EGAIN COMMUNICATIONS CORP - 10-Q Quarterly Report

(Former name, former address and former fiscal year, if changed since last report)

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.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The condensed consolidated financial statements have been prepared by eGain Communications Corp. (“eGain” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of eGain and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern. The Company has incurred significant operating losses and negative cash flows since inception. The Company has not achieved profitability and may not be able to realize sufficient revenues to achieve or sustain profitability in the future. Since inception eGain experienced substantial expenditures as it grew operations and personnel. Although eGain has repeatedly taken actions to reduce its expense rates over the last two fiscal years, it expects to incur additional operating losses, at least through the fourth quarter of fiscal 2003 if not longer. eGain’s working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular that revenue levels remain stable and that customers continue to pay on a timely basis. While eGain closed a $5 million credit facility (see Notes To Condensed Consolidated Financial Statements, Note 7: Related Party Notes Payable) in December 2002, the additional $3,000,000 in loan proceeds available under the Credit Facility is subject to eGain achieving certain performance milestones. eGain can make no assurances that it will achieve the performance milestones necessary to receive these additional loan proceeds. If eGain’s revenues fall significantly below expectations and such loan proceeds are not available, eGain may be unable to meet operating obligations and be required to initiate bankruptcy proceedings. These conditions raise doubt about eGain’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of eGain, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of eGain’s financial position, results of operations and cash flows for the periods presented. These financial statements and notes should be read in conjunction with eGain’s audited consolidated financial statements and notes thereto for the year ended June 30, 2002, included in eGain’s Annual Report on Form 10-K. The condensed consolidated balance sheet at June 30, 2002 has been derived from audited financial statements as of that date but does not include all the information and footnotes required by generally accepted accounting principals for complete financial statements. The results of eGain’s operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2003.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Certain reclassifications have been made to prior period amounts in order to conform to the current period’s presentation.

eGain recognizes revenue in accordance with Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. Under SOP 97-2, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant eGain obligations remain, the fee is fixed or determinable, and collectibility is probable. License revenue in multiple element contracts is recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the total fair value of the undelivered elements, as indicated by vendor specific objective evidence, 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. If sufficient vendor-specific objective evidence does not exist for undelivered elements in an arrangement, all revenue from the arrangement is deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist or (b) all elements of the arrangement have been delivered.

Revenue from hosting services is recognized ratably over the period of the agreement as services are provided. Hosting agreements are typically for a period of one year unless either party cancels the agreement.

Service revenue is primarily derived from consulting fees, maintenance agreements, and training. Service revenue from consulting and training billed on a time and materials basis is recognized as performed. Service revenue on fixed price service arrangements is recognized upon completion of specific contractual milestone events, or based on an estimated percentage of completion as work progresses. Maintenance agreements include the right to software updates on an if-and-when-available basis. Maintenance revenue is deferred and recognized on a straight-line basis as service revenue over the life of the related agreement, which is typically one year.

In all cases, eGain assesses whether the service element of the arrangement is essential to the functionality of the other elements of the arrangement. In this determination, eGain focuses on whether the services include significant alterations to the features and functionality of the software, whether the services involve the building of complex interfaces, the timing of payments and the existence of milestones. In making this determination, eGain considers the following: (1) the relative fair value of the services compared to the software, (2) the amount of time and effort subsequent to delivery of the software until the interfaces or other modifications are completed, (3) the degree of technical difficulty in building the interfaces or other modifications, and (4) any contractual cancellation, acceptance, or termination provisions for failure to complete the interfaces. In those instances where eGain determines that the service elements are essential to the other elements of the arrangement, eGain accounts for the entire arrangement in accordance with Accounting Research Bulletin (ARB) No. 45, “Long-Term Construction-Type Contracts,” using the relevant guidance from SOP 97-2 and SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.”

Revenue from sales to resellers are recognized either upon delivery to the reseller or on a sell-through basis, depending on the facts and circumstances of the transaction, such as eGain’s understanding of the reseller’s use of its software, the reseller’s financial status, and eGain’s past experience with the particular reseller. Accordingly, the decision whether to recognize revenue to resellers either upon delivery or on a sell-through basis requires significant management judgment. This judgment can materially impact the timing of revenue recognition.

eGain accounts for its stock-based compensation arrangements with employees using the intrinsic-value method in accordance with Accounting Principles Board 25, Accounting for Stock Issued to Employees. Deferred stock-based compensation is recorded on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options or the purchase price for the shares of common stock.

Deferred compensation is amortized on a graded vesting method over the vesting period of the individual grants. In addition, eGain records compensation expense in connection with grants of stock options to non-employees pursuant to “Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation” (“SFAS 123”). These grants are periodically revalued as they vest in accordance with SFAS 123 and “EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”

As of March 31, 2003, the outstanding balance of deferred stock compensation was $57,000. eGain amortized $31,000 and $233,000 of deferred compensation in the quarters ended March 31, 2003 and March 31, 2002, respectively. The total of amortization of deferred stock based compensation was $136,000 for the nine months period ended March 31, 2003 and $793,000 for the same period in the prior year.

eGain has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. Pro forma information regarding net income (loss) has been determined as if we had accounted for our employee stock options under the fair value method prescribed by SFAS 123 (in thousands, except per share data):

The following table provides a summary of the carrying amount of goodwill which includes amounts originally allocated to assembled workforce (in thousands):

The following table summarizes the carrying amount of other intangible assets that continue to be amortized and excludes amounts originally allocated to assembled workforce (in thousands):

Effective July 1, 2002, eGain adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” As required by SFAS No. 142, eGain no longer amortizes goodwill, but will review goodwill annually (or more frequently if impairment indicators arise) for impairment. Intangible assets with a net carrying value of $750,000, which do not qualify as separate intangible assets under SFAS No. 142, have been reclassed to goodwill. Upon initial application in connection with the transitional goodwill impairment evaluation under SFAS No. 142, the Company completed a goodwill review as of the date of adoption—July 1, 2002 and found no impairment of goodwill beyond amounts previously recorded prior to that date.

Upon adoption of Statement of Financial Accounting Standards Number 142, “Goodwill and Other Intangible Assets”, (“SFAS 142”), in its fiscal year beginning July 1, 2002, eGain is required to present specific disclosures under the transitional provisions of SFAS 142. The following table presents the loss for all periods presented, as adjusted, to exclude the amortization of goodwill (in thousands, except per share data; unaudited):

Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally 3 to 4 years. Long-lived assets, including intangible assets, are reviewed whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Recoverability of a long lived asset other than goodwill is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. An impairment charge is recorded if the carrying amount of the asset exceeds the sum of the expected undiscounted cash flows. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Fair value is determined based on discounted cash flows or appraised values, depending upon the nature of the assets. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and, should different conditions prevail or judgments be made, material write-downs of net intangible assets and/or goodwill could occur.

Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding.

The following table sets forth the calculation of basic and diluted net loss per common share (in thousands, except per share data):

Options and warrants to purchase 8,129,374 and 10,061,000 shares of common stock were outstanding at March 31, 2003 and 2002, respectively. In addition, convertible preferred stock convertible into 18,553,000 and 17,362,000 shares of common stock were outstanding at March 31, 2003 and 2002, respectively. The above amounts were excluded from the computation of net loss per common share, as their effect is anti-dilutive.

eGain’s comprehensive loss is comprised of net loss and foreign currency translation adjustments. Comprehensive loss was $2.5 million and $18.7 million for the three months ended March 31, 2003 and 2002, respectively, and $9.8 million and $59.7 million for the nine months ended March 31, 2003 and 2002, respectively.

Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by eGain’s chief operating decision-maker to make decisions about resources to be allocated to the segment and assess its performance. eGain’s chief operating decision-maker, as defined under SFAS No. 131, is its executive management team. To date, eGain has viewed its operations and manages its business as principally one segment, the development, license, implementation and support of its customer interaction management software solutions. eGain’s chief operating decision-maker reviews financial information presented on a consolidated basis, accompanied by separate information about operating results by geographic region for purposes of making operating decisions and assessing financial performance.

Information relating to eGain’s geographic areas is as follows (in thousands):

In addition, identifiable assets corresponding to eGain’s geographic areas are as follows (in thousands):

During the nine months ended March 31, 2003 and 2002, no single customer accounted for more than 10% of eGain’s total revenue.

On December 24, 2002, eGain entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Ashutosh Roy, the Company’s Chief Executive Officer, pursuant to which Mr. Roy will make loans to the Company evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of the Company’s common stock in connection with such loans (the “Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the maturity of such note. The Company has the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants will allow Mr. Roy to purchase up to a number of shares equal to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of the Company’s common stock (based on a five day trading average at the time of each loan). The warrants become exerciseable as to 50% of the warrant shares nine months after issuance of the warrant and as to 100% of the warrant shares on the first anniversary of the issuance of the warrant. An initial advance of $2,000,000 under the Credit Facility occurred on December 31, 2002. eGain recorded $1.83 million in related party notes payable and $173,000 of discount on the notes related to the value of the warrants issued in the transaction. Loans of up to an additional $3,000,000 may be made under the Credit Facility subject to the achievement by the Company of certain performance milestones set forth in the Purchase Agreement.

As of March 31, 2003, the outstanding balance of related party notes payable was $1.89 million including an accrued interest of $60,000 at an annual rate of 12%.

On September 20, 2002, eGain entered into an accounts receivable purchase agreement (the “AR Facility”) with Silicon Valley Bank (“SVB”), which replaced the existing revolving line of credit. The AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly administrative fee. As of March 31, 2003 there was approximately $500,000 outstanding under this agreement. As part of this agreement, the term loan and equipment loan were combined into one term loan facility in the amount of $1.1 million which was secured by establishing a restricted certificate of deposit for $1.1 million at March 31, 2003. This amount will be reduced as scheduled payments on the term loan are made. As of March 31, 2003 there was approximately $1,048,000 outstanding on the term loan.

