---

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UNITED
STATESSECURITIES
AND EXCHANGE COMMISSIONWASHINGTON,
D.C. 20549

FORM
10-Q

|    |  QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For
the quarterly period ended September 30, 2003

Commission
File Number 000-26881

E.PIPHANY,
INC.(Exact name of registrant as specified in its charter)

|Delaware                 |  | 77-0443392                             
|------------------------ |  | ---------------------------------------
|(State of incorporation) |  | (I.R.S. Employer Identification Number)

475
Concar DriveSan Mateo, California 94402(Address
of principal executive offices)

(650)
356-3800(Registrants
telephone number, including area code)

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

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YES X    NO

The
number of shares outstanding of the registrants common stock, par value
$0.0001 per share, as of October 31, 2003, was 74,408,277.

---

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E.PIPHANY,
INC.

QUARTERLY
REPORT ON FORM 10-QQUARTER ENDED SEPTEMBER 30, 2003

TABLE
OF CONTENTS

|        |                                                            | Page No.
|------- | ---------------------------------------------------------- | --------
|PART I  | FINANCIAL INFORMATION                                      |         
|        |                                                            |         
|Item 1. | Financial Statements                                       |         
|        |                                                            |         
|        | Condensed Consolidated Balance Sheets -                   
|        | As of September 30, 2003 and December 31, 2002             |         
|        |                                                            |         
|        | Condensed Consolidated Statements of Operations -         
|        | Three and nine months ended September 30, 2003 and 2002    |         
|        |                                                            |         
|        | Condensed Consolidated Statements of Cash Flows -         
|        | Nine months ended September 30, 2003 and 2002              |         
|        |                                                            |         
|        | Notes to Condensed Consolidated Financial Statements       |         
|        |                                                            |         
|Item 2. | Managements Discussion and Analysis of                    |         
|        | Financial Condition and Results of Operations              |         
|        |                                                            |         
|Item 3. | Quantitative and Qualitative Disclosures about Market Risk |         
|        |                                                            |         
|Item 4. | Controls and Procedures                                    |         
|        |                                                            |         

|        |                                  | 
|------- | -------------------------------- | 
|PART II | OTHER INFORMATION                | 
|        |                                  | 
|Item 1. | Legal Proceedings                | 
|        |                                  | 
|Item 6. | Exhibits and Reports on Form 8-K | 
|        |                                  | 

|              |  | 
|------------- |  | 
|SIGNATURES    |  | 
|              |  | 
|Exhibit Index |  | 

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PART I:  
FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

E.PIPHANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS(in
thousands)

|                                              | September 30,2003 |                  | December 31,2002
|--------------------------------------------- | ----------------- | ---------------- | ----------------
|
|ASSETS                                        |                   |                  |                 
|Current assets:                               |                  
|Cash and cash equivalents                     |                   | $        8,466   |                 
|Short-term investments                        |                   | 130,994          |                 
|Accounts receivable, net                      |                   | 9,357            |                 
|Prepaid expenses and other assets             |                   | 4,973            |                 
|Short-term restricted cash and investments    |                   | 1,226            |                 
|                                              |                   |                  |                 
|Total current assets                          |                   | 155,016          |                 
|Long-term investments                         |                   | 116,421          |                 
|Long-term restricted cash and investments     |                   | 7,268            |                 
|Property and equipment, net                   |                   | 7,620            |                 
|Goodwill, net                                 |                   | 81,499           |                 
|Purchased intangibles, net                    |                   | 1,434            |                 
|Other assets                                  |                   | 1,295            |                 
|                                              |                   |                  |                 
|Total assets                                  |                   | $    370,553     |                 
|                                              |                   |                  |                 
|LIABILITIES AND STOCKHOLDERS EQUITY          |                  
|Current liabilities:                          |                  
|Current portion of capital lease obligations  |                   | $             12 |                 
|Accounts payable                              |                   | 969              |                 
|Accrued compensation                          |                   | 8,671            |                 
|Accrued other                                 |                   | 6,988            |                 
|Current portion of restructuring costs        |                   | 7,547            |                 
|Deferred revenue                              |                   | 16,569           |                 
|                                              |                   |                  |                 
|Total current liabilities                     |                   | 40,756           |                 
|Restructuring costs, net of current portion   |                   | 21,766           |                 
|Other long-term liabilities                   |                   | 204              |                 
|                                              |                   |                  |                 
|Total liabilities                             |                   | 62,726           |                 
|                                              |                   |                  |                 
|Stockholders equity:                         |                  
|Common stock                                  |                   | 7                |                 
|Additional paid-in capital                    |                   | 3,818,314        |                 
|Stockholders notes receivable                |                   |                 |                 
|Accumulated other comprehensive income (loss) |                   | (302             | )               
|Deferred compensation                         |                   | (63              | )               
|Accumulated deficit                           |                   | (3,510,129       | )               
|                                              |                   |                  |                 
|Total stockholders equity                    |                   | 307,827          |                 
|                                              |                   |                  |                 
|Total liabilities and stockholders equity    |                   | $    370,553     |                 
|                                              |                   |                  |                 

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

3

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E.PIPHANY,
INC.

CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS(in
thousands, except per share amounts)(unaudited)

|                                              | Three Months EndedSeptember 30, |          | Nine Months EndedSeptember 30, |          
|--------------------------------------------- | ------------------------------- | -------- | ------------------------------ | ---------
|
|Revenues:                                     |                                 |          |                                |          
|Product license                               |                                 | $ 10,239 |                                | $   6,756
|Services                                      |                                 | 13,969   |                                | 13,039   
|                                              |                                 |          |                                |          
|                                              |                                 | 24,208   |                                | 19,795   
|                                              |                                 |          |                                |          
|Cost of revenues:                             |                                
|Product license                               |                                 | 419      |                                | 301      
|Services                                      |                                 | 6,993    |                                | 7,740    
|Amortization of purchased technology          |                                 | 755      |                                | 2,438    
|                                              |                                 |          |                                |          
|                                              |                                 | 8,167    |                                | 10,479   
|                                              |                                 |          |                                |          
|Gross profit                                  |                                 | 16,041   |                                | 9,316    
|                                              |                                 |          |                                |          
|Operating expenses:                           |                                
|Research and development                      |                                 | 7,753    |                                | 8,318    
|Sales and marketing                           |                                 | 9,947    |                                | 12,169   
|General and administrative                    |                                 | 2,831    |                                | 3,060    
|Restructuring charges                         |                                 | 518      |                                | 419      
|Amortization of purchased intangibles         |                                 | 8        |                                | 209      
|Stock-based compensation                      |                                 | 8        |                                | 68       
|                                              |                                 |          |                                |          
|Total operating expenses                      |                                 | 21,065   |                                | 24,243   
|                                              |                                 |          |                                |          
|Loss from operations                          |                                 | (5,024   | )                              | (14,927  
|Other income, net                             |                                 | 1,090    |                                | 1,324    
|                                              |                                 |          |                                |          
|Net loss before provision for taxes           |                                 | $(3,934  | )                              | $(13,603 
|Provision for taxes                           |                                 | 414      |                                |         
|                                              |                                 |          |                                |          
|Net Loss                                      |                                 | $(4,348  | )                              | $(13,603 
|                                              |                                 |          |                                |          
|                                              |                                 |          |                                |          
|Basic and diluted net loss per share          |                                 | $  (0.06 | )                              | $  (0.19 
|                                              |                                 |          |                                |          
|Shares  used in  computing  basic and diluted |                                
|net loss per share                            |                                 | 73,727   |                                | 72,099   
|                                              |                                 |          |                                |          

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

4

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E.PIPHANY,
INC.

CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS(in
thousands)(unaudited)

|                                                               | Nine Months EndedSeptember 30, |            
|-------------------------------------------------------------- | ------------------------------ | -----------
|
|Cash flows from operating activities:                          |                                |            
|Net loss                                                       |                                | $(24,657   
|Adjustments to reconcile net loss to net cash used  in         |                               
|operating activities:                                          |                               
|Depreciation and amortization                                  |                                | 5,360      
|Provision for doubtful accounts                                |                                |           
|Stock-based compensation                                       |                                | 47         
|Non-cash restructuring costs                                   |                                | 301        
|Amortization of purchased technology and purchased intangibles |                                | 4,314      
|Minority interest in net loss of consolidated subsidiaries     |                                |           
|Changes in operating assets and liabilities:                   |                               
|Accounts receivable                                            |                                | (2,505     
|Prepaid expenses and other assets                              |                                | 3,674      
|Accounts payable                                               |                                | (1,448     
|Accrued liabilities and compensation                           |                                | (1,977     
|Restructuring costs                                            |                                | (3,633     
|Deferred revenue                                               |                                | (3,957     
|                                                               |                                |            
|Net cash used in operating activities                          |                                | (24,481    
|                                                               |                                |            
|Cash flows from investing activities:                          |                               
|Purchases of property and equipment                            |                                | (1,013     
|Restricted cash and investments                                |                                | 681        
|Acquisition related costs and changes in accruals              |                                |           
|Proceeds from maturities of investments                        |                                | 143,925    
|Purchases of investments                                       |                                | (161,814   
|                                                               |                                |            
|Net cash provided by (used in) investing activities            |                                | (18,221    
|                                                               |                                |            
|Cash flows from financing activities:                          |                               
|Principal payments on capital lease obligations                |                                | (144       
|Repayments on notes receivable                                 |                                | 556        
|Proceeds from sale of common stock, net of repurchases         |                                | 3,098      
|                                                               |                                |            
|Net cash provided by financing activities                      |                                | 3,510      
|                                                               |                                |            
|Effect of foreign exchange rates on cash and cash equivalents  |                                | (577       
|                                                               |                                |            
|Net decrease in cash and cash equivalents                      |                                | (39,769    
|Cash and cash equivalents at beginning of period               |                                | 48,235     
|                                                               |                                |            
|Cash and cash equivalents at end of period                     |                                | $     8,466
|                                                               |                                |            

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

5

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E.PIPHANY,
INC.

NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)

1.  Basis of
Presentation

The
condensed consolidated financial statements included herein have been prepared
by E.piphany, Inc. (hereafter E.piphany or the Company),
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). The Condensed Consolidated Balance Sheet
as of December 31, 2002 is derived from audited consolidated financial
statements. Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with United States
Generally Accepted Accounting Principles (US GAAP) have been
condensed or omitted pursuant to the rules and regulations regarding interim
financial statements. These condensed consolidated financial statements should
be read in conjunction with the Companys audited consolidated financial
statements and notes thereto included in E.piphanys Annual Report on Form
10-K for the fiscal year ended December 31, 2002, filed with the SEC on March
27, 2003.

The
unaudited condensed consolidated financial statements included herein reflect
all adjustments (which include only normal, recurring adjustments) which are, in
the opinion of management, necessary to state fairly the financial position of
E.piphany as of September 30, 2003, the results of its operations for the three
and nine months ended September 30, 2003 and 2002, and its cash flows for the
nine months ended September 30, 2003 and 2002. The results for the three and
nine months ended September 30, 2003 are not necessarily indicative of the
results expected for the full fiscal year.

Certain
amounts from prior years have been reclassified to conform to current year
presentation.

2.  Summary
of Significant Accounting Policies

Principles
of Consolidation

The
condensed consolidated financial statements include the accounts of E.piphany
and its subsidiaries. As of September 30, 2003, the Company owns 100% of the
outstanding stock of all its subsidiaries. Intercompany accounts and
transactions have been eliminated.

Use of
Estimates in Preparation of Financial Statements

The
condensed consolidated financial statements have been prepared in accordance
with US GAAP. The preparation of these financial statements requires us to
make estimates and assumptions that affect reported assets and liabilities,
disclosure of contingent assets and liabilities as of the date of the financial
statements, and reported expenses during the reporting period. Actual results in
these particular areas could differ from those estimates.

Foreign
Currency Translation

The
functional currency of our foreign subsidiaries is the local currency. The
Company translates the assets and liabilities of non-U.S. functional currency
subsidiaries into dollars at the current rates of exchange in effect as of the
balance sheet date. Revenues and expenses are translated using rates that
approximate those in effect during the period. Gains and losses from translation
adjustments are included on the balance sheet in stockholders equity under
the caption Accumulated other comprehensive

6

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income (loss). Currency
transaction gains or losses, derived from monetary assets and liabilities stated  in a
currency other than the functional currency, are recognized in current  operations and
have not been significant to the Companys operating results  in any period.

Cash
Equivalents, Short-Term Investments, Long-Term Investments and Restricted Cash and Investments

Short-term investments as of December 31, 2002
includes $45.2 million of auction rate securities having reset dates of less
than 45 days which were previously classified as cash and cash equivalents. As
of September 30, 2003, $80.3 million of such securities are included in short
term investments.

Cash
equivalents consist of highly liquid investments that are readily convertible
into cash. Short-term investments generally consist of highly liquid securities
that the Company intends to hold for less than one year.
Long-term investments generally consist of securities that the Company intends
to hold for more than one year with maturity dates of less than two years from
the date of purchase. The Company has classified its short-term and long-term
investments as available-for-sale. Short-term and long-term investments are
carried at fair value with unrealized gains and losses reported, net of tax, as
other comprehensive income (loss) in stockholders equity. Realized gains and
losses and declines in value which are determined to be other than temporary on
available-for-sale securities are included in other income, net and are derived
using the specific identification method for determining the cost of securities
and were not significant for the three and nine month periods ending September
30, 2003 and 2002.

From
time to time, we are required to obtain letters of credit that serve as
collateral for our obligations to third parties under facility lease agreements.
These letters of credit are secured by cash and investments. As of
September 30, 2003, we had $8.5 million securing letters of credit, which are
classified as restricted cash and investments in the accompanying Condensed Consolidated Balance
Sheets. The classification of restricted cash and investments as short-term or long-term is
determined based on the termination date of the underlying lease agreement
irrespective of the expiration date of the letter of credit, as the Company is
contractually required to maintain letters of credit during the lease term.

