142"). SFAS 142 requires goodwill to be tested for
impairment under certain circumstances and written down when impaired. SFAS 142
requires purchased intangible assets other than goodwill to be amortized over
their useful lives unless these lives are determined to be indefinite. Under the
transition provisions of SFAS No. 142, there was no goodwill impairment at
January 1, 2002 based upon our analysis at that time. However, during the
quarter ended June 30, 2002, circumstances developed that indicated the goodwill
was likely impaired and we performed an impairment analysis as of June 30, 2002.
This analysis resulted in a $55.0 million impairment expense to reduce goodwill.
The circumstances that led to the impairment included the lower-than-previously-
expected revenues and net loss for the second quarter of 2002 and the revision
of estimates of our revenues and net loss for subsequent quarters, based upon
financial results for the second quarter of 2002 and the reduction of estimated
cash flows in future quarters. We used a combination of discounted cash flows
and relevant market data, including our market capitalization during the period
following the revision of estimates, to calculate an estimated fair value and
the resulting goodwill impairment. The estimated fair value was compared to the
corresponding carrying value of goodwill at June 30, 2002, which resulted in a
revaluation of goodwill as of June 30, 2002. During the three months ended June
30, 2003 we performed our annual test for goodwill impairment as required by
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). We currently operate in one reportable segment,
which is also the only reporting unit for the purposes of SFAS 142. We completed
our evaluation as of June 30, 2003 and concluded that goodwill was not impaired
as the fair value of our Company exceeded its carrying value, including
goodwill. There have been no events or circumstances from June 30, 2003 to
December 31, 2003 that have affected our June 30, 2003 conclusion regarding the
recoverability of goodwill. The remaining amount of goodwill as of December 31,
2003 was $7.4 million. Any further impairment loss could have a material adverse
impact on our financial condition and results of operations.

Impairment of Investment

In connection with the merger with Silknet in April 2000, we assumed a
$1.5 million investment in preferred stock of a privately held company. We
recorded a $1.0 million impairment charge in the fourth quarter of 2001 and
another $0.5 million impairment charge in the fourth quarter of 2003 in order to
reduce the carrying value of the investment to zero at December 31, 2003. The
impairment charge in 2003 was based upon the decline in the estimated fair value
of the asset based upon evaluation of the business prospects. The impairment
charge in 2001 was based on a substantial decline in the estimated fair value of
the investment based, in part, on the terms of a recent financing involving
significant new investors.

Other Income (Expense), net

Other income (expense), net consists of interest income, interest expense and
other income (expense). Interest income consisted primarily of interest earned
on cash and short-term investments and was approximately $315,000 and $965,000
during the years ended December 31, 2003 and 2002. The decrease in other income
(expense), net related to lower amounts of interest income earned due to lower
average interest rates and cash balances in 2003 than in 2002. Interest expense consisted primarily
of interest expense related to our line of credit and was approximately $174,000
and $107,000 during the years ended December 31, 2003 and 2002. Other income
consisted primarily of net gains on asset disposals.

Provision for Income Taxes

We have incurred operating losses on a consolidated basis for all periods
from inception through December 31, 2003. Accordingly, we have recorded a
valuation allowance for the full amount of our gross deferred tax assets, as the
future realization of the tax benefit is not currently likely. In 2003, certain
foreign entities were profitable, based upon application of our intercompany
transfer pricing agreements, which resulted in us reporting income tax expense
totaling approximately $318,000 in those foreign jurisdictions.

As of December 31, 2003, we had net operating loss carryforwards for federal
and state tax purposes of approximately $394.9 million and $149.0 million,
respectively. The federal net operating loss carryforwards, if not offset
against future taxable income, will expire from 2011 through 2023. Pursuant to
the Internal Revenue Code, the amounts and benefits from net operating loss
carryforwards may be impaired or limited in certain circumstances.  Events which
cause limitations in the amount of net operating losses that we may utilize in
any one year include, but are not limited to, a cumulative ownership change of
more than 50%, as defined, over a three year period. As such, the portion of the
net operating loss and tax credit carryforwards subject to potential expiration
has not been included in deferred tax assets.

Cumulative Effect of Change in Accounting Principle

As part of the adoption of SFAS No. 142 on January 1, 2002, unamortized
negative goodwill was to be immediately recognized as the effect of a change in
accounting principle. Accordingly, approximately $3.9 million was eliminated and
reported as the cumulative effect of accounting change in the year ended
December 31, 2002.  Additionally, under SFAS 142, goodwill is no longer
amortized. Accordingly, amortization of goodwill ceased as of January 1,
2002.

Comparison of the Years Ended December 31, 2002 and 2001

Revenues

Total revenues decreased by 13% to $79.1 million for the year ended December
31, 2002 from $90.6 million for the year ended December 31, 2001 primarily as a
result of decreased service revenues.

License revenues increased by 9% to $41.5 million for the year ended December
31, 2002 from $38.0 million for 2001. This increase in license revenue was
primarily due to an increase in the average selling price of license deals,
particularly in Europe, as well as sales of products formerly offered by
Broadbase, which were not included in our revenues prior to the June 2001 merger
(license revenues recorded by Broadbase through June 2001 totaled $16.1
million). The increase in the average selling price of license deals reflected
the growth in our sales to larger organizations that often license our
applications for more users and that need more
functionality. We believe this growth resulted, in significant part, from
our increased use of indirect channels to market and sell our products, which
allow us to market our products more effectively to Global 2000 organizations.
In addition, we believe the introduction of our KANA iCARE suite in 2001, with
its deployment and integration advantages, has facilitated sales of licenses for
multiple applications to our customers resulting in larger transaction sizes
than those involving a stand-alone application. One customer accounted for 11%
of our total revenues in 2002.

Our license revenue increased as a percentage of total revenue mostly due to
the reduction in our professional services personnel resulting from a shift in
our strategy beginning in September 2001 to encourage our customers to increase
their use of independent third party integrators to provide implementation
services, rather than purchase those services from us.

Service revenues decreased by 29% to $37.6 million for the year ended
December 31, 2002 from $52.6 million for 2001. Service revenues decreased
primarily due to our customers' increased use of independent third party
integrators for implementation services as discussed above. Revenues from
international sales were $25.5 million, or 32% of total revenues, in the year
ended December 31, 2002 and $13.8 million, or 15% of total revenues, in the year
ended December 31, 2001. The increase in international sales in 2002 is
primarily as a result of sales through our integration partner in the United
Kingdom. Our international revenues were derived from sales in Europe, Canada,
Asia Pacific and Latin America.

Cost of Revenues

Total cost of revenues decreased by 40% to $32.7 million for the year ended
December 31, 2002 from $54.3 million for the year ended December 31, 2001.

Cost of license revenues as a percentage of license revenue for 2002 was 8%
compared to 7% in 2001. The slight increase was due to greater sales of certain
licenses in 2002, which had higher associated royalty rates.

Cost of service revenues decreased to 78% of service revenues for 2002
compared to 98% for the prior year. Cost of service revenues in 2002 included
approximately $15.6 million, or 42% of service revenues, related to a loss
contract with a customer, as discussed in "Reserve for Loss Contract"
under "Critical Accounting Policies" above. The improvement in service
margins was primarily due to the change in service revenues mix following a
shift in our strategy to have customers increase their use of independent third
party integrators to provide implementation services, rather than purchase those
services from us. As a result, support revenues comprised a larger percentage of
service revenues, which have yielded better margins than professional services
revenues since the ratio of customers-to-KANA personnel is significantly higher
for customer support. Support revenues comprised $30.8 million, or 39% of
total revenues in 2002, compared to $27.9 million, or 31% in 2001.

Operating Expenses

Sales and Marketing. Sales and marketing expenses decreased by 46%
to $37.4 million for the year ended December 31, 2002 from $69.6 million for the
year ended December 31, 2001. This decrease was primarily attributable to
reductions in sales and marketing personnel since the second half of 2001, which
reduced sales and marketing-related positions from 289 positions as of June 30,
2001 to 106 positions at December 31, 2002, and related decreases in benefits,
travel, and facility costs.

Research and Development. Research and development expenses decreased
by 27% to $25.9 million for the year ended December 31, 2002 from $35.6 million
for the year ended December 31, 2001. This decrease was attributable primarily
to the reduction of personnel since the second half of 2001, which reduced
research and development-related positions from 227 as of June 30, 2001 to 128
at December 31, 2002.

General and Administrative. General and administrative expenses
decreased by 38% to $13.1 million for the year ended December 31, 2002 from
$21.2 million for the year ended December 31, 2001. This decrease was
attributable to the reduction in bad debts charged to general and administrative
expenses, from $4.2 million in 2001 to approximately $57,000 in 2002. This
decrease was also attributable to the reduction of personnel since the second
half of 2001, which reduced finance, legal and human resources-related positions
from 52 as of June 30, 2001 to 30 at December 31, 2002.

Amortization of Stock-Based Compensation. As of December 31, 2002, a
total of approximately $8.6 million of unearned deferred stock-based
compensation remained to be amortized.

The amortization of stock-based compensation by operating expense, for 2002
and 2001, is detailed as follows (in thousands):

`Year Ended December 31,
                                  -----------------------
                                     2002         2001
                                  -----------  ----------
Cost of service................. $       883  $    1,417
Sales and marketing.............       4,697       7,230
Research and development........       4,384       4,226
General and administrative......       6,656       3,007
                                  -----------  ----------
 Total.......................... $    16,620  $   15,880
                                  ===========  ==========`

Amortization of Goodwill. Amortization of goodwill ceased as of
January 1, 2002 upon our adoption of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). Under SFAS
142, goodwill is no longer amortized.

The following table presents comparative information showing the effects that
the non-amortization of goodwill provisions of SFAS 142 would have had on the
net loss and basic and diluted net loss per share for the periods shown (in
thousands, except per share amounts):



`Year Ended December 31,
                                           ----------------------------
                                               2002           2001
                                           -------------  -------------
Reported net loss........................ $     (96,110) $    (942,895)
Goodwill amortization....................            --        118,060
                                           -------------  -------------
Adjusted net loss........................ $     (96,110) $    (824,835)
                                           =============  =============

Basic and diluted net loss per share..... $       (4.29) $      (68.61)
Goodwill amortization....................            --           8.59
                                           -------------  -------------
Adjusted basic and diluted
  net loss per share..................... $       (4.29) $      (60.02)
                                           =============  =============
Shares used in computing adjusted basic
  and diluted net loss per share.........        22,403         13,743
                                           =============  =============`

Amortization of Identifiable Intangibles. We recorded $4.8 million in
amortization of identifiable intangibles in both 2002 and 2001. This
amortization relates to $14.4 million of purchased technology recorded as an
intangible asset in connection with the merger with Silknet in April 2000. The
amortization of these identifiable intangibles concluded in April 2003.

Merger and Related Cost.  There were no merger-related costs incurred
in 2002. In connection with the merger with Broadbase, we recorded $13.4 million
of merger-related expenses in 2001. The merger costs included personnel costs of
$5.6 million, and $7.8 million relating to duplicate facility and insurance
costs, redundant assets, and professional fees associated with the merger. As of
December 31, 2002, no accrued merger-related costs remained on the consolidated
balance sheet.

Restructuring Costs. For the year ended December 31, 2002, we recorded
approximately $5.1 million in restructuring cost savings related to an amendment
to a facility lease, our evaluation of real estate market conditions relating to
this and other excess leased facilities, and discussions with our other
landlords. For the year ended December 31, 2001, we incurred restructuring
charges of approximately $89.0 million primarily related to reductions in our
workforce and costs associated with certain excess leased facilities and asset
impairments. The restructuring charges included $26.4 million for assets
disposed of or removed from operations. Assets disposed of or removed from
operations consisted primarily of computer equipment and related software,
office equipment, furniture and fixtures and leasehold improvements.

The restructuring charge in 2001 also included $24.4 million for severance,
benefits and related costs associated with reductions in our workforce. We
restructured our organization throughout 2001, with net workforce reductions of
approximately 772 employees, or 65% from December 31, 2000, in order to
streamline operations, eliminate redundant positions after the merger with
Broadbase, reduce costs and bring our staffing and cost structure in line with
industry standards and current economic conditions.

The restructuring charge in 2001 also included $38.2 million resulting from
our decision to exit and reduce some of our facilities. The estimated facility
costs were based on our contractual obligations, net of estimated sublease
income, based on current comparable rates for leases in the respective markets.

The following table summarizes our restructuring expenses, payments, and
liabilities at and for the years ended December 31, 2002 and 2001 (in
thousands):

`Fixed Asset
                                           Severance     Facilities     Disposals       Totals
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2000..... $        --   $         --   $         --            --

Restructuring charge....................      24,426         38,168         26,453        89,047
Non-cash charges........................      (1,858)            --        (26,453)      (28,311)
Payments made...........................     (21,655)       (10,750)            --       (32,405)
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2001.....         913         27,418             --        28,331
                                          -----------   ------------   ------------  ------------
Non-cash reduction of restructuring.....          --         (5,086)            --        (5,086)
Payments made...........................        (696)       (12,415)            --       (13,111)
Sublease payments received..............          --            814             --           814
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2002..... $       217   $     10,731   $         --        10,948
                                          ===========   ============   ============  ============`

Goodwill Impairment.  As discussed under "Comparison of the Years
Ended December 31, 2003 and 2002" above, on January 1, 2002, we adopted
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets("SFAS 142"). Under the transition provisions of
SFAS No. 142, there was no goodwill impairment at January 1, 2002 based upon our
analysis at that time. However, during the quarter ended June 30, 2002,
circumstances developed that indicated the goodwill was likely impaired and we
performed an impairment analysis as of June 30, 2002. This analysis resulted in
a $55.0 million impairment expense to reduce goodwill. The remaining goodwill
balance was approximately $7.4 million at December 31, 2002.

In 2001, we performed an impairment assessment of the identifiable
intangibles and goodwill recorded in connection with the Silknet merger. The
assessment was performed primarily due to the significant sustained decline in
our stock price since the valuation date of the shares issued in the Silknet
acquisition (which had resulted in the net book value of our assets prior to the
impairment charge significantly exceeding our market capitalization), the
overall decline in the industry growth rates, and our lower than projected
operating results. As a result, we recorded an impairment charge of
approximately $603.4 million in the first quarter of 2001 to reduce our
goodwill. The charge was based upon the estimated discounted cash flows over the
remaining useful life of the goodwill using a discount rate of 20%.

Impairment of Investment

In connection with the merger with Silknet in April 2000, we assumed a
$1.5 million investment in preferred stock of a privately held company. We
recorded a $1.0 million impairment charge in the fourth quarter of 2001 in order
to reduce the carrying value of the investment to $500,000. The impairment
charge was based on a substantial decline in the estimated fair value of the
investment based, in part, on the terms of a recent financing involving
significant new investors. This investment is included under "other
assets" in our consolidated balance sheet at December 31, 2002.

Other Income (Expense), net

Other income (expense), net in 2002 and 2001 consisted primarily of interest
earned on cash and short-term investments offset by interest expense related to
our line of credit and other non-operating expenses such as gains and losses on
asset disposals. Other income (expense), net was $913,000 for the year ended
December 31, 2002 and $1.5 million for the year ended December 31, 2001. The
decrease in other income (expense), net related to lower amounts of interest
income earned due to lower average cash balances in 2002 than in 2001.

Provision for Income Taxes

We have incurred operating losses in each year since inception. We have
recorded a valuation allowance for the full amount of our gross deferred tax
assets, as the future realization of the tax benefit is not currently
likely.

As of December 31, 2002, we had net operating loss carryforwards for federal
and state tax purposes of approximately $388.9 million and $118.2 million,
respectively. The federal net operating loss carryforwards, if not offset
against future taxable income, will expire from 2011 through 2022. Pursuant to
the Internal Revenue Code, the amounts and benefits from net operating loss
carryforwards may be impaired or limited in certain circumstances. Events which
cause limitations in the amount of net operating losses that we may utilize in
any one year include, but are not limited to, a cumulative ownership change of
more than 50%, as defined, over a three year period. The portion of the net
operating loss and tax credit carryforwards subject to potential expiration has
not been included in deferred tax assets.

Discontinued Operation

During the second quarter of 2001, we adopted a plan to discontinue the
KANA Online business. We no longer seek any new KANA Online business or have any
remaining contractual obligations to provide KANA Online to customers.
Accordingly, KANA Online is reported as a discontinued operation. The estimated
loss on the disposal of KANA Online recorded during the second quarter of 2001
was $3.7 million, consisting of an estimated loss on disposal of the business of
$2.6 million and a provision of $1.1 million for the anticipated operating
losses during the phase-out period. The loss on disposal was recorded in the
second quarter of 2001 and adjusted in the second quarter of 2002, resulting in
a gain of $381,000.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2003, we had $33.0 million in cash,
cash equivalents and short-term investments, compared to $32.5 million as of
December 31, 2002. As of December 31, 2003, we had working capital of $4.2
million.

History and recent trends. We have had negative cash flows from
operations in each year since inception. To date, we have funded our operations
primarily through issuances of common stock and, to a lesser extent, cash
acquired in acquisitions. However, our cash used in operations has decreased
significantly in recent years, from $112.4 million in 2001 to $42.2 million in
2002 to $12.7 million in 2003. This reduction in operating cash outflows is a
result of a 73% decrease in overall cost of revenues, sales and marketing,
research and development, general and administrative, and merger and
restructuring costs from 2001 to 2003, offset in part, by a 33% decrease in
revenues during the same period. Our cost reductions have been realized through
our restructuring plan in 2001, as well as various cost controls and operational
efficiencies realized since 2001. In 2001, 2002 and 2003, we had net workforce
reductions of approximately 772, 44, and 154 employees, respectively. Of the
workforce reductions in 2003, 88 related to the shift to the outsourcing of our
development activities to our development partners with staffing overseas. We do
not expect further reductions in research and development expense based upon our
outsourcing activities, since we will invest approximately the same amount as in
recent quarters of 2003. We have experienced modest improvements in operating
cash flows in the second half of 2003 and expect the trend to continue if our
revenue expectations are met. However, we believe that quarter-to-quarter
comparisons of our operating results may not necessarily be indicative of our
future performance.

Primary driver of cash flow. Our ability to generate cash in the
future relies upon our success in generating sufficient sales transactions,
especially new license transactions. We expect our maintenance renewals in 2004
to grow slightly from 2003. Since our new license transactions are relatively
small in volume and are difficult to predict, we may not be able to generate new
license transactions as anticipated in any particular future period. From time
to time, changes in working capital will affect our cash flows. However, we do
not expect this to materially impact our future cash flows over time, since we
expect relative stability, or slight increases, in our assets and liabilities.