On March 25, 2003, eGain entered into a modification agreement with SVB. The amendment extended the original term and termination of the AR Facility for an additional 90 days through June 30, 2003.

Total borrowings under the SVB Credit Facilities were $1,548,000 at March 31, 2003, which consisted of the following (in thousands):

During the quarter ended March 31, 2003, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded a restructuring charge of $512,000 primarily due to the closure of the local office in Germany and the severance payments associated with planned worldwide headcount reductions. The charges consisted of $213,000 related to closure of the German office, $216,000 employee severance payments, $34,000 of fixed assets write-offs as well as $49,000 miscellaneous charges related to the excess facilities in North America.

During the quarter ended December 31, 2002, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded a restructuring benefit of $1,285,000 which was primarily due to the termination of one of its facility leases. The savings from the facility lease termination was $1,660,000. This benefit was partially offset by current quarter charges of $215,000 related to severance payments associated with planned worldwide headcount reductions as well as $160,000 related to the closure of local offices in Australia and Singapore. The total payments of $648,000 for the quarter consisted of $135,000 employee severance, $187,000 related to closure of local offices in Europe, Australia, and Singapore in fiscal 2003, and $326,000 for excess facilities in North America accrued in fiscal 2002.

eGain entered into a settlement with Synergism Investors on December 11, 2002 to terminate an existing lease agreement for one of eGain’s excess facilities. Under this agreement, eGain agreed to pay $1,325,000 (the “Settlement Amount”) to Synergism. Of this obligation, $325,000 was secured through a certified deposit and paid in January, 2003. The remaining balance will be paid to Synergism in the event eGain makes a distribution of cash, stock, or other consideration (each, a “Preferred Payment”) to the holders of eGain’s 6.75% Series A Cumulative Convertible Preferred Stock (the “Series A Preferred”) with respect to the shares of Series A preferred held by them. Synergism will receive prior to any such Preferred Payment to holders of Series A Preferred a cash payment equal to the lesser of (i) an amount equal to $1,000,000 (the “Initial Payment Value”) plus an amount which would increase and accumulate at an annual rate equal to 6.75% of the Initial Payment Value; or (ii) the portion of the Preferred Payment made with respect to 10 shares of Series A Preferred, which shares have an aggregated stated value of $1,000,000.

Upon entering into this settlement agreement with Synergism Investors, eGain reduced its restructuring accrual by $53,000. A restructuring accrual in the amount of $1,000,000 remains as a liability in the event eGain makes Preferred Payments under the terms of the settlement agreement.

During the three months ended September 30, 2002, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded restructuring charges totaling $1,047,000. These charges were primarily related to severance payments associated with planned headcount reductions and the closure of local offices in Holland and France. Out of the total charges, there was $38,000 in professional fees incurred and paid that were associated with legal issues in the headcount reduction. During the three months ended September 30, 2002, eGain reduced its worldwide workforce by 94 employees across all departments pursuant to the adoption of eGain’s expense management strategy. The total payments in the quarter ended September 30, 2002 were $1,587,000, which consisted of $713,000 employee severance and $38,000 professional services incurred in fiscal 2003, $796,000 related to the consolidation of facilities in North America in fiscal 2002, and $40,000 in professional services accrued since fiscal 2001.

Details of the cumulative fiscal 2002 restructuring charges are as follows (in thousands):

Details of the cumulative fiscal 2001 restructuring charges are as follows (in thousands):

Charges of $92,000 related to fiscal 2001, which were primarily related to legal and professional costs, remained unpaid as of 03/31/03.

The FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which establishes financial accounting and reporting for costs associated with exit or disposal activities. This statement is effective for disposal activities initiated after December 31, 2002. eGain adopted SFAS No. 146 on January 1, 2003 and the adoption of this statement did not have a material impact on eGain’s financial position or results of operations.

In November 2001, the Emerging Issues Task Force (“EITF”) concluded that reimbursements for out-of-pocket-expenses incurred should be included in revenue in the income statement and subsequently issued EITF 01-14, Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred in January 2002. eGain adopted EITF 01-14 effective July 1,2002. Adoption of this statement resulted in approximately $34,000 and $95,000 of reimbursable expenses reflected in both service revenue and cost of service revenue for the three and nine month periods ended March 31, 2003, respectively.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”—an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. The Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires a guarantor 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 measurement provisions of the Interpretation apply to guarantees issued or modified after December 31, 2002. eGain adopted this statement on January 1, 2003 and the adoption did not have a material impact on eGain’s financial position or results of operations.

In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition to the SFAS 123 fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 requires disclosure of the effects of any entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. eGain adopted the interim disclosure provision SFAS 148 beginning the third quarter of fiscal 2003. The interim disclosure is included in Note 3.

On October 25, 2001, a federal securities class action complaint was filed in the United States District Court for the Southern District of New York against eGain, certain of its officers, and the lead underwriters for eGain’s initial public offering. Rennel Trading Corp. v. eGain Communications Corp., et al., No. 01-CIV-9414 (SAS). The complaint alleges violations of Section 11, 12(a)(2) and Section 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, on behalf of a alleged class of plaintiffs who purchased eGain common stock between September 23, 1999 and December 6, 2000. Specifically, the complaint alleges that the prospectus eGain filed in connection with the initial public offering was materially false and misleading because it failed to disclose that the underwriter defendants solicited and received excessive and undisclosed commissions from certain investors in exchange for shares of eGain stock, and that the underwriters entered into agreements with certain investors in which these investors agreed to purchase additional shares of Company common stock in the aftermarket in exchange for receiving shares of eGain common stock in the initial public offering. The lawsuit is being prosecuted by the Plaintiffs’ Executive Committee in In re: Initial Public Offering Securities Litigation, 21 MC 92 (SAS), pending before the Honorable Shira A. Scheindlin. The Company believes it has good and valid defenses to these allegations. During 2002, motions to dismiss the claims in the action were briefed and argued. During late 2002, the plaintiffs entered into an agreement, voluntarily dismissing the claims against the certain individual defendants in return for a tolling agreement. In February 2003, the trial court rendered a decision granting the motions to dismiss in part, denying them in part, and permitting the cases to proceed in part. With respect to eGain, the court held that plaintiff did not have standing to pursue the section 11 claim for damages, and dismissed that claim. The court, however, ruled that plaintiffs could proceed with the section 10(b) claim against the company. eGain intends to defend the remaining claim vigorously. However, such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

In March 2002, eGain was named as defendant in a Wisconsin state court action alleging breach of contract/warranty, fraudulent misrepresentation and related claims arising from a software license agreement between Metavante Corp. and Inference Corporation (a wholly owned subsidiary of eGain). The suit seeks unspecified damages. Three of the four charges have been dismissed, with the breach of contract/warranty as the outstanding claim remaining. eGain intends to defend the claim vigorously and does not expect it to have a material impact on its results of operations. However, the ultimate outcome of any litigation is uncertain, and it could have an adverse material impact due to defense costs, diversion of management and other resources and other factors.

On December 13, 2002, Mindfabric, Inc. filed an action for patent infringement against eGain. eGain intends to defend this final claim vigorously and does not expect it to have a material impact on its results of operations. However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could have an adverse material impact due to defense costs, diversion of management and other resources and other factors.

On February 26, 2003, Golden Gate Plaza, LLC filed a complaint for unlawful detainer against eGain. eGain intends to defend the claim vigorously and does not expect it to have a material impact on its results of operations. However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could have an adverse material impact due to defense costs, diversion of management, and other resources and other factors.

With the exception of these matters, eGain is not a party to any other material pending legal proceedings, nor is its property the subject of any material pending legal proceeding, except routine legal proceedings arising in the ordinary course of its business and incidental to its business, none of which are expected to have a material adverse impact upon its business, financial position or results of operations.

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

This report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that involve risks and uncertainties. These statements may be identified by the use of the words such as “anticipates,” “believes,” “continue,” “could,” “would,” “estimates,” “forecasts,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “should,” or “will” and similar expressions or the negative of those terms. The forward-looking statements include, but are not limited, to the ability of eGain to continue as a going concern, the continued reduction of eGain’s expenses, the adequacy of capital resources, the factors influencing competition in eGain’s market, expected net losses, the continued need for eService solutions, the continued acceptance of eGain’s Web-native architecture, eGain’s levels of product development and technology and the overall volatility of technology companies. eGain’s actual results could differ materially from those discussed in statements relating to eGain’s future plans, product releases, objectives, expectations and intentions. Factors that could contribute to such differences include those discussed in “Factors That May Affect Future Results” and elsewhere in this document. These forward-looking statements speak only as of the date hereof. eGain expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in eGain’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

eGain Communication Corp. (“eGain” or the “Company”) is a leading provider of eService software for Global 2000 companies. eGain’s solutions are designed to enable companies to transform traditional customer call centers into knowledge-powered multi-channel contact centers. The Company’s solutions have a proven track record of helping businesses deliver a superior customer experience and establishing profitable, long-term customer relationships, while reducing operating and technology costs. eGain offers an integrated platform that is designed to enable companies to offer both assisted (email management, web collaboration, knowledge management, and call center integration tools) and unassisted (integrated set of self-service solutions) online customer service. Built using a Java-based, 100% Web-native architecture, eGain’s comprehensive eService solutions are designed to provide robust scalability, global access, diverse integration capabilities and rapid deployment. In addition, eGain’s solution is designed to integrate with leading CRM, ERP and call center systems, enabling customers to leverage investments in existing systems and provide an enterprise wide solution.