Accounts
Receivable and Deferred Revenue

Accounts
receivable consists of amounts due from customers for which revenue has been
recognized. Deferred revenue consists of amounts received from customers for
which revenue has not been recognized. Deferred license revenue is recognized
upon delivery of our product, as services are rendered, or as other requirements
requiring deferral are satisfied. Deferred maintenance revenue is recognized
ratably over the term of the maintenance agreement and deferred professional
services revenue is recognized as services are rendered or as other requirements
requiring deferral are satisfied.

Allowances
for Doubtful Accounts

We
evaluate the collectability of our accounts receivable based on a combination of
factors. When we believe a collectability issue exists with respect to a
specific receivable, we record an allowance to reduce that receivable to the
amount that we believe to be collectable. For all other receivables, we record
an allowance based on an assessment of the aging of such receivables, our
historical experience with bad debts and the general economic environment.

Fair
Value of Financial Instruments

The
carrying value of the Companys financial instruments, including cash and
cash equivalents, investments, and accounts receivable approximates fair market
value. Financial instruments that subject the Company to concentrations of
credit risk consist primarily of investments in debt securities and trade
accounts receivable. Management believes the financial risks associated with
these financial instruments are not significant. The Company invests its cash
and investments in government agencies, U.S. treasuries,

7

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money market
instruments, auction rate securities, taxable municipal bonds and corporate debt  rated
A1/P1 or higher.

Concentration
of Credit Risk and Significant Customers

The
Companys customer base consists of businesses in Asia, Australia, Europe,
Latin America and North America. The Company performs ongoing credit evaluations
of its customers and generally does not require collateral on accounts
receivable. The Company maintains reserves for potential credit losses.
Historically, such reserves have been adequate to cover the actual losses
incurred. No individual customer accounted for more than 10% of our total
revenues for the three or nine months ended September 30, 2003, or for the three
or nine months ended September 30, 2002. As of September 30, 2003, one accounts
receivable balance accounted for 16% of our total accounts receivable balance.
No individual customer accounts receivable balance accounted for more than 10%
of our total accounts receivable as of December 31, 2002.

Impairment
of Long-Lived Assets and Definite Lived Intangible Assets

The
Company evaluates long-lived assets and certain definite lived intangible assets
for impairment on a periodic basis and whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds its fair market value.

Revenue
Recognition

E.piphany
recognizes revenue under the following policies which are in accordance with the
provisions of Statement of Position 97-2, Software Revenue
Recognition as amended by SOP 98-9, Modification of SOP 97-2,
Software Revenue Recognition, with Respect to Certain Transactions:

Licenses.
Fees from licenses are recognized as revenue upon contract execution, provided
all delivery obligations have been met, fees are fixed or determinable and
collection is probable. We consider all arrangements with payment terms
extending beyond six months not to be fixed and determinable, and revenue is
recognized as payments become due from the customer, assuming all other revenue
recognition conditions are met. If collection is not considered probable,
revenue is recognized when the fee is collected. The Company uses the residual
method to recognize revenue from a license arrangement with multiple elements
when vendor specific objective evidence of the fair value exists for all of the
undelivered elements in the arrangement, but does not exist for one of the
delivered elements in the arrangement. Vendor specific objective evidence for
undelivered elements is based on normal pricing for those elements when sold
separately. Under the residual method, the fair value of the undelivered
elements is deferred and the remaining portion of the arrangement fee is
recognized as revenue. If vendor specific objective evidence does not exist to
allocate the total fee to all undelivered elements of the arrangement, revenue
is deferred until the earlier of the time at which (1) such evidence does exist
for the undelivered elements, or (2) all elements are delivered. We recognize
license fees from resellers as revenue when the above criteria have been met and
the reseller has sold the subject licenses through to the end-user.

When
licenses are sold together with consulting and implementation services, license
fees are recognized upon delivery, provided that (1) the criteria set forth in
the above paragraph have been met, (2) payment of the license fees is not
dependent upon the performance of the consulting or implementation services, and
(3) the services are not essential to the functionality of the software. For
arrangements that do not meet the above criteria, both the product license
revenues and professional services revenues are recognized under the percentage
of completion contract method in accordance with the

8

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provisions of
Statement of  Position 81-1, Accounting for Performance of Construction Type and
Certain  Production Type Contracts (SOP 81-1). To date, when the
Company has been primarily responsible for the implementation of the software,  services
have been considered essential to the functionality of the software  products and
therefore license and services revenues have been recognized  pursuant to SOP 81-1. The
Company follows the percentage of completion method  since reasonably dependable
estimates of progress toward completion of a  contract can be made. We estimate the
percentage of completion on contracts  utilizing hours incurred to date as a percentage
of the total estimated hours to  complete the project. Recognized revenues and profit are
subject to revisions as  the contract progresses to completion. Revisions in profit
estimates are charged  to income in the period in which the facts that give rise to the
revision become  known.

From
time to time, our license and services arrangements include acceptance
provisions. When acceptance provisions exist, we apply judgment in assessing the
significance of the provision. If we determine that the likelihood of
non-acceptance in these arrangements is remote, we recognize revenue once all of
the criteria described above have been met. If such a determination cannot be
made, revenue is recognized upon the earlier of customer acceptance or
expiration of the acceptance period, provided that all of the criteria described
above have been met.

Maintenance
Services.Maintenance services include technical support and unspecified
software updates to customers. Revenue derived from maintenance services is
recognized ratably over the applicable maintenance term, typically one year, and
is included in services revenue in the accompanying consolidated statements of
operations.

Consulting,
Implementation and Training Services.E.piphany provides consulting,
implementation and training services to its customers. Revenue from such
services is generally recognized as the services are performed, except when such
services are subject to acceptance provisions, as discussed above.

Warranties
and Indemnification

The
Company generally provides a warranty for its software products and services to
its customers and accounts for its warranties under the FASBs Statement of
Financial Accounting Standards No. 5, Accounting for Contingencies
(SFAS No. 5). The Companys products are generally warranted to
perform substantially as described in the associated product documentation for a
period of one year following the execution of the customer agreement. The
Companys services are generally warranted to be performed consistent with
industry standards for a period of ninety days from delivery. In the event there
is a material breach of warranty, the Company generally is obligated to correct
the product or service to conform to the warranty provision or, if the Company
is unable to do so, the customer is entitled to seek a refund of the purchase
price of the product or service. The Company did not provide for a warranty
accrual as of September 30, 2003 or December 31, 2002. To date, the
Companys product warranty expense has not been significant.

The Company generally agrees to indemnify its customers,
implementation partners and distribution partners against legal
claims that the Companys software products infringe certain third party
intellectual property rights and accounts for its indemnification obligations
under SFAS No. 5. In the event of such a claim, the Company is generally
obligated to defend its customer or partner against the claim and to either
settle the claim at the Companys expense or pay damages that the customer
or partner is legally required to pay to the third party claimant. In addition,
in the event of an infringement, the Company agrees to modify or replace the
infringing product, or, if those options are not reasonably possible, to refund
the cost of the software, on a pro-rated basis over a five-year period. To date,
the Company has not been required to make any payment
resulting from  infringement claims asserted against our customers or partners. As such,
the  Company did not provide for an infringement indemnification accrual as of  September
30, 2003 or December 31, 2002 and has not deferred revenue  recognition.

9

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During
the quarter ended September 30, 2003, the Company sold all of the outstanding
capital stock of its Japanese subsidiary, E.piphany Software, K.K.
(E.piphany Japan), to Braxton Ltd. for approximately $4.2 million in
cash. The stock purchase agreement contained customary representations,
warranties and covenants of the parties, including covenants to indemnify each
other in the event of a breach of warranty or representation. Claims under the
indemnification covenants may be submitted within 6 months, and others within two years, from the date of
closing and for a maximum of $0.7 million, and only to the extent that losses exceed 10% of the purchase price. The fair value of these
indemnification provisions were not material to the Companys financial
position, results of operations or cash flows for the three and nine months
ended September 30, 2003.

The
Company indemnifies its directors and officers in their capacity as such. To
date, the Company has not been required to make any payment resulting from these
indemnification obligations. Additionally, the fair value of these
indemnification provisions was not material to the Companys financial
position, results of operations or cash flows for the three and nine months
ended September 30, 2003.

Stock-Based
Compensation

The
Company accounts for stock issued to employees in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25). Under APB 25, compensation expense for
fixed stock options is based on the difference between the market value of the
Companys stock and the exercise price of the option on the date of grant,
if any. The following table illustrates the effect on net
loss and net loss per share as if the Company had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123), using the Black-Scholes stock option
pricing model (in thousands except per share amounts):

|                                                  | Three months endedSeptember 30, |          | Nine months endedSeptember 30, |         
|------------------------------------------------- | ------------------------------- | -------- | ------------------------------ | --------
|
|Net loss, as reported                             |                                 | $(4,348  | )                              | $(13,603
|Add: Stock-based employee compensation            |                                
|expense included in reported net loss, net of tax |                                
|effects                                           |                                 | 8        |                                | 68      
|Deduct: Total stock-based employee compensation   |                                
|expense determined under fair value based         |                                
|method for all awards, net of tax effects         |                                 | (8,146   | )                              | (14,009 
|Pro forma net loss                                |                                 | $(12,486 | )                              | $(27,544
|Loss per share:                                   |                                
|Basic and dilutedas reported                     |                                 | $  (0.06 | )                              | $  (0.19
|Basic and dilutedpro forma                       |                                 | $  (0.17 | )                              | $  (0.38

10

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3.  Related
Party Transactions

In
connection with the employment of our former chief executive officer, Roger
Siboni, the Company agreed to extend credit to Mr. Siboni in the form of three
personal loans, all of which were repaid in full as of September 30, 2003.

First,
in July 1998, the Company loaned $640,000 to Mr. Siboni in order to purchase
2,400,000 shares of common stock at $0.26 2/3 per share. This loan was due on
July 1, 2008 and accrued interest at 5.88% per annum. As of December 31, 2002,
the outstanding principal balance of this loan was $377,000 and accrued interest
was $6,000. This loan was secured by 1,245,661 shares of E.piphany common stock.
As of September 30, 2003, this loan was repaid in full.

Second,
Mr. Siboni was offered a loan of $250,000 per year for a period beginning August
1, 1998 and ending July 31, 2000, drawable on a monthly basis. This loan accrued
interest at 5.6% per annum. As of December 31, 2002, the loan was repaid in
full.

Third,
Mr. Siboni was extended a loan in the aggregate sum of $173,000 for the payment
of taxes arising from bonus payments made to him during the years 1999 and 2000.
This loan accrued interest at 5.6% per annum.   As of December 31, 2002, the
outstanding balance was $43,000. As of March 31, 2003, this loan was repaid in
full.

Mr.
Siboni is currently a member of the board of directors of two of
the Companys customers. Total revenues to E.piphany from these customers
were $0.1 million each for the three and nine months ended September 30, 2003
and $0.1 million and $0.2 million for the three and nine months ended September
30, 2002, respectively. The Company had accounts receivable balances from these
customers totaling $0.1 million and $0.1 million as of September 30, 2003 and December
31, 2002, respectively.

In
addition, four of the Companys customers have board members or executive
officers that were also on the Companys board of directors at the time
revenues from contracts with these customers were recognized. Total revenues to
the Company from these customers were $0.2 million and $0.5 million for the three
and nine months ended September 30, 2003 and $0.1 million and $1.1 million for
the three and nine months ended September 30, 2002, respectively. The Company had
accounts receivable balances from these customers totaling less than $0.1
million and $0.3 million as of September 30, 2003 and December 31, 2002,
respectively.

11

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4.  Computation of Basic and Diluted Net Loss Per Share

Basic and
diluted net loss per common share has been computed using the weighted average
number of shares of common stock outstanding during the period, less shares
subject to repurchase. The following table presents the calculation of basic and
diluted net loss per share (in thousands, except per share amounts):

|                                                    | Three Months EndedSeptember 30, |          | Nine Months EndedSeptember 30, |         
|--------------------------------------------------- | ------------------------------- | -------- | ------------------------------ | --------
|
|Net loss                                            |                                 | $(4,348  | )                              | $(13,603
|                                                    |                                 |          |                                |         
|Basic and diluted:                                  |                                
|Weighted average shares of common stock outstanding |                                 | 73,734   |                                | 72,188  
|Less: Weighted average shares subject to repurchase |                                 | (7       | )                              | (89     
|                                                    |                                 |          |                                |         
|                                                    |                                 | 73,727   |                                | 72,099  
|                                                    |                                 |          |                                |         
|Basic and diluted net loss per common share         |                                 | $  (0.06 | )                              | $  (0.19
|                                                    |                                 |          |                                |         

The
Company excludes potentially dilutive securities from its diluted net loss per
share computation when their effect would be antidilutive to net loss per share
amounts. The following common stock equivalents were excluded from the net loss
per share computation (in thousands):

|                                                       | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30, |       
|------------------------------------------------------ | ------------------------------- | ------ | ------------------------------ | ------
|
|Options excluded due to the exercise price exceeding   |                                 |        |                                |       
|the average fair market value of the Companys         |                                
|common stock during the period                         |                                 | 7,154  |                                | 11,480
|Options for which the exercise price was less than the |                                
|average fair market value of the Companys common      |                                
|stock during the period that were excluded as          |                                
|inclusion would decrease the Companys net loss        |                                
|per share                                              |                                 | 4,956  |                                | 922   
|Common shares excluded resulting from common           |                                
|stock subject to repurchase                            |                                 | 7      |                                | 89    
|                                                       |                                 |        |                                |       
|Total common stock  equivalents  excluded from diluted |                                
|net loss per common share                              |                                 | 12,117 |                                | 12,491
|                                                       |                                 |        |                                |       

5.  Commitments and Contingencies

Legal
Proceedings

As
of the date hereof, there is no material litigation pending against us other
than as disclosed in the paragraphs below. From time to time, the Company may
become a party to litigation and subject to claims incident to the ordinary
course of our business. Although the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of such
matters will not have a material adverse effect on our business, results of
operations or financial condition.