Operating cash flow. Our use of $12.7 million of cash for operating
activities for the year ended December 31, 2003, included a $21.2 million net
loss from continuing operations offset by non-cash charges of $8.1 million in
depreciation, $5.9 million in amortization of deferred stock-based compensation
and $1.5 million in amortization of identifiable intangibles. Operating
activities also included $2.5 million in net payments relating to restructuring
liabilities. Other working capital changes totaled a net $4.5 million, resulting
primarily from a $6.0 million decrease in accounts receivable, offset by a $3.6
million reduction in the allowance for doubtful accounts, $4.6 million reduction
in deferred revenue and $4.9 million reduction in accounts payable and accrued
liabilities. Our operating activities used $42.2 million of cash for the year
ended December 31, 2002 and $112.4 million of cash for the year ended December
31, 2001. These expenditures were primarily attributable to net losses
experienced during these periods, offset in part by non-cash charges related to
impairment of goodwill and amortization of intangibles and stock-based
compensation.

Investing cash flow. Our investing activities provided $2.0 million of
cash for the year ended December 31, 2003, and consisted primarily of net
transfers of short-term investments to cash totaling $3.2 million, offset by
purchases of property and equipment of $1.2 million. Our investing activities
provided $2.4 million of cash for the year ended December 31, 2002, and
consisted primarily of reductions of restricted cash of $10.6 million, net
transfers of short-term investments to cash totaling $4.1 million, offset by
purchases of property and equipment of $12.3 million. Our investing activities
provided $49.6 million of cash for the year ended December 31, 2001, which was
primarily due transfers of short-term investments and cash acquired from the
acquisition of Broadbase, offset by purchases of property and equipment of $16.8
million, and a transfer of $7.8 million of cash to restricted cash. Our
purchases of property and equipment have decreased from 2001 to 2003, from $16.8
million in 2001 to $1.2 million in 2003. The decrease is due to the reduction in
purchases of infrastructure and various employee-related equipment in 2001, as
well as the completion of $15.1 million in expenditures on internal-use software
as of January 2003. We expect our capital needs in 2004 to be relatively
consistent with 2003.

Financing cash flow. Our financing activities provided $14.2 million
in cash for the year ended December 31, 2003, due to net proceeds from issuances
of common stock and warrants, particularly the public offering in November 2003
which raised $13.1 million in net proceeds. Our financing activities provided
$36.1 million in cash for the year ended December 31, 2002, primarily due to net
proceeds of approximately $31.4 million from our private placement of
approximately 2.9 million shares of our common stock in February 2002. Our
financing activities provided $13.0 million in cash for the year ended December
31, 2001, primarily due to net proceeds of $10.1 million from a private
placement of approximately 1.0 million shares of our common stock.

Existence and timing of contractual obligations. We have a line of
credit totaling $5.0 million, which is collateralized by all of our assets,
bears interest at the bank's prime rate (4.0% as of December 31, 2003), and
expires in November 2004 at which time the entire balance under the line of
credit will be due. Total borrowings as of December 31, 2003 and 2002 were $3.4
million under this line of credit. The line of credit requires that we maintain
at least a $6.0 million dollar balance in any account at the bank or pay a one-
time fee of $10,000. The line of credit also requires that we maintain at all
times a minimum of $20.0 million as short-term unrestricted cash, cash
equivalents and investments that mature within twelve months. If we default
under this line of credit, including through a violation of any of these
covenants, the entire balance under the line of credit will become immediately
due and payable. As of December 31, 2003, we were in compliance with all
covenants of the line of credit agreement. Future payments due under debt and
lease obligations and other contractual commitments as of December 31, 2003 are
as follows (in thousands):

`Obligations     Obligations
                                                    Under           Under      Non-cancelable
                                    Line of      Outsourcing       Capital       Operating
   Year Ending December 31,         Credit      Agreements (1)      Leases       Leases (2)      Total
  --------------------------      -----------   --------------   ------------  --------------  ----------
     2004....................... $     3,427   $        3,300   $         15  $        4,330  $   11,072
     2005.......................          --               --             --           3,360       3,360
     2006.......................          --               --             --           3,124       3,124
     2007.......................          --               --             --           2,421       2,421
     2008.......................          --               --             --           2,208       2,208
     Thereafter.................          --               --             --           4,315       4,315
                                  -----------   --------------   ------------  --------------  ----------
                                 $     3,427   $        3,300   $         15  $       19,758  $   26,500
                                  ===========   ==============   ============  ==============  ==========`

(1)   Represents minimum payments to one vendor
 providing outsourced software programming, quality assurance and technical
 documentation activities in India. The agreement is cancelable with 90 days
 notice and a fee of $275,000 if notice is given by KANA prior to May 1, 2004
 or $28,000 if notice is given prior to August 1, 2004.

(2)   Future payments due under non-
 cancelable operating leases are shown net of future sublease income and includes
 leases previously subject to abandonment and included in the restructuring
 charge. As of December 31, 2003, our estimate of accrued restructuring cost
 includes an assumption of receiving $8.2 million in sublease payments that are
 not yet under contractual arrangement, and in most cases, a potential sublessor
 has not been identified. We have assumed that the majority of these sublease
 payments will begin in 2005 through 2007, and continue through the end of the
 related lease.

Significant expected cash outflows in addition to our operating expenses
through 2004 include approximately $3.3 million in lease payments, net of
contracted sublease payments, relating to accrued restructuring costs and
approximately $3.3 million of minimum payments to one vendor providing
outsourced software programming, quality assurance and technical documentation
activities in India.

Off-balance sheet arrangements. In accordance with generally accepted
accounting principals (GAAP), none of our operating lease obligations are
reflected on our balance sheet. The vast majority of our operating leases relate
to facilities and do not involve a transfer of ownership at the end of the
lease. We have no other off-balance sheet arrangements.

Cash held in foreign locations. As of December 31, 2003, we had $8.9
million in US-equivalent dollars held by our 100%-owned foreign subsidiaries,
primarily in Europe and Japan. We believe our access to this cash is
unencumbered, and would not result in withholding or repatriation charges due to
our intercompany receivable balances and transfer pricing arrangements with
these entities.

Outlook. Based on our current 2004 revenue expectations, we expect our
cash and cash equivalents and short-term investments on hand will be sufficient
to meet our working capital and capital expenditure needs through December 31,
2004. However, if we experience a decrease in demand for our products from the
level experienced in the second half of 2003, then we would need to reduce
expenditures. Our expectations as to our future cash flows and our future cash
balances are subject to a number of assumptions, including assumptions regarding
anticipated increases in our revenue, improvements in general economic
conditions and customer purchasing and payment patterns, many of which are
beyond our control.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2003, the FASB issued Interpretation No. 46
("FIN 46R") (revised December 2003), "Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51" ("ARB 51"), which addresses how a business
enterprise should evaluate whether it has a controlling interest in an entity
though means other than voting rights and accordingly should consolidate the
entity. FIN 46R replaces FASB Interpretation No. 46
("FIN 46"), which was issued in January 2003. Before concluding
that it is appropriate to apply ARB 51 voting interest consolidation model to an
entity, an enterprise must first determine that the entity is not a variable
interest entity ("VIE"). As of the effective date of FIN 46R, an
enterprise must evaluate its involvement with all entities or legal structures
created before February 1, 2003, to determine whether consolidation
requirements of FIN 46R apply to those entities. There is no grandfathering
of existing entities. Public companies must apply either FIN 46 or
FIN 46R immediately to entities created after December 15, 2003 and no
later than the end of the first reporting period that ends after March 15,
2004 for all other entities. The adoption of FIN 46 did not have a material
impact on our financial position, cash flows or results of operations.

In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity."SFAS 150 changes the
accounting for certain financial instruments that under previous guidance
issuers could account for as equity. It requires that those instruments be
classified as liabilities in balance sheets. The guidance in SFAS 150 is
generally effective for all financial instruments entered into or modified after
May 31, 2003, and otherwise became effective on July 1, 2003. The adoption of
SFAS 150 did not have a material impact on our financial position, cash flows or
results of operations.

RISK FACTORS

We operate in a dynamic and rapidly changing business environment that
involves substantial risks and uncertainty, including but not limited to the
specific risks identified below. The risks described below are not the only ones
facing our company. Additional risks not presently known to us, or that we
currently deem immaterial, may become important factors that impair our business
operations. Any of these risks could cause, or contribute to causing, our actual
results to differ materially from expectations. 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.

Our failure to complete our expected sales in any given quarter could
materially harm our operating results because of the relatively large size of
many of our orders.

Our quarterly revenues are especially subject to fluctuation because they
depend on the completion of relatively large orders for our products and related
services. The average size of our license transactions is generally large
relative to our total revenue in any quarter, particularly as we have focused on
larger enterprise customers and on licensing our more comprehensive integrated
products and have involved system integrators in our sales process. In part as a
result of this aspect of our business, our quarterly revenues and operating
results may fluctuate in future periods and we may fail to meet the expectations
of investors and public market analysts, which could cause the price of our
common stock to decline. For example, during the year ended December 31, 2002,
one customer, IBM, represented 11% of our total revenues. This dependence on
large orders makes our net revenue and operating results more likely to vary
from quarter to quarter, and more difficult to predict, because the loss of any
particular large order is significant. As a result, our operating results could
suffer if any large orders are delayed or canceled in any future period. In
addition, large orders, and orders obtained through the activities of system
integrators, often have longer sales cycles, increasing the difficulty of
predicting future revenues. We expect the concentration of revenues among fewer
customers to continue in the future.

Our dependence on large orders for our operating results in any given
quarter makes us vulnerable to prospective customers' budgetary timelines and
constraints.

Contributing to the risk that anticipated sales may not occur on expected
time frame, if at all, our sales cycle is subject to a number of significant
risks, including customers' budgetary constraints and internal acceptance
reviews, over which we have little or no control. Due to the slowdown in the
general economy over the past few years, we believe that many existing and
potential customers have reassessed and reduced their planned technology and
software investments and are deferring purchasing decisions, requiring
additional evaluations and levels of internal approval for software investment
and lengthening their purchase cycles. Further delays or reductions in business
spending for information technology could have a material adverse effect on our
revenues and operating results. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, we are
unlikely to be able to generate revenue from alternate sources in time to
compensate for the shortfall. As a result, and due to the relatively large size
of a typical order, a lost or delayed sale could result in revenues that are
lower than expected. Moreover, to the extent that significant sales occur
earlier than anticipated, revenues for subsequent quarters may be lower than
expected. Consequently, we face difficulty predicting the quarter in which sales
to expected customers will occur, which contributes to the uncertainty of our
future operating results. In recent periods, we have experienced increases in
the length of a typical sales cycle. This trend may add to the uncertainty of
our future operating results and reduce our ability to anticipate our future
revenues.

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

The long sales cycle for our products may cause license revenue and operating
results to vary significantly from period to period. To date, the sales cycle
for our products has taken anywhere from 3 to 12 months. Furthermore, selling
our products in conjunction with our systems integrators who are proposing their
implementation services of our products can involve a particularly long sales
cycle, as it typically takes more time for the prospective customer to evaluate
proposals from multiple vendors. Consequently, we face difficulty predicting the
quarter in which expected sales will actually occur. This contributes to
fluctuations in our future operating results. Our sales cycle has required pre-
purchase evaluation by a significant number of individuals in our customers'
organizations. Along with third parties that often jointly market our software
with us, 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 slowly and
deliberately, depending on the specific technical capabilities of the customer,
the size of the deployment, the complexity of the customer's network
environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products. The present economic downturn
has led to a significant increase in the time required for this process and if
the downturn continues, the sales cycle for our products may become even longer
and we may require more resources to complete sales.

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

Most of our expenses, such as employee compensation and rent, are relatively
fixed in the short term. Moreover, our forecast is based, in part, upon our
expectations regarding future revenue levels. As a result, if total revenues for
a particular quarter are 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.

If our international development partners do not provide us with adequate
support, our ability to respond to competition and customer demands would be
impaired, and our results of operations would be harmed.

In the first quarter of 2003, we began subcontracting a significant portion
of our software programming, quality assurance and technical documentation
activities to development partners with staffing in India and China. We have
little prior experience in outsourcing our product development work, and we
cannot be sure that this strategy will succeed or that it will not cause us
difficulties in responding to development challenges we may face. The operations
of these partners are based outside the U.S. and therefore subject to risks
distinct from those that face U.S.-based operations. For example, military
action or political upheaval in the host countries could force these partners to
terminate the services they are providing to us or to close their operations
entirely. If these partners fail, for any reason, to provide adequate and timely
product enhancements, updates and fixes to us, our ability to respond to
customer or competitive demands would be harmed and we would lose sales
opportunities and customers. In addition, the loss of research and development
personnel associated with this strategy will cause us to lose internal
expertise, reducing our ability to respond to these demands independently if the
partners fail to perform as required. In the year ended December 31, 2003, we
reduced the size of our research and development department by 88 employees. We
have estimated our operating costs for 2004 making various assumptions about the
amount that we will need to pay our development partners. Based on our limited
history of working with these partners, we cannot be sure that our cost
estimates will prove correct. Unanticipated increases in our operating expenses
in any given quarter would increase our net losses and could require us to
obtain additional financing sooner than expected.

If we fail 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, and such financing may not be available to us, or may
impair the rights of our existing stockholders. Our operating activities used
$12.7 million of cash in 2003. Failure to increase future orders and revenues
beyond the level achieved in the second and third quarters of 2003 would likely
require us to seek additional capital to meet our working capital needs if we
are unable to reduce expenses to the degree necessary to avoid incurring losses.
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.

Because we have a limited operating history, there is limited information
upon which you can evaluate our business.

We first recorded revenue in February 1998 and our revenue mix and operating
structure have changed substantially since then. Thus, we have a limited
operating history upon which you can evaluate our business and prospects. Due to
our limited operating history and significant changes in our business over the
past four years, it is difficult or impossible to predict our future results of
operations. For example, we cannot accurately forecast operating expenses based
on our historical results (or those of similar companies) because historical
results are limited and reflect different products, costs and business models,
and we forecast expenses in part on future revenue projections based on a number
of assumptions. Moreover, due to our limited operating history and evolving
product offerings, our insights into trends that may emerge and affect our
business are limited.

We have a history of losses and may not be able to generate sufficient
revenue to achieve and maintain profitability.

Since we began operations in 1997, our revenues have not been sufficient
to support our operations, and we have incurred substantial operating losses in
every quarter. As of December 31, 2003, our accumulated deficit was
approximately $4.3 billion, which includes approximately $2.7 billion related to
goodwill impairment charges. We continue to commit a substantial investment of
resources to sales, product marketing, and developing new products and
enhancements, and we will need to increase our revenue to achieve profitability
and positive cash flows. Our expectations as to when we can achieve positive
cash flows, 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. Our history of losses has previously caused some of our
potential customers to question our viability, which has in turn hampered our
ability to sell some of our products. Additionally, our revenue has been
affected by the uncertain economic conditions in recent years, both generally
and in our market. As a result of these conditions, we have experienced and
expect to continue to experience difficulties in attracting new customers, which
means that we may continue to experience losses, even if sales of our products
and services grow.

We rely on marketing, technology and distribution relationships for the
sale, installation and support of our products that may generally be terminated
at any time, and if our current and future relationships are not successful, our
growth might be limited.

We rely on marketing and technology relationships with a variety of
companies, including systems integrators and consulting firms that, among other
things, generate leads for the sale of our products and provide our customers
with implementation and ongoing support. If we cannot maintain successful
marketing and technology relationships or if we fail to enter into additional
such relationships, we could have difficulty expanding the sales of our products
and our growth might be limited.

A significant percentage of our revenues depend on leads generated by systems
integrators, or "SI's", and their recommendations of our products, and
we expect an increasing percentage of our revenues to be derived from our
relationships with SIs that market and sell our products. If SIs do not
successfully market our products, our operating results will be materially
harmed. In addition, many of our direct sales are to customers that will be
relying on SIs to implement our products, and if SIs are not familiar with our
technology or able to successfully implement our products, our operating results
will be materially harmed. We expect to continue building our network of SIs and
other indirect sales channels and, if this strategy is successful, our
dependence on the efforts of these third parties for revenue growth and customer
service will increase. Our reliance on third parties for these functions will
reduce our control over such activities and reduce our ability to perform such
functions internally. If we come to rely primarily on a single SI that
subsequently terminates its relationship with us, becomes insolvent or is
acquired by another company with which we have no relationship, or decides not
to provide implementation services related to our products, we may not be able
to internally generate sufficient revenue or increase the revenues generated by
our other SI relationships to offset the resulting lost revenues. Furthermore,
SIs typically suggest our solution in combination with other products and
services, some of which may compete with our solution. SIs are not required to
promote any fixed quantities of our products, are not bound to promote our
products exclusively, and may act as indirect sales channels for our
competitors. If these companies choose not to promote our products or if they
develop, market or recommend software applications that compete with our
products, our business will be harmed.

In addition, we rely on distributors, value-added resellers, systems
integrators, consultants and other third-party resellers to recommend our
products and to install these products. Our reduction in the size of our
professional services team in 2001 increased our customers' reliance on third
parties for product installations and support. If the companies providing these
services fail to implement our products successfully for our customers, we might
be unable to complete implementation on the schedule required by the customers
and we may have increased customer dissatisfaction or difficulty making future
sales as a result. We might not be able to maintain these relationships and
enter into additional relationships that will provide timely and cost-effective
customer support and service. If we cannot maintain successful relationships
with our indirect sales channel partners, we might have difficulty expanding the
sales of our products and our growth could be limited. In addition, if such
third parties do not provide the support our customers need, we may be required
to hire subcontractors to provide these professional services. Increased use of
subcontractors would harm our margins because it costs us more to hire
subcontractors to perform these services than to provide the services
ourselves.

Recent reductions in workforce may adversely affect our ability to release
products and product updates in a timely manner.

We have substantially reduced our headcount in 2003 from a total of 365
employees as of December 31, 2002 to 211 as of December 31, 2003. The majority
of this reduction was the result of our decision to shift a significant portion
of our software programming, quality assurance and technical documentation
activities to international development partners in early 2003. We reduced the
size of our research and development department by 88 employees in the year
ended December 31, 2003. Our outsourcing plan may yield unanticipated
consequences, such as an inability to release products within expected
timeframes. For example, many of the employees who were terminated possessed
specific knowledge or expertise that may prove to have been important to our
operation. As a result of these staff reductions, our ability to respond to
unexpected challenges may be impaired and we may be unable to take advantage of
new opportunities. 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.

We may be unable to hire and retain the skilled personnel necessary to
develop and grow our business.

Our reductions in force and salary levels may reduce employee morale and may
create concern among existing employees about job security, which could lead to
increased turnover and reduce our ability to meet the needs of our current and
future customers. As a result of the reductions in force, we may also need to
increase our staff to support new customers and the expanding needs of our
existing customers. Because our stock price declined drastically in recent
years, and has not experienced any sustained recovery from the decline, stock-
based compensation, including options to purchase our common stock, may have
diminished effectiveness as employee hiring and retention devices. If we are
unable to retain qualified personnel, we could face disruptions to operations,
loss of key information, expertise or know-how and unanticipated additional
recruitment and training costs. If employee turnover increases, our ability to
provide customer service and execute our strategy would be negatively
affected.

