UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

For the transition period from ________ to ________

Commission File Number 0-25361

ONYX SOFTWARE CORPORATION

1100 – 112^th Avenue NE
Suite 100
Bellevue, Washington 98004
(Address of principal executive offices) (Zip code)

(425) 451-8060
(Registrant’s telephone number)

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

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

     The number of shares of common stock, par value $0.01 per share, outstanding on August 3, 2004 was 14,553,983.

ONYX SOFTWARE CORPORATION

CONTENTS

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PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

4

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In thousands, except share data)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

5

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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ONYX SOFTWARE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Description of Business and Basis of Presentation

Description of the Company

     Onyx Software Corporation and subsidiaries (Company) is a leading provider of enterprise-wide customer relationship management (CRM) solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Using the Internet in combination with traditional forms of interaction, including phone, mail, fax and e-mail, the Company’s solution helps enterprises to more effectively acquire, manage and maintain customer, partner and other relationships. The Company markets its solution to companies that want to merge new, online business processes with traditional business processes to enhance their customer-facing operations, such as marketing, sales, customer service and technical support. The Company’s solution uses a single data model across all customer interactions, resulting in a single repository for all marketing, sales and service information. It is fully integrated across all customer-facing departments and interaction media. The Company’s solution is designed to be easy to use, widely accessible, rapidly deployable, scalable, flexible, customizable and reliable, which can result in a comparatively low total cost of ownership and rapid return on investment. The Company was incorporated in the state of Washington on February 23, 1994 and maintains its headquarters in Bellevue, Washington.

Interim Financial Information

     The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the Company’s opinion, the statements include all adjustments necessary (which are of a normal and recurring nature) for a fair presentation of the results for the interim periods presented. These financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2003, included in its Form 10-K filed with the SEC on March 15, 2004. The Company’s results of operations for any interim period are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

Reverse Stock Split

     On July 23, 2003, the Company’s shareholders approved a one-for-four reverse stock split. All share and per share amounts in the accompanying condensed consolidated financial statements have been adjusted to reflect this reverse stock split.

2. Summary of Significant Accounting Policies

Principles of Consolidation

     The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements. Changes in these estimates and assumptions may have a material impact on the financial statements. The Company has used estimates in determining certain provisions, including uncollectible trade accounts receivable, useful lives for property and equipment, intangible assets, tax liabilities and restructuring liabilities.

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Revenue Recognition

     The Company recognizes revenue in accordance with accounting standards for software companies, including Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, and related interpretations, including Technical Practice Aids.

     The Company generates revenue through two sources: (a) software license revenue and (b) support and service revenue. Software license revenue is generated from licensing the rights to use the Company’s products directly to end-users and vertical service providers (VSPs) and indirectly through value-added resellers (VARs) and, to a lesser extent, through third-party products the Company distributes. Support and service revenue is generated from sales of customer support services, consulting services and training services performed for customers that license the Company’s products.

     License revenue is recognized when a noncancellable license agreement becomes effective as evidenced by a signed contract, the product has been shipped, the license fee is fixed or determinable, and collectibility is probable.

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

     Standard terms for license agreements call for payment within 90 days. Probability of collection is based on the assessment of the customer’s financial condition through the review of its current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection. Revenue from distribution agreements with VARs is typically recognized on the earlier of receipt of cash from the VAR or identification of an end-user. In the latter case, probability of collection is evaluated based on the creditworthiness of the VAR. The Company’s agreements with its customers, VSPs and VARs do not contain product return rights.

     Revenue from maintenance arrangements is recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Revenue from consulting and training services is recognized as services are performed. Standard terms for renewal of maintenance arrangements, consulting services and training services call for payment within 30 days.

     Fees from licenses sold together with consulting services are generally recognized upon shipment of the software, provided that the above criteria are met, payment of the license fees do not depend on the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees depends on the performance of the services, both the software license and consulting fees are recognized under the percentage-of-completion method of contract accounting.

     If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If a nonstandard acceptance period is provided, revenue is recognized upon the earlier of customer acceptance and the expiration of the acceptance period.

Cash Equivalents and Restricted Cash

     The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. At December 31, 2003 and June 30, 2004, the Company’s cash equivalents consisted of money market funds.

     The Company had no restricted cash at June 30, 2004.

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Stock-Based Compensation

     The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, including Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Under APB Opinion No. 25, because the exercise price of the Company’s employee stock options generally equals the fair value of the underlying stock on the date of grant, no compensation expense is generally recognized.

     Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net loss had the fair-value-based method been applied to all outstanding and unvested awards in each period.

Other Comprehensive Income

     SFAS No. 130, “Reporting Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. The only items of other comprehensive income that the Company currently reports are foreign currency translation adjustments. Total comprehensive loss for the three months ended June 30, 2003 and 2004 was $605,000 and $238,000, respectively, which included a translation gain of $292,000 for the three months ended June 30, 2003 and a translation loss of $413,000 for the three months ended June 30, 2004. Total comprehensive loss for the six months ended June 30, 2003 and 2004 was $3.9 million and $341,000, respectively, which included a translation gain of $421,000 and $79,000, respectively.

3. Purchased Technology

     On April 7, 2004, the Company acquired business process management technology from Visuale, Inc. in an asset acquisition valued at $4.1 million. Under the terms and conditions of the purchase agreement, the Company purchased the acquired technology with a purchase price valued at $4.1 million, including (a) an initial payment of $400,000 in cash, (b) common stock of the Company valued at $1.7 million in the form of 504,891 shares, and (c) on the one-year anniversary of closing, a subsequent payment valued at $1.0 million, to be paid at the Company’s option in either cash or stock. In addition, the Company agreed to make royalty payments for a period of four years to Visuale on sales of certain Company products incorporating the acquired technology, with a guaranteed minimum royalty payment in each of the third and fourth years following closing of $500,000. The Company also assumed employee liabilities of $115,000 and had incurred professional fees associated with the acquisition of $145,000 as of June 30, 2004. The above future payments have been recorded on the balance sheet as purchased technology obligations net of imputed interest in short-term and long-term liabilities, respectively. The purchased technology will be amortized over four years starting from the general release of the product, while the imputed interest will be amortized on a straight-line basis, which approximates the effective interest method, as interest expense.

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4. Restructuring and Other Related Charges

     Restructuring and other related charges represent the Company’s efforts to reduce its overall cost structure. In April and again in September 2001, the Company approved a restructuring plan to reduce headcount, reduce infrastructure and eliminate excess and duplicate facilities. In April 2003, the Company approved a restructuring plan to reduce additional headcount. During 2001, 2002 and 2003, the Company recorded approximately $51.8 million, $8.5 million and $1.4 million, respectively, in restructuring and other related charges. During the first quarter of 2004, the Company recorded approximately $484,000 in restructuring and other related charges.

     The components of the first quarter 2004 charges and a roll-forward of the related liability follow (in thousands):

     The roll-forward of the related liability for the second quarter of 2004 follow (in thousands):

     The Company issued three five-year warrants to Bellevue Hines Development LLC (Hines) in January 2003 for the purchase of up to an aggregate of 198,750 shares of the Company’s common stock, including a warrant to purchase 66,250 shares of common stock at an exercise price of $10.38 per share, a warrant to purchase 66,250 shares of common stock at an exercise price of $12.11 per share and a warrant to purchase 66,250 shares of common stock at an exercise price of $13.84 per share. If the Company either undergoes a change of control or issues securities with rights and preferences superior to the Company’s common stock before January 2005, Hines will have the option of canceling any unexercised warrants and receiving a cash cancellation payment of $18.40 per share in the case of the $10.38 warrants, $16.00 per share in the case of the $12.11 warrants and $13.92 per share in the case of the $13.84 warrants. These contingent cash payments aggregate $3.2 million. The Company also entered into a registration rights agreement with Hines, pursuant to which the Company filed a registration statement on February 14, 2003 covering the resale of the shares of the Company’s common stock subject to purchase by Hines under the warrants. The warrant value as of December 31, 2002 was estimated at $920,000 based on (a) the estimated value of the warrants using the Black-Scholes model with an expected dividend yield of 0.0%, a risk-free interest rate of 5.0%, volatility of 85% and an expected life of five years and (b) the estimated value of the cash cancellation payments in the event of a change in control. The warrants are subject to variable accounting and the Company is required to mark the warrants to market at each reporting period. At June 30, 2004, the warrant value was estimated at $353,000 using similar assumptions to those used at December 31, 2002, and is included in long-term liabilities.

     The accounting for excess facilities is complex and requires judgment, a consequence of which is that adjustments may be required to the Company’s current restructuring charge. In particular, based on the terms of the warrants issued in connection with the partial lease termination of excess facilities in Bellevue, Washington, the warrants are subject to variable accounting and will be marked to market at each reporting period. Future cash outlays for excess facilities are anticipated through July 2006 unless estimates and assumptions change or the Company is able to negotiate to exit certain leases at an earlier date.

     The current portion of restructuring-related liabilities totaled $1.3 million at June 30, 2004, the long-term portion of restructuring-related liabilities totaled $93,000 at June 30, 2004 and the value of the warrants issued in connection with the termination of certain facility lease obligations was $353,000 at June 30, 2004.

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5. Net Income (Loss) Per Share

     Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share reflects the potential dilution of securities by including other common stock equivalents, including stock options using the treasury stock method and convertible preferred stock using the if-converted method, in the weighted average number of common shares outstanding for a period, if dilutive.

*		The effect of stock options are excluded from the computation of diluted earnings per share if the effects are antidilutive. Outstanding stock options of 3,594,162 and 3,020,830 and warrants of 205,000 and 198,750 at June 30, 2003 and 2004, respectively, were excluded from the computation of diluted earnings per share because the effect was antidilutive. Outstanding options will be included in the computation of diluted earnings per share in future periods to the extent their effects are dilutive. If the Company had been profitable during these periods reported, based on the average price of the Company’s common stock during each period using the treasury stock method, the approximate number of dilutive options included in the computation of diluted earnings per share would have been 105,000 shares and 114,000 shares for the three and six months ended June 30, 2003 and 128,000 shares for the six months ended June 30, 2004.
**		In January 2003, the Company issued warrants to purchase 198,750 shares of its common stock at exercise prices ranging from $10.38 to $13.84 per share in connection with the termination of excess facilities. In May 2003, the Company issued warrants to purchase 6,250 shares of its common stock at an exercise price of $3.25 per share in connection with the private placement of the Company’s common stock in May 2003. There were no warrants outstanding prior to January 2003. Outstanding warrants will be included in the computation of diluted earnings per share in future periods to the extent their effects are dilutive.

