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

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FORM 10-Q

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

For the quarterly period ended March 31, 2004

OR

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

For the transition period from ________to _________

Commission file number:  000-27163



KANA Software, Inc.



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

181 Constitution Drive Menlo Park, California     94025

(650) 614-8300







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 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 of
the Exchange Act).   YES [   ] NO [X]

On April 30, 2004, approximately 29,005,770 shares of the Registrant's Common Stock,
$0.001 par value, were outstanding.









KANA Software, Inc.
                                    Form 10-Q
                            Quarter Ended March 31, 2004
                                      Index



|PART I.   FINANCIAL INFORMATION                                                                                         | Page No.
|----------------------------------------------------------------------------------------------------------------------- | --------
|                                                                                                                        |         
|Item 1.   Financial Statements                                                                                          |         
|                                                                                                                        |         
|Condensed Consolidated Balance Sheets at
          
         March 31, 2004 and December 31, 2003                       | 3       
|                                                                                                                        |         
|Condensed Consolidated Statements of Operations for 
          
         the three months ended March 31, 2004 and 2003 | 4       
|                                                                                                                        |         
|Condensed Consolidated Statements of Cash Flows for
          
         the three months ended March 31, 2004 and 2003  | 5       
|                                                                                                                        |         
|Notes to the Condensed Consolidated Financial Statements                                                                | 6       
|                                                                                                                        |         
|Item 2.   Management's Discussion and Analysis of Financial
                      Condition and Results of Operations   | 16      
|                                                                                                                        |         
|Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                                    | 37      
|                                                                                                                        |         
|Item 4.   Controls and Procedures                                                                                       | 37      
|                                                                                                                        |         
|PART II.  OTHER INFORMATION                                                                                             |         
|                                                                                                                        |         
|Item 1:  Legal Proceedings                                                                                              | 38      
|                                                                                                                        |         
|Item 2:  Changes in Securities and Use of Proceeds                                                                      | 38      
|                                                                                                                        |         
|Item 3:  Defaults Upon Senior Securities                                                                                | 38      
|                                                                                                                        |         
|Item 4.   Submission of Matters to a Vote of Security Holders                                                           | 38      
|                                                                                                                        |         
|Item 5.   Other Information                                                                                             | 38      
|                                                                                                                        |         
|Item 6.   Exhibits and Reports on Form 8-K                                                                              | 38      
|                                                                                                                        |         
|Signatures                                                                                                              | 40      
|                                                                                                                        |         

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Part I: Financial Information

Item 1: Financial Statements

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KANA Software, Inc.

                     CONDENSED CONSOLIDATED BALANCE SHEETS

                                 (In thousands)
March 31,    December 31,
                                                          2004          2003
                                                      -----------   -----------
                                                              (unaudited)
ASSETS
Current assets:
 Cash and cash equivalents.........................  $    25,852  $     25,632
 Short-term investments............................        7,351         7,324
 Accounts receivable, less allowance for doubtful
   accounts of $1,189 in 2004 and $1,187 in 2003...        5,624         7,908
 Prepaid expenses and other current assets.........        2,941         3,527
                                                      -----------   -----------
   Total current assets............................       41,768        44,391
Restricted cash....................................          318           461
Property and equipment, net........................       14,003        15,435
Goodwill...........................................        8,623         7,448
Intangible assets, net.............................          381            --
Other assets.......................................        2,149         2,143
                                                      -----------   -----------
    Total assets...................................  $    67,242  $     69,878
                                                      ===========   ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Notes payable ....................................  $     3,427  $      3,427
 Accounts payable..................................        3,582         2,238
 Accrued liabilities...............................       10,164        10,678
 Accrued restructuring.............................        3,267         3,336
 Deferred revenue..................................       20,265        20,544
                                                      -----------   -----------
  Total current liabilities........................       40,705        40,223
Deferred revenue, less current portion.............        1,193         1,265
Accrued restructuring, less current portion........        6,265         6,858
                                                      -----------   -----------
    Total liabilities..............................       48,163        48,346
                                                      -----------   -----------
Stockholders' equity:
 Common stock......................................          201           201
 Additional paid-in capital........................    4,287,455     4,286,508
 Deferred stock-based compensation.................         (788)       (1,541)
 Accumulated other comprehensive income (loss).....          (29)           38
 Accumulated deficit...............................   (4,267,760)   (4,263,674)
                                                      -----------   -----------
    Total stockholders' equity.....................       19,079        21,532
                                                      -----------   -----------
    Total liabilities and stockholders' equity.....  $    67,242  $     69,878
                                                      ===========   ===========See accompanying notes to unaudited condensed consolidated financial statements.
KANA Software, Inc.

             CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

                   (In thousands, except per share amounts)
Three Months Ended
                                                             March 31,
                                                      --------------------
                                                          2004       2003
                                                      ---------  ---------
                                                            (unaudited)
Revenues:
   License.......................................... $   4,583  $   9,351
   Service..........................................     8,672      8,758
                                                      ---------  ---------
Total revenues......................................    13,255     18,109
                                                      ---------  ---------
Cost of revenues:
   License..........................................       786        918
   Service (excluding stock-based
       compensation of $40 and $103, respectively)..     2,557      2,362
                                                      ---------  ---------
Total cost of revenues..............................     3,343      3,280
                                                      ---------  ---------
Gross profit........................................     9,912     14,829
                                                      ---------  ---------
Operating expenses:
   Sales and marketing (excluding stock-based
    compensation of $213 and $549, respectively)....     6,453      7,437
   Research and development (excluding stock-based
    compensation of $199 and $513, respectively)....     4,984      6,080
   General and administrative (excluding stock-based
    compensation of $91 and $222, respectively).....     2,016      2,680
   Amortization of stock-based compensation.........       543      1,387
   Amortization of identifiable intangibles.........        19      1,200
                                                      ---------  ---------
Total operating expenses............................    14,015     18,784
                                                      ---------  ---------
Operating loss......................................    (4,103)    (3,955)
Other income, net...................................        83         90
Income tax expense..................................        66         --
                                                      ---------  ---------
Net loss............................................ $  (4,086) $  (3,865)
                                                      =========  =========

Basic and diluted net loss per share................ $   (0.14) $   (0.17)
                                                      =========  =========

Shares used in computing basic and
  diluted net loss per share........................    28,640     22,958
                                                      =========  =========See accompanying notes to unaudited condensed consolidated financial statements.
KANA Software, Inc.

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In thousands)
Three Months Ended
                                                                        March 31,
                                                                 ----------------------
                                                                     2004        2003
                                                                 ---------  -----------
                                                                        (unaudited)
Cash flows from operating activities:
   Net loss.................................................... $  (4,086) $    (3,865)
   Adjustments to reconcile net loss to net cash provided by
     (used in) operating activities, net of acquisitions:
     Depreciation..............................................     1,491        2,360
     Amortization of stock-based compensation..................       543        1,387
     Amortization of identifiable intangibles..................        19        1,200
     Change in allowance for doubtful accounts.................         2           --
     Changes in operating assets and liabilities:
         Accounts receivable...................................     2,345        3,390
         Prepaid and other current assets......................       611          236
         Other assets..........................................        60          357
         Accounts payable and accrued liabilities..............       743       (2,008)
         Accrued restructuring and merger......................      (795)        (691)
         Deferred revenue......................................      (657)      (3,191)
                                                                 ---------  -----------
     Net cash provided by (used in) operating activities.......       276         (825)
                                                                 ---------  -----------
Cash flows from investing activities:
   Purchases of short-term investments.........................      (374)        (862)
   Sales/maturities of short-term investments..................       347        9,868
   Property and equipment purchases............................       (48)        (236)
   Cash paid for acquisition...................................      (434)          --
   Cash acquired through the acquisition.......................        13           --
   Decrease in restricted cash.................................       143           --
                                                                 ---------  -----------
         Net cash provided by (used in) investing activities...      (353)       8,770
                                                                 ---------  -----------
Cash flows from financing activities:
   Payments on capital lease obligations.......................        --          (23)
   Net proceeds from issuance of common stock..................       229           62
                                                                 ---------  -----------
         Net cash provided by financing activities.............       229           39
                                                                 ---------  -----------
Effect of exchange rate changes on cash and cash equivalents...        68          217
                                                                 ---------  -----------
Net increase in cash and cash equivalents......................       220        8,201
Cash and cash equivalents at beginning of period...............    25,632       21,962
                                                                 ---------  -----------
Cash and cash equivalents at end of period..................... $  25,852  $    30,163
                                                                 =========  ===========
Supplemental disclosure of cash flow information:
 Cash paid during the period for interest...................... $      58  $        59
                                                                 =========  ===========
 Cash paid during the period for income taxes.................. $      59  $         4
                                                                 =========  ===========See accompanying notes to unaudited condensed consolidated financial statements.
KANA Software, Inc.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (unaudited)Note 1. Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared
by KANA Software, Inc. ("KANA" or the "Company"), and reflect all normal,
recurring adjustments that, in the opinion of management, are necessary for a
fair presentation of the interim financial information. The results of
operations for the interim periods presented are not necessarily indicative of
the results to be expected for any subsequent quarter or for the entire year
ending December 31, 2004. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted under the Securities and Exchange Commission's ("SEC")
rules and regulations. These unaudited condensed consolidated financial
statements and notes included herein should be read in conjunction with KANA's
audited consolidated financial statements and notes included in KANA's annual
report on Form 10-K for the year ended December 31, 2003.

