KANA Software, Inc.
TABLE OF CONTENTS
ANNUAL REPORT ON FORM 10-K
For The Year Ended December 31, 2003

Part I.		Page
Item 1.	Business	3
Item 2.	Properties	10
Item 3.	Legal Proceedings	11
Item 4.	Submission of Matters to a Vote of Security Holders	12
Part II.
Item 5.	Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	12
Item 6.	Selected Consolidated Financial Data	13
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 7a.	Quantitative and Qualitative Disclosures About Market Risk	49
Item 8.	Financial Statements and Supplementary Data	50
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	51
Item 9a.	Controls and Procedures	52
Part III.
Item 10.	Directors and Executive Officers of the Registrant	52
Item 11.	Executive Compensation	55
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	55
Item 13.	Certain Relationships and Related Transactions	55
Item 14.	Principal Accountant Fees and Services	55
Part IV.
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	56
Signatures		87

We are a leading provider of enterprise Customer Relationship Management (eCRM) software solutions, primarily, knowledge-powered customer service solutions that provide information to answer customer inquiries more efficiently, accurately, and consistently. Our solutions intelligently apply knowledge to the service resolution process, and use standards-based, modular applications that promote cost-efficient, phased implementations of our software by our customers and their implementation consultants. Our service, marketing and commerce applications enable organizations to improve the quality and efficiency of interactions with customers and partners across multiple communication points, including web contact, web collaboration, email, and telephone. Our customers include some of the largest businesses in the world, and they use our products to help them to better service, market to, and understand their customers and partners, while improving customer satisfaction and decreasing operational costs.

KANA is headquartered in the Silicon Valley in Menlo Park, California, with offices in Japan, Korea, and throughout the United States and Europe. Our revenue is primarily derived from the sale of our software and related maintenance and support of the software. To a lesser extent, we derive revenues from training and consulting. Our products are generally installed by our customers, using an integrator, such as IBM, Accenture, or Bearing Point. While coordinating with integrators is an important part of our strategy (see "Our Strategy" below), this often increases the overall project cost for our customers, which could lengthen the sales process as well as subject potential sales to additional factors not under our control. Further, in recent years we have experienced a cautious purchasing environment in our market and a lengthening in sales cycles. Consequently, we face difficulty predicting the quarter in which sales to expected customers will occur, if at all, which contributes to the uncertainty of our future operating results. Since a significant portion of our license revenues is generated by a relatively small number of transactions, we risk the likelihood that our revenues will be lower than our expectations in any given quarter.

We were incorporated in July 1996 in California and reincorporated in Delaware in September 1999. We had no significant operations until 1997. References in this annual report on Form 10-K to "KANA," "we," "our," and "us" collectively refer to KANA Software, Inc., and our predecessor, and our subsidiaries and their predecessors. Our principal executive offices are located at 181 Constitution Drive, Menlo Park, California 94025 and our telephone number is (650) 614- 8300. Our Internet website is located at http://www.kana.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

The market for our products and services is intensely competitive, evolving and subject to rapid technological change. We currently face competition for our products from solutions designed by our customers' in-house development teams and by third party development efforts. We expect that these solutions will continue to be a major source of competition for the foreseeable future. Our primary competitors for eCRM platforms are larger, more established companies such as Siebel Systems, Inc. and PeopleSoft, Inc., and to a lesser extent, Oracle and SAP. We also face competition from Kanisa, Inc., InQuira, E.piphany, Inc., Chordiant Software, Inc., Primus Knowledge Solutions, Amdocs, and Pegasystems, Inc. with respect to several specific applications we offer. We may face increased competition upon introduction of new products or upgrades from competitors, especially knowledge-powered products.

We believe that the principal competitive factors affecting our industry include having a significant base of referenceable customers, the breadth and depth of a given solution, product quality and performance, customer service, product scalability and reliability, product features, ability to implement solutions, and perception of financial position. We believe that our products currently compete favorably with respect to these factors, and, in particular, that our Web-based architecture provides us with a competitive advantage because it allows for greater product scalability and rapid implementation. However, we may not be able to maintain our competitive position against current and potential competitors, especially those with greater financial, marketing, service, support, technical and other resources, and who may, for example, be able to add features or functionality to their competing products more quickly or decide to sell their products to their existing customer bases for other products.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we have. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. We may lose potential customers to competitors for various reasons, including the ability or willingness of competitors to offer lower prices and other incentives that we cannot match. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of industry consolidations.

Deliver world-class products that focus on customer service and marketing. A significant percentage of an enterprise's cost of providing service to its customers consists of resolving individual customer questions and problems, or cases. These cases must be received, routed, tracked, and resolved by customer service agents. While many enterprises possess technology capable of routing and tracking cases, the actual resolution of customer issues is the least automated, and therefore the most costly phase. Our product portfolio addresses this largely underserved customer service resolution market. Our knowledge-powered customer service solutions focus on automating the service resolution process. The majority of our license revenues are for applications that are used by our customers' agents, or directly by their customers, empowering them with knowledge and information to solve their inquiries.

Partner with the world's leading system integrators. Our strategy is to focus our efforts on the sale of software and maintenance, while leading system integrators that have developed significant expertise with our applications provide our customers with a wide range of implementation, systems integration and consulting services. In the first quarter of 2003, we also began using the expertise of these integrators to assist in developing our applications. This has further increased their KANA product expertise, which benefits our customers who can leverage our integrators' outstanding industry knowledge, and proven integration success. In addition, these integrators employ larger sales forces than we do, and we generally collaborate our efforts with them when selling our respective software and services. As a result, our gross margins have improved since 2001 when we adopted this strategy and reduced our sales force professional services practice.

Deliver industry-specific applications. Certain industries, such as banking, telecommunications and healthcare, have high volumes of customer interactions, and providing consistent and accurate feedback to customers in these industries has become increasingly difficult as our customers' products and offerings have become increasingly complicated. We continue to expand our portfolio of industry-specific applications to address the unique needs of customers in these industries.

Hire and retain only the top performers. We maintain a continual process of evaluation of our employees and believe in rewarding good performance and only retain those with demonstrated ability.

KANA iCARE is a comprehensive eCRM suite made up of modular applications that provide Global 2000 organizations and other enterprises the ability to provide more intelligent, effective interactions with customers, leading to loyal and lasting customer relationships while reducing costs in the contact center.

The KANA iCARE suite is a flexible and scalable, Web-architected solution, integrated on a single platform that supports multiple customer communication channels. KANA iCARE provides the critical link between contact centers and marketing departments, allowing organizations to have effective, efficient interactions with customers at all points of contact (including Web contact, telephone and e-mail) and throughout the enterprise. KANA iCARE employs robust analytic tools across its entire product family to allow companies to continually analyze and improve their customer and partner relationships. These features enable Global 2000 organizations and other enterprises to reduce the cost of information access for their employees, customers and partners while creating profitable customer relationships.

Our customers can deploy KANA's iCARE applications as a complete suite or as separate applications Our iCARE applications include:

• KANA Contact Center - KANA Contact Center is a multi-channel customer service application for contact centers that provides request management, solution publishing, self-service capabilities, and extranet workflow.

• KANA IQ - Bringing together a self-service application for customers along with an assisted-service solution for contact center agents, KANA IQ is a sophisticated knowledge base that enables customers and agents alike to quickly and accurately locate the information they need.

• KANA Response - KANA Response is a high performance email management system that enables agent-assisted service with fast, high volume, intelligent, automated e-mail, Web and instant messaging request management.

• KANA ResponseIQ - KANA ResponseIQ is a tightly-integrated combination of KANA IQ and KANA Response that enables companies to better manage e-mail responses to customer inquiries by accessing a common knowledge base that routes requests through appropriate communications channels. ResponseIQ automatically responds to customers' requests with answers to their questions, and forwards requests to the most qualified agents based on the rules set by the organization.

• KANA Connect - KANA Connect automates the preparation and delivery of personalized, event-driven e-mail messages so that the enterprise can repeatedly and proactively engage with customers at lower cost.

• KANA Marketing - KANA Marketing is a multi-channel marketing automation application that provides marketing organizations with more tools to build lasting relationships with their customers, including rapid segmentation and recurring campaign functionality.

In addition, we have introduced solutions that optimize the delivery of customer service for specific industries that face a high volume of complex customer interactions. These industry solutions are:

• Agent IQ for Consumer Telecommunications - A customer service agent facing application that helps agents solve consumer wireless and wireline service issues.

• Agent IQ for Retail Banking - A customer service agent facing application the helps agents solve retail banking issues.

• Customer IQ for Retail Banking - A customer facing self-service solution that helps customers resolve retail banking issues

• Agent IQ for Branch Banking - A bank branch teller or branch manager facing application that helps solve branch customers' issues.

Our applications are designed to easily integrate with other enterprise software and legacy systems. They can be installed on systems running either Unix or Microsoft Windows NT operating systems, and provides customers with capabilities for personalization, customer profile management, inquiry management, universal business rules, knowledge management and extranet workflow. They can be linked with customers' legacy systems allowing customers to design their systems to preserve previous investments. Our eCRM architecture uses data modeling to make data located in external systems available in our application without requiring the data to be moved or replicated. These applications are built on a Web-architected platform incorporating our KANA eCRM framework, which provides users with full access to our applications using a standard Web browser and without requiring them to install additional software on their individual computers.

We partner with leading systems integrators that have developed significant expertise with our Web-architected eCRM applications and are able to provide customers with a wide range of consulting, implementation and systems integration services. Our systems integrator partners are involved in nearly all customer engagements, and in 2001 we significantly reduced the size of our professional services team and narrowed the scope of our professional services program to ensure that we do not compete with these key partners for professional services engagements. We believe that the support of these systems integrators for our products is increasingly important in influencing new customers' decisions to license our products. Our systems integration partners include Accenture, Bearing Point, HCL Technologies, BusinessEdge and IBM Business Consulting Services. These integrators have been integral to KANA's success in selling its products to large-organizations such as Advanced Micro Devices, Blue Cross and Blue Shield of Minnesota, O2, Dell Computer Corp., Highmark, Sony Consumer Products, Sprint PCS, Yahoo! and many others.

Customer Support. Our customer support group uses KANA's own eCRM applications to provide multi-channel global support for our customers and partners, including phone and e-mail support and self-service solutions via the KANA Customer and Partner support portal. As of December 31, 2003, we had 23 employees in our technical support department.

Consulting Services. Our worldwide consulting services group provides business and technical expertise to support our alliance partners and customers. Our consulting services group works closely with system integrators during implementations to provide technical experience and functional subject matter expertise of our products, to assist the integrators in providing our customers with high-quality, successful, enterprise-wide implementations. As of December 31, 2003, we had 18 employees in our consulting services department.

Education Services. Our education services group has prepared a full set of training programs and materials for our customers and partners, including a comprehensive set of courses for end users, business consultants and developers, which are available through instructor-led, Web-based and onsite classes. As of December 31, 2003, we had 5 employees in our education services department.

Each of our service groups provide up to date information to our customers and partners through quarterly newsletters, as well as real time updates to our customer and partner facing knowledge base.

Our sales strategy is to focus on Global 2000 companies through a combination of strategic alliances and our direct sales force. We maintain direct sales personnel across the United States and internationally throughout Europe, Asia-Pacific and Canada. Our direct sales force complements our system integrator and reseller alliances. As of December 31, 2003, 77 of our employees were employed in sales and marketing activities.

Our customers range from Global 2000 companies to growing companies pursuing an e-business strategy. The following is a list of customers that we believe are representative of our overall customer base:

One customer, IBM, accounted for 11% of our total revenues in 2002. No customer accounted for 10% or more of our total revenues in 2003 or 2001. A substantial portion of our license and service revenues in any given quarter has been, and we expect will continue to be, generated from a limited number of customers.

We believe that strong product development capabilities are essential to our strategy of enhancing our core technology, developing additional applications incorporating that technology and maintaining the competitiveness of our product and service offerings. We have invested significant time and resources in creating a structured process for undertaking all product development. In the first quarter of 2003, we began implementing an outsourcing strategy, which involves subcontracting a significant portion of our software programming, quality assurance and technical documentation activities to Accenture, HCL, IBM and Bearing Point with staffing in India and China. As of December 31, 2003, 40 of our employees were engaged in research and development activities.

Our success significantly depends on our ability to enhance our existing eCRM solutions and to develop new services, functionality and technology that address the increasingly sophisticated and varied needs of our prospective customers. The challenges of developing new products and enhancements require us to commit a substantial investment of resources, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead existing and potential customers to choose a competitor's products.

We spent $21.4 million, $25.9 million, and $35.6 million on research and development in 2003, 2002, and 2001, respectively.

We rely upon a combination of patent, copyright, trade secret and trademark laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. We currently have four issued U.S. patents, three of which expire in 2018 and one of which expires in 2020, and a number of U.S. patent applications pending. Our pending applications, if allowed, in conjunction with our issued patents, would cover a significant portion of the technology underlying our products and services. We have also filed international patent applications corresponding to some of our U.S. applications. In addition, we have several trademarks that are registered or pending registration in the U.S. or abroad. Although we rely on patent, copyright, trade secret and trademark law to protect our technology, we believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. As a result, our technology is susceptible to the development efforts of our competitors, who could independently develop technology that is similar or superior to ours.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology or to develop products with the same functionality as our products. Policing unauthorized use of our products is difficult. Also, the laws of other countries in which we market our products may offer little or no effective protection of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business. In addition, some of our license agreements require us to place the source code for our products into escrow. These agreements generally provide that some parties will have a limited, non-exclusive right to use this code if there is a bankruptcy proceeding instituted by or against us, we cease to do business and have no successor, or we discontinue providing maintenance and support.

Substantial litigation regarding intellectual property rights exists in our industry. We expect that software in our industry may be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. Some of our competitors in the market for customer communications software may have filed or may intend to file patent applications covering aspects of their technology that they may claim our technology infringes. Such competitors could make a claim of infringement against us with respect to our products and technology. Third parties may currently have, or may eventually be issued, patents upon which our current or future products or technology infringe. Any of these third parties might make a claim of infringement against us. See "Risk Factors-We may become involved in litigation over proprietary rights, which could be costly and time consuming."

