EGAIN COMMUNICATIONS CORP - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2002

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

For the transition period from to

Commission File No. 0-30260

eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

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

624 E. Evelyn Avenue, Sunnyvale, CA		94086
(Address of principal executive offices)		(Zip Code)

(408) 212-3400

(Registrant’s telephone number, including area code)

N/A

(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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

Class		Outstanding at September 30, 2002
Common Stock $0.001 par value		36,598,849

eGAIN COMMUNICATIONS CORPORATION

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION		1

Item 1.	Financial Statements	1

	Condensed Consolidated Balance Sheets at September 30, 2002 and June 30, 2002	1

	Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2002 and 2001	2

	Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 31, 2002 and 2001	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9

Item 3.	Quantitative and Qualitative Disclosure About Market Risk	29

Item 4.	Controls and Procedures	29

PART II. OTHER INFORMATION		30

Item 1.	Legal Proceedings	30

Item 2.	Changes in Securities	30

Item 3.	Defaults upon Senior Securities	33

Item 4.	Submission of Matters to a Vote of Security Holders	33

Item 5.	Other Information	33

Item 6.	Exhibits and Reports on Form 8-K	33

	Signatures	34

	Certifications	35

	Index to Exhibits

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

	September 30, 2002			June 30, 2002
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	2,790		$	9,892
Restricted cash		1,722			—
Accounts receivable, net		3,937			4,968
Prepaid and other current assets		3,853			4,472

Total current assets		12,302			19,332
Property and equipment, net		4,471			5,736
Goodwill, net		4,880			4,130
Intangible assets, net		2,701			4,087
Other assets		1,891			2,259

	$	26,245		$	35,544

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,462		$	3,176
Accrued compensation		1,717			2,494
Accrued liabilities		1,688			2,162
Current portion of accrued restructuring		3,076			3,116
Deferred revenue		3,828			3,555
Current portion of bank borrowings		1,914			1,999
Current portion of notes payable		114			156
Current portion of capital lease obligations		232			393

Total current liabilities		15,031			17,051
Bank borrowings, net of current portion		476			779
Capital lease obligations, net of current portion		33			52
Accrued restructuring, net of current portion		1,479			1,979
Other long term liabilities		221			214

Total liabilities		17,240			20,075
Commitments
Stockholders’ equity:
Series A cumulative convertible preferred stock;
Aggregate liquidation preference of $102,087 at September 30, 2002		96,189			94,481
Common stock		37			37
Additional paid-in capital		218,636			220,398
Notes receivable from stockholders		(104	)		(103	)
Deferred stock compensation		(137	)		(257	)
Accumulated other comprehensive income (loss)		(52	)		59
Accumulated deficit		(305,564	)		(299,146	)

Total shareholders’ equity		9,005			15,469

	$	26,245		$	35,544

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,
	2002			2001
Revenue:
Hosting	$	1,046		$	2,041
License		1,817			2,060
Services		2,808			3,939

Total revenue		5,671			8,040
Cost of revenue—direct		3,416			5,068
Cost of revenue—acquisition related		300			362

Gross profit		1,955			2,610
Operating costs and expenses:
Research and development		1,933			4,574
Sales and marketing		3,474			8,602
General and administrative		1,450			3,805
Amortization of goodwill and other intangible assets		337			9,194
Amortization of deferred compensation		66			302
Restructuring		1,047			4,785

Total operating costs and expenses		8,307			31,262

Loss from operations		(6,352	)		(28,652	)
Non-operating income (expense)		(66	)		233

Net loss		(6,418	)		(28,419	)
Dividends on convertible preferred stock		(1,708	)		(1,598	)
Beneficial conversion feature on convertible preferred stock		—			(43,834	)

Net loss applicable to common stockholders	$	(8,126	)	$	(73,851	)

Per Share information:
Basic and diluted net loss per common share	$	(0.22	)	$	(2.06	)

Weighted average shares used in computing basic and diluted net loss per common share		36,599			35,916