6. Line of Credit

     Under Loan and Security Agreements with Silicon Valley Bank (SVB), the Company has a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility. The $10.0 million working capital revolving line of credit is split between an $8.0 million domestic facility and a $2.0 million Export Import Bank of the United States (Exim Bank) facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows the Company to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and (b) $8.0 million. The Exim Bank facility allows the Company to borrow up to the lesser of (a) 75% of eligible foreign accounts receivable and (b) $2.0 million. The amount available to borrow under the working capital revolving line of credit is reduced by reserves for outstanding standby letters of credit issued by SVB on the Company’s behalf and 50% of any borrowings under the term loan facility. If the calculated borrowing base falls below the reserves, SVB may require the Company to cash secure the amount by which the reserves exceed the borrowing base. The Company was not required to restrict any cash under the loan agreement as of June 30, 2004. Due to the variability in the Company’s borrowing base, the Company may be subject to restrictions on its cash at various times throughout the year. Any borrowings will bear interest at SVB’s prime rate, which was 4.0% as of June 30, 2004, plus 1.5% (plus 2% for the term loan facility), subject to a minimum rate of 6.0%. The loan agreements require that the Company maintain certain financial covenants based on its adjusted quick ratio and tangible net worth. The Company was in compliance with these covenants at June 30, 2004. The Company is also prohibited under the loan and security agreements from paying dividends. The facilities expire in March 2005. At June 30, 2004, based on $4.8 million outstanding standby letters of credit relating to long-term lease obligations and $473,000 outstanding under the term loan facility, $371,000 of additional amounts were currently available under the revolving credit facilities.

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7. Segment and Geographic Information

     The Company and its subsidiaries are principally engaged in the design, development, marketing and support of enterprise-wide CRM solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Substantially all revenue results from licensing the Company’s software products and related consulting and customer support (maintenance) services. The Company’s Chief Executive Officer and Chief Financial Officer, who are the Company’s chief operating decision makers, review financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment, specifically the license, implementation and support of its software applications, and to have only one operating segment. The Company does not prepare reports for, or measure the performance of, its individual software applications and, accordingly, the Company has not presented revenue or any other related financial information by individual software product.

     The Company evaluates the performance of its geographic regions primarily based on revenues. In addition, the Company’s assets are primarily located in its corporate office in the United States and not allocated to any specific region. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues.

     Total revenues outside of North America for the three months ended June 30, 2003 and 2004 were $7.2 million and $5.6 million, respectively. Total revenues outside of North America for the six months ended June 30, 2003 and 2004 were $12.4 million and $10.8 million, respectively.

     The following geographic information is presented for the three and six months ended June 30, 2003 and 2004 (in thousands):

8. Guarantees

     In the ordinary course of business, the Company is not subject to potential obligations under guarantees that fall within the scope of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” except for standard indemnification and warranty provisions that are contained within many of the Company’s customer license and service agreements, and give rise only to the disclosure requirements prescribed by FIN No. 45.

     Indemnification and warranty provisions contained within the Company’s customer license and service agreements are generally consistent with those prevalent in its industry. The duration of the Company’s product warranties generally does not exceed 180 days following delivery of its products. The Company has not incurred significant obligations under customer indemnification or warranty provisions historically and does not expect to incur significant obligations in the future. Accordingly, the Company does not maintain accruals for potential customer indemnification or warranty-related obligations.

9. Onyx Japan

     In September 2000, the Company entered into a joint venture with Softbank Investment Corporation and Prime Systems Corporation to create Onyx Software Co., Ltd. (Onyx Japan), a Japanese corporation, for the purpose of distributing the Company’s technology and product offerings in Japan. In October 2000, the Company made an initial contribution of $4.3 million in exchange for 58% of the outstanding common stock of Onyx Japan. The Company’s joint venture partners invested an additional $3.1 million for the remaining 42% of the common stock of Onyx Japan. Because the Company has a controlling interest, Onyx Japan has been included in its consolidated financial statements. The minority shareholders’ interest in Onyx Japan’s earnings or losses is separately reflected in the statement of operations.

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     Under the terms of the joint venture agreement, Prime Systems may, at any time, sell its shares of Onyx Japan stock to a third party, provided that it notifies the Company 90 days prior to doing so. The Company has a right of first refusal to purchase any of Prime Systems’ shares that are offered for resale at the same price for which those shares are being offered to a third party. Further, either the Company or Prime Systems may terminate the joint venture agreement at its discretion. If Prime Systems exercises its right of termination, the Company has the right, at its election, to either (a) buy Prime Systems’ shares at the current fair market value as determined by an appraiser or (b) force a liquidation of Onyx Japan.

     The Company has entered into a distribution agreement with Onyx Japan, which was approved by the minority shareholders, that provides the Company with a fee based on license and maintenance revenues in Japan. During the three months ended June 30, 2003 and 2004, fees charged under this agreement were $51,000 and $233,000, respectively. During the six months ended June 30, 2003 and 2004, fees charged under this agreement were $186,000 and $378,000, respectively. The intercompany fees are eliminated in consolidation; however, the Company allocates 42% of the fees to the minority shareholders.

     The minority shareholders’ capital account balance as of June 30, 2004 was $141,000. Additional Onyx Japan losses above approximately $335,000 in the aggregate will be absorbed 100% by the Company, as compared to 58% in prior periods.

     Restructuring efforts carried out in the second half of 2002 significantly reduced the operating expenses of Onyx Japan and increased the probability that Onyx Japan can be cash flow positive. Nevertheless, additional funding may be required to continue the operation of the joint venture. If Onyx Japan incurs losses in future periods and no additional capital is invested, the Company may have to further restructure Onyx Japan’s operations.

10. Liquidity

     The Company has a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility with SVB. The $10.0 million working capital revolving line of credit is split between an $8.0 million domestic facility and a $2.0 million Exim Bank facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows the Company to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and (b) $8.0 million. The Exim Bank facility allows the Company to borrow up to the lesser of (a) 75% of eligible foreign accounts receivable and (b) $2.0 million. The amount available to borrow under the working capital revolving line of credit is reduced by reserves for outstanding standby letters of credit issued by SVB on the Company’s behalf and 50% of any borrowings under the term loan facility. The Company was in compliance with the financial covenants of these facilities as of June 30, 2004. If the Company is unable to maintain compliance with its covenants in the future or if SVB decides to restrict its cash deposits, the Company’s liquidity would be further limited and its business, financial condition and operating results could be materially harmed.

     The Company believes its revenue performance will be comparable to the most recent quarterly periods reported and that the Company’s existing cash and cash equivalents will be sufficient to meet its capital requirements for at least the next 12 months. Should the Company’s results for subsequent quarters fall significantly below the results the Company achieved in the second quarter of 2004, the Company would likely take action to restructure its operations to preserve its cash. Such actions would primarily consist of reductions in headcount. Due to the fact that lower cash balances could negatively impact the Company’s sales efforts, the Company may seek additional funds in the future through public or private equity financing or from other sources to fund its operations and pursue the Company’s growth strategy. The Company may experience difficulty in obtaining funding on favorable terms, if at all. Any financing the Company might obtain may contain covenants that restrict the Company’s freedom to operate its business or may require the Company to issue securities that have rights, preferences or privileges senior to its common stock and may dilute current shareholders’ ownership interest in the Company.

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

Forward-Looking Information

     Our disclosure and analysis in this report contain forward-looking statements, which provide our current expectations or forecasts of future events. Forward-looking statements in this report include, without limitation:

•

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth;

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	•		statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;
	•		statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and available bank borrowings to meet these requirements;
	•		information about the anticipated release dates of new products;
	•		statements about the expected costs and timing of terminating our excess facility commitments;
	•		other statements about our plans, objectives, expectations and intentions; and
	•		other statements that are not historical facts.

     Words such as “believes,” “anticipates” and “intends” may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in the section entitled “Important Factors That May Affect Our Business, Our Results of Operations and Our Stock Price” in this report. Other factors besides those described in this report could also affect actual results. You should carefully consider the factors described in the section entitled “Important Factors That May Affect Our Business, Our Results of Operations and Our Stock Price” in evaluating our forward-looking statements.

     You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect the occurrence of unanticipated events.

Overview

     Onyx Software Corporation is a leading provider of enterprise-wide customer relationship management, or CRM, solutions designed to promote strategic business improvement and revenue growth by enhancing the way businesses market, sell and service their products. Using the Internet in combination with traditional forms of interaction, including phone, mail, fax and e-mail, our solution helps enterprises to more effectively acquire, manage and maintain customer, partner and other relationships. We market our solution to companies that want to merge new, online business processes with traditional business processes to enhance their customer-facing operations, such as marketing, sales, customer service and technical support. Our solution is Internet-based, which means companies can take advantage of lower costs and faster deployment associated with accessing CRM software with a simple browser. Our solution uses a single data model across all customer interactions, resulting in a single repository for all marketing, sales and service information. It is fully integrated across all customer-facing departments and interaction media. Our solution is designed to be easy to use, widely accessible, rapidly deployable, scalable, flexible, customizable and reliable, which can result in a comparatively low total cost of ownership and rapid return on investment.

Overview of the Results for the Three and Six Months Ended June 30, 2004

     Key financial data points relating to our three and six month performance include:

	•		Revenue of $14.8 million, up 4% from the first quarter of 2004 and down 6% from the second quarter of 2003;
	•		License revenue of $3.6 million, down 2% from the first quarter of 2004 and up 14% from the second quarter of 2003;
	•		Service revenue of $11.2 million, up 6% from the first quarter of 2004 and down 11% from the second quarter of 2003;
	•		Service margins of 60%, up from 58% in the first quarter of 2004 and up from 57% in the second quarter of 2003;
	•		Operating expenses, excluding acquisition-related amortization, stock compensation and restructuring charges, of $9.5 million, up from $9.3 million in the first quarter of 2004 and down from $10.1 million in the second quarter of 2003;

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	•		Revenue for the first six months of 2004 of $29.0 million, down 3% from the first six months of 2003;
	•		License revenue for the first six months of 2004 of $7.2 million, up 25% from the first six months of 2003;
	•		Service revenue for the first six months of 2004 of $21.9 million, down 10% from the first six months of 2003;
	•		Service margins for the first six months of 2004 of 59%, up from 55% for the first six months of 2003;
	•		Operating expenses, excluding acquisition-related amortization, stock compensation and restructuring charges, for the first six months of 2004 of $18.9 million, down from $21.9 million for the first six months of 2003;
	•		Cash and restricted cash balances of $12.3 million at June 30, 2004, down from $13.0 million at March 31, 2004 and up from $11.9 million at December 31, 2003; and
	•		Days sales outstanding, based on end of period receivable balances, down to 68 days compared to 72 days in the first quarter of 2004 and 74 days in the second quarter of 2003.