The
Company, two of its current officers, one of its former officers and three
underwriters in its initial public offering (IPO) were named as
defendants in a consolidated shareholder lawsuit in the United States
District Court for the Southern District of New York, In re E.piphany,
Inc. Initial Public Offering Securities Litigation,01-CV-6158. 
This is one of a number of actions coordinated for pretrial purposes as In re
Initial Public Offering Securities Litigation, 21 MC 92.  Plaintiffs in
the coordinated proceeding have brought claims under the federal securities laws
against numerous underwriters, companies, and individuals, alleging generally
that defendant underwriters engaged in improper and undisclosed activities
concerning the allocation of shares in the

12

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IPOs of more
than 300 companies  during the period from late 1998 through 2000.  Specifically,
among other  things, the plaintiffs allege that the prospectus pursuant to which shares
of  Company common stock were sold in the Companys IPO contained certain false  and
misleading statements regarding the practices of the Companys  underwriters with
respect to their allocation of shares of common stock in the  Companys IPO to their
customers and their receipt of commissions from  those customers related to such
allocations, and that such statements and  omissions  caused the Companys
post-IPO stock price to be  artificially inflated. The consolidated amended complaint
in  the Companys case seeks unspecified damages on behalf of a purported class  of
purchasers of the Companys common stock between September 21, 1999 and  December 6,
2000.  The court has appointed a lead plaintiff for the  consolidated action. The
underwriter and issuer defendants have filed motions to  dismiss. These motions were
denied as to all the underwriter defendants and the  majority of issuer defendants
including the Company. The individual defendants  have been dismissed from the action
without prejudice pursuant to a tolling  agreement. A proposal has been made for the
settlement and release of claims  against the issuer defendants, including the Company. The
settlement is subject to  a number of conditions, including approval of the proposed
settling parties and  the court. The Company has elected to participate in the settlement.
If the  settlement does not occur, and litigation against the Company continues, the Company
believes it has meritorious defenses and intends to defend the case vigorously.

On
February 28, 2003, a purported securities class action lawsuit entitled Liu
v. Credit Suisse First Boston et al., Civil Action Number 03-20459, was
filed in the United States District Court for the Southern District of Florida.
Among the 166 parties named as defendants were Credit Suisse First Boston and
its personnel, issuers that completed IPOs underwritten by Credit Suisse First
Boston, and certain directors and officers of these issuers, including the
Company and two of its current officers. The complaint alleges that the
defendants violated federal and state laws by, among other things, publishing
false and misleading information regarding the issuers projected financial
performance and revenue potential and by incorrectly pricing issuers IPOs.
The complaint related generally to the ongoing IPO-related litigation currently
pending in the United States District Court for the Southern District of New
York. By court order dated July 16, 2003, the Companys defendants were
dismissed from the litigation.

Several
governmental entities have initiated investigations related to the IPO
allocation practices of Credit Suisse First Boston and other investment banks,
and their personnel. In connection with some of these proceedings, the Company
and several other public companies have been asked to provide information
relevant to these proceedings. In response, the Company has provided information
and is otherwise cooperating with these entities. Based on discussions with
these entities, the Company does not believe that it, or any of its directors
and officers, is the target of any of these investigations.

6.  Restructuring

In
the quarter ended September 30, 2001, the Company began restructuring worldwide
operations to reduce costs and improve efficiencies in response to a slower
economic environment. Since that time, operations have been streamlined, sales
models have changed in certain geographies and facilities have been abandoned to
align the Companys cost structure to current market conditions. Charges
for these restructuring activities have been recorded in accordance with
Emerging Issues Task Force No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(EITF 94-3), and with SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), as
applicable. Under EITF 94-3 and SFAS 146, specified activities are deemed the
commencement of a separate restructuring plan in the quarter in which those
activities could be specifically identified. The first plan was initiated in the
quarter ended September 30, 2001 (Plan 1). The second plan,
initiated during the quarter ended June 30, 2002, consisted of actions which
were primarily supplemental to Plan 1 (Plan 2) and a third plan was
initiated during the quarter ended March 31, 2003 (Plan 3). Charges
for these plans were based on assumptions and related estimates that were
appropriate for the economic environment that existed at the time these charges
were recorded. However, due to the continued deterioration of the commercial
real estate market, primarily in the U.S. and the United Kingdom, we have made
subsequent adjustments to the initial restructuring charges recorded under Plan
1 and Plan 2.

13

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The
following table summarizes the Companys restructuring accrual as of
September 30, 2003 (in thousands):

|                                            | Severanceand RelatedCharges | Impairmentof propertyand equipment | Lease Costs | OtherRestructuringActivities | Total
|------------------------------------------- | --------------------------- | ---------------------------------- | ----------- | ---------------------------- | -----
|Accrued balance at December 31, 2001        |                             | $      58                          |             | $                           |      
|                                            |                             |                                    |             |                              |      
|Charges accrued during 2002 - Plan 1        |                             | 1,070                              |             | 157                          |      
|Charges accrued during 2002 - Plan 2        |                             | 1,542                              |             | 2,290                        |      
|Adjustments to previous estimates - Plan 1  |                             |                                   |             |                             |      
|Adjustments to previous estimates - Plan 2  |                             | 131                                |             | 791                          |      
|Cash payments - Plan 1                      |                             | (914                               | )           |                             |      
|Cash payments - Plan 2                      |                             | (1,647                             | )           |                             |      
|Non-cash activity - Plan 1                  |                             | (214                               | )           | (157                         | )    
|Non-cash activity - Plan 2                  |                             |                                   |             | (3,081                       | )    
|                                            |                             |                                    |             |                              |      
|Accrued balance at December 31, 2002        |                             | $      26                          |             | $                           |      
|                                            |                             |                                    |             |                              |      
|Charges accrued during 2003 - Plan 3        |                             | 620                                |             | 301                          |      
|Adjustments to previous estimates - Plan 1  |                             |                                   |             |                             |      
|Adjustments to previous estimates - Plan 2  |                             | (13                                | )           |                             |      
|Cash payments - Plan 1                      |                             |                                   |             |                             |      
|Cash payments - Plan 2                      |                             |                                   |             |                             |      
|Cash payments - Plan 3                      |                             | (633                               | )           |                             |      
|Non-cash activity - Plan 2                  |                             |                                   |             |                             |      
|Non-cash activity - Plan 3                  |                             |                                   |             | (301                         | )    
|                                            |                             |                                    |             |                              |      
|Accrued balance at September 30, 2003       |                             |                                   |             |                             |      
|Less:  current portion                      |                             |                                   |             |                             |      
|                                            |                             |                                    |             |                              |      
|                                            |                             |                                    |             |                              |      
|Restructuring costs, net of current portion |                             | $                                 |             | $                           |      
|                                            |                             |                                    |             |                              |      

Severance
and related charges primarily result from involuntary termination benefits and
related payroll taxes. The impairment of property and equipment primarily
relates to leasehold improvements and other property and equipment impaired as a
result of the abandonment of leased facilities and the reduction of headcount.
Lease costs reflect remaining operating lease obligations and brokerage fees
stated at actual costs reduced by estimated sublease income. The Company
calculates the estimated costs of abandoning these leased facilities, including
estimated sublease costs and income, with the assistance of market information
trend analyses provided by commercial real estate brokerage firms retained by
the Company. Charges shown as other restructuring activities consist of the net
loss on the sale of the Companys subsidiary located in Japan and related
costs.

Year ended
December 31, 2002

In
the first quarter of 2002, the Company completed restructuring activities
associated with Plan 1 by further reducing the number of employees by 19. Of
these, 13 were engaged in sales and marketing activities, 4 were engaged in
professional services activities and 2 were engaged in general and
administrative activities. This reduction consisted primarily of sales employees
located in Asia, Australia and the United States. Included in severance and
related charges is a non-cash charge of $0.2 million for the acceleration of
vesting of certain stock options in connection with terminated employees.

In
the second quarter of 2002, the Company initiated Plan 2 which consisted of
restructuring activities that were largely supplemental to Plan 1 and were
intended to further align costs across all business functions. Under this plan,
the Company reduced the number of employees by 91. Of these, 40 were engaged in
sales and marketing activities, 21 were engaged in professional services
activities, 20 were engaged in general and administrative activities and 10 were
engaged in research and development activities. The reduction consisted of
employees across all geographies. Lease costs were recorded related to the
abandonment of leased facilities in Australia, the United Kingdom and the United
States.

14

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In
addition to these charges, the Company recorded adjustments during 2002 to
previously recorded restructuring estimates. Adjustments totaling
$6.2 million were recorded primarily to reflect changes in estimated lease
costs related to the offices in or near Boston, New York, Chicago and London
which resulted from continued deterioration of real estate markets in those
locations.

Nine months
ended September 30, 2003

On
January 1, 2003, the Company adopted the provisions of SFAS 146 which revises
the accounting for activities relating to exiting or disposing of businesses or
assets under EITF Issue No. 94-3. As of December 31, 2002, a formal commitment
to a plan to exit an activity or dispose of long-lived assets is no longer
sufficient to record a one-time charge for most exit and disposal costs.
Instead, companies must record exit or disposal costs when they are incurred and
can be measured at fair value, and must subsequently adjust the recorded
liability for changes in estimated cash flows. The provisions of SFAS 146 were
effective prospectively for exit or disposal activities initiated after December
31, 2002.

During
the first quarter of 2003, the Company initiated Plan 3 to reduce direct sales
and marketing costs in Japan, Australia, and Latin America by transitioning
these markets to an indirect sales model. This plan was completed in the third
quarter of 2003 and resulted in the sale of the Companys subsidiary
located in Japan, the abandonment of leased facilities in Australia and in a
reduction in the number of employees by 18. Of the total employee reduction,
most had been engaged in sales and marketing activities. The sale of the
Companys subsidiary closed in July, 2003 when the Company sold all of the
outstanding capital stock of E.piphany Software, K.K (E.piphany
Japan), to Braxton Ltd. for approximately $4.2 million in cash. At the
time of the sale, the subsidiary had $4.4 million in net assets resulting in a
charge to other restructuring activities of approximately $0.2 million.

For
the three and nine months ended September 30, 2003, the Company recorded a charge of $0.2 million and $0.6
million, respectively, for severance and related charges, $0.1 million and $0.3 million, respectively, for the impairment of
property and equipment, $0 and $0.1 million, respectively, of lease costs, and $0.2 million and $0.2 million, respectively, in other
restructuring activities associated with Plan 3. In addition, the Company
recorded adjustments to previously-recorded restructuring estimates totaling
$2.6 million primarily to reflect changes in estimated lease costs related to
the offices in the U.S. and the United Kingdom.

The
accrued liability of $29.3 million at September 30, 2003 is net of $31.5 million
of estimated sublease income. The current estimates accrued for abandoned
leases, net of anticipated sublease proceeds, are projected to be paid over
their respective lease terms through 2017.

7.  Segment Information

The Company
is organized and operates as one business segment, which is responsible for the
design, development, marketing and sale of software products and related
services. The Company distributes its products in the United States and in
foreign countries through direct sales personnel and indirect channel partners.

The
Company classifies revenues based on the country in which the applicable sales
contracts originate. The following table details revenues by country (in
thousands):

|               | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30, |        
|-------------- | ------------------------------- | ------- | ------------------------------ | -------
|
|Revenues:      |                                 |         |                                |        
|United States  |                                 | $15,615 |                                | $13,736
|United Kingdom |                                 | 1,775   |                                | 2,511  
|Canada         |                                 | 1,946   |                                | 72     
|Rest of world  |                                 | 4,872   |                                | 3,476  
|               |                                 |         |                                |        
|Total          |                                 | $24,208 |                                | $19,795
|               |                                 |         |                                |        

15

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8.  Goodwill
and Purchased Intangible Assets

In
the first quarter of 2002, the Company adopted SFAS 142, Goodwill and
Other Intangible Assets which states that goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed for impairment
annually, or more frequently if impairment indicators arise. The Company
completed a transitional test and an annual impairment test during the first and
fourth quarters of 2002, respectively, which did not result in an impairment
charge. The Company has not completed an impairment test during the nine months
ended September 30, 2003 as there have been no impairment indicators during this
time. The Company plans to complete an annual impairment test during the fourth
quarter of 2003. Definite lived intangible assets will continue to be amortized
over their estimated useful lives.

Information
regarding the Companys definite lived intangible assets is as follows (in
thousands):

|                     | September 30, 2003 |         | December 31, 2002 |          |  
|-------------------- | ------------------ | ------- | ----------------- | -------- | -
|
|Purchased technology |                    | $17,652 |                   | $(16,218 | )
|Customer list        |                    | 1,332   |                   | (1,332   | )
|                     |                    |         |                   |          |  
|Total                |                    | $18,984 |                   | $(17,550 | )
|                     |                    |         |                   |          |  

(1)  Gross
carrying amount is presented net of an impairment charge, taken as of September
30, 2001, and net of accumulated amortization as of that date.

The Company
will continue to amortize other intangible assets of $1.4 million on a
straight-line basis over their remaining useful lives. Amortization of other
intangible assets for the three months ended September 30, 2003 and 2002 was
$0.8 million and $2.6 million, respectively, and for the nine months ended
September 30, 2003 and 2002 was $4.3 million and $7.9 million, respectively.
Amortization related to these intangibles is expected to be $0.8 million for the
fourth quarter of 2003 and $0.6 million for fiscal year 2004.