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended September 30,
	2002			2001
Cash flows from operating activities:
Net loss	$	(6,418	)	$	(28,419	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		1,313			1,850
(Gain) loss on disposal of fixed assets		(15	)		812
Amortization of goodwill and other intangible assets		636			9,556
Amortization of deferred compensation		65			302
Changes in operating assets and liabilities:
Restricted cash		(1,722	)		—
Accounts receivable		1,031			4,121
Prepaid and other current assets		619			(88	)
Other assets		368			39
Accounts payable		(714	)		(1,788	)
Accrued compensation		(777	)		(1,093	)
Accrued liabilities		(474	)		270
Accrued restructuring		(540	)		3,466
Deferred revenue		273			(850	)
Other liabilities		7			15

Net cash used in operating activities		(6,348	)		(11,807	)
Cash flows from investing activities:
Purchases of property and equipment		(33	)		(464	)

Net cash used in investing activities		(33	)		(464	)
Cash flows from financing activities:
Payments on borrowings		(1,203	)		(277	)
Payments on capital lease obligations		(180	)		(250	)
Proceeds from borrowings		773			271
Net proceeds from issuance of common stock		—			31

Net cash used in financing activities		(610	)		(225	)
Effect of exchange rate differences on cash		(111	)		(172	)

Net increase (decrease) in cash and cash equivalents		(7,102	)		(12,668	)
Cash and cash equivalents at beginning of period		9,892			42,613

Cash and cash equivalents at end of period	$	2,790		$	29,945

Supplemental cash flow disclosures:
Cash paid for interest	$	56		$	154

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The condensed consolidated financial statements have been prepared by eGain 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 over the last fiscal year eGain has repeatedly taken actions to reduce its expense rates, it expects to incur additional operating losses, at least through the second quarter of fiscal 2003 if not longer. eGain’s working capital requirements in the foreseeable future will depend on a variety of factors and assumptions, in particular that revenue growth rates remain stable and that customers continue to pay on a timely basis, and is subject to numerous risks. If eGain does not significantly reduce its net cash outflow in the near term, as compared to fiscal 2002, eGain will require additional credit facilities, additional equity and/or debt financings and/or will need to pursue strategic alternatives in fiscal year 2003. eGain is currently focused on reducing its expenses and pursuing such alternatives in the near term. These conditions raise substantial doubt about the Company’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 principles 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.

Note 2. Software Revenue Recognition

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

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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 and automatically renew 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.

Note 3. Goodwill and Other Intangible Assets

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

	June 30, 2002			September 30, 2002
Gross carrying amount of goodwill	$	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	$	4,880		$	4,880

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):

	September 30, 2002
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Acquired customer base	$	4,901	$	(2,989	)	$	1,912
Acquired developed technology		3,694		(2,905	)		789

Total	$	8,595	$	(5,894	)	$	2,701


	June 30, 2002
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Acquired customer base	$	4,901	$	(2,472	)	$	2,429
Acquired developed technology		3,694		(2,786	)		908

Total	$	8,595	$	(5,258	)	$	3,337

Effective July 1, 2002, eGain adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” As required by SFAS No. 142, eGain is no longer amortizing goodwill, but will be reviewing annually (or more frequently if impairment indicators arise) for impairment. Intangible assets with a net carrying value of $750,000, which do not quality 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 has completed a goodwill review as of the date of adoption - July 1, 2002 and found no impairment of goodwill beyond amounts previously recorded at that date. The following adjusted earnings and earnings per share data have been presented on a pro forma basis to eliminate goodwill amortization (in thousands, except per share amounts):

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	Three Months Ended September 30,
	2002			2001
Net loss—as reported	$	(8,126	)	$	(73,851	)
Adjustments:
Amortization of goodwill	$	—		$	8,731
Amortization of acquired workforce intangible previously classified as purchased intangible	$	—		$	188

Net losss applicable to common stockholders—as adjusted	$	(8,126	)	$	(64,932	)

Basic and diluted net loss per common share—as reported	$	(0.22	)	$	(2.06	)

Basic and diluted net loss per common share—as adjusted	$	(0.22	)	$	(1.81	)

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.

For the three months ended September 30, 2002, there was no impairment of long-lived assets.