The consolidated financial statements include the financial statements of
KANA and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.

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

The Company believes that its existing cash balances and anticipated cash
flows from operations will be sufficient to meet its anticipated capital
requirements for the next 12 months. However, failure to increase future orders
and revenues beyond the level achieved in the first quarter of 2004 might
require the Company to seek additional capital to meet its working capital needs
during or beyond the next twelve months if the Company is unable to reduce
expenses to the degree necessary to avoid incurring losses. If the Company
has a need for additional capital resources, it may be required to sell
additional equity or debt securities, secure additional lines of credit or
obtain other third party financing. The timing and amount of such capital
requirements cannot be determined at this time and will depend on a number of
factors, including demand for the Company's products and services. There can be
no assurance that such additional financing will be available on satisfactory
terms when needed, if at all. Failure to raise such additional financing,
if needed, may result in the Company not being able to achieve its long-term
business objectives.

The Company accounts for its stock-based compensation arrangements with
employees using the intrinsic-value method in accordance with Accounting
Principles Board 25, "Accounting for Stock Issued to Employees". Deferred stock-
based compensation is recorded on the date of grant when the deemed fair value
of the underlying common stock exceeds the exercise price for stock options or
the purchase price for the shares of common stock.
The Company accounts for stock-based compensation arrangements with non-
employees in accordance with Emerging Issues Task Force Abstract No. 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services". Accordingly,
unvested options and warrants held by non-employees are subject to revaluation
at each balance sheet date based on the then current fair market value.

Note 2. Recent Accounting Pronouncements

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

In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150,  "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability
 (or an asset in some circumstances) because that financial instrument
embodies an obligation of the issuer. In November 2003, the FASB issued FASB
Staff Position No. FASB 150-03 which deferred the measurement provisions of SFAS
No. 150 indefinitely for certain mandatorily redeemable non-controlling
interests that were issued before November 5, 2003. The FASB plans to reconsider
implementation issues and, perhaps, classification or measurement guidance for
those non-controlling interests during the deferral period. To date, the impact
of the effective provisions of SFAS No. 150 have not had a material impact on
the Company's results of operations, financial position or cash flows. While the
effective date of certain elements of SFAS No. 150 have been deferred, the
adoption of SFAS No. 150 when finalized is not expected to have a material
impact on the Company's financial position, results of operations or cash
flows.

In March 2004, the FASB approved Emerging Issues Task Force
("EITF") Issue 03-06 "Participating Securities and the Two-Class
Method under FAS 128". EITF Issue 03-06 supersedes the guidance in Topic
No. D-95, "Effect of Participating Convertible Securities on the
Computation of Basic Earnings per Share", and requires the use of the two-
class method of participating securities. The two-class method is an earnings
allocation formula that determines earnings per share for each class of common
stock and participating security according to dividends declared (or
accumulated) and participation rights in undistributed earnings. In addition,
EITF Issue 03-06 addresses other forms of participating securities, including
options, warrants, forwards and other contracts to issue an entity's common
stock, with the exception of stock-based compensation (unvested options and
restricted stock) subject to the provisions of Opinion No. 25 and FASB No. 123.
EITF Issue 03-06 is effective for reporting periods beginning after March 31,
2004 and should be applied by restating previously reported earnings per share.
The Company is currently in the process of evaluating the impact that the
adoption of EITF Issue 03-06 will have on its financial position and results of
operations.

Note 3. Business Combinations

On February 10, 2004, the Company completed the acquisition of a 100% equity
interest in Hipbone, Inc., a provider of online customer interaction solutions.
The acquisition allows the Company to add Hipbone's Web collaboration, chat, co-
browsing and file-sharing capabilities its products. This transaction was
accounted for using the purchase method of accounting, and operations of the
acquired entity from February 10, 2004 are included in the Company's income
statement. Under the terms of the agreement, the Company paid $265,000 and
issued a total of 262,500 shares of KANA's common stock valued at approximately
$926,000 using the five-trading-day average price surrounding the date the
acquisition was announced on January 5, 2004, or $3.62 per share. The Company
incurred a total of approximately $169,000 in direct transaction costs. The
estimated purchase price was approximately $1.4 million, summarized as follows
(in thousands):

Fair market value of common stock...  $     926
Cash consideration..................        265
Acquisition related costs...........        169
                                       ---------
Total purchase price................  $   1,360
                                       =========
As of the acquisition date, the Company recorded the fair market value of
Hipbone's assets and liabilities. Fair market value is defined as the amount at
which an asset could be bought or sold in a current transaction between willing
parties. The values of the Company's intangible assets were determined with the
assistance of an independent appraiser, primarily using the income approach. To
the extent that the purchase price exceeded the fair value of the assets and
liabilities assumed, goodwill was recorded. The resulting intangible assets
acquired in connection with the acquisition are being amortized over a three-
year period. The allocation of the purchase price to assets acquired and
liabilities assumed was as follows (in thousands):
Tangible assets acquired............      $     178
Identifiable intangible assets acquired:
  Purchased technology..............            250
  Customer relationships............            150
  Goodwill..........................          1,175
Liabilities assumed.................           (393)
                                           ---------
Net assets acquired.................      $   1,360
                                           =========

Purchased intangible assets relate to $250,000 and $14.4 million of existing
technology purchased in connection with the acquisitions of Hipbone, Inc.
(Hipbone) in February 2004 and Silknet Software, Inc. (Silknet) in April 2000,
respectively, and  customer relationships valued at $150,000 in connection with
the Hipbone acquisition. Purchased intangible assets are carried at cost less
accumulated amortization. Amortization is computed over the estimated useful
lives of the asset, which is three years. The purchased intangible assets
related to Silknet were fully amortized as of April 2003. The Company reported
amortization expense on purchased intangible assets of $19,000 and $1.2 million
for the three months ended March 31, 2004 and 2003, respectively.

Note 4. Stockholders' Equity

(a) Warrants

In September 2000, in connection with a global strategic alliance with
Accenture, the Company issued to Accenture 40,000 shares of common stock and a
warrant to purchase up to 72,500 shares of common stock at $371.25 per share,
through December 2005. The shares of the common stock issued were fully vested,
and the Company reported a charge of approximately $14.8 million which was
amortized over the term of the associated alliance agreement through December
2003. As of March 31, 2004, 33,997 shares of common stock subject to the warrant
were fully vested and 38,503 had been forfeited. The warrant was valued using
the Black-Scholes model, resulting in charges totaling $2.0 million of which
$1.0 million was amortized over the term of the associated alliance agreement
through December 2003 and $1.0 million was immediately expensed in the fourth
quarter of 2000.

In September 2001, the Company issued to Accenture an additional warrant to
purchase up to 150,000 shares of common stock at $3.33 per share in connection
with its global strategic alliance. The warrant was exercised in February 2002
on a net basis, where Accenture surrendered 39,716 shares subject to the warrant
in lieu of paying the exercise price with cash. The warrant was valued using the
Black-Scholes model resulting in a charge of approximately $946,000 which was
amortized on a straight-line basis over the term of the associated alliance
agreement through December 2003.

In September 2001, the Company issued to a customer a warrant to purchase up
to 5,000 shares of common stock at $7.50 per share, until September 2006. The
warrant will be fully vested in September 2006 and has a provision for
acceleration of vesting 1,250 shares annually over four years if the customer
meets certain marketing criteria. The warrant was valued using the Black-Scholes
model resulting in a charge to stock-based compensation of approximately $29,000
which is being amortized over the five-year term of the agreement on a straight-
line basis.

In December 2003, the Company issued to a customer a warrant to purchase up
to 230,000 shares of common stock at $5.00 per share in connection with a
marketing agreement. The warrant is fully exercisable and expires five years
from the date of issuance. The warrant was valued at approximately $459,000,
using the Black-Scholes model, and its issuance was accounted for as a reduction
of revenue in the fourth quarter of 2003.
(b) Stock-Based Compensation
As discussed in Note 1, the Company accounts for its stock-based
compensation arrangements with employees using the intrinsic-value method in
accordance with Accounting Principles Board 25, "Accounting for Stock Issued to
Employees".
We amortize deferred stock-based compensation on an accelerated basis by
charges to operations over the vesting period of the options, consistent with
the method described in FIN 28. As of March 31, 2004, there was approximately
$788,000 of total deferred stock-based compensation remaining to be amortized
related to warrants and past employee stock option grants. We expect to amortize
approximately $730,000 of this deferred stock-based compensation in the
remainder of 2004, and approximately $58,000 in 2005. Amortization may be
reduced in future periods to the extent employees are terminated prior to
vesting.
The Company has adopted the disclosure requirements of SFAS No. 148,
"Accounting for Stock-Based Compensation, Transition and Disclosure". SFAS No.
148 provides alternative methods of transition for a voluntary change to the
fair-value based method of accounting for stock-based compensation provided for
by SFAS No. 123, "Accounting for Stock Based Compensation". The
following table presents pro forma amounts had the Company adopted SFAS No. 123
and accounted for stock-based compensation using the fair-value based method (in
thousands, except per share amounts (unaudited)):
Three Months Ended
                                                                March 31,
                                                       -----------------------
                                                         2004          2003
                                                       ---------     ---------
As Reported:
  Net loss.........................................  $   (4,086)   $   (3,865)

Compensation expense included in net loss (1)......  $      285    $       81

Compensation expense if FAS 123 had been adopted ..  $   (2,749)   $    1,637

Pro Forma:
  Net loss.........................................  $   (6,550)   $   (2,147)

Basic and diluted net loss per share
  As reported......................................  $    (0.14)   $    (0.17)
  Pro forma........................................  $    (0.23)   $    (0.09)(1) The Company currently records and amortizes deferred stock-based
compensation for warrants granted to non-employees.  Accordingly, the
compensation expense above relates only to employee-related options. Unearned
deferred compensation resulting from employee and non-employee option grants is
amortized on an accelerated basis over the vesting period of the individual
options, in accordance with FIN 28. Accordingly, the stock based compensation
expense noted above is net of the reversal of previously recorded accelerated
stock based compensation expense due to the forfeitures of those stock options
prior to vesting.