9.  Other
Income, Net

Other
income, net consists primarily of interest income from investments. For the nine
months ended September 30, 2003, other income also includes $0.8 million
reflecting the termination of a partner agreement executed by one of our
acquired companies in October 1999.

10.  Income
Taxes

For
the three and nine months ended September 30, 2003, the Company recorded a
provision for income taxes of $0.4 million and $0.5 million, respectively,
primarily as a result of withholding taxes on payments from certain foreign
customers.

11.  Comprehensive Income (Loss)

Comprehensive
income (loss) consists of net income (loss) plus all other non-owner changes in
equity. The components of comprehensive income are as follows (in thousands):

|                                       | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30, |         
|-------------------------------------- | ------------------------------- | ------- | ------------------------------ | --------
|
|Net loss                               |                                 | $(4,348 | )                              | $(13,603
|Change in unrealized gain (loss) on    |                                
|investments                            |                                 | (226    | )                              | 123     
|Change in foreign currency translation |                                
|adjustment                             |                                 | (385    | )                              | (271    
|                                       |                                 |         |                                |         
|Comprehensive losses                   |                                 | $(4,959 | )                              | $(13,751
|                                       |                                 |         |                                |         

16

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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 should
be read in conjunction with our financial statements and related notes. This
document contains forward-looking statements that involve risks and
uncertainties, as well as assumptions that, if prove incorrect or never
materialize, could cause our results to differ materially from those expressed
or implied by such forward-looking statements. Such forward-looking statements
include, without limitation, projections of expenses or other financial items;
statements regarding our plans, strategies, and objectives for future
operations, including the timing, execution costs and potential cost-savings of
restructuring plans; statements concerning proposed new products, services,
developments, or the anticipated performance of products or services; statements
regarding future economic conditions or performance; statements of belief and
any statement of assumptions underlying any of the foregoing. The risks,
uncertainties and assumptions referred to above include, but are not limited to,
those discussed under the heading Risk Factors in this quarterly
report and the risks discussed from time to time in our other public filings. We
assume no obligation to update any forward-looking statements.

Overview

We
develop, market and sell the E.piphany E.6 Suite of software products, a set of
customer relationship management, or CRM, software products. These CRM products
provide capabilities for the collection and analysis of customer data, the
creation of inbound and outbound marketing campaigns, and the execution of sales
and service customer interactions. Companies can implement the E.6 Suite to gain
insight into their customers characteristics and preferences, and then
take action on that insight to better and more profitably serve those customers.
To gain insight into their customers, companies use our analytic CRM products,
which collect customer data from existing software systems or other E.piphany
solutions, as well as third party data providers. To take action on this
insight, companies use our marketing, sales or service products to more
effectively interact with their customers across a variety of communication and
distribution channels.

We
were founded in November 1996 and were primarily engaged in research and
development activities until early 1998 when we shipped our first software
product and generated our first revenues from software license, consulting, and
maintenance fees. In September 1999 and January 2000, we raised a total of
approximately $426 million through the sale of our common stock in registered
public offerings to fund growth and to acquire complementary businesses and
technologies. During 2000 and 2001, we completed several acquisitions in
exchange for our stock consideration including the acquisitions of RightPoint
Software, Inc., Octane Software, Inc., eClass Direct, Inc. and Moss Software,
Inc. These acquisitions increased our customer base, increased the number of our
employees and expanded our product suite. As a result of these acquisitions, we
recorded goodwill and purchased intangible assets of approximately $3.3 billion
representing the difference between the value of the consideration paid in our
stock and the value of the net assets acquired.

From
the shipment of our first software product in early 1998 through the fourth
quarter of 2000, our revenues increased steadily each quarter due primarily to
the market acceptance and success of our products such as E.piphany Insight and
E.piphany Marketing, as well as the shipment of new products such as E.piphany
Service, which were introduced through a combination of acquisitions and
internal development. Our annual revenues grew to $131 million in 2000 from $19
million in 1999 and $3 million in 1998.

17

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During
2001 and 2002, the worldwide economy weakened and a slowdown in technology
spending by businesses occurred. As a result, our revenues declined from $131
million in 2000 to $129 million in 2001 and to $84 million in 2002. During this
period of economic slowdown, we initiated restructuring plans to reduce our
workforce and consolidate our operating facilities. We also reviewed the impact
of the change in market conditions on the carrying value of our goodwill and
intangible assets. We determined that these assets were impaired and wrote down
their fair value by recording a non-cash charge of $1.7 billion in September
2001. Net losses for the years ended December 31, 2000, 2001 and 2002 were $768
million, $2.6 billion and $78 million, respectively. The net losses in 2000 and
2001 were primarily a result of non-cash impairment and amortization of goodwill
and purchased intangibles of $697 million and $2.5 billion, respectively.

While
the worldwide economic downturn has resulted in lower revenue levels compared to
2000 and 2001, we continue to believe that there is a market for our products
and an opportunity to grow revenue from the sale of our products.  Although
we have significantly reduced our operating expenses, we continue to incur
operating losses in order to execute our strategy to grow revenue by, among
other things, improving our products, enhancing their visibility in the market,
and improving our ability to sell and distribute them. We believe that the
investments we are making will afford us an opportunity to benefit from the
market for CRM products that may exist if and when technology spending
improves.

Sources of
Revenue

We
generate revenues principally from licensing our software products directly to
customers and providing related services including implementation, consulting,
maintenance and training services. Through September 30, 2003, substantially all
of our revenues were generated by our direct sales force. Our license agreements
generally provide that customers pay a software license fee to perpetually use
one or more software products within specified limits. The amount of the license
fee varies depending on which software products are purchased, the number of
software products purchased and the scope of usage rights. Customers can
subsequently pay additional license fees to expand the right to use previously
licensed software products, or to purchase additional software products. Our
software products are made available to our customers electronically or on
compact disk.

Customers
generally require consulting and implementation services, which include
evaluating their business needs, identifying the data sources necessary to meet
these needs and installing the software solution in a manner that fulfills their
requirements. Customers can purchase these services directly from third party
consulting organizations, such as Accenture, BearingPoint (formerly KPMG
Consulting), Deloitte Consulting, eLoyalty or IBM. Alternatively, customers can
purchase these services directly from us through our internal professional
services organization. Consulting and implementation services can be acquired on
either a fixed fee or a time and expense basis. We have also historically
supplemented the capacity of our internal professional services organization by
subcontracting some of these services to third party consulting organizations.

Cost of
Revenues and Operating Expenses

Our
cost of product license revenues primarily consists of license fees payable to
third parties for technology integrated into our products. Our cost of services
revenues primarily consists of salaries and related expenses for our
professional services, maintenance and training organizations, an allocation of
facilities, information technology and depreciation expenses, as well as the
cost of reimbursable expenses and the cost of subcontracting professional
services from third party consulting organizations that provide consulting
services to our customers. Cost of revenues also includes the amortization of
purchased technology arising from our acquisitions. Our operating expenses are
classified into three general categories: sales and marketing, research and
development, and general and administrative. We classify all charges to these
operating expense categories based on the nature of the expenditures. We
allocate the costs for overhead and facilities to each of the functional areas
that use the overhead and facilities services based on headcount. These
allocated charges include facilities, information technology, communications and
depreciation expenses.

18

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Software
development costs incurred prior to the establishment of technological
feasibility are included in research and development costs as they are incurred.
Since license revenues from our software solutions are not recognized until
after technological feasibility has been established, software development costs
are not generally expensed in the same period in which license revenues for the
developed products are recognized.

Critical
Accounting Policies and Estimates

Accounting
policies, methods and estimates are an integral part of the condensed
consolidated financial statements prepared by management and are based upon
managements current judgments. Those judgments are normally based on
knowledge and experience with regard to past and current events and assumptions
about future events. Certain accounting policies, methods and estimates are
particularly sensitive because of their significance to the financial statements
and because of the possibility that future events affecting them may differ
markedly from managements current judgments. While there are a number of
accounting policies, methods and estimates affecting our financial statements,
areas that are particularly significant and subject to the exercise of judgment
include revenue recognition policies, allowances for doubtful accounts, the
measurement and recoverability of goodwill and purchased intangible assets,
restructuring accruals for the abandonment of certain leased facilities, and
stock-based compensation. These policies and our practices related to these
policies are described below and in Notes 2, 6 and 8 of Notes to Condensed
Consolidated Financial Statements.

Revenue
Recognition

We
recognize revenue in accordance with generally accepted accounting principles
which have been prescribed for the software industry and we follow detailed
guidelines discussed in Note 2 of Notes to Condensed Consolidated Financial
Statements. The accounting rules related to revenue recognition are complex and
are affected by interpretations of the rules and an understanding of industry
practices, both of which are subject to change. Consequently, the revenue
recognition accounting rules require management to make significant judgments.

We
do not record revenue on sales transactions when collectability is in doubt at
the time of sale. Rather, revenue is recognized from these transactions as cash
is collected. The determination of collectability requires significant judgment.

To
date, when we have been primarily responsible for the implementation of the
software under a customer contract, both product license revenues and service
revenues are recognized under the percentage of completion contract method in
accordance with the provisions of Statement of Position 81-1, Accounting
for Performance of Construction Type and Certain Production-Type Contracts
(SOP 81-1). This is based on our assessment that the implementation
services for these arrangements are essential to the functionality of our
software. From the first quarter of 2001 through the second quarter of 2002,
third-party consulting organizations were primarily responsible for
implementation services for the majority of our license arrangements. In the
second half of 2002, we were responsible for the implementation on the majority
of contracts, resulting in more revenue being recognized under SOP 81-1 in the
second half of 2002 and the first half of 2003.  During the nine months
ended September 30, 2003, approximately 31% of license revenue was recognized
under SOP 81-1 compared to 19% for both the nine month period ended September
30, 2002 and the fiscal year 2002. We believe that this increase was temporary
and related to a major product release in the third quarter of 2002. 
During the first nine months of 2003, third parties were responsible for the
majority of implementations.

19

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We
estimate the percentage of completion on contracts utilizing hours incurred to
date as a percentage of the total estimated hours to complete the project. The
percentage of completion method of accounting involves an estimation process and
is subject to risks and uncertainties inherent in projecting future events. A
number of internal and external factors can affect our estimates, including the
nature of the services being performed, the complexity of the customers
information technology environment and the utilization and efficiency of our
professional services employees. Recognized revenues and profit are subject to
revisions as the contract progresses to completion. Revisions in profit
estimates are charged to income in the period in which the facts that give rise
to the revision become known.

Allowances
for Doubtful Accounts

A
considerable amount of judgment is required when we assess the realization of
receivables, including assessing the probability of collection and the current
creditworthiness of each customer. When we believe a collectability issue exists
with respect to a specific receivable, we record an allowance to reduce that
receivable to the amount that we believe is collectable. For all other
receivables, we record an allowance based on an assessment of the aging of such
receivables, our historical experience with bad debts and the general economic
environment. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required that would result in additional general and
administrative expense in the period such determination is made.

Acquisitions,
Goodwill and Purchased Intangible Assets

We
record goodwill and purchased intangible assets when we acquire other companies.
The cost of the acquisition is allocated to the assets and liabilities acquired,
including purchased intangible assets, and the remaining amount is classified as
goodwill. Certain purchased intangible assets such as purchased technology and
customer lists are amortized to cost of revenues and operating expense over
time, while in-process research and development is recorded as a one-time charge
on the acquisition date. Goodwill is not amortized to expense but is
periodically assessed for impairment. The allocation of the acquisition cost
between the various purchased intangible assets including, in-process research
and development, therefore, has a significant impact on our operating results.
The allocation process involves an extensive use of estimates and assumptions,
including estimates of future cash flows to be generated by the acquired assets.

We
perform impairment tests annually or when impairment indicators are identified
with respect to previously recorded intangible assets. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the asset exceeds its fair market value.
Fair market value is determined using, among other things, discounted future
cash flow techniques. Estimating discounted future cash flows requires
significant management judgment concerning revenue, profitability and discount
rates. Differences between forecasted and actual results as well as changes in
the general economic environment could result in material write downs of
goodwill and purchased intangible assets. We performed transitional and annual
impairment tests on January 1, 2002 and on December 31, 2002, respectively, and
determined that no impairments existed at those times.

20

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Restructuring
Charges

As
discussed in Note 6 of Notes to Condensed Consolidated Financial Statements, we
have recorded significant restructuring charges, primarily in connection with
our abandonment of certain leased facilities. The lease abandonment costs were
estimated to include remaining lease liabilities and brokerage fees offset by
estimated sublease income. Estimates related to sublease costs and income are
based on assumptions regarding the period required to sublease the facilities
and the likely sublease rates. These estimates are based on market trend
information analyses provided by commercial real estate brokerage firms retained
by us. We review these estimates each reporting period and, to the extent that
market conditions and our assumptions change, adjustments to the restructuring
accrual are recorded. If the real estate market continues to worsen and we are
not able to sublease the properties as early as, or at the rates estimated, the
accrual will be increased, which would result in additional restructuring costs
in the period in which such determination is made. If the real estate market
strengthens and we are able to sublease the properties earlier or at more
favorable rates than projected, the accrual may be decreased, which would
increase net income in the period in which such determination is made. The
accrued liability of $29.3 million at September 30, 2003 is net of $31.5 million
of estimated sublease income. Of this total sublease income, $13.5 million
represents future sublease income due under non-cancelable subleases and $18.0
million represents our estimates of future sublease income on excess facilities
we expect to sublease in the future.