On December 24, 2002, eGain entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Ashutosh Roy, the Company’s Chief Executive Officer, pursuant to which Mr. Roy will make loans to the Company evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of the Company’s common stock in connection with such loans (the “Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the term of such note. The Company has the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants will allow Mr. Roy to purchase up to a number of shares equal to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of the Company’s common stock (based on a five day trading average at the time of each loan). The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrant and as to 100% of the warrant shares on the first anniversary of the issuance of the warrant. An initial loan of $2,000,000 under the Credit Facility occurred on December 31, 2002. Loans of up to an additional $3,000,000 may be made under the Credit Facility subject to the achievement by the Company of certain performance milestones set forth in the Purchase Agreement.

Since inception eGain experienced substantial expenditures as it grew operations and personnel. Although eGain has repeatedly taken actions to reduce its expense rates over the last two fiscal years, it expects to incur additional operating losses, at least through the fourth quarter of fiscal 2003 if not longer. eGain’s working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular that revenue levels remain stable and that customers continue to pay on a timely basis. While eGain closed the Credit Facility in December 2002, the additional $3,000,000 in loan proceeds available under the Credit Facility are subject to the achievement by eGain of certain performance milestones. eGain can make no assurances that it will achieve the performance milestones necessary to receive these additional loan proceeds. If eGain’s revenues fall significantly below expectations and such loan proceeds are not available, eGain may be unable to meet operating obligations and be required to initiate bankruptcy proceedings. These conditions raise doubt about eGain’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

eGain intends to continue to make investments in product development and technology at reduced levels to enhance its current products and services, develop new products and services, and further advance its solution offerings. In addition, eGain has incurred significant losses since its inception and had an accumulated deficit of approximately $308.8 million as of March 31, 2003. eGain has not achieved profitability on a quarterly or annual basis. eGain expects to continue to incur operating losses for the foreseeable future. In view of the rapidly evolving nature of its business, eGain believes that period to period comparisons of its revenue and operating results are not meaningful and should not be relied upon as indications of future performance.

eGain’s common stock was transferred from the Nasdaq National Market to the Nasdaq SmallCap Market effective with the open of business on Tuesday, November 5, 2002. eGain’s common stock will remain listed on the SmallCap Market until at least May 2003, and may be eligible for continued listing, depending on the Company’s compliance with certain Nasdaq SmallCap Market listing requirements. See further discussion of this matter under “Additional Factors that May Affect Future Results.”

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses eGain’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, valuation allowances and accrued liabilities, long-lived assets and restructuring. Management bases its estimates and judgments on historical experience and on various other factors 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.

eGain derives revenues from three sources, license fees, hosting fees and services. Services include software maintenance and support, training, and system implementation consulting. Maintenance and support consists of technical support and software upgrades and enhancements. Significant management judgments and estimates are made and used to determine the revenue recognized in any accounting period. Material differences may result in the amount and timing of its revenue for any period if different conditions were to prevail.

eGain applies the provisions of Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” to all transactions involving the sale of software products.

eGain recognizes license revenue when persuasive evidence of an arrangement exists, the product has been delivered, no significant obligations remain, the fee is fixed or determinable, and collection of the resulting receivable is probable. In software arrangements that include rights to multiple software products and/or services, eGain uses the residual method under which revenue is allocated to the undelivered elements based on vendor specific objective evidence of the fair value of such undelivered elements. The residual amount of revenue is allocated to the delivered elements and recognized as revenue. Such undelivered elements in these arrangements typically consist of services.

eGain recognizes hosting services revenue ratably over the period of the agreement as services are provided. Hosting agreements are typically for a period of one year unless either party cancels the agreement.

eGain uses a signed software license and services agreement and order form as evidence of an arrangement for sales of software, hosting, maintenance and support. eGain uses a signed engagement letter to evidence an arrangement for system implementation consulting and training.

Software is delivered to customers electronically or on a CD-ROM. eGain assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction. eGain’s standard payment terms are generally less than 90 days. In instances where payments are subject to extended payment terms, revenue is deferred until payments become due. eGain assesses collectibility based on a number of factors, including the customer’s past payment history and its current creditworthiness. If eGain determines that collection of a fee is not reasonably assured, eGain defers the revenue and recognizes it at the time collection becomes reasonably assured, which is generally upon receipt of cash payment. If an acceptance period is required, revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period.

When licenses are sold together with consulting and implementation services, license fees are recognized upon shipment, provided that (1) the above criteria have been met, (2) payment of the license fees is not dependent upon the performance of the consulting and implementation services, and (3) the services are not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and services revenues are recognized in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts.” When reliable estimates are available for the costs and efforts necessary to complete the implementation services, eGain accounts for the arrangements under the percentage of completion method pursuant to SOP 81-1. When such estimates are not available, the completed contract method is utilized.

The majority of eGain’s consulting and implementation services qualify for separate accounting. eGain uses vendor-specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. eGain’s consulting and implementation service contracts are bid either on a fixed-fee basis or on a time-and-materials basis. For a fixed-fee contract, eGain recognizes revenue upon completion of specific contractual milestones or using the percentage of completion method. For time-and-materials contracts, eGain recognizes revenue as services are performed.

Maintenance and support revenue is recognized ratably over the term of the maintenance contract, which is typically one year. Training revenue is recognized when training is provided.

Revenue from sales to resellers is recognized either upon delivery to the reseller or on a sell-through basis, depending on the facts and circumstances of the transaction, such as eGain’s understanding of the reseller’s use of its software, the reseller’s financial status and eGain’s past experience with the particular reseller. Accordingly, the decision of whether to recognize revenue to resellers either upon delivery or on a sell-through basis requires significant management judgment. This judgment can materially impact the timing of revenue recognition.

Goodwill is not amortized but is tested for impairment using a fair value approach. During the first nine months of fiscal 2003, eGain performed the first of the required impairment tests of goodwill and intangible assets deemed to have indefinite lives as of July 1, 2002, using the two-step process required under SFAS 142. Goodwill will be tested for impairment annually as well as whenever indicators of impairment exist.

Long-lived assets, including intangible assets, are reviewed whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Recoverability of a long lived asset other than goodwill is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. An impairment charge is recorded if the carrying amount of the asset exceeds the sum of the expected undiscounted cash flows. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Fair value is determined based on discounted cash flows or appraised values, depending upon the nature of the assets. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and, should different conditions prevail or judgments be made, material write-downs of net intangible assets and/or goodwill could occur. In addition, eGain’s depreciation and amortization policies reflect judgments on the estimated useful lives of assets.

eGain has taken restructuring charges related to excess facilities and established reserves at the low end of the range of estimable cost (as required by accounting standards) against outstanding commitments for leased properties that eGain has abandoned. These reserves are based upon eGain’s estimates of triggering events, such as the time required to sublease the property and the amount of sublease income that might be generated from the date of abandonment and the expiration of the lease. These estimates are reviewed based on changes in these triggering events. Adjustments to the restructuring charge will be made in future periods, if necessary, should different conditions prevail from those anticipated in eGain’s original estimate.

eGain maintains an allowance for doubtful accounts to reserve for potential uncollectible trade receivables. eGain reviews its trade receivables by aging category to identify specific customers with known disputes or collectibility issues. eGain exercises judgment when determining the adequacy of these reserves as it evaluates historical bad debt trends, general economic conditions in the U.S. and internationally, and changes in customer financial conditions. If eGain made different judgments or utilized different estimates, material differences may result in additional reserves for trade receivables, which would be reflected by charges in general and administrative expenses for any period presented.

The following table sets forth the results of operations for the periods presented expressed as a percentage of total revenue:

Total revenue decreased 12% to $5.2 million in the quarter ended March 31, 2003 from $5.9 million in the quarter ended March 31, 2002. Total revenue for the nine months ended March 31, 2003 decreased 31% to $16.7 million, compared to $24.1 million in the same period last year. The decrease in each period was primarily attributable to a decline in licensed and hosted customer orders worldwide resulting from the continued weak macro-economic environment. During the quarters and the nine months ended March 31, 2003 and 2002, no single customer accounted for more than 10% of total revenue.

Hosting revenue decreased 5% to $885,000 in the quarter ended March 31, 2003 from $931,000 in the quarter ended March 31, 2002. Hosting revenue for the nine months ended March 31, 2003 decreased 37% to $2.8 million, compared to $4.5 million in the same period last year. The decrease in each period was primarily attributable to a decline in new hosted customer contracts, coupled with the termination of existing hosted customer contracts due to decreased customer IT spending. Hosting revenue represented 17% and 16% of total revenue for the quarters ended March 31, 2003 and 2002, respectively, and 17% and 19% of total revenue for the nine months ended March 31, 2003 and 2002, respectively.

License revenue decreased 21% to $983,000 in the quarter ended March 31, 2003 from $1.2 million in the quarter ended March 31, 2002. License revenue for the nine months ended March 31, 2003 decreased 40% to $4.6 million, compared to $7.7 million in the same period last year. The decrease in each period was due primarily to the large decline in customer orders worldwide as a result of the continued weak macro-economic environment. License revenue represented 19% and 21% of total revenue for the quarters ended March 31, 2003 and 2002, respectively, and 28% and 32% of total revenue for the nine months ended March 31, 2003 and 2002, respectively.

Services revenue decreased 10% to $3.4 million in the quarter ended March 31, 2003 from $3.7 million in the quarter ended March 31, 2002. Services revenue for the nine months ended March 31, 2003 decreased 22% to $9.3 million, compared to $11.9 million in the same period last year. The decrease in each period was mainly attributable to a decline in licensed customer orders. Services revenue decreased due to a decline in maintenance contracts, customer implementations, and system integration projects, largely due to reduced IT spending consistent with the weak macro-economic environment. Services revenue represented 64% and 63% of total revenue for the quarters ended March 31, 2003 and 2002, respectively, and 55% and 49% of total revenue for the nine months ended March 31, 2003 and 2002, respectively.