For example, our ability to increase revenues in the future depends
considerably upon our success in recruiting, training and retaining effective
direct sales personnel and the success of our direct sales force. We might not
be successful in these efforts. Our products and services require sophisticated
sales efforts. We have experienced significant turnover in our sales force,
including the departure of our Vice President of Sales in October 2003.
Furthermore, there is a shortage of sales personnel with the requisite
qualifications, and competition for such qualified personnel is intense in our
industry. 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.

We face substantial competition and may not be able to compete
effectively.

The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. From time to time, some of our
competitors have reduced the prices of their products and services
(substantially in certain cases) in order to obtain new customers. Competitive
pressures could make it difficult for us to acquire and retain customers and
could require us to reduce the price of our products.

Our customers' requirements and the technology available to satisfy those
requirements are continually changing. Therefore, we must be able to respond to
these changes in order to remain competitive. If our international development
partners do not adequately perform the software programming, quality assurance
and technical documentation activities we outsourced, we may not be able to
respond to such changes as quickly or effectively. Changes in our products may
also make it more difficult for our sales force to sell effectively. In
addition, changes in customers' demand for the specific products, product
features and services of other companies' may result in our products becoming
uncompetitive. We expect the intensity of competition to increase in the future.
Increased competition may result in price reductions, reduced gross margins and
loss of market share. We may not be able to compete successfully against current
and future competitors, and competitive pressures may seriously harm our
business.

Our competitors vary in size and in the scope and breadth of products and
services offered. We currently face competition for our products from systems
designed by in-house and third party development efforts. We expect that these
systems will continue to be a major source of competition for the foreseeable
future. Our primary competitors for eCRM platforms are larger, more established
companies such as Siebel Systems, Inc. and PeopleSoft, Inc., and to a lesser
extent, Oracle and SAP. We also face competition from E.piphany, Inc., Chordiant
Software, Inc., Primus Knowledge Solutions, and Astute, Inc. with respect to
specific applications we offer. We may face increased competition upon
introduction of new products or upgrades from competitors, or if we expand our
product line through acquisition of complementary businesses or otherwise. As we
have combined and enhanced our product lines to offer a more comprehensive e-
business software solution, we are increasingly competing with large,
established providers of customer management and communication solutions as well
as other competitors. Our combined product line may not be sufficient to
successfully compete with the product offerings available from these companies,
which could slow our growth and harm our business.

Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than we have.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. We may lose potential customers to competitors for various reasons,
including the ability or willingness of competitors to offer lower prices and
other incentives that we cannot match. It is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. We also expect that competition will increase as a result of recent
industry consolidations, as well as anticipated future consolidations.

If we fail to respond to changing customer preferences in our market, demand
for our products and our ability to enhance our revenues will suffer.

If we do not continue to improve our products and develop new products that
keep pace with competitive product introductions and technological developments,
satisfy diverse and rapidly evolving customer requirements and achieve market
acceptance, we might be unable to attract new customers. The development of
proprietary technology and necessary service enhancements entails significant
technical and business risks and requires substantial expenditures and lead-
time. In addition, if our international development partners fail to provide the
development support we need, our products and product documentation could fall
behind those produced by our competitors, causing us to lose customers and
sales. We might not be successful in marketing and supporting recently released
versions of our products, or developing and marketing other product enhancements
and new products that respond to technological advances and market changes, on a
timely or cost-effective basis. In addition, even if these products are
developed and released, they might not achieve market acceptance. We have
experienced delays in releasing new products and product enhancements in the
past and could experience similar delays in the future. These delays or problems
in the installation or implementation of our new releases could cause us to lose
customers.

Failure to develop new products or enhancements to existing products on a
timely basis would hurt our sales and damage our reputation.

The challenges of developing new products and enhancements 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 be exploited by our competitors and lead potential customers to
choose alternative products. To be competitive, we must develop and introduce on
a timely basis new products and product enhancements for companies with
significant e-business customer interactions needs. Our ability to deliver
competitive products may be negatively affected by the diversion of resources to
development of our suite of products, and responding to changes in competitive
products and in the demands of our customers. If we experience product delays in
the future, we may face:

- customer dissatisfaction;
- cancellation of orders and license agreements;
- negative publicity;
- loss of revenues;
- slower market acceptance; and
- legal action by customers.

Furthermore, delays in bringing new products or enhancements to market can
result, for example, from potential difficulties with managing outsourced
research and development, including overseeing such activities occurring in
India and China or from loss of institutional knowledge through reductions in
force, or the existence of defects in new products or their enhancements.

Our stock price has been highly volatile and has experienced a significant
decline, and may continue to be volatile and decline.

The trading price of our common stock has fluctuated widely in the past and
is expected to continue to do so in the future, as a result of a number of
factors, many of which are outside our control, such as:

- variations in our actual and anticipated operating results;
- changes in our earnings estimates by analysts;
- the volatility inherent in stock prices within the emerging sector within
which we conduct business;
- and the volume of trading in our common stock, including sales of
substantial amounts of common stock issued upon the exercise of outstanding
options and warrants.

In addition, stock markets in general, and particularly the Nasdaq National
Market, have experienced extreme price and volume fluctuations that have
affected the market prices of many technology and computer software companies,
particularly Internet-related companies. Such fluctuations have often been
unrelated or disproportionate to the operating performance of these companies.
These broad market fluctuations could adversely affect the market price 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. Securities class action litigation
could result in substantial costs and a diversion of our management's attention
and resources.

Since becoming a publicly traded security listed on Nasdaq in September 1999,
our common stock has reached a closing high of $1,698.10 per share and closing
low of $0.65 per share. The last reported sale price of our shares on March 17,
2004 was $4.44 per share. Under Nasdaq's listing maintenance standards, if the
closing bid price of our common stock is under $1.00 per share for 30
consecutive trading days, Nasdaq may choose to notify us that it may delist our
common stock from the Nasdaq National Market. If the closing bid price of our
common stock did not thereafter regain compliance for a minimum of 10
consecutive trading days during the 180 days following notification by Nasdaq,
Nasdaq could delist our common stock from trading on the Nasdaq National Market.
There can be no assurance that our common stock will remain eligible for trading
on the Nasdaq National Market. If our stock were delisted, the ability of our
stockholders to sell any of our common stock at all would be severely, if not
completely, limited, causing our stock price to continue to decline.

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 customers'
organizations. If we fail to grow our customer base or 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
deployment licenses or additional development licenses. In addition, as we
introduce new versions of our products or new product lines, our current
customers might not require the functionality of our new products and might not
ultimately license these products.

Furthermore, 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. Also, if customers elect not to
renew their maintenance agreements, our services revenue could decline
significantly. If customers were unable to pay for their current products or are
unwilling to purchase additional products, our revenues would decline.

Our failure to manage multiple technologies and technological change could
reduce demand for our products.

Rapidly changing technology and operating systems, changes in customer
requirements, and evolving industry standards might impede market acceptance of
our products. Our products are designed based upon currently prevailing
technology to work on a variety of hardware and software platforms used by our
customers. However, our software may not operate correctly on evolving versions
of hardware and software platforms, programming languages, database environments
and other systems that our customers use. If new technologies emerge that are
incompatible with our products, or if competing products emerge that are based
on new technologies or new industry standards and that perform better or cost
less than our products, our key products could become obsolete and our existing
and potential customers could seek alternatives to our products. We must
constantly modify and improve our products to keep pace with changes made to
these platforms and to database systems and other back-office applications and
Internet-related applications. Furthermore, software adapters are necessary to
integrate our products with other systems and data sources used by our
customers. We must develop and update these adapters to reflect changes to these
systems and data sources in order to maintain the functionality provided by our
products. As a result, uncertainties related to the timing and nature of new
product announcements, introductions or modifications by vendors of operating
systems, databases, customer relationship management software, web servers and
other enterprise and Internet-based applications could delay our product
development, increase our product development expense or cause customers to
delay evaluation, purchase and deployment of our analytics products.
Furthermore, if our international development partners fail to respond
adequately when adaptation of our products is required, our ability to respond
would be hampered even if such uncertainties were eliminated. If we fail to
modify or improve our products in response to evolving industry standards, our
products could rapidly become obsolete.

Failure to license necessary third party software incorporated in our
products could cause delays or reductions in our sales.

We license third party software that we incorporate into our products. These
licenses may not continue to be available on commercially reasonable terms or at
all. Some of this technology would be difficult to replace. The loss of any such
license could result in delays or reductions of our applications until we
identify, license and integrate or develop equivalent software. If we are
required to enter into license agreements with third parties for replacement
technology, we could face higher royalty payments and our products may lose
certain attributes or features. In the future, we might need to license other
software to enhance our products and meet evolving customer needs. If we are
unable to do this, we could experience reduced demand for our products.

Our pending patents may never be issued and, even if issued, may provide
little protection.

Our success and ability to compete depend to a significant degree upon the
protection of our software and other proprietary technology rights. We currently
have four issued U.S. patents, three of which expire in 2018 and one of which
expires in 2020,  and multiple U.S. patent applications pending relating to our
software. None of our technology is patented outside of the United States. It is
possible that:

- our pending patent applications may not result in the issuance of patents;
- any issued patents may not be broad enough to protect our proprietary
rights;
- any issued patents could be successfully challenged by one or more third
parties, which could result in our loss of the right to prevent others from
exploiting the inventions claimed in those patents;
- current and future competitors may independently develop similar technology,
duplicate our products or design around any of our patents; and
- effective patent protection may not be available in every country in which
we do business.

We rely upon trademarks, copyrights and trade secrets to protect our
proprietary rights, which may not be sufficient to protect our intellectual
property.

We also rely on a combination of laws, such as copyright, trademark and trade
secret laws, and contractual restrictions, such as confidentiality agreements
and licenses, to establish and protect our proprietary rights. However, despite
the precautions that we have taken:

- laws and contractual restrictions may not be sufficient to prevent
misappropriation of our technology or deter others from developing similar
technologies;
- current federal laws that prohibit software copying provide only limited
protection from software "pirates," and effective trademark, copyright and trade
secret protection may be unavailable or limited in foreign countries;
- other companies may claim common law trademark rights based upon state or
foreign laws that precede the federal registration of our marks; and
- policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we may be unable to determine the extent of
this unauthorized use.

Also, the laws of other countries in which we market our products may offer
little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which would significantly harm our business.

We may become involved in litigation over proprietary rights, which could be
costly and time consuming.

The software and Internet industries are characterized by the existence of a
large number of patents, trademarks and copyrights and by frequent litigation
based on allegations of infringement or other violations of intellectual
property rights. As the number of entrants into our market increases, the
possibility of an intellectual property claim against us grows. Our technologies
may not be able to withstand any third-party claims or rights against their use.
Some of our competitors in the market for customer communications software may
have filed or may intend to file patent applications covering aspects of their
technology that they may claim our technology infringes. Such competitors could
make a claim of infringement against us with respect to our products and
technology. Third parties may currently have, or may eventually be issued,
patents upon which our current or future products or technology infringe. Any of
these third parties might make a claim of infringement against us. For example,
from time to time, companies have asked us to evaluate the need for a license of
certain patents. Although as of March 19, 2004, there are no outstanding patent
infringement claims against us, we cannot assure you that no such claims will be
filed in the future. Other companies may also have pending patent applications
(which are typically confidential until the patent or patents, if any, are
issued) that cover technologies we incorporate in our products.

In addition, many of our software license agreements require us to indemnify
our customers from any claim or finding of intellectual property infringement.
We periodically receive notices from customers regarding patent license
inquiries they have received which may or may not implicate our indemnity
obligations. Any litigation, brought by others, or us could result in the
expenditure of significant financial resources and the diversion of management's
time and efforts. In addition, litigation in which we are accused of
infringement might cause product shipment delays, require us to develop non-
infringing technology or require us to enter into royalty or license agreements,
which might not be available on acceptable terms, or at all. If a successful
claim of infringement were made against us and we could not develop non-
infringing technology or license the infringed or similar technology on a timely
and cost-effective basis, our business could be significantly harmed.

We may face higher costs and lost sales if our software contains errors.

We face the possibility of higher costs as a result of the complexity of our
products and the potential for undetected errors. Due to the mission- critical
nature of many of our products and services, errors could be particularly
problematic. In the past, we have discovered software errors in some of our
products after their introduction. We have only a few "beta" customers that test
new features and functionality of our software before we make these features and
functionalities generally available to our customers. If we are not able to
detect and correct errors in our products or releases before commencing
commercial shipments, we could face:

- loss of or delay in revenues expected from the new product and an immediate
and significant loss of market share;
- loss of existing customers that upgrade to the new product and of new
customers;
- failure to achieve market acceptance;
- diversion of development resources;
- injury to our reputation;
- increased service and warranty costs;
- legal actions by customers; and
- increased insurance costs.

Our security could be breached, which could damage our reputation and
deter customers from using our services.

We must protect our computer systems and network from physical break-ins,
security breaches and other disruptive problems caused by the Internet or other
users. 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 have been in the past, and could be in the future,
subject to denial of service, vandalism and other attacks on our systems by
Internet hackers. 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.

We may face liability claims that could result in unexpected costs and
damages to our reputation.

Our licenses 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 us for
the product or service giving rise to the damages. However, some domestic and
international jurisdictions may not enforce these contractual limitations on
liability. 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 could divert the
attention of management and key personnel, could be expensive to defend and
could result in adverse settlements and judgments.

Our international operations expose us to additional risks.

A substantial proportion of our revenues is generated from sales outside
North America, exposing us to additional financial and operational risks. Sales
outside North America represented 28% of our total revenues 2003, 32% of our
total revenues in 2002 and 15% of our total revenues in 2001. We have
established offices in the United Kingdom, Germany, Japan, the Netherlands,
France, Belgium, Hong Kong and South Korea. Sales outside North America could
increase as a percentage of total revenues as we attempt to expand our
international operations. In addition to the additional costs and uncertainties
of being subject to international laws and regulations, any expansion of our
existing international operations and entry into additional international
markets will require significant management attention and financial resources,
as well as additional support personnel. For any such expansion, we will also
need to, among other things expand our international sales channel management
and support organizations and develop relationships with international service
providers and additional distributors and system integrators. In addition, if
international operations become a larger part of our business, we could
encounter, on average, greater difficulty with collecting accounts receivable,
longer sales cycles and collection periods, greater seasonal reductions in
business activity and increases in our tax rates. Furthermore, products must be
localized, or customized to meet the needs of local users, before they can be
sold in particular foreign countries. Developing localized versions of our
products for foreign markets is difficult and can take longer than we
anticipate.

International laws and regulations may expose us to potential costs and
litigation.

Our international operations increase our exposure to international laws and
regulations. If we cannot comply with foreign laws and regulations, which are
often complex and subject to variation and unexpected changes, we could incur
unexpected costs and potential litigation. For example, the governments of
foreign countries might attempt to regulate our products and services or levy
sales or other taxes relating to our activities. In addition, foreign countries
may impose tariffs, duties, price controls or other restrictions on foreign
currencies or trade barriers, any of which could make it more difficult for us
to conduct our business. The European Union has enacted its own privacy
regulations that may result in limits on the collection and use of certain user
information, which, if applied to the sale of our products and services, could
negatively impact our results of operations.

We may suffer foreign exchange rate losses.

Our international revenues and expenses are denominated in local currency.
Therefore, a weakening of other currencies compared to the U.S. dollar could
make our products less competitive in foreign markets and could negatively
affect our operating results and cash flows. We have not yet experienced, but
may in the future experience, significant foreign currency transaction losses,
especially because we generally do not engage in currency hedging. As the
international component of our revenues grows, our results of operations will
become more sensitive to foreign exchange rate fluctuations.

If we acquire companies, products or technologies, we may face risks
associated with those acquisitions.

We recently acquired Hipbone, Inc. and if we are presented with appropriate
opportunities, we may make other investments in complementary companies,
products or technologies. We may not realize the anticipated benefits of the
Hipbone acquisition or any other acquisition or investment. If we acquire
another company, we will likely face risks, uncertainties and disruptions
associated with the integration process, including, among other things,
difficulties in the integration of the operations, technologies and services of
the acquired company, the diversion of our management's attention from other
business concerns and the potential loss of key employees of the acquired
businesses. If we fail to successfully integrate other companies that we may
acquire, our business could be harmed. Also, acquisitions can expose us to
liabilities and risks facing the company we acquire, including lawsuits or
claims against the company that are unknown at the time of the acquisition.
Furthermore, we may have to incur debt or issue equity securities to pay for any
additional future acquisitions or investments, the issuance of which could be
dilutive to our existing stockholders or us. For example, in the Hipbone
acquisition we issued approximately 262,500 shares of our common stock. In
addition, our operating results may suffer because of acquisition-related costs
or amortization expenses or charges relating to acquired goodwill and other
intangible assets.

The role of acquisitions in our future growth may be limited, which could
seriously harm our continued operations.

In the past, acquisitions have been an important part of the growth strategy
for us. To gain access to key technologies, new products and broader customer
bases, we have acquired companies in exchange for shares of our common stock.
Because the recent trading prices of our common stock have been significantly
lower than in the past, the role of acquisitions in our growth may be
substantially limited. If we are unable to acquire companies in exchange for our
common stock, we may not have access to new customers, needed technological
advances or new products and enhancements to existing products. This would
substantially impair our ability to respond to market opportunities.

We have adopted anti-takeover defenses that could delay or prevent an
acquisition of the company.

Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock. Without any further vote or action on the part of the
stockholders, the board of directors has the authority to determine the price,
rights, preferences, privileges and restrictions of the preferred stock. This
preferred stock, if issued, might have preference over and harm the rights of
the holders of common stock. Although the issuance of this preferred stock will
provide us with flexibility in connection with possible acquisitions and other
corporate purposes, this issuance may make it more difficult for a third party
to acquire a majority of our outstanding voting stock. We currently have no
plans to issue preferred stock.

Our certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase us. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are removable by the affirmative vote of
at least 66 2/3% of all classes of voting stock. These factors may further delay
or prevent a change of control of us.



Risks Related to Our Industry

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

State, federal and foreign regulators could adopt laws and regulations that
impose additional burdens on companies that conduct business online. These laws
and regulations could discourage communication by e-mail or other web-based
communications, particularly targeted e-mail of the type facilitated by our
products, 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. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
our products and services and increase our costs of doing business, or otherwise
harm our business. Any new legislation or regulations, application of laws and
regulations from jurisdictions whose laws do not currently apply to our
business, or application of existing laws and regulations to the Internet and
other online services could increase our costs and harm our growth.

The imposition of sales and other taxes on products sold by our customers
over the Internet could have a negative effect on online commerce and the demand
for our products and services.