Note 5. Net Loss Per Share

Basic net loss per share from continuing operations is computed using the
weighted-average number of outstanding shares of common stock, excluding common
stock subject to repurchase. Diluted net loss per share from continuing
operations is computed using the weighted-average number of outstanding shares
of common stock and, when dilutive, shares of common stock issuable upon
exercise of options and warrants deemed outstanding using the treasury stock
method. The following table presents the calculation of basic and diluted net
loss per share from continuing operations (in thousands, except net loss per
share (unaudited)):
Three Months Ended
                                                                     March 31,
                                                              --------------------
                                                                  2004       2003
                                                              ---------  ---------
Numerator:
Net Loss.................................................... $  (4,086) $  (3,865)
                                                              ---------  ---------
Denominator:
Weighted-average shares of common stock outstanding ........    28,640     22,964
Less: weighted-average shares subject to repurchase ........        --         (6)
                                                              ---------  ---------
Denominator for basic and diluted calculation ..............    28,640     22,958
                                                              ---------  ---------
Basic and diluted net loss per share: ...................... $   (0.14) $   (0.17)
                                                              =========  =========All warrants and outstanding stock options have been excluded from the
calculation of diluted net loss per share as all such securities were anti-
dilutive for all periods presented. The total number of shares excluded from the
calculation of diluted net loss per share was (in thousands (unaudited)):
As of March 31,
                                      ----------------------
                                          2004         2003
                                      ---------  -----------
Stock options and warrants .........     9,346        9,394
Common stock subject to repurchase .        --            1
                                      ---------  -----------
                                         9,346        9,395
                                      =========  ===========The weighted average exercise price of stock options and warrants outstanding
was $14.46 and $21.75 as of March 31, 2004 and 2003, respectively.
Note 6. Comprehensive Loss
Comprehensive loss is comprised of net loss and foreign currency
translation adjustments. The total changes in comprehensive loss during the
three ended March 31, 2004 and 2003 were as follows (in thousands
(unaudited)):
Three Months Ended
                                         March 31,
                                   ----------------------
                                     2004          2003
                                   -------      ---------
Net loss......................    $(4,086)     $  (3,865)

Other comprehensive income (loss):

  Foreign currency translation
    adjustments, net of tax...        (68)          (217)
                                   -------      ---------
Net change in other
  comprehensive income (loss).        (68)          (217)
                                   -------      ---------
Comprehensive loss............    $(4,154)     $  (4,082)
                                   =======      =========Note 7. Commitments and Contingencies

(a) Legal Proceedings

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

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

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

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

(b) Guarantees

The Company leases its facilities under noncancelable operating leases
with various expiration dates through December 2010. In connection with its
existing leases, the Company entered into letters of credit totaling $1.1
million expiring in 2004 through 2011. The letters of credit are supported by
either restricted cash or the Company's line of credit.

(c) Indemnifications

The Company enters into standard indemnification agreements in its
ordinary course of business. Pursuant to these agreements, the Company
indemnifies, holds harmless, and agrees to reimburse the indemnified party for
losses suffered or incurred by the indemnified party in connection with any
patent, copyright, or other intellectual property infringement claim by any
third party with respect to the Company's products. The term of these
indemnification agreements is generally perpetual any time after execution of
the agreement. The maximum potential amount of future payments the Company could
be required to make under these indemnification agreements is unlimited. The
Company believes the estimated fair value of these agreements is insignificant.
Accordingly, the Company has no liabilities recorded for these agreements as of
March 31, 2004.

As permitted by Delaware law, the Company has agreements whereby it
indemnifies its officers and directors for certain events or occurrences while
the officer is, or was, serving at the Company's request in such capacity. The
term of the indemnification period is for the officer's or director's lifetime.
The maximum potential amount of future payments the Company could be required to
make under these indemnification agreements is unlimited; however, the Company
has a director and officer insurance policy that limits its exposure and enables
the Company to recover a portion of any such amounts. As a result of the
Company's insurance policy coverage, the Company believes the estimated fair
value of these indemnification agreements is insignificant.  Accordingly, the
Company has no liabilities recorded for these agreements as of March 31,
2004.

(d) Warranties
The Company offers warranties on its software
products. To date, there have been no material payments or costs incurred
related to fulfilling these warranty obligations. Accordingly, the Company has
no liabilities recorded for these warranties as of March 31, 2004. The Company
assesses the need for a warranty reserve on a quarterly basis and there can be
no guarantee that a warranty reserve will not become necessary in the
future.

(e) Outsourcing Arrangements
In January 2003, the Company began
implementing an outsourcing strategy, which involves subcontracting a
significant portion of its software programming, quality assurance and technical
documentation activities to development partners with staffing in India and
China. As a result of transitioning these activities offshore, the Company
reduced its research and development department by 88 employees in 2003. The
Company signed contracts with development partners in 2003, with expected
payments in 2004 of approximately $9.2 million, primarily on a time and
materials basis. One contract is cancelable with 90 days notice and a fee
of $28,000 if notice is given prior to August 1, 2004.

Note 8. Restructuring costs

As of March 31, 2004, $9.5 million in restructuring liabilities remained
on the Company's unaudited consolidated balance sheet in accrued restructuring
costs. Cash payments for excess leased facilities during the three months ended
March 31, 2004 totaled $0.9 million. Cash received during the three months ended
March 31, 2004 from subleases charged to restructuring expense in previous
periods totaled $117,000. The following table provides a summary of
restructuring payments and liabilities during the first three months of 2004 (in
thousands (unaudited)):
Restructuring                                      Restructuring
                     Accrual at               Sublease     Effect of    Accrual at
                    December 31,   Payments   Payments      Exchange     March 31,
                        2003         Made     Received    Rate change      2004
                    ------------   --------  -----------  ----------   ------------
Severance..........$        184  $      --  $        --  $       --   $        184
Facilities.........      10,010       (912)         117         133          9,348
                    ------------   --------  -----------  ----------   ------------
Total .............$     10,194  $    (912) $       117  $      133   $      9,532
                    ============   ========  ===========  ==========   ============Should facilities operating lease rental rates continue to decrease in these
markets, or should it take longer than expected to find a suitable tenant to
sublease these facilities, the actual loss could exceed this estimate. Future
cash outlays are anticipated through December 2010 unless the Company negotiates
to exit the leases at an earlier date.




Note 9. Segment Information

The Company's chief operating decision-maker reviews financial
information presented on a consolidated basis, accompanied by disaggregated
information about revenues by geographic region for purposes of making operating
decisions and assessing financial performance. Accordingly, the Company
considers itself to be in a single industry segment, specifically the license,
implementation and support of its software applications. The Company's long-
lived assets are primarily in the United States. The following table provides
geographic information on revenue for the three months ended March 31, 2004 and
2003 (in thousands, (unaudited)):
Three Months Ended
                                             March 31,
                                      ----------------------
                                          2004         2003
                                      ---------  -----------
United States ...................... $   8,767  $    12,221
United Kingdom......................     1,684        3,451
Asia Pacific........................       587        1,026
Other (1) ..........................     2,217        1,411
                                      ---------  -----------
                                     $  13,255       18,109
                                      =========  ===========(1) Represents sales to customers located primarily in Europe, other than the
United Kingdom.



During the three months ended March 31, 2004, no customer represented greater
than 10% of total revenues. During the three months ended March 31, 2003, two
customers represented 15% and 11% of total revenues, respectively.

Note 10. Notes Payable

At March 31,
2004, the Company maintained a line of credit
totaling $5.0 million, which is collateralized by all of its assets and bears an
annual interest rate equal to the greater of the bank's prime rate or 4.0% (4.0%
as of March 31, 2004 and
4.75% as of March 31, 2003
). The line of credit expires in November 2004, at which time the entire
balance of the line of credit will be due. Total borrowings
as of March 31, 2004 and 2003 were $3.4 million under this line of credit.
The line of credit contains a financial
covenant that requires the Company to maintain at least a $6.0 million dollar
balance in cash or cash equivalents with the bank at all times or pay a one-time
fee of $10,000. The line of credit also requires that the
Company maintains at all times a minimum of $20.0 million as short-term
unrestricted cash and cash equivalents. As of March 31, 2004, the Company was in
compliance with all financial covenants.