As of December 31, 2003 and 2002, we had $27.7 million and $29.8 million, respectively, in backlog which relates to firm orders, with $5.0 million and $6.3, respectively, not expected to be recognized within one year due to either the timing of obligations in the underlying agreement or our collectibility assessment. The substantial majority of these firm orders relate to annual support contracts, and were invoiced and recorded as deferred revenue as of December 31, 2003 and 2002.

As of December 31, 2003, we had 211 full-time employees, compared to 365 full-time employees as of December 31, 2002. Of the December 31, 2003 employees, 46 were in our services and support group, 77 were in sales and marketing, 40 were in research and development, and 48 were in finance, administration and operations. In the first quarter of 2003, we began implementing an outsourcing strategy, which involves subcontracting a significant portion of our software programming, quality assurance and technical documentation activities to third- party developers with staffing in India and China. As a result of transitioning these activities, we reduced our research and development department by 88 employees during the year-ended December 31, 2003.

Our corporate office is located in Menlo Park, California, where we lease approximately 45,000 square feet under a lease that expires in April 2007. The annual base rent for this lease totals approximately $1.0 million. We also lease approximately 35,000 square feet of space in Manchester, New Hampshire. This lease expires in April 2005, and we have an option to extend the lease for two additional five-year terms. The annual base rent for the New Hampshire lease totals approximately $568,000. We also lease approximately 12,000 square feet of space in Framingham, Massachusetts at an annual base rent of approximately $155,000. This lease expires in November 2007.

In addition, we lease smaller offices in several cities throughout the United States, and internationally in Japan, Korea, and throughout Europe. The terms of these leases renew semi-annually unless terminated. We believe that our office space will be sufficient to meet our needs through at least the next 12 months.

We have a total of approximately 82,000 square feet of excess space available for sublease or renegotiation. The excess space is located in Menlo Park, California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining lease commitment terms on these leases vary from seven to eight years. We are seeking to sublease or renegotiate the obligations associated with the excess space. We have $10.2 million in accrued restructuring costs as of December 31, 2003, which is our estimate, as of that date, of the exit costs of these excess facilities. However, if we determine that any of these real estate markets continues to deteriorate, additional adjustments to this accrual may be required, which would result in additional restructuring costs in the period in which such determination is made, which could harm our results of operations. Likewise, if any of these real estate markets strengthen, and we are able to sublease the properties earlier or at more favorable rates than projected, or if we are otherwise able to negotiate early termination of obligations on favorable terms, adjustments to the accrual may be required that would increase income in the period in which such determination is made. As of December 31, 2003, our estimate of accrued restructuring cost includes an assumption of receiving $8.2 million in sublease payments that are not yet under contractual arrangement, and in most cases, a potential sublessor has not been identified. We have assumed that the majority of these sublease payments will begin in 2005 through 2007, and will continue through the end of the related lease.

ITEM 3. LEGAL PROCEEDINGS

In April 2001, Office Depot, Inc. filed a complaint against KANA in the Circuit Court for the 15th District of the State of Florida claiming that KANA breached its license agreement with Office Depot. Office Depot sought relief in the form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. We settled this matter in November 2003, which resulted in a payment by KANA of less than $50,000.

The underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Soundview Capital Corp as well as KANA and certain current and former officers of KANA were named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The cases allege violations of various securities laws by more than 300 issuers of stock, including KANA, and the underwriters for such issuers, on behalf of a class of plaintiffs who, in the case of KANA, purchased KANA's stock between September 21, 1999 and December 6, 2000 in connection with our initial public offering. Specifically, the complaints allege that the underwriter defendants engaged in a scheme concerning sales of KANA's and other issuers' securities in the initial public offering and in the aftermarket. In July 2003, we decided to join in a settlement negotiated by representatives of a coalition of issuers named as defendants in this action and their insurers. Although we believe that the plaintiffs' claims have no merit, we have decided to accept the settlement proposal to avoid the cost and distraction of continued litigation. Because the settlement will be funded entirely by KANA's insurers, we do not believe that the settlement will have any effect on our financial condition, results of operation or cash flows. The proposed settlement agreement is subject to final approval by the court. Should the court fail to approve the settlement agreement, we believe we have meritorious defenses to these claims and would defend the action vigorously.

On April 16, 2002, Davox Corporation (now Concerto Software) filed an action against KANA in the Superior Court, Middlesex, Commonwealth of Massachusetts, asserting breach of contract, breach of implied covenant of good faith and fair dealing, unjust enrichment, misrepresentation, and unfair trade practices, in relation to an OEM Agreement between KANA and Davox under which Davox has paid a total of approximately $1.6 million in fees. Davox seeks actual and punitive damages in an amount to be determined at trial, and award of attorneys' fees. This action is in its early stages and has been re-filed in the Circuit Court of Cook County, Illinois. We believe we have meritorious defenses to these claims and intend to defend the action vigorously.

Other third parties have from time to time claimed, and others may claim in the future that we have infringed their past, current or future intellectual property rights. We have in the past been forced to litigate such claims. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in our methods of doing business or could require us to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm our business.

The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on our results of operations, consolidated balance sheet and cash flows, due to defense costs, diversion of management resources and other factors.

Not applicable.

Our common stock is listed on the Nasdaq Stock Market under the symbol "KANA".

The following table sets forth the range of high and low closing sales prices for each period indicated:

There were approximately 1,300 stockholders of record of our common stock as of March 1, 2004. The actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities. We estimate that the number of beneficial owners of shares of our common stock as of March 1, 2004 was approximately 50,000.

We have not paid any cash dividends on our capital stock. We currently intend to retain any earnings to fund the development and growth of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. In addition, our existing credit facilities prohibit the payment of cash or stock dividends on our capital stock without the lender's prior written consent.

The following table provides information about our unregistered sales of KANA securities since January 1, 2003.

___________

All sales were made in reliance on Section 4(2) of the Securities Act and/or Regulation D promulgated under the Securities Act. The securities were sold to a limited number of people with no general solicitation or advertising. The purchasers had access to all relevant information necessary to evaluate the investment and who represented to the issuer that the shares were being acquired for investment.

The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the consolidated financial statements and the related notes included elsewhere in this annual report on Form 10-K, and other information we have filed with the Securities and Exchange Commission (SEC).

The consolidated statement of operations data for each of the years in the five year period ended December 31, 2003, and the consolidated balance sheet data at December 31, 2003, 2002, 2001, 2000, and 1999 are derived from our audited consolidated financial statements. The diluted net loss per share computation excludes shares of common stock issuable upon exercise or conversion of other securities, including outstanding options to purchase common stock and common stock subject to repurchase rights, because their effect would be antidilutive. See Note 1 of "Notes to the Consolidated Financial Statements" included in Item 15 of this annual report for a detailed explanation of the determination of the shares used to compute basic and diluted net loss per share. Historical results are not necessarily indicative of results to be expected for any future period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."

                                                                        Year Ended December 31,
                                                     ----------------------------------------------------------
                                                       2003        2002        2001         2000        1999
                                                     ---------  ----------  -----------  -----------  ---------
                                                              (in thousands, except per share amounts)
Consolidated Statement of Operations Data:
Revenues:
 License........................................... $  26,228  $   41,530  $    37,963  $    75,360  $  10,536
 Service...........................................    34,778      37,560       52,632       42,595      2,966
                                                     ---------  ----------  -----------  -----------  ---------
 Total revenues....................................    61,006      79,090       90,595      117,955     13,502
                                                     ---------  ----------  -----------  -----------  ---------
Cost of revenues:
 License...........................................     3,125       3,402        2,536        2,856        271
 Service...........................................     9,702      29,250       51,799       56,082      6,383
                                                     ---------  ----------  -----------  -----------  ---------
Total cost of revenues.............................    12,827      32,652       54,335       58,938      6,654
                                                     ---------  ----------  -----------  -----------  ---------
Gross profit.......................................    48,179      46,438       36,260       59,017      6,848
                                                     ---------  ----------  -----------  -----------  ---------
Operating expenses:
 Sales and marketing...............................    29,189      37,423       69,635       88,186     21,199
 Research and development..........................    21,437      25,933       35,558       42,724     12,854
 General and administrative........................     9,073      13,053       21,215       18,945      5,018
 Amortization of stock-based compensation..........     5,870      16,620       15,880       14,715     80,476
 Amortization of goodwill and
  identifiable intangibles.........................     1,453       4,800      127,660      873,022         --
 Merger and transition related costs...............        --          --       13,443        6,564      5,635
 Restructuring costs...............................     1,704      (5,086)      89,047           --         --
 In process research and development...............        --          --           --        6,900         --
 Goodwill impairment...............................        --      55,000      603,446    2,084,841         --
                                                     ---------  ----------  -----------  -----------  ---------
 Total operating expenses..........................    68,726     147,743      975,884    3,135,897    125,182
                                                     ---------  ----------  -----------  -----------  ---------
Operating loss.....................................   (20,547)   (101,305)    (939,624)  (3,076,880)  (118,334)
Impairment of investment...........................      (500)         --       (1,000)          --         --
Other income (expense), net........................       186         913        1,521        4,834       (744)
Income tax expense.................................      (318)         --           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
Loss from continuing operations....................   (21,179) $ (100,392) $  (939,103) $(3,072,046) $(119,078)
Discontinued operation:
 Income (loss) from operations of discontinued oper        --          --         (125)       1,173        335
 Gain (loss) on disposal, including provision of $1.1
  million for operating losses during phase-out per        --         381       (3,667)          --         --
Cumulative effect of accounting change related
  to the elimination of negative goodwill..........        --       3,901           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
         Net loss.................................. $ (21,179)    (96,110)    (942,895)  (3,070,873)  (118,743)
                                                     =========  ==========  ===========  ===========  =========
Basic and diluted net loss per share:
  Loss from continuing operations ................. $   (0.88) $    (4.48) $    (68.33) $   (395.83) $  (46.21)
  Income (loss) from discontinued operation........        --        0.02        (0.28)        0.15       0.13
  Gain on elimination of negative goodwill.........        --        0.17           --           --         --
                                                     ---------  ----------  -----------  -----------  ---------
  Net loss ........................................ $   (0.88) $    (4.29) $    (68.61) $   (395.68) $  (46.08)
                                                     =========  ==========  ===========  ===========  =========
Shares used in computing basic and
  diluted net loss per share amounts...............    24,031      22,403       13,743        7,761      2,577
                                                     =========  ==========  ===========  ===========  =========


                                                                           December 31,
                                                     ----------------------------------------------------------
                                                       2003        2002        2001         2000        1999
                                                     ---------  ----------  -----------  -----------  ---------
                                                                           (in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and
  short-term investments........................... $  32,956  $   32,498  $    40,130  $    76,499  $  53,217
Working capital (deficit)..........................     4,168      (4,533)     (13,697)      52,753     38,591
Total assets.......................................    69,878      80,550      160,672      980,124     70,229
Total long-term debt...............................        --          --          108          148        412
Total stockholders' equity......................... $  21,532  $   21,952  $    66,839  $   899,452  $  48,500

We are a leading provider of Customer Relationship Management (CRM) software solutions, specifically, customer service and marketing solutions. Our applications enable organizations to improve the quality and efficiency of interactions with customers and partners across multiple communication points, including web contact, web collaboration, email, and telephone. As a result, our target market is large enterprises with a high volume of customer interactions, such as banks, telecommunications companies, high-tech manufacturers, healthcare organizations, and government agencies.

To a large degree, we rely on our relationships with leading system integrators who co-develop, recommend, and install our software. This provides leverage in the selling phase, and also allows us to realize higher gross margins by selling primarily software licenses and support, which typically have higher margins than consulting and implementation services. However, since our applications are generally installed by our customers using a system integrator, these services generally increase the cost of the project substantially, subjecting their purchase to more levels of required approval and scrutiny of projected cost savings in their customer service and marketing departments. Consequently, we face difficulty predicting the quarter in which sales to expected customers will occur, if at all, which contributes to the uncertainty of our future operating results. Moreover, to the extent that significant sales occur earlier or later than anticipated, revenues for subsequent quarters may be lower or higher, respectively, than expected.

We have grown rapidly through acquisitions until recent years. These acquisitions provided us with much of the core technology used in our applications. In more recent years, we have substantially reduced the scale of our operations as we began leveraging the service and development capabilities of system integrators, and have acted to reduce costs and focus our product offerings.

In the past three years, we have experienced a cautious purchasing environment in our industry. We feel that this is largely a reaction to the uncertain economy, which had a disproportionate effect on information technology spending. While general economic conditions began to stabilize and improve in the second half of 2003, we believe that our market continued to exhibit cautiousness and uncertainty and that as a result, many enterprises continued to be reluctant to invest in large CRM applications. Since 1997 we have incurred substantial costs to develop our products and to recruit, train and compensate personnel for our engineering, sales, marketing, client services and administration departments. As a result, we have incurred substantial losses since inception. For the twelve months ended December 31, 2003, we recorded a net loss of $21.2 million. As of December 31, 2003, we had an accumulated deficit of $4.3 billion, which includes approximately $2.7 billion related to goodwill impairment charges. We expect to decrease our operating losses in 2004 as a result of our personnel and facility cost reductions throughout 2003. We expect our cash and cash equivalents and short-term investments on hand will be sufficient to meet our working capital and capital expenditures needs for the next 12 months.

In June 2001, we completed a merger with Broadbase Software. This transaction was accounted for using the purchase method of accounting. The purchase price approximated $101.4 million.

In November 2003, we announced the completion of an underwritten public offering of 4,080,000 shares of our common stock at a price to the public of $3.00 per share. We offered the common stock under our shelf registration statement. In addition to the 4,080,000 shares sold in the public offering, the underwriter exercised, in full, an option to purchase a maximum of 612,000 additional shares to cover over-allotments of shares. The proceeds from the offering, net of expenses, were approximately $13.1 million.

