# SECURITIES AND
EXCHANGE COMMISSION

# Washington, D.C. 20549

# Form 10-Q

# (X)  QUARTERLY
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended January 3, 2004

OR

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

For the transition period from ______________ to _______________

Commission file number   
   0-20109

# Kronos Incorporated

(Exact name of registrant as specified in its charter)

|                                                                |  |                                      
|--------------------------------------------------------------- |  | -------------------------------------
|Massachusetts                                                   |  | 04-2640942                           
|(State or other jurisdiction of  incorporation or organization) |  | (I.R.S. Employer  Identification No.)



297 Billerica Road, Chelmsford,
  MA              01824

(Address of principal executive
 offices)         (Zip Code)

(978) 250-9800

(Registrants telephone number, including area code)

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

Yes  __X__      
      No ____

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes __X__     
      No ____

As of January 31, 2004, 30,908,747 shares
 of the registrants common stock, $.01 par value, were outstanding.

---

# KRONOS INCORPORATED

# INDEX

|PART I.    | FINANCIAL INFORMATION                                                                                                     | Page
|---------- | ------------------------------------------------------------------------------------------------------------------------- | ----
|Item 1.    | Condensed Consolidated Financial
         Statements (Unaudited)                                                          |     
|           | Condensed Consolidated Statements
         of Income for the Three Months Ended January 3, 2004 and December 28, 2002     | 1   
|           | Condensed Consolidated Balance
         Sheets at January 3, 2004 and September 30, 2003                                  | 2   
|           | Condensed Consolidated Statements
         of Cash Flows for the Three Months Ended January 3, 2004 and December 28, 2002 | 3   
|           | Notes to Condensed Consolidated
         Financial Statements                                                             | 4   
|Item 2.    | Management's Discussion and Analysis
         of Financial Condition and Results of Operations                            | 10  
|Item 3.    | Quantitative and Qualitative
        Disclosure About Market Risk                                                         | 29  
|Item 4.    | Evaluation of Disclosure
         Controls and Procedures                                                                 | 29  
|PART II.   | OTHER INFORMATION                                                                                                         |     
|Item 6.    | Exhibits and Reports on Form 8-K                                                                                          | 31  
|Signatures |                                                                                                                           |     

---

# PART I.   FINANCIAL
INFORMATION

Item 1.    
Condensed Consolidated Financial Statements (Unaudited)

# KRONOS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS
 OF INCOME (In thousands, except share and per share amounts) UNAUDITED

|                                               | Three Months Ended
|---------------------------------------------- | ------------------
|
|Net revenues:                                  |                   
|Product                                        |                   
|Maintenance                                    |                   
|Professional services                          |                   
|                                               |                   
|                                               |                   
|Cost of sales:                                 |                   
|Costs of product                               |                   
|Costs of maintenance and professional services |                   
|                                               |                   
|                                               |                   
|                                               |                   
|Gross profit                                   |                   
|Operating expenses and other income:           |                   
|Sales and marketing                            |                   
|Engineering, research and development          |                   
|General and administrative                     |                   
|Amortization of intangible assets              |                   
|Other income, net                              |                   
|                                               |                   
|                                               |                   
|Income before income taxes                     |                   
|Provision for income taxes                     |                   
|                                               |                   
|Net income                                     |                   
|                                               |                   
|Net income per common share:                   |                   
|Basic                                          |                   
|                                               |                   
|Diluted                                        |                   
|                                               |                   
|Weighted-average common shares outstanding:    |                   
|Basic                                          |                   
|                                               |                   
|Diluted                                        |                   
|                                               |                   

See accompanying notes to condensed
consolidated financial statements.

---

# KRONOS INCORPORATED

CONDENSED CONSOLIDATED
 BALANCE SHEETS  (In thousands, except share and per share amounts)  UNAUDITED

|                                                                                       | January 3, | September 30,
|-------------------------------------------------------------------------------------- | ---------- | -------------
|
|
|Current assets:                                                                        |            |              
|Cash and equivalents                                                                   |            |              
|Marketable securities                                                                  |            |              
|Accounts receivable, less allowances of $7,551                                         |            |              
|at January 3, 2004 and $7,833 at September 30, 2003                                    |            |              
|Deferred income taxes                                                                  |            |              
|Other current assets                                                                   |            |              
|                                                                                       |            |              
|Total current assets                                                                   |            |              
|Property, plant and equipment, net                                                     |            |              
|Marketable securities                                                                  |            |              
|Intangible assets                                                                      |            |              
|Goodwill                                                                               |            |              
|Capitalized software, net                                                              |            |              
|Other assets                                                                           |            |              
|                                                                                       |            |              
|Total assets                                                                           |            |              
|                                                                                       |            |              
|LIABILITIES AND SHAREHOLDERS' EQUITY                                                   |            |              
|Current liabilities:                                                                   |            |              
|Accounts payable                                                                       |            |              
|Accrued compensation                                                                   |            |              
|Accrued expenses and other current liabilities                                         |            |              
|Deferred product revenues                                                              |            |              
|Deferred professional service revenues                                                 |            |              
|Deferred maintenance revenues                                                          |            |              
|                                                                                       |            |              
|Total current liabilities                                                              |            |              
|Deferred maintenance revenues                                                          |            |              
|Deferred income taxes                                                                  |            |              
|Other liabilities                                                                      |            |              
|Shareholders' equity:                                                                  |            |              
|Preferred Stock, par value $1.00 per share:  authorized 1,000,000 shares,              |            |              
|no shares issued and outstanding                                                       |            |              
|Common Stock, par value $.01 per share:  authorized 50,000,000 shares, 30,887,026  and |            |              
|30,439,778 shares issued at January 3, 2004 and September 30, 2003, respectively       |            |              
|Additional paid-in capital                                                             |            |              
|Retained earnings                                                                      |            |              
|Cost of Treasury Stock ( 132 shares and 260 shares at                                  |            |              
|January 3, 2004 and September 30, 2003, respectively)                                  |            |              
|Accumulated other comprehensive income:                                                |            |              
|Foreign currency translation                                                           |            |              
|Net unrealized gain on available-for-sale investments                                  |            |              
|                                                                                       |            |              
|                                                                                       |            |              
|Total shareholders' equity                                                             |            |              
|                                                                                       |            |              
|Total liabilities and shareholders' equity                                             |            |              
|                                                                                       |            |              

See accompanying notes to condensed
consolidated financial statements.

---

# KRONOS INCORPORATED

CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS (In thousands)UNAUDITED

|                                                                | Three Months Ended
|--------------------------------------------------------------- | ------------------
|
|Operating activities:                                           |                   
|Net income                                                      |                   
|Adjustments to reconcile net income to net cash and equivalents |                   
|provided by operating activities:                               |                   
|Depreciation                                                    |                   
|Amortization of intangible assets                               |                   
|Amortization of capitalized software                            |                   
|Provision for deferred income taxes                             |                   
|Changes in certain operating assets and liabilities:            |                   
|Accounts receivable, net                                        |                   
|Deferred product revenues                                       |                   
|Deferred professional service revenues                          |                   
|Deferred maintenance revenues                                   |                   
|Accounts payable, accrued compensation                          |                   
|and other liabilities                                           |                   
|Taxes payable                                                   |                   
|Other                                                           |                   
|Tax benefit from exercise of stock options                      |                   
|                                                                |                   
|Net cash and equivalents provided by operating activities       |                   
|Investing activities:                                           |                   
|Purchase of property, plant and equipment                       |                   
|Capitalized internal software development costs                 |                   
|(Increase) decrease in marketable securities                    |                   
|Acquisitions of businesses, net of cash acquired                |                   
|                                                                |                   
|Net cash and equivalents used in investing activities           |                   
|Financing activities:                                           |                   
|Net proceeds from exercise of stock options and                 |                   
|employee purchase plans                                         |                   
|Purchase of treasury stock                                      |                   
|Proceeds from call options                                      |                   
|                                                                |                   
|Net cash and equivalents provided by financing activities       |                   
|Effect of exchange rate changes on cash and equivalents         |                   
|                                                                |                   
|(Decrease) increase in cash and equivalents                     |                   
|Cash and equivalents at the beginning of the period             |                   
|                                                                |                   
|Cash and equivalents at the end of the period                   |                   
|                                                                |                   

See accompanying notes to condensed
consolidated financial statements.

