SERVICEWARE TECHNOLOGIES INC/ PA - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________

COMMISSION FILE NUMBER 000-30277
SERVICEWARE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 25-1647861
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

333 ALLEGHENY AVENUE, SUITE 301 NORTH
OAKMONT, PA 15139
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (412) 826-1158

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Class)

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

Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Act. Yes [ ] No [X]

The aggregate market value of common equity held by non-affiliates of the
registrant as of June 28, 2002, the last business day of the registrant's most
recently completed second quarter, was approximately $9,000,000, computed by
reference to the price at which the common equity was last sold on the Nasdaq
SmallCap Market on June 28, 2002, as reported in The Wall Street Journal. This
figure has been calculated by excluding shares owned beneficially by directors
and executive officers as a group from total outstanding shares solely for the
purpose of this response.

The number of shares of the registrant's Common Stock outstanding as of the
close of business on March 19, 2003 was 24,145,870.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy Statement of ServiceWare
Technologies, Inc. to be used in connection with the 2003 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference into Part III
of this Annual Report on Form 10-K to the extent provided herein. Except as
specifically incorporated by reference herein, the Proxy Statement is not to be
deemed filed as part of this Annual Report on Form 10-K.

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

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SERVICEWARE TECHNOLOGIES, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

We were initially incorporated as a Pennsylvania corporation in January
1991 as ServiceWare, Inc. In July 1999, we acquired the Molloy Group, Inc., a
leading provider of knowledge-empowered software for strengthening customer
relationships. In May 2000, we changed our name to ServiceWare Technologies,
Inc. and reincorporated as a Delaware corporation. In August 2000, we closed our
initial public offering. Prior to July 2001, we had two reportable business
segments: Software and Content. In July 2001, we completed the sale of our
Content business to RightAnswers LLC ("RightAnswers"). Financial information
regarding revenues and long lived assets attributable to the United States
versus international is found in Note 16 to the consolidated financial
statements in Item 8 below. In response to poor financial performance and the
economic downturn, during 2001 we announced strategic corporate restructuring
programs pursuant to which we have significantly reduced costs and we have
focused our business exclusively on revenue growth opportunities in our Software
business. As part of the restructuring plans, approximately 180 employees were
laid off during 2001. In August 2002, we acquired all existing technology
assets, certain customer and vendor contracts of InfoImage, Inc., a privately
held enterprise portal company which filed for bankruptcy protection prior to
our agreement to acquire these assets.

Our primary office is located at 333 Allegheny Avenue, Oakmont,
Pennsylvania 15139, and our website address is www.serviceware.com. We have not
incorporated by reference into this Annual Report on Form 10-K the information
on our Web site, and you should not consider it to be a part of this document.
Our Web site address is included in this document for reference only.

OVERVIEW

ServiceWare Technologies is a leading provider of enterprise Knowledge
Management (KM) solutions that enable organizations to deliver superior service
to customers, employees and partners by transforming information into knowledge.

ServiceWare Enterprise(TM) (formerly named eService Suite), powered by The
Cognitive Processor(R), a patented self-learning search technology, enables
organizations to capture and manage intellectual capital. This repository of
corporate knowledge, known as a knowledge base, can then be easily accessed via
a browser to effectively answer inquiries made either over the Web or through
the telephone to a customer contact center or help desk.

Customers use ServiceWare's Knowledge Management solutions to:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Integrate seamlessly with existing technology investments

ServiceWare Enterprise(TM) is a software solution that allows ServiceWare
customers to provide personalized, automated Web-based service tailored to the
needs of their users. ServiceWare Enterprise enables businesses to capture
enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. It also enables the
extended enterprise to access this knowledge online. In addition, through the
self-learning features of ServiceWare's patented Cognitive Processor technology,
the solutions generated by these products are intelligent in that they have the
capability to learn from each interaction and automatically update themselves
accordingly. ServiceWare Enterprise includes the software products ServiceWare
Self-Service(TM) (Web-based self-service for customers, partners and employees),
ServiceWare Professional(TM) (for customer service, sales and field service
personnel) and ServiceWare Architect(TM) (for quality assurance managers and
system administrators). ServiceWare also

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provides a portal solution, ServiceWare Knowledge Portal, based on the
technology acquired from InfoImage in August 2002

ServiceWare customers represent a cross-section of industry leaders in the
financial services, technology, manufacturing, healthcare, entertainment,
education and government sectors. Customers include EDS, H&R Block, AT&T
Wireless, Cingular Wireless, Fifth Third Bancorp, Green Mountain Energy,
Reuters, Stream International, and QUALCOMM.

INDUSTRY BACKGROUND

BUSINESS CASE FOR KNOWLEDGE MANAGEMENT

The information age has increased the demand for immediate access to
customer data, product information and corporate knowledge, making the need to
retain intellectual capital greater than ever. At the same time, the loss of
corporate knowledge has been perpetuated by the downsizing and reorganizations
that are common in today's economy. In order to attain a competitive advantage
in this volatile market, we believe organizations are turning to Knowledge
Management solutions to improve the creation, preservation, dissemination and
application of knowledge throughout the enterprise. Knowledge Management can be
used to achieve a wide range of strategic business objectives from providing a
superior service experience for employees and customers to managing
relationships with partners and suppliers.

REQUIREMENTS OF A COMPREHENSIVE E-SERVICE SOLUTION- KNOWLEDGE MANAGEMENT

Increasingly, companies need to improve customer loyalty and retention
while also consolidating corporate and customer information into a single
knowledge repository."Knowledge Management" is the development of a formal
process that evaluates a company's organizational processes, people, and
technology and develops a system that uses the relationships between these
components to get the right information to the right people at the right time so
as to improve productivity.

Knowledge Management is gaining acceptance, particularly due to the growth
of e-business. We believe companies understand now more than ever the need to
protect intellectual capital, capture the knowledge of its workforce and sustain
competitive advantage by focusing on the effectiveness of employees, customers
and partners. Knowledge Management provides companies with a process to capture
enterprise knowledge, organize knowledge and disseminate knowledge to key
audiences.

In order to enable businesses to provide superior service, a comprehensive
solution needs to:

- provide the option for a self-service experience;

- provide the end-user with the ability to escalate to assisted service and
seamlessly transfer information across all communication channels,
including e-mail, telephone, or chat, at any stage of interaction;

- consolidate the knowledge base and intellectual capital throughout the
organization and make it available throughout the extended enterprise;

- learn through cumulative customer feedback and rapidly develop solutions
to allow the enterprise to provide proactive service to its end-users;

- offer the flexibility necessary to integrate with existing solutions and
enable enterprises to rapidly deploy the technology; and

- scale cost-effectively as the organization's service needs grow.

CALL CENTERS ARE EVOLVING INTO MULTI-CHANNEL CONTACT CENTERS

For the last several years, many companies have spent heavily to implement
technology based Customer Relationship Management (CRM) software. The strategic
goal is to enhance pre- and post-sales customer relationships, improve customer
satisfaction and influence customer retention.

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Traditionally, companies created call centers to handle only voice
interactions. Today, there are thousands of call centers globally. Many of these
centers have evolved into multi-channel contact centers that handle customer
interactions via the phone, e-mail, chat, Web, fax, and instant messaging. As
more call centers adopt these additional communication channels, e-service
continues to play a key role in the infrastructure of contact centers.
Additionally, many companies seek to complement their ability to offer high-
quality human level based service provided by the support organization with a
Web based self-service capability, also known as e-service. The benefits of
e-service include 24/7 availability, cost-savings, scalability, consistency, and
improved customer satisfaction and customer retention.

THE SERVICEWARE SOLUTION

We provide Knowledge Management solutions that enable companies to
strengthen relationships with their customers, partners, suppliers and
employees. We license software products to enterprises that form the basis of
their Knowledge Management strategy or function as a component of their contact
center or help desk infrastructure. Our solutions enable businesses to capture
enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. Our solutions also enable
the extended enterprise to access this knowledge online. In addition, through
the self-learning capabilities of our patented Cognitive Processor search
technology the solutions generated by our products are intelligent in that they
are interactive, adaptable and have the capability to update automatically. We
believe our solutions provide our customers with a number of key benefits,
including:

- DECREASED OPERATING COSTS. By enabling end-users to access customer
service online and by aiding customer service agents to more effectively
handle user requests, our solutions often provide cost savings and
improve employee productivity. These savings and increased productivity
are a result of reduced telephone call volume, the ability to process
more end-user interactions per employee and reduced levels of employee
training.

- STRENGTHENED RELATIONSHIPS WITH THEIR END-USERS. Our solutions allow
enterprises to provide their customers and other end-users with improved,
timely and accurate service. Enterprises realize that the service
function provides them with their closest contact with their customers,
and, by providing superior self or assisted service, they can create
long-term customer satisfaction and loyalty. We believe that by providing
better and more user-friendly service, our solutions increase the
likelihood that a business' customers will complete specific transactions
and that the enterprise will be able to attract and retain its customers.

- IMPROVED DISSEMINATION OF ENTERPRISE KNOWLEDGE. Our ServiceWare
Enterprise enables our customers to develop a common knowledge base of
intellectual capital, which is collected from their business systems and
experts throughout their organization, and makes it available throughout
the extended enterprise. All communications from a business to its
customers, partners, suppliers or employees, whether through telephone
support, self-service, or e-mail, draw from this knowledge base.
Additionally, the patented Cognitive Processor technology contained in
our ServiceWare Enterprise provides a self-learning capability that
continually learns at each request, which keeps responses up to date and
provides end-users with accurate answers to their questions.

- SEAMLESS INTEGRATION WITH EXISTING SOLUTIONS. Our products are designed
for rapid deployment, typically in eight to 12 weeks. Our software helps
our customers to preserve their investments in, and deployments of, call
center and help desk products, CRM solutions, workflow tools, knowledge
bases and other applications. Our solution enhances these capabilities
and integrates them into a cohesive and automated Internet service
infrastructure by integrating with applications from leading companies
such as Clarify/Amdocs, Remedy, and Siebel Systems. As a result, this
enables our customers to deploy best-of-breed applications configured to
suit their particular e-service needs.

- CONSISTENT SERVICE ACROSS COMMUNICATION CHANNELS. Our solution allows
access to knowledge from a wide variety of communication channels. Our
proprietary software enables end-users to transfer inquiries easily from
self-help to e-mail responses to live interaction. Escalation of end-user
inquiries

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helps ensure that our clients efficiently apply the appropriate level of
resources toward their customers' satisfaction while reducing the risk of
losing a customer because of perceived unresponsiveness.

- SCALABILITY FOR LARGE AND GROWING ENTERPRISES. The architecture of the
ServiceWare Enterprise allows both large and growing organizations to
maintain a consistent level of service as the volume of traffic across
their communication channels increases. By deploying in a cluster and
capitalizing on the capabilities of our J2EE architecture, our products
provide consistent responsiveness to end-user interactions despite rising
volumes of traffic.

STRATEGY

Our solutions enable enterprises to provide a Web-based platform by which
customers, partners, suppliers and employees access and manage business critical
knowledge. Our objective is to leverage this platform to become a leading
worldwide provider of Knowledge Management solutions. To achieve our goal, we
intend to:

- ENHANCE TECHNOLOGY AND PRODUCT LEADERSHIP. We intend to broaden our
leadership position in the Knowledge Management and e-service solutions
market by continuing to increase the performance, functionality and
scalability of our solutions. We plan to continue to design our products
to be highly scalable throughout the extended enterprise, easily
configurable and able to integrate with both front-end best-of-breed
applications and existing enterprise systems. We plan to continue to
devote resources to the development of new and innovative technologies,
to increase efficiencies, offer immediate answers and minimize service
response time. We intend to expand the current offering to incorporate
advances in knowledge acquisition.

- EXPAND STRATEGIC ALLIANCES. In order to broaden our market presence,
enter new geographic and vertical markets, and increase adoption of our
solutions, we plan to strengthen existing and pursue additional strategic
alliances with consultants, systems integrators, value-added resellers
and independent software vendors of complementary products. We intend to
use these relationships to increase our sales by leveraging these
organizations' industry expertise, business relationships and sales and
marketing resources. Currently, we have strategic alliances with
Electronic Data Systems Corporation, Clarify/Amdocs, Remedy, Siebel and
EPAm Systems. Additionally, we plan to increase our service capabilities
by pursuing strategic relationships with leading systems integrators and
consultants.

- FURTHER DEVELOP INTERNATIONAL PRESENCE. To capitalize on international
opportunities for our knowledge-powered solutions, we have completed the
first stage of our product localization efforts, concentrating on
European markets. The interface is currently available in French,
Spanish, German and Dutch. Furthermore, we intend to increase our
relationships with local distributors in international markets, including
Merlin Information Systems and Al-Moammar Information Systems.

PRODUCTS

ServiceWare's Knowledge Management solutions enable organizations to easily
provide customers, partners, suppliers and employees with fast, accurate answers
to inquiries across various communication channels including the phone, e-mail,
chat and the Web. Based on our software and Cognitive Processor technology,
ServiceWare Enterprise software empowers organizations to deliver superior
service and support, while reducing expenses. ServiceWare Enterprise includes
our ServiceWare Self-Service, ServiceWare Professional and ServiceWare Architect
software products.

SERVICEWARE SELF-SERVICE allows our customers to provide Web-based
self-service to their end-users. End-users can access the Self-Service solution
through the Internet or a corporate Intranet. This Web-based e-service solution
allows self-help users to access the knowledge base at any time, using an
easy-to-use, intuitive interface via a natural language query. ServiceWare
Self-Service can be customized to adopt the look and feel of our customer's Web
site.

SERVICEWARE PROFESSIONAL provides a Web-based application interface for
customer service professionals to more easily navigate through the knowledge
base, view various components of the knowledge base, capture and revise
additional knowledge, and provide accurate answers to end-user questions.
ServiceWare Profes-
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sional includes a complete case management system that serves as a workstation
for customer service and support agents. Agents have a visual queue of cases
that can be viewed based on skills based routing. The system also contains
e-mail and chat components that enable agents to easily communicate with
customers and employees without having to pick up the phone. ServiceWare
Professional integrates with many types of customer relationship applications to
provide a seamless interface for a customer service professional.

SERVICEWARE ARCHITECT provides a robust set of knowledge tools that allows
customers' quality assurance managers and system administrators to design,
manage and maintain knowledge bases. ServiceWare Architect provides robust
quality assurance and workflow capabilities as well as administrative tools for
all necessary product suite functions.

The recent poor economic climate has contributed to stagnant IT purchasing
for our target market, Fortune 1000 companies, and we anticipate a stagnant IT
purchasing environment to continue in our target market in the near future. As a
result, we are experiencing price compression and a slowdown in overall demand
for our products and services. With that in mind, we have redirected some of our
efforts towards the mid-market. Specifically, we have redesigned parts of our
product, added the ability to host the solution and created attractive pricing
and packages for these midmarket companies. We are optimistic that this business
will increase sales opportunities and product and services revenue in 2003.

SERVICES

PROFESSIONAL SERVICES. Our professional services team provides our
customers with pre- and post-sales services. Pre-sales consulting services
include our Decision Integrity process, which applies analytical methodologies
and an understanding of business processes to help organizations make an
informed decision regarding the choice of Knowledge Management as a
technological solution. Post-sales implementation, integration and Knowledge
Management consulting services allow our customers to deploy our e-service
solutions effectively. In addition, our professional services team offers
education and training to enable our customers' internal team to understand how
to use our products, support the implementation and maintain our solutions.

CUSTOMER SUPPORT. All customers under a maintenance agreement have access
to our technical support engineers via telephone, fax or e-mail. In addition, we
provide self-service support to our customers on a 24/7 basis through our
www.serviceware.com Web site.

TECHNOLOGY AND ARCHITECTURE

We employ industry-standard technologies to create an object-based open
architecture for all of our applications. ServiceWare Enterprise is based on an
n-tiered architecture, which permits the use of multiple servers for scalability
and a clear division of responsibility between our software programs. This
division provides flexibility and scalability. The architecture is based on the
Java 2 Enterprise Edition or "J2EE" framework that includes components
specifically designed to take advantage of each element of the modern Web
environment. This enables a configurable, extensible application to be delivered
based on current Internet standards.