The imposition of new sales or other taxes could limit the growth of Internet
commerce generally and, as a result, the demand for our products and services.
Federal legislation that limited the imposition of state and local taxes on
Internet-related sales until November 1, 2003 has expired. Congress is currently
considering whether to approve either a permanent or a two-year extension of the
limits. However, they may choose not to pass the new legislation, in which case
state and local governments would be free to impose taxes on electronically
purchased goods. We believe that most companies that sell products over the
Internet do not currently collect sales or other taxes on shipments of their
products into states or foreign countries where they are not physically present.
However, one or more states or foreign countries may seek to impose sales or
other tax collection obligations on out-of-jurisdiction companies that engage in
e-commerce within their jurisdiction. A successful assertion by one or more
states or foreign countries that companies that engage in e-commerce within
their jurisdiction should collect sales or other taxes on the sale of their
products over the Internet, even though not physically in the state or country,
could indirectly reduce demand for our products.

Privacy concerns relating to the Internet are increasing, which could result
in legislation that negatively affects our business in reduced sales of our
products.

Businesses using our products capture information regarding their customers
when those customers contact them on-line with customer service inquiries.
Privacy concerns could cause visitors to resist providing the personal data
necessary to allow our customers to use our software products most effectively.
More importantly, even the perception of privacy concerns, whether or not valid,
may indirectly inhibit market acceptance of our products. In addition,
legislative or regulatory requirements may heighten these concerns if businesses
must notify Web site users that the data captured after visiting certain Web
sites may be used by marketing entities to unilaterally direct product promotion
and advertising to that user. If consumer privacy concerns are not adequately
resolved, our business could be harmed. Government regulation that limits our
customers' use of this information could reduce the demand for our products. A
number of jurisdictions have adopted, or are considering adopting, laws that
restrict the use of customer information from Internet applications. The
European Union has required that its member states adopt legislation that
imposes restrictions on the collection and use of personal data, and that limits
the transfer of personally-identifiable data to countries that do not impose
equivalent restrictions. In the United States, the Childrens' Online Privacy
Protection Act was enacted in October 1998. This legislation directs the Federal
Trade Commission to regulate the collection of data from children on commercial
websites. In addition, the Federal Trade Commission has investigated the privacy
practices of businesses that collect information on the Internet. These and
other privacy-related initiatives could reduce demand for some of the Internet
applications with which our products operate, and could restrict the use of
these products in some e-commerce applications. This could, in turn, reduce
demand for these products.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We develop products in the United States and sell these products in North
America, Europe, Asia, Australia and Latin America. In the year ended December
31, 2003, revenues from customers outside of the United States approximated 28%
of total revenues. Generally, our sales are made in the local currency of our
customers. As a result, our financial results and cash flows could be affected
by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. We rarely use derivative instruments to hedge
against foreign exchange risk. As such, we are exposed to market risk from
fluctuations in foreign currency exchange rates, principally from the exchange
rate between the US dollar and the Euro and British pound. We manage exposure to
variability in foreign currency exchange rates primarily due to the fact that
liabilities and assets, as well as revenues and expenses, are denominated in the
local currency. However, different durations in our funding obligations and
assets may expose us to the risk of foreign exchange rate fluctuations. We have
not entered into any derivative instrument transactions to manage this risk.
Based on our overall foreign currency rate exposure at December 31, 2003, we do
not believe that a hypothetical 10% change in foreign currency rates would
materially adversely affect our financial position or results of operations.

Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. The primary objective of our investment activities
is to preserve principal while at the same time maximizing yields without
significantly increasing risk. We do not consider our cash equivalents or short-
term investments to be subject to interest rate risk due to their short
maturities.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financial statements, together with related notes and
the report of PricewaterhouseCoopers LLP, independent auditors, are set forth on
the pages indicated in Item 15, and incorporated herein by this reference.



Quarterly Results of Operations

The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 2003. The information has been derived from our unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this annual report and include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of this
information when read in conjunction with our audited consolidated financial
statements and notes thereto. The operating results for any quarter are
not necessarily indicative of results for any future period.

`Quarter Ended
                                  --------------------------------------------------------------------------------
                                  Mar. 31,  June 30,  Sept. 30,   Dec 31,   Mar. 31,  June 30,  Sept. 30,  Dec 31,
                                    2002      2002      2002       2002       2003      2003      2003      2003
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
                                                                 (in thousands)
Consolidated Statement
 of Operations Data:
Revenues:
 License........................ $ 15,129  $  8,309  $   8,784  $   9,308  $  9,351  $  3,183  $   5,083  $ 8,611
 Service........................   10,014     8,881      9,243      9,422     8,758     8,872      8,750    8,398
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total revenues................   25,143    17,190     18,027     18,730    18,109    12,055     13,833   17,009
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Cost of revenues:
 License........................      965     1,056        548        833       918       507        578    1,122
 Service........................    3,907    19,891      2,762      2,690     2,362     2,708      2,381    2,251
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Total cost of revenues..........    4,872    20,947      3,310      3,523     3,280     3,215      2,959    3,373
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Gross profit (loss).............   20,271    (3,757)    14,717     15,207    14,829     8,840     10,874   13,636
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Operating expenses:
 Sales and marketing............   10,305    10,395      8,732      7,991     7,437     7,887      6,854    7,011
 Research and development.......    6,638     6,512      6,389      6,394     6,080     5,943      4,718    4,696
 General and administrative.....    3,220     3,383      3,458      2,992     2,635     2,941      1,946    1,551
 Amortization of stock-
  based compensation............    9,887     3,041      1,951      1,741     1,387     1,678      1,380    1,425
 Amortization of
  identifiable intangibles......    1,200     1,200      1,200      1,200     1,200       253         --       --
 Restructuring costs............       --        --         --     (5,086)       --        --         --    1,704
 Goodwill impairment............       --    55,000         --         --        --        --         --       --
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total operating expenses......   31,250    79,531     21,730     15,232    18,739    18,702     14,898   16,387
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Operating loss..................  (10,979)  (83,288)    (7,013)       (25)   (3,910)   (9,862)    (4,024)  (2,751)
Impairment of investment........       --        --         --         --        --        --         --     (500)
Other income (expense), net.....      298       297        175        143        90        17          5       74
Income tax expense..............       --        --         --         --       (45)      (49)       (35)    (189)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Loss from continuing operations.  (10,681)  (82,991)    (6,838)       118    (3,865)   (9,894)    (4,054)  (3,366)
Discontinued operation:
 Loss on disposal, including
   provision of $1.1 million
   for operating losses during
   phase-out period.............       --       381         --         --        --        --         --       --
Cumulative effect of accounting
 change related to the elimination
 of negative goodwill...........    3,901        --         --         --        --        --         --       --
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
         Net income (loss)...... $ (6,780) $(82,610) $  (6,838) $     118  $ (3,865) $ (9,894) $  (4,054) $(3,366)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Basic and diluted net
  income (loss) per share.......    (0.32)    (3.63)     (0.30)      0.01     (0.17)    (0.43)     (0.17)   (0.13)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Shares used in computing
  basic and diluted net
  income (loss) per share.......   21,071    22,762     22,851     22,403    22,958    23,201     23,396   26,405
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------

As a Percentage of Total Revenue
Revenues:
 License........................     60.2 %    48.3 %     48.7 %     49.7 %    51.6 %    26.4 %     36.7 %   50.6 %
 Service........................     39.8      51.7       51.3       50.3      48.4      73.6       63.3     49.4
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total revenues................    100.0     100.0      100.0      100.0     100.0     100.0      100.0    100.0
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Cost of revenues:
 License........................      3.8       6.1        3.0        4.4       5.1       4.2        4.2      6.6
 Service........................     15.6     115.8       15.4       14.4      13.0      22.5       17.2     13.2
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total cost of
   revenues.....................     19.4     121.9       18.4       18.8      18.1      26.7       21.4     19.8
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Gross profit (loss).............     80.6     (21.9)      81.6       81.2      81.9      73.3       78.6     80.2
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Selected operating
 expenses:
 Sales and marketing............     41.0      60.5       48.4       42.7      41.1      65.4       49.5     41.2
 Research and
  development...................     26.4      37.9       35.4       34.1      33.6      49.3       34.1     27.6
 General and
  administrative................     12.8 %    19.7 %     19.2 %     16.0 %    14.6 %    24.4 %     14.1 %    9.1 %`



The amount and timing of our operating expenses generally will vary from
quarter to quarter depending on our level of actual and anticipated business
activities. Our revenues and operating results are difficult to forecast and
will fluctuate, and we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful. As a result, you should
not rely upon them as an indication of future performance.

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.  Regulations
under the Securities Exchange Act of 1934 require public companies, including
our company, to maintain "disclosure controls and procedures," which
are defined to mean a company's controls and other procedures that are designed
to ensure that information required to be disclosed in the reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported, within the time periods specified in the Securities
and Exchange Commission's rules and forms.  Our Chief Executive Officer and our
Chief Financial Officer, based on their evaluation of our disclosure controls
and procedures as of the end of the period covered by this report, concluded
that our disclosure controls and procedures were effective for this purpose.

Changes in Internal Control Over Financial Reporting.  Regulations
under the Securities Exchange Act of 1934 require public companies, including
our company, to evaluate any change in our "internal control over financial
reporting," which is defined as a process to provide reasonable assurance
regarding the reliability of financial reporting and preparation of financial
statements for external purposes in accordance with accounting principles
generally accepted in the United States. In connection with their evaluation of
our disclosure controls and procedures as of the end of the period covered by
this report, our Chief Executive Officer and Chief Financial Officer did not
identify any change in our internal control over financial reporting during the
three-month period ended December 31, 2003 that materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.



PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information regarding our continuing
executive officers and directors (including their ages as of March 15,
2004):



|Name           | Age | Position                                                  
|-------------- | --- | ----------------------------------------------------------
|Chuck Bay      | 46  | Chief Executive Officer and Chairman of the Board         
|Tom Doyle      | 53  | Chief Operating Officer and President                     
|John Huyett    | 50  | Chief Financial Officer                                   
|Brian Kelly    | 38  | Executive Vice President of Marketing and Product
Strategy
|Alan Hubbard   | 46  | Executive Vice President of Research and Development      
|Mark Bertelsen | 60  | Director                                                  
|Tom Galvin     | 48  | Director                                                  
|Jerry R. Batt  | 53  | Director                                                  
|Dixie L. Mills | 56  | Director                                                  

Chuck Bay.  Mr. Bay has been our Chief Executive Officer since our
merger with Broadbase in June 2001, and became Chairman of our Board in April
2003. Mr. Bay was formerly Chief Executive Officer of Broadbase, which he joined
as Chief Financial Officer and General Counsel in January 1998. Mr. Bay also
served as Executive Vice President of Operations of Broadbase. From July 1997 to
January 1998, Mr. Bay served as Chief Financial Officer and General Counsel for
Reasoning, Inc., a software company. From January 1995 to August 1997, Mr. Bay
served as Chief Financial Officer and General Counsel, for Pure Atria Software,
Inc., a software company. From April 1994 to January 1995, Mr. Bay served as
President and Chief Financial Officer of Software Alliance Corporation, a
software company. Mr. Bay holds a B.S. degree in Business Administration from
Illinois State University and a J.D. degree from the University of Illinois.

Tom Doyle.  Mr. Doyle has been our Chief Operating Officer since our
merger with Broadbase in June 2001, and he became our President in March 2003.
From 1996 to April 1999, Mr. Doyle served first as Executive Vice President of
Sales and then as Chief Operating Officer of Broadbase. Prior to joining
Broadbase, Mr. Doyle was Senior Vice President of Worldwide Sales at Reasoning
Inc., joining Reasoning in 1996 from Tandem Computers where he was Director of
North American Sales Operations. At Tandem, he held numerous sales and sales
management positions in Houston, Texas, Atlanta, Georgia and Cupertino,
California. Before joining Tandem, Mr. Doyle participated in the start-up
operations and initial channel development with Fortune Systems. Mr. Doyle
serves on the board of directors of Privia, Inc.  Mr. Doyle obtained his B.S. in
Finance from the University of Missouri.

John Huyett. Mr. Huyett has been our Executive Vice President and
Chief Financial officer since June 2002. Previously, Mr. Huyett served as
President and Chief Executive Officer of Clickmarks, Inc. from August 2000
through March 2002. From March 1998 to July 2000 Mr. Huyett was Chief Financial
Officer and subsequently Chief Executive Officer at Magellan Corporation. Prior
to Magellan, Mr. Huyett was Chief Financial Officer, Treasurer and Vice
President of Financial and Administrative Services at Avant!. Mr. Huyett was a
partner at KPMG where he was in charge of KPMG's high technology practice in the
Carolinas. Mr. Huyett obtained his B.S. degree in Business Administration from
the University of North Carolina at Chapel Hill.

Brian Kelly. Mr. Kelly has been our Executive Vice President of Marketing
and Product Strategy since June 2003. Previously, Mr. Kelly served as Vice
President of Products at Kanisa, Inc. from February 2003 to June 2003. From
September 2001 to February 2003, Mr. Kelly served as Chief Executive Office of
Proveer, Inc., a software and services company that provides analytical
applications and business intelligence infrastructure. From December 1998 to
June 2001, Mr. Kelly was Executive Vice President of Products at Broadbase,
prior to its merger with us in June 2001, and remained as our Executive Vice
President of Products until August 2001. Mr. Kelly holds a B.S. degree in
Computer Science from the University of Cincinnati.

Alan Hubbard. Mr. Hubbard joined KANA in June 2002 and currently
serves as Executive Vice President of Research & Development. Previously,
Mr. Hubbard was the Vice President of Engineering for Altaworks Corporation from
January 2000 to February 2002. From January 1991 to January 2000, Mr. Hubbard
held various management positions at Hewlett-Packard Company, including
Worldwide Technology Program Manager - Enterprise Accounts Organization. Mr.
Hubbard holds a M.B.A. and B.S. degree in Computer Information Systems from
Bentley College.

Mark Bertelsen. Mr. Bertelsen joined our Board of Directors in March
2003. Mr. Bertelsen joined the law firm Wilson Sonsini Goodrich & Rosati in
January 1972 and became a member of the firm in January 1977. Wilson Sonsini
Goodrich & Rosati does not serve as KANA's legal counsel. Mr. Bertelsen is
also a member of the Board of Directors at Autodesk, Inc., a design software
company, and Informatica Corporation, a data management software company. Mr.
Bertelsen holds a B.A. degree in political science from the University of
California, Santa Barbara and a J.D. degree from University of California,
Berkeley.

Tom Galvin. Mr. Galvin joined our Board of Directors in December
2002. Since 1979, Mr. Galvin has served in various positions with Intel
Corporation, and currently serves as Director of Compensation and Benefits. Mr.
Galvin has also served the company in Finance, Business Development, Marketing,
and Human Resources at Intel. In Finance, Mr. Galvin last served as Controller
for Worldwide Sales, Marketing, and Advertising, with financial responsibility
for Intel's brand investments including the Intel Inside® program.
Immediately prior to managing the company's Compensation and Benefits group, Mr.
Galvin was director of Market Development for Intel's consumer software programs
in support of the Pentium®brand family of microprocessors. Mr. Galvin holds
a B.S. in Mathematics and Economics from Miami University (Ohio), and a M.B.A.
from the Kellogg School of Management at Northwestern University.

Jerry R. Batt. Mr. Batt joined our Board of Directors in 2003. Mr.
Batt is currently Chief Information Officer and Vice President at Pulte Home
Corporation since September 2003. From August 2001 to July 2003, Mr. Batt was
the Chief Information Officer and Vice President of Sprint PCS. From April 2000
to July 2001, Mr. Batt co-founded and became Chief Executive Officer of Foxfire
Consulting, an IT consulting and systems integration firm specializing in the
telecommunications industry. From 1973 to January 2000, Mr. Batt was responsible
for AT&T's consumer long distance account management, billing and customer
service platform.

Dr. Dixie L. Mills. Dr. Mills joined our Board of Directors in October
2003. Dr. Mills is currently the Dean of the College of Business at Illinois
State University since 1997. Dr. Mills is a member of the board of trustees for
the Preferred Group of Mutual Funds, managed by Caterpillar Investment
Management, Ltd. Dr. Mills received her B.A. degree from Georgetown College with
a major in history, and earned her M.B.A. and Ph.D. degrees in finance from the
University of Cincinnati.

Section 16(a) Beneficial Ownership Reporting Compliance

The members of our board of directors, our executive officers and persons
who hold more than 10% of our outstanding common stock are subject to the
reporting requirements of Section 16(a) of the Securities Exchange Act
of 1934, as amended, which require them to file reports with respect to their
ownership of the common stock and their transactions in such common stock. Based
upon the copies of Section 16(a) reports which we received from such
persons for their 2003 transactions in the common stock and their common stock
holdings and written representations received from one or more of such persons
that no annual Form 5 reports were required to be filed by them for 2003, we
believe that our executive officers and the board members have filed, on a
timely basis, all reports required under Section 16(a) for 2003.

Code of Ethics and Conduct

We have adopted a Code of Ethics within the meaning of Item 406(b) of
Regulation S-K. This Code of Ethics applies to our principal executive
officer, principal financial officer and principal accounting officer. We have
also adopted a Code of Conduct as required under the rules of the Nasdaq
National Market.  This Code of Conduct applies to all of our employees and
directors.  These Codes are publicly available on our website at www.kana.com.
If we make substantive amendments to the Code of Ethics or grant any waiver,
including any implicit waiver, we will disclose the nature of such amendment or
waiver on our website or in a report on Form 8-K within five days of such
amendment or waiver.

Audit Committee and Financial Expert

We have a separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934
comprised of Mark Bertelsen, Dr. Mills, and Tom Galvin (chairman), each of whom
is "independent" as defined under Item 7(d)(3)(iv) of Schedule 14A of
the Exchange Act. Our Board of Directors has determined that Mr. Galvin is an
"audit committee financial expert" as defined under Item 401 of
Regulation S-K.

ITEM 11. EXECUTIVE COMPENSATION

We will furnish to the Securities and Exchange Commission a definitive Proxy
Statement not later than 120 days after the close of the fiscal year ended
December 31, 2003.  Certain information required by this item is incorporated
herein by reference to the section titled "Executive Compensation and
Related Information" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

We will furnish to the Securities and Exchange Commission a definitive
Proxy Statement not later than 120 days after the close of the fiscal year ended
December 31, 2003.  Certain information required by this item is incorporated
herein by reference to the section titled "Security Ownership of Certain
Beneficial Owners and Management" and "Securities Authorized for
Issuance Under Equity Compensation Plans" in the Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Indemnification and Other Arrangements with Officers and Directors

We have entered into an indemnification agreement with each of our executive
officers and directors containing provisions that may require us, among other
things, to indemnify our executive officers and directors against liabilities
that may arise by reason of our status or service as executive officers or
directors (other than liabilities arising from willful misconduct of a culpable
nature) and to advance expenses incurred as a result of any proceeding against
them as to which they could be indemnified.