     Although recent published reports are signaling modest improvement in the global economy, we are cautious as to the speed at which macroeconomic conditions will improve, particularly as it relates to the information technology and communications industries, and believe our ability to generate new license sales will continue to be challenging in the near term. The majority of our revenue has been generated from customers in the high-technology, financial services, government and healthcare industries. Accordingly, our business is affected by the economic and business conditions of these industries and the demand for information technology within these industries. Macroeconomic conditions were extremely challenging during 2001, 2002 and 2003, and we expect these conditions to continue to impact capital-spending initiatives of our targeted new and existing customer base in the near term.

     In addition to the macro-economic factors affecting our industry, we have also been impacted by transformations in our business during recent years. Onyx was one of the first companies in the CRM industry to migrate its product architecture from client-server technology to a fully Internet-based application. In addition to this major product re-architecture, Onyx shifted its business strategy to increase its focus on larger customers. This, in turn, has changed both our marketing strategies and employee skill requirements. Onyx has invested a great deal of time and money into these transitions, and they are not fully complete.

     We will be focused on the following objectives in the near term:

	•		successful rebuilding of our sales force;
	•		increase our pipeline of sales opportunities;
	•		managing our costs toward profitable growth;
	•		focusing our resources and efforts on the market opportunities with the highest probability of success;
	•		maximizing the value of our partnerships with key system integration and technology vendors, particularly as it relates to our Embedded CRM initiative and our key vertical industries;
	•		aggressive marketing of our recent major product releases; and
	•		maintaining high customer satisfaction levels.

     We hope that, by focusing our efforts on these key objectives, we will be able to continue to be profitable in challenging economic times and successfully grow our business, although we cannot offer any assurance regarding when, or whether, this will occur.

Critical Accounting Policies and Estimates

     Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, bad debts, intangible assets, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets

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and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

 Revenue Recognition

     Revenue recognition rules for software companies are very complex and often subject to interpretation. We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.

     We recognize revenue in accordance with accounting standards for software companies, including Statement of Position, or SOP, 97-2, “Software Revenue Recognition,” as amended by SOP 98-9 and related interpretations, including Technical Practice Aids.

     We generate revenue through two sources: (a) software license revenue and (b) support and service revenue. Software license revenue is generated from licensing the rights to use our products directly to end-users and vertical service providers, or VSPs, and indirectly through value-added resellers, or VARs, and, to a lesser extent, through third-party products we distribute. Support and service revenue is generated from sales of customer support services (maintenance contracts), consulting services and training services performed for customers that license our products.

     License revenue is recognized when a noncancelable license agreement becomes effective as evidenced by a signed contract, the product has been shipped, the license fee is fixed or determinable, and collection is probable.

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

     Standard terms for license agreements call for payment within 90 days. Probability of collection is based on the assessment of the customer’s financial condition through the review of its current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection. Revenue from distribution agreements with VARs is typically recognized upon the earlier of receipt of cash from the VAR or identification of an end-user. In the latter case, probability of collection is evaluated based on the creditworthiness of the VAR. Our agreements with customers, VSPs and VARs do not contain product return rights.

     Revenue from maintenance arrangements is recognized ratably over the term of the contract, typically one year. Consulting revenue is primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Implementation services are periodically performed under fixed-fee arrangements and, in such cases, consulting revenue is recognized on a percentage-of-completion basis. Revenue from consulting and training services is recognized as services are performed. Standard terms for renewal of maintenance arrangements, consulting services and training services call for payment within 30 days.

     Revenue consisting of fees from licenses sold together with consulting services is generally recognized upon shipment of the software, provided that the above criteria are met, payment of the license fees do not depend on the performance of the services, and the consulting services are not essential to the functionality of the licensed software. If the services are essential to the functionality of the software, or payment of the license fees depends on the performance of the services, both the software license and consulting fees are recognized under the percentage of completion method of contract accounting.

     If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If a nonstandard acceptance period is provided, revenue is recognized upon the earlier of customer acceptance and the expiration of the acceptance period.

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 Allowance for Doubtful Accounts

     A considerable amount of judgment is required when we assess the ultimate realization of receivables, including assessing the probability of collection and the current creditworthiness of each customer. Although we recorded a net benefit in 2003 and recorded no expenses for the first six months of 2004, significant expenses were recorded to increase our allowance for doubtful accounts in prior years due to the rapid downturn in the economy, and in the technology sector in particular. We may record additional expenses in the future.

 Impairment of Intangible Assets

     We periodically evaluate intangible asset valuations of businesses we acquired as impairment indicators arise. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance of our acquired businesses. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired.

 Restructuring

     During 2001 and 2002, we recorded significant write-offs and accruals in connection with our restructuring program under Emerging Issues Task Force, or EITF, Issue No. 94-3. These write-offs and accruals include estimates pertaining to employee separation costs and the settlements of contractual obligations related to excess leased facilities and other contracts. Although we believe that we have made reasonable estimates of our restructuring costs in calculating these write-offs and accruals, the actual costs could differ from these estimates. With the contractual settlement of the majority of our excess facilities, the range of outcomes that must be estimated has narrowed significantly, except for the value assigned to the warrants issued in connection with the settlement, which will fluctuate in the future based on our stock price.

     In June 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting for costs associated with exit or disposal activities, and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This statement requires that a liability for a cost associated with an exit or disposal activity be recognized at fair value when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 has not had a material effect on our consolidated financial statements.

Results of Operations

     The following table presents certain financial data, derived from our unaudited statements of operations, as a percentage of total revenue for the periods indicated. The operating results for the three and six months ended June 30, 2003 and 2004 are not necessarily indicative of the results that may be expected for the full year or any future period.

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Revenue

     Total revenue, which consists of software license and support and service revenue, decreased 6% from $15.8 million in the second quarter of 2003 to $14.8 million in the second quarter of 2004. Total revenue decreased 3% from $30.0 million in the first six months of 2003 to $29.0 million in the first six months of 2004. For the three and six months ended June 30, 2003 and 2004, no single customer accounted for more than 10% of total revenue.

     License revenue increased 14%, from $3.1 million in the second quarter of 2003 to $3.6 million in the second quarter of 2004. License revenue increased 25% from $5.7 million in the first six months of 2003 to $7.2 million in the first six months of 2004. Although recent published reports are signaling modest improvement in the global economy, we are cautious as to the speed at which macroeconomic conditions will improve, and believe our ability to generate new license sales will continue to be challenged in the near term.

     Our support and service revenue decreased 11% from $12.7 million in the second quarter of 2003 to $11.2 million in the second quarter of 2004. Support and service revenue represented 80% of our total revenue in the second quarter of 2003 and 76% in the second quarter of 2004. Our support and service revenues decreased 10% from $24.3 million in the first six months of 2003 to $21.9 million in the first six months of 2004. Support and service revenues represented 81% of our total revenue in the first six months of 2003 and 75% of our total revenue in the first six months of 2004. We expect the dollar amount of our service revenue in the third quarter of 2004 to be in the same range when compared to the second quarter of 2004. We also expect the proportion of support and service revenue to total revenue to fluctuate in the future, depending in part on our customers’ direct use of third-party consulting and implementation service providers, the degree to which we provide opportunities for our partners to engage with our customers and the ongoing renewals of customer support contracts, as well as our overall sales of software licenses to new and existing customers.

     Revenue outside of North America decreased 22% from $7.2 million in the second quarter of 2003 to $5.6 million in the second quarter of 2004. Revenue outside of North America decreased 13% from $12.4 million in the first six months of 2003 to $10.8 million in the first six months of 2004. The decrease in international revenue was primarily due to the decrease in license revenue in Europe.

Cost of Revenue

     Cost of license revenue

     Cost of license revenue consists of license fees for third-party software, product media, product duplication and manuals. Cost of license revenue increased 35%, from $197,000 in the second quarter of 2003 to $266,000 in the second quarter of 2004. Cost of license revenue as a percentage of related license revenue was 6% in the second quarter of 2003 and 7% in the second quarter of 2004. The increase in the cost of license revenue as a percentage of related license revenue resulted primarily from an increase in third-party product royalties during the second quarter of 2004. Cost of license revenue decreased 5% from $482,000 in the first six months of 2003 to $459,000 in the first six months of 2004. Cost of license revenue as a percentage of related license revenue was 8% in the first six months of 2003 and 6% in the first six months of 2004. The decrease in cost of license revenue as a percentage of related license revenue resulted primarily from a decrease in third-party product royalties.

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     Amortization of acquired technology

     Amortization of acquired technology represents the amortization of capitalized technology associated with our acquisitions of EnCyc in 1998 and Market Solutions in 1999. Amortization of acquired technology was $84,000 in the second quarter of 2003 and $168,000 in the first six months of 2003. Amortization of acquired technology was completed in the fourth quarter of 2003 and, accordingly, there was no amortization of acquired technology in either the first quarter or the first six months of 2004. Purchased technology of $4.1 million from the Visuale acquisition, will be amortized over four years starting from the general release of the product, which is expected in early 2005.

     Cost of support and service revenue

     Cost of support and service revenue consists of personnel and third-party service provider costs related to consulting services, customer support and training. Cost of support and service revenue decreased 17%, from $5.4 million in the second quarter of 2003 to $4.5 million in the second quarter of 2004. Cost of support and service revenue as a percentage of related support and service revenue was 43% in the second quarter of 2003 compared to 40% in the second quarter of 2004. The decrease in cost of support and service revenue as a dollar amount in the second quarter of 2004 compared to the second quarter of 2003 resulted primarily from a reduction in consulting personnel of approximately 11% and a decrease in the use of third-party service providers, of approximately $398,000. Cost of support and service revenue decreased 18%, from $10.9 million in the first six months of 2003 to $9.0 million in the first six months of 2004. Cost of support and service revenue as a percentage of related support and service revenue was 45% in the first six months of 2003 compared to 41% in the first six months of 2004. The decrease in cost of support and service revenue as a dollar amount in the six months of 2004 compared to the six months of 2003 resulted primarily from an average reduction in consulting personnel of approximately 13%, and a decrease in the use of third-party service providers, of approximately $909,000. The cost of support and services as a percentage of support and service revenue may vary between periods primarily for two reasons: (1) the mix of services we provide (consulting, customer support, training), which have different cost structures, and (2) the resources we use to deliver these services (internal versus third parties).