Future payments due under the Company's debt and lease obligations as of
March 31, 2004 were as follows (in thousands (unaudited)):
Payments due by period
                                                -------------------------------------------------
                                                        Less than      1-3       3-5    More than
 Contractual Obligations:                        Total   1  year      years     years    5 years
                                                ------   ----------- --------   -------  --------
 Line of Credit                            $    3,427  $    3,427  $      --  $     -- $      --

 Non-cancelable Operating Lease Obligation     23,935       4,070     11,794     5,784     2,287

 Less: (Sublease Income)                       (2,617)       (414)    (1,347)     (641)     (215)

 Purchase Obligations (1)                       2,520       2,520         --        --        --
                                             ---------   ---------   --------   -------  --------
                                 Total     $   27,265  $    9,603  $  10,447  $  5,143 $   2,072
                                            ==========  ==========  =========  ======== =========(1) Represents minimum payments to one vendor providing
outsourced software programming, quality assurance and technical documentation
activities in India. The agreement is cancelable with 90 days notice and a fee
of $28,000 if notice is given prior to August 1, 2004.



Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations

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

Overview

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

KANA is headquartered in the Silicon Valley in Menlo Park, California, with
offices in Japan, Korea, and throughout the United States and Europe. Our
revenue is primarily derived from the sale of our software and related
maintenance and support of the software. To a lesser extent, we derive revenues
from training and consulting. Our products are generally installed by our
customers, using a system integrator, such as IBM, Accenture, or Bearing Point.
To a large degree, we rely on our relationships with these system integrators
who co-develop, recommend, and install our software. This provides leverage in
the selling phase, and also allows us to realize higher gross margins by selling
primarily software licenses and support, which typically have higher margins
than consulting and implementation services. However, since our applications are
generally installed by our customers using a system integrator, these services
generally increase the cost of the project substantially, subjecting their
purchase to more levels of required approval and scrutiny of projected cost
savings in their customer service and marketing departments. Consequently, we
face difficulty predicting the quarter in which sales to expected customers will
occur, if at all, which contributes to the uncertainty of our future operating
results. Moreover, to the extent that significant sales occur earlier or later
than anticipated, revenues for subsequent quarters may be lower or higher,
respectively, than expected.

We have grown rapidly through acquisitions until recent years. These
acquisitions provided us with much of the core technology used in our
applications. In 2001-2003, we have substantially reduced the scale of our
operations as we began leveraging the service and development capabilities of
system integrators, and have acted to reduce costs and focus our product
offerings.

In the past three years, we have experienced a cautious purchasing
environment in our industry. We feel that this is largely a reaction to the
uncertain economy, which had a disproportionate effect on information technology
spending. While general economic conditions began to stabilize and improve in
the second half of 2003, we believe that our market continued to exhibit
cautiousness and uncertainty and that as a result, many enterprises continued to
be reluctant to invest in large CRM applications. Since 1997 we have incurred
substantial costs to develop our products and to recruit, train and compensate
personnel for our engineering, sales, marketing, client services and
administration departments. As a result, we have incurred substantial losses
since inception. For the three months ended March 31, 2004, we recorded a net
loss of $4.1 million. As of March 31, 2004, we had an accumulated deficit of
$4.3 billion, which includes approximately $2.7 billion related to goodwill
impairment charges in prior years. We expect our operating expenses in the first
half of 2004 to be lower in absolute dollars than the same period of 2003, as a
result of our personnel and facility cost reductions throughout 2003. We expect
our cash and cash equivalents and short-term investments on hand will be
sufficient to meet our working capital and capital expenditures needs for the
next 12 months.

In the first quarter of 2003, we began implementing an outsourcing strategy,
which involves subcontracting a significant portion of our software programming,
quality assurance and technical documentation activities to Accenture, HCL, IBM
and Bearing Point with staffing in India and China.

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

In February 2004, we completed the acquisition of Hipbone, Inc., a provider
of online customer interaction solutions. The total purchase price approximated
$1.4 million. As a result of this acquisition, we now offer Hipbone's Web
collaboration, chat, co-browsing and file-sharing capabilities.

As of March 31, 2004, we had 209 full-time employees, which represents a
slight decrease from 211 employees at December 31, 2003.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires us to make estimates and judgments that affect our reported
assets, liabilities, revenues and expenses, and our related disclosure of
contingent assets and liabilities. We continually evaluate our estimates,
including those related to revenue recognition, collectibility of receivables,
goodwill and intangible assets, contract loss reserve, income taxes, and
restructuring. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances. This
forms the basis of judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.

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

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

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

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

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

Customer support revenues arise primarily from providing global support to
our customers and partners, including phone and e-mail support and self-service
solutions. Customer support service revenues are recognized ratably over the
term of the contract, typically one year.

Consulting revenues are generated primarily by providing specific subject
matter expertise as opposed to overall project management and are recognized as
services are performed.

Revenues from training services are recognized as services are performed.

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

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

Accounting for Internal-Use Software. Internal-use software costs,
including fees paid to third parties to implement the software, are capitalized
beginning when we have determined various factors are present, including among
others, that technology exists to achieve the performance requirements, we have
made a decision as to whether we will purchase the software or develop it
internally, and we have authorized funding for the project. Capitalization of
software costs ceases when the software implementation is substantially complete
and is ready for its intended use, and the capitalized costs are amortized over
the software's estimated useful life (generally five years) using the straight-
line method. As of March 31, 2004, we had $10.4 million of capitalized costs of
internal use software, net of $4.8 million accumulated depreciation.

When events or circumstances indicate the carrying value of internal use
software might not be recoverable, we assess the recoverability of these assets
by determining whether the amortization of the asset balance over its remaining
life can be recovered through undiscounted future operating cash flows of these
assets. The amount of impairment, if any, is recognized to the extent that the
carrying value exceeds the projected discounted future operating cash flows and
is recognized as a write down of the asset. In addition, if it is no longer
probable that computer software being developed will be placed in service, the
asset will be adjusted to the lower of its carrying value or fair value, if any,
less direct selling costs. Any such adjustment would result in an expense in the
period recorded, which could have a material adverse effect on our consolidated
statement of operations. Based on our assessment as of March 31, 2004, we
determined that no such impairment of internal-use software existed.

Restructuring. During 2001, we recorded significant liabilities in
connection with our restructuring program. These reserves included estimates
pertaining to contractual obligations related to excess leased facilities. We
have a total of approximately 82,000 square feet of excess space available for
sublease or renegotiation. Locations of the excess space include Menlo Park,
California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining
lease commitment terms on these leases vary from seven to eight years. We are
seeking to sublease or renegotiate the obligations associated with the excess
space. We had $9.3 million in accrued restructuring costs relating to excess
leased facilities as of March 31, 2004, which is our estimate, as of that date,
of the exit costs of these excess facilities. We have worked with real estate
brokers in each of the markets where the properties are located to help us
estimate the amount and timing of potential sub-leases for the respective
facilities. This process involves significant judgments regarding these markets.
If we determine that any of these real estate markets continues to deteriorate,
additional adjustments to this accrual may be required, which would result in
additional restructuring expenses in the period in which such determination is
made. For example, in December 2003, we recorded $1.7 million in restructuring
costs related to a change in evaluation of real estate market conditions in the
United Kingdom, and changes in sublease estimates based on communication from
current and potential subtenants in the United States. Likewise, if any of these
real estate markets strengthen, and we are able to sublease the properties
earlier or at more favorable rates than projected, or if we are otherwise able
to negotiate early termination of obligations on favorable terms, adjustments to
the accrual may be required that would increase income in the period in which
such determination is made. As of March 31, 2004, our estimate of accrued
restructuring cost assumes receipt of $11.1 million in sublease payments that
are not yet under contractual arrangement, and in most cases, a potential
sublessor has not been identified. We have assumed that the majority of these
sublease payments will begin in 2005 through 2007 and continue through the end
of the related leases.

Goodwill and Intangible Assets. Consideration paid in connection with
acquisitions is required to be allocated to the acquired assets, including
identifiable intangible assets, and liabilities acquired.  Acquired assets and
liabilities are recorded based on our estimate of fair value, which requires
significant judgment with respect to future cash flows and discount rates. For
intangible assets other than goodwill, we are required to estimate the useful
life of the asset and recognize its cost as an expense over the useful life. We
use the straight-line method to expense long-lived assets, which results in an
equal amount of expense being recorded in each period. Amortization of goodwill
ceased as of January 1, 2002 upon our adoption of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. We are now
required to test goodwill for impairment under certain circumstances and write
down goodwill when it is impaired. We have determined that our consolidated
results comprise one reporting unit for the purpose of impairment testing
through March 31, 2004.

During the three months ended June 30, 2003 we performed our annual test for
goodwill impairment as required by Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). We currently
operate in one reportable segment, which is also the only reporting unit for the
purposes of SFAS 142. We completed our evaluation and concluded that goodwill
was not impaired as the fair value of our Company exceeded its carrying value,
including goodwill. The amount of goodwill as of March 31, 2004 was $8.6
million. Future events could cause us to conclude that impairment indicators
exist and that goodwill and other intangible assets associated with our acquired
businesses are impaired.

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

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

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

Results of Operations Data

The following table sets forth selected data for the indicated periods.
Percentages are expressed as a percentage of total revenues (in thousands).