---

# KRONOS INCORPORATED 
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

# NOTE A  General

The accompanying unaudited condensed
consolidated financial statements include all adjustments, consisting of normal recurring
accruals that management of Kronos Incorporated (Kronos) considers necessary
for a fair presentation of the Companys financial position and results of operations
as of and for the interim periods presented pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although the
Company believes the disclosures in these financial statements are adequate to make the
information presented not misleading. These condensed consolidated financial statements
should be read in conjunction with the Companys audited financial statements for the
fiscal year ended September 30, 2003. The results of operations for the three months ended
January 3, 2004 are not necessarily indicative of the results for a full fiscal year.
Certain reclassifications, which are not material, have been made in the accompanying
consolidated financial statements in order to conform to the fiscal 2004 presentation.

# NOTE B  Fiscal
Quarters

The Company utilizes a system of
fiscal quarters. Under this system, the first three quarters of each fiscal year end on a
Saturday. However, the fourth quarter of each fiscal year will always end on September 30.
Because of this, the number of days in the first quarter (95 days in fiscal 2004 and 89
days in fiscal 2003) and fourth quarter (89 days in fiscal 2004 and 94 days in fiscal
2003) of each fiscal year varies from year to year. The second and third quarters of each
fiscal year will be exactly thirteen weeks long. This policy does not have a material
effect on the comparability of results of operations between quarters.

# NOTE C 
Stock-Based Compensation

The Company accounts for its
stock-based compensation plan under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees and related
Interpretations. We have adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation Transition and
Disclosure, an amendment of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, (Statement No. 123).
Therefore, no stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. The following table illustrates the effect
on net income and earnings per share if the Company had applied the fair value recognition
provisions of Statement No. 123 to stock-based employee compensation (in thousands, except
per share data).

---

|                                           | Three Months Ended
|------------------------------------------ | ------------------
|
|Net income, as reported                    |                   
|Deduct: Total stock-based employee         |                   
|compensation expense determined under fair |                   
|value based method for all awards, net of  |                   
|related tax effects                        |                   
|                                           |                   
|Pro forma net income                       |                   
|                                           |                   
|Earnings per share:                        |                   
|Basic--as reported                         |                   
|                                           |                   
|Basic--pro forma                           |                   
|                                           |                   
|Diluted--as reported                       |                   
|                                           |                   
|Diluted--pro forma                         |                   
|                                           |                   

# NOTE D  Other
Current Assets

Other current assets consists of the
following (in thousands):

|                 | January 3, 2004 | September 30, 2003
|---------------- | --------------- | ------------------
|Inventory        |                 | $5,584            
|Prepaid expenses |                 | 13,492            
|                 |                 |                   
|Total            |                 | $19,076           
|                 |                 |                   

---

# NOTE E  Intangible
Assets

Acquired intangible assets subject to
amortization are presented in the following table (in thousands).

|                          | Weighted
Average
Life in
Years | Gross Carrying Value | Accumulated
Amortization | Net Book Value
|------------------------- | ------------------------------ | -------------------- | ------------------------ | --------------
|As of January 3, 2004:    |                                |                      |                          |               
|Intangible assets:        |                               
|Customer related          |                                | 9                    | .7                       | $21,954       
|Maintenance relationships |                                | 12                   | .0                       | 8,338         
|Tax benefits              |                                | 10                   | .7                       | 2,159         
|Non-compete agreements    |                                | 4                    | .0                       | 4,162         
|                          |                                |                      |                          |               
|Total intangible assets   |                                |                      |                          | $36,613       
|                          |                                |                      |                          |               
|As of September 30, 2003: |                               
|Intangible assets:        |                               
|Customer related          |                                | 9                    | .7                       | $21,327       
|Maintenance relationships |                                | 11                   | .9                       | 8,092         
|Tax benefits              |                                | 10                   | .7                       | 2,144         
|Non-compete agreements    |                                | 4                    | .0                       | 4,060         
|                          |                                |                      |                          |               
|Total intangible assets   |                                |                      |                          | $35,623       
|                          |                                |                      |                          |               

For the three months ended January 3, 2004
and December 28, 2002, the amount of acquired goodwill increased by $2.1 million and $1.3
million, respectively.

For the three months ended January 3,
2004 and December 28, 2002, the Company recorded amortization expense for intangible
assets of $1.0 million and $0.7 million, respectively. The estimated annual amortization
expense for intangible assets for the current and next five fiscal years is as follows (in
thousands):

---

|Fiscal Year Ending
September 30,   | Estimated Annual
Amortization Expense    
|---------------------------------- | -----------------------------------------
|2004 
2005 
2006 
2007 
2008 
2009 | $3,905
 3,389
 2,954
 2,551
 2,437
 2,114

# NOTE F 
Acquisitions

During the three months ended January
3, 2004, the Company completed two immaterial acquisitions. The aggregate purchase price
for these acquisitions was $1.1 million. The results of operations for these acquisitions
are not material to the Companys results of operations and have been included in the
consolidated financial statements since their acquisition date. Acquired entities were
engaged in the sale and service of employee time and attendance, employee scheduling, data
collection and labor management software and hardware systems, including the resale of the
Companys products through a dealer relationship. As a result of these acquisitions,
the Company gained access to direct sales and service organizations, as well as access to
the entire existing maintenance revenue stream from their customers. The deferred revenue
related to the maintenance and professional services revenue streams, which was recorded
at fair value, was recognized as the Company had assumed a legal performance obligation as
described in EITF 01-03.

Certain agreements, which were
previously entered into, contain provisions that require the Company to make a guaranteed
payment and/or contingent payments based upon profitability of the business unit or if
specified minimum revenue requirements are met. These provisions expire during fiscal 2004
through 2006. Guaranteed payments are accrued at the time of the acquisition and are
included in the purchase price allocation. As of January 3, 2004, the Company has the
obligation to pay $3.7 million in guaranteed payments, which is included in the balance
sheet as accrued expenses and other liabilities. These payments will be made at various
dates through fiscal 2006. Contingent payments due under the terms of the agreements are
recognized when earned and are principally recorded as goodwill. However, under certain
circumstances, a portion of the contingent payment may be recorded as compensation
expense. There were no contingent payments earned during the three months ended January 3,
2004. There were $0.6 million of contingent payments earned during the three months ended
December 28, 2002 and all were recorded as goodwill.

# NOTE G 
Comprehensive Income

For the three months ended January 3,
2004 and December 28, 2002, comprehensive income consisted of the following (in
thousands):

---

|                                      | Three Months Ended
|------------------------------------- | ------------------
|
|Comprehensive income:                 |                   
|Net income                            |                   
|Cumulative translation adjustment     |                   
|Unrealized loss on available-for-sale |                   
|securities                            |                   
|                                      |                   
|Total comprehensive income            |                   
|                                      |                   

# NOTE H  Earnings
Per Share

The following table sets forth the
computation of basic and diluted earnings per share (in thousands, except share and per
share data):

|                                 | Three Months Ended
|-------------------------------- | ------------------
|
|Net income                       |                   
|                                 |                   
|Weighted-average shares          |                   
|Effect of dilutive securities:   |                   
|Employee stock options           |                   
|                                 |                   
|Adjusted weighted-average shares |                   
|and assumed conversions          |                   
|                                 |                   
|Basic earnings per share         |                   
|                                 |                   
|Diluted earnings per share       |                   
|                                 |                   

# NOTE I  Stock Split

On October 7, 2003, the
Companys Board of Directors approved a three-for-two stock split effected in the
form of a 50% stock dividend. This stock dividend was paid on October 31, 2003 to
stockholders of record as of October 20, 2003. Accordingly the presentation of shares
outstanding and amounts per share have been restated for all periods presented to reflect
the split. The par value of the additional shares was transferred from additional paid-in
capital to common stock.