Operating Expenses and Other

     Sales and marketing

     Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, travel and promotional expenses and facility and communication costs for direct sales offices. Sales and marketing expenses decreased 9%, from $5.1 million in the second quarter of 2003 to $4.6 million in the second quarter of 2004. Sales and marketing expenses decreased 19%, from $11.6 million in the first six months of 2003 to $9.4 million in the first six months of 2004. The decrease in dollar amount from 2003 to 2004 was primarily due to reductions in sales and marketing headcounts. Sales and marketing employees decreased 19% from June 30, 2003 to June 30, 2004. Sales and marketing expenses represented 32% of our total revenue in the second quarter of 2003, compared to 31% in the second quarter of 2004. Sales and marketing expenses represented 39% of our total revenue in the first six months of 2003, compared to 32% of our total revenue in the first six months of 2004.

     To fully realize our long-term sales growth opportunity, we believe that we may need to increase our sales and marketing efforts, particularly in support of our vertical and embedded CRM strategies, to expand our market position and further increase acceptance of our products.

Research and development

     Research and development expenses consist primarily of salaries, benefits and equipment for software developers, quality assurance personnel, program managers and technical writers, and payments to outside contractors. Research and development expenses decreased 14%, from $3.1 million in the second quarter of 2003 to $2.7 million in the second quarter of 2004. Research and development expenses decreased 15%, from $6.3 million in the first six months of 2003 to $5.3 million in the first six months of 2004. The decrease in research and development expenses was primarily due to a decrease in the use of outside contractors and a decrease in the number of development personnel. Average headcount of research and development employees decreased 10%, in the first six months of 2004 when compared to the first six months of 2003. Research and development costs represented 20% of our total revenue in the second quarter of 2003, compared to 18% in the second quarter of 2004. Research and development costs represented 21% of our total revenue in the first six months of 2003, compared to 18% in the first six months of 2004.

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     We believe that our research and development investments are essential to our long-term strategy and, to fully realize our long-term sales growth opportunity, we believe that we may need in future periods to increase our research and development investment.

General and administrative

     General and administrative expenses consist primarily of salaries, benefits and related costs for our executive, finance, human resource and administrative personnel, professional services fees and allowances for doubtful accounts. General and administrative expenses increased 21%, from $1.8 million in the second quarter of 2003 to $2.2 million in the second quarter of 2004. The increase in dollar amount from the second quarter of 2003 to the second quarter of 2004 was primarily due to an increase in hired services related to Sarbanes-Oxley work, recruiting and relocation fees related to the hiring of our new Chief Executive Officer, and a reduction of our bad debt reserve in the second quarter of 2003. General and administrative costs represented 12% of our total revenue in the second quarter of 2003, compared to 15% in the second quarter of 2004. General and administrative expenses increased 1%, from $4.1 million in the first six months of 2003 to $4.2 million in the first six months of 2004. General and administrative costs represented 14% of our total revenue in the first six months of 2003, consistent with the first six months of 2004.

     We believe that our general and administrative expenses may increase in future quarters, in particular Q3 2004, as we incur additional professional services fees related to the satisfaction of new compliance requirements under the Sarbanes-Oxley Act of 2002. In addition we believe that our general and administrative expenses may increase with a full quarters compensation cost and relocation costs associated with the hiring of our new Chief Executive Officer. We also believe that we may need to expand our administrative staff, domestically and internationally, in the future to pursue our long-term sales growth opportunities and satisfy our new compliance requirements.

Restructuring and other related charges

     Restructuring and other related charges represent our efforts to reduce our overall cost structure. In April and again in September 2001, we approved a restructuring plan to reduce headcount, reduce infrastructure and eliminate excess and duplicate facilities. In April 2003, we approved a restructuring plan to reduce additional headcount. During 2001, 2002, and 2003, we recorded approximately $51.8 million, $8.5 million and $1.4 million, respectively, in restructuring and other related charges. During the first quarter of 2004, we recorded approximately $484,000 in restructuring and other related charges.

     The components of the first quarter 2004 charges and a roll-forward of the related liability follow (in thousands):

     The roll-forward of the related liability for the second quarter of 2004 follow (in thousands):

     We issued three five-year warrants to Hines in January 2003 for the purchase of up to an aggregate of 198,750 shares of our common stock, including a warrant to purchase 66,250 shares of common stock at an exercise price of $10.38 per share, a warrant to purchase 66,250 shares of common stock at an exercise price of $12.11 per share and a warrant to purchase 66,250 shares of common

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stock at an exercise price of $13.84 per share. If we either undergo a change of control or issue securities with rights and preferences superior to our common stock before January 2005, Hines will have the option of canceling any unexercised warrants and receiving a cash cancellation payment of $18.40 per share in the case of the $10.38 warrants, $16.00 per share in the case of the $12.11 warrants and $13.92 per share in the case of the $13.84 warrants. These contingent cash payments aggregate $3.2 million. We also entered into a registration rights agreement with Hines, pursuant to which we filed a registration statement on February 14, 2003 covering the resale of the shares of our common stock subject to purchase by Hines under the warrants. The warrant value as of December 31, 2002 was estimated at $920,000 based on (a) the estimated value of the warrants using the Black-Scholes model with an expected dividend yield of 0.0%, a risk-free interest rate of 5.0%, volatility of 85% and an expected life of five years and (b) the estimated value of the cash cancellation payments in the event of a change in control. The warrants are subject to variable accounting and we are required to mark the warrants to market at each reporting period. At June 30, 2004, the warrant value was estimated at $353,000 using similar assumptions to those used at December 31, 2002, and is included in long-term liabilities.

     The accounting for excess facilities is complex and requires judgment, a consequence of which is that adjustments may be required to our current restructuring charge. In particular, based on the terms of the warrants issued in connection with the partial lease termination of excess facilities in Bellevue, Washington, the warrants are subject to variable accounting and will be marked to market at each reporting period. Future cash outlays for excess facilities are anticipated through July 2006 unless estimates and assumptions change or we are able to negotiate to exit certain leases at an earlier date.

     The current portion of restructuring-related liabilities totaled $1.3 million at June 30, 2004, the long-term portion of restructuring-related liabilities totaled $93,000 at June 30, 2004 and the value of the warrants issued in connection with the termination of certain facility lease obligations was $353,000 at June 30, 2004.We estimate the cash payments for restructuring and other liabilities will be approximately $463,000 for the third quarter of 2004.

Amortization of acquisition-related intangibles

     Amortization of acquisition-related intangibles consists of intangible amortization associated with our acquisitions of EnCyc in 1998 and Market Solutions in 1999. Amortization of other acquisition-related intangibles totaled $209,000 in the second quarter of 2003 and 2004 and $418,000 in the first six months of 2003 and 2004. Amortization of acquisition-related intangibles will be completed in the third quarter of 2004.

Amortization of stock-based compensation

     We recorded deferred stock-based compensation of $2.2 million in 1998, representing the difference between the exercise prices of options granted to acquire shares of common stock during 1997 and 1998, prior to our initial public offering, and the deemed fair value for financial reporting purposes of our common stock on the grant dates. We recorded an additional $1.8 million in deferred compensation in connection with the options granted to new employees in conjunction with the acquisition of RevenueLab in January 2001. Deferred compensation is amortized over the vesting periods of the options. We recorded stock-based compensation expense of $15,000 in the second quarter of 2003 and $0 in the second quarter of 2004. We recorded stock-based compensation expense of $28,000 in the first six months of 2003 and $0 in the first six months of 2004. Option-related deferred compensation recorded at our initial public offering and the deferred stock-based compensation in connection with the acquisition of RevenueLab have both been fully amortized.

Other Income (Expense), Net

     Other income (expense), net consists of earnings on our cash and cash equivalent and short-term investment balances and foreign currency transaction gains, offset by interest expense, bank fees associated with debt obligations and credit facilities and foreign currency transaction losses. Other income (expense), net was income of $111,000 in the second quarter of 2003 compared to expense of $(121,000) in the second quarter of 2004. Other income (expense), net was income of $120,000 in the first six months of 2003 compared to expense of $(314,000) in the first six months of 2004. The decrease in other income (expense), net was primarily related to the realized foreign currency loss related to the closure of our French subsidiary and the settlement of the intercompany accounts in the first quarter of 2004 and foreign currency transaction losses in the first six months of 2004.

Change in Fair Value of Outstanding Warrants

     Based on the terms of the warrants issued in connection with the partial lease termination of excess facilities in Bellevue, Washington, we are subject to variable accounting and will be required to mark the warrants to market at each reporting period.

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During the second quarter of 2004, we recorded a benefit of $90,000, representing the change in fair value of the outstanding warrants. The benefit recorded during the first six months of 2004 totaled $212,000.

Income Tax Provision (Benefit)

     We recorded an income tax provision of $135,000 in the second quarter of 2003 and a provision of $93,000 in the second quarter of 2004. We recorded an income tax benefit of $(79,000) in the first six months of 2003 and a provision of $149,000 in the first six months of 2004. Our income tax provision (benefit) in both 2003 and 2004 is the net result of income taxes in connection with our foreign operations, offset by the deferred tax benefit recorded as we amortize the intangibles associated with our international acquisitions. We increased the provision for our UK operation in the second quarter of 2004 and recorded a long term deferred tax asset of $92,000. We have recorded a valuation allowance for all but $425,000 of our deferred tax assets as a result of uncertainties regarding the realization of the asset balance at June 30, 2004.

Minority Interest in Consolidated Subsidiary

     Softbank Investments Corporation and Prime Systems Corporation together own 42% of Onyx Japan, our Japanese joint venture. We have a controlling interest and, therefore, Onyx Japan has been included in our consolidated financial statements. The minority shareholders’ interest in Onyx Japan’s earnings or losses is accounted for in the statement of operations each period. In the second quarter of 2003 and 2004, the minority shareholders’ interest in Onyx Japan’s losses totaled $75,000 and $31,000. In the first six months of 2003, the minority shareholders’ interest in Onyx Japan’s losses totaled $232,000. In the first six months of 2004, the minority shareholders’ interest in Onyx Japan’s income totaled $24,000. At June 30, 2004, the minority shareholders’ remaining interest in the joint venture totaled $141,000. As a result, additional Onyx Japan losses above approximately $335,000 in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods.

Liquidity and Capital Resources

     At June 30, 2004, we had unrestricted cash and cash equivalents of $12.3 million, an increase of $586,000 from unrestricted cash and cash equivalents held at December 31, 2003. At June 30, 2004, we did not have any restricted cash, a decrease of $1.7 million in restricted cash from December 31, 2003. We invest our cash in excess of current operating requirements in a portfolio of investment-grade securities. We did not hold any short-term marketable securities at December 31, 2003 or at June 30, 2004.