Total operating costs and expenses decreased 75% to $5.1 million in the quarter ended March 31, 2003 from $20.6 million in the quarter ended March 31, 2002. Total operating costs and expenses for the nine months ended March 31, 2003 decreased 75% to $17.3 million, compared to $70.4 million in the same period last year. eGain continued to implement stringent cost control measures to significantly reduce operating costs and expenses. Initiatives that contributed to the reduction of operating costs and expenses in all departments of eGain included the following:

In the short term, eGain’s costs and expenses are relatively fixed and if eGain’s revenue for a particular quarter is below expectations, it may be unable to proportionately reduce its operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on eGain’s expected operating results for that quarter. For this reason, period-to-period comparisons of eGain’s operating results may not be a good indication of its future performance. Moreover, eGain believes that any further significant reductions in expenses would be difficult to achieve given current operating levels. eGain is instead focused on maintaining current expense levels.

Cost of revenue—direct includes personnel costs for eGain’s hosting services, consulting services and customer support. It also includes depreciation of capital equipment used in eGain’s hosted network, third-party software royalties, lease costs paid to remote co-location centers and occupancy costs and related overhead. Cost of revenue-direct decreased 34% to $2.4 million in the quarter ended March 31, 2003 from $3.6 million in the quarter ended March 31, 2002. Cost of revenue-direct for the nine months ended March 31, 2003 decreased 32% to $8.4 million, compared to $12.4 million in the same period last year. The decrease in cost of revenue—direct for the nine months ended March 31, 2003 was consistent with the decrease in revenue for this period, with significant savings from a decline in headcount through planned workforce reductions. eGain anticipates that cost of revenue—direct will be relatively stable in future periods.

Cost of revenue—acquisition related decreased 37% to $227,000 in the quarter ended March 31, 2003 from $362,000 in the quarter ended March 31, 2002. Cost of revenue—acquisition related for the nine months ended March 31, 2003 also decreased 24% to $827,000, compared to $1.1 million in the same period last year. These amounts consisted of amortization of developed technology and customer base resulting from eGain’s business combinations in fiscal 2000. The decrease was primarily due to a discontinuance of the amortization of acquired workforce intangibles that was reclassified to goodwill in the quarter ended September 30, 2002 in accordance with SFAS 142. The acquired developed technology intangibles was fully amortized in the quarter ended March 31, 2003.

Research and development expenses primarily consist of compensation and benefits of engineering and quality assurance personnel, and occupancy costs and related overhead. Research and development expenses decreased 44% to $1.4 million in the quarter ended March 31, 2003 from $2.5 million in the quarter ended March 31, 2002. Research and development expenses for the nine months ended March 31, 2003 decreased 48% to $4.7 million, compared to $9.1 million in the same period last year. The decrease was primarily due to a decline in headcount through planned workforce reductions and the ongoing migration of development resources to eGain India. eGain anticipates that research and development expenses will be relatively stable in future periods.

Sales and marketing expenses primarily consist of compensation and benefits of eGain’s sales, marketing and business development personnel, advertising, trade show and other promotional costs, and occupancy costs and related overhead. Sales and marketing expenses decreased 69% to $1.8 million in the quarter ended March 31, 2003 from $6.0 million in the quarter ended March 31, 2002. Sales and marketing expenses for the nine months ended March 31, 2003 decreased 63% to $7.5 million, compared to $20.1 million in the same period last year. The decrease was primarily due to a decline in headcount through planned workforce reductions and a decrease in spending on advertising and marketing programs. eGain anticipates that sales and marketing expenses will be relatively stable in future periods.

General and administrative expenses primarily consist of compensation and benefits for eGain’s finance, human resources, administrative and legal services personnel, fees for outside professional services, bad debt expense, and occupancy costs and related overhead. General and administrative expenses decreased 58% to $1.0 million in the quarter ended March 31, 2003 from $2.4 million in the quarter ended March 31, 2002. General and administrative expenses for the nine months ended March 31, 2003 decreased 50% to $3.7 million, compared to $7.3 million in the same period last year. The decrease was attributable to a decline in headcount through planned workforce and a reduction in bad debt expense and outside consulting services. eGain anticipates that general and administrative expenses will be relatively stable in future periods.

Amortization of goodwill and other intangibles decreased 96% to approximately $327,000 during the quarter ended March 31, 2003 from $9.2 million during the quarter ended March 31, 2002. Amortization of goodwill and other intangibles for the nine months ended March 31, 2003 decreased 96% to $1.0 million, compared to $27.6 million in the same period last year. This decrease was primarily due to the adoption of SFAS No. 142 on July 1, 2002, under which the carrying values of goodwill and intangible assets deemed to have indefinite lives are no longer amortized, but are subject to an annual impairment test.

Deferred compensation is recorded in connection with grants of stock options to employees on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options. Deferred compensation is amortized on a graded vesting method over the vesting period of the individual grants. In addition, eGain records compensation expense in connection with grants of stock options to non-employees pursuant to “Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation” (“SFAS 123”). These grants are periodically revalued as they vest in accordance with SFAS 123 and “EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” eGain recorded amortization of deferred compensation of $31,000 and $233,000 in the quarters ended March 31, 2003 and 2002, respectively, and $136,000 and $793,000 in the nine months ended March 31, 2003 and 2002, respectively.

Restructuring expenses increased 57% to $512,000 for the quarter ended March 31, 2003 from $327,000 for the quarter ended March 31, 2002. eGain recorded a restructuring charges of $274,000 for the nine months ending March 31, 2003 compared to $5.6 million in the same period last year. The expenses consisted of severance costs and the closure of international offices and were partially offset by the benefit due to the reversal of $1.7 million in charges accrued for the consolidation of facilities in North America. eGain paid severance costs of $216,000 and $1.1 million during the three and nine months ended March 31, 2003, respectively. During the nine months period ended March 31, 2003, eGain reduced its worldwide workforce by 142 employees across all departments pursuant to the adoption of eGain’s expense management strategy. Other major charges included $213,000 for the closure of its office in Germany in the quarter ended March 31, 2003 in addition to $456,000 accrual for the closure of offices in Australia, Singapore, Holland and France during the six months ended December 31, 2002.

Non-operating income was $9,000 in the quarter ended March 31, 2003, compared to non-operating expense of $352,000 in the quarter ended March 31, 2002. Non-operating income was $205,000 for the nine months ended March 31, 2003, compared to non-operating expense of $146,000 in the nine months ended March 31, 2002. The total non-operating income in the nine months ended March 31, 2003 was primarily due to a real estate settlement of $357,000 in the quarter ending December 31, 2002, offsetting by interest and other expenses.

Since inception eGain experienced substantial expenditures as it grew operations and personnel. Although eGain has repeatedly taken actions to reduce its expense rates over the last two fiscal years, it expects to incur additional operating losses, at least through the fourth quarter of fiscal 2003 if not longer. eGain’s working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors in particular that revenue levels remain stable and that customers continue to pay on a timely basis. While eGain closed the Credit Facility in December 2002, the additional $3,000,000 in loan proceeds available under the Credit Facility are subject to eGain achieving certain performance milestones. eGain can make no assurances that it will achieve the performance milestones necessary to receive these additional loan proceeds. If eGain’s revenues fall significantly below expectations and such loan proceeds are not available, eGain may be unable to meet operating obligations and be required to initiate bankruptcy proceedings. These conditions raise doubt about eGain’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Prior to eGain’s initial public offering, operations were primarily financed through the private placement of convertible preferred stock, a bank line of credit, and financing for capital purchases. On September 28, 1999, eGain completed an initial public offering of common stock, in which 5.8 million shares of common stock were sold (including exercise of an over-allotment option in October 1999), at a price of $12.00 per share. Net proceeds from the offering were $63.0 million.

On August 8, 2000, eGain raised net proceeds of $82.6 million through the issuance of convertible preferred stock and warrants to purchase approximately 3.8 million shares of common stock in a private placement. The convertible preferred stock liquidation value accretes at 6.75% per annum.

On September 20, 2002, eGain entered into a new accounts receivable purchase agreement (the “AR Facility”) with Silicon Valley Bank (see Notes To Condensed Consolidated Financial Statements, Note 8: Bank Borrowings), which replaced the existing revolving line of credit. The AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly administrative fee. As part of this agreement, the term loan and equipment loan were combined into one term loan facility in the amount of $1.1 million, which was secured by establishing a restricted certificate of deposit in the amount of $1.1 million at March 31, 2003. This will be reduced as scheduled amortization payments on the term loan are made. There are no financial or operational covenant requirements under this agreement. On March 25, 2003, eGain entered into a modification agreement with SVB. The amendment extended the original term and termination of the AR Facility for an additional 90 days through June 30, 2003.

On December 24, 2002, eGain entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Ashutosh Roy, the Company’s Chief Executive Officer, pursuant to which Mr. Roy will make loans to the Company evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of the Company’s common stock in connection with such loans (the “Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the term of such note. The Company has the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants will allow Mr. Roy to purchase up to a number of shares equal to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of the Company’s common stock (based on a five day trading average at the time of each loan). The warrants become exercisable as to 50% of the warrant shares nine months after issuance of the warrant and as to 100% of the warrant shares on the first anniversary of the issuance of the warrant. An initial loan of $2,000,000 under the Credit Facility occurred on December 31, 2002. Loans of up to an additional $3,000,000 may be made under the Credit Facility subject to the achievement by the Company of certain performance milestones set forth in the Purchase Agreement.

On March 31, 2003, cash and cash equivalents were $4.3 million, a decrease of $5.6 million since June 30, 2002. Working capital at March 31, 2003 was $107,000, a decrease of $2.2 million since June 30, 2002. Of the $4.3 million cash and cash equivalents at March 31, 2003, $3.2 million was unrestricted and $1.1 million was restricted.