Stock-Based
Compensation

We
elect to account for compensation expense related to stock options issued to  employees
in accordance with Accounting Principles Board Opinion No. 25,  Accounting for
Stock Issued to Employees (APB 25). Under  APB 25, compensation expense
for fixed stock options is based on the difference  between the market value of our stock
and the exercise price of the option on  the date of grant, if any. This election is
available to companies under SFAS  No. 123, Accounting for Stock-Based Compensation (SFAS
123). Had we elected to apply the fair value method for valuing stock  options
under SFAS 123, our net loss and net loss per share would have been  substantially higher
as discussed in Note 2 to the Condensed Consolidated  Financial Statements. The fair
value method of option valuation was applied for  disclosure purposes by utilizing the
Black-Scholes option-pricing model. This  option-pricing model is commonly used by
companies to calculate the fair value  of options under SFAS 123 and utilizes certain
variables including the exercise  price of the option, expected life of the option, the
market value of the  underlying stock as of the grant date, the expected volatility of
the underlying  stock during the life of the option, and a risk-free interest rate of
return.  Although some of these variables are known at the date of grant, other variables
are based on estimates of future events. Changes in these estimates may have a  material
impact on the compensation expense calculated under the fair value  method. For example,
an increase in the estimated expected life of the option or  the stock volatility would
increase the fair market value of the option and  result in an increase to compensation
expense calculated under the fair value  method.

Results of
Operations

Revenues

The
following table sets forth our revenues for the three and nine months ended
September 30, 2003 and September 30, 2002, expressed both in absolute dollars
and as a percentage of total revenues (in thousands, except percentages):

|                | Three months ended September 30, |         | Nine months ended September 30, |     
|--------------- | -------------------------------- | ------- | ------------------------------- | ----
|
|Revenues:       |                                  |         |                                 |     
|Product license |                                  | $10,239 |                                 | 42% 
|Services        |                                  | 13,969  |                                 | 58% 
|                |                                  |         |                                 |     
|                |                                  | $24,208 |                                 | 100%
|                |                                  |         |                                 |     

The
increase in revenues for the quarter ended September 30, 2003, as compared to
the quarter ended September 30, 2002, was primarily due to an increase in
revenues from our North America region which consists of the United States and
Canada. Revenues from North America increased by $3.8 million, or 27%, revenues
from the United Kingdom decreased by $0.7 million, or 29%, and revenues from the
rest of the world increased by $1.4 million, or 40%. For the nine months ended
September 30, 2003 revenues from North America increased by $3.8
million, or 8%, revenues from the United Kingdom decreased by $0.7
million, or 11% and revenues from the rest of the world increased by $4.4
million, or 49%. We expect to focus the majority of our direct sales and
marketing activities in North America and Europe. Therefore, we expect that a
higher percentage of our revenues will be derived from these geographies in the
future.

The
increase in product license revenues for the three and nine months ended
September 30, 2003, as compared to the same periods in the prior year, was due
to an increase in the sale of product licenses in our North America region. The
increase in product license sales is primarily due to demand generated by the
release of our E.6 suite of software products during the quarter
ended September 30, 2002 and the continued maturity and market acceptance of
these products. In addition, while the sale of our product
licenses decreased in our Asia Pacific and Latin America regions, revenues in
these regions increased due to an increase in revenues recognized under SOP 81-1
on licenses sold in previous periods.

The
increase in services revenues for the quarter ended September 30, 2003, as
compared to the quarter ended September 30, 2002, was due to an increase in both
maintenance and professional services revenues. The increase in services
revenues for the nine months ended September 30, 2003, as compared to the nine
months ended September 30, 2002, was due to an increase in maintenance revenue
offset, in part, by a decrease in professional services revenue. The increase in
maintenance revenue for both the three and nine month periods ended September
30, 2003 was attributable to maintenance contracts sold with new licenses in
addition to a high rate of maintenance agreement renewals by our existing
installed base. The decrease in professional services revenue for the nine
months ended September 30, 2003 was attributable to more of our customers
contracting directly with third party integrators during the first half of 2003.

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Cost of
Revenues

The
following table sets forth our cost of revenues for the three and nine months
ended September 30, 2003 and September 30, 2002, expressed both in absolute
dollars and as a percentage of total revenues (in thousands, except
percentages):

|                                       | Three months ended September 30, |           | Nine months ended September 30, |    
|-------------------------------------- | -------------------------------- | --------- | ------------------------------- | ---
|
|Cost of revenues:                      |                                  |           |                                 |    
|Product license                        |                                  | $     419 |                                 | 2% 
|Services                               |                                  | 6,993     |                                 | 29%
|Amortization of purchased   technology |                                  | 755       |                                 | 3% 
|                                       |                                  |           |                                 |    
|Total cost of revenues                 |                                  | $  8,167  |                                 | 34%
|                                       |                                  |           |                                 |    
|Gross profit                           |                                  | $16,041   |                                 | 66%
|                                       |                                  |           |                                 |    

Cost
of revenues includes the cost of license revenues, the cost of services revenues
and the amortization of purchased technology. The cost of revenues decreased for
the three and nine month periods ended September 30, 2003 primarily due to a
decrease in the amortization of purchased technology and a decrease in the cost
of services revenues.

Cost
of product license revenues consists primarily of license fees paid to third
parties under technology license arrangements, and, as a percentage of license
revenues, have not been significant to date.

Cost
of services revenues consists primarily of personnel and related costs of
providing professional, maintenance and training services. Cost of services
revenues for the quarter ended September 30, 2003 decreased as compared to the
quarter ended September 30, 2002 primarily due to a reduction in third party
integrator costs in Europe. Cost of services revenues for the nine months ended
September 30, 2003 decreased as compared to the nine months ended September 30,
2002 as a result of a reduction in the number of internal professional services
employees and the related overhead and facilities costs, offset in part by an
increase in travel expenses. The decrease in cost of services as a percentage of
revenue is primarily due to a higher proportion of maintenance revenue, which
has more favorable margins than professional services and training revenue, as
well as a reduction of the number of services employees. The number of services
employees decreased by 40 during 2002 and by 12 during the nine months ended
September 30, 2003. Most of the reduction in services employees occurred during
the six months ended June 30, 2002, when we reduced the number of services
employees from 174 to 137. Of the total reduction, 25 related to the
restructuring of our operations and the remainder related to voluntary and other
terminations.

Amortization
of purchased technology for the three and nine months ended September 30, 2003
decreased as compared to the same periods in the prior year due primarily to the
full amortization of RightPoint purchased technology assets as of December 31,
2002. To a lesser extent, the decrease was also due to the full amortization of
Octane and eClass purchased technology assets as of May 31, 2003. Purchased
technology assets of $1.4 million are included in purchased intangibles on our
Condensed Consolidated Balance Sheets and are being amortized on a straight-line
basis over their remaining useful lives. Amortization of purchased technology is
expected to be a total of $0.8 million for the remaining three months of 2003
and $0.6 million for 2004.

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Operating
Expenses

Research and
Development

The
following table sets forth our research and development expenses for the three
and nine months ended September 30, 2003 and September 30, 2002, expressed both
in absolute dollars and as a percentage of total revenues (in thousands, except
percentages):

|                         | Three months ended September 30, |        | Nine months ended September 30, |    
|------------------------ | -------------------------------- | ------ | ------------------------------- | ---
|
|Research and development |                                  | $7,753 |                                 | 32%

Research
and development expenses consist primarily of personnel and related costs
associated with our product development efforts. The decrease in research and
development expenses for the three and nine months ended September 30, 2003 as
compared to the same periods in the prior year are due to a decrease in
localization costs related to the Japan market as well as a reduction of
facilities and overhead expenses resulting from the abandonment of facilities
under our restructuring plans. While we continue to consider ways of improving
our cost structure relative to our research and development activities,
including the use of more overseas development resources, we believe that
investments in product development are essential to our future success, and
these expenses may increase in the future.

Sales and
Marketing

The
following table sets forth our sales and marketing expenses for the three and
nine months ended September 30, 2003 and September 30, 2002, expressed both in
absolute dollars and as a percentage of total revenues (in thousands, except
percentages):

|                    | Three months ended September 30, |        | Nine months ended September 30, |    
|------------------- | -------------------------------- | ------ | ------------------------------- | ---
|
|Sales and marketing |                                  | $9,947 |                                 | 41%

Sales
and marketing expenses consist primarily of employee salaries, benefits and
commissions, and the costs of trade shows, seminars, promotional materials and
other sales and marketing programs. The decrease in sales and marketing expenses
for the three and nine months ended September 30, 2003 as compared to the same
periods in the prior year were due primarily to a reduction in the number of
sales and marketing employees and lower overhead and facilities costs as a
result of our restructuring plans. The decrease was also due to lower spending
on sales and marketing programs. The number of sales and marketing employees
decreased by 87 during 2002 and by 41 during the nine months ended September 30,
2003. Of the total reduction, 65 related to the restructuring of our operations.

General and
Administrative

The
following table sets forth our general and administrative expenses for the three
and nine months ended September 30, 2003 and September 30, 2002, expressed both
in absolute dollars and as a percentage of total revenues (in thousands, except
percentages):

|               | Three months ended September 30, |        | Nine months ended September 30, |    
|-------------- | -------------------------------- | ------ | ------------------------------- | ---
|
|General and    |                                  |        |                                 |    
|administrative |                                  | $2,831 |                                 | 12%

General
and administrative expenses consist primarily of employee salaries and related
expenses for executive, finance, legal and administrative personnel. General and
administrative expenses for the quarter ended September 30, 2003 decreased as
compared to the quarter ended September 30, 2002 primarily due to a reduction in
facilities and other overhead expenses resulting from the restructuring of our
operations. General and administrative expenses for the nine months ended
September 30, 2003 decreased as compared to the nine months ended September 30,
2002 due primarily to the reduction in spending on external professional
services such as legal, tax and temporary services as well as a reduction in the
number of general and administrative employees. The number of general and
administrative employees decreased by 28 during 2002 and by 5 during the nine
months ended September 30, 2003. Most of this reduction in general and
administrative employees occurred during the six months ended June 30, 2002 when
we reduced our general and administrative employees from 99 to 67. Of the total
reduction, 22 related to the restructuring of our operations and the remainder
related to voluntary and other terminations.

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Restructuring
Charges

The
following table sets forth our restructuring charges for the three and nine
months ended September 30, 2003 and September 30, 2002, expressed both in
absolute dollars and as a percentage of total revenues (in thousands, except
percentages):

|                      | Three months ended September 30, |      | Nine months ended September 30, |   
|--------------------- | -------------------------------- | ---- | ------------------------------- | --
|
|Restructuring charges |                                  | $518 |                                 | 2%

In
the quarter ended September 30, 2001, we began restructuring worldwide
operations to reduce costs and improve efficiencies in response to a slower
economic environment. Since that time, operations have been streamlined, sales
models have changed in certain geographies and facilities have been abandoned to
align the Companys cost structure to current market conditions. Charges
for these restructuring activities have been recorded in accordance with
Emerging Issues Task Force No. 94-3 Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity,
(EITF 94-3), and with SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146), as
applicable. Under EITF 94-3 and SFAS 146, specified activities are deemed the
commencement of a separate restructuring plan in the quarter in which those
activities could be specifically identified. The first plan was initiated in the
quarter ended September 30, 2001 (Plan 1). The second plan,
initiated during the quarter ended June 30, 2002, consisted of actions which
were primarily supplemental to Plan 1 (Plan 2) and a third plan was
initiated during the quarter ended March 31, 2003 (Plan 3). Charges
for these plans were based on assumptions and related estimates that were
appropriate for the economic environment that existed at the time these charges
were recorded. However, due to the continued deterioration of the commercial
real estate market, primarily in the United States and the United Kingdom, we
have made subsequent adjustments to the initial restructuring charges recorded
under Plan 1 and Plan 2.

During
the first quarter of 2003, we initiated Plan 3 to reduce direct sales and
marketing costs in Japan, Australia, and Latin America by transitioning these
markets to an indirect sales model. This plan was completed in the third quarter
of 2003 and resulted in the sale of our subsidiary located in Japan, the
abandonment of leased facilities in Australia and a reduction in the number of
employees across all of these geographies by 18. Of the total employee
reduction, most had been engaged in sales and marketing activities. For the nine
months ended September 30, 2003, we recorded a charge of $0.6 million for
severance and related charges, $0.3 million for the impairment of property and
equipment, $0.1 million of lease costs, and $0.2 million in other restructuring
activities associated with Plan 3. In addition, the Company recorded adjustments
to previously-recorded restructuring estimates totaling $2.6 million primarily
to reflect changes in estimated lease costs related to the offices in the U.S.
and the United Kingdom.

The
increase in restructuring charges for the period ended September 30, 2003 over
the same period last year is due to charges related to the sale of our
subsidiary in Japan during the quarter ended September 30, 2003. The decrease in
restructuring charges for the nine months ended September 30, 2003 compared to
the same period last year is primarily due to the completion of restructuring
activity under Plan 2 initiated in 2002 and a decrease in charges taken as a
result of charges in estimated lease costs. See further details in Note 6 of
Notes to Condensed Consolidated Financial Statements.

24

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Other
Income, Net

The
following table sets forth our other income, net for the three and nine months
ended September 30, 2003 and September 30, 2002, expressed both in absolute
dollars and as a percentage of total revenues (in thousands, except
percentages):

|                  | Three months ended September 30, |        | Nine months ended September 30, |   
|----------------- | -------------------------------- | ------ | ------------------------------- | --
|
|Other income, net |                                  | $1,090 |                                 | 5%

Other
income, net consists primarily of interest income from investments. Other
income, net, for the three months ended September 30, 2003 decreased as compared
to the three months ended September 30, 2002 due to a decrease in interest
income as a result of a decrease in the average rate of return on our
investments and lower average cash and investment balances. For the nine months
ended September 30, 2003, other income also includes $0.8 million reflecting the
termination of a partner agreement executed by an acquired company in October
1999. Other income, net was unchanged for the nine months ended September 30,
2003 compared to the nine months ended September 30, 2002 due to a decrease in
interest income during 2003 offset by the recognition of $0.8 million on the
termination of the partner agreement.