     At June 30, 2004, our principal obligations consisted of restructuring-related liabilities totaling $1.4 million, excluding the value assigned to warrants, of which $1.3 million is expected to be paid within the next 12 months, accrued liabilities of $2.5 million, of which $2.0 million is expected to be paid within the next 12 months, trade payables of $987,000, salaries and benefits payable of $1.2 million, and acquisition obligations, net of imputed interest, of $1.8 million, of which $943,000 is expected to be paid within the next 12 months. The majority of the restructuring-related liabilities relate to excess facilities in domestic and international markets. The majority of our accounts payable, salaries and benefits payable and accrued liabilities at June 30, 2004 will be settled during the next three months and will result in a corresponding decline in the amount of cash and cash equivalents, offset by liabilities associated with activity in the third quarter of 2004. The acquisition obligations relate to our purchase of the Visuale assets in the second quarter of 2004. We will make a subsequent payment of $1.0 million in April 2005, with the option of using either cash or common stock valued at the then-current fair market value. In addition, we will make royalty payments for a period of four years to Visuale on sales of our products incorporating the acquired technology, with a guaranteed minimum royalty payment in each of the third and fourth years following closing of $500,000. Off-balance sheet obligations as of June 30, 2004 primarily consisted of operating leases associated with facilities in Bellevue, Washington and other domestic and international field office facilities. Our contractual commitments at June 30, 2004 are substantially similar to those at December 31, 2003 that were disclosed in our annual report on Form 10-K.

     Under Loan and Security Agreements with SVB, we have a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility. The $10.0 million working capital revolving line of credit is split between an $8.0 million domestic facility and a $2.0 million Exim Bank facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows us to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and (b) $8.0 million. The Exim Bank facility allows us to borrow up to the lesser of (a) 75% of eligible foreign accounts receivable and (b) $2.0 million. The amount available to borrow under the working capital revolving line of credit is reduced by reserves for outstanding standby letters of credit issued by SVB on our behalf and 50% of any borrowings under the term loan facility. If the calculated borrowing base falls below the reserves, SVB may require us to cash secure the amount by which the reserves exceed the borrowing base. We were not required to restrict any cash under the loan agreements of June 30, 2004.

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Due to the variability in our borrowing base, we may be subject to restrictions on our cash at various times throughout the year. Any borrowings will bear interest at SVB’s prime rate, which was 4.00% as of March 31, 2004, plus 1.5% (plus 2% for the term loan facility), subject to a minimum rate of 6.0%. The loan agreements require that we maintain certain financial covenants based on our adjusted quick ratio and tangible net worth. We were in compliance with these covenants at June 30, 2004. We are also prohibited under the loan and security agreements from paying dividends. The facilities expire in March 2005. At June 30, 2004, based on $4.8 million in outstanding standby letters of credit relating to long-term lease obligations and $473,000 outstanding under the term loan facility, $371,000 of additional amounts were currently available under the revolving credit facilities.

     Our operating activities resulted in net cash outflows of $7.6 million in the first six months of 2003 and inflows of $1.1 million in the first six months of 2004. The operating cash outflow in the first six months of 2003 was primarily the result of our operating loss for the period adjusted for non-cash amortization and impairment charges, decreases in accounts payable, salaries and benefits payable and accrued liabilities, decreases in restructuring-related liabilities, decreases in deferred revenues, offset in part by cash provided by collections on accounts receivable and decreases in prepaid expenses and other assets. The operating cash inflow for the first six months of 2004 was primarily the result of cash provided by collections on accounts receivable, increases in deferred revenue, adjustment for non-cash depreciation and amortization charges, offset by our operating loss for the period and decreases in restructuring-related liabilities. The net cash outflow of $7.6 million in the first six months of 2003 includes $7.1 million in cash paid for restructured items, and the net cash inflow of $1.1 million in the first six months of 2004 includes $2.2 million in cash paid for restructured items.

     Investing activities used cash of $1.7 million in the first six months of 2003, primarily due to the restriction of cash used to secure outstanding letters of credit and capital expenditures associated with the relocation of our corporate headquarters in January 2003. Investing activities provided cash of $474,000 in the first six months of 2004, primarily due to the reduction in the restriction of cash used to secure outstanding letters of credit, offset by capital expenditures and the acquisition of the Visuale assets.

     Financing activities provided cash of $2.8 million in the first six months of 2003, primarily due to the proceeds from our private offering of common stock in May 2003, as well as due to proceeds from our employee stock purchase plan and the exercise of stock options, offset in part by payments on our long-term obligations. Financing activities provided cash of $694,000 in the first six months of 2004, primarily due by proceeds from our employee stock purchase plan, the exercise of stock options and borrowings from our term loan, offset by principal payments of the term loan.

     We believe our revenue performance will be comparable to the most recent quarterly periods reported and that our existing cash and cash equivalents will be sufficient to meet our capital requirements for at least the next 12 months. Should our results for subsequent quarters fall significantly below the results we achieved in the second quarter of 2004, we would likely take action to restructure our operations to preserve our cash. Such actions would primarily consist of reductions in headcount. Due to the fact that lower cash balances could negatively impact our sales efforts, we may seek additional funds in the future through public or private equity financing or from other sources to fund our operations and pursue our growth strategy. We may experience difficulty in obtaining funding on favorable terms, if at all. Any financing we might obtain may contain covenants that restrict our freedom to operate our business or may require us to issue securities that have rights, preferences or privileges senior to our common stock and may dilute current shareholders’ ownership interest in us.

Important Factors That May Affect Our Business, Our Results of Operations and Our Stock Price

Our operating results fluctuate and could fall below expectations of investors, resulting in a decrease in our stock price.

     Our operating results have varied widely in the past, and we expect that they will continue to fluctuate in the future. If our operating results fall below the expectations of investors, it could result in a decrease in our stock price. Some of the factors that could affect the amount and timing of our revenue and related expenses and cause our operating results to fluctuate include:

	•		general economic conditions, which may affect our customers’ capital investment levels in management information systems and the timing of their purchases;
	•		rate of market acceptance of our CRM solution;
	•		budget and spending decisions by our prospective and existing customers;

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	•		customers’ and prospects’ decisions to defer orders or implementations, particularly large orders or implementations, from one quarter to the next, or to proceed with smaller-than-forecasted orders or implementations;
	•		level of purchases by our existing customers, including additional license and maintenance revenues;
	•		our ability to enable our products to operate on multiple platforms;
	•		our ability to compete in the highly competitive CRM market;
	•		the loss of any key technical, sales, customer support or management personnel and the timing of any new hires;
	•		our ability to develop, introduce and market new products and product versions on a timely basis;
	•		variability in the mix of our license versus service revenue, the mix of our direct versus indirect license revenue and the mix of services that we perform versus those performed by third-party service providers;
	•		our ability to successfully expand our operations, and the amount and timing of expenditures related to this expansion; and
	•		the cost and financial accounting effects of any acquisitions of companies or complementary technologies that we may complete.

     As a result of all of these factors, we cannot predict our revenue with any significant degree of certainty, and future product revenue may differ from historical patterns. It is particularly difficult to predict the timing or amount of our license revenue because:

	•		our sales cycles are lengthy and variable, typically ranging between six and eighteen months from our initial contact with a potential customer to the signing of a license agreement, although the sales cycle varies substantially from customer to customer, and occasionally sales require substantially more time;
	•		a substantial portion of our sales are completed at the end of the quarter and, as a result, a substantial portion of our license revenue is recognized in the last month of a quarter, and often in the last weeks or days of a quarter;
	•		in recent quarters, the contracting process of our sales cycle has taken more time than we have historically experienced;
	•		the amount of unfulfilled orders for our products at the beginning of a quarter is small because our products are typically shipped shortly after orders are received; and
	•		delay of new product releases can result in a customer’s decision to delay execution of a contract or, for contracts that include the new release as an element of the contract, will result in deferral of revenue recognition until such release.

     Even though our revenue is difficult to predict, we base our decisions regarding our operating expenses on anticipated revenue trends. Many of our expenses are relatively fixed, and we cannot quickly reduce spending if our revenue is lower than expected. As a result, revenue shortfalls could result in significantly lower income or greater loss than anticipated for any given period, which could result in a decrease in our stock price.

We may be unable to obtain the funding necessary to support the expansion of our business, and any funding we do obtain could dilute our shareholders’ ownership interest in Onyx.

     Our future revenue may be insufficient to support the expenses of our operations, capital needs of Onyx Japan, and the expansion of our business. We may therefore need additional equity or debt capital to finance our operations. If we are unable to generate sufficient cash flow from operations or to obtain funds through additional financing, we may have to reduce our development and sales and marketing efforts and limit the expansion of our business.

     We currently have a total $10.0 million working capital revolving line of credit and a $500,000 term loan facility with SVB. The $10.0 million working capital revolving line of credit is split between an $8.0 million domestic facility and a $2.0 million Exim Bank facility. All of the facilities are secured by accounts receivable, property and equipment and intellectual property. The domestic facility allows us to borrow up to the lesser of (a) 70% of eligible domestic and individually approved foreign accounts receivable and

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(b) $8.0 million. The Exim Bank facility allows us to borrow up to the lesser of (a) 75% of eligible foreign accounts receivable and (b) $2.0 million. The amount available to borrow under the working capital revolving line of credit is reduced by reserves for outstanding standby letters of credit issued by SVB on the Company’s behalf and 50% of any borrowings under the term loan facility. At June 30, 2004, $371,000 of additional amounts were available under the lines of credit based on the level of our borrowing base and our outstanding letters of credit. We were in compliance with the financial covenants of these facilities as of June 30, 2004. If we are unable to maintain compliance with our covenants in the future or if SVB decides to restrict our cash deposits, our liquidity would be further limited and our business, financial condition and operating results could be materially harmed.

     Assuming our future revenue performance is comparable to the most recent quarterly periods reported, we believe that our existing cash and cash equivalents will be sufficient to meet our capital requirements for at least the next 12 months. Should our revenue results for subsequent quarters fall significantly below the results we achieved in the second quarter of 2004, we would likely take action to restructure our operations to preserve our cash. Due to the fact that lower cash balances could negatively impact our sales efforts, we may seek additional funds in the future through public or private equity financing or from other sources to fund our operations and pursue our growth strategy. We may experience difficulty in obtaining funding on favorable terms, if at all. Any financing we might obtain may contain covenants that restrict our freedom to operate our business or may require us to issue securities that have rights, preferences or privileges senior to our common stock and may dilute current shareholders’ ownership interest in Onyx.