---

# NOTE J  New
Accounting Pronouncements

In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46), which requires the
consolidation of a variable interest entity (as defined) by its primary beneficiary.
Primary beneficiaries are those companies that are subject to a majority of the risk or
loss or entitled to receive a majority of the variable interest entitys residual
returns, or both. In determining whether it is the primary beneficiary of a variable
interest entity, a company with a variable interest must also treat a variable interest
held by the Companys related parties in that same entity as its own interest. In
December 2003, the FASB published a revision to FIN 46 to clarify some of the provisions
of FIN 46 and to exempt certain entities from its requirements. FIN 46, as revised,
applies to variable interest entities that are commonly referred to as special-purpose
entities for periods ending after December 15, 2003 (Kronos fiscal 2004 first
quarter) and for all other types of variable interest entities for periods ending after
March 15, 2004 (Kronos fiscal 2004 second quarter).

Kronos currently has no contractual
relationship or other business relationship with a variable interest entity and therefore
the adoption of FIN No. 46 and 46-6 did not have an effect on Kronos consolidated
financial position, results of operations or cash flows.

# NOTE K  Call
Option Arrangements

The Company previously entered into a
call option arrangement, which was classified as an equity instrument in accordance with
the provisions of EITF 00-19, Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Companys Own Stock. The call option
arrangement provided the Company an opportunity to lock in a repurchase price for shares
under the Companys stock repurchase program. The call option arrangement matured in
December 2002. At maturity, the Companys stock price exceeded the strike price of
$16.67 per share and the Company received a return of its cash investment and a premium
totaling approximately $2.6 million, which was credited to additional paid-in-capital. If
at maturity the Companys stock price was less than the strike price, the Company
would use its cash investment to purchase Company shares at a predetermined price. There
were no dividend and liquidation preferences, participation rights, sinking-fund
requirements, unusual voting rights or any other significant terms pertaining to this call
option arrangement. As of January 3, 2004, the Company did not have any call option
arrangements outstanding.

---

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

# Forward-Looking
Statements

This
discussion includes certain forward-looking statements about our business and our
expectations, including statements relating to product and service revenues, revenue
growth rates, product and service gross profit, operating expenses, future acquisitions,
capital expenditures, customer purchase patterns, income tax rates, available cash,
investments and operating cash flow and the future effects of accounting pronouncements.
Any such statements are subject to risk that could cause the actual results to vary
materially from expectations. For a further discussion of the various risks that may
affect our business and expectations, see Certain Factors That May Affect Future
Operating Results at the end of Managements Discussion and Analysis of
Financial Condition and Results of Operations and in our Annual Report of Form 10-K for
the fiscal year ended September 30, 2003. The risks and uncertainties discussed herein do
not reflect the potential future impact of any mergers, acquisitions or dispositions. In
addition, any forward-looking statements represent our estimates only as of the day this
Quarterly Report was filed with the Securities and Exchange Commission and should not be
relied upon as representing our estimates as of any subsequent date. While we may elect to
update forward-looking statements at some point in the future, we specifically disclaim
any obligation to do so, even if our estimates change.

# Overview

We
provide a suite of solutions that automate employee-centric processes and provide tools to
optimize the workforce. Our solutions, which include human resources, payroll, scheduling,
and time and labor applications, are designed for a wide range of businesses from
single-site to large multi-site enterprises. We derive revenues from the licensing of our
software solutions, sales of our hardware solutions and by providing professional services
as well as ongoing customer support and maintenance.

We
have been successful in continuing to increase revenues in all periods presented. Although we
believe that the current economic environment is improving, certain factors
such as a lack of job creation and the apparent lag in technology purchasing in the
current economic recovery, as well as the diversion of resources towards compliance with new
regulatory requirements on internal controls may result in many customers deferring or
reducing their technology purchases in the future.

Regarding
expectations for the remainder of the current fiscal year, we presently anticipate that
revenue growth for the second quarter and for the entire fiscal 2004, including revenues
from customers obtained in the acquisition of businesses, will range between 10% 
14% and 12%  16%, respectively.

---

# Critical Accounting
Policies and Estimates

Managements
Discussion and Analysis of 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 financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities, revenue and expenses, and related
disclosures of contingent assets and liabilities. We base estimates on historical
experience and various other assumptions that we believe to be reasonable under the
circumstances. Actual results could differ from these estimates under different
assumptions or conditions.

We have identified the following critical accounting policies that affect the more
significant judgments and estimates used in the preparation of consolidated financial
statements. This listing is not a comprehensive list of all of our accounting policies.
Please refer to Note A in the Notes to Consolidated Financial Statements in this Quarterly
Report on Form 10-Q and in Item 15 of our Annual Report on Form 10-K for the fiscal year
ended September 30, 2003 for further information.

Revenue Recognition  We license software and sell data collection hardware and related
ancillary products to end-user customers through our direct sales force as well as
indirect channel customers, which include Automatic Data Processing, Inc.
(ADP) and other independent resellers. Substantially all of our software
license revenue is earned from perpetual licenses of off-the-shelf software requiring no
modification or customization. The software license, data collection hardware and related
ancillary product revenues from our end-user customers and indirect channel customers are
generally recognized using the residual method when:

| | o | Persuasive
evidence of an arrangement exists, which is typically when a non-cancelable sales and
software license agreement has been signed;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

| | o | Delivery,
which is typically FOB shipping point, is complete for the software (either physically or
electronically), data collection hardware and related ancillary products;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o | The customer's fee is deemed to be fixed or
 determinable and free of contingencies or significant uncertainties;
| | - | -----------------------------------------------------------------------------------------------------------------

| | o | Collectibility is probable; and
| | - | -------------------------------

| | o | Vendor-specific objective evidence of
 fair value exists for all undelivered elements,
typically maintenance and professional services.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

Under the residual method, the fair value of the undelivered elements is deferred and the
remaining portion of the arrangement fee is allocated to the delivered elements and is
recognized as revenue, assuming all other conditions for revenue recognition have been
satisfied. Substantially all of our product revenue is recognized in this manner. If we
cannot determine the fair value of any undelivered element included in an arrangement, we
will defer revenue until all elements are delivered, services are performed or until fair
value can be objectively determined.

---

As part of an arrangement, end-user customers typically purchase maintenance contracts as well as
professional services from us. Maintenance services include telephone and Web-based
support as well as rights to unspecified upgrades and enhancements, when and if we make
them generally available. Professional services are deemed to be non-essential to the
functionality of the software and typically are for implementation planning, loading of
software, installation of the data collection hardware, training, building simple
interfaces, running test data, and assisting in the development and documentation of pay
rules and best practices consulting.

Revenues from maintenance services are recognized ratably over the term of the maintenance contract
period based on vendor-specific objective evidence of fair value. Vendor-specific
objective evidence of fair value is based upon the amount charged when purchased
separately, which is typically the contracts renewal rate. Maintenance services are
typically stated separately in an arrangement. We have classified the allocated fair value
of revenues pertaining to the contractual maintenance obligations that exist for the
12-month period subsequent to the balance sheet date as a current liability, and the
contractual obligations with a term beyond 12 months as a non-current liability. Revenues
from time and material customer support services are recognized as the services are
delivered.

Revenues from professional services are generally recognized based on vendor-specific
 objective evidence of fair value when:

| | o | A non-cancelable agreement for the services
  has been signed or a customer's purchase order has been received;
| | - | ---------------------------------------------------------------------------------------------------------------

| | o | The professional services have been delivered;
| | - | ----------------------------------------------

| | o | The customer's fee is deemed
 to be fixed or determinable and free of contingencies or significant uncertainties; and
| | - | ---------------------------------------------------------------------------------------------------------------------

| | o | Collectibility is probable.
| | - | ---------------------------

Vendor-specific objective evidence of
fair value is based upon the price charged when these services are sold separately and are
typically an hourly rate for professional services and a per-class rate for training.
Based upon our experience in completing product implementations, we have determined that
these services are typically delivered within a 12-month period subsequent to the contract
signing and therefore have classified deferred professional services as a current
liability.