`Three Months Ended
                                                          March 31,
                                               ---------------------------------
                                                      2004              2003
Revenues:                                      ---------------   ---------------
     License..............................    $ 4,583      35 %   $ 9,351    52 %
     Service..............................      8,672      65       8,758    48
                                               ------- -------     ------- -----
Total revenues............................     13,255     100      18,109   100
                                               ------- -------     ------- -----
Cost of revenues:
     License..............................        786       6         918     5
     Service*.............................      2,557      19       2,362    13
                                               ------- -------     ------- -----
Total cost of revenues....................      3,343      25       3,280    18
                                               ------- -------     ------- -----
Gross profit..............................      9,912      75      14,829    82
                                               ------- -------     ------- -----
Operating expenses:
  Sales and marketing*.....................     6,453      49       7,437    41
  Research and development*................     4,984      38       6,080    34
  General and administrative*..............     2,016      15       2,680    15
  Amortization of stock-based compensation        543       4       1,387     8
  Amortization of identifiable intangibles         19    --         1,200     7
                                               ------- -------     ------- -----
Total operating expenses..................     14,015     106      18,784   105
                                               ------- -------     ------- -----
Operating loss............................     (4,103)    (31)     (3,955)  (22)
Other income (expense), net...............         83       1          90     1
Income tax expense........................         66      --        --      --
                                               ------- -------     ------- -----
Net loss..................................    $(4,086)    (30)%    (3,865)  (21)%
                                               ======= =======     ======= =====

* Excludes amortization of deferred stock based compensation`

Three Months Ended March 31, 2004 and 2003

Revenues

License revenue decreased 51% for the three months ended March 31, 2004
compared to the same period in the prior year. License revenue constituted 35%
of total revenues during the three months ended March 31, 2004, compared to 52%
for the same period last year. This decrease was the result of fewer license
transactions closed in the first quarter of 2004 compared to 2003, as well as a
51% decrease in the average sales price per transaction over $100,000 realized
during the first quarter of 2004 compared to the first quarter of 2003. We
believe the decrease in 2004 was due to a number of factors including; a
lengthening of the sales cycle as we rely more heavily on systems integrators to
source and close transactions, competitive pricing pressures and the continued
uncertainty in information technology spending in our market. This uncertainty
has resulted in the deferral of purchase decisions in order to evaluate more
deliberately, as well as purchasing smaller initial implementations of software.
While we are focused on increasing license revenue throughout the remainder of
2004, we are unable to predict such revenue from period to period with any
degree of accuracy because, among other things, the market for our products is
unpredictable and intensely competitive, and our sales cycle is long and
unpredictable. This lack of predictability has increased as we have increased
our reliance on systems integrators in our sales process. In addition, our
backlog, which relates to firm orders not yet recognized as revenue, decreased
during the quarter, from $27.7 million at December 31, 2003 to $23.0 million at
March 31, 2004. The substantial majority of these firm orders relate to annual
support contracts, and were invoiced and recorded as deferred revenue as of the
end of the period.

Our service revenues consist of support service revenue (primarily from
customer support and product maintenance) and professional services revenue
(primarily from consulting and training services). Service revenue in the three
months ended March 31, 2004 was consistent with the corresponding period of
2003, decreasing only 1%. The relative consistency of service revenues was due
to the nature of support revenues, which are recognized evenly over the related
maintenance period, and are typically renewed for one-year periods.

Revenues from domestic sales decreased $3.5 million, or 28%, from $12.2
million for the three months ended March 31, 2003 to $8.8 million for the same
period this year. Revenues from international sales decreased $1.4 million, or
24%, from $5.9 million for the three months ended March 31, 2003 to $4.5 million
for the same period this year. The decrease in both domestic and international
revenues in 2004 was primarily a result of lengthening sales cycles and the
continuing uncertainty in information technology spending in our markets, both
by our customers and potential customers. For the remainder of 2004, we expect
international revenue to fluctuate as a percentage of overall revenue.

Cost of Revenues

Cost of license revenue consists primarily of third-party software royalties,
and to a lesser extent, costs of product packaging and documentation, and
production and delivery costs for shipments to customers. Cost of license
revenue as a percentage of license revenue was 17% for the three months ended
March 31, 2004 compared to 10% for the same period in the prior year. The
increase in cost of license revenue as a percentage of license revenue in the
2004 period compared to the same period in 2003 was due to the decrease in
license revenue in 2004 while certain of our royalty costs remained constant,
regardless of the reduced number of licenses we sold, due to the fixed nature of
some of the fees in our royalty agreements with third party suppliers, such as
term licenses from those suppliers. We expect that our cost of license revenue
as a percentage of sales will improve slightly through the remainder of 2004,
but that it may vary slightly based on changes in the mix of products we
sell.

Cost of service revenues consists primarily of salaries and related expenses
for our customer support, consulting, and training services organization and
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenues as a percentage of service revenues was 29%
for the three months ended March 31, 2004 compared to 27% for the same period in
the prior year. This slight increase was associated with the change in mix of
service revenues. Professional services revenue yields a lower gross margin than
maintenance revenues, and such revenue comprised 10% of service revenues in the
three months ended March 31, 2004 compared to 11% for the same period in the
prior year. We anticipate that our cost of service revenue as a percentage of
service revenue will be relatively constant for the remainder of 2004.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and promotional
expenditures, including public relations, advertising, lead-generation programs,
and marketing materials. Sales and marketing expenses decreased $1.0 million, or
13% for the three months ended March 31, 2004 compared to the same period in the
prior year. This decrease was attributable primarily due to a net reduction of
sales and marketing positions throughout 2003 as a result of our restructuring
activities in prior years and a reduction in facilities. As of March 31, 2004,
we had 78 personnel in sales and marketing, compared to 97 as of March 31, 2003,
a 20% reduction which resulted in savings of approximately $0.5 million in
salary and benefits expenses. We also spent $0.3 million less in marketing
programs for the three months ended March 31, 2004 compared to the same period
in the prior year.

We anticipate that sales and marketing expenses will increase slightly in
absolute dollars for the remainder of 2004 compared to the first quarter of
2004. Thereafter, sales and marketing expenses may increase or decrease,
depending primarily on the amount of future revenues and our assessment of
market opportunities and sales channels.

Research and Development. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses decreased by $1.1
million, or 18% for the three months ended March 31, 2004 compared to the same
period in the prior year. This decrease was attributable to the duplicative
costs inherent in the transitioning of our software programming, quality
assurance and technical documentation activities to our international third
party development partners beginning in the first quarter of 2003. As of March
31, 2004, we had 40 personnel in research and development, compared to 88 as of
March 31, 2003, a 56% reduction that resulted in savings of approximately $2.3
million in compensation, benefits, and allocated facility and operations costs.
These reductions in personnel were offset by approximately $1.4 million in fees
associated with subcontracting a significant portion of our software
programming, quality assurance and technical documentation services to
development partners with staffing in India and China. Furthermore, expenses for
contractors in the United States decreased by $0.2 million for the three months
ended March 31, 2004 compared to the same period in the prior year.

We anticipate that quarterly research and development expenses will be fairly
consistent in absolute dollars for the remainder of 2004 compared to the first
quarter of 2004. Thereafter research and development expenses may increase or
decrease, depending primarily on the amount of future revenues, customer needs,
and our assessment of market demand.

General and Administrative. General and administrative expenses
consist primarily of compensation and related costs for finance, legal, human
resources, corporate governance, and bad debt expense. Information technology
and facilities costs are allocated among all operating departments. General and
administrative expenses decreased $0.7 million, or 25%, for the three months
ended March 31, 2004 compared to the same period in the prior year. This
decrease was primarily attributable to a reduction in finance, legal and human
resources-related positions. As of March 31, 2004, we had 23 such positions,
compared to 30 as of March 31, 2003, a 23% reduction that resulted in a cost
savings of $0.3 million. Other savings resulted from a $0.3 million reduction in
legal and professional services expense and a $0.2 million reduction in
corporate insurance during the three months ended March 31, 2004 compared to the
same period in the prior year.

We anticipate that general and administrative expenses will remain fairly
consistent in absolute dollars over the next few quarters and thereafter may
increase or decrease, depending primarily on the amount of future revenues and
corporate infrastructure requirements including insurance, professional
services, bad debt expense and other administrative costs.

Amortization of Deferred Stock-Based Compensation. We amortize
deferred stock-based compensation on an accelerated basis by charges to
operations over the vesting period of the options, consistent with the method
described in FIN 28. As of March 31, 2004, there was approximately $788,000 of
total deferred stock-based compensation remaining to be amortized related to
warrants and past employee stock option grants. We expect to amortize
approximately $730,000 of this deferred stock-based compensation in the
remainder of 2004, and approximately $58,000 in 2005. Amortization may be
reduced in future periods to the extent employees are terminated prior to
vesting. The following table details, by operating expense, our amortization of
stock-based compensation (in thousands):

`Three Months Ended
                                              March 31,
                                           2004       2003
                                         -------     -------
Cost of service ...................... $     40     $   103
Sales and marketing ..................      213         549
Research and development .............      199         513
General and administrative ...........       91        222
                                         -------     -------
Total ................................  $   543     $ 1,387
                                         =======     =======`

Amortization of Identifiable Intangibles. The amortization of
identifiable intangible assets recorded in the three months ended March 31, 2004
related to $400,000 of purchased identifiable intangibles in connection with the
Hipbone acquisition in February 2004. The amortization of identifiable
intangible assets recorded in 2003 related to $14.4 million of purchased
technology recorded as an intangible asset in connection with the merger with
Silknet in April 2000. Purchased intangible assets are carried at cost less
accumulated amortization. Amortization is computed over the estimated useful
lives of the asset, which is three years. Amortization totaled $19,000 and $1.2
million for the first quarter of 2004 and 2003, respectively. The purchased
intangible assets related to Silknet were fully amortized as of April 2003. We
expect amortization of intangibles to be $33,000 per quarter, through the first
quarter of 2007. Amortization may increase if we acquire another company.