At the core of our technology is Cognitive Processor, which provides
self-learning capability to ServiceWare Enterprise. The Cognitive Processor uses
patented algorithm technology based on neural network and Bayesian statistical
principles. Through these algorithms, the Cognitive Processor is capable of
learning from past transactions.

We are continually updating our software to run in the most common
environments. ServiceWare now supports Solaris, Windows 2000 and NT operating
environments.We support BEA Weblogic, Macromedia JRUN and IBM Websphere for the
application servers.

We provide an extensive set of integration Application Programming
Interfaces or "APIs" that allow us to integrate with a broad range of
applications using industry standard protocols. ServiceWare Enterprise is also
available as a Web service through ServiceWare's Simple Object Access Protocol
(SOAP) adapter. The SOAP adapter provides the mechanism by which ServiceWare
Enterprise will be available as a Web service
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within the enterprise. Any application will be able to utilize the Web service
to add and retrieve from a knowledge base and take advantage of ServiceWare's
patented self-learning and self-organizing search technology, the Cognitive
Processor.

CUSTOMERS

We have traditionally marketed our products and services to Global 2000
call centers and help desks in a wide range of vertical industries. EDS
accounted for 11% of our 2002 revenues. The following is a partial list of our
other customers during 2002.

Allegheny Energy Hewlett-Packard
Allina Health Systems Hughes Supply
Amgen Made2Manage Systems
AT&T Wireless Marconi Communications
Aventis NCS Pearson
Cingular Wireless Qualcomm
Concord EFS Respironics
Compaq Scientific Atlanta
EATON/Cutler-Hammer Stream International
EDS Texas Instruments
Fifth Third Bancorp US Cellular
First Union National Bank U.S. Army
Fourth Shift, a SoftBrands Company U.S. Navy
Gelco Government Services U.S. Patent & Trademark Office
H&R Block

SALES AND MARKETING

We sell our solutions primarily through our direct sales force. We have
sales personnel throughout North America and in the United Kingdom.

To increase the effectiveness of our direct selling efforts and our
penetration of the Knowledge Management solutions market, we build brand
awareness of ServiceWare and our solutions through marketing programs. These
programs include print and Web advertisements, direct mailings, public relations
activities, seminars and other major industry/partner events, market research
and our Web site.

Our marketing organization creates materials to support the sales process,
including brochures, data sheets, case studies, presentations, white papers and
demonstrations. In addition, our marketing group helps identify and develop key
alliance opportunities and channel distribution relationships.

STRATEGIC ALLIANCES

We have established strategic alliances with leading providers of
e-business software technologies. These alliances augment our sales and
marketing initiatives by enabling us to increase market awareness, distribution
and market penetration of our solutions and services, as well as to extend the
technical and functional application of our e-service solutions.

Historically, we have had several categories of alliances, including
distribution, software and services alliances. We have established distribution
alliances with leading providers of complementary e-business and CRM
technologies who resell or co-market our solutions. We benefit from the lead
generation and established marketing capabilities of these firms. In turn, our
alliance partners benefit from being able to offer more comprehensive solutions
in their product offerings and thereby increase their customers' satisfaction.
We currently have alliances with several vendors, including Clarify/Amdocs,
Remedy and Siebel Systems.

We have established service alliances with leading systems integrators,
including Electronic Data Systems Corporation to increase our breadth of
implementation services both nationally and around the globe. These service
alliance partners complete a rigorous training program to become fully certified
to implement
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our solutions, and we continue to work with our service alliance partners as a
team to ensure a fast, effective path to the deployment of our Knowledge
Management solution to enable our customers to reap the benefits of our
Knowledge Management solution immediately.

We intend to continue to build and refine our strategies in selecting
leading alliance partners. We believe that building key relationships with
market leaders increase our opportunities in global expansion, enhanced
solutions, and continued product innovations.

RESEARCH AND DEVELOPMENT

Our internal research and development team together with our outside
development resources develop our product and service offerings. In conjunction
with our outside development resources, we continue to enhance the features and
performance of our existing products and services. In addition, we are
continuing to develop our products and services to meet our customers'
expectations of ongoing innovation and enhancement within our suite of products
and services. We have entered into an agreement with EPAm Systems, of Princeton,
New Jersey, and Minsk, Belarus, to augment our research and development
capabilities. This relationship gives us access to approximately 250 developers
in a cost effective offshore model. EPAm Systems is ISO 9001 certified and has
completed complicated projects for major international corporations including
Fortune 500 companies. This relationship has allowed us to streamline operating
costs and increase productivity. Research and development is conducted by way of
a clearly defined process that is a subset of industry standard Rational Unified
Process.

We renewed our agreement with EPAm Systems on April 1, 2002. This agreement
states that consulting services will be provided in accordance with specific
work orders. Payment for these services is billed as the work is incurred or at
a fixed fee agreed upon for the work order.

Our ability to meet our customers' expectations depends on a number of
factors, including our ability to identify and respond to emerging technological
trends in our target markets, develop and maintain competitive products, enhance
our existing products and services by adding features and functionality that
differentiate them from those of our competitors and bring products and services
to market on a timely basis and at competitive prices. Consequently, we have
made, and we intend to continue to make, investments in research and
development.

For a description of our research and development related expenses, see the
Management's Discussion and Analysis of Financial Condition and Results of
Operations in Item 7 of this Form 10-K.

COMPETITION

Competition in our marketplace is rapidly evolving and intense, and we
expect competition to intensify further in the future as current competitors
expand their product offerings and new competitors enter the market. Current
competitors include in-house developed applications and providers of
commercially available Knowledge Management solutions, including Kana Software,
eGain Communications, and Primus Knowledge Solutions.

We believe that the principal competitive factors affecting our market
include referenceable customers, the breadth and depth of a given solution,
product quality and performance, core technology, product scalability and
reliability, product features and the ability to implement solutions and respond
timely to customer needs.

Although we believe that we currently compete favorably with respect to the
principal competitive factors in our market, we may not be able to maintain our
competitive position against current and potential competitors, especially those
with significantly greater financial, marketing, service, support, technical and
other resources. It is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We also
expect that competition will increase as a result of industry consolidation.

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INTELLECTUAL PROPERTY

Our success and ability to compete effectively depends, in part, upon our
proprietary rights. We rely on a combination of patent, copyright, trade secret
and trademark laws, confidentiality procedures and contractual provisions to
establish and protect our proprietary rights in our software, documentation and
other written materials. These legal protections afford only limited protections
for our proprietary rights and may not prevent misappropriation of our
technology or deter third parties from developing similar or competing
technologies.

We seek to avoid disclosure of our intellectual property by generally
entering into confidentiality or license agreements with our employees,
consultants and companies with which we have alliances, and we generally control
access to, and distribution of, our software, documentation and other
proprietary information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology or to develop products with the same functionality as our
products.

Policing unauthorized use of our proprietary information is difficult, and
we may be unable to determine the extent of unauthorized copying or use of our
products or technology. Further, third parties, which have been granted certain
limited contractual rights to use our proprietary information, may improperly
use or disclose such proprietary information. In addition, certain components of
our product suite require us to have licenses from third parties for use. These
licenses may be subject to cancellation or non-renewal. In this event, we will
be required to obtain new licenses for use of these products, which may not be
available on commercially reasonable terms, if at all, and could result in
product shipment delays and unanticipated product development costs.

EMPLOYEES

As of December 31, 2002, we had 67 employees consisting of 23 in sales, 20
in professional services and support, seven in research and development, seven
in marketing, and ten in general and administration. In spite of the difficult
economic environment, we continue to believe that one of our strengths is the
quality and dedication of our people and the shared sense of being part of a
team. We strive to maintain a work environment that fosters professionalism,
excellence, diversity and cooperation among our employees.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this Annual Report on Form 10-K constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements involve known and unknown risks,
uncertainties and other factors that may cause our or our industry's actual
results, levels of activity, performance or achievements to be materially
different than any expressed or implied by these forward-looking statements. In
some cases, you can identify forward-looking statements by terminology such as
"may", "will", "should", "expects", "plans", "anticipates", "believes",
"estimates", "predicts", "potential", "continue", or the negative of these terms
or other comparable terminology.

Although we believe that the expectations in the forward-looking statements
are reasonable, we cannot guarantee future results, levels of activity,
performance or achievements.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

Set forth below and elsewhere in this Form 10-K and in other documents we
file with the Securities and Exchange Commission are risks and uncertainties
that could cause actual results to differ materially from the results
contemplated by the forward-looking statements contained in this Form 10-K or
the results indicated or projected by our historical results.

WE MAY NEED ADDITIONAL CAPITAL TO FUND CONTINUED BUSINESS OPERATIONS AND WE
CANNOT BE SURE THAT ADDITIONAL FINANCING WILL BE AVAILABLE.

We have historically required substantial amounts of capital to fund our
business operations. Despite efforts to reduce our cost structure, we expect to
continue to experience negative cash flow from operations in

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2003. We cannot assure investors that we will attain break-even cash flow from
operations at any particular time in the future, or at all.

We continue to evaluate alternative means of financing to meet our needs on
terms that are attractive to us. Our ability to continue as a business in our
present form is largely dependent on our ability to generate additional
revenues, reduce overall operating expense, and achieve profitability and
positive cash flows or to obtain additional debt or equity financing. We believe
that we have the ability to do so and plan to fund 2003 operations through
product sales, reduced spending and utilizing the available funding under our
existing debt facilities. From time to time, we have considered and discussed
various financing alternatives and expect to continue such efforts to raise
additional funds to support our operational plan. However, we cannot be certain
that additional financing will be available to us on favorable terms when
required, or at all. Further, we believe that in order to sustain business
operations at the current level through 2004, we will need to obtain significant
additional funding.

IF WE ARE NOT ABLE TO OBTAIN NECESSARY CAPITAL, WE MAY NEED TO DRAMATICALLY
CHANGE OUR BUSINESS STRATEGY AND DIRECTION, INCLUDING PURSUING OPTIONS TO SELL
OR MERGE OUR BUSINESS, OR LIQUIDATE.

In the past, we have funded our operating losses and capital expenditures
through proceeds from equity offerings and debt. Changes in equity markets in
the recent past have adversely affected our ability to raise equity financing
and have adversely affected the markets for debt financing for companies with a
history of losses such as ours. If we raise additional funds through the
issuance of equity, equity-linked or debt securities, those securities may have
rights, preferences or privileges senior to those of the rights of our common
stock and, in light of our current market capitalization, our stockholders may
experience substantial dilution. Further, the issuance of debt securities could
increase the risk or perceived risk of our company. If we are not able to obtain
necessary capital, we may need to dramatically change our business strategy and
direction, including pursuing options to sell or merge our business, or
liquidate.

WE HAVE A HISTORY OF LOSSES, ANTICIPATE THAT WE WILL CONTINUE TO INCUR LOSSES IN
2003 AND MAY NEVER ACHIEVE PROFITABILITY.

Our limited operating history in our current line of business and the
uncertain nature of the markets in which we compete make it difficult or
impossible to predict future results of operations. As of December 31, 2002, we
had an accumulated deficit of $73.5 million. We have not achieved profitability
on a quarterly or annual basis to date. In 2002 and 2001, we incurred net losses
of $6.8 million and $29.7 million, respectively. We expect to have decreased
operating expenses as a result of our restructuring activities. However, if
revenues do not significantly increase, our losses will continue. In addition,
our history of losses may cause some of our potential customers to question our
viability, which might hamper our ability to make sales.

OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF OUR DEBT WHEN DUE.

The $3.25 million of convertible notes we issued in second quarter 2002
will be due no later than July 15, 2004. To the extent the note purchasers do
not elect to convert the notes into common stock, we will be required to retire
or refinance that debt at that time. In addition, any borrowings that we make
under our revolving debt facility will be due in October 2003. Our ability to
retire or to refinance our indebtedness will depend on our ability to generate
cash flow in the future. Our cash flow from operations will likely be
insufficient to repay this indebtedness at scheduled maturity and some or all of
our indebtedness, which is not converted to equity, will likely have to be
refinanced. If we are unable to refinance our debt or if additional financing is
not available on acceptable terms, or at all, we could be forced to dispose of
assets under circumstances that might not be favorable to realizing the highest
price for the assets or to default on our obligations with respect to this
indebtedness.

WE MAY NOT SUCCEED IN ATTRACTING AND RETAINING THE PERSONNEL WE NEED FOR OUR
BUSINESS AND THE INTEGRATION OF NEW MANAGEMENT AND PERSONNEL MAY STRAIN OUR
RESOURCES.

Our business requires the employment of highly skilled personnel,
especially experienced software developers. The inability to recruit and retain
experienced software developers in the future could result in delays in
developing new versions of our software products or could result in the release
of deficient software

11

products. Any such delays or defective products would likely result in lower
sales. We may also experience difficulty in hiring and retaining sales
personnel, product managers and professional services employees. The average
tenure of our current employees is 2.7 years.

Our senior management team consists of only two individuals, neither of
whom has been with us for more than three years. The loss of either of these
officers could have an adverse effect on our operations, business, and prospects
and our ability to carry out our business plan. We do not maintain key man
insurance on our officers.

A SIGNIFICANT PERCENTAGE OF OUR PRODUCT DEVELOPMENT IS PERFORMED BY A THIRD
PARTY INTERNATIONALLY, THE LOSS OF WHICH COULD SUBSTANTIALLY HARM OUR PRODUCT
DEVELOPMENT EFFORTS.

A significant percentage of our product development work, and some of our
implementation services, are performed by a third-party development organization
in Minsk, Belarus. Unpredictable developments in the political, economic and
social conditions in Belarus, or our failure to maintain or renew our business
relationship with this organization on terms similar to those which exist
currently, could reduce or eliminate product development and implementation
services. If access to these services were to be unexpectedly eliminated or
significantly reduced, our ability to meet development objectives vital to our
ongoing strategy would be hindered, and our business could be seriously harmed.

OUR HISTORICAL FINANCIAL RESULTS MAY NOT BE HELPFUL IN EVALUATING OUR PROSPECTS
BECAUSE OUR CURRENT LINE OF PRODUCTS IS RELATIVELY NEW.

Since the announcement of our corporate restructurings in 2001, we have
reallocated our resources to the ongoing enhancement of our software product,
and in July 2001, we sold our content business. Because our current line of
software products is relatively new, our historical financial results may not be
helpful in evaluating our prospects.

IT IS DIFFICULT TO DRAW CONCLUSIONS ABOUT OUR FUTURE PERFORMANCE BASED ON OUR
PAST PERFORMANCE DUE TO SIGNIFICANT FLUCTUATIONS IN OUR QUARTERLY OPERATING
RESULTS.

Our projected expense levels are based on our expectations regarding future
revenues and are relatively fixed in the short term. Therefore, if revenue
levels are below expectations in a particular quarter, operating results and net
income are likely to be disproportionately adversely affected because our
expenses are relatively fixed. In addition, a significant percentage of our
revenues is typically derived from relatively large orders from a limited number
of customers, so it is difficult to estimate accurately the timing of future
revenues.

Our quarterly results are also impacted by our revenue recognition
policies. Our revenues are unpredictable and in our last six quarters have
fluctuated from a low of $2.2 million in third quarter 2001 and third quarter
2002 to a high of $4.4 million in fourth quarter 2001. Because we generally
recognize license revenues upon installation and training, sales orders from new
customers in a quarter might not be recognized during that quarter. Delays in
the implementation and installation of our software near the end of a quarter
could also cause recognized quarterly revenues and, to a greater degree, results
of operations to fall substantially short of anticipated levels. We often
recognize revenues for existing customers in a shorter time frame because
installation and training can generally be completed in significantly less time
than for new customers. However, we may not be able to recognize expected
revenues at the end of a quarter due to delays in the receipt of expected orders
from existing customers.

Revenues in any one quarter are not indicative of revenues in any future
period because of these and other factors and, accordingly, we believe that
certain period-to-period comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indicators of future
performance.