Our arrangements with end-user customers and indirect channel customers do not include any
rights of return or price protection, nor do arrangements with indirect channel customers
include any acceptance provisions. Generally, our arrangements with end-user customers
also do not include any acceptance provisions. However, if an arrangement does include
acceptance provisions, they typically are based on our standard acceptance provision. Our
standard acceptance provision provides the end-user customer with a right to a refund if
the arrangement is terminated because the product did not meet our published
specifications. Generally, we determine that these acceptance provisions are not
substantive and therefore should be accounted for as a warranty in accordance with SFAS
No. 5.

---

At the time we enter into an arrangement, we assess the probability of collection of the fee
and the terms granted to the customer. For end-user customers, our typical payment terms
include a deposit and subsequent payments, based on specific due dates, such that all
payments for the software license, data collection hardware and related ancillary
products, as well as services included in the original arrangement are ordinarily due
within one year of contract signing. Our payment terms for indirect channel customers are
less than 90 days and typically payments are due within 30 days of invoice date.

If the payment terms for the arrangement are considered extended or if the arrangement
includes a substantive acceptance provision, we defer revenue not meeting the criterion
for recognition under SOP 97-2 and classify this revenue as deferred revenue, including
deferred product revenue. This revenue is recognized, assuming all other conditions for
revenue recognition have been satisfied, when the payment of the arrangement fee becomes
due and/or when the uncertainty regarding acceptance is resolved as generally evidenced by
written acceptance or payment of the arrangement fee. We report the allocated fair value
of revenues related to the product element of arrangements as a current liability because
of the expectation that these revenues will be recognized within 12 months of the balance
sheet date.

Since
fiscal 1996, we have had a standard practice of providing creditworthy end-user customers
the option of financing arrangements beyond one year.  Our policy for recognizing revenue
and the timing of the recognition for arrangements that are financed is the same as our
non-financed arrangements.  The financed arrangements, which encompass
separate fees for software license, data collection hardware and ancillary products,
maintenance and support contracts and professional services, are evidenced by distinct
standard sales, license and maintenance agreements and typically require equal monthly
payments. The term of these arrangements typically range between 18 and 48 months. At the time
we enter into an arrangement, we assess the
probability of collection and whether the arrangement fee is fixed or determinable. We
consider our history of collection without concessions as well as whether each new
transaction involves similar customers, products and arrangement economics to ensure that
the history developed under previous arrangements remains relevant to current
arrangements. If the fee is not determined to be collectible, fixed or determinable, we
will initially defer the revenue and recognize when collection becomes probable, which
typically is when payment is due assuming all other conditions for revenue recognition
have been satisfied. As a financing arrangement, we apply a present value factor using
interest rates ranging from 5% to 8%. These rates may vary depending upon when the
financing arrangement is entered into and the length of the financing arrangement.

---

Allowance
for Doubtful Accounts and Sales Returns Allowance We maintain an allowance for
doubtful accounts to reflect estimated losses resulting from the inability of customers to
make required payments. This allowance is based on estimates made by us after
consideration of factors such as the composition of the accounts receivable aging and bad
debt history. If the financial condition of customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances and bad debt expense
may be required. In addition, we maintain a sales returns allowance to reflect estimated
losses for sales returns and adjustments. Sales returns and adjustments are generally due
to incorrect ordering of product, general customer satisfaction issues or incorrect
billing. This allowance is established by us using estimates based on historical
experience. If we experience an increase in sales returns and adjustments, additional
allowances and charges against revenue may be required.

Valuation
of Intangible Assets and Goodwill In assessing the recoverability of goodwill
and other intangible assets, we must make assumptions regarding the estimated future cash
flows and other factors to determine the fair value of these assets. If these estimates or
their related assumptions change in the future, we may be required to record impairment
charges against these assets in the reporting period in which the impairment is
determined. For intangible assets, this evaluation includes an analysis of estimated
future undiscounted net cash flows expected to be generated by the assets over their
estimated useful lives. If the estimated future undiscounted net cash flows are
insufficient to recover the carrying value of the assets over their estimated useful
lives, we will record an impairment charge in the amount by which the carrying value of
the assets exceeds their fair value. For goodwill, the impairment evaluation includes a
comparison of the carrying value of the reporting unit which houses goodwill to that
reporting units fair value. We have only one reporting unit. The fair value of the
reporting unit is based upon the net present value of future cash flows, including a
terminal value calculation. If the reporting units estimated fair value exceeds the
reporting units carrying value, no impairment of goodwill exists. If the fair value
of the reporting unit does not exceed its carrying value, then further analysis would be
required to determine the amount of the impairment, if any. If we determine that there is
an impairment in either an intangible asset, or goodwill, we may be required to record an
impairment charge in the reporting period in which the impairment is determined, which may
have a negative impact on earnings. During fiscal 2003, we completed the annual testing of
the impairment of goodwill, and as a result of this test, we concluded that no impairment
of goodwill existed as of June 29, 2003, the annual goodwill impairment measurement
date.  In addition, we have determined that no events or circumstances currently
exist that would indicate that either the fair value of the reporting unit has been
reduced, or the carrying value of the intangible assets is no longer recoverable. 
Therefore, no impairment charges have been recorded in the three months ended January 3,
2004.

Capitalization
of Software Development Costs Costs incurred in the research, design and
development of software for sale to others are charged to expense until technological
feasibility is established. Thereafter, software development costs are capitalized and
amortized to product cost of sales on a straight-line basis over the lesser of three years
or the estimated economic lives of the respective products. Costs incurred in the
development of software for internal use are charged to expense until it becomes probable
that future economic benefits will be realized. Thereafter, certain costs are capitalized
and amortized to operating expense on a straight-line basis over the lesser of three years
or the estimated economic life of the software.

---

Income
Taxes We account for income taxes under the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are expected to
reverse. We record a valuation allowance in accordance with generally accepted accounting
principles to reduce our deferred tax assets to the amount of future tax benefit that is
more likely than not to be realized. While we have considered future taxable income and
ongoing prudent and feasible tax planning strategies in assessing the need for the
valuation allowance, there is no assurance that the valuation allowance will not need to
be increased to cover additional deferred tax assets that may not be realizable. Any
increase in the valuation allowance could have a material adverse impact on our income tax
provision and net income in the period in which such determination is made.

# Results of Operations

Revenues.
       
          Revenues amounted to $99.7 million for the three months ended January 3, 2004 as
          compared to $89.7 million for the comparable period in the prior fiscal year.
          Revenue growth amounted to 11% for the three months ended January 3, 2004 as
          compared to 18% for the comparable period in the prior fiscal year. This reduced rate
          of growth is principally due to the three months ended January 3, 2004 benefiting less
          from incremental revenues from acquired businesses due to the timing of
          acquisitions than the three months ended
          December 28, 2002. Revenues from core business (business generated from
          customers that have not been part of an acquired business transaction over the
          preceding four fiscal quarters) accounted for $7.7 million, or 9% of our revenue
          growth in the three month period ended January 3, 2004 and contributed $8.2
          million, or 11% in the three month period ended December 28, 2002. The principal
          factor driving revenue growth in the first quarter of fiscal 2004 was increased
          demand for our professional and maintenance services from new and existing
          customers.

Product
revenues amounted to $39.1 million for the three months ended January 3, 2004 as compared
to $38.9 million for the comparable period in the prior fiscal year. Product revenues
increased 1% for the three months ended January 3, 2004 as compared to 10% for the
comparable period in the prior fiscal year. We believe that the reduction in product
revenue growth rate in the first quarter of 2004 is principally attributable to unusually
high product sales volume in the first quarter of the prior year, and to a lesser extent,
some deferral of product sales at the end of the current quarter due to general business
shutdowns during the traditional holiday period. One factor driving the product revenue
growth experienced in the first quarter of fiscal 2003 was revenues related to the
conversion to Kronos products by, and add-on sales to, customers acquired from other
providers of labor management solutions. Product revenue derived from acquired customers
accounted for 6% of the growth in the first quarter of fiscal 2003, or $2.1 million in
revenue, whereas it was less than $.1 million in the first quarter of fiscal 2004. Other
factors driving product revenue growth in the first quarter of 2003 include increased
customer demand for Kronos products, as well as platform and capacity upgrades and
upgrades to the newest badge terminals from existing customers.