Note 4. Net Loss Per Common Share

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):

	Three Months Ended September 30,
	2002			2001
Net loss applicable to common stockholders	$	(8,126	)	$	(73,851	)

Basic and diluted:
Weighted-average shares outstanding		36,657			36,416
Less weighted-average shares subject to repurchase		(58	)		(500	)

Weighted-average shares used in computing basic and diluted net loss per common share		36,599			35,916

Basic and diluted net loss per common share	$	(0.22	)	$	(2.06	)

Options and warrants to purchase 9,147,878 and 9,216,000 shares of common stock were outstanding at September 30, 2002 and 2001, respectively. In addition, convertible preferred stock convertible into 17,949,000 and

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16,796,000 shares of common stock were outstanding at September 30, 2002 and 2001, respectively. The above amounts were excluded from the computation of net loss per common share, as their effect is anti-dilutive.

Note 5. Comprehensive Loss

eGain’s comprehensive loss is comprised of net loss, foreign currency translation adjustments and unrealized gains or losses on short-term investments held as available-for-sale. Comprehensive loss was $6.5 million and $28.6 million for the three months ended September 30, 2002 and 2001, respectively. These amounts were not materially different from net loss as reported in the consolidated statements of operations.

Note 6. Segment Information

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):

	Three Months Ended September 30,
	2002		2001
Total Revenue:
North America	$	3,097	$	4,995
Europe		2,365		2,246
Asia Pacific		209		799
India		—		—

	$	5,671	$	8,040

Operating Loss:
North America	$	4,793	$	26,427
Europe		699		1,075
Asia Pacific		280		606
India		580		544

	$	6,352	$	28,652

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

	September 30,
	2002		2001
North America	$	14,951	$	52,617
Europe		2,582		3,859
Asia Pacific		525		616
India		606		615

	$	18,664	$	57,707

During the three months ended September 30, 2002 and 2001, no single customer accounted for more than 10% of eGain’s total revenue.

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Note 7. Bank Borrowings

On September 20, 2002, eGain entered into an accounts receivable purchase agreement (the “AR Facility”) with SVB, which replaced the existing revolving line of credit. The Accounts Receivables 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 0.50% monthly administrative fee. As of September 30, 2002, there was approximately $770,000 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 $1.7 million which was secured by establishing a restricted certificate of deposit for $1.7 million. This will be reduced as scheduled amortization payments on the term loan are made.

Total borrowings under the SVB Credit Facilities were $2,390,000 at September 30, 2002, which consisted of the following (in thousands):

	Amount		Maturity Date	Interest Rate
Accounts Receivable Facility	$	770	March 31, 2003	Prime + 5.0	%
Term loan		1,620	February 29, 2004	Prime

	$	2,390

Note 8. Restructuring

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 both Holland and France. Out of the total charges, there was $38,000 in professional fees incurred and paid that were associated with the 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 payment in the quarter ended September 30, 2002 was $1,587,000, which was primarily 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, as well as $40,000 in professional services accrued since fiscal 2001.

Details of the fiscal 2003 restructuring charges are as follows (in thousands):

	Cash/Non- cash	Q1’03 Charges		Amount Paid/Used			Balance at 09/30/02
Excess facilities	Cash		296					296
Employee severance	Cash		713		(713	)		—
Professional services	Cash		38		(38	)		—

Total restructuring charges		$	1,047	$	(791	)	$	296

During fiscal year 2002, eGain recorded restructuring charges totaling $8,964,000 pursuant to a plan approved by the required level of management. These charges were primarily related to the consolidation of eGain’s facilities in North America. In the first quarter of fiscal 2002, eGain initiated the plan of consolidation of facilities in North America resulting in a charge of $4,336,000. This amount included estimated future net rental payments on exited facilities of $3,511,000, as well as $810,000 in write-offs of leasehold improvements and $15,000 in professional services associated with the exited facilities.

In the third quarter of fiscal 2002, eGain incurred an additional charge of $138,000 related to exited facilities and a $70,000 restructuring credit related to cash received for leasehold improvements that were previously written off.

In the fourth quarter of fiscal 2002, eGain decided to extend the plan of facilities consolidation which resulted in an additional charge of $2,763,000 related to exited facilities and leasehold improvement write-offs of $575,000.

During fiscal 2002, eGain recorded a total severance charge of $1,222,000, which was primarily due to the reduction in worldwide workforce by 190 employees across all departments.