Related Party Transactions

We provided support services to a company that is affiliated with Massood
Zarrabian, a director of KANA until August 2003. We recognized approximately
$54,800, $59,400 and $547,000 in revenue related to the company in the years
ended December 31, 2003, 2002 and 2001.

In addition, we purchased software and support services from this company
totaling approximately $96,000, $239,100 and $1,034,000 in the years ended
December 31, 2003, 2002 and 2001. Management believes that this contract has
rates and terms that are comparable with those entered into with independent
third parties.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

We will furnish to the Securities and Exchange Commission a definitive
Proxy Statement not later than 120 days after the close of the fiscal year ended
December 31, 2003.  Certain information required by this item is incorporated
herein by reference to the section titled "Fiscal 2003 Audit Firm Fee
Summary" in the Proxy Statement.

PART IV

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

(a) The following documents are filed as part of this Report:

1.	Financial Statements:

|                                                                                                                            |  | Page | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ---- | 
|Report of Independent Auditors                                                                                              |  | 59   | 
|Consolidated Balance Sheets as of December 31, 2003 and
2002                                                                |  | 60   | 
|Consolidated Statements of Operations and Comprehensive Loss for
the
          Years ended December 31, 2003, 2002 and 2001 |  | 61   | 
|Consolidated Statements of Stockholders' Equity for the Years
ended
     December 31, 2003, 2002 and 2001                   |  | 62   | 
|Consolidated Statements of Cash Flows for the Years ended
     December 31, 2003, 2002 and 2001                             |  | 64   | 
|Notes to Consolidated Financial Statements                                                                                  |  | 66   | 
|                                                                                                                            |  |      | 

2.	Financial Statement Schedules:

|Schedule |  |                                   | Title |    |  | Page | 
|-------- |  | --------------------------------- | ----- | -- |  | ---- | 
|II       |  | Valuation and Qualifying Accounts |       | 87 | 

Schedules not listed above have been omitted because they are
not applicable, not required, or the information required to be set forth
therein is included in the consolidated financial statements or notes
thereto.

3.	Exhibits:

|              |                                                                                                                                                                                                                            | Incorporated by
Reference |          
|------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ---------
|ExhibitNumber | Exhibit Description                                                                                                                                                                                                        | Form                      | File No. 
|3.01          | Second Amended and Restated Certificate of Incorporation, as
amended by the Certificate of Amendment dated April 18, 2000                                                                                                  | 8-K                       |          
|3.03          | Certificate of Amendment to the Second Amended and Restated
Certificate of Incorporation dated April 18, 2001                                                                                                              | S-8                       | 333-64552
|3.04          | Certificate of Amendment to the Second Amended and Restated
Certificate of Incorporation, as amended by the Certificate of Amendment dated
April 18, 2001, filed with the Delaware Secretary of State on December 11,
2001 | S-3                       | 333-77068
|3.05          | Amended and Restated Bylaws, as amended October 12,
2001                                                                                                                                                                   | 10-K                      |          
|4.01          | Form of Registrant's Specimen Common Stock
Certificate                                                                                                                                                                     | S-1/A                     | 333-82587
|10.01         | Registrant's Amended and Restated 1999 Stock Incentive
Plan                                                                                                                                                                | S-4/A                     | 333-59754
|10.02         | Registrant's Amended and Restated 1999 Employee Stock Purchase
Plan                                                                                                                                                        | S-4/A                     | 333-59754
|10.03         | Registrant's 1999 Special Stock Option Plan                                                                                                                                                                                | S-8                       | 333-32460
|10.04         | Registrant's 1999 Special Stock Option Plan-Form of Nonstatutory
Stock Option Agreement-4-year vesting                                                                                                                     | S-8                       | 333-32460
|10.05         | Registrant's 1999 Special Stock Option Plan-Form of Nonstatutory
Stock Option Agreement-30-month vesting                                                                                                                   | S-8                       | 333-32460
|10.06         | Letter of Credit dated July 9, 1999, with Silicon Valley Bank
and the Registrant                                                                                                                                           | S-1                       | 333-82587
|10.07         | Lease Agreement, dated December 23, 1999, between Broadbase and
Bohannon Trusts Partnership II                                                                                                                             | 10-Q                      |          
|10.08         | Lease Agreement, dated August 11, 2000, between Broadbase and J.
Robert S. Wheatley and Roger A. Fields, d.b.a. R & R Properties                                                                                           | 10-Q                      |          
|10.09         | Broadbase Software, Inc. 2000 Stock Incentive Plan, adopted on
May 3, 2000, and related forms of agreements                                                                                                                | S-8                       | 333-38480
|10.10         | Warrant to purchase Common Stock, dated August 7, 2001
between Kana Communications, Inc. and General Electric Capital
Corporation.                                                                                         | S-3                       | 333-77068
|10.11         | Warrant to purchase Common Stock, dated September 5, 2001
between Kana Communications, Inc. and Banca 121                                                                                                                  | S-3                       | 333-77068
|10.12         | Share Purchase Agreement dated November 28, 2001 between the
Registrant and the Investors named therein                                                                                                                    | 8-K/A                     |          
|10.13         | Form of Contingent Warrant to purchase Common Stock issued in
conjunction with the Share Purchase Agreement dated November 28, 2001 between
the Registrant and the Investors named therein                                 | 8-K/A                     |          
|10.14         | Form of Commitment Warrant to purchase Common Stock issued in
conjunction with the Share Purchase Agreement dated November 28, 2001 between
the Registrant and the Investors named therein                                 | 8-K/A                     |          
|10.15         | Assignment Agreement and First Amendment of Lease dated November
11, 2002 between the Registrant and J Robert S. Wheatley and Roger A. Fields,
d.b.a. R & R Properties                                                     | 8-K                       |          
|10.16         | Offer letter to Brian Kelly                                                                                                                                                                                                | 10-Q                      |          
|10.17         | Agreement with Chief Executive Officer                                                                                                                                                                                     | 10-Q                      |          
|10.18         | Agreement with Chief Operating Officer                                                                                                                                                                                     | 10-Q                      |          
|10.19         | Loan Modification Agreement dated November 21, 2003 between the
Registrant and Silicon Valley Bank                                                                                                                         |                           |          
|10.20         | Warrant to purchase Common Stock, dated September 5, 2001
between KANA Software, Inc. and IBM                                                                                                                              |                           |          
|21.01         | List of subsidiaries of Registrant                                                                                                                                                                                         |                           |          
|23.01         | Consent of PricewaterhouseCoopers LLP, Independent
Accountants.                                                                                                                                                            |                           |          
|31.01         | Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002                                                                                                                         |                           |          
|31.02         | Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002                                                                                                                         |                           |          
|32.01         | Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*                                                                            |                           |          
|32.02         | Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*                                                                            |                           |          

* These certifications accompany KANA's annual report on Form 10-K; they are
not deemed "filed" with the Securities and Exchange Commission and are not to be
incorporated by reference in any filing of KANA under the Securities Act of
1933, or the Securities Exchange Act of 1934, whether made before or after the
date hereof and irrespective of any general incorporation language in any
filings.

(b) Reports on Form 8-K.

On January 29, 2004, we furnished a Current Report on Form 8-K reporting
under Item 12 that KANA issued a press release announcing its financial results
for the fiscal quarter ended December 31, 2003 and certain other
information.

On November 5, 2003, we filed a Current Report on Form 8-K reporting under
Item 5 that KANA announced the public offering of 4,080,000 shares of its common
stock at a price to the public of $3.00 per share in a public offering.

On October 22, 2003, we furnished a Current Report on Form 8-K reporting
under Item 12 that KANA issued a press release announcing its financial results
for the fiscal quarter ended September 30, 2003 and certain other
information.



---

REPORT OF INDEPENDENT AUDITORS



To the Board of Directors and Stockholders of

In our opinion, the consolidated financial statements listed in the index
appearing under Item 15 (a)(1) on page 47 present fairly, in all material
respects, the financial position of KANA Software, Inc. and its subsidiaries at
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15 (a)(2) on page 48 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 4 to the Consolidated Financial Statements, effective
January 1, 2002, the Company changed its method of accounting for goodwill in
accordance with Statement of Financial Accounting Standards No.142, "Goodwill
and Other Intangible Assets."



/s/ PricewaterhouseCoopers LLP



San Jose, California
March 17, 2004

---

KANA SOFTWARE, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

`December 31,
                                                                 ------------------------
                                                                    2003         2002
                                                                 -----------  -----------
                            ASSETS
Current assets:
 Cash and cash equivalents..................................... $    25,632  $    21,962
 Short-term investments........................................       7,324       10,536
 Accounts receivable, less allowance for doubtful
  accounts of $1,187 in 2003 and $4,815 in 2002................       7,908       10,269
 Prepaid expenses and other current assets.....................       3,527        3,184
                                                                 -----------  -----------
 Total current assets..........................................      44,391       45,951
Restricted cash................................................         461          448
Property and equipment, net....................................      15,435       22,293
Goodwill.......................................................       7,448        7,448
Identifiable intangibles, net..................................          --        1,453
Other assets...................................................       2,143        2,957
                                                                 -----------  -----------
  Total assets................................................. $    69,878  $    80,550
                                                                 ===========  ===========
             LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Current portion of notes payable.............................. $     3,427  $     3,469
 Accounts payable..............................................       2,238        3,908
 Accrued liabilities...........................................      10,678       13,881
 Accrued restructuring.........................................       3,336        2,834
 Deferred revenue..............................................      20,544       26,392
                                                                 -----------  -----------
  Total current liabilities....................................      40,223       50,484
Deferred revenue, less current portion.........................       1,265           --
Accrued restructuring, less current portion....................       6,858        8,114
                                                                 -----------  -----------
  Total liabilities............................................      48,346       58,598
                                                                 -----------  -----------
Commitments and contingencies (Note 6)
Stockholders' equity:
 Preferred stock, $0.001 par value; 5,000,000
   shares authorized; no shares issued and outstanding.........          --           --
 Common stock, $0.001 par value; 100,000,000 shares authorized;
   28,436,283 and 22,939,872 shares issued and outstanding.....         201          195
 Additional paid-in capital....................................   4,286,508    4,273,029
 Deferred stock-based compensation.............................      (1,541)      (8,602)
 Accumulated other comprehensive income (losses)...............          38         (175)
 Accumulated deficit...........................................  (4,263,674)  (4,242,495)
                                                                 -----------  -----------
  Total stockholders' equity...................................      21,532       21,952
                                                                 -----------  -----------
  Total liabilities and stockholders' equity................... $    69,878  $    80,550
                                                                 ===========  ===========`





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



---



KANA SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS

(In thousands, except per share data)

`Year Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
Revenues:
 License.................................................... $   26,228  $  41,530  $   37,963
 Service....................................................     34,778     37,560      52,632
                                                              ----------  ---------  ----------
   Total revenues...........................................     61,006     79,090      90,595
                                                              ----------  ---------  ----------
Cost of revenues:
 License....................................................      3,125      3,402       2,536
 Service, excluding amortization of stock-based
   compensation of $430, $883 and $1,417....................      9,702     29,250      51,799
                                                              ----------  ---------  ----------
   Total cost of revenues...................................     12,827     32,652      54,335
                                                              ----------  ---------  ----------
Gross profit................................................     48,179     46,438      36,260
                                                              ----------  ---------  ----------
Operating expenses:
 Sales and marketing, excluding amortization of
  stock-based compensation of $2,300, $4,697
  and $7,230, respectively..................................     29,189     37,423      69,635
 Research and development, excluding
  amortization of stock-based compensation
  of $2,149, $4,384 and $4,226, respectively................     21,437     25,933      35,558
 General and administrative, excluding
  amortization of stock-based compensation
  of $991, $6,656 and $3,007, respectively..................      9,073     13,053      21,215
 Amortization of stock-based compensation...................      5,870     16,620      15,880
 Amortization of goodwill...................................         --         --     122,860
 Amortization of identifiable intangibles...................      1,453      4,800       4,800
 Merger and transition related costs........................         --         --      13,443
 Restructuring costs........................................      1,704     (5,086)     89,047
 Goodwill impairment........................................         --     55,000     603,446
                                                              ----------  ---------  ----------
   Total operating expenses.................................     68,726    147,743     975,884
                                                              ----------  ---------  ----------
Operating loss..............................................    (20,547)  (101,305)   (939,624)
Impairment of investment....................................       (500)        --      (1,000)
Other income, net...........................................        186        913       1,521
Income tax expense..........................................       (318)        --          --
                                                              ----------  ---------  ----------
Loss from continuing operations ............................    (21,179)  (100,392)   (939,103)
Discontinued operation:
 Loss from operations of discontinued operation.............         --         --        (125)
 Gain (loss) on disposal, including provision of $1.1 million
  in 2001 for operating losses during phase-out period......         --        381      (3,667)
Cumulative effect of accounting change related
  to the elimination of negative goodwill...................         --      3,901          --
                                                              ----------  ---------  ----------
         Net loss........................................... $  (21,179) $ (96,110) $ (942,895)
                                                              ----------  ---------  ----------
Other comprehensive loss:
 Net unrealized gain on available
  for sale securities.......................................         --         --          22
 Foreign currency translation adjustments...................        213      1,110        (930)
                                                              ----------  ---------  ----------
   Total other comprehensive loss...........................        213      1,110        (908)
                                                              ----------  ---------  ----------
   Comprehensive loss....................................... $  (20,966) $ (95,000) $ (943,803)
                                                              ==========  =========  ==========
Basic and diluted net loss per share:
  Loss from continuing operations .......................... $    (0.88) $   (4.48) $   (68.33)
  Income (loss) from discontinued operation.................         --       0.02       (0.28)
  Cumulative effect of accounting change related
    to the elimination of negative goodwill.................         --       0.17          --
                                                              ----------  ---------  ----------
  Net loss ................................................. $    (0.88) $   (4.29) $   (68.61)
                                                              ----------  ---------  ----------

Shares used in computing basic and diluted
 net loss per share.........................................     24,031     22,403      13,743
                                                              =========== =====================`

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

---



KANA SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

`Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
Balances,
December 31, 2000.....  9,405,184      94   4,130,231    (21,639)    (5,367)      (377)  (3,203,490)     899,452
Issuance of common
stock upon exercise
of stock options
net of
repurchases...........    249,624       1       1,132                 2,372         --           --        3,505
Issuance of common
stock for Employee Stock
Purchase Plan.........     66,407      --         245         --         --         --           --          245
Issuance of common
stock related to
Broadbase
Software, Inc.
acquisition...........  8,667,898      87      93,977    (15,485)        --         --           --       78,579
Issuance of common
stock related to
private
placement, net........  1,010,000      10      10,090         --         --         --           --       10,100
Deferred stock-based
compensation..........         --      --       1,650       (965)        --         --           --          685
Amortization of
deferred stock-based
compensation..........         --      --          --     15,880         --         --           --       15,880
Payments on notes
receivable from
stockholders, net
of interest...........         --      --          --         --      2,196         --           --        2,196
Foreign currency
translation
adjustment............         --      --          --         --         --       (908)          --         (908)
Net loss..............         --      --          --         --         --         --     (942,895)    (942,895)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2001..... 19,399,113  $  192  $4,237,325  $ (22,209) $    (799) $  (1,285) $(4,146,385) $    66,839
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------`



---

KANA SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY-continued(In thousands, except per share data)

`Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------

December 31, 2001..... 19,399,113  $  192  $4,237,325  $ (22,209) $    (799) $  (1,285) $(4,146,385) $    66,839
Issuance of common
stock upon exercise
of stock options and
warrants, net of
repurchases...........    416,232      --       1,819         --         --         --           --        1,819
Issuance of common
stock for Employee Stock
Purchase Plan.........     73,364      --         241         --         --         --           --          241
Amortization of
deferred stock-based
compensation..........         --      --          --     16,620         --         --           --       16,620
Deferred stock-based
compensation..........         --      --      (1,734)     1,734         --         --           --           --
Equity investment
received..............  2,910,000       3      31,394         --         --         --           --       31,397
Issuance of Warrants..         --      --       3,869     (4,747)        --         --           --         (878)
Exercise of warrants..    110,284      --          --         --         --         --           --           --
Issuance of stock
for services..........      9,800      --         115         --         --         --           --          115
Shares released
from escrow...........     21,079      --          --         --         --         --           --           --
Payments on notes
receivable from
stockholders, net
of interest...........         --      --          --         --        594         --           --          594
Foreign currency
translation
adjustment............         --      --          --         --         --      1,110           --        1,110
Reserve for notes
receivable from
stockholders..........         --      --          --         --        205         --           --          205
Net loss..............         --      --          --         --         --         --      (96,110)     (96,110)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2002..... 22,939,872  $  195  $4,273,029  $  (8,602) $      --  $    (175) $(4,242,495) $    21,952
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------`

---

KANA SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY-continued(In thousands, except per share data)

`Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
Balances,
December 31, 2002..... 22,939,872  $  195  $4,273,029  $  (8,602) $      --  $    (175) $(4,242,495) $    21,952
Issuance of common
stock upon exercise of
stock options, net of
share cancellations...    406,035       1         705         --         --         --           --          706
Issuance of common
stock for Employee Stock
Purchase Plan.........    293,020      --         411         --         --         --           --          411
Shares sold in
public offering, net..  4,692,000       5      13,095         --         --         --           --       13,100
Amortization of
deferred stock-based
compensation..........         --      --      (1,191)     7,061         --         --           --        5,870
Exercise of warrants..    105,356      --          --         --         --         --           --           --
Issuance of warrants..         --      --         459         --         --         --           --          459
Foreign currency
translation
adjustment............         --      --          --         --         --        213           --          213
Net loss..............         --      --          --         --         --         --      (21,179)     (21,179)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2003..... 28,436,283  $  201  $4,286,508  $  (1,541) $      --  $      38  $(4,263,674) $    21,532
                       ===========  ======  ==========  =========  =========  =========  ===========  ===========`

The accompanying notes are an integral part of these consolidated financial
                                  statements.
KANA SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)