---

Maintenance
revenues amounted to $34.1 million for the three months ended January 3, 2004 as compared
to $29.0 million for the comparable period in the prior fiscal year. Maintenance revenues
increased 18% for the first three months ended January 3, 2004 as compared to 24% for the
comparable period in the prior fiscal year.  This reduced rate of growth is principally due to
the three months ended January 3, 2004 benefiting less from incremental revenues from acquired
businesses due to the timing of acquisitions than the three months ended December 28, 2002.
Maintenance revenue from core business accounted
for 13% of our maintenance revenue growth for the three months ended January 3, 2004 as
compared to 14% of our maintenance revenue growth for the comparable period in the prior
fiscal year. Maintenance revenue growth attributable to acquisitions of businesses over
the preceding four quarters was 5% in the three months ended January 3, 2004 as compared
to 10% for the comparable period in the prior fiscal year. The increase in maintenance
revenues in both periods was principally the result of expansion of the installed base, an
increase in the value of maintenance contracts, and incremental maintenance revenues
attributable to customers obtained from the acquisition of businesses. The increase in the
value of the maintenance contracts was principally attributable to the sales of platform
and capacity upgrade licenses to existing customers. Platform and capacity upgrade sales
typically result in an increased value of maintenance contracts. In addition, we continue
to drive incremental maintenance revenues from our focus of enforcing the appropriate
effective dates on maintenance contracts upon customer reinstatements.

Professional
services revenues amounted to $26.4 million for the three months ended January 3, 2004 as
compared to $21.8 for the comparable period in the prior fiscal year. Professional
services revenues increased 21% for the three months ended January 3, 2004, as compared to
25% for the comparable period in the prior fiscal year. Professional services revenue from
core business accounted for 17% of our professional services revenue growth for the three
months ended January 3, 2004, as compared to 19% of our professional services revenue
growth for the comparable period in the prior fiscal year. Professional services revenue
growth attributable to acquisitions of businesses over the preceding four quarters was 4%
in the three months ended January 3, 2004 as compared to 6% for the comparable period in
the prior fiscal year. The growth in professional services revenues in both periods was
principally due to an increase in demand for professional services accompanying sales to
new customers, an increase in the level of professional services accompanying new and
platform conversion sales, and an increase in the delivery of services attributable to
customers obtained from the acquisition of businesses.

Gross
Profit. Gross profit as a percentage of revenues was 58% for the three months ended
January 3, 2004 as compared to 60% for the comparable period in the prior fiscal year. The
decline in gross profit in the three months ended January 3, 2004 is primarily
attributable to a higher proportion of service revenues, which typically carries a lower
gross profit and a decline in service gross profit as compared to the comparable period in
the prior year. We anticipate gross profit as a percentage of revenues to increase over
the remainder of fiscal 2004 principally as a result of our expectation that the
proportion of product revenues to total revenues will increase over the remainder of the
fiscal year.

---

Product
gross profit as a percentage of product revenues was 75% for the three months ended
January 3, 2004 as compared to 76% for the comparable period in the prior fiscal year.
Although software revenues, which typically carry a higher gross profit than hardware
revenues, were a greater proportion of total product revenues in the first quarter of 2004
than the comparable period in the prior year, increased costs related to the amortization
of capitalized software development costs and higher production costs related to our 4500
terminal offset the effect of favorable software mix.

Service
gross profit as a percentage of professional service and maintenance revenues was 47% for
the three months ended January 3, 2004 as compared to 48% for the comparable period in the
prior fiscal year. The decrease in service gross profit in the first quarter of 2004 was
principally attributable to increased volume of human resources and payroll product
implementations which are currently less efficient than our time and labor
implementations, increased overhead related to the development of training materials for
our newer products, and a decrease in the average hourly bill rate when compared to the
comparable period in the prior year. Although we anticipate productivity increases in our
human resources and payroll implementations in the latter half of the fiscal year due to
improvements in our service delivery tools and processes, we expect service margins will
continue to be negatively impacted by our continued investments in training and personnel
to support our human resources, payroll and other new product introductions planned for
the remainder of fiscal 2004.

Net
Operating Expenses.
     Net operating expenses for the three months ended January 3, 2004
increased $3.5 million, or 8%, to $46.5 million as compared to an increase of $6.1
million, or 16%, to $43.0 million for the comparable period in the prior fiscal year. The
increase in actual expenses for the three months ended January 3, 2004 was principally
attributable to investments in personnel and related compensation in response to increased
customer demand and to support the development of new products. Net operating expenses as
a percentage of revenues were 47% for the three months ended January 3, 2004, as compared
to 48% for the comparable period in the prior fiscal year. The reduction in net operating
expenses as a percentage of revenues was attributable to the leveraging of investments in
infrastructure to generate higher sales volumes, and continued corporate-wide efforts to
contain costs. Although we intend to continue efforts to contain costs and to leverage our
infrastructure to generate higher sales volume, we anticipate that net operating expenses
as a percentage of revenues will increase in the near term as we significantly invest in
initiatives related to our new product introductions and the replacement of our
information technology systems.

---

Sales
and marketing expenses for the three months ended January 3, 2004 increased $2.3 million,
or 8%, to $31.0 million as compared to an increase of $3.9 million, or 16%, to $28.7
million for the comparable period in the prior fiscal year. The increase in actual
spending in both periods was primarily attributable to investment in sales personnel and
related compensation and support costs to add new customers and to maximize the
penetration of existing accounts as well as additional spending on programs related to the
expansion of market awareness of our products and services. As a percentage of revenues,
sales and marketing expenses were 31% for the three months ended January 3, 2004 as
compared to 32% for the comparable period in the prior fiscal year. The decrease in sales
and marketing spending as a percentage of total revenues for the first three months ended
January 3, 2004 was primarily attributable to leveraging the investments in infrastructure
to generate higher sales volumes.

Engineering,
research and development expenses for the three months ended January 3, 2004 increased
$1.2 million, or 14%, to $9.7 million as compared to an increase of $0.5 million, or 7%,
to $8.5 million for the comparable period in the prior fiscal year. These expenses are net
of capitalized software development costs of $3.1 million and $2.8 million for the first
three months of fiscal 2004 and 2003, respectively. As a percentage of revenues,
engineering, research and development expenses were 10% for the three months ended January
3, 2004 as compared to 9% for the comparable period in the prior fiscal year. The increase
in spending for the three month period ended January 3, 2004 was attributable to
investment in engineering personnel and their compensation-related expenses. The increase
in spending in the first quarter of the prior year was also attributable to investment in
engineering personnel and their compensation-related expenses as well as engineering
consultants. The increases in prior years expenses were partially offset by the
reclassification of certain engineering resources focused upon information systems support
to general and administrative expenses. The significant project development efforts in the
first quarter of fiscal 2004 were principally related to further development and
enhancement of the Workforce Central® suite, including scheduling, activities and
workflow modules as well as Workforce HR, Workforce Payroll and the Kronos
4500 terminal.

General
and administrative expenses for the three months ended January 3, 2004 increased $0.4
million, or 5%, to $6.4 million as compared to an increase of $1.5 million, or 33%, to
$6.0 million for the comparable period in the prior fiscal year. General and
administrative expenses primarily consist of personnel and overhead-related expenses for
administrative, information technology, finance, legal and human resources support
functions. The increase in general and administrative expenses in both periods was
primarily due to investment in personnel and related compensation and support costs, an
increase in fees related to professional services, and continued investment in
infrastructure to support the growth of operations. The increase in prior years
expenses also includes those costs associated with the previously discussed reallocation
of engineering resources to general and administrative expenses. As a percentage of
revenues, general and administrative expenses decreased to 6% for the three months ended
January 3, 2004 as compared to 7% for the comparable period in the prior year.