Other Income, Net

Other income consists primarily of interest income earned on cash and
investments, offset by interest expense primarily relating to our line of
credit. We expect other income to fluctuate in accordance with our cash balances
and interest rates.

Provision for Income Taxes

We have incurred operating losses on a consolidated basis for all periods
from inception through March 31, 2004. Accordingly, we have recorded a valuation
allowance for the full amount of our gross deferred tax assets, as the future
realization of the tax benefit is not currently likely. In the first quarter of
2004, certain consolidated foreign entities were profitable based upon
application of our intercompany transfer pricing agreements, which resulted in
us reporting income tax expense totaling approximately $66,000 in those foreign
jurisdictions.



Liquidity and Capital Resources

As of March 31, 2004, we had $33.2 million in cash, cash equivalents and
short-term investments, compared to $33.0 million at December 31, 2003. As of
March 31, 2004, we had working capital of $1.1 million, compared to negative
$4.2 million as of March 31, 2003.

History and recent trends. We have had negative cash flows from
operations in each year since inception. To date, we have funded our operations
primarily through issuances of common stock and, to a lesser extent, cash
acquired in acquisitions. The rate of cash we have used in operations has
decreased significantly in recent years, from $112.4 million in 2001 to $42.2
million in 2002 to $12.7 million in 2003, to positive cash flow of $0.2 million
in the first quarter of 2004. This reduction in operating cash outflows is a
result of a 74% decrease in overall cost of revenues, sales and marketing,
research and development, general and administrative, and merger and
restructuring costs from 2001 to 2003, offset in part, by a 33% decrease in
revenues during the same period. Our cost reductions have been realized through
our 2001 restructuring plan, as well as various cost controls and operational
efficiencies realized since 2001. In 2001, 2002 and 2003, we implemented
successive net workforce reductions of approximately 772, 44, and 154 employees,
respectively, including 88 positions eliminated in 2003 as a result of our
outsourcing of development activities to development partners with staffing
overseas. During the first quarter of 2004, we had a net workforce reduction of
2 positions. For 2004, we do not expect significant changes in headcount.
However, staffing will change from time to time based upon the balancing of
roles between employees and outsourced staffing. Although we experienced
positive cash flow during the first quarter of 2004, we expect to experience
negative cash flow during the second quarter of 2004 because our revenues were
below expectations for the first quarter. The positive cash flow in the first
quarter was due in large part from the collection of accounts receivable
outstanding at December 31, 2003. Our cash collections during any quarter are
driven primarily by the amount of sales booked in the previous quarter. For the
second half of 2004, we expect modest positive cash flows if our revenue
expectations are met. However, we cannot be certain that we will meet our
revenue expectations in any given period.

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

Operating cash flow. We generated $0.4 million of cash from operating
activities for the first quarter of 2004, which included a $4.1 million net
loss, offset by non-cash charges of $1.5 million in depreciation and $0.5
million in amortization of deferred stock-based compensation. Operating cash
flows were positively effected by a $2.3 million reduction in accounts
receivable, a $0.6 million reduction in prepaids and other current assets, and a
$0.7 million  increase in accounts payable and accrued liabilities, offset by
$0.7 million in net payments relating to restructured facilities and a $0.7
million decrease in deferred revenue.

Investing cash flow. Our investing activities used $0.3 million of
cash for the first quarter of 2004, which consisted primarily of cash paid for
the acquisition of Hipbone of $0.4 million, offset by transfers of restricted
cash to cash upon expiration of letters of credit, totaling $0.1 million.

Financing cash flow. Our financing activities provided $0.2 million in
cash for the first quarter of 2004, due to net proceeds from issuances of common
stock to employees who exercised stock options during the quarter.

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

`Payments due by period
                                                -------------------------------------------------
                                                        Less than      1-3       3-5    More than
 Contractual Obligations:                        Total   1  year      years     years    5 years
                                                ------   ----------- --------   -------  --------
 Line of Credit                            $    3,427  $    3,427  $      --  $     -- $      --

 Non-cancelable Operating Lease Obligation     23,935       4,070     11,794     5,784     2,287

 Less: (Sublease Income)                       (2,617)       (414)    (1,347)     (641)     (215)

 Purchase Obligations (1)                       2,520       2,520         --        --        --
                                             ---------   ---------   --------   -------  --------
                                 Total     $   27,265  $    9,603  $  10,447  $  5,143 $   2,072
                                            ==========  ==========  =========  ======== =========`

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

Significant expected cash outflows in addition to our operating expenses
through the remainder of 2004 include approximately $3.7 million in lease
payments, net of contracted sublease payments, relating to accrued restructuring
costs and approximately $2.8 million of minimum payments to one vendor providing
outsourced software programming, quality assurance and technical documentation
activities in India.

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

Cash held in foreign locations. As of March 31, 2004, we had $9.3
million in US-equivalent dollars held by our 100%-owned foreign subsidiaries,
primarily in Europe and Japan. We believe our access to this cash is
unencumbered, and drawing on such cash would not result in withholding or
repatriation charges due to our intercompany receivable balances and transfer
pricing arrangements with these entities.

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

In the future, we may seek additional funds to support our strategic business
needs and may seek to raise such additional funds through private or public
sales of securities, strategic relationships, bank debt, lease financing
arrangements, or other available means. If additional funds are raised through
the issuance of equity or equity-related securities, stockholders may experience
additional dilution, or such equity securities may have rights, preferences, or
privileges senior to those of the holders of our common stock. If adequate funds
are not available or are not available on acceptable terms to meet our business
needs, our business may be harmed.

Risk Factors

We operate in a dynamic and rapidly changing business environment that
involves substantial risks and uncertainty, including but not limited to the
specific risks identified below. The risks described below are not the only ones
facing our company. Additional risks not presently known to us, or that we
currently deem immaterial, may become important factors that impair our business
operations. Any of these risks could cause, or contribute to causing, our actual
results to differ materially from expectations. Prospective and existing
investors are strongly urged to carefully consider the various cautionary
statements and risks set forth in this report and our other public filings.

Risks Related to Our Business

The large size of many of our expected license transactions could
contribute to our failure to meet expected sales in any given quarter and could
materially harm our operating results.

Our quarterly revenues are especially subject to fluctuation because they
depend on the completion of relatively large orders for our products and related
services. The average size of our license transactions is generally large
relative to our total revenue in any quarter, particularly as we have focused on
larger enterprise customers and on licensing our more comprehensive integrated
products and have involved system integrators in our sales process. In part as a
result of this aspect of our business, our quarterly revenues and operating
results may fluctuate in future periods and we may fail to meet the expectations
of investors and public market analysts, which could cause the price of our
common stock to decline. For example, during the quarter-ended March 31, 2003,
two customers, IBM and Highmark, represented 15% and 11%, respectively, of our
total revenues. This dependence on large orders makes our net revenue and
operating results more likely to vary from quarter to quarter, and more
difficult to predict, because the loss of any particular large order is
significant. Moreover, to the extent that significant sales occur earlier than
anticipated, revenues for subsequent quarters may be lower than expected. As a
result, our operating results could suffer if any large orders are delayed or
canceled in any future period. We expect the concentration of revenues among
fewer customers to continue in the future.

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

Due to the slowdown in the general economy over the past few years, we
believe that many existing and potential customers have reassessed and reduced
their planned technology and software investments and are deferring purchasing
decisions, requiring additional evaluations and levels of internal approval for
software investment and lengthening their purchase cycles. Further delays or
reductions in business spending for information technology could have a material
adverse effect on our revenues and operating results. Consequently, if sales
expected from a specific customer in a particular quarter are not realized in
that quarter, we are unlikely to be able to generate revenue from alternate
sources in time to compensate for the shortfall. As a result, a lost or delayed
sale could result in revenues that are lower than expected. Consequently, we
face difficulty predicting the quarter in which sales to expected customers will
occur, which contributes to the uncertainty of our future operating results. In
recent periods, we have experienced increases in the length of a typical sales
cycle. This trend may add to the uncertainty of our future operating results and
reduce our ability to anticipate our future revenues.

We may not be able to forecast our revenues accurately because our products
have a long and variable sales cycle and we rely on systems integrator partners
for sales.

The long sales cycle for our products may cause license revenue and operating
results to vary significantly from period to period. To date, the sales cycle
for our products has taken anywhere from 3 to 12 months. Furthermore, we
increasingly rely on systems integrators to identify, influence and manage large
transactions with customers. Selling our products in conjunction with our
systems integrators who are proposing their implementation services of our
products can involve a particularly long and unpredictable sales cycle, as it
typically takes more time for the prospective customer to evaluate proposals
from multiple vendors. In addition, when systems integrators propose the use of
our products to their customers, it is typically part of a larger project, which
can require more levels of customer approvals. Our sales cycle typically
requires pre-purchase evaluation by a significant number of individuals in our
customers' organizations. Along with third parties that often jointly market our
software with us, we invest significant amounts of time and resources educating
and providing information to prospective customers regarding the use and
benefits of our products. Many of our customers evaluate our software slowly and
deliberately, depending on the specific technical capabilities of the customer,
the size of the deployment, the complexity of the customer's network
environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products. The continuing stagnancy of
information technology spending in our markets has led to a significant increase
in the time required for this process.