As of December 31, 2003, we had 211 full-time employees, which represents a decrease from 365 employees at December 31, 2002. Over half of the decrease during 2003 was related to our elimination of 88 research and development positions in connection with our subcontracting a significant portion of our software programming, quality assurance and technical documentation activities to third-party development partners with staffing in India and China.

On February 10, 2004, we completed the acquisition of Hipbone, Inc., a leading provider of online customer interaction solutions. This transaction will be accounted for using the purchase method of accounting. The purchase price is expected to approximate $1.0 million. As a result of this acquisition, we now offer Hipbone's Web collaboration, chat, co-browsing and file-sharing capabilities.

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and our related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to revenue recognition, collectibility of receivables, goodwill and intangible assets, contract loss reserve, income taxes, and restructuring. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies and the related judgments and estimates significantly affect the preparation of our consolidated financial statements:

Revenue Recognition. Revenue recognition rules for software companies are complex, and various judgments affect the recognition of revenues. The amount and timing of our revenue is difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.

License revenue is recognized when there is persuasive evidence of an arrangement, delivery to the customer has occurred, provided the arrangement does not require significant customization or modification of the software, the fee is fixed or determinable, and collectibility is reasonably assured.

In software arrangements that include rights to multiple software products and/or services, we allocate the total arrangement fee using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements with the residual amounts of revenue being allocated to the delivered elements. Elements included in multiple element arrangements primarily consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence for software products and consulting services is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management if it is probable that the price, once established, will not change before market introduction. Vendor-specific objective evidence for maintenance is generally based on stated contractual renewal rates. Evaluating whether sufficient and appropriate vendor- specific objective evidence exists to use in allocating revenue to undelivered elements, and the interpretation of such evidence to determine the fair value of undelivered elements is subject to judgment and estimates that affect when and to what extent we may recognize revenues from a given contractual arrangement.

Probability of collection is based upon assessment of the customer's financial condition through review of their current financial statements or publicly-available credit reports. For sales to existing customers, prior payment history is also considered in assessing probability of collection. We exercise significant judgment in deciding whether collectibility is reasonably assured, and such judgments may materially affect the timing of our revenues and our results of operations.

Revenues from support are primarily for the purpose of providing global support for our customers and partners, including phone and e-mail support and self-service solutions, as well as product maintenance updates and unspecified upgrades. Support revenues are recognized ratably over the term of the contract, typically one year.

Consulting revenues in 2002 and 2003 were generated primarily by providing specific subject matter expertise as opposed to overall project management and were performed on a time-and-materials basis. In September 2001, we shifted our strategy to have our customers use third-party systems integrators for their implementation of our software. Some consulting engagements prior to September 2001 included implementation and project management and some such engagements were provided on a fixed-fee basis, under separate service arrangements. Implementation or project management services performed under fixed-fee arrangements were generally recognized on a percentage-of-completion basis. We have not entered into any new fixed-fee implementation services since September 2001. For any arrangement in which customer acceptance was not assured or an ability to reliably estimate costs was not possible, we used the completed contract method, whereby revenues and related costs were deferred until all contractual obligations were met, and acceptance, if required by the contract, was received. Revenues from training services are recognized as services are performed.

Collectibility of Receivables. In order to recognize revenue from a transaction, collectibility must be determined by management to be reasonably assured. If collectibility is not determined to be reasonably assured, amounts billed to customers are recorded as deferred revenue. For sales to existing customers, prior payment history is a factor in assessing probability of collection.

We make judgments as to our ability to collect outstanding receivables and provide allowances for receivables that may not be collectible. A considerable amount of judgment is required to assess the ultimate realization of receivables. In assessing collectibility, we consider the age of the receivable, our historical collection experience, current economic trends, and the current credit-worthiness of each customer. In the future, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.

Reserve for Loss Contract. For professional services arrangements involving a fixed fee, we assess whether a loss reserve is necessary, estimate the total expected costs of providing services necessary to complete the contract and compare these costs to the fees expected to be received under the contract. For example, we were party to a contract with a customer that provided for fixed fee payments in exchange for services upon meeting certain milestone criteria. Based on the analysis we performed in the fourth quarter of 2000, we expected the costs to complete the project to exceed the associated fees, and accordingly we recorded a loss reserve of $1.4 million in the quarter ended December 31, 2000. As a result of our restructuring in the third quarter of 2001, substantially all of the remaining professional services required under the contract were being provided by a third party, and we recorded an additional loss reserve of $6.1 million based upon an analysis of costs to complete these services. In the second quarter of 2002, we began discussions with the customer regarding the timing and scope of the project deliverables, which led to an amendment in August 2002 to the original contract. Based on the amendment and associated negotiations with a third-party integrator that had been providing implementation services to the customer, we recorded a charge of approximately $15.6 million to cost of services revenue in the second quarter of 2002 and in accordance with the terms of the amendment were relieved from providing any further implementation services under the contract. The amendment required that we transfer $6.9 million to an escrow account (which included $5.8 million previously reported as restricted cash) to compensate any third-party integrator for the continued implementation of the customer's system. The charge also included $8.5 million of fees that we had paid the third-party integrator prior to the amendment. During the second quarter of 2002, we received a scheduled payment of $4.0 million associated with the original agreement that we reported as deferred revenue. The $4.0 million is being recognized as revenue as we fulfill our support and training obligations. As of December 31, 2003, we have recognized $1.5 million of the $4.0 million as revenue, and $2.5 million remains in deferred revenue, of which $1.6 million relates to support and will be recognized evenly through the first quarter of 2006. The remaining $0.9 million relates to training and will be recognized as we perform training obligations, but not later than the third quarter of 2005 when the training credits expire.

Accounting for Internal-Use Software. Internal-use software costs, including fees paid to third parties to implement the software, are capitalized beginning when we have determined various factors are present, including among others, that technology exists to achieve the performance requirements, we have made a decision as to whether we will purchase the software or develop it internally and we have authorized funding for the project. Capitalization of software costs ceases when the software implementation is substantially complete and is ready for its intended use, and the capitalized costs are amortized over the software's estimated useful life (generally five years) using the straight- line method. As of December 31, 2003, we had $11.1 million of capitalized costs of internal use software, net of $4.0 million accumulated depreciation.

When events or circumstances indicate the carrying value of internal use software might not be recoverable, we assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is recognized to the extent that the carrying value exceeds the projected discounted future operating cash flows and is recognized as a write down of the asset. In addition, if it is no longer probable that computer software being developed will be placed in service, the asset will be adjusted to the lower of its carrying value or fair value, if any, less direct selling costs. Any such adjustment would result in an expense in the period recorded, which could have a material adverse effect on our consolidated statement of operations. Based on our assessment as of December 31, 2003, we determined that no such impairment of internal-use software existed.

Restructuring. During 2001, we recorded significant liabilities in connection with our restructuring program. These reserves included estimates pertaining to contractual obligations related to excess leased facilities. We have a total of approximately 82,000 square feet of excess space available for sublease or renegotiation. Locations of the excess space include Menlo Park, California, Princeton, New Jersey and Marlow in the United Kingdom. Remaining lease commitment terms on these leases vary from seven to eight years. We are seeking to sublease or renegotiate the obligations associated with the excess space. We had $10.2 million in accrued restructuring costs as of December 31, 2003, which is our estimate, as of that date, of the exit costs of these excess facilities. We have worked with real estate brokers in each of the markets where the properties are located to help us estimate the amount of the accrual. This process involves significant judgments regarding these markets. If we determine that any of these real estate markets continues to deteriorate, additional adjustments to this accrual may be required, which would result in additional restructuring expenses in the period in which such determination is made. Likewise, if any of these real estate markets strengthen, and we are able to sublease the properties earlier or at more favorable rates than projected, or if we are otherwise able to negotiate early termination of obligations on favorable terms, adjustments to the accrual may be required that would increase income in the period in which such determination is made. As of December 31, 2003, our estimate of accrued restructuring cost includes an assumption of receiving $8.2 million in sublease payments that are not yet under contractual arrangement, and in most cases, a potential subleasor has not been identified. We have assumed that the majority of these sublease payments will begin in 2005 through 2007 and continue through the end of the related leases.

Goodwill and Intangible Assets. Consideration paid in connection with acquisitions is required to be allocated to the acquired assets, including identifiable intangible assets, and liabilities acquired. Acquired assets and liabilities are recorded based on our estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates. For intangible assets other than goodwill, we are required to estimate the useful life of the asset and recognize its cost as an expense over the useful life. We use the straight-line method to expense long-lived assets, which results in an equal amount of expense being recorded in each period. Amortization of goodwill ceased as of January 1, 2002 upon our adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. Instead, we are now required to test goodwill for impairment under certain circumstances and write down goodwill when it is impaired. We have determined that our consolidated results comprise one reporting unit for the purpose of impairment testing through December 31, 2003.

We regularly evaluate all potential indicators of impairment of goodwill and intangible assets. Our judgments regarding the existence of impairment indicators are based on market conditions, operational performance of our acquired businesses and identification of reporting units. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired.

Under the transition provisions of SFAS No. 142, there was no goodwill impairment at January 1, 2002 based upon our analysis completed at that time. However, during the quarter ended June 30, 2002, circumstances developed that indicated goodwill was likely impaired. The circumstances that lead to the impairment included the revision of estimates of our revenues and net loss for the second quarter of 2002 and subsequent quarters, based upon preliminary revenue results late in the second quarter of 2002 and the reduction of estimated revenue and cash flows. As a result, we announced preliminary second quarter 2002 results on July 2, 2002. Following this announcement, the decline in the trading price of our common stock reduced KANA's market capitalization, and we performed an impairment analysis as of June 30, 2002. This analysis resulted in a $55.0 million impairment expense to reduce goodwill. The circumstances that led to the impairment included the lower-than-previously- expected revenues and net loss for the second quarter of 2002 and the revision of estimates of our revenues and net loss for subsequent quarters, based upon financial results for the second quarter of 2002 and the reduction of estimated cash flows in future quarters. We used a combination of discounted cash flows and relevant market data, including our market capitalization during the period following the announcement of preliminary results for the second quarter of 2002, to calculate an estimated fair value and the resulting goodwill impairment. The estimated fair value was compared to the corresponding carrying value of goodwill at June 30, 2002, which resulted in a reduction of goodwill as of June 30, 2002 by $55.0 million. During the three months ended June 30, 2003 we performed our annual test for goodwill impairment as required by Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). We currently operate in one reportable segment, which is also the only reporting unit for the purposes of SFAS 142. We completed our evaluation and concluded that goodwill was not impaired as the fair value of our Company exceeded its carrying value, including goodwill. The remaining amount of goodwill as of December 31, 2003 was $7.4 million. Any further impairment loss could have a material adverse impact on our financial condition and results of operations.

We continue to assess whether any potential indicators of impairment of goodwill have occurred and have determined that no such indicators have arisen since June 30, 2003. Any further impairment loss could have a material adverse impact on our financial condition and results of operations.

Income Taxes. We estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as net operating loss carryforwards, and stock-based compensation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We then assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. We concluded that a full valuation allowance was required for all periods presented. While we have considered future taxable income in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would be made, increasing our income in the period in which such determination was made. Pursuant to the Internal Revenue Code, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize include, but are not limited to, a cumulative change of more than 50% ownership of the company, as defined, over a three year period. The portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets.

Contingencies and Litigation. We are subject to lawsuits and other claims and proceedings. We assess the likelihood of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of loss contingency required, if any, for these matters are made after careful analysis of each individual matter. The required loss contingencies may change in the future as the facts and circumstances of each matter changes.

The following table sets forth selected data for the periods presented. Percentages are expressed as a percentage of total revenues.

                                           Years Ended December 31,
                                 -----------------------------------------------
                                       2003             2002            2001
                                 --------------   -------------   --------------
Revenues:
 License....................... $ 26,228    43 % $ 41,530   53 % $ 37,963    42 %
 Service.......................   34,778    57     37,560   47     52,632    58
                                 -------- -----   -------- ----   -------- -----
   Total revenues..............   61,006   100     79,090  100     90,595   100

Cost of revenues:
 License.......................    3,125     5      3,402    4      2,536     3
 Service.......................    9,702    16     29,250   37     51,799    57
                                 -------- -----   -------- ----   -------- -----
   Total cost of revenues......   12,827    21     32,652   41     54,335    60
                                 -------- -----   -------- ----   -------- -----
Gross profit...................   48,179    79     46,438   59     36,260    40

Operating expenses:
 Sales and marketing...........   29,189    48     37,423   47     69,635    77
 Research and development......   21,437    35     25,933   33     35,558    39
 General and administrative....    9,073    15 %   13,053   17 %   21,215    23 %

Total revenues decreased by 23% to $61.0 million for the year ended December 31, 2003 from $79.1 million for the year ended December 31, 2002, primarily as a result of fewer license deals in 2003 than in 2002, as well as a 31% decrease in the average sales price per license deal over $100,000 realized during 2003 compared to 2002. We believe the decrease in 2003 is due to a multitude of factors including competitive pricing pressures and the continuing slow down in the information technology spending environment.

License revenues include licensing fees only, and exclude associated maintenance and consulting revenue. The majority of our licenses to customers are perpetual and recognized upon shipment, provided that all revenue recognition criteria are met as discussed in "Revenue Recognition" under "Critical Accounting Policies" above.

License revenues decreased by 37% to $26.2 million for the year ended December 31, 2003 from $41.5 million for 2002. This decrease in license revenue was primarily due to a decrease in the average selling price of license deals, as well as a decrease in the number of license deals closed during the year. The decrease in the average selling price of license deals was primarily experienced in the middle of the year. We expect our average selling price to fluctuate in future quarters given the relatively low number of new deals that comprise the majority of our license revenue recognized per quarter. As an example, the average quarterly selling price of license deals exceeding $100,000 varied from a low of approximately $320,000 in the second quarter of 2003 to a high of approximately $740,000 in the fourth quarter of 2003. In addition, we expect that license deals closed in any particular quarter will continue to constitute a significant percentage of the license revenues recognized in that quarter.