`For the Year Ended December 31,
                                                                ------------------------------------
                                                                   2003        2002         2001
                                                                ----------  -----------  -----------
Cash flows from operating activities:
 Net loss..................................................... $  (21,179) $   (96,110) $  (942,895)
 Adjustments to reconcile net loss to net
  cash used in operating activities:
  Depreciation expense........................................      8,088        9,130       10,072
  Amortization of stock-based compensation,
   goodwill and identifiable intangible assets................      7,323       21,420      143,540
  Goodwill impairment.........................................         --       55,000      603,446
  Provision for doubtful accounts.............................     (3,628)      (2,028)       4,878
  Non-cash portion of restructuring charge....................      1,704          212       26,453
  Reduction of restructuring reserve..........................         --       (5,086)          --
  Impairment of investment....................................        500           --        1,000
  Other non-cash charges......................................        459       (3,697)       3,002
  Changes in operating assets and liabilities,
   net of effects through acquisitions:
  Accounts receivable.........................................      5,989        8,563       36,775
  Prepaid expenses and other assets...........................        (29)       2,313       14,477
  Accounts payable and accrued liabilities....................     (4,873)     (13,779)     (28,145)
  Accrued restructuring and merger............................     (2,458)     (22,328)      26,909
  Deferred revenue............................................     (4,583)       4,212      (11,720)
  Other liabilities...........................................         --           --         (233)
                                                                ----------  -----------  -----------
  Net cash used in operating activities.......................    (12,687)     (42,178)    (112,441)
                                                                ----------  -----------  -----------
Cash flows from investing activities:
 Sales of short-term investments..............................     11,803       36,657      114,468
 Purchases of short-term investments..........................     (8,591)     (32,540)     (73,881)
 Purchases of property and equipment..........................     (1,230)     (12,252)     (16,780)
 Cash acquired through acquisitions...........................         --           --       33,556
 Expiration/(purchase) of restricted cash.....................        (13)      10,570       (7,800)
                                                                ----------  -----------  -----------
  Net cash provided by investing activities...................      1,969        2,435       49,563
                                                                ----------  -----------  -----------
Cash flows from financing activities:
 Borrowings on notes payable..................................         --        1,998           --
 Payments on notes payable....................................        (42)          --         (579)
 Net proceeds from issuance of common stock and warrants......     14,217       33,458       11,478
 Payments on stockholders' notes receivable...................         --          594        2,087
                                                                ----------  -----------  -----------
  Net cash provided by financing activities...................     14,175       36,050       12,986
                                                                ----------  -----------  -----------
Effect of exchange rate changes on cash and cash equivalents..        213          179         (834)
                                                                ----------  -----------  -----------
Net change in cash and cash equivalents.......................      3,670       (3,514)     (50,726)
Cash and cash equivalents at beginning of year................     21,962       25,476       76,202
                                                                ----------  -----------  -----------
Cash and cash equivalents at end of year...................... $   25,632  $    21,962  $    25,476
                                                                ==========  ===========  ===========
Supplemental disclosure of cash flow information:
 Cash paid during the year for interest....................... $      173  $       100  $       147
                                                                ==========  ===========  ===========
 Cash paid during the year for income taxes................... $      289  $       117  $        --
                                                                ==========  ===========  ===========
 Noncash activities:
  Issuance of common stock and assumption of options
   and warrants related to acquisitions ...................... $       --  $        --  $    94,064
                                                                ==========  ===========  ===========
  Issuance of warrants to a customer.......................... $      459  $        --  $       330
                                                                ==========  ===========  ===========
  Impairment of investment.................................... $      500  $        --  $     1,000
                                                                ==========  ===========  ===========`

The accompanying notes are an integral part of these consolidated financial
                                  statements.
KANA SOFTWARE, INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
KANA Software, Inc. and its subsidiaries ("the Company" or
"KANA") develop, market and support customer communications software
products. The Company sells its products primarily in the United States and
Europe, and to a lesser extent, in Asia, through its direct sales force and
third party integrators.

Since its inception, the Company has been successful in completing several
rounds of financing. During the same period, the Company has incurred
substantial losses and negative cash flows from operations for every period
since inception. As of December 31, 2003, the Company had an accumulated deficit
of $4.3 billion. For the year ended December 31, 2003, the Company incurred an
operating loss of $20.5 million and negative cash flows from operations of
$12.7 million.

The Company believes that its existing cash balances and anticipated cash
flows from operations will be sufficient to meet its anticipated capital
requirements for the next 12 months.  However, a decline in future orders and
revenues might require the Company to seek additional capital to meet its
working capital needs during or beyond the next twelve months if the Company is
unable to reduce expenses to the degree necessary to avoid incurring losses.  If
the Company has a need for additional capital resources, it may be required to
sell additional equity or debt securities, similar to the equity offering
completed in November 2003, secure additional lines of credit or obtain other
third party financing.  The timing and amount of such capital requirements
cannot be determined at this time and will depend on a number of factors,
including demand for the Company's existing and new products, if any, and
changes in technology in the CRM software sector.  There can be no assurance
that such additional financing will be available on satisfactory terms when
needed, if at all.  Failure to raise such additional financing, if needed, may
result in the Company not being able to achieve its long-term business
objectives.  To the extent that additional capital is raised through the sale of
additional equity or convertible debt securities, the issuance of such
securities would result in additional dilution to the Company's
shareholders.

(b) Stock Splits

The Board of Directors recommended and the stockholders approved a one-
for-ten reverse stock split of the common stock for stockholders of record on
December 13, 2001. The Board of Directors approved a two-for-one stock split of
the common stock for stockholders of record on January 28, 2000. The
accompanying consolidated financial statements have been retroactively restated
to reflect these stock splits.

(c) Principles of Consolidation

The consolidated financial statements include the financial statements of
KANA and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation. Certain
reclassifications have been made to the prior year's financial statements to
conform to the current year's presentation. These reclassifications had no
effect on prior year's stockholders' equity or results of operations.

(d) Use of Estimates

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

(e) Foreign Currency Translation

The functional currency for the Company's international subsidiaries is
the local currency of the country in which it operates. Assets and liabilities
are translated using the exchange rate at the balance sheet date. Foreign equity
balances, primarily retained earnings or deficits, are translated at historical
cost. Revenues, expenses, gains, and losses are translated at the average
exchange rates prevailing during the year. Any translation adjustments are
included in accumulated other comprehensive income (losses).

(f) Cash Equivalents and Short-Term Investments

The Company considers all highly liquid investments with an original
maturity date of three months or less to be cash equivalents. The Company has
classified its short-term investments as "available for sale." These items are
carried at fair value, based on the quoted market prices, and unrealized gains
and losses, are reported as a separate component of accumulated other
comprehensive losses in stockholders' equity. All short-term investments mature
in less than one year. To date, unrealized and realized gains or losses have not
been material.

(g) Fair value of financial instruments

The carrying values of the Company's financial instruments, including
cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and notes payable approximates their fair values due to their
relatively short maturities or payment terms.

(h) Concentration of Credit Risk

Financial instruments subjecting the Company to concentrations of credit
risk consist primarily of cash and cash equivalents, short-term investments and
trade accounts receivable. The Company maintains cash and cash equivalents with
three domestic financial institutions. From time to time, the Company's cash
balances with its financial institutions may exceed Federal Deposit Insurance
Corporation insurance limits.

The Company's customers are currently concentrated in the United States and
Europe. The Company performs ongoing credit evaluations, generally does not
require collateral and establishes an allowance for doubtful accounts based upon
factors surrounding the credit risk of customers, historical trends and other
information. As of December 31, 2003, one customer represented more than 10% of
total accounts receivable.  As of December 31, 2002, no customer represented
more than 10% of total accounts receivable.

(i) Restricted Cash

(j) Internal Use Software

Software costs for internal use, including costs incurred to purchase
third party software, are capitalized beginning when the Company has determined
certain factors are present, including among others, that technology exists to
achieve the performance requirements, buy versus internal development decisions
have been made and the Company's management has authorized the funding of the
project. Capitalization of software costs ceases when the software is
substantially complete and is ready for its intended use and is amortized over
its estimated useful life using the straight-line method.

When events or circumstances indicate the carrying value of internal use
software might not be recoverable, the Company will assess the recoverability of
these assets by determining whether the amortization of the asset balance over
its remaining life can be recovered through undiscounted future operating cash
flows. The amount of impairment, if any, is recognized to the extent that the
carrying value exceeds the projected discounted future operating cash flows and
is recognized as a write-down of the asset.  In addition, when it is no longer
probable that the software being developed will be placed in service, the asset
will be recorded at the lower of its carrying value or fair value, if any, less
direct selling costs.

(k) Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the respective assets, generally three to five
years. Leasehold improvements are amortized over the lesser of the related lease
term or the life of the improvement. Depreciation expense for the years ended
December 31, 2003, 2002 and 2001 was $8.1 million, $9.1 million and $10.1
million, respectively.

The Company evaluates property and equipment for impairment whenever changes
in circumstances indicate that the carrying amount of the 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 future net cash flows expected
to be generated by the asset. If assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amounts exceed the fair values of the assets. Assets to be disposed of are
reported at the lower of carrying values or fair values, less costs of
disposal.

(l) Goodwill and Identifiable Intangible assets

Goodwill and identifiable intangibles are carried at cost less
accumulated amortization and impairments. Identifiable intangibles are amortized
on a straight-line basis over their estimated useful lives, which is three
years. On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets("SFAS
142"). The impact of adoption of SFAS 142 is discussed in Note 4.

(m) Revenue Recognition

License revenue is recognized when there is persuasive evidence of an
arrangement, delivery to the customer has occurred, provided the arrangement
does not require significant customization of the software, the fee is fixed or
determinable and collectibility is reasonably assured.

In software arrangements that include rights to multiple software products
and/or services, the fees from the total arrangement are allocated among each of
the deliverables using the residual method, under which revenue is allocated to
undelivered elements based on vendor-specific objective evidence of fair value
of such undelivered elements with the residual amounts of revenue being
allocated to the delivered elements. Elements included in multiple element
arrangements primarily consist of software products, maintenance (which includes
customer support services and unspecified upgrades), or consulting services.
Vendor-specific objective evidence for software products and consulting services
is based on the price charged when an element is sold separately or, in the case
of an element not yet sold separately, the price established by authorized
management, if it is probable that the price, once established, will not change
before market introduction. Vendor-specific objective evidence for maintenance
is based on the residual method generally using stated contractual renewal
rates.

Probability of collection is based upon assessment of the customer's
financial condition through review of their current financial statements or
credit reports. For sales to existing customers, prior payment history is also
considered in assessing probability of collection. The Company is required to
exercise significant judgment in deciding whether collectibility is reasonably
assured, and such judgments may materially affect the timing of our revenues and
our results of operations.

Revenues from customer support services are recognized ratably over the term
of the contract, typically one year. Consulting revenues are primarily from
providing specific subject matter expertise as opposed to overall project
management. Such services are performed on a time-and-materials basis. In
certain situations prior to September 2001, consulting services included
implementation and project management and some such engagements were provided on
a fixed-fee basis, under separate service arrangements. Implementation services
performed under fixed-fee arrangements were generally recognized on a
percentage-of-completion basis. When acceptance is not assured or an ability to
reliably estimate costs is not possible, the Company uses the completed contract
method, whereby revenues are deferred until all contractual obligations are met,
and acceptance, if required in the contract, is received. Revenues from
consulting and training services are recognized as services are performed.

For contracts requiring significant services, in order to assess whether a
loss reserve is necessary, the Company estimates the total expected costs of
providing services necessary to complete the contract and compares these costs
to the fees expected to be received under the contract. If the costs are
expected to exceed the fees to be received, an accrual is made to record the
loss at the time of assessment.

(n) 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.

(o) Advertising Costs

The Company expenses advertising costs as incurred.  Advertising expense
was $0.7 million for the years ended December 31, 2003 and 2002, and $2.4
million for the year ended December 31, 2001.

(p) Stock-Based Compensation

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

Deferred stock-based compensation resulting from option grants to employees,
and warrants issued to non-employees, is amortized on an accelerated basis over
the vesting period of the individual options, generally four years, in
accordance with Financial Accounting Standards Board Interpretation No. 28,
Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans.

The Company has adopted the disclosure requirements of Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation,
Transition and Disclosure". The following table presents what the net
loss and net loss per share would have been adjusted to the following pro forma
amounts had the Company adopted FAS 123 (in thousand, except per share
amounts):

`Year Ended December 31,
                                                      ---------------------------------
                                                        2003       2002        2001
                                                      ---------  ---------  -----------
As Reported:
  Net loss.......................................... $ (21,179) $ (96,110) $  (942,895)
  Basic and diluted net loss per share.............. $   (0.88) $   (4.29) $    (68.61)

Compensation expense included in net loss........... $     648  $   6,687  $    11,885

Compensation expense if FAS 123 had been adopted.... $   7,012  $  39,345  $   (34,038)

Pro Forma:
  Net loss.......................................... $ (27,543) $(128,768) $  (896,972)
  Basic and diluted net loss per share.............. $   (1.15) $   (5.75) $    (65.27)`

(q) Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. A valuation allowance is recorded to reduce deferred tax assets to an
amount whose realization is more likely than not.

In 2003, certain foreign entities were profitable, based upon application of
the Company's intercompany transfer pricing agreements, which resulted in income
tax expense totaling approximately $318,000 in those foreign jurisdictions.

(r) Comprehensive Income (Loss)

Other comprehensive income (loss) reported by the Company for the years ended
December 31, 2003, 2002 and 2001 was primarily attributable to foreign currency
translation adjustments.

(s) Net Loss Per Share

Basic net loss per share from continuing operations is computed using the
weighted-average number of outstanding shares of common stock, excluding common
stock subject to repurchase.  Diluted net loss per share from continuing
operations is computed using the weighted-average number of outstanding shares
of common stock and, when dilutive, potential common shares from options and
warrants using the treasury stock method.

The following table presents the calculation of basic and diluted net loss
per share from continuing operations:

`Years Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
                                                                 (in thousands, except net loss
                                                                      per share amounts)
Numerator:
 Net loss from continuing operations before
  cumulative effect of accounting change.................... $  (21,179) $(100,392) $ (939,103)
                                                              ----------  ---------  ----------
Denominator:
 Weighted-average shares of common
  stock outstanding.........................................     24,033     22,420      13,880
 Less weighted-average shares subject
  to repurchase.............................................         (2)       (17)       (137)
                                                              ----------  ---------  ----------
 Denominator for basic and diluted calculation..............     24,031     22,403      13,743
                                                              ==========  =========  ==========
Basic and diluted net loss per
 common share from continuing operations
 before cumulative effect of accounting change.............. $    (0.88) $   (4.48) $   (68.33)
                                                              ==========  =========  ==========`

All warrants, outstanding stock options and shares subject to repurchase by
KANA have been excluded from the calculation of diluted net loss per share
because all such securities were anti-dilutive for all periods presented. The
total number of shares excluded from the calculation of diluted net loss per
share is as follows (in thousands):

`Years Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
Stock options and warrants..................................      8,628      7,917       6,753
Common stock subject to repurchase..........................         --         18          28
                                                              ----------  ---------  ----------
                                                                  8,628      7,935       6,781
                                                              ==========  =========  ==========`

The weighted average exercise price of stock options and warrants outstanding
was $17.30, $26.38 and $50.05 as of December 31, 2003, 2002 and 2001,
respectively.

(t) Segment Reporting

KANA's chief operating decision maker reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. Accordingly, KANA considers itself to be in
a single industry segment, specifically the licensing and support of its
software applications. Revenue classification is based upon customer location.
Geographic information on revenue for the years ended December 31, 2003, 2002,
and 2001 are as follows (in thousands):

`Years Ended December 31,
                                               -------------------------------------
                                                  2003         2002         2001
                                               -----------  -----------  -----------
United States................................ $    43,851  $    53,589  $    76,794
United Kingdom...............................       9,353       13,432        5,426
Asia Pacific.................................       2,176        3,372        3,271
Other (1)....................................       5,626        8,697        5,104
                                               -----------  -----------  -----------
                                              $    61,006  $    79,090  $    90,595
                                               ===========  ===========  ===========`

1. Represents sales to customers located primarily in
Europe, other than the United Kingdom.



During the year ended December 31, 2003, no customer represented more than
10% of total revenues. During the year ended December 31, 2002, one customer
represented 11% of total revenues. During the year ended December 31, 2001, no
customer represented more than 10% of total revenues. Revenue from the United
Kingdom accounted for approximately 15% and 17% of total revenues in the years
ended December 31, 2003 and 2002, respectively. Revenue to any one foreign
country did not exceed 10% of total revenue in 2001.

Geographic information on KANA's long-lived assets, based on physical
location, is as follows (in thousands):

`Year ended December 31
                       ----------------------
                          2003        2002
                       ----------  ----------
United States........ $   23,206  $   32,416
International........      1,820       1,735
                       ----------  ----------
                      $   25,026  $   34,151
                       ==========  ==========`

(u) Recent Accounting Pronouncements

In December 2003, the FASB issued Interpretation No. 46
("FIN 46R") (revised December 2003), "Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51" ("ARB 51"), which addresses how a business
enterprise should evaluate whether it has a controlling interest in an entity
though means other than voting rights and accordingly should consolidate the
entity. FIN 46R replaces FASB Interpretation No. 46
("FIN 46"), which was issued in January 2003. Before concluding
that it is appropriate to apply ARB 51 voting interest consolidation model to an
entity, an enterprise must first determine that the entity is not a variable
interest entity ("VIE"). As of the effective date of FIN 46R, an
enterprise must evaluate its involvement with all entities or legal structures
created before February 1, 2003, to determine whether consolidation
requirements of FIN 46R apply to those entities. There is no grandfathering
of existing entities. Public companies must apply either FIN 46 or
FIN 46R immediately to entities created after December 15, 2003 and no
later than the end of the first reporting period that ends after March 15,
2004 for all other entities. The adoption of FIN 46 did not have a material
impact on the Company's financial position, cash flows or results of
operations.

In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS 150 changes the accounting
for certain financial instruments that under previous guidance issuers could
account for as equity. It requires that those instruments be classified as
liabilities in balance sheets. The guidance in SFAS 150 is generally effective
for all financial instruments entered into or modified after May 31, 2003, and
otherwise became effective on July 1, 2003. The adoption of SFAS 150 did not
have a material impact on our financial position, cash flows or results of
operations.

2. Business Combinations

In June 2001, the Company finalized the acquisition of Broadbase. In
connection with the merger, each share of Broadbase common stock outstanding
immediately prior to the consummation of the merger was converted into the right
to receive .105 shares of KANA common stock (the "Exchange Ratio") and KANA
assumed Broadbase's outstanding stock options and warrants based on the Exchange
Ratio, issuing approximately 8.7 million shares of KANA common stock and
assuming options and warrants to acquire approximately 2.7 million shares of
KANA common stock. The transaction was accounted for using the purchase method
of accounting.

The allocation of the purchase price to assets acquired and liabilities
assumed is as follows (in thousands):

`Tangible assets acquired.................................. $   125,144
Deferred compensation ....................................      15,485
Liabilities assumed ......................................     (34,975)
Deferred credit - negative goodwill ......................      (4,282)
                                                            -----------
 Net assets acquired...................................... $   101,372
                                                            ===========`

Deferred compensation recorded in connection with the merger will be
amortized over a four-year period using FASB Interpretation No. 28. Negative
goodwill was to be amortized over its estimated useful life of three years.
However, due to the Company's adoption of SFAS 142 on January 1, 2002, negative
goodwill was eliminated in the first quarter of 2002 resulting in a gain of $3.9
million.