We have incurred losses in prior periods, and may not be able to maintain profitability, which could cause a decrease in our stock price.

     We incurred net losses in each quarter from Onyx’s inception through the third quarter of 1994, from the first quarter of 1997 through the second quarter of 1999, and from the first quarter of 2000 through the first quarter of 2004. Although we achieved slight profitability on a quarterly basis in the second quarter of 2004, we may not be able to achieve or maintain profitability in future quarters. As of June 30, 2004, we had an accumulated deficit of $128.6 million. Our accumulated deficit and financial condition have caused some of our potential customers to question our viability, which we believe has in turn hampered our ability to sell some of our products.

     In the near-term, we believe our costs and operating expenses, excluding restructuring-related charges, may increase in certain areas as we fund new initiatives. While we expect our costs and operating expenses in the near-term to be at a level that is in line with our expected revenue, we may not be able to increase our revenue sufficiently to keep pace with any growth in expenditures. As a result, we may be unable to maintain profitability in future periods.

     Although profitable in the third and fourth quarters of 2003 and the first quarter of 2004, Onyx Japan incurred substantial losses in previous periods. The minority shareholders’ capital account balance as of June 30, 2004 was $141,000. Additional Onyx Japan losses above approximately $335,000 in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods, which could impact our ability to achieve profitability in future periods.

Economic and business conditions could adversely affect our revenue growth and ability to forecast revenue.

     Our revenue growth and potential for profitability depend on the overall demand for CRM software and services. Because our sales are primarily to corporate customers, we are also impacted by general economic and business conditions. A softening of demand for computer software caused by the weakened economy, both domestic and international, has affected our sales and may continue to result in decreased revenue and growth rates. When economic conditions weaken, sales cycles for software products tend to lengthen, and, as a result, we experienced longer sales cycle in 2001, 2002, 2003, and the first six months of 2004. We expect to continue to experience longer sales cycles than usual in the foreseeable future. As a result of the economic downturn, we have also experienced and may continue to experience difficulties in collecting outstanding receivables from our customers.

     Our management team uses our software to identify, track and forecast future revenue, backlog and trends in our business. Our sales force monitors the status of all proposals, such as the date when they estimate that a transaction will close and the potential dollar amount of such sale. We aggregate these estimates regularly in order to generate a sales pipeline and then evaluate the pipeline at various times to look for trends in our business. While this pipeline analysis provides us with visibility about our potential customers and the associated revenue for budgeting and planning purposes, these pipeline estimates may not consistently correlate to revenue in a particular quarter or over a longer period of time. The slowdown in the domestic and international economies, as well as the effects of terrorist activity and actual and threatened armed conflict, may continue to cause customer purchasing decisions to be delayed, reduced in amount or cancelled, which could reduce the rate of conversion of the pipeline into contracts during a particular period of

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time. We believe that our customers also face increasing budgetary pressures due to increased compliance costs in the current regulatory environment, such as costs associated with establishing and maintaining satisfactory internal controls under Sarbanes-Oxley Section 404.

     As a result of the economic slowdown and these increasing budget pressures, we believe that a number of our potential customers may delay or cancel their purchase of our software, consulting services or customer support services or may elect to develop their own CRM solution or solutions. A variation in the pipeline or in the conversion of the pipeline into contracts could adversely affect our business and operating results. In addition, because a substantial portion of our sales are completed at the end of the quarter, and often in the last weeks or days of a quarter, we may be unable to adjust our cost structure in response to a variation in the conversion of the pipeline into contracts in a timely manner, which could adversely affect our business and operating results. We have also recently experienced a trend of smaller initial orders by new purchasers of our software. Some customers are reluctant to make large purchases before they have had the opportunity to observe how our software performs in their organization, and have opted instead to make their planned purchase in stages. Additional purchases, if any, may follow only if the software performs as expected. We believe that this trend is a symptom of poor economic conditions, lack of successful deployments by competitors and increasing averseness to risk among our customers and potential customers. To the extent that this trend continues, it will adversely affect our revenues.

Fluctuations in support and service revenue could decrease our total revenue or decrease our gross margins, which could cause a decrease in our stock price.

     Although our support and service revenue represented a lower percentage of our total revenue in the first six months of 2004 when compared to the first six months of 2003, during 2001, 2002 and 2003, our support and service revenue represented a higher percentage of our total revenue than in past periods, which negatively impacted our gross margins. To the extent that this trend continues, our gross margins will continue to suffer. Due largely to the decrease in license revenue in 2001, 2002 and 2003, support and service revenue represented 62% of our total revenue in 2001, 67% of our total revenue in 2002 and 79% of our total revenue in 2003. In the first six months of 2004, support and service revenue represented 75% of our total revenue. We anticipate that support and service revenue will continue to represent a significant percentage of total revenue. Because support and service revenue has lower gross margins than license revenue, a continued increase in the percentage of total revenue represented by support and service revenue or a further decrease in license revenue, as we experienced in 2001, 2002 and 2003, could have a detrimental effect on our overall gross margins and thus on our operating results. Our support and service revenue is subject to a number of risks. First, we subcontract some of our consulting, customer support and training services to third-party service providers. Third-party contract revenue generally carries even lower gross margins than our service business overall. As a result, our support and service revenue and related margins may vary from period to period, depending on the mix of third-party contract revenues. Second, support and service revenue depends in part on ongoing renewals of support contracts by our customers, some of which may not renew their support contracts. Finally, support and service revenue could decline further if customers select third-party service providers to install and service our products more frequently than they have in the past. If support and service revenue is lower than anticipated, our operating results could fall below the expectations of investors, which could result in a decrease in our stock price.

We have a limited operating history and are subject to the risks of new enterprises.

     We commenced operations in February 1994 and commercially released the first version of our flagship product in December 1994. Accordingly, we have a limited operating history, and we face all of the risks and uncertainties encountered by early-stage companies. These risks and uncertainties include:

	•		no history of sustained profitability;
	•		uncertain growth in the market for, and uncertain market acceptance of, our solution;
	•		reliance on one product family;
	•		the risk that competition, technological change or evolving customer preferences, such as preferences for different computing platforms, could harm sales of our solution;
	•		the need to implement our sales, marketing and after-sales service initiatives, both domestically and internationally;
	•		the need to execute our product development activities;

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	•		dependence on a limited number of key technical, customer support, sales and managerial personnel; and
	•		the risk that our management will be unable to effectively manage growth, a downturn or any acquisition we may undertake.

     The evolving nature of the CRM market increases these risks and uncertainties. Our limited operating history makes it difficult to predict how our business will develop.

If we are unable to compete successfully in the highly competitive CRM market, our business will fail.

     Our solution targets the CRM market. This market is intensely competitive, fragmented, rapidly changing and significantly affected by new product introductions. We face competition in the CRM market primarily from front-office software application vendors, large enterprise software vendors and our potential customers’ information technology departments, which may seek to develop proprietary CRM systems. The dominant competitor in our industry is Siebel Systems, Inc., which holds a significantly greater percentage of the CRM market than we do. Other companies with which we compete include, but are not limited to, Amdocs Limited, E.piphany, Inc., Kana Communications, Inc., Microsoft Corporation, Oracle Corporation, PeopleSoft, Inc., Pivotal Corporation (recently acquired by CDC Software), RightNow Technologies, Salesforce.com, SalesLogix (part of Sage, Inc.) and SAP AG.

     In addition, as we develop new products, including new product versions operating on new platforms, we may begin competing with companies with whom we have not previously competed. It is also possible that new competitors will enter the market. In 2002, we experienced an increase in competitive pressures in our market, which has resulted in enhanced pricing competition among our competitors. A continued increase in competitive pressures in our market or our failure to compete effectively may result in pricing reductions, reduced gross margins and loss of market share. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, marketing and other resources than we do. Furthermore, we believe that there may be ongoing consolidation among our competitors. As a result of consolidation among our competitors, our competitors may be able to adapt more quickly to new technologies and customer needs, devote greater resources to promoting or selling their products and services, initiate and withstand substantial price competition, take advantage of acquisition or other strategic opportunities more readily or develop and expand their product and service offerings more quickly than we can. In addition, our competitors may form strategic relationships with each other and with other companies in attempts to compete more successfully against us. These relationships may take the form of strategic investments, joint marketing agreements, licenses or other contractual arrangements, any of which may increase our competitors’ ability, relative to ours, to address customer needs with their software and service offerings and that may enable them to rapidly increase their market share.

If we do not retain our key employees and management team, and integrate our new senior management personnel, our ability to execute our business strategy will be limited.

     Our future performance will depend largely on the efforts and abilities of our key technical, sales, customer support and managerial personnel and on our ability to attract and retain them. In addition, our ability to execute our business strategy will depend on our ability to recruit additional experienced management personnel and to retain our existing executive officers. The competition for qualified personnel in the computer software and technology markets is particularly intense. We have in the past experienced difficulty in hiring qualified technical, sales, customer support and managerial personnel, and we may be unable to attract and retain such personnel in the future. In addition, due to the intense competition for qualified employees, we may be required to increase the level of compensation paid to existing and new employees, which could materially increase our operating expenses. Our key employees are not obligated to continue their employment with us and could leave at any time. On June 7, 2004, we announced the appointment of Janice P. Anderson as our new Chief Executive Officer. To integrate into Onyx, Ms. Anderson must spend a significant amount of time learning our business model and establishing a management system, in addition to performing her regular duties. Accordingly, Ms. Anderson’s integration could result in some disruption to our business.

     The market price of our common stock has fluctuated substantially since our initial public offering in February 1999. Consequently, potential employees may perceive our equity incentives such as stock options as less attractive, and current employees whose options are no longer priced below market value may choose not to remain employed by us. In that case, our ability to attract or retain employees will be adversely affected.

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Recently enacted changes in the securities laws and regulations are likely to increase our costs and we may be unable to obtain the attestation of the adequacy of our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002.

     The Sarbanes-Oxley Act of 2002 that became law in July 2002 (the “Act”) has required changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of that Act, the SEC and Nasdaq have promulgated new rules. Compliance with these new rules has significantly increased our legal, financial and accounting costs, and we expect these increased costs to continue through at least the end of 2004.