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

	Cash/Non- cash	FY02 Charges		Amount Paid/Used			Balance at 09/30/02
Excess facilities	Cash	$	6,412	$	(2,245	)	$	4,167
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	$	(4,001	)	$	4,167

During fiscal 2001, eGain recorded restructuring charges totaling $1,443,000. These charges primarily related to a reduction in eGain’s worldwide workforce by 141 employees across all departments and office closures in North America pursuant to the adoption of eGain’s expense management strategy. The total charges were primarily comprised of $917,000 related to severance costs, $263,000 related to office closure costs and $263,000 related to legal and professional costs associated with the employee terminations. Of the total charges, $132,000, which was primarily related to legal and professional costs, remained unpaid as of June 30, 2002.

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

	Cash/Non- cash	FY01 Charges		Amount Paid/Used			Balance at 09/30/02
Excess facilities	Cash		263		(263	)		—
Employee severance	Cash		917		(917	)		—
Professional services	Cash		263		(171	)		92

Total restructuring charges		$	1,443	$	(2,051	)	$	92

The remaining restructuring accrual balance is related to $92,000 of charges for professional services related to fiscal 2001 that eGain is expecting to pay whenever a lawsuit is filed related to the planned headcount reduction.

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Note 9. New Accounting Pronouncements

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 does not expect the adoption of this accounting pronouncement to have a material effect on its consolidated financial position or results of operations.

Note 10. Litigation

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, and eGain intends to defend the action vigorously. However, these 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, which has only recently been filed, seeks unspecified damages. eGain intends to defend this 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 November 5, 2002, a complaint was filed in the Santa Clara County Superior Court against the Company by Synergism Investors, a landlord for space formerly occupied by eGain, for damages allegedly due under a Lease Termination Agreement. On November 12, 2002, the plaintiff sought and obtained a Temporary Protective Order in the amount of $245,124.74, pending a hearing on a right to attach order currently scheduled for December 17, 2002.

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 expansion of eGain’s eService platform, the continued expansion of global distribution capabilities, the development of eGain’s strategic relationships, the factors influencing competition in eGain’s market, eGain’s limited operating history, expected net losses, the adequacy of capital resources, the continued need for eService solutions, the continued acceptance of eGain’s Web-native architecture, eGain’s levels of investment in research and development and sales and marketing 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, and other assumptions underlying or relating to any of these statements. 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

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any change in eGain’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Overview

eGain 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 providing an enterprise wide solution.

Recent Developments

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 fiscal year, it expects to incur additional operating losses, at least through the second quarter of fiscal 2003 if not longer. As of September 30, 2002, eGain had a working capital deficit of $2.7 million. eGain’s working capital requirements in the foreseeable future will depend on a variety of factors in particular that revenue growth rates remain stable and that customers continue to pay on a timely basis, and are subject to numerous risks. eGain is currently focused on reducing its expenses and pursuing strategic alternatives and/or additional equity or debt financing in the near term. There can be no assurance that eGain will be able to consummate a strategic transaction on terms favorable to eGain stockholders or at all. In addition, eGain believes it is unlikely that additional financing is available in the near term, or that if available, such financing would be on terms favorable to eGain or eGain’s stockholders. If eGain is unable to consummate a strategic transaction in the near term and if such financing is not available, eGain may be unable to meet operating obligations and could be required to initiate bankruptcy proceedings. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

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 November 18, 2002, and may be eligible for continued listing, depending on the Company’s compliance with certain Nasdaq SmallCap Market listing requirements. While eGain expects that an additional 180-day grace period for the $1 minimum bid price requirement will be available following November 18, 2002, there can be no assurance that this will in fact be the case. See further discussion of this matter under “Additional Factors that May Affect Future Results.”

Critical Accounting Policies and Estimates

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.

Revenue Recognition

eGain derives revenues from three sources, hosting fees, license fees and services. Services include software maintenance and support, training and system implementation consulting. Maintenance and support consists of technical support and software upgrades

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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 and automatically renew unless either party cancels the agreement.

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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 recognize 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 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.

Valuation of Long-Lived Assets

Goodwill is not amortized but is tested for impairment using a fair value approach. During the first six months of fiscal 2003, eGain will perform 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. eGain has not yet determined what effect these tests will have on its earnings and financial position. Goodwill will be tested for impairment annually during the fourth quarter of each year 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

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intangible assets and/or goodwill could occur. In addition, eGain’s depreciation and amortization policies reflect judgments on the estimated useful lives of assets.

Restructuring

eGain has taken restructuring charges related to excess facilities and have 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 estimate 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.