THE KNOWLEDGE MANAGEMENT MARKET IS EVOLVING AND, IF IT DOES NOT GROW RAPIDLY,
OUR BUSINESS WILL BE ADVERSELY AFFECTED.

The Knowledge Management solutions market is an emerging industry, and it
is difficult to predict how large or how quickly it will grow, if at all.
Customer service historically has been provided primarily in person or over the
telephone with limited reference materials available for the customer service
representative. Our

12

business model assumes that companies which provide customer service over the
telephone will find value in aggregating institutional knowledge by using our
software and will be willing to access our content over the Internet. Our
business model also assumes that companies will find value in providing some of
their customer service over the Internet rather than by telephone. Our success
will depend on the broad commercial acceptance of, and demand for, these
Knowledge Management solutions.

WE CURRENTLY HAVE ONE PRODUCT FAMILY. IF THE DEMAND FOR THIS LINE OF PRODUCTS
DECLINES, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

ServiceWare's Knowledge Management solution, ServiceWare Enterprise,
includes our ServiceWare Self-Service, ServiceWare Professional and ServiceWare
Architect software products. Our past and expected future revenues consist
primarily of license fees for these software solutions and fees for related
services. Factors adversely affecting the demand for these products and our
products in general, such as competition, pricing or technological change, could
materially adversely affect our business, financial condition, operating results
and the value of our stock price. Our future financial performance will
substantially depend on our ability to sell current versions of our entire suite
of products and our ability to develop and sell enhanced versions of our
products.

DUE TO THE LENGTHY SALES CYCLES OF OUR PRODUCTS AND SERVICES, THE TIMING OF OUR
SALES IS DIFFICULT TO PREDICT AND MAY CAUSE US TO MISS OUR REVENUE EXPECTATIONS.

Our products and services are typically intended for use in applications
that may be critical to a customer's business. In certain instances, the
purchase of our products and services involves a significant commitment of
resources by prospective customers. As a result, our sales process is often
subject to delays associated with lengthy approval processes that accompany the
commitment of significant resources. These delays may worsen in the future as a
significant amount of our total revenues will be derived from our ServiceWare
Enterprise solutions, for which contracts have a higher average dollar value.
For these and other reasons, the sales cycle associated with the licensing of
our products and subscription for our services typically ranges between six and
eighteen months and is subject to a number of significant delays over which we
have little or no control. While our customers are evaluating whether our
products and services suit their needs, we may incur substantial sales and
marketing expenses and expend significant management effort. We may not realize
forecasted revenues from a specific customer in the quarter in which we expend
these significant resources because of the lengthy sales cycle for our products
and services.

WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS INTERNATIONALLY, AND, IF WE DO, WE
FACE RISKS RELATING TO INTERNATIONAL OPERATIONS.

Our business strategy includes efforts to attract more international
customers. We are currently exploring business opportunities in the United
Kingdom and continental Europe. To date, we have only limited experience in
providing our products and services internationally. If we are not able to
market our products and services successfully in international markets, our
expenses may exceed our revenues. By doing business in international markets we
face risks, such as unexpected changes in tariffs and other trade barriers,
fluctuations in currency exchange rates, difficulties in staffing and managing
foreign operations, political instability, reduced protection for intellectual
property rights in some countries, seasonal reductions in business activity
during the summer months in Europe and certain other parts of the world, and
potentially adverse tax consequences, any of which could adversely impact our
international operations and may contribute further to our net losses.

IF WE ARE NOT ABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE, SALES OF OUR
PRODUCTS MAY DECREASE.

The software industry is characterized by rapid technological change,
including changes in customer requirements, frequent new product and service
introductions and enhancements and evolving industry standards. If we fail to
keep pace with the technological progress of our competitors, sales of our
products may decrease.

13

WE DEPEND ON TECHNOLOGY LICENSED TO US BY THIRD PARTIES, AND THE LOSS OF THIS
TECHNOLOGY COULD DELAY IMPLEMENTATION OF OUR PRODUCTS, INJURE OUR REPUTATION OR
FORCE US TO PAY HIGHER ROYALTIES.

We rely, in part, on technology that we license from a small number of
software providers for use with our products. After the expiration of these
licenses, this technology may not continue to be available on commercially
reasonable terms, if at all, and may be difficult to replace. The loss of any of
these technology licenses could result in delays in introducing or maintaining
our products until equivalent technology, if available, is identified, licensed
and integrated. In addition, any defects in the technology we may license in the
future could prevent the implementation or impair the functionality of our
products, delay new product introductions or injure our reputation. If we are
required to enter into license agreements with third parties for replacement
technology, we could be subject to higher royalty payments.

PROBLEMS ARISING FROM THE USE OF OUR PRODUCTS WITH OTHER VENDORS' PRODUCTS COULD
CAUSE US TO INCUR SIGNIFICANT COSTS, DIVERT ATTENTION FROM OUR PRODUCT
DEVELOPMENT EFFORTS AND CAUSE CUSTOMER RELATIONS PROBLEMS.

Our customers generally use our products together with products from other
companies. As a result, when problems occur in a customer's systems, it may be
difficult to identify the source of the problem. Even when these problems are
not caused by our products, they may cause us to incur significant warranty and
repair costs, divert the attention of our technical personnel from our product
development efforts and cause significant customer relations problems.

IF CERTAIN COMPANIES CEASE TO PROVIDE OPEN PROGRAM INTERFACES FOR THEIR CUSTOMER
RELATIONSHIP MANAGEMENT SOFTWARE, IT WILL BE DIFFICULT TO INTEGRATE OUR SOFTWARE
WITH THEIRS. THIS WILL DECREASE THE ATTRACTIVENESS OF OUR PRODUCTS.

Our ability to compete successfully also depends on the continued
compatibility and interoperability of our products with products and systems
sold by various third parties, specifically including CRM software sold by
Clarify/Amdocs, Remedy, and Siebel Systems. Currently, these vendors have open
applications program interfaces, which facilitate our ability to integrate with
their systems. If any one of them should close their programs' interface or if
they should acquire one of our competitors, our ability to provide a close
integration of our products could become more difficult, or impossible, and
could delay or prevent our products' integration with future systems. Inadequate
integration with other vendors' products would make our products less desirable
and could lead to lower sales.

WE FACE INTENSE COMPETITION FROM BOTH ESTABLISHED AND RECENTLY FORMED ENTITIES,
AND THIS COMPETITION MAY ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY BECAUSE
WE COMPETE IN THE EMERGING MARKET FOR KNOWLEDGE MANAGEMENT SOLUTIONS.

We compete in the emerging market for Knowledge Management solutions and
changes in the Knowledge Management solutions market could adversely affect our
revenues and profitability. We face competition from many firms offering a
variety of products and services. In the future, because there are relatively
low barriers to entry in the software industry, we expect to experience
additional competition from new entrants into the Knowledge Management solutions
market. It is also possible that alliances or mergers may occur among our
competitors and that these newly consolidated companies could rapidly acquire
significant market share. Greater competition may result in price erosion for
our products and services, which may significantly affect our future operating
margins.

IF OUR SOFTWARE PRODUCTS CONTAIN ERRORS OR FAILURES, SALES OF THESE PRODUCTS
COULD DECREASE.

Software products frequently contain errors or failures, especially when
first introduced or when new versions are released. In the past, we have
released products that contained defects, including software errors in certain
new versions of existing products and in new products after their introduction.
In the event the information contained in our products is inaccurate or
perceived to be incomplete or out-of-date, our customers could purchase our
competitors' products or decide they do not need Knowledge Management solutions
at all. In either case, our sales would decrease. Our products are typically
intended for use in applications that may be critical to a customer's business.
As a result, we believe that our customers and potential customers have a great
sensitivity to product defects.

14

WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF PRODUCT LIABILITY CLAIMS BECAUSE
OUR PRODUCTS ARE CRITICAL TO THE OPERATIONS OF OUR CUSTOMERS' BUSINESSES.

Our products are critical to the operations of our customers' businesses.
Any defects or alleged defects in our products entail the risk of product
liability claims for substantial damages, regardless of our responsibility for
the failure. Although our license agreements with our customers typically
contain provisions designed to limit our exposure to potential product liability
claims, these provisions may not be effective under the laws of certain
jurisdictions. In addition, product liability claims, even if unsuccessful, may
be costly and divert management's attention from our operations. Software
defects and product liability claims may result in a loss of future revenue, a
delay in market acceptance, the diversion of development resources, damage to
our reputation or increased service and warranty costs.

IF OUR CUSTOMERS' SYSTEM SECURITY IS BREACHED AND CONFIDENTIAL INFORMATION IS
STOLEN, OUR BUSINESS AND REPUTATION COULD SUFFER.

Users of our products transmit their and their customers' confidential
information, such as names, addresses, social security numbers and credit card
information, over the Internet. In our license agreements with our customers, we
typically disclaim responsibility for the security of confidential data and have
contractual indemnities for any damages claimed against us. However, if
unauthorized third parties are successful in illegally obtaining confidential
information from users of our products, our reputation and business may be
damaged, and if our contractual disclaimers and indemnities are not enforceable,
we may be subject to liability.

WE MAY ACQUIRE OR MAKE INVESTMENTS IN COMPANIES OR TECHNOLOGIES THAT COULD CAUSE
DISRUPTIONS TO OUR BUSINESS.

We intend to explore opportunities to acquire companies or technologies in
the future. Entering into an acquisition entails many risks, any of which could
adversely affect our business, including:

- failure to integrate the acquired assets and/or companies with our
current business

- the price we pay may exceed the value we eventually realize

- potential loss of share value to our existing stockholders as a result of
issuing equity securities as part or all of the purchase price

- potential loss of key employees from either our current business or the
acquired business

- entering into markets in which we have little or no prior experience

- diversion of management's attention from other business concerns

- assumption of unanticipated liabilities related to the acquired assets

- the business or technologies we acquire or in which we invest may have
limited operating histories and may be subject to many of the same risks
we are.

WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH MAY CAUSE
US TO INCUR SIGNIFICANT COSTS IN LITIGATION AND AN EROSION IN THE VALUE OF OUR
BRANDS AND PRODUCTS.

Our business is dependent on proprietary technology and the value of our
brands. We rely primarily on patent, copyright, trade secret and trademark laws
to protect our technology and brands. Our patents may not survive a legal
challenge to their validity or provide meaningful protection to us. Litigation
to protect our patents would be expensive and the loss of our patents would
decrease the value of our products. Defending against claims of patent
infringement would also be expensive and, if successful, we could be forced to
redesign our products, pay royalties, or cease selling them. In addition,
effective trademark protection may not be available for our trademarks. The use
by other parties of our trademarks would dilute the value of our brands.

Notwithstanding the precautions we have taken, a third party may copy or
otherwise obtain and use our software or other proprietary information without
authorization or may develop similar software indepen-
15

dently. Policing unauthorized use of our technology is difficult, particularly
because the global nature of the Internet makes it difficult to control the
ultimate destination or security of software or other transmitted data. Further,
we have granted certain third parties limited contractual rights to use
proprietary information which they may improperly use or disclose. The laws of
other countries may afford us little or no effective protection of our
intellectual property. The steps we have taken may not prevent misappropriation
of our technology, and the agreements entered into for that purpose may not be
enforceable. The unauthorized use of our proprietary technologies could also
decrease the value of our products.

THE SUCCESS OF OUR SOFTWARE PRODUCTS DEPENDS ON THEIR ADOPTION BY OUR CUSTOMERS'
EMPLOYEES. IF THESE EMPLOYEES DO NOT ACCEPT THE IMPLEMENTATION OF OUR PRODUCTS,
OUR CUSTOMERS MAY FAIL TO RENEW THEIR SERVICE CONTRACTS AND WE MAY HAVE
DIFFICULTY ATTRACTING NEW CUSTOMERS.

The effectiveness of our ServiceWare Enterprise depends in part on
widespread adoption and use of our software by our customers' customer service
personnel and on the quality of the solutions they generate. Resistance to our
software by customer service personnel and an inadequate development of the
knowledge base may make it more difficult to attract new customers and retain
old ones.

Some of our customers have found that customer service personnel
productivity initially drops while customer service personnel become accustomed
to using our software. If an enterprise deploying our software has not
adequately planned for and communicated its expectations regarding that initial
productivity decline, customer service personnel may resist adoption of our
software.

The knowledge base depends in part on solutions generated by customer
service personnel and, sometimes, on the importation of our customers' legacy
solutions. If customer service personnel do not adopt and use our products
effectively, necessary solutions will not be added to the knowledge base, and
the knowledge base will not adequately address service needs. In addition, if
less-than-adequate solutions are created and left uncorrected by a user's
quality-assurance processes or if the legacy solutions are inadequate, the
knowledge base will similarly be inadequate, and the value of our solutions to
end-users will be impaired. Thus, successful deployment and broad acceptance of
ServiceWare Enterprise will depend in part on whether our customers effectively
roll-out and use our software products and the quality of the customers'
existing knowledge base of solutions.

WE DEPEND ON INCREASED BUSINESS FROM OUR NEW CUSTOMERS AND, IF WE FAIL TO GROW
OUR CLIENT BASE OR GENERATE REPEAT BUSINESS, OUR OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.

If we fail to grow our customer base or generate repeat and expanded
business from our current and future customers, our business and operating
results will be seriously harmed. Some of our customers initially make a limited
purchase of our products and services for pilot programs. If these customers do
not successfully develop and deploy such initial applications, they may choose
not to purchase complete deployment or development licenses. Some of our
customers who have made initial purchases of our software have deferred or
suspended implementation of our products due to slower than expected rates of
internal adoption by customer service personnel. If more customers decide to
defer or suspend implementation of our products in the future, we will be unable
to increase our revenue from these customers from additional licenses or
maintenance agreements, and our financial position will be seriously harmed.

In addition, as we introduce new versions of our products or new products,
our current customers may not need our new products and may not ultimately
license these products. Any downturn in our software licenses revenues would
negatively impact our future service revenues because the total amount of
maintenance and service fees we receive in any period depends in large part on
the size and number of licenses that we have previously sold. In addition, if
customers elect not to renew their maintenance agreements, our service revenues
could be significantly adversely affected.

A DECLINE IN INFORMATION TECHNOLOGY SPENDING COULD REDUCE THE SALE OF OUR
PRODUCTS.

The license fees for our products typically range from approximately
several hundred thousand to several million dollars. These fees often represent
a significant expenditure of Information Technology ("IT") capital for our
customers. Due to the slowdown in the national and global economy and the
uncertainties resulting

16

from recent acts of terrorism, we believe that many existing and potential
customers are reducing or reassessing their planned IT expenditures. Such
reductions in or eliminations of IT spending could cause us to be unable to
maintain or increase our sales volumes, and therefore, have a material adverse
affect on our revenues, operating results and stock price.

INCREASING GOVERNMENT REGULATION OF THE INTERNET COULD HARM OUR BUSINESS.

As e-business, Knowledge Management and the Internet continue to evolve, we
expect that federal, state and foreign governments will adopt laws and
regulations tailored to the Internet covering issues like user privacy, taxation
of goods and services provided over the Internet, pricing, content and quality
of products and services. If enacted, these laws and regulations could limit the
market for e-business and Knowledge Management and, therefore, the market for
our products and services.

The Telecommunications Act of 1996 prohibits certain types of information
and content from being transmitted over the Internet. The prohibition's scope
and the liability associated with a violation of the Telecommunications Act's
information and content provisions are currently unsettled. The imposition upon
us and other software and service providers of potential liability for
information carried on or disseminated through our applications could require us
to implement measures to reduce our exposure to this liability. These measures
could require us to expend substantial resources or discontinue certain
services. In addition, although substantial portions of the Communications
Decency Act, the act through which the Telecommunications Act of 1996 imposes
criminal penalties, were held to be unconstitutional, similar legislation may be
enacted and upheld in the future. It is possible that this new legislation and
the Communications Decency Act could expose companies involved in e-business to
liability, which could limit the growth of Internet usage and e-business
generally and, therefore, the demand for Knowledge Management solutions. In
addition, similar or more restrictive laws in other countries could have a
similar effect and hamper our plans to expand overseas.