     As directed by Section 404 of the Act, the SEC adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting. In addition, the public accounting firm auditing the company’s financial statements must attest to and report on management’s assessment of the effectiveness of the company’s internal control over financial reporting. Although we intend to conduct a rigorous review of our internal control over financial reporting to help achieve compliance with the Section 404 requirements, if our independent registered certified public accounting firm interprets the Section 404 requirements and the related rules and regulations differently from us or if our independent registered certified public accounting firm is not satisfied with our internal control over financial reporting or with the level at which it is documented, operated or reviewed, they may decline to attest to management’s assessment or may issue a qualified report. This could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our shares to decline.

Our solution may not achieve significant market acceptance.

     Continued growth in demand for and acceptance of CRM systems remains uncertain. Even if the market for CRM systems grows, businesses may purchase our competitors’ solutions or develop their own. We believe that many of our potential customers are not fully aware of the benefits of CRM systems and that, as a result, CRM systems have not achieved, and may not achieve, market acceptance. We also believe that many of our potential customers perceive the implementation of a CRM system to require a great deal of time, expense and complexity. This perception has been exacerbated by well-publicized failures of certain CRM projects of some of our competitors. This, in turn, has caused some potential customers to approach purchases of CRM systems with caution or to postpone their orders or decline to make a purchase altogether. We have spent, and will continue to spend, considerable resources educating potential customers not only about our solution but also about CRM systems in general. Even with these educational efforts, however, continued market acceptance of our solution may not increase. We will not succeed unless we can educate our target market about the benefits of CRM systems and the cost effectiveness, ease of use and other benefits of our solution.

If potential customers do not accept the Onyx product family, our business will fail.

     We rely on one product family for the success of our business. License revenue from the Onyx product family has historically accounted for nearly all of our license revenue. We expect product license revenue from the Onyx product family to continue to account for a substantial majority of our future revenue. As a result, factors adversely affecting the pricing of or demand for the Onyx product family, such as competition or technological change, could dramatically affect our operating results. If we are unable to successfully deploy current versions of the Onyx product family and to develop, introduce and establish customer acceptance of new and enhanced versions of the Onyx product family, our business will fail.

If we are unsuccessful in our attempt to enable our products to operate on multiple platforms, our revenue growth could be limited.

     We originally designed our products to operate exclusively on the Windows NT and Microsoft BackOffice platforms. As a result, our primary market has historically been to customers that have developed or are willing to develop their enterprise computing systems around these platforms, which limits our potential sales. We announced the general availability of an Oracle version of Onyx Employee Portal, or OEP, designed to operate on the Unix platform in June 2002. Later in 2002, we also introduced an Oracle version of OEP designed to run on IBM AIX. Subsequent product versions have been released on these platforms. If these product versions or new product versions do not achieve general market acceptance, our revenue growth will be limited. We believe that our ability to effectively expand our business into large enterprises depends in part on the successful release and market acceptance of our new platform versions. If we are unable to expand into large enterprises, the growth of our business and our revenue will be limited. Moreover, enabling our products to run on multiple platforms could lengthen the development cycle, thus delaying the release date of future product versions or new products, which could further restrict our revenue growth.

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

     The effectiveness of our solution relies on the storage and use of customer data collected from various sources, including information derived from customer registrations, billings, purchase transactions and surveys. The collection and use of such data by our customers 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. These security measures may not, however, be effective against all potential security threats. If a well-publicized breach of customer data security were to occur, our solution may be perceived as less desirable, which could limit our revenue growth.

     In addition, due to privacy concerns, some Internet commentators, consumer advocates and governmental or legislative bodies have suggested legislation to limit the use of customer profiling technologies. The European Union and some European countries have already adopted some restrictions on the use of customer profiling data. If major countries or regions adopt legislation or other restrictions on the use of customer profiling data, our solution would be less useful to customers, and our sales could decrease.

We may be unable to efficiently restructure or expand our sales organization, which could harm our ability to expand our business.

     To date, we have sold our solution primarily through our direct sales force. As a result, our future revenue growth will depend in large part on recruiting, training and retaining direct sales personnel and expanding our indirect distribution channels. These indirect channels include VARs, VSPs, original equipment manufacturer, or OEM, partners, system integrators and consulting firms. We have experienced and may continue to experience difficulty in recruiting qualified direct sales personnel and in establishing third-party relationships with VARs, VSPs, OEM partners, systems integrators and consulting firms.

If our customers cannot successfully implement our products in a timely manner, demand for our solution will be limited.

     The implementation of our products involves a significant commitment of resources by prospective customers. Our customers frequently deploy our products to large numbers of sales, marketing and customer service personnel, who may not accept our products. Our products are also used with a number of third-party software applications and programming tools. This use may present significant technical challenges, particularly as large numbers of personnel attempt to use our software concurrently. If an implementation is not successful, we may be required to deliver additional consulting services free of charge in order to remedy the problem. If our customers have difficulty deploying our software or for any other reason are not satisfied with our software, our operating results and financial condition may be harmed.

Rapid changes in technology could render our products obsolete or unmarketable, and we may be unable to introduce new products and services successfully and in a timely manner.

     The CRM market is characterized by rapid change due to changing customer needs, rapid technological developments and advances introduced by competitors. Existing products can become obsolete and unmarketable when products using new technologies are introduced and new industry standards emerge. New technologies could change the way CRM systems are sold or delivered. We may also need to modify our products when third parties change software that we integrate into our products. As a result, the life cycles of our products are difficult to estimate.

     To be successful, we must continue to enhance our current product line and develop new products that successfully respond to changing customer needs, technological developments and competitive product offerings. We may not be able to successfully develop or license the applications necessary to respond to these changes, or to integrate new applications with our existing products. We have delayed enhancements or new product release dates several times in the past, and may be unable to introduce enhancements or new products successfully or in a timely manner in the future. If we delay release of our products and product enhancements, or if they fail to achieve market acceptance when released, it could harm our reputation and our ability to attract and retain customers, and our revenue may decline. In addition, customers may defer or forego purchases of our products if we, our competitors or major technology vendors introduce or announce new products or product enhancements.

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If we do not expand our international operations and successfully overcome the risks inherent in international business activities, the growth of our business will be limited.

     To be successful in the long term, we will need to expand our international operations. This expansion may be delayed as a result of our recent operating expense reduction measures and general economic conditions. If we do expand internationally, it will require significant management attention and financial resources to successfully translate and localize our software products to various languages and to develop direct and indirect international sales and support channels. Even if we successfully translate our software and develop new channels, we may not be able to maintain or increase international market demand for our solution. We, or our VARs or VSPs, may be unable to sustain or increase international revenues from licenses or from consulting and customer support. In addition, our international sales are subject to the risks inherent in international business activities, including

	•		costs of customizing products for foreign countries;
	•		export and import restrictions, tariffs and other trade barriers;
	•		the need to comply with multiple, conflicting and changing laws and regulations;
	•		reduced protection of intellectual property rights and increased liability exposure; and
	•		regional economic, cultural and political conditions, including the direct and indirect effects of terrorist activity and armed conflict in countries in which we do business.

     As noted above, Onyx Japan has incurred substantial losses in previous periods. The minority shareholders’ capital account balance at June 30, 2004 was $141,000. Additional Onyx Japan losses above approximately $335,000 in the aggregate will be absorbed 100% by Onyx, as compared to 58% in prior periods. Additional funding may be required to continue the operation of the joint venture. Our joint venture partners are not obligated to participate in any capital call and have indicated that they do not currently intend to invest additional sums in Onyx Japan. We are, however, discussing other ways our partners can assist Onyx Japan. If Onyx Japan incurs losses in future periods and no additional capital is invested, we may have to further restructure Onyx Japan’s operations.

     Our foreign subsidiaries operate primarily in local currencies, and their results are translated into U.S. dollars. We do not currently engage in currency hedging activities, but we may do so in the future. Changes in the value of the U.S. dollar relative to foreign currencies have not materially affected our operating results in the past. Our operating results could, however, be materially harmed if we enter into license or other contractual agreements involving significant amounts of foreign currencies with extended payment terms if the values of those currencies fall in relation to the U.S. dollar over the payment period.

If we are unable to develop and maintain effective long-term relationships with our key partners, or if our key partners fail to perform, our ability to sell our solution will be limited.

     We rely on our existing relationships with a number of key partners, including consulting firms, system integrators, VARs, VSPs and third-party technology vendors, that are important to worldwide sales and marketing of our solution. We expect an increasing percentage of our revenue to be derived from sales that arise out of our relationships with these key partners. Key partners often provide consulting, implementation and customer support services, and endorse our solution during the competitive evaluation stage of the sales cycle.

     Although we seek to maintain relationships with our key partners, and to develop relationships with new partners, many of these existing and potential key partners have similar, and often more established, relationships with our competitors. These existing and potential partners, many of which have significantly greater resources than we have, may in the future market software products that compete with our solution or reduce or discontinue their relationships with us or their support of our solution. In addition, our sales will be limited if

	•		we are unable to develop and maintain effective, long-term relationships with existing and potential key partners;
	•		our existing and potential key partners endorse a product or technology other than our solution;
	•		we are unable to adequately train a sufficient number of key partners; or

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•

our existing and potential key partners do not have or do not devote the resources necessary to implement our solution.

We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively.

     Our success depends in part on our ability to protect our proprietary rights. To protect our proprietary rights, we rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions such as those contained in license agreements with consultants, vendors and customers, although we have not signed these agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. Other parties may breach confidentiality agreements and other protective contracts we have entered into, and we may not become aware of, or have adequate remedies in the event of, a breach. We face additional risk when conducting business in countries that have poorly developed or inadequately enforced intellectual property laws. While we are unable to determine the extent to which piracy of our software products exists, we expect piracy to be a continuing concern, particularly in international markets and as a result of the growing use of the Internet. In any event, competitors may independently develop similar or superior technologies or duplicate the technologies we have developed, which could substantially limit the value of our intellectual property.

Intellectual property claims and litigation could subject us to significant liability for damages and result in invalidation of our proprietary rights.

     In the future, we may have to resort to litigation to protect our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of its success, would probably be costly and require significant time and attention of our key management and technical personnel. Although we have not been sued for intellectual property infringement, we may face infringement claims from third parties in the future. The software industry has seen frequent litigation over intellectual property rights, and we expect that participants in the industry will be increasingly subject to infringement claims as the number of products, services and competitors grows and the functionality of products and services overlaps. Infringement litigation could also force us to

	•		stop or delay selling, incorporating or using products that incorporate the challenged intellectual property;
	•		pay damages;
	•		enter into licensing or royalty agreements, which may be unavailable on acceptable terms; or
	•		redesign products or services that incorporate infringing technology, which we might not be able to do at an acceptable price, in a timely fashion or at all.