Allowance for Doubtful Accounts

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.

Results of Operations

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

	Three Months September 30,
	2002		2001
Revenue:
Hosting	18	%	25	%
License	32	%	26	%
Services	50	%	49	%

Total revenue	100	%	100	%
Cost of revenue—direct	60	%	63	%
Cost of revenue—acquisition related	5	%	4	%

Gross profit	35	%	33	%

Operating costs and expenses:
Research and development	34	%	57	%
Sales and marketing	61	%	107	%
General and administrative	26	%	47	%
Amortization of goodwill and other intangible assets	6	%	114	%
Amortization of deferred compensation	1	%	4	%
Restructuring	19	%	60	%

Total operating costs and expenses	147	%	389	%

Loss from operations	(112	)%	(356	)%

Total revenue decreased 29% to $5.7 million in the quarter ended September 30, 2002 from $8.0 million in the quarter ended September 30, 2001. The decrease was primarily attributable to a sharp decline in licensed and hosted customer orders worldwide resulting from the continued weak macro-economic environment. During the

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quarters ended September 30, 2002 and September 30, 2001, no single customer accounted for more than 10% of total revenue.

Hosting revenue decreased 49% to $1.0 million in the quarter ended September 30, 2002 from $2.0 million in the quarter ended September 30, 2001. The decrease 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 18% and 25% of total revenue for the quarters ended September 30, 2002 and 2001, respectively.

License revenue decreased 12% to $1.8 million in the quarter ended September 30, 2002 from $2.1 million in the quarter ended September 30, 2001. The decrease was due primarily to the large decline in customer orders worldwide as a result of the continued weak macro-economic environment. License revenue represented 32% and 26% of total revenue for the quarters ended September 30, 2002 and 2001, respectively.

Services revenue decreased 29% to $2.8 million in the quarter ended September 30, 2002 from $3.9 million in the quarter ended September 30, 2001. The decrease was mainly attributable to a decline in licensed customer orders in North America during the six months ended September 30, 2002, compared to the same periods last year. North America services revenue decreased due to a decline in maintenance contracts, customer implementations, system integration projects, largely due to reduced IT spending consistent with the weak macroeconomic environment. Services revenue represented 50% and 49% of total revenue for the quarters ended September 30, 2002 and 2001, respectively.

Cost of Revenue – Direct

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, to a lesser extent, occupancy costs and related overhead. Cost of revenue-direct decreased 33% to $3.4 million in the quarter ended September 30, 2002 from $5.1 million in the quarter ended September 30, 2001. The decrease was primarily due to a decline in headcount through planned workforce reductions, a decline in outside contractor services and a reduction in co-location lease costs offset by an increase in third-party software royalties. Additionally, there was a reduction in facilities-related expenses in each period resulting from the consolidation of eGain’s excess facilities in North America during the quarter ended September 30, 2001. eGain anticipates that costs of revenue will decrease in the following quarter as a result of temporary and ongoing cost control measures.

Cost of Revenue – Acquisition Related

Cost of revenue – acquisition related decreased 17% to $300,000 in the quarter ended September 30, 2002 from $362,000 in the quarter ended September 30, 2001. 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. These amounts consisted of amortization of developed technology resulting from eGain’s business combinations in fiscal 2000.

Research and Development

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 58% to $1.9 million in the quarter ended September 30, 2002 from $4.6 million in the quarter ended September 30, 2001. The decrease was primarily due to a decline in headcount through planned workforce reductions, a decline in outside contractor services and the ongoing migration of development resources to eGain India. eGain anticipates that research and development expenses will decrease in the following quarter as a result of temporary and ongoing cost control measures.

Sales and Marketing

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

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related overhead. Sales and marketing expenses decreased 60% to $3.5 million in the quarter ended September 30, 2002 from $8.6 million in the quarter ended September 30, 2001. 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 decrease in the following quarter as a result of temporary and ongoing cost control measures.

General and Administrative

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 62% to $1.5 million in the quarter ended September 30, 2002 from $3.8 million in the quarter ended September 30, 2001. The decrease was primarily due to a decline in bad debt expense in comparison to the quarter ended September 30, 2001 in which eGain took a very large charge for bad debt. The lower general and administrative expenses were also the result of the decrease in headcount through planned workforce reductions as well as a decline in outside professional services. eGain anticipates that general and administrative expenses will decrease in the following quarter as a result of temporary and ongoing cost control measures.