Provision
for Taxes

The
following table sets forth our provision for taxes for the three and nine months
ended September 30, 2003 and September 30, 2002, expressed both in absolute
dollars and as a percentage of total revenues (in thousands, except
percentages):

|                    | Three months ended September 30, |      | Nine months ended September 30, |   
|------------------- | -------------------------------- | ---- | ------------------------------- | --
|
|Provision for taxes |                                  | $414 |                                 | 2%

Provision
for taxes consists primarily of withholding taxes due on payments from certain
foreign customers.

Liquidity
and Capital Resources

As
of September 30, 2003, our primary sources of liquidity consisted of $140.7
million in cash, cash equivalents and short-term investments and $123.7 million
in long-term investments for a total of $264.4 million in cash and investments.
Long-term investments generally consist of securities that we intend to hold for
more than one year with maturity dates of less than two years from the date of
purchase.

Net
cash used in operating activities for the nine months ended September 30, 2003
totaled $24.5 million and is a decrease from the $38.1 million cash used in
operating activities for the same period in the prior year. The decrease in cash
used in operations is primarily due to a reduction in our net loss offset, in
part, by a decrease in deferred revenue and other liabilities. Our net loss
decreased primarily due to the restructuring of our operations and our continued
focus on cost control as well as an increase in revenue.

We
expect to incur significant operating expenses, particularly research and
development and sales and marketing expenses, for the foreseeable future in
order to execute our business plan. We anticipate that such operating expenses
will comprise a material expenditure of our cash resources. As a result, our net
cash flows will depend on the level of future revenues and our ability to
effectively manage costs.

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Net
cash used in investing activities totaled $18.2 million for the nine months
ended September 30, 2003 due primarily to the net movement from investments to
cash and cash equivalents for the purpose of funding operating activities. For
the same period in the prior year net cash provided by investing
activities was $12.3 million which was primarily due to the maturities of investments.
Investments purchased are primarily comprised of investment grade securities
such as government notes and bonds with maturities which do not exceed 24
months.

Net
cash provided by financing activities totaled $3.5 million and $5.4 million for
the nine months ended September 30, 2003 and 2002, respectively. Cash provided
by financing activities for each period resulted primarily from the receipt of
proceeds from the issuance of common stock pursuant to the exercise of stock
options and our employee stock purchase plan.

From
time to time, we are required to obtain letters of credit that serve as
collateral for our obligations to third parties under facility lease agreements.
These letters of credit are secured by cash, cash equivalents and investments and are
recorded as restricted cash and investments in the Condensed Consolidated Balance Sheets. As of
September 30, 2003, we had $8.5 million of restricted cash and investments, $1.2 million of
which is classified as short-term and relates to facility lease agreements that
have expiration dates within 12 months, and $7.3 million of which are classified
as long-term and relate to facility lease agreements that have expiration dates
greater than twelve months from September 30, 2003.

We
lease certain equipment and our facilities under capital and operating lease
agreements, which expire at various dates through 2017. In addition, we receive
sublease income from noncancelable subleases of excess facilities. Future
minimum lease payments due and receivable under these leases as of September 30,
2003 were as follows (in thousands):

Sublease

|Year Ending December 31, | CapitalLeases Due | OperatingLeases Due | IncomeReceivable | Total,Net
|------------------------ | ----------------- | ------------------- | ---------------- | ---------
|2003                     |                   | $       12          |                  | $   3,354
|2004                     |                   |                    |                  | 11,575   
|2005                     |                   |                    |                  | 9,061    
|2006                     |                   |                    |                  | 6,333    
|2007                     |                   |                    |                  | 6,348    
|2008 and thereafter      |                   |                    |                  | 28,612   
|                         |                   |                     |                  |          
|                         |                   | $       12          |                  | $ 65,283 
|                         |                   |                     |                  |          

Net
operating lease commitments shown above include $29.3 million of operating lease
commitments under leases for abandoned facilities, which are recorded as
restructuring costs in the Condensed Consolidated Balance Sheets as of September
30, 2003. We do not have commercial commitments under lines of credit, standby
lines of credit, guarantees, standby repurchase obligations or other such
arrangements.

Although
our existing cash, cash equivalents and investment balances are expected to
decline in the aggregate, we believe that these balances will be sufficient to
meet our anticipated liquidity needs for working capital and capital
expenditures for at least 12 months. If we require additional capital resources
to grow our business internally or to acquire complementary technologies and
businesses at any time in the future, we may seek to liquidate our long-term
investments, issue additional equity or debt securities or secure a bank line of
credit. The sale of additional equity or convertible debt securities could
result in additional dilution to our stockholders. We cannot assure you that any
financing arrangements will be available in amounts or on terms acceptable to us
in the future.

26

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RISK FACTORS

An
investment in our common stock is very risky. You should carefully consider the
risks discussed below, together with all of the other information included in
this quarterly report on Form 10-Q and other reports filed with, or furnished
to, the Securities and Exchange Commission before buying or selling our
securities. If any of the following risks actually occur, our business,
financial condition or results of operations could be materially adversely
affected, the trading price of our common stock could decline, and you may lose
all or part of your investment.

We have a history of losses, expect losses in the future and may not ever become
profitable.

We incurred net losses of $24.7 million for the nine months ended September 30,
2003, $71.7 million for the year ended December 31, 2002, $2.6 billion for the
year ended December 31, 2001 and $768.5 million for the year ended December 31,
2000. We had an accumulated deficit of $3.5 billion as of September 30, 2003. We
expect to continue to incur losses in the foreseeable future. These losses may
be substantial and we may never become profitable. Our operating results will be
harmed if our revenues do not keep pace with our expenses or are not sufficient
for us to achieve profitability. If we do achieve profitability in any period,
it cannot be certain that we will sustain or increase profitability on a
quarterly or annual basis.

Our revenues may be harmed if general and industry specific economic conditions do
not improve or continue to worsen.

Our revenues are dependent on the health of the economy and the growth of our
customers and potential future customers. If the economies in the United States
or in other territories in which we do business worsen, or do not substantially
improve, our customers may delay or reduce their spending on customer
relationship management software. When economic conditions weaken, sales cycles
for software products tend to lengthen and companies information
technology budgets tend to be reduced. When this happens, our revenues suffer
and our stock price may decline.

Competition from other software vendors could adversely affect our ability to sell our
products and services and could result in pressure to price our products in a
manner that reduces our margins.

Competitive pressures could prevent us from growing, reduce our market share or require us
to reduce prices of our products and services, any of which could harm our
business. We compete principally with vendors of traditional customer
relationship management software, enterprise resources planning software and
data analysis and marketing software. Our competitors include, among others,
companies such as Chordiant, Kana Communications, NCR, Onyx, Oracle, PeopleSoft,
Pivotal, SAP, SAS Institute, Siebel Systems and Unica.

Many
of these companies have significantly greater financial, technical, marketing,
sales, service and other resources than we do. Many of these companies also have
a larger installed base of users, have been in business longer and/or have
greater name recognition than we do. In addition, some large companies have and
will continue to attempt to build capabilities into their products that are
similar to the capabilities of our products. Some of our competitors
products may be more effective than our products at performing particular
functions or be more customized for customers particular needs. Even if
these functions are more limited than those provided by our products, our
competitors software products could discourage potential customers from
purchasing our products.

32

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Further, our competitors may be able to respond more  quickly than we can to changes in customer
requirements.

We have recently experienced price erosion with respect to some of our products as
new competitors enter the market and existing competitors reduce prices. Our
strategy is to develop, market and support a broad set of customer relationship
management products. If we are not effectively able to develop, market and
support a diversified portfolio of products, our revenues and operating margins
will be harmed.

Our competitors have made and may continue to make strategic acquisitions or
establish cooperative relationships among themselves or with other software
vendors. This may increase the ability of their products and reduce or eliminate
the need for our software products. Our competitors may also establish or
strengthen cooperative relationships with our current or future distributors,
partners or other parties with whom we have relationships, thereby limiting our
ability to sell through these channels, reducing the promotion of our products
and limiting the number of personnel available to implement our software.

Variations in quarterly operating results may cause our operating results to fall below the
expectations of market analysts and investors and our stock price to decline.

We expect our quarterly operating results to fluctuate. We believe, therefore, that
quarter-to-quarter comparisons of our operating results may not be a good
indication of our future performance, and you should not rely on them to predict
our future performance or the future performance of our stock price. Our
short-term expense levels are relatively fixed and are based on our expectations
of future revenues. As a result, a reduction in revenues in a quarter may harm
our operating results for that quarter. Our quarterly revenues, expenses and
operating results could vary significantly from quarter to quarter. If our
operating results in future quarters fall below the expectations of market
analysts and investors, the trading price of our common stock will fall. Factors
that may cause our operating results to fluctuate on a quarterly basis or fall
below the expectations of market analysts and investors in a particular quarter
are:

| |  | varying
size, timing and contractual terms of orders for our products and  services,
|- |  | ------------------------------------------------------------------------------------

| |  | our
ability to timely complete our service obligations related to product sales,
|- |  | --------------------------------------------------------------------------------

| |  | changes
in the mix of revenue attributable to higher-margin product license revenue as  opposed
to substantially lower-margin service revenue,
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | customers decisions
to defer or cancel orders or implementations,  particularly large orders or
implementations, from one quarter to the next,
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes
in demand for our software or for enterprise software generally,
|- |  | ------------------------------------------------------------------------

| |  | reductions
in the rate at which opportunities in our pipeline convert into binding license
agreements,
|- |  | ------------------------------------------------------------------------------------------------------

| |  | announcements
or introductions of new products by us or our competitors,
|- |  | ------------------------------------------------------------------------

| |  | software
defects and other product quality problems,
|- |  | ----------------------------------------------------

| |  | our
ability to release new, competitive products on a timely basis,
|- |  | -------------------------------------------------------------------

33

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| |  | any
increase in our need to supplement our professional services organization by
subcontracting to more expensive consulting organizations to help provide  implementation
services when our own capacity is constrained,
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | restructuring
and other non-recurring costs, including severance and lease  abandonment costs,
|- |  | ----------------------------------------------------------------------------------------------

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

| |  | our
ability to hire, train and retain qualified engineering, consulting, training,  sales and
other personnel.
|- |  | --------------------------------------------------------------------------------------------------------------

Our financial results for a particular quarter may be materially adversely affected
by the delay or cancellation of large transactions.

Although no single customer accounted for more than 10% of total revenues for the three
and nine months ended September 30, 2003 or for the year ended December 31,
2002, a few large license transactions may from time to time account for a
substantial amount of our license revenues. For example, for the quarter ended
March 31, 2002, revenues from one customer accounted for 12% of total revenues.
For the quarter ended December 31, 2002, revenues from one customer accounted
for 17% of total revenues. If a customer or potential customer cancels or does
not enter into a large transaction that we may anticipate in a certain quarter,
or delays the transaction beyond the end of the quarter, our financial results
in that quarter may be materially adversely affected.

Our limited operating history makes financial forecasting and evaluation of our
business difficult.

Our limited operating history makes it difficult to forecast our future operating
results. We were founded in November 1996. Our revenue and income potential is
unproven. We received our first revenues from licensing our software and
performing related services in early 1998. Since we do not have a long history
upon which to base forecasts of future operating results, any predictions about
our future revenues and expenses may not be as accurate as they would be if we
had a longer business history.

If our internal professional services organization does not provide implementation
services effectively and according to schedule, our revenues and profitability
would be harmed.

Customers that license our products typically require consulting and implementation
services and can obtain them from our internal professional services
organization, or from outside consulting organizations. When we are primarily
responsible for implementation services, we generally recognize software license
revenue as the implementation services are performed. If our internal
professional services organization does not effectively implement our products,
or if we are unable to maintain our internal professional services organization
as needed to meet our customers needs, the recognition of revenue from
such transactions will be delayed. In addition, our ability to sell software,
and accordingly our revenues, will be harmed. We may be required to increase our
use of subcontractors to help meet our implementation and service obligations,
which would result in lower gross margins. In addition, we may be unable to
negotiate agreements with subcontractors to provide a sufficient amount and
quality of services. If we fail to retain sufficient qualified subcontractors,
our ability to sell software for which these services are required will be
harmed and our revenues will suffer.

Our products are new, and if they contain defects, or our services are not perceived
as high quality, we could lose potential customers or be subject to damages.

34

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We began shipping our first products in early 1998. Our products are complex and
may contain currently unknown errors, defects or failures, particularly since
they are new and recently released. In the past, we have discovered software
errors in our products after introduction. We may not be able to detect and
correct errors before releasing our products commercially. If our commercial
products contain errors, we may be required to:

| |  | expend
significant resources to locate, correct or work around the error,
|- |  | -------------------------------------------------------------------------

| |  | delay
introduction of new products or commercial shipment of products, or
|- |  | -------------------------------------------------------------------------

| |  | experience
reduced sales and harm to our reputation from dissatisfied customers.
|- |  | --------------------------------------------------------------------------------

Our customers also may encounter system configuration problems that require us to
spend additional consulting or support resources to resolve these problems.