WE MAY BECOME INVOLVED IN SECURITIES CLASS ACTION LITIGATION WHICH COULD DIVERT
MANAGEMENT'S ATTENTION AND HARM OUR BUSINESS.

In recent years, the common stocks of technology companies have experienced
significant price and volume fluctuations. These broad market fluctuations may
cause the market price of our common stock to decline. In the past, following
periods of volatility in the market price of a particular company's securities,
securities class action litigation has often been brought against that company.
We may become involved in that type of litigation in the future. Litigation is
often expensive and diverts management's attention and resources, which could
harm our business and operating results.

THE LOW PRICE OF OUR COMMON STOCK AND THE AMOUNT OF OUR STOCKHOLDERS' EQUITY
COULD RESULT IN THE DELISTING OF OUR COMMON STOCK.

On March 18, 2003, we received a letter from Nasdaq that our common stock
will be delisted as of March 27, 2003. We have filed an appeal, and the
delisting will be delayed pending the outcome of the appeal. We cannot assure
investors that our stock will continue to be listed on Nasdaq after our appeal
is heard.

If our common stock is delisted by Nasdaq, we expect that our securities
will begin to trade on the OTC Bulletin Board maintained by Nasdaq, another
over-the-counter quotation system, or on the pink sheets. As a result, investors
may find it more difficult to dispose of or obtain accurate quotations as to the
market value of the securities. In addition, we would be subject to a Rule
promulgated by the Securities and Exchange Commission that, if we fail to meet
criteria set forth in such Rule, imposes various practice requirements on
broker-dealers who sell securities governed by the Rule to persons other than
established customers and accredited investors. For these types of transactions,
the broker-dealer must make a special suitability determination for the
purchaser and have received the purchaser's written consent to the transactions
prior to sale. Consequently, the Rule may deter broker-dealers from recommending
or selling our common stock, which may further affect the liquidity of our
common stock.

Delisting from Nasdaq would make trading our shares more difficult for
investors, potentially leading to further declines in our share price. It would
also make it more difficult for us to raise additional capital.

17

Further, if we are delisted we could also incur additional costs under state
blue sky laws in connection with any sales of our securities.

OUR MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMPANY AND WILL BE ABLE TO
EXERCISE SIGNIFICANT INFLUENCE OVER OUR ACTIONS.

We are controlled by our officers and directors, who in the aggregate
directly or indirectly could control more than 50% of our outstanding common
stock and voting power, assuming conversion of all of our convertible notes.
These stockholders collectively will likely be able to control our management
policy, decide all fundamental corporate actions, including mergers, substantial
acquisitions and dispositions, and elect our board of directors.

TERRORIST ATTACKS SUCH AS THE ATTACKS THAT OCCURRED IN NEW YORK AND WASHINGTON,
D.C. ON SEPTEMBER 11, 2001 AND OTHER ATTACKS OR ACTS OF WAR MAY ADVERSELY AFFECT
THE MARKETS ON WHICH OUR COMMON STOCK TRADES, OUR FINANCIAL CONDITION AND OUR
RESULTS OF OPERATIONS.

On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scope. In March 2003, the United States and allied
nations commenced a war in Iraq. These attacks and the war in Iraq have caused
major instability in the United States and other financial markets. There could
be further acts of terrorism in the United States or elsewhere that could have a
similar impact. Armed hostilities or further acts of terrorism could cause
further instability in financial markets and could directly impact our financial
condition and our results of operations.

ITEM 2. PROPERTIES

We own no real property. Our largest facility is located in Oakmont,
Pennsylvania, where we lease office space. The term of the lease expires in
2006. We also lease an office in Iselin, New Jersey, replacing a small executive
office suite that was sublet in Princeton, New Jersey. We also continue to lease
small offices in Atlanta, Georgia; Phoenix, Arizona; Pittsford, New York; and
the United Kingdom. We believe that our current facilities are adequate to
support our existing operations. We also believe that we will be able to obtain
suitable additional facilities on commercially reasonable terms on an "as
needed" basis.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any material legal proceedings.

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

During the fourth quarter of 2002, no matters were submitted to a vote of
the security holders. However, we held a Special Meeting of Stockholders on
February 10, 2003. Two matters were considered and voted upon at the Special
Meeting:

- the approval of an amendment to our Certificate of Incorporation to
effect a reverse stock split of our Common Stock and to grant our Board
of Directors the authority to set the ratio for the reverse split or to
not complete the reverse split

- the approval of an amendment to our Certificate of Incorporation to
decrease the number of authorized shares of Common Stock to 50,000,000
shares subject to completion of the reverse stock split

The votes on the matters presented to our Stockholders were as follows:

18

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET FOR THE COMPANY'S COMMON STOCK

Our common stock has been quoted on the Nasdaq National Market from August
25, 2000 until April 24, 2002 and on the Nasdaq SmallCap Market since that time.
On March 19, 2003, the last sale price of our common stock was $0.29 per share.
The following table sets forth the range of high and low sale prices for our
common stock for the periods indicated.

As of March 19, 2003, there were approximately 350 holders of record of our
common stock. We believe that a substantially larger number of beneficial owners
hold shares of our common stock in depository or nominee form.

DIVIDEND POLICY

We do not anticipate paying any cash dividends in the foreseeable future.
We currently intend to retain any future earnings to finance the expansion of
our business. Moreover, our bank credit facility restricts our ability to pay
cash dividends.

19

ITEM 6. SELECTED FINANCIAL DATA

The following financial information for the five years ended December 31,
2002 has been derived from our consolidated financial statements. You should
read the selected consolidated financial data set forth below along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes.

20

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

The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes.

OVERVIEW

We are a leading provider of enterprise Knowledge Management (KM) solutions
that enable organizations to deliver superior service to customers, employees
and partners by transforming information into knowledge. Founded in 1991 in
Oakmont, Pennsylvania, we sell our products throughout the United States and
have a European subsidiary based in the United Kingdom.

ServiceWare Enterprise(TM) (formerly named eService Suite), powered by The
Cognitive Processor(R) (formerly known as MindSync), a patented self-learning
search technology, enables organizations to capture and manage intellectual
capital. This repository of corporate knowledge, known as a knowledge base, can
then be easily accessed via a browser to effectively answer inquiries made
either over the Web or through the telephone to a customer contact center or
help desk.

Customers use ServiceWare's Knowledge Management solutions to:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Integrate seamlessly with existing technology investments

ServiceWare Enterprise(TM) is a software solution that allows our customers
to provide personalized, automated Web-based service tailored to the needs of
their users. ServiceWare Enterprise enables businesses to capture enterprise
knowledge, solve customer problems, reuse solutions and share captured knowledge
throughout the extended enterprise. It also enables the extended enterprise to
access this knowledge online. In addition, through the self-learning features of
ServiceWare's patented Cognitive Processor technology, the solutions generated
by these products are intelligent in that they have the capability to learn from
each interaction and automatically update themselves accordingly. ServiceWare
Enterprise includes the software products ServiceWare Self-Service(TM)
(Web-based self-service for customers, partners and employees), ServiceWare
Professional(TM) (for customer service, sales and field service personnel) and
ServiceWare Architect(TM) (for quality assurance managers and system
administrators). We also provide a portal solution, ServiceWare Knowledge
Portal, based on the technology acquired from InfoImage in August 2002.

Prior to July 2001, we had two reportable business segments: Software and
Content. In July 2001, we completed the sale of all of our Content segment to
RightAnswers LLC ("RightAnswers"). The Content segment is reported as a
discontinued operation, and all previously reported financial information has
been restated accordingly. See Note 6 to our consolidated financial statements.

In response to poor financial performance and the economic downturn, during
2001 we announced strategic corporate restructuring programs pursuant to which
we have significantly reduced costs and we have focused our business exclusively
on revenue growth opportunities in our Software business. As part of the
restructuring plans, approximately 180 employees were laid off during 2001. The
savings from the restructuring plans offset by a decrease in revenues and
increased interest expenses related to our convertible notes resulted in a
decrease in our net loss for 2002 to $6.8 million, or $0.28 per share, compared
to a loss of $29.7 million, or $1.23 per share for 2001.

On March 18, 2003, we received a delisting notice from The Nasdaq Stock
Market. In this letter, Nasdaq informed us that our common stock has continued
to fail to maintain a minimum bid price per share of $1.00, that we do not
qualify for any further extensions and that our common stock will be delisted as
of March 27, 2003. We have filed an appeal, and the delisting will be delayed
pending the outcome of the appeal. We cannot assure investors that our common
stock will continue to be listed on Nasdaq after our appeal is heard.

21

At a special meeting of our stockholders on February 10, 2003, our
stockholders approved an amendment to our Certificate of Incorporation to effect
a reverse stock split of our common stock and to grant our board of directors
the authority to set the ratio for the reverse split or to not complete the
reverse split. As necessary, we intend to consider implementing a reverse stock
split if we believe it would increase the probability that we would be able to
continue to meet the Nasdaq SmallCap Market listing requirements.

On August 21, 2002, we acquired all existing technology assets, certain
customer and vendor contracts of InfoImage, Inc., a privately held enterprise
portal company which filed for bankruptcy protection prior to our agreement to
acquire these assets. We paid initial consideration of $100,000 and will pay
contingent consideration not to exceed a total of $1.5 million to be
predominantly based on future sales of InfoImage products and services.
InfoImage's feature product, Decision Portal, provides companies with an
enterprise portal framework that consolidates key information from disparate
data sources and provides collaboration tools in one unified view.

On October 16, 2002, we entered into a $2.5 million loan and security
agreement with Comerica Bank -- California (the "Bank"). The agreement allows
for a revolving line of credit and a term loan. Borrowings on the revolving line
can be in amounts up to the lesser of $2.0 million or 75% of eligible
receivables and mature October 1, 2003. Such amounts will bear interest at a
rate of 1.5% above the Bank's prime rate. Advances of up to $0.5 million on the
term loan can be taken until October 16, 2003, and the term loan will mature one
year from the date of the advance. Such amounts are to be repaid in 12 monthly
installments and will bear interest at the Bank's prime rate which was 4.25% at
December 31, 2002. In conjunction with this loan agreement, a Warrant was issued
to the Bank to purchase 50,000 shares of our common stock at an exercise price
of $0.46 per share, with a 10-year maturity. The Warrant includes assignability
to Bank's affiliates, antidilution protection and a net exercise provision. In
addition, the Bank can require us to repurchase the Warrant for $69,000 after a
change of control as defined in the agreement.

FACTORS AFFECTING FUTURE OPERATIONS

Our operating losses, as well as our negative operating cash flow, have
been significant to date. We expect to have positive operating margins over time
by increasing our customer base without significantly increasing related capital
expenditures and other operating costs. We do not know if we will be able to
achieve these objectives.

DESCRIPTION OF STATEMENT OF OPERATIONS

REVENUES

We market and sell our products primarily in North America through our
direct sales force. Internationally, we market our products through value-added
resellers, software vendors and system integrators as well as our direct sales
force. International revenues were 12% and 8% of total revenues in 2002 and
fiscal 2001. We derive our revenues from licenses for software products and from
providing related services, including installation, training, consulting,
customer support and maintenance contracts. License revenues primarily represent
fees for perpetual licenses. Service revenues contain variable fees for
installation, training and consulting, reimbursements for travel expenses that
are billed to customers, as well as fixed fees for customer support and
maintenance contracts.

COST OF REVENUES

Cost of license revenues consists primarily of the expenses related to
royalties, the cost of media on which our product is delivered, product
fulfillment costs, amortization of purchased technology, and salaries, benefits,
direct expenses and allocated overhead costs related to product fulfillment.
Cost of service revenues consists of the salaries, benefits, direct expenses and
allocated overhead costs of customer support and services personnel,
reimbursable expenses for travel that are billed to customers, fees for
sub-contractors, and the costs associated with maintaining our customer support
site.

22

OPERATING COSTS

We classify our core operating costs into four general categories: sales
and marketing, research and development, general and administrative, and
intangible assets amortization based upon the nature of the costs. Special one
time charges, including restructuring costs, are presented separately as
restructuring and other non-recurring charges to enable the reader to determine
core operating costs. We allocate the total costs for overhead and facilities,
based upon headcount, to each of the functional areas that benefit from these
services. Allocated charges include general overhead items such as building
rent, equipment-leasing costs, telecommunications charges and depreciation
expense. Sales and marketing expenses consist primarily of employee compensation
for direct sales and marketing personnel, travel, public relations, sales and
other promotional materials, trade shows, advertising and other sales and
marketing programs. Research and development expenses consist primarily of
expenses related to the development and upgrade of our proprietary software and
other technologies. These expenses include employee compensation for software
developers and quality assurance personnel and third-party contract development
costs. General and administrative expenses consist primarily of compensation for
personnel and fees for outside professional advisors. Intangible assets
amortization expense consists primarily of the amortization of intangible assets
acquired through our acquisition of the Molloy Group in 1999. These assets
(other than goodwill) are amortized on a straight line basis over their
respective estimated useful lives. Restructuring and other non-recurring charges
consist of costs incurred for restructuring plans and other costs related to the
separation of senior executives.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES

In 2001, we implemented a strategic restructurings to reduce our cost
structure and focus on revenue growth opportunities in the Knowledge Management
software market. The plans of restructuring approved by our board of directors
included severance and other benefit costs, costs for reduction and relocation
of facilities, termination costs for certain service contracts and an equipment
write off. As part of the restructuring plan, 55 employees were laid off on
February 28, 2001. In July 2001, we implemented a revision to our organizational
structure and a workforce reduction of an additional 75 employees. In October
2001, we implemented a workforce reduction of approximately 50 people to further
reduce our cost structure.

A portion of the restructuring charge related to potential costs for
terminating certain real estate leases at our corporate headquarters, in
addition to amounts related to unused capacity within the building. We have been
successful in sub-leasing much of the unused capacity and consequently we have
reduced our reserve for excess capacity. Additionally, we decided not to
terminate the lease on the property as anticipated and accordingly reversed
approximately $302,000 in exit reserves in 2002. Furthermore, a change in the
estimate of the termination costs for certain service contracts was recorded as
a reduction to the restructuring expense of $130,000 in 2002.

The remaining restructuring liability of $116,000, related to reduction of
facilities, is expected to be fully amortized by June 2003.

23

A summary of the restructuring activity is as follows (amounts in
thousands):

Other non-recurring charges consist of severance costs for senior
executives, forgiveness of loans in connection with repurchases of common stock,
and income tax gross-ups related to the loan forgiveness.

DISCONTINUED OPERATIONS

We sold our Content business segment in July 2001. As a result, all
financial data for the Content business has been presented separately as
discontinued operations. Financial information for prior periods has been
restated accordingly. Net income from discontinued operations represents the net
results of operations of the Content business through July 20, 2001, the date of
sale.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles. 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
on-going basis, we evaluate our estimates, including those related to allowance
for doubtful accounts and intangible assets. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following
critical accounting policies affect our more significant judgments and estimates
used in the preparation of our consolidated financial statements.

REVENUE RECOGNITION

We recognize revenues on license fees after a non-cancelable license
agreement is signed, the product is delivered, the fee is fixed, determinable
and collectible, and there is vendor-specific objective evidence to support the
allocation of the total fee to elements of a multiple-element arrangement using
the residual method. We recognize revenues on installation, training and
consulting on a time-and-material basis. Customer support and maintenance
contracts are recognized over the life of the contract.

Our revenue recognition policy is governed by Statement of Position (SOP)
97-2, "Software Revenue Recognition", issued by the American Institute of
Certified Public Accountants (AICPA), as amended by SOP 98-9 "Modification of
SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions".
These statements provide guidance on applying generally accepted accounting
principles in recognizing revenue on software and services transactions. In
addition, the AICPA and its Software Revenue Recognition

24

Task Force continue to issue interpretations and guidance for applying the
relevant standards to a wide range of sales contract terms and business
arrangements that are prevalent in the software industry. Also, the Securities
and Exchange Commission (SEC) has issued Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements," which provides guidance related
to revenue recognition based on interpretations and practices followed by the
SEC, and the Emerging Issues Task Force of the Financial Accounting Standards
Board continues to issue additional guidance on revenue recognition. Future
interpretations of existing accounting standards or changes in our business
practices could result in future changes in our revenue accounting policies that
could have a material effect on our financial condition and results of
operations.