Amortization
of intangible assets as a percentage of revenues was 1% for both periods presented. Other
income, net as a percentage of revenues was 2% for the three months ended January 3, 2004,
as compared to 1% for the comparable period in the prior fiscal year. Other income, net is
principally interest income earned from cash as well as investments in our marketable
securities and financing arrangements.

---

Income Taxes.     The provision for income taxes as a percentage of pre-tax income was
34.9% for the three months ended January 3, 2004 and 36.0% for the comparable period in
the prior fiscal year. Our effective income tax rate may fluctuate between periods as a
result of various factors, including income tax credits, foreign tax rate differentials
and state income taxes. We currently anticipate that the income tax rate will range
between 34% and 35% for the remainder of the fiscal year.

Newly Issued Accounting Standards.     In January 2003, the Financial Accounting Standards Board
(FASB) issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46), which requires the consolidation of a variable interest
entity (as defined) by its primary beneficiary. Primary beneficiaries are those companies
that are subject to a majority of the risk or loss or entitled to receive a majority of
the variable interest entitys residual returns, or both. In determining whether it
is the primary beneficiary of a variable interest entity, a company with a variable
interest must also treat a variable interest held by the Companys related parties in
that same entity as its own interest. In December 2003, the FASB published a revision to
FIN 46 to clarify some of the provisions of FIN 46 and to exempt certain entities from its
requirements. FIN 46, as revised, applies to variable interest entities that are commonly
referred to as special-purpose entities for periods ending after December 15, 2003 (our
fiscal 2004 first quarter) and for all other types of variable interest entities for
periods ending after March 15, 2004 (our fiscal 2004 second quarter).

We currently have no contractual relationship or other business relationship with a variable
interest entity and therefore the adoption of FIN No. 46 and No. 46-6 did not have an effect on our
consolidated financial position, results of operations or cash flows.

# Liquidity and Capital
Resources

We fund our business through cash generated by operations. If near-term demand for our
products weakens or if significant anticipated sales in any quarter do not close when
expected, the availability of such funds may be adversely impacted. We believe, however,
that we have more than adequate financing to sustain our operations through the next
fiscal year.

Cash,
cash equivalents and marketable securities (which includes both short- and long-term
securities) amounted to $145.0 million as of January 3, 2004 and $131.0 million as of
September 30, 2003. This increase in cash, cash equivalents and marketable securities is
due to cash generated from operations. Working capital as of January 3, 2004 amounted to
$33.0 million as compared with $21.2 million as of September 30, 2003. This increase in
working capital is primarily due to an increase in cash resulting from cash provided by
operations.

---

Cash provided by operations amounted to $14.8 million for the three months ended January 3,
2004 as compared to $13.8 million for the comparable period in the prior fiscal year. The
increase in cash provided by operations in the first three months of fiscal 2004 is
principally attributable to collection of accounts receivable from trade customers, the
tax benefit from the exercise of stock options as well as increased non-cash charges that
are added back in the calculation of cash flow from operations. These are partially offset
by a reduced rate of increase in our deferred revenues as well as an increase in cash used
due to timing of tax-related payments.

Cash used for property, plant and equipment was $3.0 million for the three months ended January
3, 2004 as compared to $2.2 million for the comparable period of the prior fiscal year.
Our use of cash for property, plant and equipment in all periods presented includes
investments in information system and infrastructure to improve and support expanding
operations. We anticipate making significant capital investments during the remainder of
fiscal 2004 in conjunction with the replacement of information technology systems. To
date, we have invested approximately $1.3 million related to this project. We expect our
total investment in this project to range between $3.0 million and $4.0 million in fiscal
2004. Our use of cash for the acquisition of businesses in all periods presented was
principally related to the acquisitions of specified assets and/or businesses of our
resellers and/or other providers of labor management solutions. Cash used for acquisitions
of businesses during the three months ended January 3, 2004 was $1.3 million. We are
assessing several acquisition opportunities that may be completed over the next twelve
months, although there can be no assurance that these acquisitions will be completed.
Excess cash reserves not required for operations, investments in property, plant and
equipment or acquisitions are invested in marketable securities. Net investments in
marketable securities increased by $34.1 million for the three months ended January 3,
2004 as compared to a decrease of $3.2 million for the comparable period of the prior
fiscal year.

We repurchased no shares of common stock during the three months ended January 3, 2004 under
our stock repurchase program, compared to 97,500 shares of common stock at a cost of $2.5
million during the comparable period of the prior fiscal year. The common stock
repurchased under the program is used for our employee stock option plans and employee
stock purchase plan. During the first quarter of fiscal 2003, we received $2.6 million
upon the maturity of a call option arrangement. As of January 3, 2004, we did not have any
outstanding call option arrangements. Please refer to Note K in the Notes to Condensed
Consolidated Financial Statements for further details regarding call option arrangements.

We lease certain office space, manufacturing facilities and equipment under long-term
operating lease agreements. In addition, certain acquisition agreements contain provisions
that require us to make a guaranteed payment and/or contingent payments based upon
profitability of the business unit or if specified minimum revenue requirements are met.
Future minimum rental commitments under operating leases with non-cancelable terms of one
year or more, and future payment obligations related to guaranteed payments are as
follows:

---

|Payments Due by Period
(in thousands) 
|--------------------------------------
|
|Operating lease
         obligations  
|Guaranteed payment
        obligations
|                                      
|Total                                 
|                                      

We believe that we have adequate cash and investments and operating cash flow to fund our
investments in property, plant and equipment, software development costs, cash
requirements under operating leases, cash payments related to acquisitions, if any, and
any additional stock repurchases for the foreseeable future.

# Certain Factors That May
Affect Future Operating Results

Except
for historical matters, the matters discussed in this Quarterly Report on Form 10-Q are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (the Act). We desire to take advantage of the
safe harbor provisions of the Act and include this statement for the express purpose of
availing ourselves of the protection of the safe harbor with respect to all
forward-looking statements that involve risks and uncertainties.

Actual
operating results may differ from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by us from time to time because
of a number of factors including the potential fluctuations in quarterly results, timing
and acceptance of new product introductions by us and our competitors, the dependence on
our time and labor product line, the ability to attract and retain sufficient technical
personnel, the protection of our intellectual property and the potential infringement on
our intellectual property rights, competitive pricing pressure, and the dependence on
alternate distribution channels and on key vendors, as further described below and in our
Annual Report on Form 10-K for the fiscal year ended September 30, 2003, which are
specifically incorporated by reference herein.

Potential Fluctuations in Results.     Our operating results,
 including revenue growth, sources of revenue, effective tax rate and liquidity, may fluctuate as a result of a
variety of factors, including general economic conditions and related effect on workforce size,
the purchasing patterns of our customers, the diversion of public companies' resources to address
compliance with new regulatory requirements on internal controls, the mix of products and services
sold, the ability to effectively integrate acquired businesses into our operations, the
timing of the introduction of new products and product enhancements by us and our
competitors, the strategy employed by us to enter the human resources and payroll market,
market acceptance of new products and competitive pricing pressure.  We historically have
realized a relatively larger percentage of our annual
revenues and profits in the third and fourth quarters and a relatively smaller percentage
in the first and second quarters of each fiscal year, although there can be no assurance
that this pattern will continue. In addition, substantially all of our product revenue and
profits in each quarter result from orders received in that quarter. If near-term demand
for our products weakens or if significant anticipated sales in any quarter do not close
when expected, our revenues for that quarter will be adversely affected. We believe that
our operating results for any one period are not necessarily indicative of results for any
future period.

---

Competition. 
      