Amortization of Goodwill and Other Intangible Assets

Amortization of goodwill and other intangibles decreased 96% to approximately $337,000 during the quarter ended September 30, 2002 from $9.2 million during the quarter ended September 30, 2001. This decrease was 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.

Amortization of Deferred Compensation

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 $66,000 and $302,000 in the quarters ended September 30, 2002 and 2001, respectively.

Restructuring

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. 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.

Non-operating Income (expense)

Non-operating expense was $66,000 in the quarter ended September 30, 2002, compared to non-operating income of $233,000 in the quarter ended September 30, 2001. The decrease primarily consisted of a decrease in interest income resulting from a decline in eGain’s average cash balance and lower interest rates, coupled by an increase in interest expense from increased bank borrowings.

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Liquidity and Capital Resources

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. eGain is using the net proceeds from this private placement for general corporate purposes.

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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 7: 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 0.50% 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 $1.7 million which was secured by establishing a restricted certificate of deposit for $1.7 million. This will be reduced as scheduled amortization payments on the term loan are made. There was no covenant requirement under this agreement.

As of September 30, 2002, $770,000 was outstanding under the Revolver, which bears interest at the bank’s prime rate plus 5.0%, while $1.6 million was outstanding under the Term Loan, which bears interest at the bank’s prime rate. With the restructuring agreement in September 2002, the line of credit was replaced by a factoring arrangement and the term loan was 100% cash collateralized. There was no covenant requirement for eGain.

On September 30, 2002, cash and cash equivalents were $4.5 million, a decrease of $5.4 million since June 30, 2002. Working capital at September 30, 2002 was $(2.7) million, a decrease of $5 million since June 30, 2002. The $4.5 million cash and cash equivalents consist of $2.8 million unrestricted and $1.7 million restricted.

Net cash used in operating activities was $6.3 million and $11.8 million in the three months ended September 30, 2002 and 2001, respectively. Cash used in operating activities in each period was primarily the result of net losses, partially offset by non-cash charges.

Net cash used in investing activities was $33,000 and $464,000 in the three months ended September 30, 2002 and 2001, respectively. Cash used in investing activities in each period was primarily due to property and equipment purchases.

Net cash used in financing activities was $610,000 and $225,000 in the three months ended September 30, 2002 and 2001, respectively. Cash used in financing activities in each period was primarily due to payments on borrowings and capital leases, partially offset by proceeds from borrowings.

The following table summarizes eGain’s contractual obligations as of September 30, 2002 and the effect such obligations are expected to have on its liquidity and cash flow in future periods (in thousands):

	Year Ended June 30,
	2003		2004		2005		2006		Total
Capital leases	$	208	$	47	$	10	$	—	$	265
Operating leases		3,818		3,113		2,058		31		9,020
Bank borrowings and notes payable		2,028		476		—		—		2,504

	$	6,054	$	3,636	$	2,068	$	31	$	11,789

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Additional Factors That May Affect Future Results

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 of $6.4 million for the quarter ended September 30, 2002. As of September 30, 2002, eGain had an accumulated deficit of approximately $305.6 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 will need additional capital, and raising additional capital may be difficult or impossible and will likely dilute existing stockholders

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

eGain has spent heavily on technology and infrastructure development. eGain expects to continue to spend substantial financial and other resources on developing and introducing product and service offerings. Accordingly, if eGain’s revenue does not correspondingly increase, its business and operating results could suffer.

eGain was incorporated in September 1997 and shipped its first product in September 1998. Because of this limited operating history and other factors, eGain’s quarterly revenue and operating results are difficult to predict. In addition, 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:

•

the macroeconomic environment and the corresponding growth rate of ecommerce;

•

demand for eService software solutions;

•

competitive pressure from new and existing market participants;

•

eGain’s ability to attract and retain customers and maintain customer satisfaction;

•

eGain’s ability to upgrade, develop and maintain its systems and infrastructure;

•

eGain’s ability to develop new products and services;

•

the amount and timing of operating costs and capital expenditures relating to eGain’s business and infrastructure;

•

technical difficulties or system outages;

•

eGain’s ability to attract and retain qualified personnel with software and Internet industry expertise;