The estimated purchase price was approximately $101.4 million, measured as
the average fair market value of KANA's outstanding common stock from April 7 to
April 11, 2001, two trading days before and after the merger agreement was
announced plus the Black-Scholes calculated value of the options and warrants of
Broadbase assumed by KANA in the merger, and other costs directly related to the
merger is as follows (in thousands):

`Fair market value of common stock..........................$    81,478
Fair market value of options and warrants assumed...........    12,586
Acquisition-related costs...................................     7,308
                                                            -----------
Total......................................................$   101,372
                                                            ===========`

In connection with the Broadbase merger, KANA recorded $13.4 million of
merger-related integration expenses and transition costs during the year ended
December 31, 2001. These amounts consisted primarily of personnel costs of $5.6
million and duplicate facility and insurance costs, redundant assets, and
professional fees associated with the merger of $7.8 million.  As of December
31, 2001, the Company had approximately $10.3 million remaining in accrued
merger-related costs on the consolidated balance sheet in accrued restructuring
and merger costs, which were paid in 2002.

The following unaudited pro forma net revenues, net loss and net loss per
share data for the year ended December 31, 2001 and 2000 is based on the
respective historical financial statements of the Company and Broadbase. The pro
forma data reflects the consolidated results of operations as if the merger with
Broadbase occurred at the beginning of each of the periods indicated and
includes the amortization of the resulting negative goodwill and deferred
compensation. The pro forma results include the results of the pre-acquisition
period for companies acquired by Broadbase prior to its acquisition by KANA. The
pro forma financial data presented are not necessarily indicative of the
Company's results of operations that might have occurred had the transaction
been completed at the beginning of the period specified, and do not purport to
represent what the Company's consolidated results of operations might be for any
future period.

`(Unaudited
                                                             Pro forma)
                                                             Year Ended
                                                            December 31,
                                                               2001
                                                            -----------
                                                            (In thousands
                                                              except per
                                                            share amounts
                                                            -------------
Net revenues ............................................. $   113,347
Net loss ................................................. $(1,965,075)
Basic and diluted net loss per share ..................... $   (108.92)
Shares used in basic and diluted net loss
  per share calculation ..................................      18,042`

3. Financial Statement Detail

Cash and cash equivalents are carried at fair value and consisted of the
following (in thousands):

`December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Cash......................................... $    13,624  $    11,481
Money market funds...........................       2,658        8,514
Municipal securities.........................       9,350        1,853
Certificate of Deposit.......................          --          114
                                               -----------  -----------
                                              $    25,632  $    21,962
                                               ===========  ===========`

Short-term investments consisted of the following (in thousands):

`December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Municipal securities......................... $       375  $     3,784
Corporate notes / bonds......................       6,949        6,752
                                               -----------  -----------
                                              $     7,324  $    10,536
                                               ===========  ===========`

Unrealized gains and losses on available-for-sale securities at December 31,
2003 and 2002 were immaterial in both years.

Property and equipment, net consisted of the following (in thousands):

`December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Computer equipment........................... $    23,533  $    22,692
Furniture and fixtures.......................       2,966        2,898
Leasehold improvements.......................       4,173        4,058
Internal use software........................      15,157       15,116
                                               -----------  -----------
                                                   45,829       44,764
Less accumulated depreciation and amortizatio     (30,394)     (22,471)
                                               -----------  -----------
                                              $    15,435  $    22,293
                                               ===========  ===========`

Accrued liabilities consisted of the following (in thousands):

`December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Accrued payroll and related expenses......... $     2,286  $     3,851
Other accrued liabilities....................       8,392       10,030
                                               -----------  -----------
                                              $    10,678  $    13,881
                                               ===========  ===========`

Other income (expense), net consisted of the following (in thousands):

`Year Ended December 31,
                                               -------------------------------------
                                                  2003         2002         2001
                                               -----------  -----------  -----------
Interest income.............................. $       315  $       965  $     2,266
Interest expense.............................        (174)        (107)        (152)
Other........................................          45           55         (593)
                                               -----------  -----------  -----------
                                              $       186  $       913  $     1,521
                                               ===========  ===========  ===========`

Interest income consists primarily of interest earned on cash and short-term
investments.  Interest expense consists primarily of interest expense related to
the Company's line of credit.  Other income and expense consists primarily of
other non-operating expenses such as gains and losses on asset disposals.

4.  Goodwill

Consideration paid in connection with acquisitions is required to be
allocated to the acquired assets, including identifiable intangible assets, and
liabilities acquired. Acquired assets and liabilities are recorded based on the
Company's estimate of fair value, which requires significant judgment with
respect to future cash flows and discount rates. For intangible assets other
than goodwill, the Company is required to estimate the useful life of the asset
and recognize its cost as an expense over the useful life. The Company uses the
straight-line method to expense long-lived assets, which results in an equal
amount of expense in each period. Amortization of goodwill ceased as of January
1, 2002 upon the Company's adoption of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets ("SFAS
142"). Instead, the Company is now required to test goodwill for impairment
under certain circumstances and write down goodwill when it is impaired.

The Company regularly evaluates acquired businesses for potential indicators
of impairment of goodwill and intangible assets. The Company's judgments
regarding the existence of impairment indicators are based on market conditions,
operational performance of our acquired businesses and identification of
reporting units. Future events could cause the Company to conclude that
impairment indicators exist and that goodwill and other intangible assets
associated with the Company's acquired businesses are impaired.

Under the transition provisions of SFAS No. 142, the Company determined there
was no transitional goodwill impairment at January 1, 2002. However, during the
quarter ended June 30, 2002, circumstances developed that indicated the goodwill
was likely impaired. Accordingly, the Company performed an impairment analysis
as of June 30, 2002. This analysis resulted in a $55.0 million impairment
expense. Circumstances that led to the impairment included the lower-than-
previously-expected revenues and net loss for the second quarter of 2002 and the
revision of estimates of the Company's revenues and net loss for subsequent
quarters, based upon financial results for the second quarter of 2002 and the
reduction of estimated revenue and cash flows in future quarters. The Company
used a combination of discounted cash flows and relevant market data, including
KANA's market capitalization during the period following the revision of
estimates, to calculate an estimated fair value and the resulting goodwill
impairment. The estimated fair value was compared to the corresponding carrying
value of goodwill at June 30, 2002, which resulted in a revaluation of goodwill
as of June 30, 2002. During the three months ended June 30, 2003 the Company
performed its annual test for goodwill impairment as required by Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). The Company currently operates in one reportable segment, which is
also the only reporting unit for the purposes of SFAS 142. The Company completed
its evaluation and concluded that goodwill was not impaired as the fair value of
the Company exceeded its carrying value, including goodwill. There have been no
events or circumstances from June 30, 2003 to December 31, 2003 that have
affected the Company's June 30, 2003 conclusion regarding the recoverability of
goodwill. The remaining amount of goodwill as of December 31, 2003 was $7.4
million. Any further impairment loss could have a material adverse impact on the
Company's financial condition and results of operations.

In 2001, the Company also performed an impairment assessment of the
identifiable intangibles and goodwill recorded in connection with the
acquisition of Silknet, under the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of. The
assessment was performed primarily due to the significant and sustained decline
in the Company's stock price since the valuation date of the shares issued in
the Silknet acquisition which resulted in the net book value of the Company's
assets prior to the impairment charge significantly exceeding its market
capitalization, the overall decline in the industry growth rates, and the
Company's lower-than-projected operating results. As a result, the Company
recorded an impairment charge of approximately $603.4 million and $2.1 billion
to reduce goodwill in the quarters ended March 31, 2001 and December 31, 2000,
respectively. The charges were based upon the estimated discounted cash flows
over the remaining useful life of the goodwill using a discount rate of 20%. The
assumptions supporting the cash flows, including the discount rate, were
determined using the Company's best estimates as of such date.

The Company ceased amortizing goodwill as of the beginning of fiscal 2002.
The following table presents comparative information showing the effects that
the non-amortization of goodwill provisions of SFAS 142 would have had on the
net loss and basic and diluted net loss per share for the periods shown (in
thousands, except per share amounts):



`Year Ended December 31,
                                           -------------  ---------------------------
                                               2003           2002           2001
                                           -------------  -------------   -----------
Reported net loss........................ $     (21,179)       (96,110)  $  (942,895)
Goodwill amortization....................            --             --       122,860
                                           -------------  -------------   -----------
Adjusted net loss........................ $     (21,179)       (96,110)  $  (820,035)
                                           =============  =============   ===========

Basic and diluted net loss per share..... $       (0.88)         (4.29)  $    (68.61)
Goodwill amortization....................            --             --          8.94
                                           -------------  -------------   -----------
Adjusted basic and diluted
  net loss per share..................... $       (0.88)         (4.29)  $    (59.67)
                                           =============  =============   ===========
Shares used in computing adjusted basic
  and diluted net loss per share.........        24,031         22,403        13,743
                                           =============  =============   ===========`

The components of goodwill and other intangibles are as follows (in
thousands):

`December 31,
                                           ----------------------------
                                               2003           2002
                                           -------------  -------------
Goodwill, net............................         7,448          7,448
                                           -------------  -------------

Purchased technology.....................        14,400         14,400
Less: accumulated amortization...........       (14,400)       (12,947)
                                           -------------  -------------
Intangibles, net.........................            --          1,453
                                           -------------  -------------
Goodwill and intangibles, net............ $       7,448  $       8,901
                                           =============  =============`

There was no change in the carrying amount of goodwill during 2003.

5. Notes Payable

At December 31, 2003, the Company maintained
a line of credit totaling $5.0 million, which is collateralized by all of its
assets and bears an annual interest rate equal to the greater of the bank's
prime rate or 4.0% (4.0% as of December 31, 2003 and 4.5% as of December 31,
2002). The line of credit expires in November 2004, at which time the entire
balance of the line of credit will be due. Total borrowings
as of December 31, 2003 and 2002 were $3.4 million under this line of credit.
The line of credit contains a financial
covenant that requires the Company to maintain at least a $6.0 million dollar
balance in cash or cash equivalents with the bank at all times or pay a one-time
fee of $10,000. The line of credit also requires that the
Company maintains at all times a minimum of $20.0 million as short-term
unrestricted cash and cash equivalents. As of December 31, 2003, the Company was
in compliance with all financial covenants.

Included in notes payable are the Company's capital lease obligations at
December 31, 2003, totaling approximately $15,000.

6. Commitments and Contingencies

(a) Lease Obligations

The Company leases its facilities under noncancelable operating leases
with various expiration dates through December 2010. In connection with its
existing leases, the Company entered into letters of credit totaling $1.2
million expiring in 2004 through 2011. The letters of credit are supported by
either restricted cash or the Company's line of credit.

Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):



`Non-cancelable     Less:       Non-cancelable
                                                   Operating       Sublease       Operating
   Year Ending December 31,                      Leases, gross      Income       Leases, net
  --------------------------                     -------------  --------------  --------------
     2004...................................... $       5,103             774           4,329
     2005......................................         4,134             774           3,360
     2006......................................         3,897             774           3,123
     2007......................................         3,195             774           2,421
     2008......................................         2,698             490           2,208
     Thereafter................................         4,817             502           4,315
                                                 -------------  --------------  --------------
     Total minimum lease payments.............. $      23,844           4,088          19,756
                                                 =============  ==============  ==============`

Rent expense for properties in use, net of sublease payments, was
approximately $2.5 million, $4.2 million and $8.7 million for the years ended
December 31, 2003, 2002 and 2001, respectively. Restructuring expense related to
restructured properties was $1.7 million, a gain of $5.1 million and expense of
$38.2 million for the years ended December 31, 2003, 2002 and 2001,
respectively. Sublease payments were approximately $348,000, $814,000 and
$637,000 in the years ended December 31, 2003, 2002 and 2001, respectively.

(b) Litigation

In April 2001, Office Depot, Inc. filed a complaint against KANA in the
Circuit Court for the 15th District of the State of Florida claiming that KANA
breached its license agreement with Office Depot. Office Depot is seeking relief
in the form of a refund of license fees and maintenance fees paid to KANA,
attorneys' fees and costs. The Company settled this matter in November 2003,
which included payments by KANA of under $50,000.

The underwriters for KANA's initial public offering, Goldman Sachs & Co.,
Lehman Bros, Hambrecht & Quist LLC, Wit Soundview Capital Corp as well as
KANA and certain current and former officers of KANA were named as defendants in
federal securities class action lawsuits filed in the United States District
Court for the Southern District of New York. The cases allege violations of
various securities laws by more than 300 issuers of stock, including KANA, and
the underwriters for such issuers, on behalf of a class of plaintiffs who, in
the case of KANA, purchased KANA's stock between September 21, 1999 and December
6, 2000 in connection with the Company's initial public offering. Specifically,
the complaints allege that the underwriter defendants engaged in a scheme
concerning sales of KANA's and other issuers' securities in the initial public
offering and in the aftermarket. In July 2003, the Company decided to join in a
settlement negotiated by representatives of a coalition of issuers named as
defendants in this action and their insurers. Although KANA believes that the
plaintiffs' claims have no merit, the Company has decided to accept the
settlement proposal to avoid the cost and distraction of continued litigation.
The proposed settlement agreement is subject to final approval by the court.
Should the court fail to approve the settlement agreement, KANA believes it has
meritorious defenses to these claims and would defend the action vigorously.
Because the settlement will be funded entirely by KANA's insurers, KANA does not
believe that the settlement will have any effect on its financial condition,
results of operation or cash flows.

On April 16, 2002, Davox Corporation (now Concerto Software) filed an action
against the Company in the Superior Court, Middlesex, Commonwealth of
Massachusetts, asserting breach of contract, breach of implied covenant of good
faith and fair dealing, unjust enrichment, misrepresentation, and unfair trade
practices, in relation to an OEM Agreement between the Company and Davox under
which Davox has paid a total of approximately $1.6 million in fees. Davox seeks
actual and punitive damages in an amount to be determined at trial, and award of
attorneys' fees. This action is in its early stages and has been re-filed in the
Circuit Court of Cook County, Illinois. Management believes the Company has
meritorious defenses to these claims and intends to defend the action
vigorously. In the opinion of management, the Company does not believe that the
settlement will have any effect on its financial condition, results of operation
or cash flows.

Third parties have from time to time claimed, and others may claim in the
future that the Company has infringed their past, current or future intellectual
property rights. The Company has in the past been forced to litigate such
claims. These claims, whether meritorious or not, could be time-consuming,
result in costly litigation, require expensive changes in our methods of doing
business or could require the Company to enter into costly royalty or licensing
agreements, if available. As a result, these claims could harm the Company's
business.

(c) Commitments

The Company has a commitment of approximately $3.3 million of minimum
payments in 2004 to one vendor providing outsourced software programming,
quality assurance and technical documentation activities in India. The agreement
is cancelable with 90 days notice and a fee of $275,000 if notice is given by
the Company prior to May 1, 2004 or $28,000 if notice is given prior to August
1, 2004.

7. Stockholders' Equity

(a) Private Placement and Public Offerings

In November 2003 the Company sold 4,692,000 shares of its common stock at
a price to the public of $3.00 per share, for gross proceeds of $14.1 million
(before transaction-related costs of $1.0 million).

In February 2002, the Company completed the sale of an aggregate of
approximately 2.9 million shares of its common stock to institutional investors
in a private placement, for gross proceeds of approximately $34.5 million
(before transaction-related costs of $3.1 million).

In November 2001, the Company sold 1,000,000 shares of its common stock for
gross and net proceeds of $10.0 million in a private placement transaction, and
an additional 10,000 shares for gross and net proceeds of $100,000 to the same
investor in December 2001.

(b) Stock Compensation Plans

The KANA 1999 Employee Stock Purchase Plan ("KANA ESPP") allows
eligible employees to purchase common stock through payroll deductions of up to
15% of an employee's compensation. Each offering period will have a maximum
duration of 24 months and will consist of four six-month purchase periods. The
purchase price of the common stock will be equal to 85% of the fair market value
per share on the participant's entry date into the offering period, or, if
lower, 85% of fair market value per share on each semi-annual purchase date. The
KANA ESPP qualifies as an employee stock purchase plan under Section 423 of the
Internal Revenue Code of 1986, as amended. As of December 31, 2003, 381,905
shares were issued from the KANA ESPP.

Upon the merger with Broadbase in June 2001, the Company assumed Broadbase's
1999 Employee Stock Purchase Plan (the "Broadbase ESPP"). The Broadbase ESPP has
terms similar to the KANA ESPP. This plan expired on June 30, 2003, at which
time 160,756 shares had been issued.

The Company's 1999 Stock Incentive Plan (the "1999 Plan"), as
successor to the 1997 Stock Option/Stock Issuance Plan (the "1997
Plan"), provides for a total of 5,804,120 shares of the Company's common
stock to be granted to employees, independent contractors, officers, and
directors. Options are granted at an exercise price equivalent to the closing
fair market value on the date of grant. All options are granted at the
discretion of the Company's Board of Directors and have a term not greater than
10 years from the date of grant. Options are immediately exercisable and
generally vest monthly over four years. Plans of acquired companies have similar
terms as those of the 1999 Plan. Outstanding options under all these plans were
assumed in the respective merger or acquisition.

Upon the merger with Broadbase in June 2001, the Company assumed Broadbase's
existing 1999 and 2000 Stock Incentive Plans (Broadbase Incentive Plans). These
Broadbase Incentive Plans have similar terms as the 1999 Plan. Upon the date of
the merger, 2,515,984 and 5,251,061 options were outstanding and available for
grant, respectively, under the Broadbase Incentive Plans.

In December 1999, the board of directors approved the 1999 Special Stock
Option Plan and 100,000 shares of common stock were reserved for issuance under
this plan. The Special Stock Option Plan has similar terms as those of the 1999
Plan, except that options may be granted with an exercise price less than, equal
to, or greater than the fair market value of the option shares on the grant
date. This plan expired upon the merger with Broadbase in June 2001.