Our license revenue decreased as a percentage of total revenue due to the reduction in the average selling price of license deals and the number of license deals closed in 2003 as discussed above. We expect license revenues to increase moderately in absolute dollars in 2004 from 2003, primarily due to our expectations of an increase in the average selling price, particularly from the second and third quarters of 2003 since those quarters had relatively few large deals. However, the market for our products is unpredictable and intensely competitive, and the economic environment over the last few years has had an effect on corporate purchasing which has impacted sales of our products.

Our service revenues consist of either support revenues or professional services. Support revenues relate to providing customer support and product maintenance, product updates and unsepcified upgrades to our customers. Professional services revenues relate to providing consulting, training and, to a lesser extent, implementation services to our customers. Service revenues decreased by 7% to $34.8 million for the year ended December 31, 2003 from $37.6 million for 2003. The decrease in service revenues was primarily in professional services, due to our customers' increased use of independent third party integrators for implementation services in 2003. Support revenues were relatively consistent with 2002, at $30.6 million in 2003 versus $30.8 million in 2002. The reduction in the sales of new licenses in 2003 affected service revenues less than license revenues because the majority of our service revenues relate to ongoing support contracts with existing customers. We expect that service revenues in 2004 will be fairly consistent with 2003 in absolute dollars as we continue to focus on license sales and using third-party integrators for implementation services.

Revenues from international sales were $17.2 million, or 28% of total revenues, in the year ended December 31, 2003 and $25.5 million, or 32% or total revenues, in the year ended December 31, 2002. The decrease in international sales in 2003 is primarily as a result of large sales through our integration partner in the United Kingdom in 2002 that did not recur to the same extent in 2003. Our international revenues were derived from sales in Europe, Canada, Asia Pacific and Latin America.

During 2003 we experienced an increase in sales to companies in the telecommunications and financial services sector, representing approximately 41% and 30%, respectively, of our revenues in 2003 compared to approximately 27% and 10%, respectively, in 2002. We also experienced a decrease in sales to companies in the high technology sector, representing approximately 5% of our revenues in 2003 compared to approximately 23% in 2002. We expect the concentration of sales to the telecommunications and financial services sectors to decrease slightly in 2004, offset by relative increases in sales in various other sectors in 2004.

Total cost of revenues decreased by 61% to $12.8 million for the year ended December 31, 2003 from $32.7 million for the year ended December 31, 2002.

Cost of license revenues consists of third party software royalties, and to a leser extent, costs of product packaging, documentation, and production and delivery costs for shipments to customers. Cost of license revenues as a percentage of license revenue for 2003 was 12% compared to 8% in 2002. The increase was due to royalty costs associated with a relatively higher proportion of non-revenue-related shipments, such as upgrades and updates during 2003. We expect that our cost of license revenue as a percentage of sales in 2004 will decrease slightly from 2003 due to renegotiations of our royalty agreements in late 2003, which allow for royalties based on a percentage of revenue for large deals as opposed to a fixed amount per licensed seat.

Cost of service revenues consists primarily of salaries and related expenses for our customer support, consulting, and training services organizations. Cost of service revenues decreased to 28% of service revenues, or $9.7 million, for 2003 compared to 78%, or $29.3 million, for the prior year. Cost of service revenues in 2002 included approximately $15.6 million, or 42% of service revenues, related to a loss contract with a customer, as discussed in "Reserve for Loss Contract" under "Critical Accounting Policies" above. The improvement in service margins in 2003 was also due to the change in service revenues mix throughout 2002 following a shift in our strategy in September 2001 to have customers use independent third party integrators to provide implementation services, rather than purchase those services from us. As a result, support revenues comprised a larger percentage of service revenues during the entire year of 2003, which yielded better margins than professional services revenues since the ratio of customers-to-personnel is significantly higher for customer support. Support revenues comprised $30.6 million, or 50% of total revenues in 2003, compared to $30.8 million, or 39% in 2002. We anticipate that our cost of service revenues will remain relatively constant in dollars, and as a percentage of service revenue, in 2004 compared to 2003.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related costs for sales and marketing personnel and promotional expenditures, including public relations, advertising, trade shows and marketing materials. Sales and marketing expenses decreased by 22% to $29.2 million for the year ended December 31, 2003 from $37.4 million for the year ended December 31, 2002. This decrease was primarily attributable to reductions in sales and marketing personnel during 2003 by 27%, from 106 positions as of December 31, 2002 to 77 positions at December 31, 2003, which resulted in approximately $4.2 million in savings in salaries and related benefits. In addition, commission expense in 2003 was $2.3 million lower than in 2002 due to decreases in license revenues in 2003 discussed above. We also spent $2.2 million less in marketing programs in 2003 than in 2002. We anticipate that sales and marketing expenses in 2004 will be fairly consistent with 2003 in absolute dollars, and will fluctuate as a percentage of revenues depending on the timing and amount of revenues.

Research and Development. Research and development expenses consist primarily of compensation and related costs for research and development employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses decreased by 17% to $21.4 million for the year ended December 31, 2003 from $25.9 million for the year ended December 31, 2002. This decrease was attributable primarily to the reduction of personnel during 2003 by 69%, from 128 as of December 31, 2002 to 40 at December 31, 2003 and resulted in savings of approximately $8.5 million in compensation, benefits, and allocated facility and operations costs. These reductions in personnel were offset by approximately $6.0 million in fees associated with our outsourcing strategy begun in the first quarter of 2003, which involves subcontracting a significant portion of our software programming, quality assurance and technical documentation activities to development partners with staffing in India and China. Likewise, expense for contractors in the United States decreased by $0.8 million in 2003 compared to 2002. We also realized savings in depreciation expense charged to research and development of $0.9 million in 2003 compared to 2002 due to assets placed in service in 2000 becoming fully depreciated in 2003. We anticipate that research and development expenses will be slightly lower in absolute dollars in 2004 than in 2003, particularly in the first and second quarters of 2004 compared to the same periods in 2003, and will fluctuate as a percentage of revenues depending on the timing and amount of revenues. The anticipated reduction in research and development expense in these periods is due to the fact that we had not yet completed our transition to outsourcing in the first half of 2003 and thus incurred duplicative costs during that period.

General and Administrative. General and administrative expenses consist primarily of compensation and related costs for finance, legal, human resources, corporate governance, and bad debt expense. Information technology and facilities costs are allocated among all operating departments. General and administrative expenses decreased by 30% to $9.1 million for the year ended December 31, 2003 from $13.1 million for the year ended December 31, 2002. This decrease was attributable to the 23% reduction in general and administrative personnel during 2003, from 30 finance, legal and human resources-related positions at December 31, 2002 to 23 such positions at December 31, 2003, as well as $2.0 million in net reductions to bad debt expense in 2003. We anticipate that general and administrative costs will be slightly lower in absolute dollars in 2004 compared to 2003, and will fluctuate as a percentage of revenues depending on the timing and amount of revenues.

Amortization of Stock-Based Compensation. In connection with certain stock option grants to employees, and warrants issued to non-employees, we recorded unearned stock-based compensation charges. These charges represent the total difference between the exercise prices of stock options and the deemed fair value of the underlying common stock for accounting purposes on the date these stock options were granted. Amortization of stock-based compensation was $5.9 million and $16.6 million for the years ended December 31, 2003 and 2002, respectively. In 2003, there were no options granted with an exercise price below the fair value of the option shares on the date of grant. We reversed $1.1 million of stock-based compensation associated with expenses related to unvested options granted previously that were cancelled during 2003 in connection with employee terminations. In 2002, options granted with an exercise price below the fair value of the option shares on the date of grant resulted in a charge of $138,000. We reversed $1.8 million of stock-based compensation associated with expenses related to unvested options granted previously that were cancelled during 2002.

In connection with the merger with Broadbase, we recorded unearned stock- based compensation totaling approximately $15.5 million during the year ended December 31, 2001. These amounts are included as a component of stockholders' equity and are being amortized on an accelerated basis by charges to operations over the vesting period of the options.

In September 2000, we issued to Accenture 40,000 shares of common stock and a warrant to purchase up to 72,500 shares of our common stock at an exercise price of $371.25 per share pursuant to a stock and warrant purchase agreement in connection with our global strategic alliance. The shares of the common stock issued were fully vested, and we recorded a deferred stock-based compensation charge of approximately $14.8 million which was amortized through December 31, 2003, consistent with the term of the related original alliance agreement. As of December 31, 2003, 33,997 shares of common stock subject to the warrant were fully vested and 38,503 had been forfeited. The vested portion of the warrant was valued using the Black-Scholes model resulting in charges totaling $2.0 million of which $1.0 million was immediately expensed in the fourth quarter of 2000 and $1.0 million is being amortized over the term of the related alliance agreement. The warrants are exercisable through December 30, 2005. In September 2001, we issued to Accenture a fully-vested warrant to purchase up to 150,000 shares of common stock at an exercise price of $3.33 per share pursuant to a warrant purchase agreement in connection with our original global strategic alliance. The warrant was valued using the Black-Scholes model resulting in a charge of approximately $946,000 which was amortized through December 31, 2003, coincident with the term of the original related alliance agreement. Accenture exercised this additional warrant in March 2002.

In September 2001, we issued to a customer a warrant to purchase up to 5,000 shares of common stock at an exercise price of $7.50 per share pursuant to a warrant purchase agreement. The warrant will become fully vested in September 2006 and has a provision for acceleration of vesting by 1,250 shares annually over four years if the customer meets certain marketing criteria. As of December 31, 2003, no such marketing criteria has been met. The warrant was valued using the Black-Scholes model, resulting in a deferred stock-based compensation charge of approximately $29,000, which is being amortized over the four-year term of the agreement.

In November 2001, we issued to two investment funds warrants to purchase up to 386,118 shares of our common stock at an exercise price of $10.00 per share in connection with a proposed financing which was to have been completed in February 2002 upon attaining stockholder approval. These warrants were initially exercisable for an aggregate of 193,059 shares. The exercisable warrants were valued using the Black-Scholes model resulting in a charge of approximately $1.0 million to deferred stock-based compensation. On February 1, 2002, our stockholders voted against the proposed financing, which resulted in us terminating the share purchase agreement and caused the warrants to become exercisable with respect to all 386,118 shares. The warrants were exercisable for two years from the date the share purchase agreement was terminated. The warrants expired unexercised. Using the Black-Scholes model, the warrants issued in November 2001 that were initially exercisable were re-valued as of February 1, 2002, and the warrants that became exercisable on February 1, 2002 were valued as of such date, resulting in a charge totaling approximately $4.7 million which was reflected as amortization of stock-based compensation in the first quarter of 2002.

In November 2002, we issued to our landlords warrants to purchase up to 200,000 shares of common stock at $1.61 per share in connection with an amendment to our existing facility lease. The warrants were valued using the Black-Scholes model which resulted in a charge of approximately $137,000 which was accounted for as a reduction to our restructuring liability in the fourth quarter of 2002. The warrant was exercised in November 2003.

In December 2003, we issued to a customer warrants to purchase up to 230,000 fully vested shares of common stock at $5.00 per share in connection with a marketing agreement. The warrants were valued at approximately $459,000, using the Black-Scholes model. This amount was accounted for as a reduction of revenue in the fourth quarter of 2003.

As of December 31, 2003, a total of approximately $1.5 million of unearned deferred stock-based compensation remained to be amortized. We anticipate stock-based compensation expense to approximate from $1.0 to $1.4 million in 2004, and the remainder in 2005. The amortization of stock-based compensation for 2003 and 2002, by operating expense, is detailed as follows (in thousands):

                                   Year Ended December 31
                                  -----------------------
                                     2003         2002
                                  -----------  ----------
Cost of service................. $       430  $      883
Sales and marketing.............       2,300       4,697
Research and development........       2,149       4,384
General and administrative......         991       6,656
                                  -----------  ----------
 Total.......................... $     5,870  $   16,620
                                  ===========  ==========

Amortization of Identifiable Intangibles. The amortization of identifiable intangible assets recorded in the current and prior year relates to $14.4 million of purchased technology recorded as an intangible asset in connection with the merger with Silknet in April 2000. The amortization of these assets concluded in April 2003. Amortization during totaled $1.5 million and $4.8 million for the years ended December 31, 2003 and 2002, respectively.

Restructuring Costs. During the fourth quarter of 2003, we recorded $1.7 million in restructuring costs related to a change in evaluation of real estate market conditions in the United Kingdom, and changes in sublease estimates based on communication from current and potential subtenants in the United States. For the year ended December 31, 2002, we recorded approximately $5.1 million in restructuring cost savings related to an amendment to a facility lease, our evaluation of real estate market conditions relating to this and other excess leased facilities, and discussions with our other landlords.

The following table summarizes our restructuring expenses, payments, and liabilities at and for the years ended December 31, 2003 and 2002 (in thousands):

                                                                       Fixed Asset
                                           Severance     Facilities     Disposals       Totals
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2000..... $        --   $         --   $         --  $         --
                                          -----------   ------------   ------------  ------------
Restructuring charge....................      24,426         38,168         26,453        89,047
Non-cash reduction of restructuring.....      (1,858)            --        (26,453)      (28,311)
Payments made...........................     (21,655)       (10,750)            --       (32,405)
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2001.....         913         27,418             --        28,331
                                          -----------   ------------   ------------  ------------
Non-cash reduction of restructuring.....          --         (5,086)            --        (5,086)
Payments made...........................        (696)       (12,415)            --       (13,111)
Sublease payments received..............          --            814             --           814
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2002.....         217         10,731             --        10,948
                                          -----------   ------------   ------------  ------------
Restructuring charge....................          --          1,704             --         1,704
Payments made...........................         (33)        (2,773)            --        (2,806)
Sublease payments received..............          --            348             --           348
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2003..... $       184   $     10,010   $         --  $     10,194
                                          ===========   ============   ============  ============

We expect payments relating to restructuring liabilities to approximate $3.3 million in 2004, net of contractual sublease payments, with the remainder being paid fairly evenly from 2005 until 2011.