Net cash used in operating activities was $7.0 million and $23.5 million in the nine months ended March 31, 2003 and 2002, respectively. Cash used in operating activities in each period was primarily the result of net losses, partially offset by non-cash charges including depreciation and amortization of intangible assets.

Net cash provided from investing activities was $165,000 and net cash used was $1.1 million in the nine months ended March 31, 2003 and 2002, respectively. Cash provided from investing activities for the nine months ended March 31, 2003 was primarily due to a settlement from a previous purchase of property and equipment. Cash used in investing activities was primarily due to property and equipment purchases.

Net cash provided from financing activities was $339,000 and net cash used was $2.4 million in the nine months ended March 31, 2003 and 2002, respectively. Cash used in financing activities in the quarter ended March 31, 2003 was $398,000. The balance consisted of $500,000 proceeds from borrowing through the AR Facility with SVB. Payments on borrowings and capital leases totaled $898,000 in the three month period ended March 31, 2003.

The following table summarizes eGain’s contractual obligations as of March 31, 2003 and the effect such obligations are expected to have on its liquidity and cash flow in future periods (in thousands):

eGain expects continuing losses and may never achieve profitability, which in turn may harm its future operating performance and may cause the market price of eGain common stock to decline

eGain incurred a net loss applicable to common stockholders of $4.2 million for the quarter ended March 31, 2003. As of March 31, 2003, eGain had an accumulated deficit of approximately $308.8 million. eGain does not know when or if it will become profitable. If eGain does not become profitable within the timeframe expected by financial analysts or investors, the market price of eGain common stock may decline. Even if eGain does achieve profitability, it may not be able to sustain or increase profitability in the future.

eGain’s revenue and operating expenses may fluctuate as eGain adjusts its business, and this fluctuation may harm its operating results and financial condition

eGain has spent heavily on technology and infrastructure development. eGain expects to continue to spend financial and other resources at reduced levels on developing and introducing product and service offerings. Accordingly, if eGain’s revenue declines, its business and operating results could suffer.

Due to the emerging nature of the eService market and other factors, eGain’s revenue and operating results may fluctuate from quarter to quarter. It is possible that eGain’s operating results in some quarters will be below the expectations of financial analysts or investors. In this event, the market price of eGain’s common stock is likely to decline.

A number of factors are likely to cause fluctuations in eGain’s operating results, including, but not limited to, the following:

eGain bases its expense levels in part on its expectations regarding future revenue levels. In the short term, eGain’s expenses, such as employee compensation and rent, are relatively fixed and if eGain’s revenue for a particular quarter is below expectations, it may be unable to proportionately reduce its operating expenses for that quarter. Accordingly, such a revenue shortfall would have a disproportionate effect on eGain’s expected operating results for that quarter. For this reason, period-to-period comparisons of eGain’s operating results may not be a good indication of its future performance. Moreover, eGain believes that any further significant reductions in expenses would be difficult to achieve given current operating levels. eGain is instead focused on maintaining current expense levels.

Like most companies, eGain’s business is linked to the health of the U.S. and international economies. Economic growth has slowed significantly, and spending for enterprise software has weakened considerably over the past two years. At this time, it is difficult to predict if and when the market for eGain products and services will show a meaningful and sustained recovery. In addition, the threat of additional terrorist attacks and the related possibility for international hostilities create additional uncertainty that it could materially affect eGain’s business and results of operations.

The market for eService software remains relatively new and intensely competitive. Other than product development, there are no substantial barriers to entry in this market, and established or new entities may enter this market in the near future. eGain competes with companies that develop and maintain internally developed eService software applications. eGain also competes directly with companies that provide licensed eService software, including AskJeeves, Inc.; Avaya, Inc.; E.piphany, Inc.; Firepond, Inc.; Genesys Telecommunications (a wholly-owned subsidiary of Alcatel); Kana Software, Inc.; Primus Knowledge Solutions, Inc.; RightNow Technologies, Inc.; Serviceware; and Talisma Corp. eGain also faces actual or potential competition from larger, front office software companies such as Amdocs Limited (which acquired the Clarify, Inc. business from Nortel Networks); Onyx Software Corporation; PeopleSoft, Inc.; Pivotal Corp.; and Siebel Systems, Inc. Furthermore, established enterprise software companies, including IBM; Microsoft Corporation; Oracle Corporation; SAP, Inc.; and similar companies, may seek to leverage their existing relationships and capabilities to offer eService solutions.

eGain believes competition will increase as its current competitors increase the sophistication of their offerings and as new participants enter the market. Many of eGain’s current and potential competitors have:

These competitors may enter into strategic or commercial relationships with larger, more established and better-financed companies. These competitors may be able to:

Further, any delays in the general market acceptance of eGain’s eService applications would likely harm its competitive position. Any delay would allow eGain’s competitors additional time to improve their eService product offerings, and also provide time for new competitors to develop eService applications and solicit prospective customers within eGain’s target markets. Increased competition could result in pricing pressures, reduced operating margins and loss of market share.

eGain faces possible Nasdaq delisting which would result in a limited public market for its common stock and make obtaining future equity financing more difficult

On November 5, 2002, the listing of eGain’s common stock was transferred to the Nasdaq SmallCap Market from the Nasdaq National Market. eGain must satisfy a number of requirements to maintain its listing on the Nasdaq SmallCap Market, including maintaining a minimum bid price for its common stock of $1.00 per share required by Nasdaq Marketplace Rule 4310(c). A company fails to satisfy this requirement if its closing bid price remains below $1.00 per share for 30 consecutive trading days. eGain is currently exempt from the minimum bid price listing requirement due to the application of a grace period to regain compliance with such requirement following the transfer of the listing of eGain’s common stock to the Nasdaq SmallCap Market. eGain’s bid price grace period is scheduled to expire on approximately May 17, 2003; however, on January 30, 2003, Nasdaq announced the extension of a pilot program governing bid price rules for Nasdaq SmallCap issuers which may have the effect of extending the bid price grace period in the event that issuers can demonstrate compliance with several core Nasdaq SmallCap listing requirements. eGain can offer no assurance that this additional bid price grace period will be available.

On November 1, 2002 eGain’s stockholders authorized the Company’s board of directors discretion to effect a reverse split of the Company’s common stock in the following ratios: one-for-ten, one-for-fifteen or one-for-twenty. While a reverse split of eGain’s common stock, if effected by the board of directors, may bring the Company into compliance with the Nasdaq SmallCap Market bid price requirement, eGain can offer no assurance that its common stock will continue to meet the $1 bid price requirement or that eGain will meet the other requirements for the continued listing of its common stock on the Nasdaq SmallCap Market.

If a delisting from the Nasdaq SmallCap Market were to occur, shares of eGain’s common stock would likely trade in the over-the-counter market in the so-called “pink sheets” maintained by Pink Sheets LLC, or on the OTC Bulletin Board owned by The Nasdaq Stock Market, Inc., which was established for securities that do not meet the listing requirements of the Nasdaq National Market or the Nasdaq SmallCap Market. The “pink sheets” and the OTC Bulletin Board are generally considered less efficient than the Nasdaq SmallCap Market. Consequently, selling eGain common stock would be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and securities analysts’ and news media coverage of eGain may be reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of common stock.

Such delisting from the Nasdaq SmallCap Market, or further declines in eGain’s stock price, could also greatly impair its ability to raise additional necessary capital through equity or debt financing, and significantly increase the ownership dilution to stockholders caused by any issuance of equity in financing or other transactions. The price at which eGain issues shares in such transactions is generally based on the market price of its common stock and a decline in the stock price could result in the need for eGain to issue a greater number of shares to raise a given amount of funding or acquire a given dollar value of goods or services.

In addition, if eGain’s common stock is not listed on the Nasdaq SmallCap Market, eGain may become subject to Rule 15g-9 under the Securities and Exchange Act of 1934, as amended. That rule imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell eGain’s common stock and affect the ability of holders to sell their shares of eGain common stock in the secondary market. Moreover, investors may be less interested in purchasing low-priced securities because the brokerage commissions, as a percentage of the total transaction value, tend to be higher for such securities, and some investment funds will not invest in low-priced securities (other than those which focus on small-capitalization companies or low-priced securities).

eGain may need additional capital, and raising additional capital may be difficult or impossible and will likely dilute existing stockholders

While eGain closed a $5 million credit facility in December 2002, the additional $3,000,000 in loan proceeds available under the Credit Facility is subject to eGain achieving certain performance milestones. eGain can make no assurances that it will achieve the performance milestones necessary to receive these additional loan proceeds.

The conversion of eGain’s preferred shares and the exercise of the related warrants would result in a substantial number of additional shares being issued, which could result in a decline in the market price of eGain’s common stock

On August 8, 2000, eGain issued 35.11 shares of non-voting Series A Cumulative Convertible Preferred Stock (“Series A”), $100,000 stated value per share, and 849.89 shares of non-voting Series B Cumulative Convertible Preferred Stock (“Series B”), $100,000 stated value per share in a private placement to certain investors. The Series B shares automatically converted into Series A shares upon stockholder approval on November 20, 2000 at the annual stockholders meeting. In addition, the investors received warrants to purchase 3.8 million shares of eGain’s common stock with a current warrant exercise price of $5.6875 per share. The Series A shares have a liquidation preference of $100,000 per share, or an aggregate liquidation preference of $88.5 million, which increases on a daily basis at an annual rate of 6.75% from August 8, 2000, compounded on a semi-annual basis (the “Liquidation Value”). The Series A shares are convertible into common stock (including all amounts accreted from August 8, 2000) at a conversion price of $5.6875 per share. By way of illustration, at the current conversion price of $5.6875 per share, the Series A shares would be convertible into 17.7 million shares of common stock.