ACCOUNTS RECEIVABLE

We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of customers to make required payments. If the financial
condition of these customers were to deteriorate, resulting in an impairment of
their ability of make payments, we may require additional allowances or we may
defer revenue until we determine that collectibility is probable. We perform a
quarterly analysis to determine the appropriate allowance for doubtful accounts.
This analysis includes a review of specific individual balances in our accounts
receivable, our history of collections, as well as the overall economic
environment.

INTANGIBLE ASSETS AND GOODWILL

Since adoption of SFAS No. 142, goodwill is no longer amortized but instead
is assessed for impairment at least as often as annually and as triggering
events occur. In making this assessment, we rely on a number of factors
including operating results, business plans, economic projections, anticipated
future cash flows, and transactions and market place data. There are inherent
uncertainties related to these factors and management's judgment in applying
them to the analysis of goodwill impairment. Since our judgment is involved in
performing goodwill valuation analyses, there is risk that the carrying value of
our goodwill may be misstated. As a result of implementing SFAS No. 142, expense
of $2.3 million was not recognized during 2002 that would have otherwise fully
amortized the balance of goodwill. During 2002, we performed the required
impairment tests of goodwill and indefinite lived intangible assets as of
January 1, 2002 and determined that we did not have an impairment loss.

CONTRACTUAL OBLIGATIONS

Our contractual obligations as of December 31, 2002 consist of the
following:

During 2001, we entered into a sublease for part of our office space in
Oakmont, Pennsylvania. The term of the sublease is concurrent with our lease
which is through March 31, 2006, however, the sublease may be terminated by
either party with 90 days written notice at any time. In 2002 and 2001, we
received $71,124 and $25,811 in rental payments for this sublease.

25

RESULTS OF OPERATIONS

The following table sets forth consolidated statement of operations data as
a percentage of revenues for the periods indicated:

YEARS ENDED DECEMBER 31, 2002 AND 2001

REVENUES

Total revenues decreased 18.3% to $10.2 million in 2002 from $12.4 million
in 2001 caused by a variety of factors. The biggest factor was and continues to
be the poor economic climate. This has translated into significant cuts in
enterprise software purchases and stagnant IT purchasing for our target market,
Fortune 1000 companies. We anticipate a stagnant IT purchasing environment to
continue in our target market in the near future. As a result, we are
experiencing price compression and a slowdown in overall demand for our products
and services.

License revenues decreased 36.0% to $3.8 million in 2002 from $5.9 million
in 2001. Although the number of contracts with new customers increased to 21 in
2002 from 14 in 2001, the average amount recognized per contract decreased to
$119,000 in 2002 from $357,000 in 2001 which was the primary reason for the
overall decrease in license revenues. The decrease in license revenues from
contracts with new customers was offset in part by an increase in license
revenues from contracts with existing customers. In 2002, there were 31
contracts with existing customers averaging $41,000 per contract which was an
increase from 2001 where there were 26 contracts averaging $25,000 per contract.

26

Service revenues decreased 2.1% to $6.4 million in 2002 from $6.5 million
in 2001. A $0.1 million increase in the amount of software maintenance revenue
was offset by a $0.2 million decrease in the amount of professional service
revenues. Professional services revenues decreased as a result of a 9.6%
decrease in billable hours rendered.

COST OF REVENUES

Cost of revenues decreased to $4.6 million in 2002 from $11.4 million in
2001. Cost of revenues as a percentage of revenues decreased to 45.6% from
92.0%. Cost of license revenues decreased to $1.0 million in 2002 from $2.7
million in 2001. As a percentage of revenues, it decreased to 9.5% from 21.6%.
The decrease in the cost of license revenues was primarily attributable to a
decrease in product royalties payable to third parties, costs incurred only in
2001 for equipment for specific implementations, and a decrease in amortization
of purchased technology, which was fully amortized in July 2002.

Cost of service revenues decreased to $3.7 million in 2002 from $8.7
million in 2001. As a percentage of revenues, it decreased to 36.1% from 70.4%.
The decrease in the cost of service revenues was principally the result of a
42.4% decrease in customer support and services personnel to an average of 19 in
2002 from an average of 33 in 2001 primarily attributable to the 2001
restructurings. In addition, there was a decrease in the use of third parties to
perform services and a decrease in travel and recruiting expenses.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing expenses decreased to $5.4 million, or
52.9% of revenues, in 2002 from $13.6 million, or 109.2% of revenues, in 2001.
The decrease is attributable to a reduction in sales and marketing staff of
53.4% to an average of 24 in 2002 from an average of 52 in 2001 primarily
attributable to the 2001 restructurings and a decrease in expenses for marketing
programs of 87.4% to $0.3 million in 2002 from $2.5 million in 2001.
Additionally, significant decreases in commission expense, travel and recruiting
costs contributed to the decrease in sales and marketing expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses decreased to $2.9
million, or 28.5% of revenues, in 2002 from $6.3 million, or 51.1% of revenues,
in 2001. The decrease is principally the result of a 61.8% reduction in software
development staffing levels to an average of seven in 2002 from an average of 18
in 2001 primarily attributable to the 2001 restructurings.

GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased to
$3.0 million, or 29.2% of revenues in 2002 from $3.6 million, or 29.2% of
revenues in 2001. The decrease was primarily attributable to a 50.0% reduction
in general and administrative staffing levels to an average of 11 in 2002 from
an average of 22 in 2001 and reductions of bad debt, third party contractor and
legal and accounting expenses.

INTANGIBLE ASSETS AMORTIZATION. Intangible assets amortization decreased to $0.3
million, or 3.4% of revenues in 2002 from $4.8 million, or 38.9% of revenues in
2001. Intangible assets amortization consists of the amortization expense in
respect of the consideration in excess of the fair value of assets acquired and
liabilities assumed in our acquisition of the Molloy Group in 1999. The decrease
is primarily the result of the implementation of new accounting rules that
discontinue the amortization of goodwill and provide for write off of the
goodwill value should it become impaired.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES. Restructuring and other
non-recurring charges decreased to $(0.4) million in 2002 from $4.5 million, or
36.6% of revenues, in 2001. In 2001, restructuring charges totaling $2.6 million
primarily represent excess facilities costs and severance benefits resulting
from reductions in force of approximately 180 employees in 2001. A portion of
these restructuring charges related to potential costs for terminating certain
real estate leases. However, we have been able to sublease a significant portion
of our unused space and have decided not to terminate the lease. Consequently,
we have reduced this accrual by $0.4 million in 2002 to reflect changes in
assumptions made for the initial charge. Additionally, a credit of $0.1 million
to restructuring expense was recorded in 2002 representing a change in the
estimate of termination costs for certain service contracts.

27

Other non-recurring charges in 2002 of $112,000 consist of adjustments to a
tax gross-up related to forgiveness of stockholder loans and a reserve for
accrued interest related to outstanding stockholder loans. Other non-recurring
charges in 2001 consist of $1.1 million in costs recognized in conjunction with
forgiveness of stockholder loans to certain executives in connection with their
severance agreements and the related taxes as well as severance costs for senior
executives of $0.6 million and a reserve for stockholder loans of $0.3 million.

OTHER INCOME (EXPENSE), NET

Other income (expense), net consists primarily of interest income received
from short-term investments, offset by interest expense and other fees related
to our convertible notes entered into in second quarter 2002 and bank
borrowings. Other income (expense), net decreased to $(1.2) million in 2002 from
$449,000 or 3.6% of revenues in 2001. The decrease was primarily the result of
increased interest expense incurred in conjunction with our convertible notes as
well as a decrease in interest earned on investments. The interest expense
primarily represents amortization of the beneficial conversion feature
recognized in conjunction with the issuance of the convertible notes, in
addition to the 10% interest, amortization of the discount, and debt issue costs
on the convertible notes.

YEARS ENDED DECEMBER 31, 2001 AND 2000

REVENUES

Total revenues decreased 30.3% to $12.4 million in 2001 from $17.8 million
in 2000 caused by a variety of factors including a general weakness in the
technology sector. License revenues decreased 47.1% to $5.9 million in 2001 from
$11.2 million in 2000. The decrease in license revenues was primarily
attributable to a decreased number of contracts with new customers. In 2001, we
recognized revenue for 13 contracts versus 71 contracts in 2000. Service
revenues decreased slightly with $6.5 million reported in 2001 compared to $6.6
million reported in 2000. An increase in the amount of software maintenance
revenue was offset by a decrease in the amount of professional service revenues.

COST OF REVENUES

Cost of revenues increased to $11.4 million in 2001 from $10.2 million in
2000. Cost of revenues as a percentage of revenues increased to 92.0% from
57.5%. Cost of license revenues increased to $2.7 million in 2001 from $1.4
million in 2000. As a percentage of revenues, it increased to 21.6% from 7.9%.
The increase in the cost of license revenues was primarily attributable to an
increase in product royalties paid to third parties as a result of new
agreements entered into late in 2000.

Cost of service revenues decreased slightly to $8.7 million in 2001 from
$8.8 million in 2000. As a percentage of revenues, it increased to 70.4% from
49.6%. The decrease in the cost of service revenues was primarily attributable
to higher personnel costs in 2001 which was more than offset by a decrease in
the use of third parties to perform services and reimbursable expenses.

The increases in cost of revenues, cost of license revenues and cost of
service revenues, as a percentage of total revenues was related more to a
reduction in the amount of license revenues, which resulted in a reduction of
total revenues, than to an increase in cost.

OPERATING EXPENSES

SALES AND MARKETING. Sales and marketing expenses decreased to $13.6 million, or
109.2% of revenues, in 2001 from $16.6 million, or 93.2% of revenues, in 2000.
The decrease in sales and marketing expenses is primarily the result of
significant decreases in sales personnel costs including salaries, bonus,
commission and recruiting fees. The number of sales employees decreased
throughout the year to 17 at December 31, 2001 from 76 at December 31, 2000, an
overall decrease of 78%. Additionally, a decrease in marketing spending for
tradeshows and advertising as well as amounts spent in 2000 that were not spent
in 2001 to change our name and update our corporate image and to hold a user
group conference contributed to the decrease in sales and

28

marketing expenses. The increase as a percentage of revenues was attributable to
the decrease in revenues exceeding the decrease in sales and marketing expenses.

RESEARCH AND DEVELOPMENT. Research and development expenses increased to $6.3
million, or 51.1% of revenues, in 2001 from $4.4 million, or 24.7% of revenues,
in 2000. The increase is a result of no allocation of software development costs
to discontinued operations in 2001 as opposed to 2000 where a portion of
software development costs were allocated to discontinued operations and greater
use of third party contractors to perform research and development work in 2001.

GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
slightly to $3.6 million, or 29.2% of revenues in 2001 from $3.5 million, or
19.4% of revenues in 2000. The increase in general and administrative expenses
was primarily the result of increased legal, accounting, investor relations and
other expenses related to being a public company for the full year 2001 versus
four months in 2000.

INTANGIBLE ASSETS AMORTIZATION. Intangible assets amortization decreased to $4.8
million, or 38.9% of revenues in 2001 from $5.1 million, or 28.4% of revenues in
2000. Intangible assets amortization consists of the amortization expense in
respect of the consideration in excess of the fair value of assets acquired and
liabilities assumed in our acquisition of the Molloy Group in 1999.

RESTRUCTURING AND OTHER NON-RECURRING CHARGES. Restructuring and other
non-recurring charges increased to $4.5 million, or 38.9% of revenues, in 2001
from $0.4 million, or 2.4% of revenues, in 2000. In 2001, restructuring charges
totaling $2.6 million primarily represent excess facilities costs and severance
benefits resulting from reductions in force of approximately 180 employees in
2001.

Other non-recurring charges in 2001 consist of $1.1 million in costs
recognized in conjunction with forgiveness of stockholder loans to certain
executives in connection with their severance agreements and the related taxes
as well as severance costs for senior executives of $0.6 million and a reserve
for stockholder loans of $0.3 million. Other non-recurring charges in 2000
consist of severance charges for senior executives of $0.3 million and
forgiveness of stockholder loans of $0.1 million.

OTHER INCOME (EXPENSE), NET

Other income (expense), net consists primarily of interest income received
from short-term investments, offset by interest expense and other fees related
to our bank borrowings. Other income (expense), net decreased to $449,000 or
3.6% of revenues in 2001 from $602,000 or 3.4% of revenues in 2000. The decrease
was primarily the result of a decrease in interest earned on investments offset
by a decrease in interest paid on outstanding debt.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have satisfied our cash requirements primarily through
private placements of convertible preferred stock and common stock, our initial
public offering, and incurrence of debt.

On April 1, 2002, we signed a binding commitment letter to sell a total of
$3,000,000 of convertible notes. A note purchase agreement was signed on May 6,
2002, and we received $1,425,000 less transaction costs of approximately
$150,000 from the closing of the first tranche of convertible notes in May 2002.
In accordance with their terms, the convertible notes did not become convertible
until stockholder approval of the transaction was obtained. Following
stockholder approval on June 11, 2002, the size of the transaction was increased
to $3,250,000 and on June 19, 2002, the second tranche of convertible notes was
issued with an aggregate principal amount of $1,825,000. At that time, we
received $1,825,000 less transaction costs of approximately $125,000. Of the
total amount of $3,250,000 of convertible notes issued, convertible notes with
an aggregate principal amount of $2,635,000 were acquired by a director of ours
and his affiliated entities, who collectively owned approximately 20% of our
stock prior to the acquisition of convertible notes and would collectively own
approximately 45% of our stock if all of their notes were converted. The
convertible notes mature 18 months from the closing date, bear interest at 10%
per annum, and are convertible at any time at the option of the holder, into
shares of our common stock at a conversion price of $0.30 per share. The holders
of our convertible notes have agreed to an amendment of these notes under which
the maturity date of the
29

convertible notes has been extended until July 15, 2004 and the conversion price
of the convertible notes has been reduced to $0.25 per share. Interest can be
paid in cash or additional convertible notes, at our option. The convertible
notes are senior unsecured obligations that will rank senior to all future
subordinated indebtedness, pari passu to all existing and future senior,
unsecured indebtedness and subordinated to all existing and future senior
secured indebtedness. While the notes are outstanding, we are restricted from
paying or declaring dividends on common stock, making any other distribution on
common stock, or repurchasing or redeeming any shares of common stock.

On October 16, 2002, we entered into a loan and security agreement with
Comerica Bank -- California (the "Bank"). The agreement allows for a revolving
line of credit and a term loan. Borrowings on the revolving line can be in
amounts up to the lesser of $2.0 million or 75% of eligible receivables and
mature October 1, 2003. Such amounts will bear interest at a rate of 1.5% above
the Bank's prime rate. Advances of up to $0.5 million on the term loan can be
taken until October 16, 2003, and mature one year from the date of the advance.
Such amounts are to be repaid in 12 monthly installments and will bear interest
at the Bank's prime rate which was 4.25% on December 31, 2002. In conjunction
with this agreement, a warrant was issued to the Bank to purchase 50,000 shares
of our Common Stock at an exercise price of $0.46 per share, with a 10-year
maturity. The warrant includes assignability to Bank's affiliates, antidilution
protection and a net exercise provision. In addition, the Bank can require us to
repurchase the warrant for $69,000 after a change of control.

Borrowings under the loan agreement are collateralized by essentially all
of our tangible and intangible assets. Borrowings shall also be secured in
accordance with a pledge of one or more certificates of deposit initially in the
aggregate face amount of $500,000 to be held by the Bank. The aggregate face
amount of such certificates of deposit required to be pledged to the Bank shall
be adjusted on a monthly basis to reflect reductions in the outstanding
principal balance of the Term Advance.