          The employee relationship management (ERM) market, which includes
          time and labor, scheduling, human resources and payroll, is highly competitive.
          Technological changes such as those allowing for increased use of the Internet
          have resulted in new entrants into the market. Increased competition could
          adversely affect our operating results through price reductions and/or loss of
          market share. With our efforts to expand our labor management offering with the
          recent introduction of our human resources and payroll product suite, we will
          continue to meet strong competition. Many of these competitors may be able to
          adapt more quickly to new or emerging technologies or to devote greater
          resources to the promotion and sale of their human resources and payroll
          products. Many of our human resources and payroll competitors have significantly
          greater financial, technical and sales and marketing resources than us, as well
          as more experience in delivering human resources and payroll solutions. Although
          we believe our organization has core competencies that position us strongly in
          the marketplace, maintaining our technological and other advantages over
          competitors will require continued investment in research and development as
          well as marketing and sales programs. There can be no assurance that we will
          have sufficient resources to make such investments or be able to achieve the
          technological advances necessary to maintain our competitive advantages. There
          can be no assurance that we will be able to compete successfully in the human
          resources and payroll marketplace, and our failure to do so could have a
          material adverse impact upon our business, prospects, financial condition and
          operating results.

Dependence on Time and Labor Product Line.     To date,
 more than 90% of our revenues have been
attributable to sales of labor management systems and related services. Although we have
introduced products for the licensed human resources and payroll market during fiscal
2002, we expect that our dependence on the time and labor product line for revenues will
continue for the foreseeable future. Competitive pressures or other factors could cause
our time and labor products to lose market acceptance or experience significant price
erosion, adversely affecting the results of our operations.

Product Development and Technological Change.    Continual
change and improvement in computer
software and hardware technology characterize the markets for ERM systems. Our future
success will depend largely on our ability to enhance the capabilities and increase the
performance of our existing products and to develop new products and interfaces to
third-party products on a timely basis to meet the increasingly sophisticated needs of our
customers. Although we are continually seeking to further enhance our ERM offerings and to
develop new products and interfaces, there can be no assurance that these efforts will
succeed, or that, if successful, such product enhancements or new products will achieve
widespread market acceptance, or that our competitors will not develop and market products
which are superior to our products or achieve greater market acceptance.

---

Dependence on Alternate Distribution Channels.    
 We market and sell our products
through our direct sales organization, independent resellers and ADP under an OEM agreement.
In the first three months of fiscal 2004, approximately 9% of our revenue was generated through sales
to resellers and ADP. We do not anticipate that our entrance into the human resources and
payroll market will have a negative impact on our relationship with ADP. During fiscal
2003, we signed an agreement with ADP extending our business relationship for an
additional term of five years. However, a reduction in the sales efforts of either our
major resellers or ADP, or termination or changes in their relationships with us, could
have a material adverse effect on the results of our operations.

Attracting
and Retaining Sufficient Technical Personnel for Product Development, Support and
Sales.     We have encountered intense competition for experienced technical personnel for
product development, technical support and sales and expect such competition to continue
in the future. Any inability to attract and retain a sufficient number of qualified
technical personnel could adversely affect our ability to produce, support and sell
products in a timely manner.

Protection
of Intellectual Property.     We have developed, and through our acquisitions of
businesses and software, acquired proprietary technology and intellectual property rights.
Our success is dependent upon our ability to further develop and protect our proprietary
technology and intellectual property rights. We seek to protect products, software,
documentation and other written materials primarily through a combination of trade secret,
patent, trademark and copyright laws, confidentiality procedures and contractual
provisions. While we have attempted to safeguard and maintain our proprietary rights, it
is unknown whether we have been or will be successful in doing so.

Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt to copy
aspects of our products or obtain and use information that is regarded as proprietary.
Policing unauthorized use of our products is difficult. While we are unable to determine
the extent to which piracy of our software products exists, software piracy can be
expected to be a persistent problem, particularly in foreign countries where the laws may
not protect proprietary rights as fully as in the United States. We can offer no assurance
that we can adequately protect our proprietary rights or that our competitors will not
reverse engineer or independently develop similar technology.

---

Infringement
of Intellectual Property Rights.     We cannot provide assurance that others will not
claim that our developed or acquired intellectual property rights infringe on their
intellectual property rights or that we do not in fact infringe on those intellectual
property rights.

Any
litigation regarding intellectual property rights could be costly and time-consuming and
divert the attention of our management and key personnel from business operations. The
complexity of the technology involved and the uncertainty of intellectual property
litigation increase these risks. Claims of intellectual property infringement might also
require us to enter into costly royalty or license agreements, and in this event, we may
not be able to obtain royalty or license agreements on acceptable terms, if at all. We may
also be subject to significant damages or an injunction against the use of our products. A
successful claim of patent or other intellectual property infringement against us could
cause immediate and substantial damage to our business and financial condition.

# Additional Stock Option
Program Information

Option Program Description.     We intend that our stock option program be our primary vehicle
for offering long-term incentives and rewarding executives and key employees. Stock
options are granted to key employees based upon prior performance, the importance of our
retaining their services and the potential for their performance to help us attain our
long-term goals. However, there is no set formula for the award of options to individual
executives or employees.

Stock options are generally granted
annually in conjunction with the Compensation Committees formal review of the
individual performance of key executives, including our Chief Executive Officer, and their
contributions to the Company. In the three month period ended January 3, 2004, 74% of the
options granted went to employees other than our Named Executive Officers (as
set forth in the table below). All the options awarded are granted from the same plan.
Options, which are granted at the fair market value on the date of grant, typically vest
in four equal annual installments beginning one year from the date of grant and have a
contractual life of four years and six months.

The
presentation of share and per share amounts have been restated to reflect our
three-for-two stock split effected in the form of a 50% common stock dividend that was
paid on October 31, 2003 to stockholders of record as of October 20, 2003.

---

# Distribution and Dilutive Effect of Options.

Employee and Executive
Option Grants:

|                                                           | For the Three
Month Period
Ended January 3, 2004 | For the Fiscal
Year Ended
September 30, 2003 | For the Fiscal
Year Ended
September 30, 2002
|---------------------------------------------------------- | ------------------------------------------------ | -------------------------------------------- | --------------------------------------------
|Net grants during
        period as % of outstanding       |                                                  | 3                                            | .7%                                         
|shares                                                     |                                                 
|Grants to Named Executive
         Officers* during period |                                                  | 25                                           | .5%                                         
|as % of options granted                                    |                                                 
|Grants to Named Executive
         Officers*               |                                                  | 0                                            | .9%                                         
|during period as % of shares
         outstanding          |                                                 

*The following individuals are Kronos Named Executive Officers for fiscal 2003 and for
the first quarter of fiscal 2004:

|                  |                                                                      
|----------------- | ---------------------------------------------------------------------
|Mark S. Ain       | Chief Executive
Officer and Chairman                                 
|Paul A. Lacy      | Executive Vice President,
 Chief Financial and Administrative Officer
|Aron J. Ain       | Executive Vice President,
 Chief Operating Officer                   
|Peter C. George   | Vice President, Engineering
 and Chief Technology Officer            
|James Kizielewicz | Vice President, Marketing
 and Corporate Strategy                    



The figures for fiscal 2002 reflect
the Named Executive Officers as reported in our definitive proxy statement for our 2003
Annual Meeting of Shareholders.

---

# General Option Information.

Summary of Option Activity (in
thousands, except per share data)

|                                          |  | Shares Available for
Options | Number of
Shares | Weighted-Average Exercise
Price
per Share
|----------------------------------------- |  | ---------------------------- | ---------------- | -----------------------------------------
|Outstanding at
        September 30, 2003 |  |                              |                  | 1,229                                    
|Grants                                    |  |                              |                  | (1,144                                   
|Exercises                                 |  |                              |                  | --                                       
|Cancellations (1)                         |  |                              |                  | 2                                        
|                                          |  |                              |                  |                                          
|Outstanding at
        January 3, 2004    |  |                              |                  | 87                                       
|                                          |  |                              |                  |                                          

(1)  Includes 9,679 shares cancelled under
 the 1992 Equity Incentive Plan, which expired under its terms on March 27, 2002.