During 2003 and 2002, we did not incur any restructuring costs related to personnel. During 2003 and 2002, we realized personnel-related costs savings associated with reductions in headcount as a result of our restructuring in 2001, of approximately $36.1 million in each year. Cost savings in 2003 relating to facilities reductions from our restructuring in 2001 included $348,000 in sublease payments received and $2.1 million in reduced rent obligations relating to an amendment in 2002 to a facility lease. Cost savings in 2002 relating to facilities reductions from our restructuring in 2001 included $814,000 in sublease payments received and $340,000 in reduced rent obligations relating to the lease amendment in 2002. Reductions in rent obligations related to this amendment ranged from approximately $2.1 million in 2003, increasing to approximately $2.8 million in 2010. To the extent we are able to sublease excess facilities sooner than anticipated, or for greater dollar amounts than assumed, we will experience further cost reductions. Likewise, to the extent that our sublease expectations are not met, we may experience adjustments to our restructuring reserve in future periods that may have a material adverse effect on our financial statements.

Goodwill Impairment. On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 142 requires goodwill to be tested for impairment under certain circumstances and written down when impaired. SFAS 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. Under the transition provisions of SFAS No. 142, there was no goodwill impairment at January 1, 2002 based upon our analysis at that time. However, during the quarter ended June 30, 2002, circumstances developed that indicated the goodwill was likely impaired and we performed an impairment analysis as of June 30, 2002. This analysis resulted in a $55.0 million impairment expense to reduce goodwill. The circumstances that led to the impairment included the lower-than-previously- expected revenues and net loss for the second quarter of 2002 and the revision of estimates of our revenues and net loss for subsequent quarters, based upon financial results for the second quarter of 2002 and the reduction of estimated cash flows in future quarters. We used a combination of discounted cash flows and relevant market data, including our market capitalization during the period following the revision of estimates, to calculate an estimated fair value and the resulting goodwill impairment. The estimated fair value was compared to the corresponding carrying value of goodwill at June 30, 2002, which resulted in a revaluation of goodwill as of June 30, 2002. During the three months ended June 30, 2003 we performed our annual test for goodwill impairment as required by Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). We currently operate in one reportable segment, which is also the only reporting unit for the purposes of SFAS 142. We completed our evaluation as of June 30, 2003 and concluded that goodwill was not impaired as the fair value of our Company exceeded its carrying value, including goodwill. There have been no events or circumstances from June 30, 2003 to December 31, 2003 that have affected our June 30, 2003 conclusion regarding the recoverability of goodwill. The remaining amount of goodwill as of December 31, 2003 was $7.4 million. Any further impairment loss could have a material adverse impact on our financial condition and results of operations.

In connection with the merger with Silknet in April 2000, we assumed a $1.5 million investment in preferred stock of a privately held company. We recorded a $1.0 million impairment charge in the fourth quarter of 2001 and another $0.5 million impairment charge in the fourth quarter of 2003 in order to reduce the carrying value of the investment to zero at December 31, 2003. The impairment charge in 2003 was based upon the decline in the estimated fair value of the asset based upon evaluation of the business prospects. The impairment charge in 2001 was based on a substantial decline in the estimated fair value of the investment based, in part, on the terms of a recent financing involving significant new investors.

Other income (expense), net consists of interest income, interest expense and other income (expense). Interest income consisted primarily of interest earned on cash and short-term investments and was approximately $315,000 and $965,000 during the years ended December 31, 2003 and 2002. The decrease in other income (expense), net related to lower amounts of interest income earned due to lower average interest rates and cash balances in 2003 than in 2002. Interest expense consisted primarily of interest expense related to our line of credit and was approximately $174,000 and $107,000 during the years ended December 31, 2003 and 2002. Other income consisted primarily of net gains on asset disposals.

We have incurred operating losses on a consolidated basis for all periods from inception through December 31, 2003. Accordingly, we have recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future realization of the tax benefit is not currently likely. In 2003, certain foreign entities were profitable, based upon application of our intercompany transfer pricing agreements, which resulted in us reporting income tax expense totaling approximately $318,000 in those foreign jurisdictions.

As of December 31, 2003, we had net operating loss carryforwards for federal and state tax purposes of approximately $394.9 million and $149.0 million, respectively. The federal net operating loss carryforwards, if not offset against future taxable income, will expire from 2011 through 2023. Pursuant to the Internal Revenue Code, the amounts and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. As such, the portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets.

As part of the adoption of SFAS No. 142 on January 1, 2002, unamortized negative goodwill was to be immediately recognized as the effect of a change in accounting principle. Accordingly, approximately $3.9 million was eliminated and reported as the cumulative effect of accounting change in the year ended December 31, 2002. Additionally, under SFAS 142, goodwill is no longer amortized. Accordingly, amortization of goodwill ceased as of January 1, 2002.

Total revenues decreased by 13% to $79.1 million for the year ended December 31, 2002 from $90.6 million for the year ended December 31, 2001 primarily as a result of decreased service revenues.

License revenues increased by 9% to $41.5 million for the year ended December 31, 2002 from $38.0 million for 2001. This increase in license revenue was primarily due to an increase in the average selling price of license deals, particularly in Europe, as well as sales of products formerly offered by Broadbase, which were not included in our revenues prior to the June 2001 merger (license revenues recorded by Broadbase through June 2001 totaled $16.1 million). The increase in the average selling price of license deals reflected the growth in our sales to larger organizations that often license our applications for more users and that need more functionality. We believe this growth resulted, in significant part, from our increased use of indirect channels to market and sell our products, which allow us to market our products more effectively to Global 2000 organizations. In addition, we believe the introduction of our KANA iCARE suite in 2001, with its deployment and integration advantages, has facilitated sales of licenses for multiple applications to our customers resulting in larger transaction sizes than those involving a stand-alone application. One customer accounted for 11% of our total revenues in 2002.

Our license revenue increased as a percentage of total revenue mostly due to the reduction in our professional services personnel resulting from a shift in our strategy beginning in September 2001 to encourage our customers to increase their use of independent third party integrators to provide implementation services, rather than purchase those services from us.

Service revenues decreased by 29% to $37.6 million for the year ended December 31, 2002 from $52.6 million for 2001. Service revenues decreased primarily due to our customers' increased use of independent third party integrators for implementation services as discussed above. Revenues from international sales were $25.5 million, or 32% of total revenues, in the year ended December 31, 2002 and $13.8 million, or 15% of total revenues, in the year ended December 31, 2001. The increase in international sales in 2002 is primarily as a result of sales through our integration partner in the United Kingdom. Our international revenues were derived from sales in Europe, Canada, Asia Pacific and Latin America.

Total cost of revenues decreased by 40% to $32.7 million for the year ended December 31, 2002 from $54.3 million for the year ended December 31, 2001.

Cost of license revenues as a percentage of license revenue for 2002 was 8% compared to 7% in 2001. The slight increase was due to greater sales of certain licenses in 2002, which had higher associated royalty rates.

Cost of service revenues decreased to 78% of service revenues for 2002 compared to 98% for the prior year. Cost of service revenues in 2002 included approximately $15.6 million, or 42% of service revenues, related to a loss contract with a customer, as discussed in "Reserve for Loss Contract" under "Critical Accounting Policies" above. The improvement in service margins was primarily due to the change in service revenues mix following a shift in our strategy to have customers increase their use of independent third party integrators to provide implementation services, rather than purchase those services from us. As a result, support revenues comprised a larger percentage of service revenues, which have yielded better margins than professional services revenues since the ratio of customers-to-KANA personnel is significantly higher for customer support. Support revenues comprised $30.8 million, or 39% of total revenues in 2002, compared to $27.9 million, or 31% in 2001.

Sales and Marketing. Sales and marketing expenses decreased by 46% to $37.4 million for the year ended December 31, 2002 from $69.6 million for the year ended December 31, 2001. This decrease was primarily attributable to reductions in sales and marketing personnel since the second half of 2001, which reduced sales and marketing-related positions from 289 positions as of June 30, 2001 to 106 positions at December 31, 2002, and related decreases in benefits, travel, and facility costs.

Research and Development. Research and development expenses decreased by 27% to $25.9 million for the year ended December 31, 2002 from $35.6 million for the year ended December 31, 2001. This decrease was attributable primarily to the reduction of personnel since the second half of 2001, which reduced research and development-related positions from 227 as of June 30, 2001 to 128 at December 31, 2002.

General and Administrative. General and administrative expenses decreased by 38% to $13.1 million for the year ended December 31, 2002 from $21.2 million for the year ended December 31, 2001. This decrease was attributable to the reduction in bad debts charged to general and administrative expenses, from $4.2 million in 2001 to approximately $57,000 in 2002. This decrease was also attributable to the reduction of personnel since the second half of 2001, which reduced finance, legal and human resources-related positions from 52 as of June 30, 2001 to 30 at December 31, 2002.

Amortization of Stock-Based Compensation. As of December 31, 2002, a total of approximately $8.6 million of unearned deferred stock-based compensation remained to be amortized.

The amortization of stock-based compensation by operating expense, for 2002 and 2001, is detailed as follows (in thousands):

                                  Year Ended December 31,
                                  -----------------------
                                     2002         2001
                                  -----------  ----------
Cost of service................. $       883  $    1,417
Sales and marketing.............       4,697       7,230
Research and development........       4,384       4,226
General and administrative......       6,656       3,007
                                  -----------  ----------
 Total.......................... $    16,620  $   15,880
                                  ===========  ==========

Amortization of Goodwill. Amortization of goodwill ceased as of January 1, 2002 upon our adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). Under SFAS 142, goodwill is no longer amortized.

The following table presents comparative information showing the effects that the non-amortization of goodwill provisions of SFAS 142 would have had on the net loss and basic and diluted net loss per share for the periods shown (in thousands, except per share amounts):

                                              Year Ended December 31,
                                           ----------------------------
                                               2002           2001
                                           -------------  -------------
Reported net loss........................ $     (96,110) $    (942,895)
Goodwill amortization....................            --        118,060
                                           -------------  -------------
Adjusted net loss........................ $     (96,110) $    (824,835)
                                           =============  =============

Basic and diluted net loss per share..... $       (4.29) $      (68.61)
Goodwill amortization....................            --           8.59
                                           -------------  -------------
Adjusted basic and diluted
  net loss per share..................... $       (4.29) $      (60.02)
                                           =============  =============
Shares used in computing adjusted basic
  and diluted net loss per share.........        22,403         13,743
                                           =============  =============

Amortization of Identifiable Intangibles. We recorded $4.8 million in amortization of identifiable intangibles in both 2002 and 2001. This amortization relates to $14.4 million of purchased technology recorded as an intangible asset in connection with the merger with Silknet in April 2000. The amortization of these identifiable intangibles concluded in April 2003.

Merger and Related Cost. There were no merger-related costs incurred in 2002. In connection with the merger with Broadbase, we recorded $13.4 million of merger-related expenses in 2001. The merger costs included personnel costs of $5.6 million, and $7.8 million relating to duplicate facility and insurance costs, redundant assets, and professional fees associated with the merger. As of December 31, 2002, no accrued merger-related costs remained on the consolidated balance sheet.

Restructuring Costs. For the year ended December 31, 2002, we recorded approximately $5.1 million in restructuring cost savings related to an amendment to a facility lease, our evaluation of real estate market conditions relating to this and other excess leased facilities, and discussions with our other landlords. For the year ended December 31, 2001, we incurred restructuring charges of approximately $89.0 million primarily related to reductions in our workforce and costs associated with certain excess leased facilities and asset impairments. The restructuring charges included $26.4 million for assets disposed of or removed from operations. Assets disposed of or removed from operations consisted primarily of computer equipment and related software, office equipment, furniture and fixtures and leasehold improvements.

The restructuring charge in 2001 also included $24.4 million for severance, benefits and related costs associated with reductions in our workforce. We restructured our organization throughout 2001, with net workforce reductions of approximately 772 employees, or 65% from December 31, 2000, in order to streamline operations, eliminate redundant positions after the merger with Broadbase, reduce costs and bring our staffing and cost structure in line with industry standards and current economic conditions.

The restructuring charge in 2001 also included $38.2 million resulting from our decision to exit and reduce some of our facilities. The estimated facility costs were based on our contractual obligations, net of estimated sublease income, based on current comparable rates for leases in the respective markets.

The following table summarizes our restructuring expenses, payments, and liabilities at and for the years ended December 31, 2002 and 2001 (in thousands):

                                                                       Fixed Asset
                                           Severance     Facilities     Disposals       Totals
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2000..... $        --   $         --   $         --            --

Restructuring charge....................      24,426         38,168         26,453        89,047
Non-cash charges........................      (1,858)            --        (26,453)      (28,311)
Payments made...........................     (21,655)       (10,750)            --       (32,405)
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2001.....         913         27,418             --        28,331
                                          -----------   ------------   ------------  ------------
Non-cash reduction of restructuring.....          --         (5,086)            --        (5,086)
Payments made...........................        (696)       (12,415)            --       (13,111)
Sublease payments received..............          --            814             --           814
                                          -----------   ------------   ------------  ------------
Restructuring reserve at 12/31/2002..... $       217   $     10,731   $         --        10,948
                                          ===========   ============   ============  ============

Goodwill Impairment. As discussed under "Comparison of the Years Ended December 31, 2003 and 2002" above, on January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). Under the transition provisions of SFAS No. 142, there was no goodwill impairment at January 1, 2002 based upon our analysis at that time. However, during the quarter ended June 30, 2002, circumstances developed that indicated the goodwill was likely impaired and we performed an impairment analysis as of June 30, 2002. This analysis resulted in a $55.0 million impairment expense to reduce goodwill. The remaining goodwill balance was approximately $7.4 million at December 31, 2002.