We are required to maintain all of our primary cash management, investment
and transaction accounts with the Bank. We must also comply with certain monthly
reporting and financial covenants. As of December 31, 2002, we were not in
compliance with our financial covenants, but have subsequently received a waiver
of these covenants through February 28, 2003 from the Bank and new covenants
have been established. In the event of default of the covenants, the Bank may
declare any outstanding amounts to be immediately due and payable, cease future
borrowings or credit, and/or exercise its rights under the loan agreement.

We incurred a net loss of $6.8 million for 2002. We have taken substantial
measures to reduce our costs and improve our chances to achieve profitability in
2003, however we may continue to incur net losses for the foreseeable future.

Net cash used for operating activities in 2002 is principally the result of
our net losses. The amount of cash used by current operations has been
substantially lower during 2002 due to lower personnel and office costs as a
result of our restructuring activities during 2001. The significant decrease in
amortization of intangible assets from 2001 is primarily due to the
discontinuation of amortization of goodwill in 2002 in accordance with SFAS 142
which resulted in $2.3 million expense not taken in the year and other
intangibles becoming fully amortized. The significant decrease in deferred
revenue in 2002 is primarily the result of revenue recognized in 2002 for
contracts deferred at December 31, 2001 and for new contracts in 2002 recognized
and not deferred at year end.

Net cash used in investing activities in 2002 was primarily attributable to
net purchases of short-term investments. Consistent with our overall cost
cutting, our need for capital spending for new equipment has declined for both
years.

Net cash provided by financing activities in 2002 was primarily from the
proceeds received upon issuance of our convertible notes and borrowings on our
revolving line of credit.

As of December 31, 2002, we had $3.0 million in cash and cash equivalents
and short term investments. Our ability to continue as a business in our present
form is largely dependent on our ability to generate additional revenues, reduce
overall operating expense, and achieve profitability and positive cash flows or
to obtain additional debt or equity financing. We believe that we have the
ability to do so and plan to fund 2003 operations through product sales, reduced
spending and utilizing the available funding under our existing debt
30

facilities of which we have $750,000 available at February 28, 2003. We also
expect to pursue additional funding to finance our operations and the
development of our business. We have taken steps to reduce our recurring costs
to approximate our anticipated level of revenues. These steps included layoffs
in 2001 of approximately 180 employees. Our future capital needs will be highly
dependent on market demand for our products and services as well as our ability
to control expenses and to manage the restructuring of operations. The holders
of our convertible notes have agreed to an amendment of these notes under which
the maturity date of the convertible notes has been extended until July 15, 2004
and the conversion price of the convertible notes has been reduced to $0.25 per
share. Although we continue to pursue these plans, there is no assurance that we
will be successful in obtaining sufficient license and service fees from our
products or additional financing on terms acceptable to us. Further, we believe
that in order to sustain business operations at the current levels through 2004,
we will need to obtain significant additional funding.

Our short term investments are held in an account with an investment firm
that is related to a director of ours and his affiliated entities, who
collectively owned approximately 20% of our stock prior to the acquisition of
convertible notes and would collectively own approximately 45% of our stock if
all of their notes were converted. Also, as investments are purchased and sold,
a cash balance may be held by this firm.

There can be no assurance that additional capital will be available to us
on reasonable terms, if at all, when needed or desired. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock. Furthermore, because of the low trading price of our
common stock, the number of shares of new equity or equity-related securities
that we may be required to issue may be greater than it otherwise would be. As a
result, our stockholders may suffer significant additional dilution. Further,
the issuance of debt securities could increase the risk or perceived risk of our
company.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Financial Accounting Standards Board ("FASB") issued
FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45
addresses the disclosures to be made by a guarantor in interim and annual
financial statements about its obligations under guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of this interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002.

Under the indemnification provisions of our standard product license
agreement, we guarantee to defend and indemnify our licensees against any
proceeding based upon infringement of any patent, copyright, trade secret or
other intellectual property right by the products we license to our customers.
We do not expect to incur any infringement liability as a result of the customer
indemnification clauses as of December 31, 2002.

In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities",
effective for fiscal years beginning after December 15, 2002. Under the new
rules, a liability for a cost associated with an exit or disposal activity must
only be recognized when the liability is incurred. Under the previous guidance
of EITF 94-3, a liability for exit costs was recognized at the date of an
entity's commitment to an exit plan. In the past, we have been subject to the
provisions of EITF 94-3 when adopting plans to exit activities and therefore, if
we were to commit to further exit plans subsequent to the effective date, we
would be subject to the new rules regarding expense recognition.

31

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Nearly all of our revenues recognized to date have been denominated in
United States dollars and are primarily from customers in the United States. We
have a European subsidiary located in London, England. Revenues from
international clients were 12% in 2002 and 8% in 2001, but previously had not
been substantial, and nearly all of these revenues have been denominated in
United States dollars. In the future, a portion of the revenues we derive from
international operations may be denominated in foreign currencies. We incur
costs for our overseas office in the local currency of that office for staffing,
rent, telecommunications and other services. As a result, our operating results
could become subject to significant fluctuations based upon changes in the
exchange rates of those currencies in relation to the United States dollar.
Furthermore, to the extent that we engage in international sales denominated in
United States dollars, an increase in the value of the United States dollar
relative to foreign currencies could make our services less competitive in
international markets. Although currency fluctuations are currently not a
material risk to our operating results, we will continue to monitor our exposure
to currency fluctuations and when appropriate, consider the use of financial
hedging techniques to minimize the effect of these fluctuations in the future.
We cannot assure you that exchange rate fluctuations will not harm our business
in the future. We do not currently utilize any derivative financial instruments
or derivative commodity instruments.

Our interest income is sensitive to changes in the general level of United
States interest rates, particularly because the majority of our investments are
in short-term instruments. With respect to market risk relating to interest
expense, our convertible notes bear interest at a fixed rate, but mature in
fourth quarter 2003. As a result, we do not believe that we are currently
subject to material interest rate risk.

32

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following consolidated financial statements as of December 31, 2002 and
2001 and for the three years ended December 31, 2002 are included herein:

33

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Stockholders of ServiceWare Technologies, Inc.

In our opinion, the accompanying consolidated balance sheet as of December
31, 2002 and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended present fairly, in all material
respects, the financial position of ServiceWare Technologies, Inc. at December
31, 2002, and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. The financial statements of
the Company as of December 31, 2001 and for the two years then ended were
audited by other independent accountants whose report dated January 25, 2002
expressed an unqualified opinion on those statements.

As more fully discussed in Note 1 to the consolidated financial statements,
the Company has incurred a net loss and has negative cash flows from operations.
The Company's plans for providing liquidity during fiscal 2003 are also
discussed in Note 1. Additionally as discussed in Note 2 to the consolidated
financial statements, effective January 1, 2002, the Company changed its
accounting for intangible assets pursuant to the provisions of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets."

/s/ PricewaterhouseCoopers LLP

Philadelphia, Pennsylvania
January 29, 2003, except for Note 1 and Note 19,
as to which date is March 31, 2003

34

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and
Stockholders of ServiceWare Technologies, Inc.

We have audited the accompanying consolidated balance sheet of ServiceWare
Technologies, Inc., as of December 31, 2001, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
two years in the period ended December 31, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ServiceWare Technologies, Inc., at December 31, 2001, and the results of its
operations and its cash flows for each of the two years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.

/s/ ERNST & YOUNG LLP

Pittsburgh, Pennsylvania
January 25, 2002

35

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to the financial statements.
36

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to the financial statements.
37

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

See accompanying notes to the financial statements.
38

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)

See accompanying notes to the financial statements.
39

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)

See accompanying notes to the financial statements.
40

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)

See accompanying notes to the financial statements.
41

SERVICEWARE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to the financial statements.
42

SERVICEWARE TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2002

NOTE 1. ORGANIZATION OF THE COMPANY

ServiceWare Technologies is a leading provider of enterprise Knowledge
Management (KM) solutions that enable organizations to deliver superior service
to customers, employees and partners by transforming information into knowledge.

ServiceWare Enterprise(TM) (formerly named eService Suite), powered by The
Cognitive Processor(R), a patented self-learning search technology, enables
organizations to capture and manage intellectual capital. This repository of
corporate knowledge, known as a knowledge base, can then be easily accessed via
a browser to effectively answer inquiries made either over the Web or through
the telephone to a customer contact center or help desk.

Customers use ServiceWare's Knowledge Management solutions to:

- Strengthen relationships with customers, partners, suppliers and
employees

- Decrease operating costs

- Improve creation, dissemination and sharing of enterprise knowledge

- Integrate seamlessly with existing technology investments

ServiceWare Enterprise(TM) is a software solution that allows ServiceWare
customers to provide personalized, automated Web-based service tailored to the
needs of their users. ServiceWare Enterprise enables businesses to capture
enterprise knowledge, solve customer problems, reuse solutions and share
captured knowledge throughout the extended enterprise. It also enables the
extended enterprise to access this knowledge online. In addition, through the
self-learning features of ServiceWare's patented Cognitive Processor technology,
the solutions generated by these products are intelligent in that they have the
capability to learn from each interaction and automatically update themselves
accordingly. ServiceWare Enterprise includes the software products ServiceWare
Self-Service(TM) (Web-based self-service for customers, partners and employees),
ServiceWare Professional(TM) (for customer service, sales and field service
personnel) and ServiceWare Architect(TM) (for quality assurance managers and
system administrators). ServiceWare also provides a portal solution, ServiceWare
Knowledge Portal, based on the technology acquired from InfoImage in August
2002.

The Company had two reportable business segments: Software and Content.
However, in July 2001, the Company completed the sale of all of its Content
segment to RightAnswers LLC ("RightAnswers"). The Content segment is reported as
a discontinued operation, and all previously reported financial information has
been restated accordingly. See Note 6.

The accompanying financial statements have been prepared on a basis which
assumes that the Company will continue as a going concern and which contemplates
the realization of assets and the satisfaction of liabilities and commitments in
the normal course of business. The Company has an accumulated deficit of
$73,505,734 at December 31, 2002, incurred a net loss of $6,825,361 and had
negative cash flows from operations of $5,258,438 for the year then ended, and
expects to incur additional losses and negative cash flows in 2003. The ability
of the Company to continue in its present form is largely dependent on its
ability to generate additional revenues, reduce overall operating expense, and
achieve profitability and positive cash flows or to obtain additional debt or
equity financing. Management believes that it has the ability to do so and plans
to fund 2003 operations through product sales, reduced spending and utilizing
the available funding under existing debt facilities. In March 2003, the holders
of the Company's convertible notes agreed to an amendment of these notes under
which their maturity date was extended until July 15, 2004 and their conversion
price was reduced to $0.25 per share. Although management continues to pursue
these plans, there is no assurance that the Company will be successful in
obtaining sufficient license and service fees from its

43

products or additional financing on terms acceptable to the Company. Further,
management believes that in order to sustain business operations at the current
levels through 2004, it will be necessary to obtain significant additional
funding.

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries after elimination of all significant
intercompany accounts and transactions.

RECLASSIFICATION

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

REVENUE RECOGNITION

The Company's revenue recognition policy is governed by Statement of
Position (SOP) 97-2, "Software Revenue Recognition", issued by the American
Institute of Certified Public Accountants (AICPA), as amended by SOP 98-9
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions". The Company derives its revenues from licenses for its products
sold directly to end-users and indirectly through distributors as well as from
providing related services, including installation and training, consulting,
customer support and maintenance contracts. Revenues are recognized only if
persuasive evidence of an agreement exists, delivery has occurred, all
significant vendor obligations are satisfied, the fee is fixed or determinable,
and collection of the amount due from the customer is deemed probable.
Additionally, in sales contracts that have multi-element arrangements, the
Company recognizes revenue using the residual method. The total fair value of
the undelivered elements as indicated by vendor-specific objective evidence
(price charged when the undelivered element is sold individually) is deferred
and the difference between the total arrangement fee and the amount deferred for
the undelivered elements is recognized as revenue related to the delivered
elements. Additional revenue recognition criteria by revenue type are listed
below.

Licenses revenues

Licenses revenues include fees for perpetual and annual licenses. The
Company recognizes revenues on license fees after a non-cancelable license
agreement has been signed, the product has been delivered, the fee is fixed,
determinable and collectible, and there is vendor-specific objective evidence to
support the allocation of the total fee to elements of a multiple-element
arrangement. Product returns and sales allowances (which have not been
significant through December 31, 2002) are estimated and provided for at the
time of sale.

Services revenues

Services revenues are derived from variable fees for installation,
training, consulting and building customized knowledge bases as well as from
fixed fees for customer support and maintenance contracts.

Maintenance and support revenues are derived from the sale of maintenance
and support contracts, which provide end-users with the right to receive
maintenance releases of the licensed products, access to the support Web site
and access to the customer support staff. Maintenance and support revenues are
recognized on a straight-line basis over the term of the contract. Payments for
maintenance and support revenues are normally received in advance and are
nonrefundable.

Revenues for installation and training, implementation and system
integration projects, and consulting services are recognized as the services are
performed.

44

COST OF REVENUES

Cost of licenses revenues consists primarily of the expenses related to
royalties, the cost of media on which product is delivered, product fulfillment
costs, amortization of purchased technology and salaries, benefits, direct
expenses and allocated overhead costs related to product fulfillment.

Cost of services revenues consists of direct and indirect costs related to
service revenues which primarily include salaries, benefits, direct expenses and
allocated overhead costs related to the customer support and services personnel,
fees for subcontractors and the cost associated with maintaining our customer
support site.

Deferred revenues relate to product licenses, maintenance services, and
professional services, all of which generally have been paid for in advance.
Additionally, deferred revenues include amounts that are unbilled that represent
non-cancelable amounts billable by the Company at future dates based on payment
terms.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash and interest-bearing money market
deposits with financial institutions having original maturities of ninety days
or less. Cash equivalents are stated at cost, which approximates market value.
The amounts held by major financial institutions may exceed the amount of
insurance provided on such deposits. These deposits may generally be redeemed
upon demand and, therefore, subject the Company to minimal risk.

Borrowings under the Company's loan and security agreement with Comerica
Bank -- California are to be secured in accordance with a pledge of one or more
certificates of deposit initially in the aggregate face amount of $500,000 to be
held by the Bank (see also Note 5). However, this requirement was waived for
borrowings outstanding at December 31, 2002.

INVESTMENTS

The Company considers all investments as available-for-sale. Accordingly,
these investments are carried at fair value and unrealized holding gains and
losses, net of the related tax effect, are excluded from earnings and are
reported as a separate component of other comprehensive income (loss) until
realized. Realized gains and losses from the sale of available-for-sale
securities are determined on a specific identification basis.

Our short term investments are held in an account with an investment firm
that is related to a Director of the Company and his affiliated entities (see
Note 17).

OTHER CURRENT ASSETS

Other current assets consist primarily of deposits and prepayments for
expenses to be realized within the next year.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the related assets
(generally two to five years). Leasehold improvements are amortized over the
lesser of their useful lives or the remaining term of the lease. Amortization of
assets recorded under capital leases is included in depreciation expense.
Capital leases, which are for office equipment, are amortized over the term of
the lease. Upon disposal, assets and related accumulated depreciation are
removed from the Company's accounts and the resulting gains or losses are
reflected in the statement of operations.

INTERNAL USE COMPUTER SOFTWARE

The Company applies AICPA Statement of Position No. 98-1 "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP No.
98-1"). Accordingly, the Company capitalizes internal and external costs related
to software and implementation services in connection with its internal use
software systems.
45

INTANGIBLE ASSETS AND GOODWILL

Intangible assets and goodwill resulted primarily from the acquisition of
Molloy Group on July 23, 1999 and consist of the following at December 31, 2002:

Intangible assets and goodwill are recorded at cost, net of accumulated
amortization. Amortization is computed using the straight-line method over the
estimated useful lives of the related assets (one to four years). The remaining
amortization on intangible assets of $146,745 will be expensed in 2003.