We have little or no control over the sales cycle of an integrator-led
transaction or our customers' budgetary constraints and internal decision-making
and acceptance processes.  As a result, we have faced increased difficulty in
predicting our operating results for any given period, and have experienced
significant unanticipated fluctuations in our revenues from period to period.
Any failure to achieve anticipated revenues for a period could cause our stock
price to decline.

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

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

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

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

If we fail to generate sufficient revenues to support our business and
require additional financing, failure to obtain such financing would affect our
ability to maintain our operations and to grow our business, and the terms of
any financing we obtain may impair the rights of our existing stockholders.

In the future, we may be required to seek additional financing to fund our
operations or growth, and such financing may not be available to us, or may
impair the rights of our existing stockholders. Our operating activities used
$12.7 million of cash in 2003. Failure to increase future orders and revenues
beyond the level achieved in the first quarter of 2004 would likely require us
to seek additional capital to meet our working capital needs if we are unable to
reduce expenses to the degree necessary to avoid incurring losses. Factors such
as the commercial success of our existing products and services, the timing and
success of any new products and services, the progress of our research and
development efforts, our results of operations, the status of competitive
products and services, and the timing and success of potential strategic
alliances or potential opportunities to acquire or sell technologies or assets
may require us to seek additional funding sooner than we expect. In the event
that we require additional cash, we may not be able to secure additional
financing on terms that are acceptable to us, especially in the current
uncertain market climate, and we may not be successful in implementing or
negotiating other arrangements to improve our cash position. If we raise
additional funds through the issuance of equity or convertible debt securities,
the percentage ownership of our stockholders would be reduced and the securities
we issue might have rights, preferences and privileges senior to those of our
current stockholders. If adequate funds were not available on acceptable terms,
our ability to achieve or sustain positive cash flows, maintain current
operations, fund any potential expansion, take advantage of unanticipated
opportunities, develop or enhance products or services, or otherwise respond to
competitive pressures would be significantly limited.

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

We first recorded revenue in February 1998 and our revenue mix and operating
structure have changed substantially since then. For example, we now rely much
more heavily on systems integrators and development partners, and we are still
developing our ability to forecast our results using this new operating
structure.  Additionally, our increased reliance on integrator-led transactions
results in both larger transactions and reduced control of these transactions,
both of which contribute to our ability to predict our revenues and which could
have a material impact on our business.  We expect our reliance on integrator-
led transactions and larger transactions to continue as the business develops.
Due to our limited operating history and significant changes in our business
over the past four years, it is difficult or impossible to predict our future
results of operations. For example, we cannot accurately forecast operating
expenses based on our historical results (or those of similar companies) because
historical results are limited and reflect different products, costs and
business models, and we forecast expenses in part on future revenue projections
based on a number of assumptions. Moreover, due to our limited operating history
and evolving product offerings, our insights into trends that may emerge and
affect our business are limited.

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

Our business model generally depends on the sale of our products to new
customers as well as on expanded use of our products within our customers'
organizations. If we fail to grow our customer base or generate repeat and
expanded business from our current and future customers, our business and
operating results will be seriously harmed. In some cases, our customers
initially make a limited purchase of our products and services for pilot
programs. These customers may not purchase additional licenses to expand their
use of our products. If these customers do not successfully develop and deploy
initial applications based on our products, they may choose not to purchase
deployment licenses or additional development licenses. In addition, as we
introduce new versions of our products or new product lines, our current
customers might not require the functionality of our new products and might not
ultimately license these products.

Furthermore, because the total amount of maintenance and support fees we
receive in any period depends in large part on the size and number of licenses
that we have previously sold, any downturn in our software license revenue would
negatively affect our future services revenue. Also, if customers elect not to
renew their maintenance agreements, our services revenue could decline
significantly. If customers were unable to pay for their current products or are
unwilling to purchase additional products, our revenues would decline.
Additionally, most of our sales in the first quarter of 2004 were to repeat
customers.  If a significant existing customer or a group of existing customers
decide not to repeat business with us, our revenues would decline and our
business would be harmed.

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

Since we began operations in 1997, our revenues have not been sufficient
to support our operations, and we have incurred substantial operating losses in
every quarter. As of March 31, 2004, our accumulated deficit was approximately
$4.3 billion, which includes approximately $2.7 billion related to goodwill
impairment charges. We continue to commit a substantial investment of resources
to sales, product marketing, and developing new products and enhancements, and
we will need to increase our revenue to achieve profitability and positive cash
flows. Our expectations as to when we can achieve positive cash flows, and as to
our future cash balances, are subject to a number of assumptions, including
assumptions regarding improvements in general economic conditions and customer
purchasing and payment patterns, many of which are beyond our control. Our
history of losses has previously caused some of our potential customers to
question our viability, which has in turn hampered our ability to sell some of
our products. Additionally, our revenue has been affected by the uncertain
economic conditions in recent years, both generally and in our market. As a
result of these conditions, we have experienced and expect to continue to
experience difficulties in attracting new customers, which means that we may
continue to experience losses, even if sales of our products and services grow.

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

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

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

In addition to recommending our products, we also rely on SIs and other
third-party resellers to install and support our products. Our substantial
reduction in the size of our professional services team in 2001, and to a lesser
extent in 2002, increased our customers' reliance on third parties for product
installations and support. If the companies providing these services fail to
implement our products successfully for our customers, we might be unable to
complete implementation on the schedule required by the customers and we may
have increased customer dissatisfaction or difficulty making future sales as a
result. We might not be able to maintain our relationships with SIs and other
indirect sales channel partners and enter into additional relationships that
will provide timely and cost-effective customer support and service. If we
cannot maintain successful relationships with our indirect sales channel
partners, we might have difficulty expanding the sales of our products and our
growth could be limited. In addition, if such third parties do not provide the
support our customers need, we may be required to hire subcontractors to provide
these professional services. Increased use of subcontractors would harm our
margins because it costs us more to hire subcontractors to perform these
services than to provide the services ourselves.

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

We substantially reduced our headcount in 2003 from a total of 365 employees
as of December 31, 2002 to 211 as of December 31, 2003. As of March 31, 2004, we
had 209 employees. The majority of this reduction was the result of our decision
to shift a significant portion of our software programming, quality assurance
and technical documentation activities to international development partners in
early 2003. We reduced the size of our research and development department by 88
employees in the year ended December 31, 2003 to 40 employees at the end of the
year. Our outsourcing plan may yield unanticipated consequences, such as an
inability to release products within expected timeframes. For example, many of
the employees who were terminated possessed specific knowledge or expertise that
may prove to have been important to our operation. As a result of these staff
reductions, our ability to respond to unexpected challenges may be impaired and
we may be unable to take advantage of new opportunities. Personnel reductions
may also subject us to the risk of litigation, which may adversely impact our
ability to conduct our operations and may cause us to incur significant
expense.

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

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

For example, our ability to increase revenues in the future depends
considerably upon our success in recruiting, training and retaining effective
direct sales personnel and the success of our direct sales force. We might not
be successful in these efforts. Our products and services require sophisticated
sales efforts. We have experienced significant turnover in our sales force,
including the departure of our Vice President of Sales in October 2003, and may
experience further turnover in future periods. Furthermore, there is a shortage
of sales personnel with the requisite qualifications, and competition for such
qualified personnel is intense in our industry. Also, it may take a new
salesperson a number of months to become a productive member of our sales force.
Our business will be harmed if we fail to hire or retain qualified sales
personnel, or if newly hired salespeople fail to develop the necessary sales
skills or develop these skills more slowly than anticipated.

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

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

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

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

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

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

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

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

The challenges of developing new products and enhancements require us to
commit a substantial investment of resources to development, and we might not be
able to develop or introduce new products on a timely or cost-effective basis,
or at all, which could be exploited by our competitors and lead potential
customers to choose alternative products. To be competitive, we must develop and
introduce on a timely basis new products and product enhancements for companies
with significant e-business customer interactions needs. Our ability to deliver
competitive products may be negatively affected by the diversion of resources to
development of our suite of products, and responding to changes in competitive
products and in the demands of our customers. If we experience product delays in
the future, we may face:

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

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

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

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

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

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

Since becoming a publicly traded security listed on Nasdaq in September 1999,
our common stock has reached a closing high of $1,698.10 per share and closing
low of $0.65 per share. The last reported sale price of our shares on May 12,
2004 was $2.95 per share. Under Nasdaq's listing maintenance standards, if the
closing bid price of our common stock is under $1.00 per share for 30
consecutive trading days, Nasdaq may choose to notify us that it may delist our
common stock from the Nasdaq National Market. If the closing bid price of our
common stock did not thereafter regain compliance for a minimum of 10
consecutive trading days during the 180 days following notification by Nasdaq,
Nasdaq could delist our common stock from trading on the Nasdaq National Market.
There can be no assurance that our common stock will remain eligible for trading
on the Nasdaq National Market. If our stock were delisted, the ability of our
stockholders to sell any of our common stock at all would be severely, if not
completely, limited, causing our stock price to continue to decline.