Because our software products are used for important decision-making processes and
enable our customers to interact with their customers, product defects may also
give rise to liability claims. Although our license agreements with customers
typically contain provisions designed to limit our exposure, some courts may not
enforce all or part of these limitations. Although we have not experienced any
such liability claims to date, we may encounter these claims in the future.
Liability claims, whether or not successful, could:

| |  | divert
the attention of our management and key personnel from our business,
|- |  | ---------------------------------------------------------------------------

| |  | be
expensive to defend, and
|- |  | ---------------------------

| |  | result
in large damage awards.
|- |  | ------------------------------

Our liability insurance may not be adequate to cover all of the expenses resulting
from a claim. In addition, if our customers do not find our services to be of
high quality or are otherwise dissatisfied with our services, we may lose
revenue.

If customers do not contract directly with third party consulting organizations to
implement our products, our revenues, profitability and margins may be harmed.

We focus on providing software products rather than services. As a result, we
encourage our customers to purchase consulting and implementation services
directly from third party consulting organizations instead of purchasing these
services from us. While we do not receive any fees directly from these
consulting organizations when they contract directly with our customers, we
believe that these consulting organizations increase market awareness and
acceptance of our software products and allow us to focus on software
development, marketing, licensing and support.

From time to time, our customers nonetheless require that we provide services
directly to them, especially when such customers have licensed new releases of
our products. If consulting organizations are unwilling or unable to provide a
sufficient amount and quality of services directly to our customers or if
customers are unwilling to contract directly with these consulting
organizations, we may not realize these benefits and our revenues and
profitability may be harmed.

When we provide consulting and implementation services to our customers, we do so
either directly through our internal professional services organization or
indirectly through subcontractors we hire to perform these services on our
behalf. Because our margins on service revenues are less than our margins on
license revenues, our overall margins decline when we provide these services to
customers. This is particularly true if

35

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we hire subcontractors to perform these  services because it costs us more to hire subcontractors
to perform these  services than to provide the services ourselves.

Our products have long sales cycles that make it difficult to plan expenses and
forecast results.

It typically takes us between six and twelve months to complete a sale of our
products, but it can take us longer. It is difficult, therefore, to predict if,
and the quarter in which, a particular sale will occur and to plan expenditures
accordingly. The period between initial contact with a potential customer and
their purchase of products and services is relatively long due to several
factors, including:

| |  | the
complex nature of our products,
|- |  | -----------------------------------

| |  | our
need to educate potential customers about the uses and benefits of our products,
|- |  | ------------------------------------------------------------------------------------

| |  | the
purchase of our products requires a significant investment of resources by a  customer,
|- |  | -------------------------------------------------------------------------------------------

| |  | our
customers have budget cycles which affect the timing of purchases,
|- |  | ----------------------------------------------------------------------

| |  | uncertainty
regarding future economic conditions,
|- |  | -------------------------------------------------

| |  | many
of our potential customers require competitive evaluation and internal  approval before
purchasing our products,
|- |  | ---------------------------------------------------------------------------------------------------------------------

| |  | potential
customers delay purchases due to announcements or planned  introductions of new products
by us or our competitors, and
|- |  | --------------------------------------------------------------------------------------------------------------------------------

| |  | many
of our potential customers are large organizations, which may require a  long time to
make decisions.
|- |  | ----------------------------------------------------------------------------------------------------------

The delay or failure to complete sales in a particular quarter could reduce our
revenues in that quarter, as well as subsequent quarters over which revenues for
the sale would likely be recognized. Our sales cycles lengthen when economic
conditions worsen and spending on information technology declines. If our sales
cycles unexpectedly lengthen in general, or for one or more large orders, our
revenues could be adversely affected.

In addition, some customers receive the right to perform acceptance testing after
the sale of our products with respect to some or all of the products licensed.
If these customers do not accept the products or otherwise terminate their
customer agreements, our revenues could be adversely affected.

Also, some customers elect to initially license our products on a preliminary or
proof of concept basis to enable them to evaluate the extent to
which such products meet their specific needs within their technical
environment. If such customers conclude the products meet their needs, they may
elect to expand the scope of usage rights to deploy our products more broadly
within their enterprises. Our customers election to license our products
on this basis could delay or place at risk our receipt of revenue with respect
to such transactions.

If the market for our products does not grow, our revenues will not increase.

If the market for customer relationship management software does not grow as
quickly, or become as large, as we anticipate, our revenues will be lower than
our

36

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expectations. Our market is still emerging, and our success depends, in  part, on its growth. Our
potential customers may:

| |  | not
understand or see the benefits of using these products,
|- |  | -----------------------------------------------------------

| |  | not
achieve favorable results using these products,
|- |  | ---------------------------------------------------

| |  | experience
technical difficulty in implementing or using these products,
|- |  | ------------------------------------------------------------------------

| |  | use
alternative methods to solve the same or similar business problems, or
|- |  | --------------------------------------------------------------------------

| |  | attribute
less priority to customer relationship management products relative to  other enterprise
software products and services.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------

If we fail to establish, maintain or enhance our relationships with third parties,
our ability to grow revenues could be harmed.

In order to grow our business, we must generate, retain and strengthen
relationships with third parties. To date, we have established relationships
with several companies, including consulting organizations and system
integrators that implement our software, including Accenture, BearingPoint
(formerly KPMG Consulting), Deloitte Consulting, eLoyalty and IBM; resellers,
including Accenture, EDS, Harte-Hanks and Hewlett-Packard; hardware and software
technology partners, including BEA Systems, IBM and Sun Microsystems, as well as
outsourcing or application services providers that use our software products to
provide hosted services to their customers over the internet, including
Harte-Hanks. If the third parties with whom we have relationships do not provide
sufficient, high-quality service or integrate and support our software
correctly, our revenues may be harmed. In addition, the third parties with whom
we have relationships may offer products of other companies, including products
that compete with our products. We typically enter into contracts with third
parties that generally set out the nature of our relationships. Our contracts,
however, do not typically require these third parties to devote substantial
resources to promoting, selling or supporting our products. We, therefore, have
little control over the actions of these third parties. We cannot assure you
that we can generate and maintain relationships that offset the significant time
and effort that are necessary to develop these relationships. In addition, our
pricing policies and contract terms with our distribution partners are designed
to support each partner with a minimum level of channel conflict. If we fail to
minimize channel conflicts between our direct sales force and our channel
partners, or among our channel partners, our operating results and financial
condition could be harmed.

Our marketing and sales activities in international markets may require us to incur
significant expenses.

We have limited experience in marketing, selling and supporting our products and
services abroad. Doing business internationally involves greater expense and
many additional risks and challenges, particularly:

| |  | unexpected
changes in regulatory requirements, taxes, trade laws and tariffs,
|- |  | -----------------------------------------------------------------------------

| |  | differing
intellectual property rights,
|- |  | ---------------------------------------

| |  | differing
labor regulations,
|- |  | ----------------------------

| |  | changes
in a specific countrys or regions political or economic conditions,
|- |  | -----------------------------------------------------------------------------

| |  | greater
difficulty in managing foreign operations,
|- |  | --------------------------------------------------

37

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| |  | the
complexity and cost of developing and maintaining international versions of our
products, and
|- |  | -------------------------------------------------------------------------------------------------

| |  | fluctuating
exchange rates.
|- |  | ---------------------------

Despite our plans to reduce our direct marketing and sales activities by transitioning
to an indirect sales model in international territories, our international
operations require a significant amount of attention from our management and
substantial financial resources. As of September 30, 2003, we had 74 employees
located in Asia, Australia, Canada, Europe and Latin America.

If we fail to manage reductions in the size of our business, our operating results
will be harmed.

We have grown quickly, both through acquisitions and hiring, at times since our
inception. Recently, however, we have restructured our operations by, among
other things, reducing the size of our workforce. Although we have significantly
reduced our expenses, we may need to further reduce expenses in the future. If
we are unable to effectively address the effects of reducing the workforce, such
as the deterioration of employee morale and productivity, unfavorable publicity
and the general reduction of available human resources, our business may be
harmed. In addition, future expansion in the size of our business will require
that we hire, train and integrate new personnel in key areas. If future
expansion becomes necessary and we are unable to successfully expand our
workforce, our revenues will be harmed.

If we fail to develop new products or improve our existing products to meet or
adapt to the changing needs and standards of our industry, sales of our products
may decline.

Our future success depends on our ability to address the rapidly changing needs of
our customers and potential customers. We must maintain and improve our existing
products and develop new products that include new technological developments,
keep pace with products of our competitors and satisfy the changing requirements
of our customers. If we do not, we may not achieve market acceptance of our
products and we may be unable to attract new customers. We may also lose
existing customers to whom we seek to sell additional software products and
services. To achieve increased market acceptance of our products, we must, among
other things, continue to:

| |  | introduce
new and improved customer relationship management software products,
|- |  | ------------------------------------------------------------------------------

| |  | improve
the effectiveness and performance of our software, particularly in  implementations
involving very large databases and large numbers of simultaneous  users,
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | enhance
the flexibility and configurability of our software to enable our  customers to better
address their needs at a lower cost of deployment and  maintenance,
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | enhance
our softwares ease of use and administration,
|- |  | ------------------------------------------------------

| |  | develop
software for vertical markets,
|- |  | --------------------------------------

| |  | make
available international versions of our software,
|- |  | ------------------------------------------------------

| |  | improve
our softwares ability to extract data from existing software systems, and
|- |  | ----------------------------------------------------------------------------------

38

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| |  | adapt
to rapidly changing computer operating system and database standards and  Internet
technology.
|- |  | ----------------------------------------------------------------------------------------------------

We may not be successful in developing and marketing these or other new or improved
products. If we are not successful, we may lose sales to competitors.

39

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If our products do not stay compatible with currently popular software programs, we
may lose sales and revenues.

Our products must work with commercially available software programs that are
currently popular. If these software programs do not remain popular, or we do
not update our software to be compatible with newer versions of these programs,
we may lose customers.

We have made a strategic decision to base our products on the Java 2, Enterprise
Edition (J2EE) family of technologies. Although J2EE is a widely adopted
industry standard, a competing technology from Microsoft called .NET seeks to
challenge J2EE as an enterprise IT architecture. If .NET gains competitive
advantage over J2EE in the marketplace at large, we may be competitively
disadvantaged, and may need to re-engineer our products to adopt the .NET
architecture. This capability affords our customers greater flexibility in the
deployment of our software products. If we fail to successfully develop and
maintain products compatible with these operating systems, database versions or
programming standards, we may lose sales and revenues. In addition, users access
our products on their network through standard Internet browsers such as
Microsoft Internet Explorer. If we fail to obtain access to developer versions
of any of these software products, we may be unable to build and enhance our
products on schedule. After installation, our products collect and analyze data
to profile customers characteristics and preferences. This data may be
stored in a variety of our customers existing software systems, including
systems from Oracle, PeopleSoft, Siebel Systems and SAP, running on a variety of
computer operating systems. If we fail to enhance our software to collect data
from new versions of these products, we may lose potential and existing
customers. If we lose customers, our revenues and profitability may be harmed.

If we fail to enhance our market awareness and sales effectiveness, we will not be
able to increase revenues.

In order to grow our business, we need to increase market awareness of our company
and products and enhance the effectiveness and productivity of our direct sales
force and indirect sales channels. If we fail to do so, this failure could harm
our revenues. We currently receive substantially all of our revenues from direct
sales, but we may increase sales through indirect sales channels in the future.

If we acquire additional companies or technologies in the future, they could prove
difficult to integrate, disrupt our business, dilute stockholder value or
adversely affect our operating results.

In addition to the acquisitions that we have already completed, we may acquire or
make investments in other complementary companies, services and technologies in
the future. If we fail to successfully integrate acquired technologies and
employees, our business and operating results will be harmed. To successfully
complete and integrate acquired technologies and employees, we must:

| |  | properly
evaluate the business, personnel and technology of the company to be  acquired,
|- |  | ----------------------------------------------------------------------------------------

| |  | accurately
forecast the financial impact of the transaction, including  accounting charges and
transaction expenses,
|- |  | --------------------------------------------------------------------------------------------------------------------

| |  | integrate
and retain personnel,
|- |  | -------------------------------

| |  | combine
potentially different corporate cultures,
|- |  | -------------------------------------------------

40

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| |  | effectively
integrate products, research and development, sales, marketing and  support operations,
and
|- |  | -------------------------------------------------------------------------------------------------------

| |  | maintain
focus on our day-to-day operations.
|- |  | --------------------------------------------

Further, the financial consequences of our acquisitions and investments may include
potentially dilutive issuances of equity securities, one-time write-offs,
impairment charges, amortization expenses related to other intangible assets and
contingent liabilities.

If others claim that we are infringing their intellectual property, we could incur
significant expenses or be prevented from selling our products.

We cannot assure you that others will not claim that we are infringing their
intellectual property rights or that we do not in fact infringe those
intellectual property rights. We have not conducted a search for existing
intellectual property registrations and we may be unaware of intellectual
property rights of others that may cover our technology.

From time to time, patent holders contact us for the purpose of licensing to us
various intellectual property rights. We cannot assure you that the holder of
the patents will not file litigation against us or that we would prevail in the
case of such litigation. Any litigation regarding intellectual property rights
could be costly and time-consuming and divert the attention of our management
and key personnel from our business operations. This is true even if we are
ultimately successful in defending against such litigation. The complexity of
the technology involved and the uncertainty of intellectual property litigation
increase these risks. Claims of intellectual property infringement might also
require us to enter into costly royalty or license agreements or result in
infringement claims against our licensees, giving rise to an obligation by
us to indemnify and hold our licensees harmless against such claims. Further, we
may not be able to obtain royalty or license agreements on terms acceptable to
us, or at all. We also may be subject to significant damages or an injunction
limiting or prohibiting the distribution or use of our products. A successful
claim of patent or other intellectual property infringement against us would
have an immediate material adverse effect on our business and financial
condition.

If we are unable to protect our intellectual property rights, this inability could
weaken our competitive position, reduce our revenues and increase our costs.