On an ongoing basis, when there are indicators of impairment such as
declining revenues or recurring losses, the Company evaluates the carrying value
of long lived assets resulting from business acquisitions. If such indicators
are apparent, the Company compares the carrying value of the assets to the
estimated future undiscounted cash flows expected to be generated from the
businesses acquired over the remaining life of the assets. If the undiscounted
cash flows are less than the carrying value of the assets, the cash flows will
be discounted to present value and the assets will be reduced to this amount.
There was no impairment for the years ended December 31, 2002, 2001 and 2000.

As described above, goodwill amortization ceased as of December 31, 2001.
The following reflects adjusted net income and the effect of goodwill
amortization on net loss per share as if SFAS 142 had been in effect from the
beginning of each of the years ended December 31, 2001 and 2000:

CONCENTRATION OF CREDIT RISK / MAJOR CUSTOMERS

Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of accounts receivable. The
Company sells its products to end-users directly, and the Company's customer
base is dispersed across many different geographic areas primarily throughout
North America and parts of Europe. The Company performs ongoing credit
evaluations of its customers' financial condition, and

46

generally no collateral is required. The Company maintains adequate reserves for
potential credit losses and such losses have been minimal and within
management's estimates.

In 2002, two customers accounted for 11% and 8% of total revenues and 0%
and 34% of total accounts receivable at December 31, 2002. In 2001, three
customers accounted for 22%, 12% and 10% of total revenues and 0%, 51% and 8% of
total accounts receivable at December 31, 2001. In 2000, three customers
accounted for a total of 7% of total revenues and 42% of total accounts
receivable at December 31, 2000.

RESEARCH AND DEVELOPMENT

Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers provided recoverability is reasonably assured. The Company follows the
"working model" approach, whereby technological feasibility is established at
the time the Company has a beta customer. The Company releases updated products
periodically soon after technological feasibility has been established for new
enhancements. For 2002, 2001, and 2000, costs which were eligible for
capitalization were insignificant and, thus, the Company has charged its
software development costs to research and development expense in the
accompanying statements of operations with the exception of the technology
acquired from the Molloy Group on July 23, 1999 whereby $1,777,367 was
capitalized and the technology acquired from InfoImage on August 21, 2002
whereby $100,000 was capitalized. These amounts are classified as purchased
technology and are being amortized on a straight line basis over two to three
years.

In 2001, the Company entered into an agreement to use a third party
contractor to perform research and development work. In 2002, this contractor
completed most of the Company's research and development as well as customer
support and professional services work.

ADVERTISING COSTS

Advertising and sales promotions are charged to expense during the period
in which they are incurred. Total advertising and sales promotions expense for
the years ended December 31, 2002, 2001, and 2000 were approximately $207,000,
$1,704,000, and $2,315,000, respectively.

FOREIGN CURRENCY TRANSLATION

The functional currency of the Company's foreign subsidiary is the local
currency in the country in which the subsidiary is located. Assets and
liabilities denominated in foreign currencies are translated to U.S. dollars at
the exchange rate in effect on the last day of the month of the balance sheet
date. Revenues and expenses are translated at the average rates.

STOCK BASED COMPENSATION

The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). SFAS No. 123 permits the Company to continue
accounting for stock-based compensation as set forth in Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB Opinion
No. 25"), provided the Company discloses the pro forma effect on net income and
earnings per share of adopting the full provisions of SFAS No. 123. Accordingly,
the Company continues to account for stock-based compensation under APB Opinion
No. 25 (see Note 9).

47

The following proforma disclosure presents the Company's net loss and loss
per share had compensation cost for the Company's stock option plans been
determined based upon the fair value at the grant date for awards under these
plans consistent with the methodology prescribed under SFAS 123.

The average fair value of the options granted is estimated at $0.37 during
2002, $0.65 during 2001 and $1.16 during 2000, on the date of grant using the
Black-Scholes pricing model with the following assumptions:

The effects of applying SFAS 123 in this pro forma disclosure are not
likely to be representative of the effects on reported net income for future
years. SFAS 123 does not apply to awards prior to 1995 and additional awards in
future years are anticipated.

STATEMENT OF CASH FLOWS

Noncash transactions for the years ended December 31, 2002, 2001, and 2000
include capital lease additions of approximately $92,000, $84,000, and $146,000,
respectively. Additionally, noncash transactions for the year ended December 31,
2002 include an increase to additional paid in capital of $2,338,067 for the
beneficial conversion feature related to the convertible notes issued during the
year.

USE OF ESTIMATES

The preparation of the Company's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the balance sheet dates and the reported
amounts of revenue and expenses during the reporting periods. Actual results
could differ from those estimates.

NET LOSS PER SHARE

In accordance with SFAS No. 128, "Earnings Per Share", basic and dilutive
net loss per share have been computed using the weighted-average number of
shares of common stock outstanding during the period. All potential dilutive
securities have not been included in the calculation of net loss per share due
to their anti-dilutive effect.

48

OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) consists of foreign currency translation
adjustments and net unrealized gains from securities available-for-sale.
Statements of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" requires only additional disclosures in the financial statements; it
does not affect the Company's financial position or operations.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2002, the Financial Accounting Standards Board ("FASB") issued
FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45
addresses the disclosures to be made by a guarantor in interim and annual
financial statements about its obligations under guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of this interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002.

Under the indemnification provisions of the Company's standard product
license agreement, the Company guarantees to defend and indemnify the licensee
against any proceeding based upon infringements of any patent, copyright, trade
secret or other intellectual property right by the products the Company licenses
to its customers. The Company does not expect to incur any infringement
liability as a result of the customer indemnification clauses as of December 31,
2002.

In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities", effective for fiscal years beginning after
December 15, 2002. Under the new rules, a liability for a cost associated with
an exit or disposal activity must only be recognized when the liability is
incurred. Under the previous guidance of EITF 94-3, "Liability Recognition for
Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)", a liability for exit costs was recognized at the date of an
entity's commitment to an exit plan. In the past, we have been subject to the
provisions of EITF 94-3 when adopting plans to exit activities and therefore, if
we were to commit to further exit plans subsequent to the effective date, we
would be subject to the new rules regarding expense recognition.

NOTE 3. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of the Company's financial instruments consisting
principally of cash and cash equivalents, short term investments, accounts
receivable and payable, debt, and note receivable from common stockholder
approximate their fair values at December 31, 2002 and 2001.

NOTE 4. RECEIVABLES

Receivables consist of the following:

49

Activity in the allowance for doubtful accounts is as follows:

NOTE 5. DEBT

CREDIT FACILITIES

On October 16, 2002, the Company entered into a $2.5 million Loan and
Security Agreement (the "Agreement") with Comerica Bank -- California (the
"Bank"). The Agreement allows for a revolving line of credit ("Revolving
Facility") and a term loan ("Term Advance"). Advances on the Revolving Facility
can be in amounts up to the lesser of $2.0 million or 75% of eligible
receivables and mature October 1, 2003. Such amounts will bear interest at a
rate of 1.5% above the Bank's prime rate. Term Advances of up to $0.5 million
can be taken until October 16, 2003 and will mature one year from the date of
the advance. Such amounts are to be repaid in 12 monthly installments and will
bear interest at the Bank's prime rate.

Borrowings under the Agreement are collateralized by essentially all of the
Company's tangible and intangible assets. Borrowings shall also be
collateralized in accordance with a pledge of one or more certificates of
deposit initially in the aggregate face amount of $500,000 to be held by the
Bank. The aggregate face amount of such certificates of deposit required to be
pledged to the Bank shall be adjusted on a monthly basis to reflect reductions
in the outstanding principal balance of the Term Advance. However, this
requirement was waived for borrowings outstanding at December 31, 2002.

The Company is required to maintain all of its primary cash management,
investment and transaction accounts with the Bank. The Company must also comply
with certain monthly reporting and financial covenants. The financial covenants
consisting of the following:

- Quick Ratio. A ratio of (Quick Assets) to (Current Liabilities
(including undrawn letters of credit and credit card sublimits, if any)
plus all non-cash collateralized indebtedness to Bank minus deferred
maintenance contract revenue) of at least 1.50 to 1.00.

- Minimum EBITDA. Minimum EBITDA calculated on a trailing three-month
basis in amounts as further defined in the Agreement.

- Total Liabilities Minus Convertible Subordinated Debt to Tangible Net
Worth plus Convertible Subordinated Debt. A ratio of (Total Liabilities
(including but not limited to undrawn letters of credit and credit card
sublimits, if any) minus Convertible Subordinated Debt (defined as
Subordinated Debt which by its terms is convertible into equity of
Borrower)) to (Tangible Net Worth plus Convertible Subordinated Debt) of
not more than 2.25 to 1.00.

As of December 31, 2002, the Company was not in compliance with its
financial covenants, but has subsequently received a waiver of these covenants
from the Bank.

In the event of default of the covenants, the Bank may declare any
outstanding amounts to be immediately due and payable, cease future borrowings
or credit, and/or exercise its rights under the loan agreement.

50

In conjunction with this loan agreement, a warrant was issued to the Bank
to purchase 50,000 shares of the Company's Common Stock at an exercise price of
$0.46 per share, with a 10-year maturity. The warrant includes assignability to
Bank's affiliates, antidilution protection and a net exercise provision. In
addition, the Bank can require the Company to repurchase the warrant for $69,000
upon a change of control (as further defined in the warrant agreement). The
warrant is treated as consideration for the Agreement and was valued at $22,990
on the date of the issuance using the Black Scholes option valuation model. As
such, the warrant value was recorded as a debt issue cost and is being amortized
to interest expense over the life of the agreement. As the warrant contains a
put option, the warrant value was accrued as a liability and not recorded as
equity.

At December 31, 2002, $800,000 was outstanding on the Revolving Facility
and the weighted average interest rate on these borrowings was 5.75%. No amount
was outstanding on the Term Advance.

Previously, the Company had a secured credit facility with PNC Bank. In
April 2002, the remaining outstanding loan of $200,820 was repaid in full. At
December 31, 2002, this agreement had expired and no amounts were outstanding.
At December 31, 2001, $258,197 was outstanding and classified as other current
liabilities due to the uncertainty of the Company's ability to meet the loan
covenants.

CONVERTIBLE NOTES

On April 1, 2002, the Company signed a binding commitment letter for the
sale of convertible notes. The closing of the transaction took place in two
tranches on May 6 and June 19, 2002 with total proceeds of $2,975,000 being
received, net of transaction costs of $275,000.

Of the total amount of $3,250,000 of convertible notes issued, convertible
notes with an aggregate principal amount of $2,635,000 were acquired by a
director of the Company and his affiliated entities, who collectively owned
approximately 20% of the Company's stock prior to the acquisition of convertible
notes and would collectively own approximately 45% of the Company's stock if all
of his notes were converted.

The convertible notes mature 18 months from the closing date, bear interest
at 10% per annum, and are convertible at any time at the option of the holder,
into shares of the Company's common stock at a conversion price of $0.30 per
share. Interest can be paid in cash or additional convertible notes, at the
option of the Company. The convertible notes are senior unsecured obligations
that will rank senior to all future subordinated indebtedness, pari passu to all
existing and future senior, unsecured indebtedness and subordinated to all
existing and future senior secured indebtedness. While the notes are
outstanding, the Company is restricted from paying or declaring dividends on
common stock, making any other distribution on common stock, or repurchasing or
redeeming any shares of common stock.

In accordance with EITF 00-27, "Application of EITF Issue No. 98-5,
'Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios,' to Certain Convertible Instruments",
the Company recognized a beneficial conversion feature ("BCF") in the aggregate
amount of $2,225,000 as the difference between the market value of the Company's
common stock on the commitment date and the conversion price of the convertible
notes, reduced for the investors' transaction costs. The BCF was recorded as an
increase in additional paid in capital and a discount on debt on the
accompanying balance sheet. Additionally, the Company incurred total legal and
other expenses of approximately $54,000 related to the transaction which is also
recorded as a discount on debt in the accompanying balance sheet. The aggregate
discount is being amortized as interest expense over the 18 month term of the
convertible notes.

On October 31, 2002, the first interest payment was due on the convertible
notes and was paid by issuing additional convertible notes in the amount of
$135,681. These additional convertible notes have the same terms as the original
convertible notes. Furthermore, the Company recognized additional BCF of
$113,067.

51

NOTE 6. DISCONTINUED OPERATIONS

On July 20, 2001, the Company completed the sale of its Content business
segment to RightAnswers. The sale was completed in accordance with the terms of
a Purchase and Sale Agreement (the "Agreement"), dated July 20, 2001, between
the Company and RightAnswers.

RightAnswers is a limited liability company that was formed to acquire the
Company's Content business. The Chief Executive Officer of RightAnswers, Mark
Finkel, was the Company's Chief Financial Officer from January 2000 to July
2001. In addition, Mr. Finkel owns an equity interest in RightAnswers.

The consideration for the business consisted of the assumption of
approximately $0.5 million of net liabilities associated with the business.
Revenues for the Content segment were $2.9 million and $12.0 million for the
years ended December 31, 2001 and 2000, respectively.

NOTE 7. RESTRUCTURING AND OTHER NON-RECURRING CHARGES

In 2001, the Company implemented strategic restructurings to reduce its
cost structure and focus on revenue growth opportunities in the Knowledge
Management software market. The plans of restructuring approved by the Board of
Directors included severance and other benefit costs, costs for reduction and
relocation of facilities, termination costs for certain service contracts and an
equipment write off. As part of the restructuring plan, 55 employees were laid
off on February 28, 2001. In July 2001, the Company implemented a revision to
its organizational structure and a workforce reduction of an additional 75
employees. In October 2001, the Company implemented a workforce reduction of
approximately 50 people to further reduce its cost structure.

A portion of the restructuring charge related to potential costs for
terminating certain real estate leases at the Company's corporate headquarters,
in addition to amounts related to unused capacity within the building. The
Company has been successful in sub-leasing much of the unused capacity and
consequently reduced its reserve for excess capacity. Additionally, management
has decided not to terminate the lease on the property as anticipated and
accordingly has reversed approximately $302,000 in exit reserves in 2002.
Furthermore, a change in the estimate of the termination costs for certain
service contracts was recorded as a reduction to the restructuring expense of
$130,000 in 2002.

The remaining restructuring liability of $116,000, related to reduction of
facilities, is expected to be fully amortized by June 2003.

A summary of the restructuring activity is as follows (amounts in
thousands):

52

Other non-recurring charges consist of severance costs for senior
executives, forgiveness of loans in connection with repurchases of common stock,
and income tax gross-ups related to the loan forgiveness. The restructuring and
other non-recurring charges of separated executives consist of the following
amounts:

NOTE 8. INITIAL PUBLIC OFFERING

On August 30, 2000, the Company closed its initial public offering (IPO) of
4,500,000 shares of its common stock, and on September 27, 2000, the Company
closed its offering of an additional 675,000 shares of common stock issued in
connection with the exercise of the underwriters' overallotment option. Net
proceeds of the offering were approximately $31.6 million, after deducting
underwriting discounts, commissions and other offering expenses. Simultaneously
with the closing of the initial public offering, all 8,786,392 shares of Series
A, Series B, Series C, Series D, Series E and Series F convertible preferred
stock were automatically converted into an aggregate of 10,822,023 shares of
common stock at various conversion ratios.

NOTE 9. STOCKHOLDERS' EQUITY

The Company has two classes of capital stock consisting of common stock and
preferred stock. At December 31, 2002, a total of 100,000,000 shares are
authorized for common stock and 5,000,000 are authorized for preferred stock.

COMMON STOCK

The Company has reserved 17,519,189 shares of common stock. Of this total,
11,285,601 are reserved for the conversion of the convertible notes, 5,568,300
shares are reserved for exercise of stock options, and 665,288 shares are
reserved for exercise of warrants.