In 2001, we performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the Silknet merger. The assessment was performed primarily due to the significant sustained decline in our stock price since the valuation date of the shares issued in the Silknet acquisition (which had resulted in the net book value of our assets prior to the impairment charge significantly exceeding our market capitalization), the overall decline in the industry growth rates, and our lower than projected operating results. As a result, we recorded an impairment charge of approximately $603.4 million in the first quarter of 2001 to reduce our goodwill. The charge was based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 20%.

In connection with the merger with Silknet in April 2000, we assumed a $1.5 million investment in preferred stock of a privately held company. We recorded a $1.0 million impairment charge in the fourth quarter of 2001 in order to reduce the carrying value of the investment to $500,000. The impairment charge was based on a substantial decline in the estimated fair value of the investment based, in part, on the terms of a recent financing involving significant new investors. This investment is included under "other assets" in our consolidated balance sheet at December 31, 2002.

Other income (expense), net in 2002 and 2001 consisted primarily of interest earned on cash and short-term investments offset by interest expense related to our line of credit and other non-operating expenses such as gains and losses on asset disposals. Other income (expense), net was $913,000 for the year ended December 31, 2002 and $1.5 million for the year ended December 31, 2001. The decrease in other income (expense), net related to lower amounts of interest income earned due to lower average cash balances in 2002 than in 2001.

We have incurred operating losses in each year since inception. We have recorded a valuation allowance for the full amount of our gross deferred tax assets, as the future realization of the tax benefit is not currently likely.

As of December 31, 2002, we had net operating loss carryforwards for federal and state tax purposes of approximately $388.9 million and $118.2 million, respectively. The federal net operating loss carryforwards, if not offset against future taxable income, will expire from 2011 through 2022. Pursuant to the Internal Revenue Code, the amounts and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. The portion of the net operating loss and tax credit carryforwards subject to potential expiration has not been included in deferred tax assets.

During the second quarter of 2001, we adopted a plan to discontinue the KANA Online business. We no longer seek any new KANA Online business or have any remaining contractual obligations to provide KANA Online to customers. Accordingly, KANA Online is reported as a discontinued operation. The estimated loss on the disposal of KANA Online recorded during the second quarter of 2001 was $3.7 million, consisting of an estimated loss on disposal of the business of $2.6 million and a provision of $1.1 million for the anticipated operating losses during the phase-out period. The loss on disposal was recorded in the second quarter of 2001 and adjusted in the second quarter of 2002, resulting in a gain of $381,000.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2003, we had $33.0 million in cash, cash equivalents and short-term investments, compared to $32.5 million as of December 31, 2002. As of December 31, 2003, we had working capital of $4.2 million.

History and recent trends. We have had negative cash flows from operations in each year since inception. To date, we have funded our operations primarily through issuances of common stock and, to a lesser extent, cash acquired in acquisitions. However, our cash used in operations has decreased significantly in recent years, from $112.4 million in 2001 to $42.2 million in 2002 to $12.7 million in 2003. This reduction in operating cash outflows is a result of a 73% decrease in overall cost of revenues, sales and marketing, research and development, general and administrative, and merger and restructuring costs from 2001 to 2003, offset in part, by a 33% decrease in revenues during the same period. Our cost reductions have been realized through our restructuring plan in 2001, as well as various cost controls and operational efficiencies realized since 2001. In 2001, 2002 and 2003, we had net workforce reductions of approximately 772, 44, and 154 employees, respectively. Of the workforce reductions in 2003, 88 related to the shift to the outsourcing of our development activities to our development partners with staffing overseas. We do not expect further reductions in research and development expense based upon our outsourcing activities, since we will invest approximately the same amount as in recent quarters of 2003. We have experienced modest improvements in operating cash flows in the second half of 2003 and expect the trend to continue if our revenue expectations are met. However, we believe that quarter-to-quarter comparisons of our operating results may not necessarily be indicative of our future performance.

Primary driver of cash flow. Our ability to generate cash in the future relies upon our success in generating sufficient sales transactions, especially new license transactions. We expect our maintenance renewals in 2004 to grow slightly from 2003. Since our new license transactions are relatively small in volume and are difficult to predict, we may not be able to generate new license transactions as anticipated in any particular future period. From time to time, changes in working capital will affect our cash flows. However, we do not expect this to materially impact our future cash flows over time, since we expect relative stability, or slight increases, in our assets and liabilities.

Operating cash flow. Our use of $12.7 million of cash for operating activities for the year ended December 31, 2003, included a $21.2 million net loss from continuing operations offset by non-cash charges of $8.1 million in depreciation, $5.9 million in amortization of deferred stock-based compensation and $1.5 million in amortization of identifiable intangibles. Operating activities also included $2.5 million in net payments relating to restructuring liabilities. Other working capital changes totaled a net $4.5 million, resulting primarily from a $6.0 million decrease in accounts receivable, offset by a $3.6 million reduction in the allowance for doubtful accounts, $4.6 million reduction in deferred revenue and $4.9 million reduction in accounts payable and accrued liabilities. Our operating activities used $42.2 million of cash for the year ended December 31, 2002 and $112.4 million of cash for the year ended December 31, 2001. These expenditures were primarily attributable to net losses experienced during these periods, offset in part by non-cash charges related to impairment of goodwill and amortization of intangibles and stock-based compensation.

Investing cash flow. Our investing activities provided $2.0 million of cash for the year ended December 31, 2003, and consisted primarily of net transfers of short-term investments to cash totaling $3.2 million, offset by purchases of property and equipment of $1.2 million. Our investing activities provided $2.4 million of cash for the year ended December 31, 2002, and consisted primarily of reductions of restricted cash of $10.6 million, net transfers of short-term investments to cash totaling $4.1 million, offset by purchases of property and equipment of $12.3 million. Our investing activities provided $49.6 million of cash for the year ended December 31, 2001, which was primarily due transfers of short-term investments and cash acquired from the acquisition of Broadbase, offset by purchases of property and equipment of $16.8 million, and a transfer of $7.8 million of cash to restricted cash. Our purchases of property and equipment have decreased from 2001 to 2003, from $16.8 million in 2001 to $1.2 million in 2003. The decrease is due to the reduction in purchases of infrastructure and various employee-related equipment in 2001, as well as the completion of $15.1 million in expenditures on internal-use software as of January 2003. We expect our capital needs in 2004 to be relatively consistent with 2003.

Financing cash flow. Our financing activities provided $14.2 million in cash for the year ended December 31, 2003, due to net proceeds from issuances of common stock and warrants, particularly the public offering in November 2003 which raised $13.1 million in net proceeds. Our financing activities provided $36.1 million in cash for the year ended December 31, 2002, primarily due to net proceeds of approximately $31.4 million from our private placement of approximately 2.9 million shares of our common stock in February 2002. Our financing activities provided $13.0 million in cash for the year ended December 31, 2001, primarily due to net proceeds of $10.1 million from a private placement of approximately 1.0 million shares of our common stock.

Existence and timing of contractual obligations. We have a line of credit totaling $5.0 million, which is collateralized by all of our assets, bears interest at the bank's prime rate (4.0% as of December 31, 2003), and expires in November 2004 at which time the entire balance under the line of credit will be due. Total borrowings as of December 31, 2003 and 2002 were $3.4 million under this line of credit. The line of credit requires that we maintain at least a $6.0 million dollar balance in any account at the bank or pay a one- time fee of $10,000. The line of credit also requires that we maintain at all times a minimum of $20.0 million as short-term unrestricted cash, cash equivalents and investments that mature within twelve months. If we default under this line of credit, including through a violation of any of these covenants, the entire balance under the line of credit will become immediately due and payable. As of December 31, 2003, we were in compliance with all covenants of the line of credit agreement. Future payments due under debt and lease obligations and other contractual commitments as of December 31, 2003 are as follows (in thousands):

                                                 Obligations     Obligations
                                                    Under           Under      Non-cancelable
                                    Line of      Outsourcing       Capital       Operating
   Year Ending December 31,         Credit      Agreements (1)      Leases       Leases (2)      Total
  --------------------------      -----------   --------------   ------------  --------------  ----------
     2004....................... $     3,427   $        3,300   $         15  $        4,330  $   11,072
     2005.......................          --               --             --           3,360       3,360
     2006.......................          --               --             --           3,124       3,124
     2007.......................          --               --             --           2,421       2,421
     2008.......................          --               --             --           2,208       2,208
     Thereafter.................          --               --             --           4,315       4,315
                                  -----------   --------------   ------------  --------------  ----------
                                 $     3,427   $        3,300   $         15  $       19,758  $   26,500
                                  ===========   ==============   ============  ==============  ==========

                                                                 Quarter Ended
                                  --------------------------------------------------------------------------------
                                  Mar. 31,  June 30,  Sept. 30,   Dec 31,   Mar. 31,  June 30,  Sept. 30,  Dec 31,
                                    2002      2002      2002       2002       2003      2003      2003      2003
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
                                                                 (in thousands)
Consolidated Statement
 of Operations Data:
Revenues:
 License........................ $ 15,129  $  8,309  $   8,784  $   9,308  $  9,351  $  3,183  $   5,083  $ 8,611
 Service........................   10,014     8,881      9,243      9,422     8,758     8,872      8,750    8,398
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total revenues................   25,143    17,190     18,027     18,730    18,109    12,055     13,833   17,009
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Cost of revenues:
 License........................      965     1,056        548        833       918       507        578    1,122
 Service........................    3,907    19,891      2,762      2,690     2,362     2,708      2,381    2,251
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Total cost of revenues..........    4,872    20,947      3,310      3,523     3,280     3,215      2,959    3,373
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Gross profit (loss).............   20,271    (3,757)    14,717     15,207    14,829     8,840     10,874   13,636
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Operating expenses:
 Sales and marketing............   10,305    10,395      8,732      7,991     7,437     7,887      6,854    7,011
 Research and development.......    6,638     6,512      6,389      6,394     6,080     5,943      4,718    4,696
 General and administrative.....    3,220     3,383      3,458      2,992     2,635     2,941      1,946    1,551
 Amortization of stock-
  based compensation............    9,887     3,041      1,951      1,741     1,387     1,678      1,380    1,425
 Amortization of
  identifiable intangibles......    1,200     1,200      1,200      1,200     1,200       253         --       --
 Restructuring costs............       --        --         --     (5,086)       --        --         --    1,704
 Goodwill impairment............       --    55,000         --         --        --        --         --       --
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total operating expenses......   31,250    79,531     21,730     15,232    18,739    18,702     14,898   16,387
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Operating loss..................  (10,979)  (83,288)    (7,013)       (25)   (3,910)   (9,862)    (4,024)  (2,751)
Impairment of investment........       --        --         --         --        --        --         --     (500)
Other income (expense), net.....      298       297        175        143        90        17          5       74
Income tax expense..............       --        --         --         --       (45)      (49)       (35)    (189)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Loss from continuing operations.  (10,681)  (82,991)    (6,838)       118    (3,865)   (9,894)    (4,054)  (3,366)
Discontinued operation:
 Loss on disposal, including
   provision of $1.1 million
   for operating losses during
   phase-out period.............       --       381         --         --        --        --         --       --
Cumulative effect of accounting
 change related to the elimination
 of negative goodwill...........    3,901        --         --         --        --        --         --       --
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
         Net income (loss)...... $ (6,780) $(82,610) $  (6,838) $     118  $ (3,865) $ (9,894) $  (4,054) $(3,366)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Basic and diluted net
  income (loss) per share.......    (0.32)    (3.63)     (0.30)      0.01     (0.17)    (0.43)     (0.17)   (0.13)
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Shares used in computing
  basic and diluted net
  income (loss) per share.......   21,071    22,762     22,851     22,403    22,958    23,201     23,396   26,405
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------

As a Percentage of Total Revenue
Revenues:
 License........................     60.2 %    48.3 %     48.7 %     49.7 %    51.6 %    26.4 %     36.7 %   50.6 %
 Service........................     39.8      51.7       51.3       50.3      48.4      73.6       63.3     49.4
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total revenues................    100.0     100.0      100.0      100.0     100.0     100.0      100.0    100.0
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Cost of revenues:
 License........................      3.8       6.1        3.0        4.4       5.1       4.2        4.2      6.6
 Service........................     15.6     115.8       15.4       14.4      13.0      22.5       17.2     13.2
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
  Total cost of
   revenues.....................     19.4     121.9       18.4       18.8      18.1      26.7       21.4     19.8
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Gross profit (loss).............     80.6     (21.9)      81.6       81.2      81.9      73.3       78.6     80.2
                                  --------  --------  ---------  ---------  --------  --------  ---------  -------
Selected operating
 expenses:
 Sales and marketing............     41.0      60.5       48.4       42.7      41.1      65.4       49.5     41.2
 Research and
  development...................     26.4      37.9       35.4       34.1      33.6      49.3       34.1     27.6
 General and
  administrative................     12.8 %    19.7 %     19.2 %     16.0 %    14.6 %    24.4 %     14.1 %    9.1 %