In-the-Money and Out-of-the-Money
Option Information as of January 3, 2004 (in thousands, except per share data)

|                          | Exercisable | Unexercisable | Total
|------------------------- | ----------- | ------------- | -----
|
|In-the-Money              |             | 1,122         |      
|Out-of-the-Money (1)      |             | --            |      
|                          |             |               |      
|Total Options Outstanding |             | 1,122         |      
|                          |             |               |      

(1)  Out-of-the-Money options are those options
with an exercise price equal to or above the closing price of $40.88 at the end of the current quarter.

---

Executive Options.    The following tables summarize option grants and exercises during the three
months ended January 3, 2004 to our Named Executive Officers and the value of the options
held by such persons at January 3, 2004.

Options Granted to Named
Executive Officers

|                          | Individual Grants | Potential Realizable Value at
        Assumed Annual Rates of Stock Price Appreciation for Option Term (4) | 
|------------------------- | ----------------- | ---------------------------------------------------------------------------------------------------------- | 
|
|Mark S. Ain               |                   | 88,500                                                                                                     | 
|CEO
         and Chairman |                  
|Paul A. Lacy              |                   | 58,500                                                                                                     | 
|Exec. V.P. and Chief      |                  
|Financial and             |                  
|Administrative Officer    |                  
|Aron J. Ain               |                   | 58,500                                                                                                     | 
|Exec. V.P. and Chief      |                  
|Operating Officer         |                  
|Peter C. George           |                   | 43,500                                                                                                     | 
|V.P., Engineering and     |                  
|Chief Technology Officer  |                  
|James Kizielewicz         |                   | 43,500                                                                                                     | 
|V.P., Marketing and       |                  
|Corporate Strategy        |                  



| | (1) | Each option vests in four equal annual installments commencing one year from the
               date of grant.
| | --- | --------------------------------------------------------------------------------------------------------------

| | (2) | Based on an aggregate of 1,144,250 shares subject to options granted to our
               employees in the three month period ended January 3, 2004.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------

---

| | (3) | The exercise price of each option was equal to the fair market value of our
               common stock on the date of grant as reported by The NASDAQ National
               Market®.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | Amounts represent hypothetical gains that could be achieved for the respective
               options if exercised at the end of the option term. These gains are based on
               assumed rates of stock appreciation of 5% and 10% compounded annually from the
               date the respective options were granted to their expiration date (and are shown
               net of the option exercise price, but do not include deductions for taxes or
               other expenses associated with the exercise of the options or the sale of the
               underlying shares.) Actual gains, if any, on stock option exercises will depend
               on the future performance of the common stock, the option holders
               continued employment with us through the option vesting period and the date on
               which the options are exercised.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Option Exercises and Remaining
 Holdings of Named Executive Officers

|Name              | Shares Acquired
        on Exercise | Value Realized(1) | Number of SecuritiesUnderlying
        Unexercised Optionsat Fiscal Year-EndExercisable/Unexercisable | Value of UnexercisedIn-The-Money Options at
        Fiscal Year-End (2)Exercisable/Unexercisable
|----------------- | ----------------------------------- | ----------------- | ----------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------
|Mark S. Ain       |                                     | 112,500           |                                                                                                       | $2,599,875                                                                                      
|Paul A. Lacy      |                                     | 12,375            |                                                                                                       | 292,793                                                                                         
|Aron J. Ain       |                                     | 12,375            |                                                                                                       | 299,244                                                                                         
|Peter C. George   |                                     | 28,125            |                                                                                                       | 704,612                                                                                         
|James Kizielewicz |                                     | 15,375            |                                                                                                       | 338,261                                                                                         



| | (1) | Represents the difference between the exercise price and the fair market value
               of the common stock on the date of exercise.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Based on the fair market value of the common stock on January 3, 2004 ($40.88),
               the last day of the first quarter of our 2004 fiscal year, less the option
               exercise price.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

# Item 3. Quantitative and
Qualitative Disclosures About Market Risk

We
are exposed to a variety of market risks, including changes in interest rates affecting
the return on our investments, foreign currency fluctuations and decreases in our common
stock price affecting capped call options. Refer to Note A, Summary of Significant
Accounting Policies, in the Notes to Consolidated Financial Statements in the Annual
Report on Form 10-K for the year ended September 30, 2003 for further discussion regarding
marketable securities, foreign currency forward exchange contracts and capped call option
arrangements. Our marketable securities that expose us to market rate risks are comprised
of debt securities. A decrease in interest rates would not adversely impact interest
income or related cash flows pertaining to securities held at January 3, 2004, as all of
these securities have fixed rates of interest. A 100 basis point increase in interest
rates would not adversely impact the fair value of these securities by a material amount
due to the size and average duration of the portfolio. Our exposure to market risk for
fluctuations in foreign currency relate primarily to the amounts due from subsidiaries.
Exchange gains and losses related to amounts due from subsidiaries have not been material.
For foreign currency exposures existing at January 3, 2004, a 10% unfavorable movement in
the foreign exchange rates for each subsidiary location would not expose us to material
losses in earnings or cash flows. The calculation assumes that each exchange rate would
change in the same direction relative to the U.S. dollar.

We
previously entered into short-term capped call options in conjunction with our stock
repurchase initiatives. During the first quarter of fiscal 2003, we received $2.6 million
upon the maturity of a call option arrangement. For more information on this call option,
please refer to Note K in the Notes to Consolidated Financial Statements in this Quarterly
Report on Form 10-Q. As of January 3, 2004, there were no capped call option arrangements
outstanding.

# Item 4. Controls and
Procedures.

(a)        
 Evaluation of Disclosure Controls and Procedures

The Companys management, with
the participation of the Companys Chief Executive Officer and Chief Financial
Officer, evaluated the effectiveness of the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934, as amended (the Exchange Act)) as of January 3, 2004. Based on this
evaluation, the Companys Chief Executive Officer and Chief Financial Officer
concluded that, as of January 3, 2004, the Companys disclosure controls and
procedures were (1) designed to ensure that material information relating to the Company,
including its consolidated subsidiaries, is made known to the Companys Chief
Executive Officer and Chief Financial Officer by others within those entities,
particularly during the period in which this report was being prepared and (2) effective,
in that they provide reasonable assurance that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SECs
rules and forms.

---

(b)        
Changes in Internal Controls

No change in the Companys
internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) occurred during the fiscal quarter ended January 3, 2004 that has
materially affected, or is reasonably likely to materially affect, the Companys
internal control over financial reporting.

---

PART II.     OTHER
INFORMATION

Item 6.   Exhibits and Reports on Form 8-K

(a)         
 Exhibits

| | 31.1
Certification by Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended.
| | ----------------------------------------------------------------------------------------------------------------------------

| | 31.2
Certification by Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended.
| | ----------------------------------------------------------------------------------------------------------------------------

| | 32.1
Certificate by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(b)        
          Reports on Form 8-K

| | On
January 6, 2004, the Company furnished a Current Report on Form 8-K under Item 12,
containing a copy of its earnings release, dated January 6, 2004, for the period ending
January 3, 2004 pursuant to Item 12 (Results of Operations and Financial Condition).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
January 29, 2004, the Company furnished a Current Report on Form 8-K under Item 12,
containing a copy of its earnings release, dated January 29, 2004, for the period ending
January 3, 2004 pursuant to Item 12 (Results of Operations and Financial Condition).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
February 2, 2004, the Company filed a Current Report on Form 8-K under Item 5, containing
an amendment to a proposal contained in the Companys definitive proxy materials
regarding the approval of the issuance of additional common stock for the Companys
2002 Stock Incentive Plan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---

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.

February 17, 2004

KRONOS INCORPORATED

| | By /s/ Paul A. Lacy                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | Paul A. Lacy
Executive Vice President,
Chief Financial and Administrative Officer
(Duly Authorized Officer and
Principal Financial Officer)



---

# KRONOS INCORPORATED 
EXHIBIT INDEX

|Exhibit
        Number | Description                                                                                                                                                                   
|---------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1                   | Certification by Chief Executive Officer
pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                                                       
|31.2                   | Certification by Chief Financial Officer
 pursuant to Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended.                                                     
|32.1                   | Certificate by Chief Executive Officer
 and Chief Financial Officer pursuant  to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.