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•

the announcement or introduction of new or enhanced products and services by eGain’s competitors;

•

changes in eGain’s pricing policies and those of its competitors;

•

litigation relating to proprietary rights;

•

seasonal trends in technology purchases;

•

timing and revenue recognition of large customer contracts;

•

changes in market conditions limiting eGain’s ability to raise capital;

•

general business conditions in the industry;

•

failure to increase eGain’s North American and international sales; and

•

governmental regulation regarding the Internet and ecommerce in particular.

eGain bases its expense levels in part on its expectations regarding future revenue levels. In the short term, eGain’s expenses are generally fixed and if eGain’s revenue for a particular quarter is lower than it expects, it may be unable to proportionately reduce its operating expenses for that quarter. Period-to-period comparisons of eGain’s operating results may not be a good indication of its future performance.

Like all 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 eighteen months. 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.

eGain must compete successfully in its market segment

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 recently 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:

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•

longer operating histories;

•

larger customer bases;

•

greater brand recognition;

•

more diversified lines of products and services; and

•

significantly greater financial, marketing and other resources.

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

•

undertake more extensive marketing campaigns;

•

adopt more aggressive pricing policies; and

•

make more attractive offers to businesses to induce them to use their products or services.

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

eGain must satisfy a number of requirements to maintain its listing on the Nasdaq Stock Market (comprised of the Nasdaq National Market and the Nasdaq SmallCap Market), including maintaining a minimum bid price for

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its common stock of $1.00 per share. A company fails to satisfy this requirement if its closing bid price remains below $1.00 per share for 30 consecutive trading days.

eGain’s common stock commenced trading on the Nasdaq SmallCap Market on November 6, 2002, pending approval by The Nasdaq Stock Market, Inc. of its November 6, 2002 application to transfer the listing of its common stock from the Nasdaq National Market to the Nasdaq SmallCap Market. eGain determined to apply voluntarily for transfer to the Nasdaq SmallCap Market in order to avoid anticipated Nasdaq National Market delisting proceedings and to take advantage of the Nasdaq SmallCap Market rule which provides an extended grace period for compliance with the $1.00 per share minimum bid requirement. eGain had received a letter from Nasdaq on May 20, 2002, notifying eGain that during the preceding 30 consecutive trading days, the bid price of its common stock had closed below the minimum bid price of $1.00 per share as required by the Nasdaq National Market under Nasdaq Marketplace Rule 4450(a)(5). The letter stated that eGain had 90 calendar days to demonstrate compliance with such rule and that, if eGain were not in compliance by that date, Nasdaq would notify eGain that its securities would be delisted from the Nasdaq National Market.

eGain’s application to transfer the listing of its common stock to the Nasdaq SmallCap Market stayed Nasdaq National Market delisting proceedings related to non-compliance with the Nasdaq National Market’s $1.00 per share minimum bid price requirement. eGain has until November 18, 2002 to satisfy the Nasdaq SmallCap Market’s $1.00 per share minimum bid price requirement. After that, eGain could also be eligible for an additional 180 calendar day grace period provided that at such time eGain meets the initial listing requirements for the Nasdaq SmallCap Market under Nasdaq Marketplace Rule 4310(c)(2)(A), which requires, generally, an issuer to have (i) stockholders’ equity of $5 million, (ii) a market capitalization of $50 million or (iii) net income of $750,000 (excluding extraordinary or non-recurring items) in the most recently completed fiscal year or in two of the three most recently completed fiscal years. While eGain expects that an additional 180-day grace period for the $1 minimum bid price requirement will be available following November 18, 2002, there can be no assurance that this will in fact be the case.

If a delisting from the Nasdaq National Market or 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 National Market and 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 National Market or 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 National Market or 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).

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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.

eGain preferred stock carries a substantial liquidation preference

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 the total value of the transaction would be less than the Liquidation Value and, a buyer would be unwilling 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’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 must recruit and retain its key employees to expand its business

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. eGain recently underwent a transition at the Chief Financial Officer position, and while eGain believes that it has an effective transition plan in place, the loss of such a significant member of its management team presents significant challenges and risks. 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 recruit, retain and motivate other highly skilled engineering, sales, marketing and other personnel. If eGain fails to retain and recruit 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.