A summary of stock option activity for all plans
follows:

`Options Outstanding
                                                  -----------------------
                                                                Weighted
                                        Shares                  Average
                                       Available   Number of    Exercise
                                       for Grant    Shares       Price
                                      ----------- -----------  ----------
Balances, December 31, 2000..........    173,032   2,482,174      397.80
  Additional shares authorized.......  1,500,000          --          --
  Option plan assumed................  5,251,061   2,515,984      131.97
  Options granted.................... (4,636,083)  4,636,083       13.81
  Options exercised..................         --    (537,314)       4.81
  Options canceled and retired.......  1,399,025  (2,802,287)     208.82
                                      ----------- -----------  ----------
Balances, December 31, 2001..........  3,687,035   6,294,640       48.63
  Additional shares authorized.......  2,133,745          --          --
  Options granted.................... (3,563,236)  3,563,236        5.05
  Options exercised..................         --    (426,422)       4.06
  Options canceled and retired.......  2,186,628  (2,226,601)      62.84
                                      ----------- -----------  ----------
Balances, December 31, 2002..........  4,444,172   7,204,853       25.42
  Additional shares authorized.......  2,119,726          --          --
  Options granted.................... (4,088,102)  4,088,102        3.30
  Options exercised..................         --    (442,001)       1.61
  Options canceled and retired.......  2,958,565  (2,959,668)      27.21
                                      ----------- -----------  ----------
Balances, December 31, 2003..........  5,434,361   7,891,286  $    14.62
                                      =========== ===========  ==========`

The following table summarizes information about fixed stock options
outstanding at December 31, 2003:

`Options Outstanding          Options Exercisable
                    --------------------------------- ----------------------
                                 Weighted
                                 Average    Weighted               Weighted
                                Remaining    Average                Average
                      Number    Contractual Exercise    Number     Exercise
                     of shares     Life       Price    of shares     Price
                    ----------- ----------  --------- -----------  ---------
$0.10--$1.63.......  1,140,608        8.6  $    1.50     424,215  $    1.40
$2.05--$2.95.......  1,228,214        9.5       2.70     159,115       2.51
$3.01--$3.85.......  2,039,129        9.2       3.27     399,564       3.28
$4.07--$8.76.......  1,143,976        7.9       6.73     595,615       7.40
$9.48--$14.41......  1,955,922        8.0      13.25   1,136,937      12.79
$14.57--$153.70....    306,963        7.0      67.69     194,264      67.36
$207.20--$1,395.80.     76,474        6.3     644.02      68,063     658.63
                    ----------- ----------  --------- -----------  ---------
                     7,891,286        8.5  $   14.62   2,977,773  $   26.59
                    =========== ==========  ========= ===========  =========`

The weighted average exercise price of stock options outstanding was $25.42
and $48.63 as of December 31, 2002 and December 31, 2001, respectively. With the
exception of grants for which the charges are referred to below, the fair value
of stock options granted equaled the exercise price on the date of grant.

The Company uses the intrinsic-value method in accounting for its stock-based
compensation plans. Accordingly, compensation cost has been recognized in the
financial statements for those options issued with exercise prices at less than
fair value at date of grant. These amounts are included as a component of
stockholders' equity and are being amortized on an accelerated basis by charges
to operations over the vesting period of the options, consistent with the method
described in FASB Interpretation No. 28. No options were granted with an
exercise price below the fair market value during 2003. Options granted with an
exercise price below the fair market value resulted in a charge of $1.5 million
in 2002 and $2.6 million in 2001. Cancellations of grants with previous
associated charges resulted in a reduction of compensation expense of $1.1
million in 2003, $1.2 million in 2002 and $3.0 million in 2001.

The fair value of the Company's stock-based awards was estimated assuming no
expected dividends and the following weighted average assumptions:

`Options                         ESPP
                    ------------------------------ ------------------------------
                    Interest                       Interest
                      Rate      Term    Volatility   Rate      Term    Volatility
                    --------- --------- ---------- --------- --------- ----------
2003...............     2.11%   3 yrs         111%     1.08%   6 mths         73%
2002...............     3.02%   3 yrs         127%     1.27%   6 mths        127%
2001...............     3.62%   3 yrs         100%     1.82%   6 mths        100%`

The weighted average fair value of the employee stock purchase rights granted
under the 1999 ESPP during 2003, 2002 and 2001 was $1.74, $5.71, and $18.31
respectively.

The weighted average fair value and exercise price of the options granted are
as follows:

`Weighted Average Exercise Price  Weighted Average Fair Value
                                                     ------------------------------  ------------------------------
                                                       2003      2002       2001       2003      2002       2001
                                                     --------  --------  ----------  --------  --------  ----------
Exercise price does not exceed fair value on grant  $   3.30  $   5.05  $    14.01  $   2.27  $   3.64  $    11.30
Exercise price exceeds fair value on grant date.... $     --  $     --  $    12.51  $     --  $     --  $     7.56
Total options...................................... $   3.30  $   5.05  $    13.81  $   2.27  $   3.64  $    10.79`

(c) Warrants

In September 2000, the Company issued to Accenture 40,000 shares of
common stock and a warrant to purchase up to 72,500 shares of common stock
pursuant to a stock and warrant purchase agreement in connection with its global
strategic alliance. The shares of the common stock issued were fully vested, and
the Company reported a charge of approximately $14.8 million to be amortized
over the four-year term of the agreement. As of December 31, 2003, warrants to
purchase 33,997 shares of common stock are fully vested and 38,503 have been
forfeited. The vested warrants were valued using the Black-Scholes model
resulting in charges totaling $2.0 million of which $1.0 million was amortized
over the term of the associated alliance agreement through December 2003 and
$1.0 million was immediately expensed in the fourth quarter of 2000.

In June 2001, the Company entered into an agreement to issue to a customer a
fully vested and exercisable warrant to purchase up to 25,000 shares of common
stock pursuant to a warrant purchase agreement. The value of the warrants, using
the Black-Scholes model was $330,000 and was accounted for as a reduction of
revenue in 2001.

In September 2001, the Company issued to Accenture an additional warrant to
purchase up to 150,000 shares of common stock pursuant to a warrant purchase
agreement in connection with its global strategic alliance. The warrant is fully
vested and exercisable as of September 2001. The warrants were valued using the
Black-Scholes model resulting in a charge of approximately $946,000 which was
amortized on a straight-line basis over the term of the associated alliance
agreement through December 2003.

In September 2001, the Company issued to a customer a warrant to purchase up
to 5,000 shares of common stock pursuant to a warrant purchase agreement. The
warrant fully vests in September 2006 and has a provision for acceleration of
vesting 1,250 shares annually over four years if the customer meets certain
marketing criteria. The warrants were valued using the Black-Scholes model
resulting in a charge to stock-based compensation of approximately $29,000 which
is being amortized over the five-year term of the agreement on a straight-line
basis.

In November 2001, the Company issued to two investment funds warrants to
purchase up to 386,118 shares of common stock at $10.00 per share in connection
with a proposed financing which was to have been completed in February 2002 upon
attaining stockholder approval. These warrants were initially exercisable into
193,059 shares. The exercisable warrants were valued using the Black-Scholes
model resulting in a charge of approximately $1.0 million to deferred stock-
based compensation. On February 1, 2002, the stockholders voted against the
proposed financing, which resulted in the Company terminating the share purchase
agreement and caused the warrants to become exercisable with respect to all
386,118 shares. The warrants were exercisable for two years from the date the
share purchase agreement was terminated. The warrants expired unexercised. Using
the Black-Scholes model, the warrants issued in November 2001 that were
initially exercisable were re-valued as of February 1, 2002, and the warrants
that became exercisable on February 1, 2002 were valued as of such date,
resulting in a charge totaling approximately $4.7 million which was reflected as
amortization of stock-based compensation in the statement of operations in the
first quarter of 2002.

In November 2002, the Company issued to its landlords warrants to purchase up
to 200,000 shares of common stock at $1.61 per share in connection with an
amendment to its existing facility lease. The warrants were valued using the
Black-Scholes model with an assumed interest rate of 6.0% and volatility of
100%, which resulted in a charge of approximately $137,000 which was accounted
for as a reduction to the Company's restructuring liability in the fourth
quarter of 2002. The warrant was exercised in November 2003, for a net exercise
of 105,356 shares and no cash proceeds.

In December 2003, the Company issued to a customer warrants to purchase up to
230,000 shares of common stock at $5.00 per share in connection with a marketing
agreement. The warrants were valued at approximately $459,000, using the Black-
Scholes model with an assumed interest rate of 5.0% and volatility of 100%. This
amount was accounted for as a reduction of revenue in the fourth quarter of
2003.

As of December 31, 2003, there was approximately $1.5 million of total
unearned deferred stock-based compensation remaining to be amortized.

8. Restructuring Costs

In 2000 and 2001, the Company has experienced substantial increases in
expenditures consistent with growth in its operations and personnel. To reduce
its expenditures, the Company restructured in several areas, including reduced
staffing, expense management and capital spending. In 2001, the Company incurred
restructuring charges of approximately $89.0 million related to the reductions
in its workforce and costs associated with certain excess leased facilities and
asset impairments. Included in the $89.0 million are non-cash charges totaling
$28.3 million primarily related to disposals of fixed assets. The restructuring
costs in 2001 include $26.4 million for assets disposed of or removed from
operations. Assets disposed of or removed from operations consisted primarily of
computer equipment and related software, office equipment, furniture and
fixtures, and leasehold improvements.

The restructuring costs in 2001 also include $24.4 million, for severance,
benefits and related costs due to the reduction in workforce. As of
December 31, 2001, the Company had 409 full-time employees. The Company
restructured the organization throughout 2001 with net workforce reductions of
approximately 772 employees, or 65% from December 31, 2000, in order to
streamline operations, eliminate redundant positions after the merger with
Broadbase, and reduce costs and bring staffing and structure in line with
industry standards and current economic conditions. These reductions have been
significant, particularly in light of the increase of approximately 896
employees upon the acquisition of Broadbase Software in June of 2001.

The restructuring costs in 2001 also include $38.2 million due to the
Company's decision to exit and reduce certain facilities. The estimated facility
costs are based on the Company's contractual obligations, net of assumed
sublease income based on current comparable rates for leases in the respective
markets.

In November of 2002, the Company entered into an amendment to a facility
lease. In connection with this lease amendment, our evaluation of real estate
market conditions relating to this and other excess leased facilities, and
discussions with its other landlords, the Company reduced its associated
restructuring reserve by approximately $9.1 million. This reduction in
restructuring reserve was primarily comprised of a $4.0 million payment made in
connection with the lease amendment, as well as approximately $5.1 million in
cost savings resulting from this amendment that were reflected in the Company's
operating results for the quarter ended December 31, 2002.

In December 2003, the Company recorded $1.7 million in restructuring costs
related to a change in evaluation of real estate market conditions in the United
Kingdom, and changes in sublease estimates based on communication from current
and potential subtenants in the United States.

Should facilities operating lease rental rates continue to decrease in these
markets or should it take longer than expected to find a suitable tenant to
sublease these facilities, the actual loss could exceed this estimate. Future
cash outlays are anticipated through December 2010 unless the Company negotiates
to exit the leases at an earlier date.

A summary of restructuring expenses, payments, and liabilities for the years
ended and as at December 31, 2001, 2002 and 2003 is as follows (in
thousands):

`Fixed Asset
                                         Severance      Facilities      Disposals        Totals
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2000... $        --   $           --   $         --  $           --
                                        -----------   --------------   ------------  --------------
Restructuring charge..................      24,426           38,168         26,453          89,047
Non-cash reduction of restructuring...      (1,858)              --        (26,453)        (28,311)
Payments made.........................     (21,655)         (10,750)            --         (32,405)
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2001...         913           27,418             --          28,331
                                        -----------   --------------   ------------  --------------
Non-cash reduction of restructuring...          --           (5,086)            --          (5,086)
Payments made.........................        (696)         (12,415)            --         (13,111)
Sublease payments received............          --              814             --             814
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2002...         217           10,731             --          10,948
                                        -----------   --------------   ------------  --------------
Restructuring charge..................          --            1,704             --           1,704
Payments made.........................         (33)          (2,773)            --          (2,806)
Sublease payments received............          --              348             --             348
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2003... $       184   $       10,010   $         --  $       10,194
                                        ===========   ==============   ============  ==============`

9. Retirement Plan

The Company has a 401(k) retirement plan, which covers substantially all
employees.  Eligible employees may make salary deferral (before tax)
contributions up to a specified amount. The Company, at its discretion, may make
additional matching contributions on behalf of the participants of the
retirement plan. The Company made no contributions for the years ended December
31, 2003, 2002 and 2001.

10. Income Taxes

The 2003, 2002 and 2001 income tax benefit differed from the amounts
computed by applying the U.S. federal income tax rate of 34% to pretax loss as a
result of the following (in thousands):

`Year Ended December 31,
                                                 ---------------------------------------------
                                                     2003            2002            2001
                                                 -------------  --------------  --------------
Federal tax benefit at statutory rate.......... $      (7,283) $      (31,659) $     (320,272)
Stock-based compensation ......................            --              --             379
Merger costs...................................            --              --           2,584
Current year net operating losses and temporary
   differences, no tax benefit recognized......         6,683          12,160              --
Amortization and goodwill impairment...........           494          19,006         248,447
Change in valuation allowance..................            --              --          68,302
Other permanent differences....................           106             493             560
Foreign taxes..................................           318              --              --
                                                 -------------  --------------  --------------
Total tax expense.............................. $         318  $           --  $           --
                                                 =============  ==============  ==============`

The tax expense in 2003 relates to income taxes incurred by our foreign
entities.

The types of temporary differences that give rise to significant portions of
the Company's deferred tax assets and liabilities are set as follows (in
thousands):

`December 31,
                                                 -----------------------------
                                                     2003            2002
                                                 -------------  --------------
 Deferred tax assets:
   Accruals and reserves....................... $       1,321  $        2,010
   Property and equipment......................        10,195           4,170
   Credit carryforward.........................         2,559              --
   Stock option deduction......................        44,092          42,009
   Other.......................................         5,386           4,940
   Net operating loss..........................       143,493         139,576
                                                 -------------  --------------
 Gross deferred tax assets.....................       207,046         192,705
 Valuation allowance...........................      (207,046)       (192,705)
                                                 -------------  --------------
   Net deferred tax assets..................... $          --  $           --
                                                 =============  ==============`

The net change in the valuation allowance for the year ended December 31,
2003 was an increase of approximately $14.3 million. Management believes that
sufficient uncertainty exists as to whether the deferred tax assets will be
realized, and accordingly, a valuation allowance is required.

As of December 31, 2003, the Company had net operating loss carryforwards for
federal and state tax purposes of approximately $395.9 million and $149.0
million, respectively. The federal net operating loss carryforwards, if not
offset against future taxable income, will expire from 2011 through 2023.

Pursuant to the Internal Revenue Code, the amounts and benefits from net
operating loss carryforwwards may be impaired or limited in certain
circumstances. Events which cause limitations in the amount of net operating
losses that the Company may utilize in any one year include, but are not limited
to, a cumulative ownership change of more than 50%, as defined, over a three
year period. The portion of the net operating loss and tax credit carryforwards
subject to potential expiration has not been included in deferred tax assets.

11. Discontinued Operation

As of the quarter ended June 30, 2001, the Company adopted a plan to
discontinue the KANA Online business. The Company no longer seeks new business
for KANA Online, but continued to service all ongoing contractual obligations it
has to its existing customers through April 2002. Accordingly, KANA Online is
reported as a discontinued operation for the years ended December 31, 2003, 2002
and 2001. The estimated loss on the disposal of KANA Online was $3.7 million as
of June 30, 2001, consisting of an estimated loss on disposal of the assets of
$2.6 million and a provision of $1.1 million for the anticipated operating
losses during the phase-out period.  The loss on disposal was reported in the
second quarter of 2001 and adjusted in the second quarter of 2002, resulting in
a gain of $0.4 million.

This operation has been presented as a discontinued operation for all periods
presented. The KANA Online operating results are as follows (in thousands):

`Year Ended December 31,
                                                            ----------------------------
                                                              2003      2002      2001
                                                            --------  --------  --------
Revenues ................................................. $     --  $     --  $  3,161

Loss from operations of discontinued operation ...........       --        --      (125)
Gain/(loss) on disposal ..................................       --       381    (3,667)
                                                            --------  --------  --------
Total income (loss) on discontinued operations ........... $     --  $    381  $ (3,792)
                                                            ========  ========  ========`

12. Related Party Transactions

The Company provided support services to a company that is affiliated
with Massood Zarrabian, a director of KANA until August 2003. KANA recognized
approximately $54,800, $59,400 and $547,000 in revenue related to the company in
the years ended December 31, 2003, 2002 and 2001.

In addition, KANA purchased software and support services from this company
totaling approximately $96,000, $239,100 and $1,034,000 in the years ended
December 31, 2003, 2002 and 2001. Management reviewd the contractual rates and
terms to assess that they were comparable with those entered into with
independent third parties.

13. Subsequent Events

In January 2004, the Compensation Committee to the Board of Directors
approved grants of approximately 1.3 million stock options to the majority of
employees and new hires, excluding officers of the Company. The options were
granted in connection with the Company's 1999 Stock Incentive Program and have a
weighted average exercise price of $4.74. See Note 7 for further information
regarding this stock incentive plan.

On February 10, 2004, we completed the acquisition of Hipbone, Inc., a
leading provider of online customer interaction solutions. This transaction
will be accounted for using the purchase method of accounting. Under the terms
of the agreement, the Company paid $265,000 and issued a total of 262,500 shares
of KANA's common stock valued at approximately $1.0 million using the five-trading-
day average price surrounding the date the acquisition was announced of $3.62
per share, less estimated registration costs. The Company expects to incur a
total of approximately $215,000 direct transaction costs. As a result of this
acquisition, the Company has added Hipbone's Web collaboration, chat, co-
browsing and file-sharing capabilities to the KANA iCARE(TM) suite.

---

SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
KANA SOFTWARE, INC.

`Balance    Amounts
                                         at      recorded in               Balance
                                      Beginning  Revenues and              at End
                                       of Year    Expenses     Deductions  of Year
                                      ---------  -----------   ---------  ---------
Allowance for Doubtful Accounts:
 Year ended December 31, 2003....... $   4,815  $    (2,004)  $  (1,624) $   1,187

 Year ended December 31, 2002.......     6,844           57      (2,086)     4,815

 Year ended December 31, 2001.......     1,966       13,970      (9,092)     6,844`

`Additions
                                       Balance   Charged to
                                         at       Deferred                 Balance
                                      Beginning   Tax Asset                at End
                                       of Year    Valuation    Deductions  of Year
                                      ---------  -----------   ---------  ---------
Deferred Tax Asset Valuation Allowance:
 Year ended December 31, 2003....... $ 192,705  $    14,341   $      --  $ 207,046

 Year ended December 31, 2002.......   198,174           --      (5,469)   192,705

 Year ended December 31, 2001.......    50,143      148,031          --    198,174`

---

SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of Menlo Park, state of
California, on the 19th day of March, 2004.

| | KANA Software, Inc.                                                                                    
| | -------------------------------------------------------------------------------------------------------
| |                                                                                                        
| | /s/ CHUCK BAY
Chuck Bay
Chief Executive Officer and Chairman of the Board
(Principal Executive Officer)



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

`Date:     March 19, 2004          By     /s/ CHUCK BAY                     
			Chuck Bay
			Chief Executive Officer and
			Chairman of the Board (Principal Executive Officer)

Date:     March 19, 2004          By     /s/ JOHN HUYETT                   
			John Huyett
			Chief Financial Officer
			(Principal Financial and Accounting Officer)


Date:     March 19, 2004          By     /s/ MARK BERTELSEN
			Mark Bertelsen
			Director

Date:     March 19, 2004          By     /s/ TOM GALVIN
			Tom Galvin
			Director 

Date:     March 19, 2004          By     /s/ JERRY R. BATT
			Jerry R. Batt
			Director

Date:     March 19, 2004          By     /s/ DIXIE L. MILLS
			Dixie L. Mills
			Director`