Our success depends in large part on our proprietary technology. We rely on a
combination of patents, copyrights, trademarks and trade secrets,
confidentiality procedures and licensing arrangements to establish and protect
our proprietary rights. We may be required to spend significant resources to
monitor and police our intellectual property rights. If we fail to successfully
enforce our intellectual property rights, our competitive position may be
harmed.

Our pending patent and trademark applications may not be allowed or competitors may
successfully challenge the validity or scope of these applications. In addition,
our patents may not provide a significant competitive advantage. Other software
providers could copy or otherwise obtain and use our products or technology
without authorization. They also could develop similar technology independently,
which may infringe our proprietary rights. We may not be able to detect
infringement and may lose a competitive position in the market before we do so.
In addition, competitors may design around our technology or develop competing
technologies. The laws of some foreign countries do not protect proprietary
rights to the same extent as do the laws of the United States, which could
impair our ability to protect our intellectual property rights in such
jurisdictions.

41

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In addition, we typically charge for our software based on the number of users at a
particular site that are authorized to use the software or by restricting other
rights, such as the number of servers. Customers that have licenses to use our
products could allow unauthorized use of our software. Unauthorized use is
difficult to detect and, to the extent that our software is used without
authorization, we may lose potential license fees.

The loss of key personnel, or inability to attract and retain additional personnel,
could affect our ability to successfully grow our business.

Our future success will depend in large part on our ability to hire and retain a
sufficient number of qualified personnel, particularly in sales, marketing,
research and development, service and support. If we are unable to do so, our
ability to advance our business could be affected. Our future success also
depends upon the continued service of our executive officers and other key
sales, engineering and technical staff. The loss of the services of our
executive officers and other key personnel would harm our operations. None of
our officers or key personnel is bound by an employment agreement and we do not
maintain key person insurance on any of our employees. We would also be harmed
if one or more of our officers or key employees decided to join a competitor or
otherwise compete with us.

The market price of our common stock has fluctuated substantially since our initial
public offering in September 1999. Consequently, potential employees may
perceive our equity incentives, such as stock options, as less attractive and
current employees whose stock options are priced above market value may choose
not to remain employed by us. In that case, our ability to attract or retain
employees will be adversely affected.

Privacy and security concerns, particularly related to the use of our software, may
limit the effectiveness of, and reduce the demand for, our products.

The effectiveness of our software products relies on the storage and use of customer
data collected from various sources, including information collected on web
sites, as well as other data derived from customer registrations, billings,
purchase transactions and surveys. The collection and use of such data for
customer profiling may raise privacy and security concerns. Our customers
generally have implemented security measures to protect customer data from
disclosure or interception by third parties. However, the security measures may
not be effective against all potential security threats. If a well-publicized
breach of customer data security were to occur, our software products may be
perceived as less desirable, impacting our future sales and profitability. In
addition, governments in some jurisdictions have enacted or are considering
enacting legislation that governs and restricts the use of personal identifying
information. Any such legislation could limit the usefulness of our software
products in such jurisdictions, which could impair our ability to license our
software.

Provisions in our charter documents and Delaware law may delay or prevent an acquisition of
E.piphany.

Our certificate of incorporation and bylaws contain provisions that could make it
harder for a third party to acquire us without the consent of our board of
directors. For example, if a potential acquirer were to make a hostile bid for
us, the acquirer would not be able to call a special meeting of stockholders to
remove members of our board of directors or act by written consent without a
meeting. In addition, the members of our board of directors have staggered
terms, which makes it difficult to remove them all at once. The acquirer also
would be required to provide advance notice of its proposal to remove directors
at an annual meeting. The acquirer also would not be able to cumulate

42

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votes at a
meeting, which would require the acquirer to hold more shares to gain  representation on
our board of directors than if cumulative voting were  permitted.

Our board of directors also has the ability to issue preferred stock without
stockholder approval. As a result, we could adopt a shareholder rights plan that
could significantly dilute the equity ownership of a hostile acquirer. In
addition, Section 203 of the Delaware General Corporation Law limits business
combination transactions with 15% stockholders that have not been approved by
the board of directors. These provisions and other similar provisions make it
more difficult for a third party to acquire us without negotiation. These
provisions may apply even if the offer may be considered beneficial by some
stockholders.

Our board of directors could choose not to negotiate with an acquirer that it did
not feel was in the strategic interests of our company. If the acquirer was
discouraged from offering to acquire us, or prevented from successfully
completing a hostile acquisition by the anti-takeover measures, you could lose
the opportunity to sell your shares at a favorable price.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discusses our exposure to market risk related to changes in foreign
currency exchange rates and interest rates. This discussion contains
forward-looking statements that are subject to risks and uncertainties. Actual
results could vary materially as a result of a number of factors including those
set forth in the Risk Factors section of this quarterly report on Form 10-Q.

Foreign Currency Exchange Rate Risk

The majority of our operations are based in the United States and, accordingly, the
majority of our transactions are denominated in U.S. dollars. However, we do
have foreign-based operations where transactions are denominated in foreign
currencies and are subject to market risk with respect to fluctuations in the
relative value of currencies. As of September 30, 2003, we had international
operations in Asia, Australia, Europe and Latin America and conduct transactions
in the local currency of each location. To date, our exposure to fluctuations in
the relative value of other currencies has been limited because substantially
all of our assets are denominated in U.S. dollars, and those assets which are
not denominated in U.S. dollars have generally been denominated in historically
stable currencies. The impact to our financial statements has therefore not been
material. To date, we have not entered into any foreign exchange hedges or other
derivative financial instruments. We will continue to evaluate our exposure to
foreign currency exchange rate risk on a regular basis.

Interest Rate Risk

Our exposure to market risk for changes in interest rates primarily affects our
investment portfolio. The primary objective of our investment activities is to
preserve principal while maximizing yields without significantly increasing
risk. This is accomplished by investing in diversified investments, consisting
only of investment grade securities having maturity dates of less than 24
months. We do not use derivative financial instruments in our investment
portfolio.

As of September 30, 2003, we held $9.7 million in cash and cash equivalents and
restricted cash and investments consisting of highly liquid investments having maturity dates of
no more than 90 days from the date of purchase. Declines of interest rates over
time would reduce our interest income from these highly liquid investments.
Based upon our balance as of September 30, 2003, a decrease in interest rates of
100 basis points would cause a

43

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corresponding
decrease in our annual interest  income of approximately $0.1 million. Due to the nature
of these investments, a  change in interest rates would not materially change their fair
market value.

As of September 30, 2003, we held $247.4 million in short-term investments and
long-term investments, each of which consisted of taxable fixed income
securities having maturity dates between three months and two years from the
date of purchase. A decline in interest rates over time would reduce our
interest income from our short-term investments and long-term investments. A
decrease in interest rates of 100 basis points would cause a corresponding
decrease in our annual interest income of approximately $2.5 million. An
increase in interest rates over time would cause the fair market value of our
portfolio to decline. An immediate and uniform increase in interest rates of 100
basis points would cause the fair market value of these items to decrease by
approximately $2.0 million.

As of September 30, 2003, we did not have any debt outstanding other than capital
lease obligations.

The following summarizes our short-term and long-term investments and the weighted
average yields of each category of such investments as of September 30, 2003 (in
thousands, except interest rates):

|                            | Expected Maturity Dates | 
|--------------------------- | ----------------------- | 
|
|Corporate bonds             |                         | 
|Weighted average yield      |                         | 
|Government notes/bonds(1)   |                         | 
|Weighted average yield      |                         | 
|Auction rate securities(2)  |                         | 
|Weighted average yield      |                         | 
|                            |                         | 
|Total investment securities |                         | 
|                            |                         | 

(1) Government notes/bonds consists primarily of government agency notes and
includes, to a lesser extent, taxable municipal bonds.

(2) Auction rate securities consist primarily of taxable municipal bonds having reset dates
of less than 45 days. A significant portion of the Companys short term investments consist of these instruments as they typically provide a higher rate of return than money market funds while
maintaining a low level of risk and a high degree of liquidity.

44

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report on Form 10-Q, our
management including our Chief Executive Officer and Chief Financial Officer,
carried out an evaluation of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934, as amended). Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective to ensure that information we are required
to disclose in reports that we file or furnish under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission rules and forms.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred
over the period covered by this quarterly report on Form 10-Q that materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

As of the date hereof, there is no material litigation pending against us other
than as disclosed in the paragraph below. From time to time, we may become a
party to litigation and subject to claims incident to the ordinary course of our
business. Although the results of litigation and claims cannot be predicted with
certainty, we believe that the final outcome of such matters will not have a
material adverse effect on our business, results of operations or financial
condition.

E.piphany, two of our current officers, one of our former officers and three underwriters in
our initial public offering (IPO) were named as defendants in a
consolidated shareholder lawsuit in the United States District Court
for the Southern District of New York, In re E.piphany,
Inc. Initial Public Offering Securities Litigation,01-CV-6158. 
This is one of a number of actions coordinated for pretrial purposes as In re
Initial Public Offering Securities Litigation, 21 MC 92.  Plaintiffs in
the coordinated proceeding have brought claims under the federal securities laws
against numerous underwriters, companies, and individuals, alleging generally
that defendant underwriters engaged in improper and undisclosed activities
concerning the allocation of shares in the IPOs of more than 300 companies
during the period from late 1998 through 2000.  Specifically, among other
things, the plaintiffs allege that the prospectus pursuant to which shares of
our common stock were sold in our IPO contained certain false and misleading
statements regarding the practices of our underwriters with respect to their
allocation of shares of common stock in our IPO to their customers and their
receipt of commissions from those customers related to such allocations, and
that such statements and omissions caused
our post-IPO stock price to be artificially inflated.  The
consolidated amended complaint in our case seeks unspecified damages on
behalf of a purported class of purchasers of our common stock between September
21, 1999 and December 6, 2000.  The court has appointed a lead plaintiff
for the consolidated action. The underwriter and issuer defendants have filed
motions to dismiss. These motions were denied as to all of the underwriter
defendants and the majority of issuer defendants including E.piphany. The
individual defendants have been dismissed from the action without prejudice
pursuant to a tolling agreement. A proposal has been made for the settlement and
release of claims against the issuer defendants, including E.piphany. The

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settlement is
subject to a number of conditions, including approval of the  proposed settling parties
and the court. E.piphany has elected to participate in  the settlement. If the settlement
does not occur, and litigation against  E.piphany continues, E.piphany believes it has
meritorious defenses and intends  to defend the case vigorously.

On February 28, 2003, a purported securities class action lawsuit entitled Liu
v. Credit Suisse First Boston et al., Civil Action Number 03-20459, was
filed in the United States District Court for the Southern District of Florida.
Among the 166 parties named as defendants were Credit Suisse First Boston and
its personnel, issuers that completed IPOs underwritten by Credit Suisse First
Boston, and certain directors and officers of these issuers, including E.piphany
and two of its current officers. The complaint alleges that the defendants
violated federal and state laws by, among other things, publishing false and
misleading information regarding the issuers projected financial
performance and revenue potential and by incorrectly pricing issuers IPOs.
The complaint related generally to the ongoing IPO-related litigation currently
pending in the United States District Court for the Southern District of New
York. By court order dated July 16, 2003, the E.piphany defendants were
dismissed from the litigation.

Several governmental entities have initiated investigations related to the IPO
allocation practices of Credit Suisse First Boston and other investment banks,
and their personnel. In connection with some of these proceedings, E.piphany and
several other public companies have been asked to provide information relevant
to these proceedings. In response, we have provided information and are
otherwise cooperating with these entities. Based on discussions with these
entities, we do not believe that E.piphany, or any of its directors and
officers, is the target of any of these investigations.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

|(a) |  | Exhibits
|--- |  | --------

| | See Exhibit Index attached hereto.
| | ----------------------------------

|(b) |  | Reports on Form 8-K
|--- |  | -------------------

| | On
July 24, 2003, we furnished our earnings release for the second quarter of 2003  to the
Securities and Exchange  Commission on a Form 8-K.
| | ---------------------------------------------------------------------------------------------------------------------------------------------

| | On
July 28, 2003, we reported to the Securities and Exchange Commission on a Form  8-K that
that on or about Tuesday,  July 29, 2003, Roger Siboni, the  Companys
Chairman of the Board and  former President and Chief  Executive Officer,
intended to sell 200,000 shares of Company common stock.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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.

|      |                   | E.PIPHANY, INC.
|----- | ----------------- | ---------------
|     
|DATE: | November 12, 2003 | SIGNATURE:     
|      |                  
|      |                   |                
|      |                   |                
|     
|DATE: | November 12, 2003 | SIGNATURE:     
|      |                  
|      |                   |                
|      |                   |                

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EXHIBIT INDEX

|Number | Exhibit Title                                                                                                                                                                  
|------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*   | Restated Certificate of Incorporation of the Registrant, as amended on December 18, 2000                                                                                       
|3.2**  | Restated Bylaws of the Registrant.                                                                                                                                             
|4.1*** | Form of Stock Certificate.                                                                                                                                                     
|10.1   | Non-Employee Director Deferred Compensation Plan, Amended and Restated as of August 15, 2003.                                                                                  
|31     | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|32     | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

|* |  | Incorporated
by reference to the Registrant's annual report on Form  10-K for the year ended December
31, 2002 (Registration No. 000-27183)  filed with the Securities and Exchange Commission
on March 27, 2003.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** |  | Incorporated
by reference to the Registrant's quarterly report on Form  10-Q for the quarter ended
September 30, 2002 (Registration No.  000-27183) filed with the Securities and Exchange
Commission on  November 13, 2002.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|*** |  | Incorporated
by reference to the Registrant's Registration Statement  on Form S-1 (Registration No.
333-82799) declared effective by the  Securities and Exchange Commission on September 21,
1999.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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