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

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

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

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

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

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

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

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

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

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

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

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

The software and Internet industries are characterized by the existence of a
large number of patents, trademarks and copyrights and by frequent litigation
based on allegations of infringement or other violations of intellectual
property rights. As the number of entrants into our market increases, the
possibility of an intellectual property claim against us grows. Our technologies
may not be able to withstand any third-party claims or rights against their use.
Some of our competitors in the market for customer communications software may
have filed or may intend to file patent applications covering aspects of their
technology that they may claim our technology infringes. Such competitors could
make a claim of infringement against us with respect to our products and
technology. Third parties may currently have, or may eventually be issued,
patents upon which our current or future products or technology infringe. Any of
these third parties might make a claim of infringement against us. For example,
from time to time, companies have asked us to evaluate the need for a license of
certain patents, and. we cannot assure you that patent infringement claims will
not be filed against us in the future. Other companies may also have pending
patent applications (which are typically confidential for the first eighteen
months following filing) that cover technologies we incorporate in our
products.

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

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

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

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

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

We must protect our computer systems and network from physical break-ins,
security breaches and other disruptive problems caused by the Internet or other
users. Computer break-ins could jeopardize the security of information stored in
and transmitted through our computer systems and network, which could adversely
affect our ability to retain or attract customers, damage our reputation and
subject us to litigation. We have been in the past, and could be in the future,
subject to denial of service, vandalism and other attacks on our systems by
Internet hackers. Although we intend to continue to implement security
technology and establish operational procedures to prevent break-ins, damage and
failures, these security measures may fail. Our insurance coverage in certain
circumstances may be insufficient to cover losses that may result from such
events.

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

Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service giving rise to the damages. However, some domestic and
international jurisdictions may not enforce these contractual limitations on
liability. We may be subject to claims based on errors in our software or
mistakes in performing our services including claims relating to damages to our
customers' internal systems. A product liability claim could divert the
attention of management and key personnel, could be expensive to defend and
could result in adverse settlements and judgments.

Our international operations expose us to additional risks.

A substantial proportion of our revenues is generated from sales outside
North America, exposing us to additional financial and operational risks. Sales
outside North America represented 34% of our total revenues during the first
quarter of 2004, and 28% of our total revenues in 2003. We have established
offices in the United Kingdom, Germany, Japan, the Netherlands, Belgium, Hong
Kong and South Korea. Sales outside North America could increase as a percentage
of total revenues as we attempt to expand our international operations. In
addition to the additional costs and uncertainties of being subject to
international laws and regulations, any expansion of our existing international
operations and entry into additional international markets will require
significant management attention and financial resources, as well as additional
support personnel. For any such expansion, we will also need to, among other
things expand our international sales channel management and support
organizations and develop relationships with international service providers and
additional distributors and system integrators. In addition, if international
operations become a larger part of our business, we could encounter, on average,
greater difficulty with collecting accounts receivable, longer sales cycles and
collection periods, greater seasonal reductions in business activity and
increases in our tax rates. Furthermore, products must be localized, or
customized to meet the needs of local users, before they can be sold in
particular foreign countries. Developing localized versions of our products for
foreign markets is difficult and can take longer than we anticipate.

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

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

We may suffer foreign exchange rate losses.

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

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

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

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

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

Our reported financial results may be adversely affected by changes in
applicable accounting principles.

Generally accepted accounting principles in the United States are subject to
interpretation by the FASB, the American Institute of Certified Public
Accountants, the SEC, and various other bodies formed to promulgate and
interpret appropriate accounting principles. A change in these principles or
interpretations could have a significant effect on our reported financial
results, and could affect the reporting of transactions completed before the
announcement of a change. For example, we currently are not required to record
stock-based compensation charges if the employee's stock option exercise price
is equal to or exceeds the deemed fair value of our common stock at the date of
grant. However, several companies have recently elected to change their
accounting policies and begun to record the fair value of stock options as an
expense, and the Financial Accounting Standards Board and other regulatory
bodies are currently considering proposals to require all public companies to
adopt this accounting policy. These and other potential changes could materially
increase the expenses we report under accounting principles generally accepted
in the United States of America and adversely affect our consolidated operating
results.

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

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

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



Risks Related to Our Industry

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

State, federal and foreign regulators could adopt laws and regulations that
impose additional burdens on companies that conduct business online. These laws
and regulations could discourage communication by e-mail or other web-based
communications, particularly targeted e-mail of the type facilitated by our
products, which could reduce demand for our products and services.

The growth and development of the market for online services may prompt calls
for more stringent consumer protection laws or laws that may inhibit the use of
Internet-based communications or the information contained in these
communications. The adoption of any additional laws or regulations may decrease
the expansion of the Internet. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
our products and services and increase our costs of doing business, or otherwise
harm our business. Any new legislation or regulations, application of laws and
regulations from jurisdictions whose laws do not currently apply to our
business, or application of existing laws and regulations to the Internet and
other online services could increase our costs and harm our growth.

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

The imposition of new sales or other taxes could limit the growth of Internet
commerce generally and, as a result, the demand for our products and services.
Federal legislation that limits the imposition of state and local taxes on
Internet-related sales will expire on November 1, 2007. Congress may choose to
modify this legislation or to allow it to expire, in which case state and local
governments would be free to impose taxes on electronically purchased goods. We
believe that most companies that sell products over the Internet do not
currently collect sales or other taxes on shipments of their products into
states or foreign countries where they are not physically present. However, one
or more states or foreign countries may seek to impose sales or other tax
collection obligations on out-of-jurisdiction companies that engage in e-
commerce within their jurisdiction. A successful assertion by one or more states
or foreign countries that companies that engage in e-commerce within their
jurisdiction should collect sales or other taxes on the sale of their products
over the Internet, even though not physically in the state or country, could
indirectly reduce demand for our products.

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

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

Item 3: Quantitative and Qualitative Disclosures
About Market Risk

We develop products in the United States and sell these products in North
America, Europe, Asia, Australia and Latin America. In the three months ended
March 31, 2004, revenues from customers outside of the United States
approximated 34% of total revenues. Generally, our sales are made in local
currency. As a result, our financial results and cash flows could be affected by
factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. We do not currently use derivative instruments to
hedge against foreign exchange risk.

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

We are exposed to market risk from fluctuations in foreign currency exchange
rates, principally from the exchange rate between the US dollar and the Euro and
British pound. We manage exposure to variability in foreign currency exchange
rates primarily through the use of natural hedges, as both liabilities and
assets are denominated in the local currency. However, different durations in
our funding obligations and assets may expose us to the risk of foreign exchange
rate fluctuations. We have not entered into any derivative instrument
transactions to manage this risk. Based on our overall foreign currency rate
exposure at March 31, 2004, we do not believe that a hypothetical 10% change in
foreign currency rates would materially adversely affect our financial
position.

Item 4: Controls and Procedures

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

Changes in Internal Control Over Financial Reporting.  Regulations
under the Securities Exchange Act of 1934 require public companies, including
our company, to evaluate any change in our "internal control over financial
reporting," which is defined as a process to provide reasonable assurance
regarding the reliability of financial reporting and preparation of financial
statements for external purposes in accordance with accounting principles
generally accepted in the United States. In connection with their evaluation of
our disclosure controls and procedures as of the end of the period covered by
this report, our Chief Executive Officer and acting Chief Financial Officer did
not identify any change in our internal control over financial reporting during
the three-month period ended March 31, 2004 that materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.

Part II: Other Information

Item 1. Legal Proceedings.

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

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

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

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

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities.

Recent Unregistered Sales of Securities

The following table provides information about our unregistered sales of
KANA securities since January 1, 2004.

|Reason for Issuance          | Recipients                                              | Date of Issuance  | Title of Securities | Number of Securities | Aggregate Consideration
|---------------------------- | ------------------------------------------------------- | ----------------- | ------------------- | -------------------- | -----------------------
|Acquisition of Hipbone, Inc. | Certain employees and security holders of
Hipbone, Inc. | February 10, 2004 | Common Stock        | 262,500              | $1,231,125*            

___________

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

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

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not applicable.

Item 5. Other Information.

On May 4, 2004, we announced that Michelle Philpot was
appointed Acting Chief Financial Officer and John Huyett had resigned as our
Executive Vice President and Chief Financial Officer. Ms. Philpot, who joined
KANA in September 2001, had been serving as our Vice President Finance.

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

(a) Exhibits:

|              |                                                                                                                                                  | Incorporated by
Reference |         
|------------- | ------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------- | --------
|ExhibitNumber | Exhibit Description                                                                                                                              | Form                      | File No.
|              |                                                                                                                                                  |                           |         
|10.1          | Separation agreement between John Huyett and KANA dated May 3,
2004                                                                              |                           |         
|10.2          | Offer letter to Tim Angst dated April 23, 2004                                                                                                   |                           |         
|31.1          | Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.                                              |                           |         
|31.2          | Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.                                              |                           |         
|32.1          | Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* |                           |         
|32.2          | Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* |                           |         

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

(b)  Reports on Form 8-K:

On January 28, 2004 and January 29, 2004, we furnished a Current Report and
amended Current Report on Form 8-K reporting under Item 12 that KANA issued a
press release announcing its financial results for the fiscal quarter ended
December 31, 2003 and certain other information.

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.



|May 13, 2004 | KANA Software, Inc.                                                                                              
|------------ | -----------------------------------------------------------------------------------------------------------------
|             |                                                                                                                  
|             | /s/ Chuck Bay
Chuck Bay
Chairman of the Board and Chief Executive Officer 
(Principal Executive Officer)         
|             |                                                                                                                  
|             | /s/ Michelle Philpot
Michelle Philpot
Acting Chief Financial Officer
(Principal Financial and Accounting Officer)