STOCK OPTION PLAN

Effective April 2000, the Company's Board of Directors approved the
ServiceWare Technologies, Inc. 2000 Stock Incentive Plan (the "Plan") which
amended and restated the 1996 ServiceWare, Inc. Amended and Restated Stock
Option Plan (the "1996 Plan"). The Plan is administered by the Board of
Directors and provides for awards of stock options to employees, officers,
directors, consultants and advisors. A total of 6,750,000 shares of the
Company's Common Stock plus any shares of Common Stock previously reserved for
stock options granted under the 1996 Plan which are forfeited prior to exercise
may be issued pursuant to the Plan. The exercise price of incentive stock
options was determined by management and the Board of Directors for the period
from April 2000 through the IPO date. After the IPO, the exercise price is the
closing market price of the Company's Common Stock on the date of the grant. The
exercise price of nonqualified options is also determined by the Board of
Directors. Options generally vest over a two year period in equal annual
amounts, or over such other period as the Board of Directors determines, and may
be accelerated in the event of certain transactions such as merger or sale of
the Company. These options expire within ten years after the date of grant.
During 2002, the Company recorded $78,344 in stock based compensation expenses
related to accelerated vesting of outstanding options. During 2001, the Company
recorded $1,125,194 in reversals of deferred compensation in conjunction with
repurchasing shares of restricted stock and forgiving stockholder loans (see
Note 11 for further explanation), $350,350 in reversals of deferred compensation
for cancelled

53

options, and $51,882 in stock based compensation expenses. During 2000, the
Company recorded $2,386,665 and $864,055 in deferred compensation and stock
based compensation expenses, respectively.

The following table summarizes option activity for the years ended December
31, 2002, 2001, and 2000:

The options outstanding as of December 31, 2002 have been segregated into
ranges for additional disclosure as follows:

On August 28, 2002, the Company offered our full-time and part-time
employees and non-employee directors the opportunity to exchange their
outstanding stock options for an equal number of new options (adjusted for a
reverse stock split or similar event, should this happen) to be granted on the
first business day that is at least six months plus one day after the expiration
of the offer. The offer expired September 30, 2002, and options for 436,460
shares of common stock were tendered. New options are expected to be granted
March 31, 2003 to those participants who are employed by ServiceWare on both the
date this offer expired and the date that the new options are granted.

EMPLOYEE STOCK PURCHASE PLAN

In May 2000, the Company adopted the Employee Stock Purchase Plan (ESPP).
Under the terms of the ESPP, the Company is authorized to issue up to 500,000
shares of common stock, plus annual increases as

54

defined by the plan document. The ESPP enables employees to purchase shares of
the Company's common stock at a discounted price through after-tax payroll
deductions. Shares are offered to employees in six month offering periods.
Eligible employees elect to have deducted from 1% to 15% of their base
compensation. The amounts deducted can be used to purchase the Company's common
stock at the lesser of 85% of the fair value on the first day of the offering
period or 85% of the fair value on last day of the offering period (purchase
date). At December 31, 2002, 404,797 shares remained available for purchase
under the plan.

NOTE 10. WARRANTS

The following table summarizes warrant activity for the years ended
December 31, 2002, 2001 and 2000:

The valuation of warrants was calculated using the Black-Scholes pricing
model. The holders of the warrants have the right to exercise their warrants for
shares of the Company's common stock at anytime until the expiration of the
warrant. Expiration dates of the warrants outstanding at December 31, 2002 are
as follows:

Warrant amortization recorded as a reduction of revenue was $104,346 and
$159,725 during 2002 and 2001, respectively, and relates to warrants issued to a
customer primarily in connection with a master license agreement entered into in
2000.

NOTE 11. NOTES RECEIVABLE FROM COMMON STOCKHOLDERS

In January and February 2000, certain executive officers exercised options
to purchase shares of Common Stock, and issued promissory notes to the Company
in conjunction with the purchases. These officers are personally liable for the
principal and interest due on their loans. Each loan is secured by the shares
purchased

55

with the proceeds of that loan. Each loan becomes due and payable three years
from the date it was made or earlier if the individual's employment is
terminated or he or she no longer owns the shares. These loans were made at
interest rates between 5.8% and 6.1%, which were the applicable Federal rates in
effect under Section 1274(d) of the Internal Revenue Code of 1986, as amended,
on the date of issuance. The respective total number of shares purchased and the
amounts loaned as well as amounts repurchased due to employment termination are
set forth in the table below.

During 2001, five of the loans were forgiven in the amount of $2,030,422 in
exchange for 826,750 restricted and unrestricted shares outstanding under the
loans. In accordance with repurchase agreements, restricted shares were
repurchased at the price paid for the shares (exercise price of the option).
Unrestricted shares were repurchased at the fair market value on the date of
termination. The difference between the principal of the loan balance and the
value of the shares repurchased of $732,323 was recorded as compensation expense
and is classified as restructuring and other non-recurring charges during 2001.
An amount of $307,160 was recorded to treasury stock in 2001 for the repurchased
shares, which was the fair market value of the shares on the date of
termination. Amounts in excess of fair market value have been recorded as
additional paid in capital. Additionally, $1,125,914 of deferred stock based
compensation was reversed for the restricted shares that were repurchased from
the executives.

Under severance agreements with four of the executives, the Company agreed
to pay any personal tax liability arising from these transactions. As a result,
the Company recorded an expense of $350,546 in 2001 which has been classified as
restructuring and other non-recurring charges. An additional expense of $49,711
was recognized in 2002 as actual personal tax liabilities were determined. All
amounts were paid by December 31, 2002. Additionally, interest on the loans of
$191,175 was also forgiven. This income was reversed and is classified as other
expense in 2001.

On January 24, 1999, a former president of the Company exercised options to
purchase 86,956 shares of Common Stock at a purchase price of $2.30 per share. A
promissory note in the amount of $199,999 was issued in conjunction with the
sale. The note bears interest at the applicable federal rate defined in the
Internal Revenue Code of 1986, as amended and is due September 2003.

As of December 31, 2002, the loan made on January 24, 1999 and one loan
made on January 31, 2000 remain outstanding. The total principal amount of these
loans is $319,789, which has been fully reserved for in 2001. Additionally, in
2002 the Company reserved for an additional $62,636 for interest accrued on
these notes in the event these loans become uncollectible. No additional
interest income has been recorded for these notes.

56

NOTE 12. CAPITAL AND OPERATING LEASES

The Company has several capital and operating leases covering office space
and certain equipment. Future minimum lease payments due under noncancelable
capital and operating leases are as follows:

Total rent expense under all operating leases amounted to $464,108,
$1,426,416 and $1,554,924 in 2002, 2001 and 2000, respectively.

During 2001, the Company entered into a sublease for part of its office
space in Oakmont, Pennsylvania. The monthly lease payment is $5,927. The term of
the sublease is concurrent with the Company's lease which is through March 31,
2006, however, the sublease may be terminated by either party with 90 days
written notice at any time after January 31, 2002. The Company received $71,124
and $25,811 in 2002 and 2001, respectively, in rental payments for this
sublease.

NOTE 13. INCOME TAXES

A reconciliation of the benefit for income taxes on operations computed by
applying the federal statutory rate of 34% to the loss from operations before
income taxes and the reported benefit for income taxes on operations is as
follows:

57

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31 are as
follows:

Management has recorded a valuation allowance against the deferred tax
assets until such time that the Company demonstrates an ability to generate
taxable income on a consistent basis.

At December 31, 2002, the Company had net operating loss carryforwards of
approximately $58,403,000 which expire between 2002-2022. Utilization of certain
net operating loss carryforwards is subject to limitation under Section 382 of
the Internal Revenue Code.

NOTE 14. NET LOSS PER SHARE

The following table sets forth the computation of basic and diluted
earnings (loss) per share:

Dilutive securities include convertible notes, options and warrants as if
converted. Potentially dilutive securities totaling 17,519,189, 4,981,292 and
3,794,873 for the years ended December 31, 2002, 2001 and 2000, respectively,
were excluded from historical basic and diluted loss per share because of their
antidilutive effect.

58

NOTE 15. RETIREMENT PLAN

The Company has a 401(k) profit sharing plan (the "Plan") covering all of
its employees subject to certain age and service requirements. Under provisions
of the Plan, participants may contribute up to 15% of their eligible
compensation to the Plan. The Company contributed $186,547, $419,125 and
$230,716 in matching contributions to the Plan in 2002, 2001 and 2000,
respectively.

NOTE 16. SEGMENT REPORTING

Subsequent to the sale of the Content segment in July 2001, the Company has
only one business segment (see Note 6).

Geographic Information

(a) Revenues are attributed to the United States and International based on
customer location.

(b) Long-lived assets include non-current assets of the Company.

Major Customers

Sales are made primarily through the Company's direct sales force. See
discussion of major customers in Note 2.

NOTE 17. RELATED PARTY TRANSACTIONS

Our short term investments are held in an account with an investment firm
that is related to a director of the Company and his affiliated entities, who
collectively owned approximately 20% of the Company's stock prior to the
acquisition of convertible notes and would collectively own approximately 45% of
the Company's stock if all of their notes were converted (see Note 5). Also, as
investments are purchased and sold, a cash balance may be held by this
investment firm. At December 31, 2002 and 2001, the cash balance with this
investment firm was $0 and $913,891, respectively. The maximum balance in the
short term investments and cash accounts during 2002 and 2001 was $3,707,787 and
$15,392,301, respectively.

Of the total amount of $3,250,000 of convertible notes issued, convertible
notes with an aggregate principal amount of $2,635,000 less transaction costs of
$275,000 were acquired by a director of the Company and his affiliated entities,
who collectively owned approximately 20% of the Company's stock prior to the
acquisition of convertible notes and would collectively own approximately 45% of
the Company's stock if all of their notes were converted (see Note 5).

In January 1999 and January 2000, two former executives exercised options
to purchase shares of Common Stock, and promissory notes were issued to the
Company in conjunction with the sales which are outstanding at December 31, 2002
(see Note 11).

59

NOTE 18. QUARTERLY FINANCIAL DATA (UNAUDITED)

60

NOTE 19. SUBSEQUENT EVENTS

As of December 31, 2002, the Company was not in compliance with its
financial covenants under the Loan and Security Agreement with Comerica
Bank--California, but has subsequently received a waiver of these covenants
through February 28, 2003 from the Bank and new covenants have been established
that include the following:

- Maintain a minimum EBITDA calculated on a trailing three month basis in
amounts as further defined in the Agreement

- Maintain a cash balance of 1.5 times the outstanding borrowings.

- A $250,000 borrowing cap was established for the Term Advance until June
30, 2003. After June 30, 2003, the cap shall be eliminated as soon as the
Company can demonstrate three consecutive months of positive EBITDA.

On March 18, 2003, the Company received a delisting notice from The Nasdaq
Stock Market informing the Company that its common stock would be delisted as of
March 27, 2003 due to its failure to maintain a minimum bid price per share of
$1.00. As of March 31, 2002, the Company has filed an appeal, and the delisting
has been delayed pending the outcome of the appeal. The Company cannot assure
investors that its common stock will continue to be listed on Nasdaq after its
appeal is heard.

At a special meeting of stockholders on February 10, 2003, the stockholders
approved an amendment to the Company's Certificate of Incorporation to effect a
reverse stock split of its common stock and to grant its board of directors the
authority to set the ratio for the reverse split or to not complete the reverse
split. As necessary, the Company intends to consider implementing a reverse
stock split if it believes it would increase the probability that it would be
able to continue to meet the Nasdaq SmallCap Market listing requirements.

In March 2003, The holders of the Company's convertible notes agreed to an
amendment of these notes under which their maturity date was extended until July
15, 2004 and their conversion price was reduced to $0.25 per share.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

The information required by this Item was previously disclosed in a Form
8-K dated April 15, 2002.

61

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated by reference to the
data under the captions "Election of Directors", "Executive Officers" and
"Section 16(a) beneficial ownership reporting compliance" in the Proxy Statement
to be used in connection with the solicitation of proxies for our annual meeting
to be held June 11, 2003, which Proxy Statement is to be filed with the
Commission.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated by reference to the
data under the caption "Executive Compensation" in the Proxy Statement to be
used in connection with the solicitation of proxies for our annual meeting to be
held June 11, 2003, which Proxy Statement is to be filed with the Commission.

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

The information required by this Item is incorporated by reference to the
data under the caption "Security Ownership of Certain Beneficial Owners and
Management" in the Proxy Statement to be used in connection with the
solicitation of proxies for our annual meeting to be held June 11, 2003, which
Proxy Statement is to be filed with the Commission.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated by reference to the
data under the subcaption "Certain Relationships and Related Party Transactions"
in the Proxy Statement to be used in connection with the solicitation of proxies
for our annual meeting to be held June 11, 2003, which Proxy Statement is to be
filed with the Commission.

ITEM 14. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Our principal
executive officer and our principal financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in Exchange
Act Rules 13a-14(c) and 15d-14(c)) on March 11, 2003, have concluded that, as of
such date, our disclosure controls and procedures were adequate and effective to
ensure that material information relating to our company and our consolidated
subsidiaries would be made known to them by others within those entities.

(b) Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect our
disclosure controls and procedures subsequent to the date of their evaluation,
nor were there any significant deficiencies or material weaknesses in our
internal controls. As a result, no corrective actions were required or
undertaken.

62

PART IV

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

1. Financial Statements and Supplementary Data. The following consolidated
financial statements of the Company are included in Part II, Item 8:

2. Financial Statement Schedules. Schedules are not submitted because they
are not required or are not applicable, or the required information is
shown in the consolidated financial statements or notes thereto.

3. Exhibits. The Exhibits listed below are filed or incorporated by
reference as part of this Form 10-K. Where so indicated by footnote,
exhibits which were previously filed are incorporated by reference. For
exhibits incorporated by reference, the location of the exhibit in the
previous filing is indicated in the footnote.

- ------------------------

I Portions of these exhibits have been omitted based on a grant of
confidential treatment by the Commission. The omitted portions of the
exhibits have been filed separately with the Commission.

(1) Incorporated by reference to our Current Report on Form 8-K filed on
August 6, 2001.

(2) Incorporated by reference to our Annual Report on Form 10-K for the fiscal
year ended December 31, 2000.

(3) Incorporated by reference to our Registration Statement on Form S-1, as
amended, filed on August 18, 2000.

(4) Incorporated by reference to our Registration Statement on Form S-3 filed
on June 19, 2002.

(5) Incorporated by reference to our the Registration Statement on Form S-1
filed on March 31, 2000.

(6) Incorporated by reference to our Registration Statement on Form S-1, as
amended, filed on April 7, 2000.

(7) Incorporated by reference to our Registration Statement on Form S-1, as
amended, filed on July 13, 2000.

(8) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2001.

(9) Incorporated by reference to our Annual Report on Form 10-K for the fiscal
year ended December 31, 2001.

(10) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002.

(11) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002.

* Filed herewith.

(b) Reports on Form 8-K

The registrant did not file any Reports on Form 8-K during the quarter
ended December 31, 2002.

64

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of Oakmont,
Commonwealth of Pennsylvania on March 27, 2003.

SERVICEWARE TECHNOLOGIES, INC.

By: /s/ KENT HEYMAN
------------------------------------
Kent Heyman
Chief Executive Officer

Each person whose signature appears below hereby appoints Kent Heyman and
Scott Schwartzman, and both of them, either of whom may act without the joinder
of the other, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K, and to file the same, with all exhibits thereto and all
other documents in connection therewith, with the Commission, granting unto said
attorneys-in-fact and agents full power and authority to perform each and every
act and thing appropriate or necessary to be done, as fully and for all intents
and purposes as he might or could do in person, hereby ratifying and confirming
all that said attorneys-in-fact and agents or their substitute or substitutes
may lawfully do or cause to be done by virtue hereof.

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

CERTIFICATIONS

I, Kent Heyman, certify that:

1. I have reviewed this annual report on Form 10-K of ServiceWare
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;

b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):

a. all significant deficiencies in the design or operation of
internal controls, which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

By: /s/ KENT HEYMAN
------------------------------------
Kent Heyman
Principal Executive Officer

Date: March 27, 2003

CERTIFICATIONS

I, Scott Schwartzman, certify that:

1. I have reviewed this annual report on Form 10-K of ServiceWare
Technologies, Inc.;

2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;

b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):

a. all significant deficiencies in the design or operation of
internal controls, which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

By: /s/ SCOTT SCHWARTZMAN
------------------------------------
Scott Schwartzman
Principal Financial Officer

Date: March 27, 2003

INDEX TO EXHIBITS