                                                                       December 31,
                                                                 ------------------------
                                                                    2003         2002
                                                                 -----------  -----------
                            ASSETS
Current assets:
 Cash and cash equivalents..................................... $    25,632  $    21,962
 Short-term investments........................................       7,324       10,536
 Accounts receivable, less allowance for doubtful
  accounts of $1,187 in 2003 and $4,815 in 2002................       7,908       10,269
 Prepaid expenses and other current assets.....................       3,527        3,184
                                                                 -----------  -----------
 Total current assets..........................................      44,391       45,951
Restricted cash................................................         461          448
Property and equipment, net....................................      15,435       22,293
Goodwill.......................................................       7,448        7,448
Identifiable intangibles, net..................................          --        1,453
Other assets...................................................       2,143        2,957
                                                                 -----------  -----------
  Total assets................................................. $    69,878  $    80,550
                                                                 ===========  ===========
             LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Current portion of notes payable.............................. $     3,427  $     3,469
 Accounts payable..............................................       2,238        3,908
 Accrued liabilities...........................................      10,678       13,881
 Accrued restructuring.........................................       3,336        2,834
 Deferred revenue..............................................      20,544       26,392
                                                                 -----------  -----------
  Total current liabilities....................................      40,223       50,484
Deferred revenue, less current portion.........................       1,265           --
Accrued restructuring, less current portion....................       6,858        8,114
                                                                 -----------  -----------
  Total liabilities............................................      48,346       58,598
                                                                 -----------  -----------
Commitments and contingencies (Note 6)
Stockholders' equity:
 Preferred stock, $0.001 par value; 5,000,000
   shares authorized; no shares issued and outstanding.........          --           --
 Common stock, $0.001 par value; 100,000,000 shares authorized;
   28,436,283 and 22,939,872 shares issued and outstanding.....         201          195
 Additional paid-in capital....................................   4,286,508    4,273,029
 Deferred stock-based compensation.............................      (1,541)      (8,602)
 Accumulated other comprehensive income (losses)...............          38         (175)
 Accumulated deficit...........................................  (4,263,674)  (4,242,495)
                                                                 -----------  -----------
  Total stockholders' equity...................................      21,532       21,952
                                                                 -----------  -----------
  Total liabilities and stockholders' equity................... $    69,878  $    80,550
                                                                 ===========  ===========

                                                                   Year Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
Revenues:
 License.................................................... $   26,228  $  41,530  $   37,963
 Service....................................................     34,778     37,560      52,632
                                                              ----------  ---------  ----------
   Total revenues...........................................     61,006     79,090      90,595
                                                              ----------  ---------  ----------
Cost of revenues:
 License....................................................      3,125      3,402       2,536
 Service, excluding amortization of stock-based
   compensation of $430, $883 and $1,417....................      9,702     29,250      51,799
                                                              ----------  ---------  ----------
   Total cost of revenues...................................     12,827     32,652      54,335
                                                              ----------  ---------  ----------
Gross profit................................................     48,179     46,438      36,260
                                                              ----------  ---------  ----------
Operating expenses:
 Sales and marketing, excluding amortization of
  stock-based compensation of $2,300, $4,697
  and $7,230, respectively..................................     29,189     37,423      69,635
 Research and development, excluding
  amortization of stock-based compensation
  of $2,149, $4,384 and $4,226, respectively................     21,437     25,933      35,558
 General and administrative, excluding
  amortization of stock-based compensation
  of $991, $6,656 and $3,007, respectively..................      9,073     13,053      21,215
 Amortization of stock-based compensation...................      5,870     16,620      15,880
 Amortization of goodwill...................................         --         --     122,860
 Amortization of identifiable intangibles...................      1,453      4,800       4,800
 Merger and transition related costs........................         --         --      13,443
 Restructuring costs........................................      1,704     (5,086)     89,047
 Goodwill impairment........................................         --     55,000     603,446
                                                              ----------  ---------  ----------
   Total operating expenses.................................     68,726    147,743     975,884
                                                              ----------  ---------  ----------
Operating loss..............................................    (20,547)  (101,305)   (939,624)
Impairment of investment....................................       (500)        --      (1,000)
Other income, net...........................................        186        913       1,521
Income tax expense..........................................       (318)        --          --
                                                              ----------  ---------  ----------
Loss from continuing operations ............................    (21,179)  (100,392)   (939,103)
Discontinued operation:
 Loss from operations of discontinued operation.............         --         --        (125)
 Gain (loss) on disposal, including provision of $1.1 million
  in 2001 for operating losses during phase-out period......         --        381      (3,667)
Cumulative effect of accounting change related
  to the elimination of negative goodwill...................         --      3,901          --
                                                              ----------  ---------  ----------
         Net loss........................................... $  (21,179) $ (96,110) $ (942,895)
                                                              ----------  ---------  ----------
Other comprehensive loss:
 Net unrealized gain on available
  for sale securities.......................................         --         --          22
 Foreign currency translation adjustments...................        213      1,110        (930)
                                                              ----------  ---------  ----------
   Total other comprehensive loss...........................        213      1,110        (908)
                                                              ----------  ---------  ----------
   Comprehensive loss....................................... $  (20,966) $ (95,000) $ (943,803)
                                                              ==========  =========  ==========
Basic and diluted net loss per share:
  Loss from continuing operations .......................... $    (0.88) $   (4.48) $   (68.33)
  Income (loss) from discontinued operation.................         --       0.02       (0.28)
  Cumulative effect of accounting change related
    to the elimination of negative goodwill.................         --       0.17          --
                                                              ----------  ---------  ----------
  Net loss ................................................. $    (0.88) $   (4.29) $   (68.61)
                                                              ----------  ---------  ----------

Shares used in computing basic and diluted
 net loss per share.........................................     24,031     22,403      13,743
                                                              =========== =====================

                                                        Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
Balances,
December 31, 2000.....  9,405,184      94   4,130,231    (21,639)    (5,367)      (377)  (3,203,490)     899,452
Issuance of common
stock upon exercise
of stock options
net of
repurchases...........    249,624       1       1,132                 2,372         --           --        3,505
Issuance of common
stock for Employee Stock
Purchase Plan.........     66,407      --         245         --         --         --           --          245
Issuance of common
stock related to
Broadbase
Software, Inc.
acquisition...........  8,667,898      87      93,977    (15,485)        --         --           --       78,579
Issuance of common
stock related to
private
placement, net........  1,010,000      10      10,090         --         --         --           --       10,100
Deferred stock-based
compensation..........         --      --       1,650       (965)        --         --           --          685
Amortization of
deferred stock-based
compensation..........         --      --          --     15,880         --         --           --       15,880
Payments on notes
receivable from
stockholders, net
of interest...........         --      --          --         --      2,196         --           --        2,196
Foreign currency
translation
adjustment............         --      --          --         --         --       (908)          --         (908)
Net loss..............         --      --          --         --         --         --     (942,895)    (942,895)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2001..... 19,399,113  $  192  $4,237,325  $ (22,209) $    (799) $  (1,285) $(4,146,385) $    66,839
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------

                                                        Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------

December 31, 2001..... 19,399,113  $  192  $4,237,325  $ (22,209) $    (799) $  (1,285) $(4,146,385) $    66,839
Issuance of common
stock upon exercise
of stock options and
warrants, net of
repurchases...........    416,232      --       1,819         --         --         --           --        1,819
Issuance of common
stock for Employee Stock
Purchase Plan.........     73,364      --         241         --         --         --           --          241
Amortization of
deferred stock-based
compensation..........         --      --          --     16,620         --         --           --       16,620
Deferred stock-based
compensation..........         --      --      (1,734)     1,734         --         --           --           --
Equity investment
received..............  2,910,000       3      31,394         --         --         --           --       31,397
Issuance of Warrants..         --      --       3,869     (4,747)        --         --           --         (878)
Exercise of warrants..    110,284      --          --         --         --         --           --           --
Issuance of stock
for services..........      9,800      --         115         --         --         --           --          115
Shares released
from escrow...........     21,079      --          --         --         --         --           --           --
Payments on notes
receivable from
stockholders, net
of interest...........         --      --          --         --        594         --           --          594
Foreign currency
translation
adjustment............         --      --          --         --         --      1,110           --        1,110
Reserve for notes
receivable from
stockholders..........         --      --          --         --        205         --           --          205
Net loss..............         --      --          --         --         --         --      (96,110)     (96,110)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2002..... 22,939,872  $  195  $4,273,029  $  (8,602) $      --  $    (175) $(4,242,495) $    21,952
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------

                                                        Deferred     Notes    Accumulated
                                                         Stock-    Receivable   Other                    Total
                          Common Stock      Additional    Based      from      Compre-                  Stock-
                       -------------------   Paid-In     Compen-    Stock-     hensive   Accumulated   holders'
                         Shares     Amount   Capital     sation     holders    Losses      Deficit      Equity
                       -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
Balances,
December 31, 2002..... 22,939,872  $  195  $4,273,029  $  (8,602) $      --  $    (175) $(4,242,495) $    21,952
Issuance of common
stock upon exercise of
stock options, net of
share cancellations...    406,035       1         705         --         --         --           --          706
Issuance of common
stock for Employee Stock
Purchase Plan.........    293,020      --         411         --         --         --           --          411
Shares sold in
public offering, net..  4,692,000       5      13,095         --         --         --           --       13,100
Amortization of
deferred stock-based
compensation..........         --      --      (1,191)     7,061         --         --           --        5,870
Exercise of warrants..    105,356      --          --         --         --         --           --           --
Issuance of warrants..         --      --         459         --         --         --           --          459
Foreign currency
translation
adjustment............         --      --          --         --         --        213           --          213
Net loss..............         --      --          --         --         --         --      (21,179)     (21,179)
Balances,              -----------  ------  ----------  ---------  ---------  ---------  -----------  -----------
December 31, 2003..... 28,436,283  $  201  $4,286,508  $  (1,541) $      --  $      38  $(4,263,674) $    21,532
                       ===========  ======  ==========  =========  =========  =========  ===========  ===========

                                                                  For the Year Ended December 31,
                                                                ------------------------------------
                                                                   2003        2002         2001
                                                                ----------  -----------  -----------
Cash flows from operating activities:
 Net loss..................................................... $  (21,179) $   (96,110) $  (942,895)
 Adjustments to reconcile net loss to net
  cash used in operating activities:
  Depreciation expense........................................      8,088        9,130       10,072
  Amortization of stock-based compensation,
   goodwill and identifiable intangible assets................      7,323       21,420      143,540
  Goodwill impairment.........................................         --       55,000      603,446
  Provision for doubtful accounts.............................     (3,628)      (2,028)       4,878
  Non-cash portion of restructuring charge....................      1,704          212       26,453
  Reduction of restructuring reserve..........................         --       (5,086)          --
  Impairment of investment....................................        500           --        1,000
  Other non-cash charges......................................        459       (3,697)       3,002
  Changes in operating assets and liabilities,
   net of effects through acquisitions:
  Accounts receivable.........................................      5,989        8,563       36,775
  Prepaid expenses and other assets...........................        (29)       2,313       14,477
  Accounts payable and accrued liabilities....................     (4,873)     (13,779)     (28,145)
  Accrued restructuring and merger............................     (2,458)     (22,328)      26,909
  Deferred revenue............................................     (4,583)       4,212      (11,720)
  Other liabilities...........................................         --           --         (233)
                                                                ----------  -----------  -----------
  Net cash used in operating activities.......................    (12,687)     (42,178)    (112,441)
                                                                ----------  -----------  -----------
Cash flows from investing activities:
 Sales of short-term investments..............................     11,803       36,657      114,468
 Purchases of short-term investments..........................     (8,591)     (32,540)     (73,881)
 Purchases of property and equipment..........................     (1,230)     (12,252)     (16,780)
 Cash acquired through acquisitions...........................         --           --       33,556
 Expiration/(purchase) of restricted cash.....................        (13)      10,570       (7,800)
                                                                ----------  -----------  -----------
  Net cash provided by investing activities...................      1,969        2,435       49,563
                                                                ----------  -----------  -----------
Cash flows from financing activities:
 Borrowings on notes payable..................................         --        1,998           --
 Payments on notes payable....................................        (42)          --         (579)
 Net proceeds from issuance of common stock and warrants......     14,217       33,458       11,478
 Payments on stockholders' notes receivable...................         --          594        2,087
                                                                ----------  -----------  -----------
  Net cash provided by financing activities...................     14,175       36,050       12,986
                                                                ----------  -----------  -----------
Effect of exchange rate changes on cash and cash equivalents..        213          179         (834)
                                                                ----------  -----------  -----------
Net change in cash and cash equivalents.......................      3,670       (3,514)     (50,726)
Cash and cash equivalents at beginning of year................     21,962       25,476       76,202
                                                                ----------  -----------  -----------
Cash and cash equivalents at end of year...................... $   25,632  $    21,962  $    25,476
                                                                ==========  ===========  ===========
Supplemental disclosure of cash flow information:
 Cash paid during the year for interest....................... $      173  $       100  $       147
                                                                ==========  ===========  ===========
 Cash paid during the year for income taxes................... $      289  $       117  $        --
                                                                ==========  ===========  ===========
 Noncash activities:
  Issuance of common stock and assumption of options
   and warrants related to acquisitions ...................... $       --  $        --  $    94,064
                                                                ==========  ===========  ===========
  Issuance of warrants to a customer.......................... $      459  $        --  $       330
                                                                ==========  ===========  ===========
  Impairment of investment.................................... $      500  $        --  $     1,000
                                                                ==========  ===========  ===========

                                                           Year Ended December 31,
                                                      ---------------------------------
                                                        2003       2002        2001
                                                      ---------  ---------  -----------
As Reported:
  Net loss.......................................... $ (21,179) $ (96,110) $  (942,895)
  Basic and diluted net loss per share.............. $   (0.88) $   (4.29) $    (68.61)

Compensation expense included in net loss........... $     648  $   6,687  $    11,885

Compensation expense if FAS 123 had been adopted.... $   7,012  $  39,345  $   (34,038)

Pro Forma:
  Net loss.......................................... $ (27,543) $(128,768) $  (896,972)
  Basic and diluted net loss per share.............. $   (1.15) $   (5.75) $    (65.27)

                                                                   Years Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
                                                                 (in thousands, except net loss
                                                                      per share amounts)
Numerator:
 Net loss from continuing operations before
  cumulative effect of accounting change.................... $  (21,179) $(100,392) $ (939,103)
                                                              ----------  ---------  ----------
Denominator:
 Weighted-average shares of common
  stock outstanding.........................................     24,033     22,420      13,880
 Less weighted-average shares subject
  to repurchase.............................................         (2)       (17)       (137)
                                                              ----------  ---------  ----------
 Denominator for basic and diluted calculation..............     24,031     22,403      13,743
                                                              ==========  =========  ==========
Basic and diluted net loss per
 common share from continuing operations
 before cumulative effect of accounting change.............. $    (0.88) $   (4.48) $   (68.33)
                                                              ==========  =========  ==========