To the extent the preferred shares are converted into common stock (including all amounts accreted from August 8, 2000), a significant number of shares of common stock may be sold into the market, which could decrease the price of eGain’s common stock. If not sooner converted, on August 8, 2005 eGain must either, at its option, (i) redeem each outstanding share of Series A, at a redemption price equal to the Liquidation Value plus any declared but unpaid dividends or (ii) convert the Series A shares into common stock at a price per share equal to 95% of the average closing bid price per share of the common stock on the 20 consecutive trading days immediately prior to the redemption date.

In the event of a liquidation, dissolution or winding up of eGain, the holders of Series A shares would be entitled to receive, prior to distribution of any proceeds to holders of common stock, proceeds equal to the greater of (i) $88.5 million (plus increases in such liquidation preference at an annual rate of 6.75% from August 8, 2000) or (ii) the amount the holders of the Series A shares would have received had they converted their shares into common stock immediately prior to such liquidation, dissolution or winding up. If eGain enters into a transaction pursuant to which it sells or transfers all or substantially all of its assets or it enters into a merger with another company, then at the option of the holder of Series A shares, (A) each share of Series A may be converted into convertible equity securities of the entity acquiring eGain or (B) each Series A share may convert into shares of common stock based on the Liquidation Value, calculated as of the later of (x) the closing date of such transaction or (y) August 8, 2003. In the event that eGain were to enter into a merger or sale in which the total value of the transaction would be less than the Liquidation Value, a buyer would unlikely be willing to assume the liquidation preferences and other obligations represented by the Series A shares. Consequently, eGain currently anticipates that a transaction resulting in the sale of the Company would result in substantially all of the proceeds of such transaction being distributed to the holders of the Company’s Series A shares.

eGain may engage in future acquisitions or investments that could dilute eGain’s existing stockholders, cause eGain to incur significant expenses or harm its business

eGain may review acquisition or investment prospects that might complement its current business or enhance its technological capabilities. Integrating any newly acquired businesses or their technologies or products may be expensive and time-consuming. To finance any acquisitions, it may be necessary for eGain to raise additional funds through public or private financings. Additional funds may not be available on terms that are favorable to eGain, if at all, and, in the case of equity financings, may result in dilution to eGain’s existing stockholders. eGain may not be able to operate acquired businesses profitably or otherwise implement its growth strategy successfully. If eGain is unable to integrate newly acquired entities or technologies effectively, eGain’s operating results could suffer. Future acquisitions by eGain could also result in large and immediate write-offs, the conversion of the Company’s preferred stock into common stock, incurrence of debt and contingent liabilities, or amortization of expenses related to goodwill and other intangibles, any of which could harm eGain’s operating results.

eGain’s cost reduction initiatives may adversely affect the morale and performance of eGain’s personnel and its ability to hire new personnel

In connection with eGain’s effort to streamline operations and reduce costs to better align operating costs and expenses with revenue trends, eGain has been restructuring its organization for the past several quarters, resulting in substantial reductions in eGain’s workforce. eGain has reduced its employees’ salaries numerous times since the quarter ended December 31, 2001 in order to reduce operating expenses. eGain’s reductions in workforce and salary levels may reduce employee morale and may create concern among existing employees about job security, which may lead to attrition beyond eGain’s planned workforce reductions and reduce eGain’s ability to meet the needs of its current and future customers.

In addition, many of the employees who were terminated possessed specific knowledge or expertise that may prove to have been important to eGain’s operations. In that case, their absence may create significant difficulties. This personnel reduction may also subject eGain to the risk of litigation, which may adversely impact eGain’s ability to conduct its operations and may cause eGain to incur significant expense.

eGain’s success will depend on the skills, experience and performance of eGain’s senior management, engineering, sales, marketing and other key personnel. The loss of the services of any of eGain’s senior management or other key personnel, including eGain’s Chief Executive Officer and co-founder, Ashutosh Roy, and eGain’s President and co-founder, Gunjan Sinha, could harm its business. In addition to eGain’s senior management, the workforce reductions completed by eGain have increased eGain’s dependence on its remaining employees. Any attrition beyond eGain’s planned workforce reductions could reduce eGain’s ability to meet the needs of its current and future customers.

In addition, eGain does not have employment agreements with, or life insurance policies on, most of its key employees. Most of these employees may terminate their employment with eGain at any time. eGain’s success also will depend on its ability to retain and motivate other highly skilled engineering, sales, marketing and other personnel. If eGain fails to retain necessary engineering, sales and marketing, customer support or other personnel, eGain’s business and its ability to develop new products and services and to provide acceptable levels of customer service could suffer. In addition, companies in the software industry whose employees accept positions with competitors frequently claim that competitors have engaged in unfair hiring practices. eGain could incur substantial costs in defending itself against any of these claims, regardless of the merits of such claims.

eGain has expanded and in the future may expand its international operations and enter additional international markets. eGain, through eGain India, currently has a significant number of employees representing in excess of 50% of its total workforce located in India. The management of these operations will require significant management attention and financial resources that could adversely affect eGain’s operating performance. eGain’s international operations are subject to a variety of risks, including:

Any of these risks could have a significant impact on one or more of the following business functions:

If eGain fails to expand its sales activities, it may be unable to expand its business

The company has experienced significant turnover of its North America sales force. Expansion of business is very much dependant on eGain’s ability to rebuild its North America sales force. If eGain does not successfully expand its sales activities, eGain may not be able to expand its business, and eGain’s common stock price could decline. The complexity of eGain’s eService platform and related products and services requires it to have highly trained sales personnel to educate prospective customers regarding the use and benefits of eGain’s products and services as well as provide effective customer support. With eGain’s relatively brief operating history and its plans for future growth, eGain has considerable need to train and retain qualified sales staff. Any delays or difficulties eGain encounters in these staffing efforts could impair its ability to attract new customers and enhance its relationships with existing customers. This in turn would adversely affect the timing and extent of eGain’s revenue.

eGain’s failure to expand third-party distribution channels would impede its revenue growth

To increase its revenue, eGain must increase the number of its marketing and distribution partners, including software and hardware vendors and resellers. eGain’s existing or future marketing and distribution partners may choose to devote greater resources to marketing and supporting the products of competitors which could also harm eGain. eGain’s failure to expand third-party distribution channels would impede its revenue growth.

Similarly, to increase its revenue and implementation capabilities, eGain must develop and expand relationships with systems integrators. eGain relies on systems integrators to recommend eGain’s products to their customers and to install and support eGain’s products for their customers. Systems integrators may develop, market or recommend software applications that compete with eGain’s products. Moreover, if these firms fail to implement eGain’s products successfully for their customers, eGain may not have the resources to implement its products on the schedule required by their customers.

Due to the lengthy sales cycles of some of eGain’s products, the timing of its sales is difficult to predict and may cause eGain to miss its revenue targets

The long sales cycle for eGain’s products may cause license revenue and operating results to vary significantly from period to period. eGain’s sales cycle for its products can be six months or more and varies substantially from customer to customer. While eGain’s potential customers are evaluating eGain’s products before executing definitive agreements, eGain may incur substantial expenses and spend significant management effort in connection with the potential customer. eGain’s multi-product offering and the increasingly complex needs of its customers contribute to a longer and unpredictable sales cycle. Consequently, eGain faces difficulty predicting the quarter in which expected sales will actually occur. This contributes to the uncertainty and fluctuations in eGain’s future operating results. In addition, the economic slowdown in North America may cause potential customers to delay or cancel major information technology purchasing decisions. If this slowdown continues, eGain’s average sales cycle could increase and, in some cases, prevent deals from closing that eGain has been forecasting as likely to close. Consequently, eGain may not meet its revenue forecast and may incur significant expenses that are not offset by corresponding revenue.

Difficulties in implementing eGain’s products could harm its revenues and margins

eGain generally recognizes revenue from a customer sale when persuasive evidence of an arrangement exists, the product has been delivered, the arrangement does not involve significant customization of the software, the license fee is fixed or determinable and collection of the fee is probable. If an arrangement requires significant customization or implementation services from eGain, recognition of the associated license and service revenue could be delayed. The timing of the commencement and completion of the these services is subject to factors that may be beyond eGain’s control, as this process requires access to the customer’s facilities and coordination with the customer’s personnel after delivery of the software. In addition, customers could delay product implementations. Implementation typically involves working with sophisticated software, computing and communications systems. If eGain experiences difficulties with implementation or does not meet project milestones in a timely manner, eGain could be obligated to devote more customer support, engineering and other resources to a particular project. Some customers may also require eGain to develop customized features or capabilities. If new or existing customers have difficulty deploying eGain’s products or require significant amounts of eGain professional services, support, or customized features, revenue recognition could be further delayed or canceled and eGain’s costs could increase, causing increased variability in eGain’s operating results.

eGain depends on the widespread acceptance and use of eService applications as an effective solution for businesses seeking to manage high volumes of customer communication over the Internet while providing improved customer service. eGain cannot estimate the size or growth rate of the potential market for its product and service offerings, and does not know whether its products and services will achieve broad market acceptance. The market for eService software is new and rapidly evolving, and concerns over the security and reliability of online transactions, the privacy of users and quality of service or other issues may inhibit the growth of the Internet and commercial online services. If the market for eService applications fails to grow or grows more slowly than eGain currently anticipates, its business will be seriously harmed.

eGain may be unable to develop or enhance products or services that address the changing needs of the eService market

To be competitive in the eService market, eGain must continually improve the performance, features and reliability of eGain products and services, including eGain’s existing eService product suite, and develop new products, services, functionality and technology that address changing industry standards and customer needs. If eGain cannot bring new or enhanced products to market in a timely and effective way, its business and operating results will suffer. More generally, if eGain cannot adapt or respond in a cost-effective and timely manner to changing industry standards, market conditions or customer requirements, eGain’s business and operating results will suffer.