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

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. Because many of eGain’s current sales personnel have recently joined eGain and have limited experience working together, eGain’s sales organization may not be able to compete successfully against bigger and more experienced competing organizations.

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

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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 recent 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’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.

eGain depends on broad market acceptance of eService applications

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

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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 not be able to upgrade its systems and hosted operations to accommodate growth

eGain faces risks related to the ability of its hosted operations to accommodate higher activity levels while maintaining expected performance. As the volume and complexity of online customer communications increase, eGain will need to expand its systems and hosted network infrastructure. The expansion and adaptation of eGain’s network infrastructure will require financial, operational and management resources. Customer demand for eGain’s products and services could be greatly reduced if eGain fails to maintain high capacity data transmission. In addition, as eGain upgrades its network, eGain is likely to encounter equipment or software incompatibility. eGain may not be able to expand or adapt its hosted operations to meet additional demand or eGain’s customers’ changing requirements in a timely manner or at all.

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. eGain expects a significant portion of its revenue to be derived from customers who use the hosted operations. 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

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license encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach.

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

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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, eGain has been contacted by a company that has suggested that eGain may need to license certain patents held by this company. Although this company has not filed any claims against eGain, eGain cannot be sure that it (or some other party) will not do so in the future. 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 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 business and operating results.

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eGain’s stock price may be volatile

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:

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the prospect of a delisting order from the Nasdaq SmallCap Market;

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actual or anticipated fluctuations in eGain’s operating results;

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ability to meet announced or anticipated profitability goals;

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changes in or failure to meet securities analysts’ expectations;

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concerns related to liquidity or cash balances;

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announcements of technological innovations;

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introduction of new services by eGain or its competitors;

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developments with respect to intellectual property rights;

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conditions and trends in the Internet and other technology industries; and

•

general market conditions.

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

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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 notes 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 will only be able to execute its business plan if Internet usage continues to grow

eGain’s business will be seriously harmed if Internet usage does not continue to grow or grows at significantly lower rates compared to current trends. The continued growth of the Internet depends on various factors, most of which are outside eGain’s control. These factors include the following:

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the Internet infrastructure may be unable to support the demands placed on it;

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the performance and reliability of the Internet may decline as usage grows;

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security and authentication concerns with respect to transmission over the Internet of confidential information, such as credit card numbers, and attempts by unauthorized computer users, so-called hackers, to penetrate online security systems; and

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privacy concerns, including those related to the ability of Web sites to gather user information without the user’s knowledge or consent.

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,

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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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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.

ITEM 4. CONTROLS AND PROCEDURES

eGain maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in eGain’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” in Rule 13a-14(c). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Within 90 days prior to the date of this report, eGain carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of eGain’s disclosure controls and procedures. Based on the foregoing, eGain’s Chief Executive Officer and Chief Financial Officer concluded that its disclosure controls and procedures were effective.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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, and eGain intends to defend the action vigorously. However, these claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

Item 2. Changes in Securities

None.

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Item 3. Defaults upon Senior Securities

None.

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

None.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a)	Exhibits	Exhibit Description

	10.1	Third Waiver and Loan Modification Agreement between eGain and Silicon Valley Bank, dated August 30, 2002, filed as Exhibit 10.21 to eGain’s Annual Report on Form 10-K for the year ended June 30, 2002, and incorporated by reference herein.

	10.2	Accounts Receivable Purchase Agreement between eGain and Silicon Valley Bank, dated September 20, 2002.

(b) Reports on Form 8-K

The Company did not file any reports on Form 8-K with the Securities and Exchange Commission during the quarter ended September 30, 2002.

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SIGNATURES

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.

Dated: November 14, 2002	eGAIN COMMUNICATIONS CORPORATION

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

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CERTIFICATIONS

I, Ashutosh Roy, Chief Executive Officer, certify that:

I have reviewed this quarterly report on Form 10-Q of eGain Communications Corporation;

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

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

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

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

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

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

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

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

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

The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 14, 2002

By:		/s/ Ashutosh Roy
		Ashutosh Roy

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I, Eric Smit, Chief Financial Officer, certify that:

I have reviewed this quarterly report on Form 10-Q of eGain Communications Corporation;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

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

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

Date: November 14, 2002

By:		/s/ Eric Smit
		Eric Smit

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