                                                                   Years Ended December 31,
                                                              ---------------------------------
                                                                 2003       2002        2001
                                                              ----------  ---------  ----------
Stock options and warrants..................................      8,628      7,917       6,753
Common stock subject to repurchase..........................         --         18          28
                                                              ----------  ---------  ----------
                                                                  8,628      7,935       6,781
                                                              ==========  =========  ==========

                                                       Years Ended December 31,
                                               -------------------------------------
                                                  2003         2002         2001
                                               -----------  -----------  -----------
United States................................ $    43,851  $    53,589  $    76,794
United Kingdom...............................       9,353       13,432        5,426
Asia Pacific.................................       2,176        3,372        3,271
Other (1)....................................       5,626        8,697        5,104
                                               -----------  -----------  -----------
                                              $    61,006  $    79,090  $    90,595
                                               ===========  ===========  ===========

                       Year ended December 31
                       ----------------------
                          2003        2002
                       ----------  ----------
United States........ $   23,206  $   32,416
International........      1,820       1,735
                       ----------  ----------
                      $   25,026  $   34,151
                       ==========  ==========

Tangible assets acquired.................................. $   125,144
Deferred compensation ....................................      15,485
Liabilities assumed ......................................     (34,975)
Deferred credit - negative goodwill ......................      (4,282)
                                                            -----------
 Net assets acquired...................................... $   101,372
                                                            ===========

Fair market value of common stock..........................$    81,478
Fair market value of options and warrants assumed...........    12,586
Acquisition-related costs...................................     7,308
                                                            -----------
Total......................................................$   101,372
                                                            ===========

                                                            (Unaudited
                                                             Pro forma)
                                                             Year Ended
                                                            December 31,
                                                               2001
                                                            -----------
                                                            (In thousands
                                                              except per
                                                            share amounts
                                                            -------------
Net revenues ............................................. $   113,347
Net loss ................................................. $(1,965,075)
Basic and diluted net loss per share ..................... $   (108.92)
Shares used in basic and diluted net loss
  per share calculation ..................................      18,042

                                                       December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Cash......................................... $    13,624  $    11,481
Money market funds...........................       2,658        8,514
Municipal securities.........................       9,350        1,853
Certificate of Deposit.......................          --          114
                                               -----------  -----------
                                              $    25,632  $    21,962
                                               ===========  ===========

                                                       December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Municipal securities......................... $       375  $     3,784
Corporate notes / bonds......................       6,949        6,752
                                               -----------  -----------
                                              $     7,324  $    10,536
                                               ===========  ===========

                                                       December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Computer equipment........................... $    23,533  $    22,692
Furniture and fixtures.......................       2,966        2,898
Leasehold improvements.......................       4,173        4,058
Internal use software........................      15,157       15,116
                                               -----------  -----------
                                                   45,829       44,764
Less accumulated depreciation and amortizatio     (30,394)     (22,471)
                                               -----------  -----------
                                              $    15,435  $    22,293
                                               ===========  ===========

                                                       December 31,
                                               ------------------------
                                                  2003         2002
                                               -----------  -----------
Accrued payroll and related expenses......... $     2,286  $     3,851
Other accrued liabilities....................       8,392       10,030
                                               -----------  -----------
                                              $    10,678  $    13,881
                                               ===========  ===========

                                                        Year Ended December 31,
                                               -------------------------------------
                                                  2003         2002         2001
                                               -----------  -----------  -----------
Interest income.............................. $       315  $       965  $     2,266
Interest expense.............................        (174)        (107)        (152)
Other........................................          45           55         (593)
                                               -----------  -----------  -----------
                                              $       186  $       913  $     1,521
                                               ===========  ===========  ===========

                                                      Year Ended December 31,
                                           -------------  ---------------------------
                                               2003           2002           2001
                                           -------------  -------------   -----------
Reported net loss........................ $     (21,179)       (96,110)  $  (942,895)
Goodwill amortization....................            --             --       122,860
                                           -------------  -------------   -----------
Adjusted net loss........................ $     (21,179)       (96,110)  $  (820,035)
                                           =============  =============   ===========

Basic and diluted net loss per share..... $       (0.88)         (4.29)  $    (68.61)
Goodwill amortization....................            --             --          8.94
                                           -------------  -------------   -----------
Adjusted basic and diluted
  net loss per share..................... $       (0.88)         (4.29)  $    (59.67)
                                           =============  =============   ===========
Shares used in computing adjusted basic
  and diluted net loss per share.........        24,031         22,403        13,743
                                           =============  =============   ===========

                                                  December 31,
                                           ----------------------------
                                               2003           2002
                                           -------------  -------------
Goodwill, net............................         7,448          7,448
                                           -------------  -------------

Purchased technology.....................        14,400         14,400
Less: accumulated amortization...........       (14,400)       (12,947)
                                           -------------  -------------
Intangibles, net.........................            --          1,453
                                           -------------  -------------
Goodwill and intangibles, net............ $       7,448  $       8,901
                                           =============  =============

                                                 Non-cancelable     Less:       Non-cancelable
                                                   Operating       Sublease       Operating
   Year Ending December 31,                      Leases, gross      Income       Leases, net
  --------------------------                     -------------  --------------  --------------
     2004...................................... $       5,103             774           4,329
     2005......................................         4,134             774           3,360
     2006......................................         3,897             774           3,123
     2007......................................         3,195             774           2,421
     2008......................................         2,698             490           2,208
     Thereafter................................         4,817             502           4,315
                                                 -------------  --------------  --------------
     Total minimum lease payments.............. $      23,844           4,088          19,756
                                                 =============  ==============  ==============

                                                    Options Outstanding
                                                  -----------------------
                                                                Weighted
                                        Shares                  Average
                                       Available   Number of    Exercise
                                       for Grant    Shares       Price
                                      ----------- -----------  ----------
Balances, December 31, 2000..........    173,032   2,482,174      397.80
  Additional shares authorized.......  1,500,000          --          --
  Option plan assumed................  5,251,061   2,515,984      131.97
  Options granted.................... (4,636,083)  4,636,083       13.81
  Options exercised..................         --    (537,314)       4.81
  Options canceled and retired.......  1,399,025  (2,802,287)     208.82
                                      ----------- -----------  ----------
Balances, December 31, 2001..........  3,687,035   6,294,640       48.63
  Additional shares authorized.......  2,133,745          --          --
  Options granted.................... (3,563,236)  3,563,236        5.05
  Options exercised..................         --    (426,422)       4.06
  Options canceled and retired.......  2,186,628  (2,226,601)      62.84
                                      ----------- -----------  ----------
Balances, December 31, 2002..........  4,444,172   7,204,853       25.42
  Additional shares authorized.......  2,119,726          --          --
  Options granted.................... (4,088,102)  4,088,102        3.30
  Options exercised..................         --    (442,001)       1.61
  Options canceled and retired.......  2,958,565  (2,959,668)      27.21
                                      ----------- -----------  ----------
Balances, December 31, 2003..........  5,434,361   7,891,286  $    14.62
                                      =========== ===========  ==========

                          Options Outstanding          Options Exercisable
                    --------------------------------- ----------------------
                                 Weighted
                                 Average    Weighted               Weighted
                                Remaining    Average                Average
                      Number    Contractual Exercise    Number     Exercise
                     of shares     Life       Price    of shares     Price
                    ----------- ----------  --------- -----------  ---------
$0.10--$1.63.......  1,140,608        8.6  $    1.50     424,215  $    1.40
$2.05--$2.95.......  1,228,214        9.5       2.70     159,115       2.51
$3.01--$3.85.......  2,039,129        9.2       3.27     399,564       3.28
$4.07--$8.76.......  1,143,976        7.9       6.73     595,615       7.40
$9.48--$14.41......  1,955,922        8.0      13.25   1,136,937      12.79
$14.57--$153.70....    306,963        7.0      67.69     194,264      67.36
$207.20--$1,395.80.     76,474        6.3     644.02      68,063     658.63
                    ----------- ----------  --------- -----------  ---------
                     7,891,286        8.5  $   14.62   2,977,773  $   26.59
                    =========== ==========  ========= ===========  =========

                               Options                         ESPP
                    ------------------------------ ------------------------------
                    Interest                       Interest
                      Rate      Term    Volatility   Rate      Term    Volatility
                    --------- --------- ---------- --------- --------- ----------
2003...............     2.11%   3 yrs         111%     1.08%   6 mths         73%
2002...............     3.02%   3 yrs         127%     1.27%   6 mths        127%
2001...............     3.62%   3 yrs         100%     1.82%   6 mths        100%

                                                      Weighted Average Exercise Price  Weighted Average Fair Value
                                                     ------------------------------  ------------------------------
                                                       2003      2002       2001       2003      2002       2001
                                                     --------  --------  ----------  --------  --------  ----------
Exercise price does not exceed fair value on grant  $   3.30  $   5.05  $    14.01  $   2.27  $   3.64  $    11.30
Exercise price exceeds fair value on grant date.... $     --  $     --  $    12.51  $     --  $     --  $     7.56
Total options...................................... $   3.30  $   5.05  $    13.81  $   2.27  $   3.64  $    10.79

                                                                       Fixed Asset
                                         Severance      Facilities      Disposals        Totals
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2000... $        --   $           --   $         --  $           --
                                        -----------   --------------   ------------  --------------
Restructuring charge..................      24,426           38,168         26,453          89,047
Non-cash reduction of restructuring...      (1,858)              --        (26,453)        (28,311)
Payments made.........................     (21,655)         (10,750)            --         (32,405)
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2001...         913           27,418             --          28,331
                                        -----------   --------------   ------------  --------------
Non-cash reduction of restructuring...          --           (5,086)            --          (5,086)
Payments made.........................        (696)         (12,415)            --         (13,111)
Sublease payments received............          --              814             --             814
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2002...         217           10,731             --          10,948
                                        -----------   --------------   ------------  --------------
Restructuring charge..................          --            1,704             --           1,704
Payments made.........................         (33)          (2,773)            --          (2,806)
Sublease payments received............          --              348             --             348
                                        -----------   --------------   ------------  --------------
Restructuring reserve at 12/31/2003... $       184   $       10,010   $         --  $       10,194
                                        ===========   ==============   ============  ==============

                                                         Year Ended December 31,
                                                 ---------------------------------------------
                                                     2003            2002            2001
                                                 -------------  --------------  --------------
Federal tax benefit at statutory rate.......... $      (7,283) $      (31,659) $     (320,272)
Stock-based compensation ......................            --              --             379
Merger costs...................................            --              --           2,584
Current year net operating losses and temporary
   differences, no tax benefit recognized......         6,683          12,160              --
Amortization and goodwill impairment...........           494          19,006         248,447
Change in valuation allowance..................            --              --          68,302
Other permanent differences....................           106             493             560
Foreign taxes..................................           318              --              --
                                                 -------------  --------------  --------------
Total tax expense.............................. $         318  $           --  $           --
                                                 =============  ==============  ==============

                                                          December 31,
                                                 -----------------------------
                                                     2003            2002
                                                 -------------  --------------
 Deferred tax assets:
   Accruals and reserves....................... $       1,321  $        2,010
   Property and equipment......................        10,195           4,170
   Credit carryforward.........................         2,559              --
   Stock option deduction......................        44,092          42,009
   Other.......................................         5,386           4,940
   Net operating loss..........................       143,493         139,576
                                                 -------------  --------------
 Gross deferred tax assets.....................       207,046         192,705
 Valuation allowance...........................      (207,046)       (192,705)
                                                 -------------  --------------
   Net deferred tax assets..................... $          --  $           --
                                                 =============  ==============

                                                                Year Ended December 31,
                                                            ----------------------------
                                                              2003      2002      2001
                                                            --------  --------  --------
Revenues ................................................. $     --  $     --  $  3,161

Loss from operations of discontinued operation ...........       --        --      (125)
Gain/(loss) on disposal ..................................       --       381    (3,667)
                                                            --------  --------  --------
Total income (loss) on discontinued operations ........... $     --  $    381  $ (3,792)
                                                            ========  ========  ========

                                       Balance    Amounts
                                         at      recorded in               Balance
                                      Beginning  Revenues and              at End
                                       of Year    Expenses     Deductions  of Year
                                      ---------  -----------   ---------  ---------
Allowance for Doubtful Accounts:
 Year ended December 31, 2003....... $   4,815  $    (2,004)  $  (1,624) $   1,187

 Year ended December 31, 2002.......     6,844           57      (2,086)     4,815

 Year ended December 31, 2001.......     1,966       13,970      (9,092)     6,844

                                                  Additions
                                       Balance   Charged to
                                         at       Deferred                 Balance
                                      Beginning   Tax Asset                at End
                                       of Year    Valuation    Deductions  of Year
                                      ---------  -----------   ---------  ---------
Deferred Tax Asset Valuation Allowance:
 Year ended December 31, 2003....... $ 192,705  $    14,341   $      --  $ 207,046

 Year ended December 31, 2002.......   198,174           --      (5,469)   192,705

 Year ended December 31, 2001.......    50,143      148,031          --    198,174

Date:     March 19, 2004          By     /s/ CHUCK BAY                     
			Chuck Bay
			Chief Executive Officer and
			Chairman of the Board (Principal Executive Officer)

Date:     March 19, 2004          By     /s/ JOHN HUYETT                   
			John Huyett
			Chief Financial Officer
			(Principal Financial and Accounting Officer)


Date:     March 19, 2004          By     /s/ MARK BERTELSEN
			Mark Bertelsen
			Director

Date:     March 19, 2004          By     /s/ TOM GALVIN
			Tom Galvin
			Director 

Date:     March 19, 2004          By     /s/ JERRY R. BATT
			Jerry R. Batt
			Director

Date:     March 19, 2004          By     /s/ DIXIE L. MILLS
			Dixie L. Mills
			Director