Unknown software defects could disrupt eGain’s products and services, which could harm eGain’s business and reputation

eGain’s product and service offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when new versions are released. eGain may not discover software defects that affect its new or current services or enhancements until after they are deployed. It is possible that, despite testing by eGain, defects may occur in the software. These defects could result in damage to eGain’s reputation, lost sales, product liability claims, delays in or loss of market acceptance of eGain’s products, product returns and unexpected expenses, and diversion of resources to remedy errors.

Problems arising from use of eGain’s products with other vendors’ products could cause eGain to incur significant costs, divert attention from eGain’s product development efforts and cause customer relations problems

eGain’s customers generally use eGain products together with products from other companies. As a result, when problems occur in the network, it may be difficult to identify the source of the problem. Even when eGain’s products do not cause these problems, these problems may cause eGain to incur significant warranty and repair costs, divert the attention of eGain’s engineering personnel from product development efforts and cause significant customer relations problems.

eGain may need to license third-party technologies and may be unable to do so

To the extent eGain needs to license third-party technologies, it may be unable to do so on commercially reasonable terms or at all. In addition, eGain may fail to successfully integrate any licensed technology into its products or services. Third-party licenses may expose eGain to increased risks, including risks associated with the integration of new technology, the diversion of resources from the development of eGain’s own proprietary technology, and eGain’s inability to generate revenue from new technology sufficient to offset associated acquisition and maintenance costs. eGain’s inability to obtain and successfully integrate any of these licenses could delay product and service development until equivalent technology can be identified, licensed and integrated. This in turn would harm eGain’s business and operating results.

eGain may be unable to protect its intellectual property and proprietary rights

eGain regards its patents, copyrights, service marks, trademarks, trade secrets and similar intellectual property as critical to its success, and relies on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with eGain employees, customers and partners to protect its proprietary rights. eGain has numerous registered trademarks and trademark applications pending in the United States and internationally, as well as common law trademark rights. In addition, eGain owns several patents in the area of case-based reasoning, and has patents pending relating to various technologies. eGain will seek additional trademark and patent protection in the future. eGain does not know if its trademark and patent applications will be granted, or whether they will provide the protection eGain desires, or whether they will subsequently be challenged or invalidated. It is difficult to monitor unauthorized use of technology, particularly in foreign countries, where the laws may not protect eGain’s proprietary rights as fully as in the United States. Furthermore, eGain’s competitors may independently develop technology similar to eGain’s technology.

Despite eGain’s efforts to protect its proprietary rights through confidentiality and license agreements, unauthorized parties may attempt to copy or otherwise obtain and use eGain’s products or technology. These precautions may not prevent misappropriation or infringement of eGain’s intellectual property. In addition, eGain routinely requires its employees, customers, and potential business partners to enter into confidentiality and nondisclosure agreements before eGain will disclose any sensitive aspects of its products, technology, or business plans. In addition, eGain requires employees to agree to surrender to eGain any proprietary information, inventions or other intellectual property they generate or come to possess while employed by eGain. In addition, some of eGain’s license agreements with certain customers and partners require eGain to place the source code for its products into escrow. These agreements typically provide that some party will have a limited, non-exclusive right to access and use this code as authorized by the license agreement if there is a bankruptcy proceeding instituted by or against eGain, or if eGain materially breaches a contractual commitment to provide support and maintenance to the party.

eGain may face intellectual property infringement claims that could be costly to defend

Third parties may infringe or misappropriate eGain’s copyrights, trademarks and similar proprietary rights. In addition, other parties may assert infringement claims against eGain. For example, on December 13, 2002, Mindfabric, Inc. filed suit against eGain alleging infringement of eGain products on one or more patents owned by Mindfabric, Inc. eGain intends to vigorously defend the claim. However, these claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. In addition, because the contents of patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to eGain’s software products. eGain may be subject to legal proceedings and claims from time to time in the ordinary course of its business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming and could divert management’s attention away from running eGain’s business. This litigation could also require eGain to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all, in the event of a successful claim of infringement. eGain’s failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm its business.

eGain may face liability associated with its management of sensitive customer information

eGain’s applications manage sensitive customer information, and eGain may be subject to claims associated with invasion of privacy or inappropriate disclosure, use or loss of this information. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage, could harm eGain’s reputation and its business and operating results.

eGain may become involved in additional securities class action litigation which could divert management’s attention and harm its business

The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stocks of technology companies, particularly Internet companies. These broad market fluctuations may cause the market price of eGain common stock to increase and 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. In addition to the proceeding described in “Legal Proceedings,” eGain may become involved in this type of litigation in the future. Litigation is often expensive and diverts management’s attention and resources, which could harm eGain’s business and operating results.

The price at which eGain common stock trades has been and will likely continue to be highly volatile and fluctuate substantially due to factors such as the following:

Unplanned system interruptions and capacity constraints could reduce eGain’s ability to provide hosting services and could harm its business and reputation

eGain’s customers have in the past experienced some interruptions with the eGain hosted operations. eGain believes that these interruptions will continue to occur from time to time. These interruptions could be due to hardware and operating system failures. As a result, eGain’s business will suffer if it experiences frequent or long system interruptions that result in the unavailability or reduced performance of its hosted operations or reduce eGain’s ability to provide remote management services. eGain expects to experience occasional temporary capacity constraints due to sharply increased traffic, which may cause unanticipated system disruptions, slower response times, impaired quality, and degradation in levels of customer service. If this were to continue to happen, eGain’s business and reputation could be seriously harmed.

eGain’s success largely depends on the efficient and uninterrupted operation of its computer and communications hardware and network systems. Most of eGain’s computer and communications systems are located in Sunnyvale, California. eGain’s systems and operations are vulnerable to damage or interruption from fire, earthquake, power loss, telecommunications failure and similar events.

eGain has entered into service agreements with some of its customers that require minimum performance standards, including standards regarding the availability and response time of eGain’s remote management services. If eGain fails to meet these standards, eGain’s customers could terminate their relationships with eGain, and eGain could be subject to contractual monetary penalties. Any unplanned interruption of services may harm eGain’s ability to attract and retain customers.

eGain may be liable for activities of its customers or others using eGain’s hosted operations

As a provider of eService software for the Internet, eGain faces potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the actions of eGain customers or others using eGain solutions. This liability could result from the nature and content of the communications transmitted by eGain customers through the hosted operations. eGain does not and cannot screen all of the communications generated by its customers, and eGain could be exposed to liability with respect to this content. Furthermore, some foreign governments have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the United States.

If eGain’s system security is breached, eGain’s business and reputation could suffer

A fundamental requirement for online communications and transactions is the secure transmission of confidential information over public networks. Third parties may attempt to breach eGain’s security or that of eGain’s customers. eGain may be liable to its customers for any breach in its security and any breach could harm its business and reputation. Although eGain has implemented network security measures, eGain’s servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays, or loss of data. eGain may be required to expend significant capital and other resources to license encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach.

eGain’s business is premised on an emerging business model that is not fully tested

eGain’s business is premised on business assumptions that are still evolving. Historically, customer service has been conducted primarily in person or over the telephone. eGain’s business model assumes that both customers and companies will increasingly elect to communicate via the Internet (assisted and unassisted online service), as well as demanding integration of the online channels into the traditional telephone-based call center. eGain’s business model also assumes that many companies recognize the benefits of a hosted delivery model and will seek to have their eService applications hosted by eGain. If any of these assumptions is incorrect, eGain’s business will be seriously harmed.

Because eGain provides its eService software to companies conducting business over the Internet, eGain’s business could suffer if efficient transmission of data over the Internet is interrupted

The recent growth in the use of the Internet has caused frequent interruptions and delays in accessing the Internet and transmitting data over the Internet. Because eGain provides Internet-based eService software, interruptions or delays in Internet transmissions will harm eGain customers’ ability to receive and respond to online interactions. Therefore, eGain’s market depends on improvements being made to the entire Internet infrastructure to alleviate overloading and congestion.

Governmental regulation and legal uncertainties could impair the growth of the Internet and decrease demand for eGain’s services or increase eGain’s cost of doing business

Governmental regulation may impair the growth of the Internet or commercial online services. This could decrease the demand for eGain’s products and services, increase its cost of doing business or otherwise harm its business and operating results. Although there are currently few laws and regulations directly applicable to the Internet and the use of the Internet as a commercial medium, a number of laws have been proposed involving the Internet. These proposed laws include laws addressing user privacy, pricing, content, copyrights, distribution, antitrust, and characteristics and quality of products and services. Further, the growth and development of the market for commercial online transactions may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies engaged in ecommerce. Moreover, the applicability to the Internet of existing laws in various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve.

eGain develops products in the United States and India and sells these products internationally. Generally, sales are made in local currency. As a result, eGain’s financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. To date, the effect of changes in foreign currency exchange rates on revenues and operating expenses has not been material. eGain does not currently use derivative instruments to hedge against foreign exchange risk.

eGain’s exposure to market rate risk for changes in interest rates relates primarily to its investment portfolio. eGain’s investments consist primarily of commercial paper and money market funds, which have an average fixed rate of 1.0% to 3.5%, and have maturities of three months or less. eGain does not consider its cash equivalents to be subject to interest rate risk due to their short maturities.

(a) Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of a date within 90 days prior to the filing date of this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

(b) Changes in internal controls. There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

In March 2002, eGain was named as defendant in a Wisconsin state court action alleging breach of contract/warranty, fraudulent misrepresentation and related claims arising from a software license agreement between Metavante Corp. and Inference Corporation (a wholly owned subsidiary of eGain). Three of the four charges have been dismissed, with the breach of contract/warranty as the outstanding claim remaining. eGain intends to defend this final claim vigorously and does not expect it to have a material impact on its results of operations. However, the ultimate outcome of any litigation is uncertain, and it could have an adverse material impact due to defense costs, diversion of management and other resources and other factors.