Our products may suffer from defects or errors, which could result in loss of revenues, delayed or limited market acceptance of our products, increased costs and reputational damage.

     Software products as complex as ours frequently contain errors or defects, especially when first introduced or when new versions are released. Our customers are particularly sensitive to such defects and errors because of the importance of our solution to the day-to-day operation of their businesses. We have had to delay commercial release of past versions of our products until software problems were corrected, and in some cases have provided product updates to correct errors in released products. Our new products or releases may not be free from errors after commercial shipments have begun. Any errors that are discovered after commercial release could result in loss of revenues or delay in market acceptance, diversion of development resources, damage to our reputation, increased service and warranty costs or claims against us.

     In addition, the operation of our products could be compromised as a result of errors in the third-party software we incorporate into our software. It may be difficult for us to correct errors in third-party software because that software is not in our control.

You may be unable to resell your shares at or above the price at which you purchased them, and our stock price may be volatile.

     Since our initial public offering in February 1999, the price of our common stock has been volatile. Our common stock, on a split-adjusted basis, reached a high of $176.00 per share on March 6, 2000 and traded as low as $2.24 per share on April 30, 2003. As a

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result of fluctuations in the price of our common stock, you may be unable to sell your shares at or above the price at which you purchased them. The trading price of our common stock could be subject to fluctuations for a number of reasons, including

	•		future announcements concerning us or our competitors;
	•		actual or anticipated quarterly variations in operating results;
	•		changes in analysts’ earnings projections or recommendations;
	•		announcements of technological innovations;
	•		the introduction of new products;
	•		changes in product pricing policies by us or our competitors;.
	•		proprietary rights litigation or other litigation;
	•		changes in accounting standards that adversely affect our revenues and earnings; or
	•		trading activity by shareholders with large holdings in our common stock.

     In addition, future sales of substantial numbers of shares of our common stock in the public market, or the perception that these sales could occur, could adversely affect the market price of our common stock.

     Stock prices for many technology companies fluctuate widely for reasons that may be unrelated to operating results of these companies. These fluctuations, as well as general economic, market and political conditions, such as national or international currency and stock market volatility, recessions or military conflicts, may materially and adversely affect the market price of our common stock, regardless of our operating performance and may expose us to class action securities litigation which, even if unsuccessful, would be costly to defend and distracting to management.

Our articles of incorporation and bylaws and Washington law contain provisions that could discourage a takeover.

     Certain provisions of our restated articles of incorporation and bylaws, our shareholder rights plan and Washington law would make it more difficult for a third party to acquire us, even if doing so would be beneficial for our shareholders. This could limit the price that certain investors might be willing to pay in the future for shares of our common stock. For example, certain provisions of our articles of incorporation or bylaws

	•		stagger the election of our board members so that only one-third of our board is up for reelection at each annual meeting;
	•		allow our board to issue preferred stock without any vote or further action by the shareholders;
	•		eliminate the right of shareholders to act by written consent without a meeting, unless the vote to take the action is unanimous;
	•		eliminate cumulative voting in the election of directors;
	•		specify a minimum threshold for shareholders to call a special meeting;
	•		specify that directors may be removed only with cause; and
	•		specify a supermajority requirement for shareholders to change those portions of our articles that contain the provisions described above.

     In October 1999, we adopted a shareholder rights plan, which is triggered upon commencement or announcement of a hostile tender offer or when any one person or group acquires 15% or more of our common stock. Once triggered, the rights plan would result in the issuance of preferred stock to the holders of our common stock other than the acquirer. The holders of this preferred stock

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would be entitled to ten votes per share on corporate matters. In addition, these shareholders receive rights under the rights plan to purchase our common stock, and the stock of the entity acquiring us, at reduced prices.

     We are also subject to certain provisions of Washington law that could delay or make more difficult a merger, tender offer or proxy contest involving us. In particular, Chapter 23B.19 of the Washington Business Corporation Act prohibits corporations based in Washington from engaging in certain business combinations with any interested shareholder for a period of five years unless specific conditions are met.

     These provisions of our articles of incorporation, bylaws and rights plan and Washington law could have the effect of delaying, deferring or preventing a change in control of Onyx, including, without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock. The provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

     We are exposed to financial market risks, including changes in interest rates and foreign currencies.

Interest Rate Risk

     We typically do not attempt to reduce or eliminate our market exposures on our investment securities because all of our investments are short-term in nature and are classified as cash equivalents as of June 30, 2004. Due to the short-term nature of these investments, their fair value would not be significantly impacted by either a 100 basis point increase or decrease in interest rates. We do not use any hedging transactions or any financial instruments for trading purposes and we are not a party to any leveraged derivatives.

Foreign Currency Risk

     In 2003, international revenue accounted for 39% of our consolidated revenue and in the first six months of 2004, international revenue accounted for 37% of our consolidated revenue. International revenue, as well as most of the related expenses incurred, is denominated in the functional currencies of the corresponding country. Results of operations from our foreign subsidiaries are exposed to foreign currency exchange rate fluctuations as the financial results of these subsidiaries are translated into U.S. dollars upon consolidation. As exchange rates vary, revenues and other operating results, when translated, may differ materially from expectations. The effect of foreign exchange transaction gains and losses were not material to Onyx during the first six months of 2004 or in prior fiscal years.

     At June 30, 2004, we were also exposed to foreign currency risk related to the current assets and current liabilities of our foreign subsidiaries, in particular our consolidated joint venture, which is denominated in Japanese Yen, and our United Kingdom operation, which is denominated in British pounds. Cumulative unrealized translation losses related to the consolidation of Onyx Japan amounted to $475,000 at June 30, 2004. Cumulative unrealized translation gains related to the consolidation of Onyx Software UK Limited, including the goodwill and other intangible assets resulting from the acquisition of Market Solutions, amounted to $2.2 million at June 30, 2004. The cumulative unrealized gain at June 30, 2004 specifically associated with the goodwill and other acquisition-related intangibles of Market Solutions amounted to $1.5 million. These unrealized translation gains and losses, combined with the cumulative unrealized translation gains related to the consolidation of our other foreign subsidiaries, resulted in net consolidated cumulative unrealized translation gains of $1.9 million.

     Although we have not engaged in foreign currency hedging to date, we may do so in the future.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

     Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report, have concluded that as of that date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in this quarterly report is accumulated and communicated by our management, to allow timely decisions regarding required disclosure.

Changes in internal controls

     There have been no changes in our internal control over financial reporting that occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     We, several of our officers and directors and Dain Rauscher Wessels were named as defendants in a series of related lawsuits filed in the United States District Court for the Western District of Washington on behalf of purchasers of publicly traded Onyx common stock during various time periods. The consolidated amended complaint in these lawsuits alleged that we violated the Securities Act of 1933, or Securities Act, and the Securities Exchange Act of 1934, and sought certification of a class action for purchasers of Onyx common stock in Onyx’s February 12, 2001 public offering and on the open market during the period January 23, 2001 through July 24, 2001. The parties settled the matter on terms that will not require a payment by any of the defendants, inasmuch as the settlement consideration will be paid entirely by insurance proceeds. In an order dated June 10, 2004, the court approved this settlement.

     Onyx’s directors and some of its officers were named as defendants in a shareholder derivative lawsuit filed in the Superior Court of Washington in and for King County. The complaint alleged that the individual defendants breached their fiduciary duty and their duty of care to Onyx by allegedly failing to supervise Onyx’s public statements and public filings with the Securities and Exchange Commission, or SEC. The complaint alleged that, as a result of these breaches, misinformation about Onyx’s financial condition was disseminated into the marketplace and filed with the SEC. The complaint asserted that these actions exposed Onyx to harmful and costly securities litigation that could potentially result in an award of damages against Onyx, and sought to recover on behalf of Onyx any amounts Onyx would be required to pay in such litigation. The parties settled the matter on terms that will not require a payment by any of the defendants, inasmuch as the settlement consideration will be paid entirely by insurance proceeds. In an order dated June 25, 2004 the court approved this settlement.

     Onyx, one of its officers and one of its former officers have also been named as defendants in a lawsuit filed in the United States District Court for the Southern District of New York on behalf of purchasers through December 6, 2000 of Onyx common stock sold under the February 12, 1999 registration statement and prospectus for our initial public offering. The complaint alleges that Onyx and the individual defendants violated the Securities Act by failing to disclose excessive commissions allegedly obtained by our underwriters pursuant to a secret arrangement whereby the underwriters allocated initial public offering shares to certain investors in exchange for the excessive commissions. The complaint also asserts claims against the underwriters under the Securities Act and the Exchange Act in connection with the allegedly undisclosed commissions. The parties have executed an agreement to settle the matter, along with similar lawsuits against more than 300 other issuers. The terms of the settlement requires Onyx and the other issuers to contribute to the settlement, which is being funded by a consortium of insurance carriers for the various issuers, only in the event that their carriers become insolvent or their insurance coverage is exhausted. We believe it is unlikely that any such contribution by Onyx will be required. The settlement is contingent on receipt of final court approval.

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

     On April 6, 2004, we issued 504,891 shares of our common stock valued at $1.7 million to a corporation from which we purchased certain technology. This transaction was exempt from registration under Section 4(2) of the Securities Act and Regulation D promulgated under the Securities Act on the basis that the transaction did not involve a public offering and each purchaser was an accredited investor.

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

     Onyx held its 2004 annual meeting of shareholders on June 3, 2004 at Onyx’s corporate headquarters in Bellevue, Washington. A total of 12,929,342 shares of common stock (representing 89.19% of the outstanding shares of common stock) were present at the meeting, either in person or represented by proxy, which constituted a quorum for purposes of the meeting, and voted as follows:

(1)		Elect two Class 1 directors to Onyx’s board of directors for a three-year term.
		The incumbent Class 1 directors who stood for reelection were elected with the following voting results.

(2)

Ratify the appointment of KPMG LLP as independent auditors for the year ending December 31, 2004

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

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(b)		Current Reports on Form 8-K
(a)		On April 8, 2004, we filed a current report on Form 8-K announcing an asset acquisition of business management process technology from Visuale, Inc.
(b)		On April 8, 2004, we furnished a current report on Form 8-K announcing our preliminary financial results for the quarter ended March 31, 2004.
(c)		On April 27, 2004, we furnished a current report on Form 8-K announcing our final financial results for the quarter ended March 31, 2004.
(d)		On June 9, 2004, we filed a current report on Form 8-K announcing the appointment of Janice P. Anderson as Onyx’s President and Chief Executive Officer, and as a director and Chairman of the Board.

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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.

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EXHIBIT INDEX

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