On December 13, 2002, Mindfabric, Inc. filed an action for patent infringement against eGain. eGain intends to defend the claim vigorously and does not expect it to have a material impact on its results of operations. However, even if these claims are not meritorious, the ultimate outcome of any litigation is uncertain, and it could have an adverse material impact due to defense costs, diversion of management, and other resources and other factors.

We filed one report on Form 8-K for the quarter ended March 31, 2003 as follows:

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 15, 2003

By:		/s/ ASHUTOSH ROY
		Ashutosh Roy

Date: May 15, 2003

By:		/s/ ERIC SMIT
		Eric Smit

Delaware		77-0466366
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Class		Outstanding at March 31, 2003
Common Stock $0.001 par value		36,645,338

		Page
PART I. FINANCIAL INFORMATION		1

Item 1.	Financial Statements	1

	Condensed Consolidated Balance Sheets at March 31, 2003 and June 30, 2002	1

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended March 31, 2003 and 2002	2

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 2003 and 2002	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3.	Quantitative and Qualitative Disclosure About Market Risk	33

Item 4.	Control and Procedures	33

PART II. OTHER INFORMATION		34

Item 1.	Legal Proceedings	34

Item 2.	Changes in Securities	35

Item 3.	Defaults upon Senior Securities	35

Item 4.	Submission of Matters to a Vote of Security Holders	35

Item 5.	Other Information	35

Item 6.	Exhibits and Reports on Form 8-K	35

	Signatures	36

	Certifications	37

	March 31, 2003			June 30, 2002
	(unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	3,234		$	9,892
Restricted cash		1,088			—
Accounts receivable, net		3,356			4,968
Prepaid and other current assets		3,237			4,472

Total current assets		10,915			19,332

Property and equipment, net		2,169			5,736
Goodwill, net		4,880			4,130
Intangible assets, net		1,510			4,087
Other assets		812			2,259

	$	20,286		$	35,544

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,629		$	3,176
Accrued compensation		825			2,494
Accrued liabilities		2,256			2,162
Current portion of accrued restructuring		1,013			3,116
Deferred revenue		3,446			3,555
Current portion of bank borrowings		1,548			1,999
Current portion of notes payable		77			156
Current portion of capital lease obligations		14			393

Total current liabilities		10,808			17,051

Bank borrowings, net of current portion		—			779
Related party notes payable, net of current portion		1,887			—
Capital lease obligations, net of current portion		17			52
Accrued restructuring, net of current portion		1,297			1,979
Other long term liabilities		261			214

Total liabilities		14,270			20,075

Commitments

Stockholders’ equity:
Series A cumulative convertible preferred stock; Aggregate liquidation preference of $105,522 at March 31, 2003		99,624			94,481
Common stock		37			37
Additional paid-in capital		215,360			220,398
Notes receivable from stockholders		(101	)		(103	)
Deferred stock compensation		(57	)		(257	)
Accumulated other comprehensive income (loss)		(81	)		59
Accumulated deficit		(308,766	)		(299,146	)

Total shareholders’ equity		6,016			15,469

	$	20,286		$	35,544

	Three Months Ended March 31,						Nine Months Ended March 31,
	2003			2002			2003			2002
Revenue:
Hosting	$	885		$	931		$	2,842		$	4,503
License		983			1,242			4,619			7,739
Services		3,355			3,737			9,256			11,875

Total revenue		5,223			5,910			16,717			24,117
Cost of revenue—direct		2,372			3,592			8,401			12,444
Cost of revenue—acquisition related		227			362			827			1,086

Gross profit		2,624			1,956			7,489			10,587

Operating costs and expenses:
Research and development		1,381			2,452			4,695			9,058
Sales and marketing		1,840			6,003			7,538			20,098
General and administrative		1,007			2,401			3,670			7,333
Amortization of goodwill		—			8,731			—			26,193
Amortization of other intangible assets		327			463			1,001			1,389
Amortization of deferred compensation		31			233			136			793
Restructuring		512			327			274			5,578

Total operating costs and expenses		5,098			20,610			17,314			70,442

Loss from operations		(2,474	)		(18,654	)		(9,825	)		(59,855	)
Non-operating income (expense)		9			(352	)		205			(146	)

Net loss		(2,465	)		(19,006	)		(9,620	)		(60,001	)

Dividends on convertible preferred stock		(1,727	)		(1,617	)		(5,143	)		(4,813	)
Beneficial conversion feature on convertible preferred stock		—			—			—			(43,834	)

Net loss applicable to common stockholders	$	(4,192	)	$	(20,623	)	$	(14,763	)	$	(108,648	)

Per Share information:
Basic and diluted net loss per common share	$	(0.11	)	$	(0.57	)	$	(0.40	)	$	(3.01	)

Weighted average shares used in computing basic and diluted net loss per common share		36,645			36,318			36,627			36,137

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Table of Contents

Table of Contents

Table of Contents

Table of Contents

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Table of Contents

	Three months ended March 31,						Nine months ended March 31,
	2003			2002			2003			2002
As Reported:
Net loss applicable to common stockholders	$	(4,192	)	$	(20,623	)	$	(14,763	)	$	(108,648	)
Basic and diluted net loss per share		(0.11	)		(0.57	)		(0.40	)		(3.01	)

Add: Stock-based employee compensation expense included in reported net income		31			233			136			793
Deduct: Total stock-based employee compensation expense determined under fair value based method		101			2,129			257			2,583

Pro Forma:
Net loss	$	(4,262	)	$	(22,519	)	$	(14,884	)	$	(110,438	)
Basic and diluted net loss per share		(0.12	)		(0.62	)		(0.41	)		(3.06	)

	March 31, 2003			June 30, 2002
Gross carrying amount of goodwill after impairment charge	$	86,664		$	84,409
Gross carrying amount of assembled workforce		—			2,255

Adjusted gross carrying amount of goodwill		86,664			86,664
Accumulated amortization of goodwill		(81,784	)		(80,279	)
Accumulated amortization of assembled workforce reclassified to goodwill		—			(1,505	)

Net carrying amount of goodwill including assembled workforce		4,880			4,880
Assembled workforce reclassified to goodwill upon adoption of FAS 142		—			(750	)

Net carrying amount of goodwill	$	4,880		$	4,130

	March 31, 2003
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Acquired customer base	$	4,901	$	(3,391	)	$	1,510
Acquired developed technology		3,694		(3,694	)		—

Total	$	8,595	$	(7,085	)	$	1,510

	March 31, 2003		June 30, 2002
North America	$	9,828	$	22,466
Europe		2,552		3,635
Asia Pacific		833		599
India		683		627

	$	13,896	$	27,327

	Amount		Maturity Date	Interest Rate
Accounts Receivable Facility	$	500	June 30, 2003	Prime + 5.0% + 0.5% monthly fee

Term loan		1,048	February 29, 2004	Prime

	$	1,548

	Cash/Non-cash	FY 03 Charges		Amount Paid/Used			Balance at 03/31/03
Excess facilities	Cash	$	707	$	(290	)	$	417
Employee severance	Cash		1,179		(1,179	)		—
Professional services	Cash		48		(48	)		—

Total restructuring charges		$	1,934	$	(1,517	)	$	417

	Cash/Non-cash	FY 02 Charges		Amount Paid/Used			Adjustment			Balance at 03/31/03
Excess facilities	Cash	$	6,412	$	(2,951	)	$	(1,660	)	$	1,801
Leasehold improvement write-offs	Non-cash		1,315		(1,315	)		—			—
Employee severance	Cash		1,222		(1,222	)		—			—
Professional services	Cash		15		(15	)		—			—

Total restructuring charges		$	8,964	$	(5,503	)	$	(1,660	)	$	1,801

	Cash/Non-cash	FY 01 Charges		Amount Paid/Used			Balance at 03/31/03
Excess facilities	Cash	$	263	$	(263	)	$	—
Employee severance	Cash		917		(917	)		—
Professional services	Cash		263		(171	)		92

Total restructuring charges		$	1,443	$	(1,351	)	$	92

	Three Months March 31,				Nine Months March 31,
	2003		2002		2003		2002
Revenue:
Hosting	17	%	16	%	17	%	19	%
License	19	%	21	%	28	%	32	%
Services	64	%	63	%	55	%	49	%

Total revenue	100	%	100	%	100	%	100	%
Cost of revenue—direct	45	%	61	%	50	%	52	%
Cost of revenue—acquisition related	5	%	6	%	5	%	4	%

Gross profit	50	%	33	%	45	%	44	%

Operating costs and expenses:
Research and development	26	%	41	%	28	%	38	%
Sales and marketing	35	%	102	%	45	%	83	%
General and administrative	19	%	41	%	22	%	31	%
Amortization of goodwill and other intangible assets	6	%	156	%	6	%	114	%
Amortization of deferred compensation	1	%	4	%	1	%	3	%
Restructuring	10	%	5	%	2	%	23	%

Total operating costs and expenses	97	%	349	%	104	%	292	%

Loss from operations	(47	%)	(316	%)	(59	%)	(248	%)

	Year Ended June 30,
	2003		2004		2005		2006		2007		Total
Capital leases	$	14	$	17	$	—	$	—	$	—	$	31
Operating leases		315		926		562		483		—		2,286
Bank borrowings and notes payable		1,625		—		—		—		2,000		3,625

Total	$	1,954	$	943	$	562	$	483	$	2,000	$	5,942

Date		Item Reported on

May 6, 2003		We announced our preliminary operating results in a press release issued on May 5, 2003.

Dated: May 15, 2003	eGAIN COMMUNICATIONS CORPORATION

	By	/s/ ERIC SMIT
		Eric Smit Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)